The decision to open up more of the business retail market to competition very soon, and in due course all of it, will give customers the choice of supplier they have craved. The policy of aligning the market processes in England and Scotland, skilfully promoted by the Scottish regulator Wics, will benefit customers in both countries. The White Paper does not accept one of my proposals: to impose legal separation of retail on English incumbents. There are, however, alternative ways of combating the risk that competitors will face discrimination in retail markets, and competition law makes such conduct at least risky. Some companies may choose to separate voluntarily.
What will happen at the other end of the value chain is less clear. There is a short-run but important problem with over-abstraction, and the long-run problem of devising a flexible, preferably price-based mechanism to deal with a supply situation that will worsen because of climate change. I had hoped we would have a better grasp by this time of whether efficient markets in abstraction rights in different areas could lead to the right decisions being made on trade in water and investment in new storage and treatment assets, or whether a more directive system of administrative price setting is needed. One option worth considering is to work on both options, allowing trade in the market gradually to supersede regulator-set prices. We will have to await the results of the further studies proposed.
The White Paper supports a significant number of upstream competition options. Much attention has been focused on extending bulk supply arrangements, supported by strengthened obligations on incumbents to seek out the cheapest ways of meeting their customer needs. There may be resistance in practice to this approach, but it is a comparatively simple and quick way of imposing competitive pressure. Incumbents will find it easiest to offer their surplus capacity to their neighbours in this way. New entrants will be able to join in too, but they will find it harder to make headway since they lack existing rights and spare treatment capacity.
The White Paper envisages competition that involves bilateral contracts between retailers and non-domestic customers on one hand and wholesalers of water on the other. Both this and retail competition require replacement of the so-called costs principle, which imposes on competitors an excessive burden of charges levied by the incumbent and offers them an inadequate margin. This task has to be accomplished in legislation before the process of competitive challenge develops.
These changes should bring new ideas into a sector from which both competition and structural change have largely been excluded. Although the government has not yet spelt out the detailed reforms it wants to make to the special water merger regime, some relaxation of it seems very likely. Like the competition changes, this should encourage new thinking and innovation in the sector.
Assuming that Defra gets the parliamentary time it needs, by 2015 we should have in place a competition regime that will offer choice to customers and put more pressure on operators, without putting at risk the supply of cheap, long-run finance that the sector needs. We should also have a regime that has the capacity to adapt flexibly to future developments as they occur. If the changes are complemented by simultaneous regulatory reforms from Ofwat, the benefits will be enhanced.
Martin Cave, author of the 2009 Independent Review of Competition and Innovation in the Water Sector. From January 2012, he will be a deputy chair of the Competition Commission