Water Bill

Written e vidence submitted by Ofwat (WB 17)

 

Bill Overview

1. Ofwat warmly welcomes the key measures in the Water Bill, which will benefit customers and the environment. The Bill represents the first major reform of the water sector since its privatisation in 1989. It will help the sector to respond to the future challenges it is facing – particularly climate change, population growth, changes in consumer behaviour and ever-rising customer expectations. It will also help the sector continue to attract much-needed investment and protect the environment while keeping customer bills as low as possible.

Ofwat’s challenge on customer bills

2. Since privatisation in 1989, £116 billion has been invested in improving water and wastewater services for customers, and protecting the natural environment on which customers depend for their water. Ofwat’s challenge to companies in that time has meant that bills are a third lower than they would have been otherwise, and bills for the 2010-15 period are 10% lower than the water companies wanted. We are currently considering the companies’ investment plans for 2015-20: we have reformed how we regulate to put customers at the heart of this process. Our regulation helps ensure the sector is resilient and sustainable in the face of the future pressures set out above.

3. Alongside our own reforms to the regulation of the water sector, the Bill will deliver about £4 billion worth of benefit [1] – keeping bills down for customers, managing the available water resources in a more sustainable way and opening up new streams of investment.

Retail

4. One of the key planks of the Bill is the extension of retail competition to all non-household customers, for both water and wastewater services. Business Stream figures show that since being given choice in 2008 business customers in Scotland have reduced water use by 17 billion litres – saving £35 million (as well as cutting carbon emissions). Customers in England have been calling for the chance to benefit from these as well [2] .

Upstream

5. Alongside opening up the retail market, the reforms to the upstream market will allow more water resources to be made available for public supply – this will help take the pressure off over-abstracted rivers by ensuring the most sustainable sources can be used rather than only those that are available to water companies currently.

6. The UK Government estimates that an upstream market could generate about £1.9 billion of savings for customers [3] and there are a range of upstream suppliers with sources of water seeking to enter the market and increase the resilience of services.

7. For example, the Peel Group has experience in utilities, including being the appointed water company for the Media City UK development in Salford (which houses the BBC), next to the Manchester Ship Canal. Several of its sites (such as the Trafford Centre) are supplied by on-site boreholes. Peel would like to be able to sell that ‘product’ further afield, including on its other developments, but is currently unable to do so economically because of the pricing rules set out in legislation.

Will upstream markets lead to rises in customers’ bills from ‘de-averaging’?

8. Prices for water and wastewater services generally (although not entirely) have a regional character and are ‘averaged’ across each company’s area. For example, this means that customers who cost more to serve because they live in rural areas pay the same as those who cost less. Some stakeholders have raised concerns that upstream markets will lead to
de-averaging of prices, because competition law will mean companies are required to set prices that better reflect local costs – effectively ‘de-averaging’ prices, with some customers seeing significant rises in their bills and others seeing a reduction.

9. The interaction with competition law does not necessarily imply de-averaging of prices. This has not happened in other regulated utility sectors such as gas, electricity and telecoms. In any case, the Bill’s reforms will only apply to 10% of the water sector – the remaining 90% core monopoly will continue to be regulated as now. And under the current charging arrangements there are certain charges which are effectively ‘de-averaged’. For example, some companies choose to ‘average’ charges for surface water drainage services even though the costs of providing these services would be much higher for customers with a large impermeable site who therefore produce more surface water compared to those with a smaller site area. Other companies choose to vary these charges according to the site area of customers.

10. Two independent experts have reviewed this issue – Professor George Yarrow for Ofwat and Professor Martin Cave for the Consumer Council for Water. Both experts confirmed that it should be entirely possible for Ofwat to facilitate upstream competition and maintain the regional character of prices.

How will upstream markets impact on the environment?

11. We support the Government’s work to reform the outdated abstraction licensing system. Defra has put safeguards in place to ensure the upstream reforms can be taken forward in advance of these without damaging the water environment. We think that the upstream reforms will help the environment as they will enable water companies to take water from the most sustainable sources.

Wales

12. Ofwat recognises the Welsh Government’s decision not to extend the market in Wales, and has committed to ensuring that the companies operating wholly or mainly in Wales will continue to improve their service to their customers.

Opportunities to further improve the Bill for the benefit of customers and the environment

13. While we support the Water Bill, we think that there are several missed opportunities to increase its benefits for customers and the environment. We propose:

14. Provision for companies to voluntarily exit the whole of the retail market if they wish, including both household and non-household retail. This would create the most efficient market for water companies and customers because those companies that excelled at providing a retail service would be able to take over serving the customers of companies that would rather focus on the wholesale side of their businesses. Such exit would be voluntary and a decision for the individual water companies. The Water Industry Commission for Scotland estimates the potential benefits to customers of retail exit from the new retail market to be about £400 million [4] . Retail exit would provide greater flexibility for investors and more merger and acquisition opportunities in retailing, which has significant scale economies. Our own analysis suggests that greater merger and consolidation in the retail market could reduce the operating costs of the acquired company by 12% (an on-going saving). Applying this saving conservatively to the 7–11 smallest companies’ retail operations would suggest further on-going savings of between £50 million and £210 million for customers [5] .

15. The ability for Ofwat to modify water company licences on the basis of majority agreement rather than requiring individual agreement from all monopoly companies. This would enable us to make changes which underpin the level playing field necessary to ensure the market works well for customers. It would be consistent with other sectors. This would require amendment to section 13 of the Water Industry Act 1991.

16. Open the closed upstream market in the Bill to ensure greater benefit to customers and the environment. The current Schedule 1 paragraph (5) restricts the market to trading of water between existing water companies: it doesn't allow new entrants to introduce water into the system unless they will also be taking that water out further down the line. This is a restriction on effective competition: the Bill should ensure effective competition through an amendment to Schedule 1 paragraph 5.Extension beyond two years (from commencement of the relevant provision) of our ability to make consequential licence modifications so that we can respond appropriately once the retail market opens. This would require amendment to clause 39 of the Water Bill.

17. ‘Fully unbundled licences’. The Water White Paper said that the Government would ‘unbundle’ the combined supply licence so that entrants could input their own water into a water company’s system without also being obliged to provide retail services to customers. This has only been done in part, with the Bill containing a requirement that water is put in "in connection with" the activity of a licensed retailer (whether themselves or another company). We would like these licences to be fully unbundled, enabling entrants to specialise in the services they wish to provide and potentially creating new and innovative sources of water for customers of both entrants and incumbent companies. This would require amendment to Schedules 1 (5) (a) and 2 (1) (i.e. new section 66B (1) (a) of the WIA 1991) of the Water Bill.

Regulatory independence

18. We also think that there are some places where the Bill goes too far in constraining our independence – which keeps bills down for customers both through our challenge to companies and via investor confidence. We set out the two prime concerns below:

19. We regulate within the policy framework set by Government, including the Strategic Policy Statement (SPS) from the Secretary of State. However, we consider that the requirement in clause 24 for us to carry out our functions in accordance with the SPS compromises the Government’s Principles of Economic Regulation and our position as an independent economic regulator. The slow decline of the independence of economic regulators is a growing weakness in the UK utility regulatory model and one that will not help to attract the much-needed investment that the sector needs in the future and certainly not at the low cost of borrowing the sector currently enjoys and which is reflected in customer bills. We think it would be more effective for customers, the environment and attracting the necessary finance for investment if the Bill were to mirror our existing requirement at section 2A (3) of the Water Industry Act 1991 to have regard to guidance from the Secretary of State through its Guidance on social and environmental matters, consistent with other sectors.

20. We will continue to regulate within the duties set for us by Parliament. But we think that our current mix of duties gives us the tools to regulate for a resilient and sustainable sector – as is evidenced by our reforms to the price review process and the response from the companies. These reforms are incentivising companies away from concrete pouring towards more sustainable and resilient solutions such as catchment management and water efficiency. We have yet to analyse fully the company business plans, which we received on 2 December, but the sector’s draft Water Resources Management Plans for 2015-40 are already showing a 50:50 split between capex and opex – a significant shift from the previous bias towards capital expenditure on assets.

21. We do not consider a change to our duties is necessary to deliver resilience and sustainability – these are already fundamental to our regulation and to company delivery (including through our secondary duty to contribute to the achievement of sustainable development). In particular, we are concerned that the resilience duty may increase customer bills without their consent. T o the extent that customers want resilience and are willing to pay for it our price review process encourages companies to provide it, rendering a duty un necessary. A duty would only make a difference in situations where customers did not want or were willin   g to pay for it , i n which case it would be adding cost into bills.


December 2013


[1] UK Government’s Summary impact assessment for the Bill

[1] PriceWaterhouseCoopers Impact Assessment of Ofwat’s PR14 methodology – October 2013

[2] CCWater’s ‘Understanding the Needs of Small and Medium Enterprise Customers’

[3] Government Impact Assessment on upstream competition

[4] Hansard, Water Bill Committee, 2nd December 2013

[5] Based on a 0.7% per annum saving against the retail cost base, this would give an NPV over 30 years (in line with the IA) of £60 million for the smallest seven companies or £210 million for the smallest 11 companies using a discount rate of 3.5%.

Prepared 11th December 2013