Competition in the Water Industry � The Cave and Ofwat Reviews

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					Competition in the Water Industry – The Cave and Ofwat Reviews

Response by:
Professor Paul W Jowitt
Director
The Scottish Institute of Sustainable Technology
Heriot Watt University
Edinburgh

Contact details:
14 Belford Mews
Edinburgh
Email      p.w.jowitt@hw.ac.uk
Telephone 0131 451 3143 or 07771 571 559


Comments

Overview

The general tenor of both documents is that Market Competition in the water industry would
be beneficial to the consumer (domestic and business) and the only issues are the extent to
which it is introduced. The documents also assert that Competition would also benefit the
environment. The evidence for such assertions is not detailed nor questioned, except with
respect to customer charges and water company efficiencies achieved through regulation
since water privatisation in England and Wales.

It would be worth standing back for a moment to see a more complete picture. My
comments are confined at this stage to this aspect, rather than accepting the base
proposition and answering the detailed questions posed by the reviews based on its
acceptance.

The trend towards utility privatisation, especially that in the water industry, was driven by:

   1. The need to find a way of dealing with a backlog of underinvestment;
   2. The need for new investment in the light of regulatory requirements (eg EU water
      quality legislation);
   3. The need to drive greater efficiency into the utility sector after years of complacent
      management and practices whilst in the public sector and the associated difficulty in
      accessing government borrowing/capital investment in the face of other political
      priorities;
   4. The need to avoid landing the required investment costs on the PSBR and/or through
      taxation.

Of course, the customer would still end up with paying the bill, but it was assumed that the
rigour of the private sector – even allowing for a reasonable return on capital investment to
the private sector – would reduce the cost increases to the customer. This proved to be the
case.

The role of Ofwat was to act as a surrogate for competition though such as frontier
benchmarking/yardstick competition. This process has proved effective.

The conclusion now seems to be to more or less eliminate the need for economic regulation
as a limiter of allowable prices and instead move to some form of full competition with the
regulator reduced to a regulating the market place.

This conclusion is deeply flawed.
The water industry provides a vital public service – to domestic and industrial customers alike
- that must operate in the public interest. It relies on infrastructure that generally has a long
life-span and which it would make no sense to multiplicate by having different providers. The
sources of water and sinks for treated wastewaters and solids are limited and generally of
strategic interest. Creating a market within such a system requires an elaborate set of
artifices which will lead to little if any real benefit.

Of all the utilities, water and wastewater services are the most natural monopoly. It would be
better to recognise this rather than trying to reinvent the water industry as an experimental
economics laboratory in which water is treated simply and simplistically as just another
commodity. It isn’t. Water has other stakeholders, including the environment generally and
sometimes its customers in another guise.

Markets exist to provide efficient solutions, not necessarily effective or equitable ones. This
is especially true in some of the key utility sectors. In the electricity sector, economic
efficiency and the need limit energy prices led to the “dash for gas”, the creations of a retail
competition between suppliers, a fortuitous reduction on CO2 emissions coupled with
dependency on the febrile global energy market – and with consequences now coming home
to roost. So much for bowing blindly to the mantra of competition. It is worth recalling the
statement in the Stern Review: The Economics of Climate Change - “Climate change is the
greatest and widest-ranging market failure ever seen”. Part of this has been leaving the
satisfaction of energy needs to the market.

Introducing a retail market to the water industry, whatever its supposed benefits, has some
serious downsides.

It is unlikely to lead to much technical innovation in the processes of water resources,
treatment, distribution, wastewater collection and wastewater treatment, and certainly no
more than would be achieved by intelligent regulation. Any innovation that will be achieved
is likely to be in the marketing of bundled services, billing services etc, with little impact on
core capex and opex costs. Incomers to the market will be predominantly interested in
attractive customers, leaving the incumbent monopoly supplier increasingly as a supplier of
last resort with the customers who are least attractive and bringing with it the serious risk of
stranded assets which have to be paid for over periods of time much longer that short term
customer contracts, and by a reducing number of customers. Eventually the bubble will
burst, though perhaps not before a few market entrants have made their money and gone.

The consultation papers make reference to the recently introduced retail competition in
Scotland for business customers. It is important to note the following:

England and Wales had regional water companies between 1974 until privatisation in 1989.
Privatisation retained that regional structure.

In Scotland, there was no regional system of water management until 1997. The water
industry remained the responsibility of local authorities until 3 publicly owned regional water
authorities were established in 1996. These were then merged into a single public water
authority, Scottish Water, in 2002. An economic regulator for the Scottish Water was
established in 1999, and which adopted similar yardstick competition methods to Ofwat’s to
compare the performance of Scottish Water against the privatised English and Welsh plcs
and the water only companies. At that time the performance of Scottish Water was assessed
as being far behind that of the English and Welsh companies, in terms of opex and capex
efficiency, customer service and environmental and drinking water quality. By 2008, Scottish
Water’s performance across almost all categories of performance – including charges to
customers – is within the pack of the English and Welsh water companies. The rate of
improvement outstripped anything achieved by the privatised water utilities in England and
Wales. Scottish Water has remained in the public sector.
What this demonstrates is the effectiveness of robust regulation, and the ability of
determined management within Scottish Water to deliver, not the intrinsic tendency of any
one ownership model to out-perform another.

The much vaunted introduction of retail competition in Scotland – alluded to in the
competition consultation documents – should be reflected on carefully. It has necessitated
the construction of a complex switching mechanism (the CMA), and led to artificial business
separation (at the insistence of the regulator) within Scottish Water to the extent that Scottish
Water’s CEO is precluded from being involved in any way in its wholly owned retail
subsidiary company.

By the time that all the retail competitors have made a reasonable return on capital (including
Scottish Water’s own retail company) it is doubtful if the consumer will see much long term
benefit. And even before the market has really started, one of the much heralded new
entrants has gone into receivership.

Furthermore, the need to move to more sustainable water management has been hindered
by retail competition, for example in terms of leakage reduction – following retail competition,
detailed consumption data is no longer available to the wholesaler (ie Scottish Water) in the
detail and at the frequency necessary to match consumption to water put into supply.

It is often averred that regulation is a second best compared to competition. There is little
evidence for this with natural monopolies such as water – and where water services are only
part of the overall equation. The benefits of intelligent regulation need to be recognised as
actually being at least as good as competition in the provision of value for money services to
business and domestic customers, and in the wider scheme of things, superior to a
competition model in which water is treated simply as a commodity to be bought and sold.


Notes about the Author

Professor Paul Jowitt is Professor of Civil Engineering Systems and Executive Director of the
Scottish Institute of Sustainable Technology at Heriot Watt University.

He is a Vice President of the Institution of Civil Engineers, a Fellow of the City of Guilds of
London Institute, and a Fellow of the Royal Society of Edinburgh.

He was a Board Member of Scottish Water from 2002-2008, a Board Member of the East of
Scotland Water Authority from 1999-2002 and Member of the East Region Board of SEPA
from 2000-2004.


The views expressed in this Consultation Response are a personal opinion and are not
intended to represent the views of any of the above organisations.

				
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