The Government has finally published its long-awaited first draft of the Water Bill for pre-legislative scrutiny, ahead of its introduction to Parliament. The Bill promises much in the wake of the various reviews, in particular that in relation to competition led by Professor Martin Cave [1], which culminated in the Water White paper at the end of 2011 [2].
The Water Bill promises a greatly expanded scope for competition in the water and wastewater sectors. Retail competition was previously choked by a combination of regulation, unfeasibly high access prices and a limited market size. The Bill aims to remove these impediments. Importantly the Bill also extends competition to sewerage services for the first time, enabling greater chances for economies of scope.
There is much in the Bill that will please business customers and in particular developers who should see greater flexibility in the cost of service infrastructure. There will be greater opportunities for new entrants as well although questions remain.
Ofwat has also launched its consultation on the 2014 price review. With changes proposed for existing company licences as well, it looks like a busy couple of years in the industry.
Retail market opens and includes sewerage services
The market will open delivering choice for all non-household customers in England and will for the first time allow entry to the sewerage market. As expected the measures will not generally extend to Wales.
Reduce Regulatory Barriers to Entry
The Bill aims to remove some of the existing regulatory requirements that act as a barrier to new entrants wishing to enter the market, notably this includes doing away with the costs principle. Under the current regime, the costs principle delivered access prices which were unfeasibly high and in effect created a margin squeeze that excluded new entry. The costs principle was much criticised both in the Cave review and in the Competition Appeal Tribunal [3].
Given the accounting separation work that Ofwat has been conducting for a while now, there should not be too many surprises here for the industry. Ofwat will be responsible for issuing charging rules (subject to Ministerial guidance – see below) which it is hoped will prevent household customers cross-subsidising business customers.
The Bill follows changes currently in the pipeline in the Enterprise and Regulatory Reform Bill which will allow 'in-area' trading by incumbent retail entities.
New licences
The government also plans to liberalise licensing options. There are several new licences for new entrants to choose from allowing them greater opportunity to enter the market in different and new areas. These are radical changes and allow new entrants to become sewerage suppliers for the first time. The new licences in England [4]:
Retail authorisation:
Similar to today's retail licence, it allows the supplier to use the local undertaker's system to supply water to the licensee's customers. In addition it introduces the retail sewerage authorisation allowing the licensee to provide sewerage services for the first time to its customers. Given the limited margin available for suppliers in retail, even with the repeal of the costs principle, and given the Scottish experience, it remains to be seen whether this will generate customer switching and generate efficiency benefits.
Wholesale authorisation:
The wholesale licence allows the licensee to introduce water in an undertaker's system. The definition of undertaker's system now includes its treatment plants and storage systems giving raw water suppliers a potential new market.
Network infrastructure authorisation:
This new licence will allow the licensee to own and operate their own infrastructure which is connected to an incumbent's system allowing it to by-pass parts of that system. However, the licensee's system must connect back into the same system and it will not permit it to interconnect between two systems of different undertakers.
Retail infrastructure authorisation:
This new licence will enable the licensee to provide the last mile of infrastructure to connect eligible premises. It offers the advantage for current inset appointees in not having to apply for a new appointment each time, since it would be a national licence. Initially for supply to commercial and industrial premises, the Bill will contain a power for government to allow licence holders to supply households. As such it is expected that this system will eventually replace the inset regime for un-served areas and large users. Indeed, there will be no new companies allowed to be inset appointees going forward.
It is not clear whether infrastructure licensees will enjoy similar powers to the current undertakers, especially those necessary to install infrastructure in public areas. Without such powers, there may be competition issues.
The Bill will also introduce a self-supply arrangement which may be attractive for large geographically spread organisations such as supermarkets.
Market Codes and standard terms
The Bill will allow Ofwat, in a similar way to other regulators, to establish market codes to help new competitive markets run more effectively. Instead of the current situation where access is a bespoke negotiation, the Bill would introduce "market codes" which would set out standard terms and conditions. Highlighted as an area which requires attention, current inset appointees know only too well the delays caused by non-uniform pricing and supply arrangements. With the change in licensing, this promises to make life easier for licensees and insets generally.
Market integration with Scotland
The Bill aims to facilitate the development of a seamless retail market for water and sewerage services for operators that wish to supply services both in Scotland and in England. The Bill also aims to allow for joint approaches to licensing for new entrants.
Upstream and wholesale markets reform
A more flexible upstream pricing regime together with wholesale licensing liberalisation should help stimulate wholesale activity in water supply and sewerage services. There will be changes to the regulation of bulk supply arrangements as well as the introduction of new types of wholesale and network infrastructure licences. However, there are some omissions, the reform of the abstraction regime has been put off for another day. Also one of Cave's recommendations, that incumbent undertakers should be subject to an economic purchasing obligation in respect of water, has also been left out.
Reform of the special merger regime
The current merger regime was an area highlighted by Cave as in need of change. He argued that the current regime limits management incentives and the spread of best practice.
The Bill would dilute the current water merger regime to exclude some mergers from automatically being referred to the Competition Commission. It would afford the Office of Fair Trading greater discretion by accepting undertakings in lieu of a reference. Finally it also requires Ofwat to set out its views on the value of comparators - a key fundamental in how Ofwat regulates the sector. The reforms are likely to enhance the prospect of M&A activity in the water sector for smaller companies but not perhaps for the larger water and sewerage companies.
Enhanced regulatory powers
Ofwat and the Secretary of State will have new powers to impose a financial penalty in respect of infringements which are older than one year (which is the current situation) up to a period of five years. There are also changes to Ofwat's information gathering powers.
Changes charges and standards regulation
The Bill will repeal the requirement for Ofwat authorisation of Charges Schemes. Ofwat will instead be required to introduce rules which companies would be obliged to follow. These in turn would be subject to guidance issued at ministerial level. This guidance adds to that relating to social tariffs as introduced by the Flood and Water Management Act 2010 and raises potential question marks over the extent of regulatory independence.
Similarly the regime regarding connection charges will also be altered. Instead of detail residing in the legislation, the requirements will instead subsist in rules to be issued by Ofwat. This should help developers and Ofwat. In relation to customer service standards, there will be powers in the Bill to allow for these standards to apply to all water customers, including for the first time, water supply licensee customers.
