Almost everyone associated with the water industry recognises that there is a need for change. Change in how companies meet the on-going need for environmental improvements. Change in the way that companies are regulated. Change in the way companies interact with the economic regulator. Change in the voice given to customers in what we ask them to pay for.
I understand the attractions of the status quo. But a series of small steps allowing customers to be involved in key decisions and to encourage companies to innovate and pursue positive NPV projects would help us to address these challenges.
More controversially, it is time to change the current vertical integration of the water and sewerage industry – but limited to separating wholesale and retail activities.
I recognise, because I have been through it, that separating retail takes time and that there are many steps involved – although none of these are particularly difficult. And the evidence – and not just from Scotland – is that the benefits to customers, investors and managers are very real.
The case for separating retail activities is based on our experience in Scotland and the success of the Wessex/Bristol Joint Venture. But it is equally the case that there are no obvious economies of scope which require retail and wholesale activities to be performed within a single legal entity.
We now have approaching three years’ experience of the actual costs and benefits. The costs are much lower and the benefits rather more wide-ranging than we originally assumed.
I will restrict myself to talking about costs. The NPV of the steps that we have taken in Scotland is some £138 million. To this we should add the benefits of the on-going rivalry that exists in a competitive market and is usually considered to boost trend improvement – so-called dynamic efficiency.
If we make even more conservative assumptions about the opportunity for dynamic efficiency than were included in Martin Cave’s review, the NPV increases to £333 million.
The separation of retail activities allows a more commercial relationship to develop between empowered buyers of water and sewerage services and wholesale network and treatment businesses.
Such a dynamic could change economic regulation almost as dramatically as the replacement of rate of return with price cap regulation. And it could substantially reduce regulatory risk.
But separation takes time and must be done carefully, allocating risks and responsibilities where they are most easily dealt with.
In Scotland we have successfully separated retail activities and agreed the remit of the new Customer Forum. The forum will negotiate with Scottish Water to achieve as good a settlement as it can. The Commission will chair these negotiations and provide comments for discussion.
Ultimately, it would remain the Commission’s role to formalise the outcome of these negotiations in its draft determination. But customers will have a direct say over those aspects of service that they most worry about – such as security of supply, sewer flooding, odour and water pressure. And the Commission would not want to second guess the views of customers on such important matters!
Could this approach be used without a wholesale/retail separation? Yes, perhaps – but I do not believe that it would be likely to be as effective. The counterparty representing the customer needs to have real “skin in the game” if it is to be maximally effective. And the more effective it is, the less the regulator needs to intervene!
Involving customers in the price review also allows us to invite Scottish Water to pursue NPV-positive projects, which either require a higher return or a longer payback than the previous framework would have allowed. As such we could envision agreeing incentives for Scottish Water to pursue water efficiency, asset rationalisation, water trading or any other initiative that benefits customers and provides an appropriate return.
We have just published a paper, written jointly with our solicitors, Shepherd and Wedderburn, about the lessons we learned in implementing the retail competition framework in Scotland.
Perhaps the most important of these is that it takes time to implement and then to bed in the new framework. We worked over more than four years on the design of the market, the operations, market, disconnections and governance codes and the template wholesale services agreement.
During this time we worked closely with Scottish Water and other interested parties through a Licensing Framework Implementation Group. This group comprised representatives from a multi-utility, three English water and sewerage companies and smaller potential entrants. It allowed us to understand and debate the concerns of both the incumbent supplier and potential new entrants. We see this group as having been instrumental in allowing us to have opened the market successfully on the agreed schedule.
In almost all respects the opening of the market worked just as we had planned. To be honest, the overwhelming emotion was one of relief rather than triumph or even satisfaction. It involved an awful lot of hard work. I should like to pay tribute to the team in the Commission and to Gordon Downie and his team at Shepherd and Wedderburn for their efforts in ensuring that everything worked as well as it did.
The market framework was tested almost immediately. The failure of Aquavitae required us to trigger the provider of last resort processes much quicker than we might have liked. However, I am pleased to say that no customer suffered any loss or disruption to their supply. With the easy benefit of hindsight, it was perhaps good to have undergone this challenge so early on.
In Scotland we continue to work on improving how trade effluent, new connections and metering services are provided in the new market. Indeed Aimera, one of the new entrants to the market, handled the water and sewerage connection for our new office most efficiently! The results of our work with stakeholders in these areas will be announced in the next few weeks.
But the lesson is clear. It takes time to implement this framework and time to get it fully bedded in. This inevitably limits the scope of the changes that the industry can successfully implement in any given period.