Chief executive’s view: A checklist for water reform

Alan Sutherland sets out some crucial questions that should (and should not) be addressed in the Water Bill.

By the time you read this, we may finally have had the second reading of the UK government’s Water Bill. Politicians of all parties are now looking critically at the water sector. There may be attempts to make social tariffs compulsory, extend metering, bring forward abstraction reform and amend the government’s proposals for competition. There may even be suggestions that the industry is hit by a windfall tax or is made to pay more tax.
It is important that we look beyond these immediate political debates and take decisions that will benefit customers and the environment in the long term.
If we take, for example, the call for a windfall tax; customers would, in the end, pay more because the cost of finance would increase. A similar fate would befall customers if companies have to pay more tax because rules are introduced to limit interest tax relief or limit the capital allowances on investment in improving services. And what about the poor taxpayer if we put off potential investors in the UK’s infrastructure?
We must rebuild trust in our industry. Jonson Cox has started the ball rolling, demanding greater clarity in company corporate structures and governance. Equally important is Cox’s expectation that any excess profits should be shared with customers.
A second example is the debate about social tariffs. We should recognise that metering households substantially unwinds significant social cross-subsidies. It can only become progressively more difficult to re-introduce them in the form of social tariffs.
This is not to downplay the role metering can play in managing demand. Meters should be introduced when the benefits (including environmental and resilience gains) exceed the costs (including any social impact). Perhaps we should consider whether metering could be combined with maintaining social cross-subsidies?
Government seems intent on delegating responsibility for social tariffs to individual companies. As a result the assistance available may depend less on how affordable the bill is and more on where the customer lives. How will this work where different companies supply water and sewerage services? As a minimum, government should set out clear criteria, to apply nationally, about who should be eligible for social tariffs.
Another example where the longer term interest must trump short-term expediency is the decision not to allow exit from the retail non-household market. This appears a marked contrast to the Office of Fair Trading’s report Orderly Exit published in December last year, which says trying to avoid or prevent exit from a market only increases the likelihood of future disorderly exit. Is this a path we knowingly wish to tread?
Disallowing exit may have reassured investors in the short run, but I wonder how many understand that most companies will see profits fall by up to 5 per cent. Pursuing this option can only increase the cost of capital for some companies in the longer run – to the detriment of all.
There is a way forward here. A relatively straightforward amendment to the Bill could allow controlled exit, where companies can only sell their customer base to organisations that hold retail licences (and subject to the secretary of state’s approval).
This approach would allow economies of scale to be realised, help ensure a genuinely level playing field for new entrants, and increase the chance that retailers from other sectors might enter the market. Any other course will risk raising expectations only to disappoint – 2003 all over again.
 The Bill also lacks clarity in its apparent reliance on negotiation between new entrants and incumbents. We have been reassured that the intention is to create regulated access, yet there is no requirement for published wholesale charges (which would go a long way to reassure entrants) and it isn’t clear to me how non-price discrimination will be ruled out.
Perhaps most worryingly, there remains a potential link between new retailers and potential new suppliers of water resources. It is unclear how this link could be effective in delivering greater resilience overall. New entrants would naturally focus on areas where they can reduce customers’ bills, which will be areas where it is possible to supply water for less than the incumbent monopoly’s regionally averaged price.
This direct link creates a risk that tariffs end up being de-averaged by default. We should be very careful! In Scotland we specifically ruled out any direct link between retailers and upstream activities (unless there was an overall cost saving that could benefit all customers). De-averaging may deliver lower charges for some, but will result in eye-watering increases for others. Our joint analysis, with Oxera and Scottish Water, confirms that in Scotland 50 per cent increases are required from two-thirds of non-household customers to allow the other third to enjoy the benefits of a de-averaged charge. I will leave you to ponder what could happen to smaller businesses in rural areas.
Finally, we must ensure we do not create perverse incentives for wholesale businesses to treat less favourably retailers that offer tailored services, including water efficiency. In Scotland we have prevented this by including a specific “no detriment” provision to protect the wholesaler, Scottish Water – again this could be relatively easily addressed by introducing a similar clause in the Bill.
The Water Bill is a real opportunity to build on the sector’s achievements. Pursuing palliative, short-term responses may be superficially attractive but it will not serve us well. Instead we should think more expansively and build on strengths. Government has an important role to play in setting a clearly defined policy agenda but the whole industry needs to think carefully about the Bill’s implications and ensure that a long-term, balanced approach is taken.