A potentially far-reaching piece of draft legislation was presented to Parliament for pre-legislative scrutiny on 10th July – a draft Water Bill. Introduced by Defra, the main aim of the Bill is the modernisation of the water sector, by driving greater innovation from the industry, reducing red tape and giving more choice to consumers.
For some, the Bill has been long awaited. The water industry in England and Wales is largely vertically integrated, and compared to other utility sectors, the pace of change has been slow. Whilst the current regime was essentially put in place with privatisation in the late 1980s, the structure reflects the geographical footprint of the former area water boards, which evolved alongside the smaller statutory water companies established by the Victorians.
Today, the bulk of production, distribution and retail water supply in England and Wales is handled on a regional basis by one of 21 local, privately owned, water companies, appointed by regulator Ofwat. With limited opportunities in the legislative framework for consumers to shop around at the retail supply end, and the business of managing the pipeline distribution network a monopoly activity, it is unsurprising that few competitors have had the proclivity to navigate the intensive red tape in this area and enter the market to challenge the incumbents.
Indeed, following limited retail market reforms introduced by the Water Act 2003 to encourage new entrants and stimulate customer switching (but only for the very largest business customers), just 7 new entrants hold a water supply licence from Ofwat. Of these, apparently only 1 actually has a customer (from amongst 2,200 qualifying businesses able to switch).
These previous reforms have operated alongside an inset regime in the original privatisation legislation, whereby the developers of greenfield sites can choose an alternative to the local water company, but again take-up has been very low. As a result, at least on the face of it, competition is in weak state - although the threat of competition has encouraged incumbents to keep their prices competitive for larger customers.
This all looks set to change, however, because at the heart of the draft Bill are measures to allow businesses and public sector bodies a choice in who supplies their water and sewerage services. For businesses now familiar with the idea of shopping around for electricity and gas, this is good news because it could potentially result in reduced costs.
Significantly, the process for new entrants to enter the market is also set to be simplified, with more options for newcomers in terms of the scope of their supply chain activities, and a simplified set of governance rules in the form of market ‘codes’ (emulating the gas and electricity industry). Notably, the proposals in this area include “unbundling” of upstream water supply activities from retail supply, by the creation of 6 separate “authorisations”, including wholesale supply, which can operate independently under a single water supply licence.
The government hopes that opening up the water market and allowing customer switching could deliver benefits to the economy of £2 billion over 30 years. The Scottish model, which has already undergone similar reforms, is an interesting comparison, and looks set to deliver around £20 million of savings for the public sector alone over the next 3 years.
Who is set to gain from these proposals?
At the moment, only business consumers that use very large volumes of water have any choice over their supplier, and even then the process of switching is arduous. Although the qualifying annual consumption threshold under the Water Act 2003 reforms was reduced from 50 million litres to 5 million litres back in December 2011, the draft Bill will further extend the market by abolishing the threshold altogether.
The existing inset regime will also be phased out. This will mean around 1.2 million businesses and public sector bodies will have the freedom to shop around for their water and sewerage services for the first time. For procurement managers, this will be a welcome relief, particularly as potential costs savings of up to £80,000 per year have been projected for multi-site companies.
Some of the reductions in red tape will also be a welcome boost to developers, notably some streamlining of the charging regime for new connections to introduce more transparency and flexibility. In another welcome move for developers, the ‘one stop shop’ environmental permitting regime will also be expanded beyond pollution prevention to include water abstraction and impounding licences, flood defence consents and fish pass approvals.
Other beneficiaries of the changes may well be those existing water companies which are most efficient and charge the lowest bills, who will be well placed to respond as market competition takes hold. Some welcome relaxation of the water company merger regime might also result in upstream consolidation, which could see water companies expanding their focus of investment out of their regions. Whilst a national water grid is probably not feasible, it is sensible to see greater interconnection between regional networks, so that water can more easily be moved around the country to manage local supply constraints.
Does the Bill go far enough?
But with the problems of water scarcity in some parts of the country, and an underlying scenario of climate change, the draft Bill may not do enough to encourage more demand management at the end of the supply chain. We still tend to take water for granted in this country.
For example, in the gas and electricity sectors, a compulsory roll out of smart meters across all households is set to be complete by 2019. In the water sector, many consumers are not even metered. Whilst the draft Bill contains some measures to boost demand management by businesses, it stops short of requiring meters to be installed.
Also, the draft Bill does not extend freedom of choice to domestic consumers, again unlike gas and electricity. However, given the complexity of delivering the changes required, it is perhaps understandable that Defra prefers to get things in place and working for the larger consumers first.
Some will also be disappointed that the draft Bill does not require some separation of the various components of the supply chain, in other words a splitting of the vertically integrated incumbent water companies. To some degree that was the theory behind electricity market reforms some years ago, and yet we now have a small number of dominant energy suppliers with their own affiliated generating plant portfolios, and some have even owned regional distribution networks.
Who owns what is probably not the issue here. What needs to be in place for competition to deliver is effective regulation of monopoly activity, against the backdrop of a sophisticated competition law regime, which is already in place. Notably, the draft Bill proposes more consumer protection powers for Ofwat, including a power to introduce a code of practice on mis-selling.
The government has indicated it expects the Bill to receive Royal Assent in 2014, with a likely target date for market opening of April 2017.