The pros and cons of domestic competition

Ofwat has started the wheels turning on its cost/benefit review of domestic competition in the water retail market by publishing the draft terms of reference. What will the regulator consider?

The Treasury dropped the domestic competition bombshell at the very end of November last year, taking the water sector by surprise – it was expected that non-domestic retail competition would be well underway before domestic competition was considered.

Analysts warn that the Treasury’s plans will increase business risk, hitting the earnings of incumbent water companies, and could even deter foreign investment in the water sector.

However, Ofwat points out there is a “wealth of evidence” from other utility sectors and the broader economy that market forces can deliver a range of “significant benefits” to customers, including reducing costs, improving service and providing strong incentives for innovation.

“In line with our duty to protect the interests of consumers, wherever appropriate by promoting effective competition, we welcome the opportunity to assess the costs and benefits of household competition,” it says.

The companies themselves are still reluctant to air their views, but insist that they will support Ofwat as it analyses the pros and cons of extending retail competition to household customers in England, with Water UK saying they will “actively engage in reform of the sector” and work alongside the government and Ofwat to ensure the “best possible deal for our customers”.

The landscape of the water industry has changed since 2009, when the ‘Cave Review’ of competition and innovation in water markets was published by the Department for the Environment, Food and Rural Affairs (Defra).

The government now wants Ofwat to look at the existing evidence with fresh eyes, and consider new evidence, to make an assessment about whether domestic competition would be of sufficient benefit to consumers to be worthwhile.

The review will look at opportunities for introducing competition for the provision of water and sewerage retail services to household customers and the different scenarios through which this could happen and, where potential barriers to effective competition or risks to consumers from household retail competition are identified, Ofwat will consider what forms of price control and other protection mechanisms they could implement to allow effective choice.

As part of the review, the regulator will look at the different ways in which competition could be introduced. “This could range from competition for the market to competition in the market,” it says. The array of scenarios will include an extension of the approach Ofwat is current implementing in the non-household retail market, a separate household retail market, or auction-style competition.

Competitive retail market scenarios will include:

Thin – where market activities are limited to providing core retail activities, such as billing and payment handling.

Thick – in which retailers can undertake a wider scope of activities, including resource procurement, local distribution networks, meter provision and metering, new connections and more customer interactions.

Narrow – where a specific sub-set of household customers are contestable, allowing different regions or segments of the market to open at different times.

Wide – in which all household customers are contestable.

Quantifying the benefits of competition, especially those which are more dynamic such as innovation, can be “notoriously hard”, Ofwat says.

It will assess each scenario against its own objectives: value for money for customers and the quality of service they receive, and protecting vulnerable customers; protecting the environment and maintaining and improving resilience within the sector; encouraging water efficiency and sustainability of supply; investment in infrastructure; and ensuring regulation remains proportionate and targeted.

The tone of the Treasury’s announcement suggests the outcome of the review is a given. But Ofwat chief executive Cathryn Ross insists this isn’t so, telling Utility Week: “I think what you can infer is that government is keen on the idea, but they wouldn’t have asked us to do a review of costs and benefits if the thing was already a forgone conclusion. And we’re certainly not treating it as that.”

The timeframe is tight. Ofwat has begun gathering evidence and must put out its initial findings in July for comment, before publishing a full review by September. This, it says, will then inform decisions on policy that will be taken by the UK government.

And does the stringent timetable for the domestic competition review put additional pressure on the timetable for business market opening? Ross says not. “There’s no reason why it should.”