Ofwat: the work doesn't stop here

Since privatisation two decades ago much has been achieved by the water companies under Ofwat's regulation. But, says the watchdog's Vaibhav Tyagi, innovation will be the key to success in the years ahead.

In only two decades the water and sewerage sectors in England and Wales have made substantial progress. At privatisation in 1989, we were regarded as the dirty man of Europe. But today, for example, leakage levels are 35% lower than they were at their peak in the mid-1990s; there is higher environmental compliance, with 98.6% of bathing waters in England and Wales meeting the required EU standards; and consumers have access to excellent drinking water, with 99.96% compliance with tough EU standards.

To deliver this, the water companies invested more than £90B – largely funded from financial markets. At the same time, customers’ bills are more than £100 lower than they would otherwise have been. These are achievements we can all be proud of. But we cannot be complacent. We now face a number of new challenges, including:

• A changing and unpredictable climate
• Population growth, particularly in south-east England where water is already scarce
• Economic uncertainty and affordability issues
• Rising environmental standards, including implementing the EU Water Framework Directive

The scale and complexity of these challenges – and the uncertainties associated with them – will make planning and delivering sustainable water and sewerage services increasingly difficult over the long term. However, one thing is clear – we need to find better, cheaper and cleaner ways of doing things. Innovation will be crucial.

As the economic regulator, we think we have a clear part to play in creating the right frameworks to encourage and promote innovation. This is why, for example, at the 2009 price review we introduced the capital expenditure incentive scheme. This increases the incentives on offer to the companies to outperform our assumptions.

Had we used the same approach that we used at the 2004 price review, the £22B we allowed as part our final determinations would have been £1.5B lower. If the companies step up to this challenge, they will be able to deliver significant returns to their shareholders – which will benefit customers in five years' time.

Our price limits also included more than 100 catchment management schemes and investigations that the companies proposed in their final business plans.

The companies will work with landowners and others in water catchments to address deteriorating raw water quality. While the outcome of these schemes is far from certain, they have the potential to offer a more sustainable option than pursuing traditional, capital and carbon-intensive treatment solutions.

We have also been working with the Technology Strategy Board (TSB) to establish a water platform for water. If successful, this will provide an additional mechanism for encouraging innovative technology and approaches – and not just by the companies – to address key long-term challenges for the sectors.

But we are not stopping there. That is why we are carrying out a broad review of the tools we use to regulate these sectors.

For example, through our future regulation programme, we are looking at new mechanisms, such as markets. We think markets can add significantly to the sector’s ability and desire to innovate, and signal where innovation is needed most.

We are also developing accounting separation, which requires the companies to report on different parts of their business. This could help indicate where innovation is urgently needed.

Another thing we are doing is to carry out a more fundamental review of some of our more familiar regulatory mechanisms. This includes going back to the principles of price setting.

Over the past 21 years this has been enormously successful, particularly in encouraging the companies to be more efficient. But we now need it to encourage other forms of innovation, such as greater resource efficiency, as we look to develop a more sustainable industry.

Framework

Irrespective of the future structure of the sectors, or the outcome of the UK coalition government’s review of our responsibilities, there will continue to be a role for economic regulation in this area. We want to build on the successes of the strong and stable regulatory environment that we have developed since privatisation.

We will continue to:

• Protect consumers' interests
• Develop long-term approaches to environmental planning
• Provide the regulatory certainty necessary to enable efficient water companies to attract investment from competitive financial markets

We think that our independence, expertise and value for money make us best placed to meet these goals – while developing new tools to meet them. However, creating the right framework to encourage innovation and actually delivering the innovations that benefit customers and the environment are very different things.

Overcoming the challenges to water and sewerage services over the long term will require everyone to play their part.

That is why taking the time to recognise and reward innovation in all its forms is so important. And it is why this year we are again delighted to support the Water Industry Achievement Awards and sponsor the Outstanding Innovation 2011 award category.

We would like to wish all of the entrants good luck! I look forward to finding out more about some of the excellent examples of innovation that the sectors have produced over the past year.

Vaibhav Tyagi is the innovation manager at Ofwat. www.ofwat.gov.uk

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