Regulating Privatised Water: Lessons from England and Wales

1. Regulating Privatised Water: Lessons from England and Wales Regina Finn Chief Executive

2. Overview • The Water Industry in England and Wales • The Role of Comparative Competition • Development of Market Competition • Conclusion and Questions

3. The Context: Long Term Challenges • Water Industry affected by long term drivers: • Climate change – adaptation and mitigation • Weather volatility – floods and droughts • Population growth and location – water stress • Demand for water and how we value water • Ofwat is regulating to protect consumers, promote value and safeguard the future.

4. The Water Industry in England and Wales

5. England and Wales Water Industry Water and sewerage companies 1 Anglian 2 Dŵr Cymru 3 Northumbrian 4 Severn Trent 5 South West 6 Southern 7 Thames 8 United Utilities 9 Wessex 10 Yorkshire Water only companies 11 Bournemouth & West Hampshire 12 Bristol 13 Cambridge 14 Dee Valley 15 Folkestone & Dover 16 Mid Kent 17 Portsmouth 18 South East 19 South Staffordshire 20 Sutton & East Surrey 21 Tendring Hundred 22 Three Valleys 21 22 20

6. Industry snapshot 500 450 400 350 £ 300 250 200 150 100 Southern Wessex Thames Anglian SevernTrent Yorkshire South West Dwr Cymru United Utilities Northumbrian 2009-10 2004-05 2005-06 Key facts • 22 vertically integrated monopolies. (39 at privatisation) • 23 million connected properties • Average annual capital investment £3 to £3.5 billion • £70bn capital investment since 1989 • Real bill increase in 10 years from 2000-10 will be 7% Water & sewerage bills 2004-05 to 2009-10(in 2004-05 prices) Average bills 2007-08: Industry average: £325 unmetered £285 metered South West (highest): £650 unmetered £378 metered

7. Ownership of Companies • Five listed companies (United Utilities, Northumbrian, Severn Trent, South West and Dee Valley) • One recently delisted (Yorkshire) • Rest privately owned • Range of owners including private equity firms and pension funds

8. Ownership Structures by Regulatory Capital Value (RCV) Note - Correct at November 2007

9. Gearing by RCV Note - Correct at November 2007

10. The Role of Comparative Competition

11. Comparative Competition Key tool for regulating monopoly water industry: • Simple metrics - such as interruptions to water and supply number of complaints • Advanced modelling of expenditure and procurement efficiency, and • International benchmarking where possible

12. Advantages of Comparative Competition • Keeps regulation “small” • Uses real information to drive performance – difficult to challenge • Allows companies to manage their own business • Lets company performance speak for itself

13. What the Regulatory Regime Has Delivered (1) • Significant capital investment privately financed • £70bn invested in water sector since 1989 • Major efficiency gains resulting in lower bills to customers • The average customer bill in 2010 will be £100 lower than it would have been

14. What the Regulatory Regime Has Delivered (2) • Total Operating Expenditure

15. What the Regulatory Regime Has Delivered (3) • Essential services safeguarded • Improved reliability and quality of service • Improved water quality - safe, reliable drinking water • Reduced leakage • Reduced risk of sewer flooding

16. Reduced Leakage Total leakage 1994-95 to 2004-05 (Ml/d) 5500 5112 4980 5000 4505 4500 3989 4000 3649 3608 3605 3551 3414 3500 3306 3243 3000 2500 2000 1994-95 1995-96 1996-97 1997-98 1998-99 1999-2000 2000-01 2001-02 2002-03 2003-04 2004-05 Total Leakage Year

17. Service Improvements

18. Drawbacks of Comparative Competition • Imperfect proxy for effective competition • Companies tempted to ‘game’ • Data collection is an onerous and expensive exercise for both companies and regulator • Information asymmetry – companies have the advantage And…

19. Overall Performance Assessment (Water)

20. Overall Performance Assessment - Water and Waste Water

21. So What Next? • Evolution of the comparative competition – eg capital incentive scheme • Review what we compare and measure – eg customer experience measures • Promote effective competition in the market – reduce regulation

22. The Promotion of Market Competition

23. Promoting Competition: Why? • Ofwat has a duty to promote competition • Competition can drive dynamic efficiency and innovation • Comparative competition has delivered • But risk of diminishing returns over time • Competition has delivered benefits elsewhere • Customers want choice

24. Ofwat Competition Review – Part One Conclusions: • Existing regime ineffective • Need to remove the access pricing rule from primary legislation • Replace with principles • Reduce the threshold for non-household customer competition from 50Ml to zero • Enable retail competition for sewerage • Develop accounting separation…

25. Accounting Separation • Meets multiple goals, including promoting competition • Will require separation of the natural monopoly part of the value chain from contestable activities • Will provide greater visibility for new entrants on costs and potential margins • Will facilitate cost reflective access tariffs • Will ensure level playing field between incumbents and entrants • New reporting from 2009

26. Ofwat Competition Review – Part Two • Inform Government Review of competition in the sector • Will examine the potential for competition throughout the value chain; • Detailed paper in Spring • Objective • Secure innovative entry, efficient investment and customer benefits; • Protect water quality and security • Contribute to social and environmental objectives

27. Ofwat Competition Review – Part Two Key principles: • Similarities with other network utilities • Regulatory unbundling – early step • Structural unbundling of retail – early step • Mechanisms to secure innovation in resources • All customers should benefit • Separate cross-subsidies from the functioning of the market • Simple and transparent market models and access pricing

28. Conclusion • The England and Wales Regulatory Regime has delivered significant benefits for water consumers • To continue to deliver, we need to build on the success of the past and develop new tools to tackle the challenges of the future

29. More information is available from our website: www.ofwat.gov.uk