My previous blog about the United Utilities’ sponsored ICS Consulting report on vertical integration was quite negative about its approach to the question of separating retail and wholesale activities.
However, this report does make a number of good points: the importance of coordination (and thinking through system impacts of actions); the importance of time; and the impact of asset specificity.
In Scotland we have experience of the potential difficulty of managing wholesale fragmentation. This comes from the fact that some half of Scottish Water’s waste water treatment and 80% of its sludge treatment is done by PPP contractors. Odour problems at Seafield, performance issues at Dalmuir and the impact on asset strategy planning for the future are all real issues for which Scottish Water is responsible and for which their ability to ensure effective delivery is limited.
It could be argued that this results from the long-term nature of the contracts and the poor (an ex post judgement) specification of service levels and change protocols. But this ignores the fact that the water industry is as long a term business as there is. Traditionally, the expectation has been that assets will be replaced when they reach the end of their natural lives. Once built, there is always the concern that assets could be wholly or partially stranded – that is why such store has been placed on the RCV. Long-term contracts, such as the PPPs, were the alternative.
Looking forward, it is possible that assets may be required for shorter periods or revenue solutions may work for a temporary period. The industry will have to adjust to this. Some of the answer may lie in smarter regulation – moving to total expenditure regulation rather than separate treatment of operating and capital expenditure. Some may lie in encouraging trading between companies and more innovation. And encouraging innovation will require all of us to be more understanding if or when problems with innovative solutions arise.
But the key point is that there needs to be active consideration not just of the effects across the whole wholesale business, but also attention has to be paid to the marginal risk and payback of new approaches. Adding to the RCV may have been fine in the past – but it is unlikely to have the desired effect going forward. Unless, of course, we want to see future customers continue to pay for benefits that are no longer being received.
It is also important to think about the impact of assets already built and operating. It is not easy to change these and once built there is a significant cost in adapting or operating them at lower capacity than was planned. Such assets could also impact directly on other sectors that need access to raw water – but for whom the marginal cost of foregoing water may be lower in the short run even if potentially higher in the longer run.
These are complex issues. Clarity from Government and strategic and long-term planning of water and waste water assets by wholesale water businesses will both be vital.