Competition in water and wastewater services Presentation to RPI conference 16 September 2008

1. Competition in water and wastewater servicesPresentation to RPI conference 16 September 2008 PHILLIP DIXON Head of Competition www.Ofwat.gov.uk

2. Summary • Recap - Ofwat’s review of competition • Responses to Ofwat’s May paper • 2 current issues • Accounting separation • Abstraction • Next steps

3. Recap - Review of competition • WSL regime not working • April 07 – outcomes of internal review: Costs Principle and threshold • July 07 – wider review, WSL and everything else • Dec 07 – recommendations to Govt on WSL • Jan 08 – begin accounting separation project (pilots) • Feb 08 – Cave review begins • May 08 – recommendations to Govt on wider issues • November 08 – Cave review interim report • Spring 09 – Cave review final report • Floods and Water Bill?

4. What are we recommending? • Revamp WSL. • Flexibility to set access price methods • Lower eligibility threshold • Include sewerage • More customer confidence (SOLR) • More competition ‘upstream’ (resources and treatment) and ‘downstream’ (sludge). • Improve abstraction trading – rights and water. • Vertically-separate business units, retail legally separate. • Legislative flexibility to enable competition to develop. • Progressive approach - competition where customers benefit. • Competition and regulation – horses for courses.

5. Responses to May paper 29 August deadline, still receiving responses. A flavour… • Clear progress, but need more detail. • Don’t forget innovation. • Accounting separation is necessary and desirable but may increase risk and should be progressive. • Retail competition (including sewerage) is welcome by most but debt may be an issue. • Household competition is desirable (with safeguards). • Abstraction / trading is desirable but need to take account of security of supply. • Some support for sewerage competition beyond retail.

6. Accounting separation • Involves identifying discrete activities and functions and treating each of these as if it were a separate business unit. Each unit 'trades' with others, but there is no legal or structural separation of the business units. • Is both necessary (but not sufficient) for competition to be effective, and desirable for competition and regulatory aims. • Can improve cost transparency, revealing redundant services and increasing efficiency, facilitate innovative tariffs and service offerings, make market entry simpler. • Used in gas, electricity and telecommunications sectors to help competition to develop.

7. Accounting separation We propose.. • Retailers should ‘own’ the final consumers. • To make all customer-facing activities part of retail business. • Separate contestable from non-contestable activities. • To separate resources from treatment, and sludge from sewage, into different business units. • Report retail costs in detail, and split between household and non-household. • 2009-10 is the first reporting year Leads to formal price control separation for period after 2015. Supports proposal for legal separation of retail businesses

8. Accounting separation - issues • Identify all the activities and put them in the correct boxes. • Allocation rules for indirect / common costs. • Retailers are responsible for correcting operational issues. • Indivisible assets (e.g. borehole + treatment works) – which business unit? • Raw water transport / sludge treatment + disposal – separate units? • Data quality - will improve over time. • Consulted on 12 September – responses by 14 November.

9. Abstraction • Need access to resources to underpin ‘upstream’ competition. • Raw water not economically valued, either by scarcity or by location – wrong (perverse) signals for investment. • Better knowledge about economic value can lead to better (more efficient) decisions about investment in water networks and environmental protection. • Revealed value can improve both regulatory and competitive frameworks, promote innovation, help balance supply and demand.

10. Abstraction - issues • Resources are unevenly distributed across E+W. • Regional rather than national market likely. • Not a lot of ‘spare’ (unlicensed) water available. • Many existing licences are held in perpetuity. What regulatory value should these licences have? • High sunk costs to compete against. • Market dominance in some areas unavoidable? • Who is responsible for overall security of supplies? Drought and resource planning? System balancing?

11. Abstraction - possible approaches Possible mechanisms to improve access to resources include: • Forced release of abstraction rights (e.g. 90/10 rule and gas release programme in 1990s). • Voluntary release of rights, incentivised by revealed value / market price. • Allow sharing of existing rights. • Market to allow trading of (surplus) water and water rights. Spot and futures markets? Financial instruments? • Create separate licence-holding company with specific duties to supply water to anyone on non-discriminatory terms. • More visibility about available water – CAMS, internet bulletin boards.

12. Next steps and milestones • Lots of work to do on detailed models on a range of issues. • Gather evidence and opinion. • Publish responses to May paper (Oct 08). • Cave review interim report (Nov 08). • Revise Regulatory Accounting Guidelines. • Prepare for Floods and Water Bill.

13. Prospects for competition in water and wastewater servicesPresentation to RPI conference 16 September 2008 PHILLIP DIXON Head of Competition www.Ofwat.gov.uk