Is competition healthy?

The government believes competition could spur water companies to greater efficiency and improved performance, and provide customers with lower prices and new and improved services. But, asks Sally Nash, is competition in the sector viable?

Competition in the water industry took a step forward in June when Ofwat announced a proposal to create the first new water and sewerage company to serve domestic customers since privatisation 18 years ago.

The news that Scottish & Southern Energy (SSE), which provides electricity and gas services, has been given the go-ahead to create a new water and sewerage company to serve domestic customers in Wiltshire is a key development for the industry. This new kid on the block marks a turning point in terms of competition, and the move will be watched closely.

Geoff Slaughter, energy product manager at uSwith.com, a price comparison website, is just one person who believes that bringing new blood into the industry could be healthy. "SSE comes with an excellent pedigree in customer service," he says. This has clearly not gone unnoticed by Ofwat. And I suspect the regulator will be hoping SSE's success in this area may be the kick water companies need to start taking service seriously."

SSE, which described the Wiltshire development as "dipping its toe in the water", wants to see what it can achieve in this sector. It has also applied for a licence in south-west London and SSE says it is already in discussions with the Water Industry Commissioner for Scotland about the possible issuing of licences.

Water has traditionally been seen as an industry characterised by regional or local natural monopoly, with franchising and contracting out, yardstick competition, and capital market competition being feasible, but not direct competition

Competition was introduced under the water supply licensing (WSL) regime contained in the 2003 Act. What is clear is that the regulator is taking steps to try to increase competition in the water industry following criticisms from the Competition Appeal Tribunal and Parliament relating to the failure of competition to take off.

Keith Mason, Ofwat's director of Regulatory Finance and Competition, is on record as saying: "We take our duty to promote competition very seriously and are disappointed by the lack of progress. We want to see effective competition in its most appropriate form across the whole range of water company activities. This will benefit consumers and the water industry as a whole."

A few years ago Ofwat said that it believed competition could "spur water companies to greater efficiency and improved performance, and provide customers with lower prices and new and improved services". But is competition in the water sector viable?

Jeanne Golay, economic regulation adviser at Water UK, says the organisation does not know what other kinds of competition could establish themselves in water. She says there is already stiff competition in the supply chain, capital project contracting and private finance initiatives (Scotland).

Competition for customers (in the market) is quite rare, Golay says. And, at the moment, this mainly takes the form of inset appointment only. Competition in the market normally takes the forms of retail and common carriage competition.

"However, in water, the retail element is a small part of overall costs - smaller than for other utilities - and there may not be enough turnover to generate a profit," says Golay. "It might be a viable business proposition for a company that provides such services in other utilities as well and thrives by providing a one-stop service to customers. We'll need to see. For common carriage, the issue is where raw water resources come from.

"There is no market, only the Environment Agency that allocates abstraction licences, or permits them to be traded. Viability will depend on how the EA allocates resources, which is difficult to predict. The EA is rather in the mode of clawing abstraction licences back."

How would competition work compared with other utility sectors? Water UK says that compared with other sectors, the big difference is that water cannot be manufactured (like electricity or telecommunications) or discovered (like gas).

But water can be found because a known source of water can be used thanks to the entrepreneurship of a competitor. This finding process, though, may be expensive and limited to individual customers with specific needs. It may not be suitable for a water company running a large pipe network.

On the issue of improved rates for customers, Water UK believes that the scope for price cuts is very limited compared with other sectors.

"The main reason is the weight of the network costs in final customer bills, including the costs of the obligations which water companies have towards the environment," says Golay. "These would have to be shared with all customers, including those served by competitors, and that means that bills cannot come down very much.

"Customers who are not connected to a network and are served by an inset appointment which does not buy water or sewerage services from a water company may avoid the cost of these obligations.

"However, if inset appointments were just a way to avoid paying the cost of obligations put on water companies, this would not be efficient competition," she adds.

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