In the Emergency Budget today, the Chancellor will outline a series of measures aimed at raising productivity. One industry which is in dire need of an injection of competition and productivity growth is water. The water industry remains relatively insulated from competition with 19 regional monopolies. They collect the water from the source, treat it to an appropriate standard and send it to customers’ taps via company-owned infrastructure and the rates are controlled by OfWat which is the independent regulator.
Since privatisation in 1989, it is generally accepted that capital investment has seen substantial improvements. However, despite a recent cut in regulated prices, the chronic lack of competition has contributed to almost 50% real terms increases in water bills. In the Water Act 2014, the Government implemented some measures to increase upstream competition; for example, ending the requirement for upstream providers to provide retail services and vice versa.
Upstream competition has been limited and as a result the current water companies have felt little pressure to increase their efficiency. The Government should aim to have a faster introduction of retail sector competition in the water industry than the current April 2017 target. Retail competition enables water companies to compete over the provision of services such as customer care, billing and meter reading. It is estimated these services comprise 10% of the total value of water delivered.
The Government should also extend water industry competition to households. The Water Supply Licence regime has allowed some very limited competition but the reality is that extremely high consumption thresholds have restricted this to only the very largest of consumers. The ability to switch supplier remains restricted for the vast majority of consumers and thus acts as a major barrier to competition. Allowing companies, charities and the public sector ie all non-households, to switch suppliers will be a hugely liberalising step and help to exert real competitive pressures on price and quality.
However, the Government should also give a commitment to extend this freedom to households as well. Non-household competition was introduced in Scotland in 2008 and the benefits have clearly been significant. More than 45,000 businesses have been able to renegotiate the terms of their contracts and substantial savings have been made through lower prices and lower water usage.
The Government also decided against letting incumbent water companies exit the non-household retail market. The main reason was that it could increase the cost of capital leading to higher water prices. Never mind “Too Big to Fail”, the water companies are “Legally Forbidden to Fail”. Indeed, the Government estimates that a 1% increase in the cost of capital would lead to a £20 increase in customer bills. The Government should nevertheless be aware of the longer term benefits to competition, innovation and productivity from allowing freer entry and exit. It should therefore commit to re-examining the case for retail market exit.
The water industry may have been privatised but in no way can it be described as a freely and competitively functioning market. With water, the Government needs to be bold both when it comes to upstream and downstream. A gust of competition is needed.