“We’ve only just begun”: Cox’s latest challenge to the water sector

Two years ago, there were “howls of protest” (his words) when incoming Ofwat chairman Jonson Cox set out a vision for the water sector that included companies sharing financial pain and gain with customers, tightening up governance, and reforming regulation. This time round, at the packed Ideas Space in London’s Westminster yesterday afternoon, the audience of chief executives, analysts and policymakers was more friendly, though once again, there were tough messages in store.

Cox’s speech deliberately echoed that of two years ago, in which he threw down the gauntlet to the industry with a six point plan for reform. 24 months later, what once looked radical has now become the common wisdom, as water companies focus on affordability and transparency throughout their businesses. But, as PR14 finally comes to an end (unless you’re Bristol Water), the message was clear: “Reform isn’t over. In fact, it’s just beginning.”

In 2013, Cox focused on six areas of reform. Today, there were seven: customers and affordability; the strategic role of information; Regulated Capital Value (RCV) and indexation to the Retail Price Index (RPI); vertical integration; service in a fragmented structure; mergers and consolidation; and managing the unexpected.

First up were customers, service and affordability. The regulator’s focus here has been clear throughout PR14 and, to borrow Cox’s words, “I don’t need to say much more.” He added: “I look forward to seeing significant differentiation in all services – a real frontier shift.”

Next on the agenda was the strategic role of information. From this summer, Ofwat will publish “a suite of data that enables third parties easily to see how the company is performing compared to its commitments.” This information will also form the basis of Ofwat’s decisions on enhanced status in the next price review.

On the “difficult issue” of the indexation of RCV to RPI, Cox indicated a determination to change, while acknowledging that would prove controversial: “Our industry is index-linked to RPI which systematically over-counts inflation by up to 100 basis points above CPI (Consumer Price Index). We recognise and are fully aware of the quantum of index-linked debt in the market. Financial markets are nothing if not adaptable but we realise that change may take some time, innovation and potentially ‘grand-fathering’ of some elements.”

On vertical integration too the message was clear: “The logic of vertical integration no longer works. The money investor in this sector seeks the asset base. The capital intensive nature is largely confined to the network and treatment businesses. It’s very clear now, that the argument which was decried by management two years ago, of retail separation, is catching on in water companies.”

Cox also looked forward to the further disaggregation of the value chain through upstream reform. He acknowledged that he had “started off sceptical”, but now saw “we have to allow the innovation that results from having a choice of sources.”

He was careful to emphasise that the fragmentation of the value chain should not affect service quality: “We and companies need to think about how customers will be directed to get the quickest possible resolution in an area where different corporate entities will provide different parts of the service.”

On mergers and consolidation, Cox reiterated that Ofwat was open to such activity, but that the traditional model of putting two companies together to achieve efficiencies of scale would not be enough to satisfy the regulator. He said: “We’re interested in different ideas. Why do water companies need to be water and wastewater companies? Would there be more efficiencies available by two companies putting together their water businesses and their wastewater businesses as two separate entities?”

Finally, Cox warned there would be unexpected events in AMP6, as there were in AMP5. He said the regulator would strike a balance between reacting to events and providing regulatory stability: “The overriding principle for us is the maintenance of trust and confidence in the sector. If we see unexpected events which challenge the trust and legitimacy of the sector in a material way we will continue to raise that with the industry.”

Throughout the speech and following question and answer session, Cox was careful to emphasise the importance of dialogue, and the continuity of his vision with Ofwat’s strategy of maintaining ‘trust and confidence’ in water, launched by chief executive Cathryn Ross at a similar gathering earlier this year. He reflected on the “Section 13 debacle” he had walked in to when joining Ofwat in 2013, when a lack of dialogue and trust caused a near-catastrophic breakdown in relationships between the water companies and the regulator.

There’s no doubt that relations between the industry and the regulator have improved out of sight over the past two years, from breakdown to a solid working relationship. Still, the iron fist was quietly in evidence – Cox repeated several times: “dialogue is not negotiation.” This, like the reforms in his speech, did not come as a surprise, and as PR14 draws to a close, it’s clear the real work has only just begun.