Ofwat takes steps to promote competition

May 14, 2007 at 12:54 pm

Are you fed up with the rising cost of water rates, with no discernible improvement in services to accompany it? Frustrated with not being able to switch providers? Well, you’re not alone. The good news is that things may soon change for the better, with Ofwat recently announcing steps to increase competition in the water industry.

Ofwat is canvassing opinion, asking industry experts and organisations with an interest in water issues to comment on two proposals which could kick-start competition. The consultations, which end on 1st June, have come about following an earlier internal review conducted by Ofwat, which highlighted disappointingly slow progress on several issues, including costing and size threshold, embodied in the Water Supply Licensing regime.

The Costs Principle

A key element of water industry regulation is the price control system. When privatisation of utilities occurred, a price cap system, RPI-x, was used to fill the gap between the state monopoly and a competitive market. Supposedly this was the nearest regulatory equivalent to a competitive market, in which innovative companies (those which reduce costs, improve services or introduce new products) succeed.

In the price cap system, Ofwat caps the price which the provider is allowed to charge. If the provider is able to supply the product for significantly below the capped price, they can retain these additional profits until the next price review. In the water industry, these reviews take place every 5 years. To stop companies reducing quality, the regulator generally offers an incentive for improved quality, and penalises companies if quality standards are not met. In reality, regulators have imposed unrealistic price caps which have produced such low profit margins that the potential for retail competition has actually been limited.

The Water Supply Licensing (WSL) regime

Domestic customers currently have no choice about who provides their water and sewerage services. Since the introduction of the WSL in 2005, businesses can choose their supplier, but must meet a number of criteria in order to be eligible. The new competition regime, introduced in 2005, allows commercial customers using at least 50 megalitres (50 million litres) of water per annum to choose their supplier. This means a very select group of 2,200 customers and, although Ofwat has granted seven WSLs, not a single commercial consumers has yet switched.

The consultations

Ofwat’s first consultation will focus on revisions to the WSL regime, designed to stimulate competition and increase the volume of eligible customers.

The second consultation will address the way in which water supply licensees can buy ‘spare’ water from another water company, in order to supply their customers in a different geographic area. Both consultation documents can be found on the Ofwat website.

Keith Mason is Director of Regulatory Finance and Competition at Ofwat. He acknowledges that the Costs Principle and size threshold are key factors limiting competition, and says that “Ofwat is now proposing in these consultations to take some further steps under the current regime to promote competition”.

As the Water Services Regulation Authority, Ofwat is tasked with protecting the interests of consumers wherever appropriate by promoting effective competition. Unlike the regulators for telecoms, gas and electricity, however, Ofwat seems content to “facilitate” rather than actively promote competition. The Government seems unwilling to intervene to improve competition, preferring to set leakage targets rather than reducing regulation so as to allow the market to decide. Hopefully, the current consultation will be the first step towards improved competition so that businesses, and eventually domestic customers, can get a better deal.

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