Regulation of the water industry Contents

Conclusions and recommendations

Increasing supply

1.Reform of the abstraction system was long overdue, and we welcome the focus on catchment-based approaches. The Government and Environment Agency must make a rigorous assessment of whether a voluntary approach will be sufficient to protect water resources and the natural environment in the long-term. The legislative demands of Brexit must not prevent statutory reform, should it become necessary. In its update to Parliament in 2019, the Government should include an assessment of the need for statutory reform. (Paragraph 13)

2.Although there are infrastructure and environmental challenges to be overcome, water transfers should play an important role in increasing supply and resilience. Although transfers might be difficult to put in place during short-term episodes of drought, they would help companies to manage their resources effectively in the long-term. It is therefore disappointing that only 4 per cent of water is currently traded. This suggests that Ofwat’s incentives are not strong enough. (Paragraph 19)

3.We note Defra’s suggestion that 8 per cent of total supply will need to be transferred in the next 10 to 20 years. The Government and Ofwat should make a strategic assessment of the need for water transfer infrastructure and confirm a long-term target for water transfers. We are concerned that existing incentives in PR19 are not strong enough to incentivise water companies to invest in water transfers. (Paragraph 20)

4.A shocking amount of water is lost through leakage daily. As well as being wasteful, it gives a poor impression to the public about the value of water. Reducing leakage should be a top priority for the water industry. (Paragraph 28)

5.We are pleased that Ofwat has shown enthusiasm to levy strong penalties on water companies that fail to reach their leakage reduction targets. (Paragraph 29)

6.Ofwat’s target for water companies to reduce leakage by 15% by 2025 is not ambitious enough and Ofwat should set a long-term target for water companies to reduce leakage. This would help focus efforts beyond the five-year period of PR19. We consider that continuing the trajectory set by the target of 15% by 2025, the water industry should collectively be aiming to reduce leakage by 50% by 2040, rather than 2050. (Paragraph 30)

Reducing demand

7.Per capita consumption (PCC) targets provide an incentive for water companies to help consumers reduce demand for water. Ambitious targets can also lead to more innovation in the water industry. (Paragraph 36)

8.It is disappointing that the Government has not yet supported a specific PCC target. A cross-Government target for PCC reduction over the next 25 years should be published, alongside plans for how the target could be achieved. (Paragraph 37)

9.We consider that using meters to ensure customers pay for the water they use, rather than basing bills on the outdated system of rateable values, sends a strong message to customers about the value of water. There is strong evidence that metering helps to reduce water use and to detect leaks. (Paragraph 44)

10.Allowing compulsory metering only in water-stressed areas causes regional disparities that are inappropriate given the national need to conserve water. We endorse the recommendation of the National Infrastructure Commission that Defra should amend regulations by the end of 2019 to allow all water companies to implement compulsory metering, using smart meters. Water companies should use these powers to help achieve ambitious PCC reduction targets, while also engaging customers about the value of water and the benefits of using a meter. Support for economically vulnerable customers should be strengthened should metering lead to significant bill increases. (Paragraph 45)

Water company performance

11.Some water companies have unnecessarily convoluted processes for dealing with customer complaints, resulting in customers giving up before their complaint is properly resolved. Ofwat should review how the complaints process within water companies could be streamlined. This could include a mechanism whereby water companies either automatically pay complainants a fixed sum or escalate complaints to CCWater if the complaint is not resolved by the company within 15 days. (Paragraph 50)

12.The financing arrangements of some water companies fall below the standards that we expect from providers of an essential public service. High levels of executive pay, shareholder dividends and debt ratios risk reducing public trust in the water industry. We welcome the Secretary of State’s focus on this issue and consider that water companies should instead invest more in their businesses. Ofwat should have firmly tackled the imbalances in the financial models of some water companies much earlier, and we were not satisfied with its explanations as to why it had not done so. (Paragraph 55)

13.In the absence of real competition in the sector, Ofwat must strike a difficult balance between consumer interests and making it financially worthwhile for water companies to satisfy their investors. That balance has been skewed in favour of the latter. The regulator’s proposals to “balance the sector” are now heading in the right direction but we are sceptical about whether they go far enough. Ofwat should review the changes implemented by water companies on financial engineering, dividend policies and linking executive bonuses to delivering for customers and publish a written update to us by April 2019. (Paragraph 56)

14.After Ofwat has published the results of its consultation on governance principles, the Government should give Ofwat powers to bind water companies to the principles through licence conditions. (Paragraph 57)

15.The continued failure of water companies to prevent serious pollution incidents may have been exacerbated by previous penalties being merely seen as operational costs. We are pleased that fines for pollution incidents have increased and consider that the threat of fines of up to 1 per cent of company turnover should apply sufficient pressure on water companies to reduce pollution. (Paragraph 61)

16.We recommend that the Government reviews whether the Environment Agency has the necessary powers and resources to enforce a drastic reduction in sewage overflows into our rivers. (Paragraph 62)

The water retail market

17.It is interesting to note that the water retail market was first introduced in the UK in Scotland in the context of a publicly owned water industry. The water retail market in England and Wales is in its infancy and we expect teething problems to occur. However, the first year has delivered unimpressive results for water efficiency and we are concerned at suggestions that water retailers may not be taking water efficiency seriously enough. (Paragraph 73)

18.It is disappointing that small and medium enterprises (SMEs) have not engaged well in the market as customers. Big businesses should not be the main beneficiaries of the retail market. As market frictions are reduced, we would like to see water retailers attracting more SME customers. Ofwat should consider ways to incentivise this. (Paragraph 74)

19.Although water retailers are private companies, they have a key role in improving water efficiency and resilience, which are in the public interest. We are pleased that Ofwat has reviewed the state of the market. We recommend that Ofwat undertake annual reviews until the market is shown to be delivering real competition and water efficiency. (Paragraph 75)

Is regulation fit for purpose?

20.The water industry in England and Wales is diverse, and in the drive to mimic and create competition, economic regulation has become very complex. The introduction of the water retail market is an interesting experiment, the success of which remains to be seen. (Paragraph 81)

21.While Ofwat has increasingly tried to take a less prescriptive approach and focus more on outcomes, the price review methodology has become more lengthy and detailed. It is unclear whether economic regulation has overall become more or less burdensome for water companies and what the impact is. (Paragraph 82)

22.We recommend that the Government commissions an independent review of whether the water industry and regulation are fit to meet future needs such as drought resilience, as well as delivering value for money for customers. Consideration should also be given to whether the price review cycle is too short to allow long-term planning in the industry. Our recommended review should begin immediately so that it can influence the 2024 price review. A strong, independent regulator will be needed in England and Wales in the future, under all circumstances. (Paragraph 83)

Published: 9 October 2018