I believe firmly that competitive forces lead to lower costs, better levels of service and increased innovation. Separating non-household retail and wholesale activities has benefitted all water customers in Scotland. But the question remains: How do we ensure that upstream activities become as innovative and focused on improving value for money?
The status quo is not an option. So the choice is clear – either we seek to introduce a competition framework for upstream activities or the regulatory framework needs to be adapted to encourage innovation and the pursuit of as many NPV-positive projects as possible.
Competition could be introduced by allowing participation in the market in direct competition with current incumbents or by letting periodic contracts for service delivery (for the whole of an appointed area or a subset of it). Such contracts are the norm in many parts of the world. I am not clear though that there is any evidence that such ‘for the market’ competition has led to better outcomes either in efficiency or in innovation from what exists already. And tendering for these contracts can be very expensive – with customers ultimately footing the bill!
Potentially, competition ‘in the market’ looks more attractive. New entrants would have to be lower cost and offer greater reliability and improved service in order to carve out a successful and sustainable niche. But when I look at the detail of how this might be implemented, I begin to have some real doubts:
- It is not immediately clear that there are naturally defined activities in upstream service delivery. For example, storage of treated water could be, in different circumstances, an abstraction or a network or a treatment activity.
- Assets tend to have extended asset lives. As such, it is marginal revenues and costs that are important for the incumbent (at least in the short to medium run), whereas average costs are immediately important for the new entrant.
- Any involvement in upstream activities has to be negotiated with the current service provider – even new connections on a greenfield site are the incumbents to refuse!
In different ways each of these factors could complicate the development of a robust framework for competition and may lead to increased costs – at least in the short to medium run.
There may be a better way of encouraging the innovation that would ultimately lead to lower prices and better levels of service to customers. There are five evolutionary changes we could make:
- Allow Scottish Water to retain the benefits of pursuing lower cost or better levels of service for a sufficiently long period that the company has achieved payback at a reasonable investment hurdle rate.
- Provide a framework for returns earned by Scottish Water, including the sharing of higher returns with customers.
- Allow for a higher return to be earned on innovative approaches – provided the ultimate cost is lower to customers. These returns should be available for the duration of the proposed project.
- Ensure that customers, their retailers, third parties and the incumbent can benefit from innovative approaches.
- Involve customers in decision making. Customers will have a view on how services should or could be improved – including, for example, the trade-offs between lower carbon, less certain, lower price and higher return options and more conservative, traditional approaches.
These five changes are at the root of our changes to the regulatory framework in Scotland. So I am much encouraged by Scottish Water’s intention to increase further its dialogue with retailers about the opportunities that may exist to improve value for money to customers.