Water has long been taken for granted. Indeed, many people see it as a public service. But in the context of increasingly extreme weather, particularly in the
southeast where demand is forecast to continue to grow, government plans for water trading could transform that perception so water is viewed as an asset.
In the 2014 price review, the water industry will be required to consider water trading – so that companies with surpluses sell water to those with deficits. Ofwat is consulting now on options for water trading incentives to operate from 2015 and beyond (see box, opposite page). The regime has traditionally favoured investing in water resources rather than trading, as it has allowed water companies to make return on their investments, but not on water purchases. “Trading should be among the different options, so for instance if it’s 50 per cent cheaper to buy water from another company than building a desalinisation plant, then do the trade,” says Neil Corrigall, regulation and business strategy manager with Severn Trent Water.
Ofwat believes water trading will sharpen companies’ customer focus, create new services and management processes, ensure water supplies are located more efficiently and redistribute water between areas – in other words drive innovation, get water to where it is most needed and get a better idea of its true value. Inevitably, though, there are difficulties. “Water is different from other utilities in that it is expensive to move, it’s heavy, and depending if it’s in the wrong place, such as during flooding, it can even be a liability,” explains Andrew Entwistle, chartered surveyor with consultancy Water Value.
According to Bill Easton, utilities director with Ernst & Young, water on average costs just £1.40/tonne, making it one of the cheapest bulk commodities by some margin. And UK households use a lot of it – 150 litres a day, according to the Department for Environment, Food and Rural Affairs, compared with 127 litres in Germany. Therefore costs such as transportation can very quickly mount up and make a big difference to the end price.
“Because of the nature of water, it won’t make economic sense to have a water grid in the same way as you have grids for gas and electricity,” says Easton. As such, transportation over long distances is uneconomic. However, Corrigall notes: “We currently have a set of regional grids in the UK. Much of the infrastructure is in place for trading except for a few strategic interconnectors.” That means company A could conceivably sell water to B, which in turn sells to company C, which faces a shortage.
The idea of water trading is not new. According to Richard Laikin, UK water sector leader with PwC, historically around 5-10 per cent of water is traded across boundaries, mainly as a result of long-term supply agreements. He believes there is potential to do more via interconnectors between water companies, but: “For water trading to occur there needs to be some way of properly valuing it. Over the long term you could have an exchange to set reference prices that are then adapted to local conditions.”
There are water trading schemes in other countries – such as Australia, Chile, the US and South Africa – from which the UK can draw some inspiration. Australia has a system of trading temporary water allocations set up around the Murray-Darling basin, which involves four states and began in the 1980s. According to Australia’s National Water Commission, trading has helped alleviate the impact of drought. Because water has a value, farmers can make trade-offs between growing grass to feed livestock versus selling water and buying in grain instead. So the market ends up redirecting water to higher value industries and urban uses.
Some people caution, though, that the lessons are limited. “The Australian model is different in that it is very interconnected,” says Corrigall. And the UK’s Environment Agency notes that the system was not robust enough to allocate severely reduced volumes of water during years of intense drought and protect abstractors and the environment.
At an Ofwat trading working group earlier this year, general support emerged for: a model contract; a means of terminating legacy special arrangements to achieve standardisation; the production of consistent and transparent data with which to judge if a bulk supply contract makes economic sense; and more flexibility over calculating a security of supply index.
Entwistle believes that water trading will bring about more locational pricing and that prices could even influence where low margin industries, which need lots of water, locate their plants. Power generators, which use water for cooling, are already concerned that a market system could result in rising costs for them. Entwistle also thinks that if water starts to carry a market value, it will incentivise water companies to focus more on repairing leaks.
The move towards water trading is likely to be slow, giving stakeholders time to prepare. The Environment Agency found that the industry fears sudden changes and inconsistency. However, if the Australian example is anything to go by, any trading framework is likely to be accompanied by frequent tweaks – often due to factors beyond anyone’s control such as
prolonged drought.
Justin Pugsley is a freelance journalist
Incentives
According to Ofwat, the two main hurdles to water trading are, first, that import costs are treated as an operating expense and adversely effect efficiency assessments, and second, the financial benefits for the exporter are only bankable for five years, after which they have to be passed to customers.
In its consultation on wholesale incentives for the 2014 price review, the regulator considers a number of options to address these barriers. It believes that water trading can be encouraged by allowing exporters to retain a greater proportion of the financial benefits from the transaction. It also considers deregulating bulk supplies, although notes concerns that this could result in assets associated with exports no longer being included in a company’s regulatory capital value, which in turn would discourage exporting.
Ofwat still believes this could be an option for the future, but in the meantime is leaning towards a framework which either financially incentivises exporters only or one where the benefits are shared between the two parties. The regulator says importers should benefit from its proposed changes to equalise incentives between opex and capex, which should reduce the need to give specific incentives for importers. However, the regulator also acknowledges that if any changes to cost performance incentives do not address all the relevant barriers faced by importers, there may be a need to consider targeted financial incentives for them.
This article first appeared in Utility Week’s print edition of 21st September 2012.
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