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< Anne McIntosh to scrutinise Defra | Pamela Taylor on the water industry's wishlist for the future >
Ofwat's root and branch review questions future of water sector
Where to now? Long term sector scenarios up for debate
Ofwat has put the whole gamut of future water possibilities on the table for debate. Bill Easton reports.
Barely a month after the deadline for water companies to accept the price limits set out in the 2009 price review (PR09), Ofwat announced a substantial programme of work to explore possible changes across all parts of the water cycle and many aspects of the regulatory framework.
Coalition quiet
Its Delivering Sustainable Water strategy strikes a sharp contrast with the new government's hitherto limited insight into what approach should be taken to the issues facing the water industry. While the Queen's Speech 25 May contained detail on energy issues, comments on water were vague. "We will examine the conclusions of the Cave and Walker Reviews, and reform the water industry to ensure more efficient use of water and the protection of poorer households," it said.
While reform is mentioned, the unspecified changes come only after the Cave and Walker conclusions are further examined. While there are risks attached to trying to place any interpretation on what was said in just 29 words, the overall picture is hardly one of radical or rapid reform.
Other stakeholders have been more proactive, though. Shortly after Ofwat announced its review, Severn Trent published a comprehensive paper setting out its ideas on what a sustainable future would require. Its title, Changing Course, neatly summarised its overall prescription.
Energy parallel
The energy sector, too, has been active. Over the past 18 months or so, it has begun speaking about a policy trilemma - by which it means the need to achieve outcomes that balance efficiency, environmental concerns and security of supply. Although there are important differences in terminology and emphasis, and the environmental issues in water cover more than just carbon dioxide emissions, in essence this challenge also now faces the water industry. Indeed, given the extent to which post-privatisation investment programmes in water have been shaped by environmental legislation, arguably this is really the challenge that the water industry has been facing all along.
This does raise the question, why review the status quo now? Some companies will no doubt feel that Ofwat missed an opportunity to start tackling these issues when key areas of capital expenditure plans were cut during PR09. However, given the complexity of the issues faced and the number of stakeholders involved - Ofwat identifies no less than 49 different stakeholder groups - it is difficult to see how these issues could have been dealt with properly during the timetable of a price review process. Ofwat is "only" the economic regulator, and as Severn Trent highlights, this inevitably raises issues about co-ordination between regulatory bodies.
Areas up for review
At any rate, the launch presentations accompanying the main strategy document identified seven specific areas of activity. The first of these, the development of a set of long-term industry scenarios, mirrors some of the work done by Ofgem. Ofgem's scenarios have been a considerable success, crystallising debates about the future requirements that energy networks will be required to meet. However, as Ofgem has also found, identifying potential challenges is one thing, developing agreed solutions is quite another.
The second and third areas of work concern future price limits and the burden of regulatory compliance and reporting. These are effectively Ofwat's own version of another Ofgem project, the RPI-X@20 review. Ofwat expects this to take until mid-2011 to complete - a speedy outcome compared with the likely duration of almost three years for Ofgem.
Economy vs environment
The next two of Ofwat's areas of work concern the interactions between economic and environmental regulation, looking at the impact of European directives and the specific challenges of sustainable drainage. These are difficult areas, because of the inherent complexity of the issues and the range of parties involved. While some may be concerned about Ofwat looking at issues outside its remit, many in the industry will welcome the focus that the work will bring, with the opportunity to highlight the economic costs and alignment with customer willingness to pay.
Finally - and presumably it is not intended to be a case of last means least important - there are work areas which align closely with the Walker and Cave Reviews on metering and charging, and then market reform. The outline timetable for the market reform work suggests raw water trading in 2012 and a competitive retail services market from 2013. Many aspects of this work have been touched upon in previous consultations by Ofwat and the Department for Environment, Food and Rural Affairs, but since the new government intends to revisit the conclusions of both reviews, it is not immediately clear how these areas will now progress.
Given Ofwat's role, it is inevitably still in consultation mode, highlighting views on issues and areas of work, but taking care to present an open mind about the need for change. This does make it somewhat difficult to draw any firm conclusions, but the depth of thinking and tone of presentation certainly convey the sense that Ofwat believes that all of these work areas are very important.
Severn's strategy
The Severn Trent paper is also based on a theme of sustainability, but goes further than the Ofwat paper in several important respects. Rather than describing only areas of possible change, the paper sets out six areas where Severn Trent has already concluded that change is required and also offers at least outline solutions for each. Interestingly, Severn Trent has also quantified its views on the benefits in terms of reduced bills, reduced carbon emissions and reduced capex.
As might be expected, there is a high degree of overlap between the areas considered, although Severn Trent places more emphasis on funding issues and continued participation by equity investors than Ofwat. Severn Trent is also able to comment more fully on the role that it believes regulators other than Ofwat need to play, and the leadership role that needs to come from government in prioritising issues that cross regulatory remits. There is also a recognition that the industry itself will need to adapt, especially with regard to levels of innovation.
Danger in keeping quiet
Reaction to both the Ofwat and Severn Trent papers has been rather muted. The run-up to the election may have contributed to this, but with little guidance on priorities or timescales in the Queen's Speech, it is not entirely clear what will happen next.
The uncertainty probably means some companies will be tempted to adopt a wait and see approach rather than progressing their own thinking. However, experience from the energy industry shows that this does carry risks, especially when a regulator is determined to move ahead with its own programme of work.
Without an agreed direction and a clear roadmap, the dialogue between the industry and the regulator about major changes can all too easily become mired in detail. Dialogue on operational practicalities can then start to be perceived as "we don't really want to do this" messages in disguise, potentially resulting in increased costs and risks for the companies, regulators and ultimately customers.
Ofgem started its RPI-X@20 review with a clear two-year window before the next price control process was due. However, despite the fact that this was looking only at network regulation rather than the whole value chain, as will happen in water, Ofgem has had to postpone price controls because the review is taking much longer than expected.
So while it might appear that there is plenty of time for the water industry ahead of the next price review in 2014, in reality the degree of progress in the next six months will probably be critical in shaping the success and timeliness of the review.
Bill Easton is a director in Ernst & Young's power and utilities team.
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