Down some corridors and through some doors from Ofwat’s Bloomsbury Street offices, Alan Sutherland sits alone in Open Water’s echoing HQ, putting the finishing touches to the final framework for the competitive water market.
If this were a movie, it couldn’t have been shot better: Sutherland, the Scottish water regulator by day, has taken on much of the work of opening the English market; and today he reveals to Utility Week that his role is about to become official, with the organisation he runs, the Water Industry Commission for Scotland (Wics), set to be Ofwat’s delivery partner for Open Water in name as well as fact.
Sutherland was always going to play a significant role in the market opening, given his experience of the Scottish opening, the ambition for an Anglo-Scottish market and his subsequent position on the Open Water board. But his role has expanded as the programme has been buffeted by a series of unexpected and unfortunate events that started with the departure of chief executive Keith Fowler at the beginning of the year, and ended with the abandonment of the company set up to manage the project, Open Water Markets Limited (OWML), after some Treasury-imposed red tape at the end of the summer.
Today, the redoubtable Sutherland seems pleased to have the official stamp put on his position, though he stretches credulity somewhat by saying there is nothing unusual in having the Scottish regulator step in to open the English market.
He is keen to put to rest concerns raised by the Drinking Water Inspectorate, the environmental regulator, that competition could put drinking water quality at risk, and to emphasise the heavy lifting that companies must now do after the publication of the final framework on Thursday, a tome formally known as the Market Architecture Plan 2 (MAP2).
First, governance: “Looking back, it is now fairly clear that with OWML having been established, it was not established in a way that, with the benefit of hindsight, was going to make its role easy or even very doable.” The reasons for this are well documented: the Treasury refusing to classify OWML as a private body, so it would have been subject to the Byzantine procurement and staffing rules of the public sector, which would have held the project back. Sutherland concedes “the whole classification thing has been frustrating”, and while he usually prickles at any criticism of the Open Water programme, this one he “will take on the chin”.
As Sutherland quite reasonably points out, the brouhaha over OWML has not significantly held back the programme, with a huge amount of work going on behind the scenes, with the industry, leading to this week’s publication of MAP2. Much of this has been done by Sutherland, and that arrangement is soon to become formal with a “protocol” agreement that will appoint Wics the delivery partner for Open Water. The protocol is “progressing” but not yet signed, and is subject to approval by the Wics board.
As a result, the original plan announced by Ofwat when OWML’s unsuitability became clear – to wind down the organisation until a later date and recruit a programme director reporting to chief regulation officer Sonia Brown – goes in the bin and Sutherland takes (or keeps hold of) the reins.
The part of the programme covered by the delivery partner arrangement has four key areas: work on codes and processes, or the “rules of the game”; establishment and finessing of the market operator; communication and engagement; and maintaining the work plans. Certain other areas – the licensing framework, charging, questions of who is eligible to participate in the market – remain under Ofwat’s direct control.
The obvious question is “why?” Sutherland has an explanation: “Right from the start, there were exchanges of letters between the Scottish government and Westminster about the potential value of having seamless markets in England and Scotland. Clearly there’s a market already in existence in Scotland, the white paper made reference to Anglo-Scottish markets and benefits, companies operate on both sides of the border, if you’re a multi-site operator you don’t really want a different set of rules on one side than on the other.
“From a purely Scottish customer standpoint, encouraging English companies to compete for customers in Scotland has to mean better services and prices for end customers in Scotland. From a Scottish taxpayer standpoint, allowing Business Stream as a public entity an opportunity to compete on a level playing field with companies in England has to be good as well.”
But this is still a pretty unusual arrangement, isn’t it? “I don’t find anything unusual about it at all,” insists Sutherland. “I think it’s entirely sensible that there be collaborative working between regulators.” He cites co-operation with Ofwat going back decades, and asks “what’s the point of reinventing the wheel?”
In similar vein, Sutherland bats away questions about costs (“Ofwat will pay costs as they are incurred, no more, no less” from the same special license condition used to fund Open Water to date, with a new budget set to be agreed from April 2015); governance (“we expect to work very closely with Ofwat at all levels”); and what happens to regulation in Scotland while he’s busy down south (“it carries on as it is, I’ll do that the rest of the time”), before concluding with a grin, “now, I think that’s all pretty clear.”
On to the next thorny issue. Last week, the Drinking Water Inspectorate’s chief inspector Jeni Colbourne told Utility Week that opening the market creates “a lot of risk” for consumers and supplies. Sutherland is respectful: “The DWI has an incredibly important role, you don’t listen to them and any concerns they have at your peril.” He says he’s not clear what the “concrete issue” is, but that there have been ongoing conversations with the inspectorate and changes made to the plan to accommodate its concerns on various points.
“I understand that there could be a perception that when you have a separation between retail and wholesale functions then you make conditional risks, I think that is a perception. The reason I say that is even within the current vertically integrated structure, the people who take the call are not necessarily the same people who commission the bit of work or the team who resolve the issue, and they’re certainly not the people who go out and fix the issue, so there are a series of human hand-offs that take place today within a vertically integrated water company and it depends how well managed that company is as to how effective those hand-offs are. It’s not entirely clear to me what the difference actually is.”
Those two troublesome areas ticked off, Sutherland happily moves on to the real business of the day: the publication of the MAP2 and the subsequent questions that companies must now answer, which he neatly arranges into four headlines.
Number one is about creating a level playing field. The statutory codes provided for in the Water Act 2014 govern how an appointed wholesale business interacts with a licensed retailer – but do not apply to the ways in which the two parts of a vertically integrated company interact. Therefore, if a company chooses to remain vertically integrated, it will have to work very hard to provide, and be seen to provide, a level playing field between its relationship with its own retailer, outside the statutory code, and competitor retailers.
One alternative that has arisen from the 11th hour introduction of the option to exit the retailer market is for a company to transfer its non-domestic customers outside its regulatory ring fence, consolidate them with any customers it may win in the competitive market, and operate the whole as a separate company.
“Water companies have historically much preferred vertical integration, and water companies have always had a strong culture of compliance. These two things come a little bit into conflict – the more that one stays vertically integrated, the more risks one could be seen to be running with regard to the level playing field.”
Headline number two concerns the gross retail margin. On Friday, as part of the final determinations, Ofwat will tell each company its permitted gross retail margin for the non-domestic market. The company must allocate that between different classes of customer in a way that both reflects its costs and avoids accusations of margin-squeezing – in other words, not too high and not too low.
Companies must also be mindful of the newly competitive arena: for example, if a public sector client is paying the same averaged cost of bad debt as other business customers, when its risk of bad debt is much lower, that opens the door for a competitor to come in and undercut the incumbent by charging a price that reflects the actual risk of bad debt.
Headline number three is data. Companies must cleanse their data and prepare it to be uploaded to the market systems in a format compliant with that set out in the MAP.
Headline four is about setting up the market operator, and questions about public or private ownership resurface. Sutherland insists the market operator must be a private entity to give it flexibility with staffing and procurement. Three water companies – United Utilities, Anglian and Northumbrian – have helpfully set up just such a body, Industry Market Operator Services Limited, which Sutherland says “is potentially very good news indeed”. The next question is about the procurement of the central systems that, if done by a private body, could be either a public or private process. Both options are being explored.
It’s complicated, technical stuff, and Sutherland is understandably anxious that water companies absorb the implications of the numerous decisions they now have to make. The near-simultaneous publication of MAP2 and the final determinations this week puts them in a good position to do so, as does the final, pragmatic solution to the governance issues around Open Water. As Sutherland bids Utility Week farewell and settles down in his empty office to put the finishing touches to MAP2, 2017 seems very close indeed.