The Water White Paper in December 2011 may well be defined as a tipping point for the water sector, the moment when we all realised that, to deliver a sustainable future, things needed to change for good.
Let’s be honest, Water For Life might not have been everyone in the water sector’s idea of a good read, with its focus on competition and sustainability. Change is rarely welcomed in all quarters, and this is particularly true for many monopolies that have grown used to the status quo. But the changes we are about to see are inevitable and are good for the water sector, good for customers and will continue to be good for investors into the longer term. We should embrace them and make them work.
To ensure a sustainable future, we need to think and act differently about water. If the challenge of the past 20 years was ensuring higher quality standards, the challenges of the next 20 will be different, but no less demanding, with climate change putting resilience and security of supply top of the water sector agenda.
There is a strong emphasis in the Water White Paper on the need to put in place mechanisms that allow the true social, economic and environmental cost of water to be made visible, and at Severn Trent, we think that’s the right thing to do.
The UK has a growing issue of water scarcity, particularly in the south and east of the country. Over the next 20 years this will become an issue that will affect us all. Water is essential to life, our economy and the communities in which we live and work. We all have a role to play in ensuring we continue to maintain that supply and deliver high standards.
There is much in the White Paper that we like and which supports the views expressed in our own Changing Course publications. We were particularly pleased to see support for proposals for a greater focus on interconnection in the water supply network and particularly water trading, with the Environment Agency taking a more challenging view on companies’ 25 year water resource management plans, where alternative sources of water could be available.
Applied effectively, this will help to correct our country’s supply and demand imbalance, and mark the beginning of more bilateral water trades where the economics make sense and environmental damage is minimised. Increasing movement of water across areas has the potential to address these deficits at reduced cost and lower environmental impact than the current practice, which promotes the development of carbon and capital-intensive local investment.
We were also pleased to see support for the trading of abstraction licences, although with change potentially this significant, we need to ensure full consultation has taken place. The government sets out a sensible timetable, with the new regime expected to be implemented by the mid to late 2020s.
The greater encouragement of catchment management as an alternative to expensive end-of-pipe solutions to tackling pollution is also a welcome step and we are eager to share our own positive experience of the five active catchment management pilots in the Midlands over the past few years.
Taken together, these initiatives should help to improve the resilience of the UK to future drought and water scarcity and reduce bills and carbon impacts. Incentives for water companies to reduce consumption are also mooted and for the sustainable economic level of leakage calculation to be revisited.
With the focus on supply-side management, it’s also worth remembering the key role that customers can play in reducing water use. As an industry, we need to work much harder to educate customers and create more fundamental changes in the way consumers think about, value and
use water.
We are pleased to see mandated universal metering ruled out, because in our view metering needs to make sense in the supply and demand balance for a particular area, and our experience shows it’s more effective when coupled with behavioural change. Customers need more incentives to save water and we are constantly surprised that other companies cannot match our low per capita water consumption, which at 128 litres per day is the lowest in the UK.
The issue of affordability is also a key theme in the White Paper and there is no doubt that in the present climate, customers are looking for good value for money from their suppliers. Part of this is keeping bills no higher than they need to be. Bills could be lower if we tackled bad debt and companies followed the principles of the White Paper, with its emphasis on catchment management and smarter environmental solutions. Let’s make sure we focus on the root causes.
And so to the areas of Water For Life that we like but feel that further work or clarification is required to maintain the clarity and predictability of the regulatory framework for the capital markets. Despite the move to more sustainable operations, there is no doubt that the water sector will still need to continue to invest significant sums in improving resilience and meeting the requirements of the Water Framework Directive. We will continue to rely on the capital markets to ensure access to sustainable financing.
To be fair, the government recognises this and has moved to reassure investors that any reforms will be evolution rather than revolution. It has also steered away from fundamental structural change, such as the legal separation of companies’ retail operations. Nevertheless, there are a number of areas where we need to move forward, but cautiously and in full consultation with all stakeholders involved.
One of the key talking points is the move towards introducing more competition into the water sector. The “C” word has been the elephant in the room for a number of years now, and those of us who have dared to utter the word have often been told politely to shut up. Well, it is clear that we are all going to be talking a lot more about this in future.
While retail competition for domestic customers is sensibly ruled out, the government has said it will take steps to make the existing retail competition for business customers more effective. This move is long overdue. We have positioned Severn Trent to be able to take advantage of increased competitive opportunities in this market. We expect competition will largely be around service innovation, rather than price alone.
We are supportive of scrapping the cost principle, which, if implemented correctly, could give customers a better deal by promoting competition where it is appropriate. But it needs to be replaced with something more sensible. Given the minefield of complexity and legal cases, Ofwat would be well advised to work alongside the Office of Fair Trading in designing a better system of access prices rather than rushing to a conclusion with the risk of passing the cost on to domestic customers. This may mean waiting to abolish the cost principle from law and not leaving the industry in limbo.
Changes to the Water Services Licence to introduce upstream competition should be treated with equal caution in our view because investors might fear the weakening of the fundamental business model.
On mergers and acquisitions, relaxation of the merger thresholds is not particularly significant, but clearly the government sees the benefits of network scale in delivering security of supply and resilience and is signalling that it is not adverse to larger mergers under certain conditions. Again, we would like to see more discussion on this subject. Our long-held view is that with 22 companies, there is certainly room for further consolidation.
In summary, the case for change has already been made and the direction is set. The water sector has performed well since privatisation, but we are in a very different position to where we were 20 years ago and continuing in the same way is
not sustainable or affordable. Water For Life is the start of a process of breaking down some of the rigidity that has grown to characterise our sector over the past two decades by creating space for competition and in so doing, creating more flexibility. This will enable us to meet the challenges of climate change, affordability and carbon reduction.
Our call to the sector would be to engage. Whatever points of concern we have got about elements of its application, we should get behind the Water White Paper and figure out the best outcomes.
Tony Wray, chief executive, Severn Trent.