Environment, Food and Rural Affairs CommitteeWritten evidence submitted by Ofwat

Introduction

1. Ofwat is the economic regulator of the water and sewerage sectors in England and Wales. Our primary duties are to:

protect the interests of consumers, wherever appropriate by promoting effective competition; and

enable efficient water and sewerage companies to carry out and finance their functions.

2. We also have a range of secondary duties. These include:

contributing to sustainable development;

promoting economy and efficiency;

ensuring there is no undue discrimination against particular customers; and

to have regard to the principles of best regulatory practice.

3. Since privatisation, our regulation has helped the water and sewerage sectors to deliver major improvements to customers and the environment while keeping bills lower than they otherwise would have been.

4. But as the Water White Paper—“Water for Life”—recognises, the sectors now face a new set of challenges that require a different response from Government, regulators and the companies.

5. We welcome the Water White Paper (WWP) as a significant step forward. It proposes a package of necessary reforms to help to tackle the challenges facing the sectors and help deliver sustainable water and sewerage services, now and for future generations. We support the introduction of legislation to implement the proposals in the WWP. We also believe there are some areas where those proposals can be improved to deliver the Government’s aims.

6. In particular, we welcome the Government’s focus on:

ensuring more sustainable water use, by reforming the abstraction framework, and introducing measures to encourage more water trading between companies and other water users;

delivering more customer-focused sectors, including measures to help address affordability and giving choice to all non-household customers; and

introducing competition so that market forces drive innovation and improvements in the way that companies deliver water and sewerage services.

7. Ofwat is already taking forward proposals to reform the regulatory framework in a way that both aligns with and is complimentary to the reforms set out in the WWP.1 But to deliver fully on the Government’s vision we need legislation to bring about a number of the changes—for example, to change water supply licences to allow a fully functioning retail market. We look forward to working with Defra on the forthcoming Water Bill.

8. Ofwat’s duty to contribute to sustainable development is a vital part of our work. This means delivering social, environmental and financial sustainability. It also means ensuring sectors serve customers now and in the future.2 The proposals in the WWP will help us continue to do this. But any unnecessary amendments to our duties could create uncertainty around the regulatory framework and undermine confidence in the sectors.

9. We encourage the Government to identify any particular concerns about how Ofwat’s decisions contribute to sustainability and reflect those concerns in targeted guidance it issues to us.3

Environmental Sustainability

10. We welcome the commitment in the WWP to secure sustainable and resilient water resources. As the WWP recognises, the following proposals in our future price limits (FPL) framework will also help achieve this.

Incentives for water trading and interconnections.

An abstraction incentive mechanism (AIM).

Measures to address any perceived or real bias to capital, carbon-intensive solutions.

A planning framework that encourages effective demand management.

11. Long-term sustainability requires measures to tackle the lack of value on water from source to tap. Proposals set out in the WWP to reform the abstraction framework are essential and we look forward to working with Government and the Environment Agency to ensure changes happen soon.4

12. We consider that the ability of the sector to deliver more efficient use of this scarce resource will be further enhanced by allowing incumbent companies to purchase water not only from each other, but also from new licensees. Those new licensees could have access to water sources that are less environmentally damaging than those of incumbent companies. Restricting the ability of incumbent companies to choose the best source of water—environmentally and economically—is likely to reduce the effectiveness of the WWP reforms.

13. We welcome the Government’s commitment to dealing with diffuse pollution through innovative means. We look to the companies to put in place catchment management schemes where these deliver best value for money for customers.

Social Sustainability

14. We welcome the WWP’s central commitment to create more customer-focused water and sewerage sectors for both non-household and household consumers.

15. We have taken steps to change our own regulatory processes to improve the sectors’ accountability and engagement with customers. These include:

changing the way that companies set targets and report performance so they deliver for—and are accountable to—customers rather than the regulator;5 and

ensuring that companies engage with—and are challenged by—their customers in the plans they bring forward the next time we set price limits.6

16. Choice and competition can also create a powerful incentive to improve customer service. Evidence from Scotland and other sectors shows how market forces can both drive down prices and encourage customers to use water more efficiently through the more effective provision of added value services, such as water efficiency advice.7

17. Affordability is a growing problem for some customers. If customers are unable to pay their bills, there is a risk that bad debt will increase, which can have an impact on investor confidence.

18. The companies should take responsibility for identifying and supporting those customers who are at risk of not being able to pay their bills. To make this effective, and to keep the administrative burden and cost to a minimum, it is important that:

Government guidance sets a clear policy framework for how the companies develop social tariffs; and

the assistance to be provided to South West Water customers is delivered in a way that ensures transparency without unnecessary regulatory burden.

Financial Sustainability

19. We welcome the WWP’s recognition of the need for continued investment in water and sewerage infrastructure. Our own proposals are also designed to ensure this—for example, by protecting the regulatory capital value (RCV) of the wholesale business.8

20. We consider that financial sustainability would be further served by ensuring that regulation and restrictions on businesses are kept to a minimum, consistent with our primary duties of protecting customers and ensuring financeability. This could be achieved by allowing incumbent companies to choose to have separate wholesale and retail licences. This would enable the companies and their investors to choose the most efficient structures for their businesses. This, in turn, would create more opportunities for companies to deliver the most efficient and lowest-cost services to customers and sustainable investment in infrastructure.

21. Separate licences would give a company the power to choose to exit from one part of its licence and focus on, for example, wholesale activities only. This would leave retail services to those better able to deliver them and provide scope for new entrants to innovate in this area. It would also allow customers to gain from the clear economies of scale in retail activities through mergers.9

Delivering “Water for Life”

22. Meeting all of the objectives set out in the WWP will require new legislation.

23. There has been no significant reform of the water and sewerage sectors since privatisation in1989. There is an opportunity now for new legislation to:

reduce regulatory burdens, and promote innovation and investment;

promote choice and better service for customers; and

enable more efficient use of scarce water resources.

January 2012