A stated aim of the recently published Water Bill is to stimulate innovation in the UK water sector. The industry has traditionally been slow to embrace new ideas and new technologies.
The Water Bill, alongside Ofwat’s 2014 price review (PR14), contains some elements of progress on the innovation front. The moves towards total expenditure, or totex, and an outcomes-based approach are sensible and should stimulate some level of new thinking.
Unfortunately, they do not go far enough. In most part the Water Bill is disappointing and will do little to encourage any acceleration in innovation. There remain fundamental structural barriers to innovation that could and should be addressed. A far more radical structural transformation of the water industry and its regulation is
required if UK utilities are to meet rapidly emerging risks associated with providing clean water.
The UK currently practices “micro-regulation”, where individual investment programmes are reviewed and approved by Ofwat for funding. This creates inertia, locks in specific investment programmes over five years and constrains flexibility to introduce innovation in a shorter cycle time.
The setting of leakage targets is an excellent example. Ambitious initial targets stimulated a wave of innovation in the industry. But over the past ten years leakage targets have remained essentially flat, based on the incorrect assumption that the sustainable economic level of leakage has remained the same. That lack of ambition in setting leakage targets has eliminated almost all the pressure on utilities to find more effective ways of reducing leakage.
The Water Bill includes tentative moves towards structural change focused on introducing more competition into the industry. But using competition as a mechanism to stimulate innovation in the water industry is an ideologically driven mirage. Experiences in the energy sector have shown that it is highly unlikely to result in any significant developments.
A challenge to many investment initiatives is the lack of a realistic internal value of water. As UK utilities manage the entire water production line, from source to tap, they often only consider the marginal costs of producing water in any business case. That places an artificially low value on the business impact of many innovations.
Separating water companies into wholesale and retail divisions would, however, stimulate significant levels of innovation to the benefit of customers and shareholders. It would also improve environmental performance and encourage a more realistic price and value for water. It would be the engine for innovation because each retail distributor would be required to weigh up the cost of investment alongside the real value of water conserved.
The role of the regulator would then be to ensure that the customer was protected, and that the price and service delivered to the customer were fair. It would be able to set the pricing and service level requirements from the wholesaler to ensure prices are not inflated at this stage. Regulation could then focus on the boundaries between the wholesaler and retailer, and also between the retailer and customer. Beyond that there could be deregulation. There should be no micro-regulation of individual investments and projects.
By separating retail and wholesale, and regulating only at the boundaries, we could create the freedom and commercial incentives to drive continuous innovation.
This structure would lock in the commercial incentive for the retailer to continuously improve their operations (while maintaining their service levels), since that would maximise profits and returns to shareholders.
This approach avoids force-fitting a competitive market on to the industry and would free retailers to make their service delivery as cost effective as possible in whatever way they saw fit.
It would also help create the conditions in which the UK could lead the world in smart water technologies and services. The water industry represents a strategically important economic growth opportunity for UK plc. It is an exciting global market that UK utilities and their supply chains are well placed to take advantage of.
The need to manage water provision more effectively and efficiently around the world is being driven by climate change, urbanisation and population growth pressures. Water scarcity is being forced up the global risk agenda. Traditional approaches to network management will simply not be efficient enough to meet future demand for water.
Despite a conservative approach over the past few years, the UK water industry retains a strong reputation for best practices in water network management. The radical restructuring outlined in this article would also help create the conditions in which the UK could lead the world in smart water technologies and services.
It is no coincidence that many of the pioneering leakage-related technologies now in use around the world were developed and first adopted in the UK. The setting of leakage targets in 1990s created many of the tools and techniques that much of the rest of the world has now taken on board.
The UK’s water utilities and the supply chain that supports them have the potential to lead the world market for smart water networks. We need to be bold and unleash that potential.
Real innovation in the UK would benefit utility customers and their shareholders, as well as the environment, and encourage high technology, export-driven economic growth in new, cleaner water technologies.
Chris Phillips is a director at i20 Water