As the retail market for providing water and sewerage services to non-household customers opens on 1 April we reflect on developments so far and consider what may happen next.
Lead-up to market opening
Although the water industry in England and Wales was privatised in 1989, up until now each water company has largely remained as a vertically integrated regional monopoly and only businesses using more than 50 million litres of water a year were able to switch water suppliers. In practice this only affected 26,000 customers, and they could not choose their sewerage provider, only their water supply service.
This is no longer the case. As of 1 April, the biggest water retail market in the world will be open to competition and 1.2 million customers will be able to switch their water and/or sewerage supplier.
This monumental change was enacted by the Water Act 2014 and has been a long time in the planning. We at Addleshaw Goddard have been advising market participants for a number of years now and are excited to see the plans finally come to fruition. 1 April 2017 is the date we have been working towards, with a shadow market in operation since October 2016 and the opportunity for companies to exit the retail water market in advance if they chose not to take part.
So now is a good time to take stock and have a look at what has been happening amongst the industry players so far and what we think is likely to happen after market opening.
Licences so far
From 1 April, companies wanting to supply water and/or sewerage services to businesses need to have a new water supply and/or sewerage licence (WSSL) with a retail authorisation. So far 25 companies have been granted a WSSL, the latest being Everflow Limited, a Scottish new entrant, and Peel Water, a utility company part of the Peel Group, on 17 March. Glas Cymru subsidiary Cambrian Utilities awaits the outcome of its application. The licensees are a pretty even split of established players and new entrants, with a variety of backgrounds including some retail arms of incumbents, a number of which are themselves likely to seek customers outside their associated company's area.
The lead up to market opening has led companies to consider their strategies and how they might succeed in the new environment. As expected, there have been a number of mergers and joint ventures in the lead up to market opening, as companies put their plans into place, for example to gain critical mass to operate more efficiently as a retailer, or exit altogether.
The most high profile merger is probably Severn Trent and United Utilities, who have combined their business retail activities to form Water Plus, the largest retailer in the market. This was cleared by the CMA in May 2016 and has an estimated 25% market share across England and Scotland.
Pennon (South West Water and Bournemouth Water) and South Staffordshire Group (South Staffordshire Water and Cambridge Water) merged their business retail activities to create a new joint venture in November 2016 under the existing Pennon Water Services brand and will trade out-of-area under a new brand called Source for Business. The Pennon Water Services JV makes it the fourth largest retailer in the non-household retail water market, with an 8% market share and a customer base of 180,000 accounts.
Most recently, Business Stream (an existing Scottish water retailer) and Veolia (a resource management company) announced a partnership to provide business customers with a “complete retail water package”, offering an “end-to-end solution” for all their water, energy and waste needs via a single provider.
Exits from the market
Not all water companies have chosen to participate in the retail water market. They had until 1 November 2016 to announce any planned exits that would take effect at market opening. Decisions made to exit the retail market are irreversible. A number of water companies transferred their business retail arm to a new group company, but there are three notable exits from the market altogether:
- Portsmouth Water (January 2016), transferring its existing business customer base to Scottish retailer Castle Water
- Southern Water (June 2016), transferring its existing business customer base to Scottish supplier Business Stream
- Thames Water (July 2016), transferring to Castle Water.
Interestingly, Yorkshire Water were all set to transfer their non-domestic customers to their newly-created retail spin-out, Three Sixty, but it is being reported that those plans may be changing.
Lessons from Scotland
The Scottish retail water market has been open to competition since 2008. Although much smaller, with only one wholesaler (Scottish Water), a handful of retailers and 130,000 customers, it will now combine with the English market to make a cross-border offering that will be attractive to many businesses. It is no surprise that the majority of Scottish water retailers have applied for a WSSL to be part of the English water retail market also.
Looking at what happened when the Scottish market opened to competition, we can get an idea of what might happen in these next few weeks as the English market starts to bed down. In Scotland, customer engagement and transparency between participants was good, but ensuring market data was of high quality, and always putting the customer first, did not always happen. Hopefully the industry can learn from this. Quality of data, in particular, has been at the forefront of industry discussions in a bid to ensure that those customers transferring from the companies exiting the market will not experience any disruption this week.
Likely future developments
We are not expecting a great deal of activity the minute the market opens; but a more gradual level of switching (or re-negotiations with existing suppliers) as customers become more aware of the market opening. The Open Water campaign has raised awareness, but it may well be third party intermediaries (TPIs) that drive engagement. For now, customer awareness of the new market remains relatively low.
However, there are over 50 TPIs likely to move into the water market and arguably this number is unsustainable and some will need to consolidate. Unlike energy, the margins in water are much lower and TPIs will need to offer a wider service than just finding the best price; not all will have the experience to do this. TPIs are unregulated at present, but Ofwat would like formal powers to be able to regulate them. There will no doubt be some "rogue" TPIs, as is the case in the energy market, which will lead to customer complaints and disputes with suppliers.
Self-supply is where a water retailer is licensed to supply its own premises only. The brewer Greene King has been granted a self-supply licence in England, ready for market opening. Greene King has entered into a contract with Waterscan to take on the retail functions including meter reading, central market opening system transactions, wholesaler management, paying water and sewerage charges through the settlement process, and finding further water efficiency savings.
A week after Greene King applied for its self-supply licence, Earls Gate Water, partnering with Everflow, became the first to apply for a self-supply licence in Scotland, even though this has been an option since the Scottish water market opened in 2008. So are these applications the first of many we can expect?
The advantage of self-supply is that the licensee pays wholesale prices for its water, and not a retail margin added by suppliers in the open water market. It has not been well publicised by retailers (unsurprisingly, as it is an alternative to using a retailer) but Ofwat is keen to make businesses aware of it as an option.
The disadvantages are the cost of becoming a self-supplier (over £5000 to apply for a licence) and the perception that it involves a lot of regulation and bureaucracy. The cost savings are probably only significant for multi-site organisations with a high water usage. But companies such as Waterscan (a water management consultancy) are setting up as a managing agent for customers that want to self-supply, which will take away some of the administration.
An alternative to self-supply is SES Business Water's new Wholesale Tracker Plus product that tracks the annual water wholesale rate and gives businesses access to the most competitive prices in the market. Innovative products such as this are likely to become more common over time.
We can expect to see water and sewerage retail services offered as part of a package with other utilities such as gas and electricity. Certainly many of the energy brokers are looking to enter the water market and offer water retail as an extra service. Some of the licenced retailers such as Regent Water (a subsidiary of Regent Gas) and Business Stream's partnership with Utilitywise, an energy consultancy, will no doubt offer a package of services. Many retailers will have water efficiency advice as part of their offering, at the very least.
There will undoubtedly be further change, as some companies wait and see how things go in the first phase of market opening before taking permanent strategic decisions.
The new market creates interesting opportunities for an important group of customers, but also represents the first significant shift in the structure of the water and sewerage market as a whole since privatisation. It will require a fundamental shift in the behaviours of companies as, for the first time, they must consider themselves as participants in a competitive market. It will also be a challenge for new entrants, who will not all find their niche in this new environment. Inevitably, there will be some who will be more successful in making that shift than others, and potentially some friction in the coming months and years as the market evolves. This may manifest as disputes over the application of industry codes, or complaints over anti-competitive behaviour.
This is only a beginning. Ofwat has already signalled its intention to encourage opening of upstream markets through the Water 2020 programme and the prospect of a retail market for household customers remains a possibility. However, the talk of competition in the sector for more than 20 years has now finally become a reality.