Retail competition in water: is the market fully switched on?

Tom Kiedrowski writes for Utility Week about his unique experience of the open water retail market.

The first day I sat at my desk as the new director of market reform at Ofwat HQ overlooking most of Birmingham, I thought: “this is the toughest gig of my professional career”. The work had already slipped by almost a year and the debate over whether choice for non-households was a good idea at all had been raging for more than three years.

Over the ensuing weeks and months my team and I meticulously developed a detailed road map, not only to introduce market mechanisms and increase choice for non-households at the retail level, but how to get the water companies to innovate upstream and facilitate wholesale trading between the existing water companies.

All of this was based on lessons from energy, telecoms, post and water liberalisation in Scotland. We received several push backs and refinements to those early proposals and the water companies were almost in meltdown when it was provisionally suggested that retail competition should commence in 2015.

Eventually Ofwat realised it didn’t have the capacity to manage the process itself and government took the correct step of establishing Open Water with input from the regulator, the water companies and consultants. I passed on the baton in November 2012 to help set up the Competition and Markets Authority (CMA), but brilliant and hard-working colleagues across the sector turned a questionable ambition into a tangible reality in April 2017. The result? Well MOSL announced earlier this month that over 100,000 eligible business sites had switched water and sewerage supplier since the market opening in April 2017.

That’s no mean feat given that right prior to market opening there was a great deal of uncertainty as to the extent to which non-household customers would make the switch apart from a few larger multi-site customers looking to consolidate their bills. I knew that market opening would be more than a damp squib, not least when I had hands on experience working as an interim director at Bristol Water and I saw at first hand the medium-sized companies expressing an interest in switching back in 2016.

It’s not all plain sailing

There is huge relief at Ofwat that after all the struggle, design, planning and implementation that the market is buoyant with 22 national retailers, 12 regional retailers, a couple of self-supply retailers and seemingly new retail licensee applicants being announced regularly by the regulator on their website.

There is relief too north of the border, where market opening for non-households had taken place back in 2007 and WICS were concerned where else was there to go in such a small market after the initial liberalisation.

Of course, it’s not all plain sailing: Ofwat are keen to see more transparency from retailers about offers available to customers. In terms of processes, MOSL continues to fine tune market governance arrangements between wholesalers and retails with 32 changes already being considered in under a year.

In terms of what market opening delivers to the customer there are of course the savings in terms of management time and cost from bill consolidation but also whenever I go to a retail-related event what I notice is that customers are looking innovative solutions to achieve efficiencies with respect to water use and leakage.

There is always going to be a lively debate over price, but it remains to be seen how much more room for manoeuvre there is given the majority of the wholesale cost is regulated. Wearing my other consultancy hat for a second, what a telecommunications provider would say to a water retailer is they really need to up their game with respect to using technology if customers are going to receive any significant efficiencies.

Companies have to be allowed to exit a market as well as enter it

Perhaps one of the overlooked aspects of market opening is how the incumbent water companies have voluntarily done what the Cave Review namely to separate the retail from the wholesale businesses.

The argument that Professor Martin Cave had made was that in order to have proper functioning market you needed legal separation of the water companies between wholesale and retail to avoid discrimination and therefore facilitate entry but also to allow companies to specialise at what they were best at doing rather than trying to do everything from source to tap.

In the end the government bottled Cave’s recommendation for legal separation because of fears it would spook investors. Later, when it came to introducing the Water Act in 2014, Defra officials realised that if you introduce market forces companies have to be allowed to exit a market as well as enter it.

This has produced a very interesting dynamic. Okay it’s not legal separation and it’s not been systematically applied by every English water company but when boards released what retail competition entailed, some of them have chosen to exit the retail market or come up with solutions to deal with the new realities in innovative ways.

When I was developing credible scenarios for market entry at Ofwat, I envisaged incumbent water companies competing out of area alongside entrants either from other utility sectors or from existing water retailers moving into new markets south of the border.

It’s still early days

What I didn’t foresee was that rather than doing just that companies like Business Stream and Castle Water would buy the retail business customers of the water incumbents, leaving companies like Thames and Southern to increasingly focus on their wholesale businesses. Other companies have followed Bristol Water’s and Wessex Water’s lead and form joint ventures as in the case of Water Plus (between United Utilities and Severn Trent) – and Wave (between Anglian and Northumbrian).

What was expected at Ofwat Towers prior to market opening, was that the WOCs would be taken over by their larger brethren but it’s still early days to see this turning from a trickle into a flood. We have seen Pennon takeover South Staffs Water and Severn Trent take over Dee Valley Water.

Whatever the uncertainties about water sector landscape of the next few years, further joint ventures and acquisitions are unlikely to end here now that the market dynamic is well and truly open.  It’s also likely as we have seen in other sector that some companies will exit the market as they struggle with small margins and face companies with greater scale.

Prior to the EU referendum and the last general election, there was a lot of excitement about extending competition to the domestic market. This has become most subdued of late as civil servants struggle with preparing for Brexit and the government is faced with a much-reduced majority following Theresa May’s failed gamble.

Borrowing billions to renationalise water, while possible, might not be an immediate priority

If that wasn’t enough a resurgent Corbyn-led Labour Party is now calling for the renationalisation of the water companies and placing them into regionalised cooperatives. It will be interesting to see if this leads the current Conservative government to be more cautious with further market reforms or put clear blue water between themselves and more overtly socialist Labour opposition at the next election.

If the Conservatives where re-elected and extended competition to households as well as non-households, the utilities sector would most likely see even more profound change as companies started to see the logic of bundling gas, electricity and water and perhaps even broadband based on their large and overlapping customer databases. It would also put pressure on the government to remove any existing limits on mergers in the water sector as the case of benchmarking as a substitute for competition would be severely weakened.

If, on the other hand, we face the prospect of a post-Brexit Labour government would they really wipe the slate clean and start all over again. I could see rationalisation being a priority with respect to rail services and being also extremely popular with the electorate and passengers.

However, in cash strapped times, the prospects of borrowing billions to renationalise water, while possible, might not be an immediate priority and it would take some time to achieve. Once non-household customers get used to switching their water companies and the benefits it brings, would Labour really want to throw all that away? Perhaps but after ten-years of struggle and final delivery it would be great pity to see it go to waste when all they have to do is focus on the wholesale part of the business.

Tom Kiedrowski is managing director, Cedar Tree Advisory Service and is a member of the Institute of Water and of the Essential Services Access Network (ESAN). He is former director market reform at Ofwat and interim director of strategy and regulation at Bristol Water.