As consumers we are all probably glad that the water industry is very conservative. None of us wants undue risks being taken with public health or with our environment. I accept therefore that those who seek to change the way in which the industry operates or is regulated should explain why they think change is necessary and what the impact of change is likely to be.
Before I make the case for change, I think it is important to recognise the improvements the industry has made in levels of service to customers; in its efficiency; and in improving both water quality and waste water discharges to our environment.
However, this worthy performance in the past is not a sufficient reason to remain with the status quo. Nor does it mean that further improvements could not be made. The current economic regulatory framework imposes a five-year delivery cycle. It is not clear that a project with a positive NPV that pays back in seven years would be pursued by a regulated company. Even if any capital expenditure were included in the RCV, it is far from certain that investors would achieve pay back on their investment – let alone a reasonable return.
The separate regulation of operating costs and capital expenditure may exacerbate the pursuit of the lowest whole life cost solution or satisfactory returns for owners. Asset creation earns a return; any other spending does not. As such it is better to own vehicles than to lease them. It is better to build a reservoir than to buy water from a neighbour. Indeed the current framework may reclaim any extra revenue generated from trading water and regard expenditure on traded water as operating costs and, perhaps, as a source of relative inefficiency!
Allowing the same return on potentially more risky projects that are, in some way, out of the ordinary could similarly limit the benefits that could accrue to customers. For example, the pursuit of a catchment management solution may earn little or no return for a water company. Yes, it is risky but it could likely be much cheaper to customers than the likely alternative: the construction of an asset.
A second example could be where the delivery of a major project represented a significant proportion of a company's RCV. There is a valid question whether the marginal rate of return on a large and potentially risky project should be the same as for a portfolio of already completed assets or even a large portfolio of assets that are in construction using tried and tested methods.
Given these weaknesses in the current regulatory framework, it seems to me difficult to justify the collection of extensive data returns, or indeed lengthy and detailed business plans from Scottish Water. Regulation should be proportionate if it is to be effective and, even more important, legitimate.
One advantage of the substantial information collected was to allow comparisons to be drawn between companies. We made extensive use of such comparisons in our initial challenge to the three authorities and to Scottish Water to improve the efficiency of the industry in Scotland.
But what about customers? What I have described is an extended dialogue, sometimes cordial, sometimes rather adversarial, between the regulated company and the regulator. Both sides, at different times, lay claim to represent the interests of customers best. Even when we each ask customers, it has tended to be adversarial – whose research is better?
And what of those customers who want choice: would they be satisfied with a regulatory solution? Certainly the regulator could set higher and more stringent customer satisfaction benchmarks, but at what cost given the broad agreement that the regulatory burden for companies should be lowered not raised? And to what extent will incrementally increased service levels, which is all a regulatory solution could ever hope to achieve, placate those demanding choice?
Perhaps we need to pause and ask: “Why do we do what we do?” It seems to me that both the regulator and the regulated company should be working in the interests of customers. And if there are opportunities for a management, an owner or, heaven forbid, a regulator to take a short-term approach, should this not be seen as a failure on the part of each participant in the process?
So I rest my case. The compromises inherent in the current regulatory framework are too great and it does not position us well for the new challenges, such as addressing climate change, that lie ahead. Those who may favour the status quo should be able to suggest how the issues I have outlined above are to be addressed. I do not think that this will be an easy case to construct!
In Scotland, we are working with Scottish Water to make the regulatory framework more flexible, to encourage innovation and to welcome any project that could add value, while improving the level of service provided to customers or to the environment.
Scottish Water and the Commission are also working with Consumer Focus Scotland to establish a Customer Forum. This Forum will represent both household and non-household customers and will be empowered to make the trade-offs that are important to customers within the policy framework set by the Scottish Government. Interestingly, the participation of retailers – with interests in other parts of the country – can ensure that the incumbent wholesaler can be challenged to at least match the performance of its neighbours!
And, of course, the retail competition framework allows those companies or public sector organisations for whom choice is important to choose the service and price offering that best meets their needs. All the while, the wholesaler knows that there will be no detriment to its activities. This certainty should lead to a greater willingness to innovate – especially given the more flexible regulatory framework that we are in the process of establishing.
Could we do better? Without question – but only by talking further. Not by engaging in the polemics that have unfortunately characterised the debate so far!