Quest for the Holy Grails

Faced with a challenging future, the government is focusing on competition and innovation to improve efficiency and reduce demand and wastage. Competition is inadequate, writes Chris Hoggart, but innovation is a different story.

Back in February this year, environment secretary Hilary Benn launched Future Water, Defra's water strategy for England, with the following statement: "Climate change means that we will all have to value water more as we find a fairer way of paying for it."

Referring to the upcoming pressures on water supplies associated with climate change and population growth Benn also said: "We must find ways of improving efficiency, and of reducing demand and wastage."

Quite easy then - we just need to deliver all the Holy Grails of water supply at the same time. That is, we need to use and waste less water while improving supply efficiency and all at a fair cost.

Clearly there are challenging times ahead, so it is reasonable to suppose there is a need for a fundamentally different approach. This being the case, it should be no surprise the government is putting considerable reliance on competition and innovation to deliver these goals. Indeed, Defra's water strategy, referred to above, discusses the following approaches:
  • Using new technology and future innovation to reduce per capita water consumption from the current average of 150l/d to 120l/d by 2030
  • The development of regional water grids to share water resources (although a national grid is not recommended)
  • Using an innovation fund (already established) to support projects aimed at promoting innovative approaches to flood risk management
  • Using a commitment secured from Water UK that water companies will seek to ensure at least 20% of energy used by the UK water industry comes from renewables by 2020
  • Seeking to use so-called intelligent-metering technology to apply more complex water tariffs such that, for example, water charges are greater when supply is more critical
  • Conducting a review of competition and innovation in the water industry
The latter point has led Defra to set up the Cave Review - an independent review of competition and innovation in the water sector, led by Professor Martin Cave (see www.defra.gov.uk/environment/water/industry/cavereview. This review has two main aims as follows:
  • To deliver benefits to both business and household customers (through lower bills, better service, more responsive products etc)
  • To increase the efficiency and sustainability of water use
Professor Cave and his team are due to report their findings in the spring of 2009.
As you might expect, Ofwat too has been busily working on competition in the water industry and has also recently published a document aimed at contributing to the Cave Review. Called Ofwat's review of competition in the water and sewerage industries: Part II, the publication sets out recommendations for wider reform of the competition framework in the water and sewerage industries. Not before time, some may think as, according to many informed sources, Ofwat could do much better in this area.

The House of Lords Select Committee on Regulators seemed less than impressed with Ofwat's record in this area when it reported on UK Economic Regulators in November 2007. In discussing whether it was the legislation or Ofwat's interpretation of it that was required to change to allow greater competition, the House of Lords committee suggested that Ofwat should "examine critically whether it could not find a
more constructive approach".

Unsurprisingly, Ofwat took one day and one sentence to reject the House of Lords criticisms (see www.ofwat.gov.uk/aptrix/ofwat/publish.nsf/Content/pn4107) - although the sentence in question started off in a positive vein, saying: "Ofwat will consider carefully the conclusions and recommendations of the House of Lords Committee on regulators announced today." This is a strange way to start a sentence that finishes: "But it rejects the suggestion that the failure of competition to develop in the water sector has arisen because of Ofwat's interpretation of legislation."

In Ofwat's review of competition, referred to above, the regulator makes the point that competition is already present in the following areas:
  • Capital market competition, in which organisations compete with each other to own water companies
  • Outsourcing, where suppliers are competing with each other to sell products and services to water companies
  • Comparative (yardstick) competition, in which Ofwat compares the performance of water companies against each other and takes appropriate regulatory action
  • "Inset appointments", where water supply incumbents can be replaced by new market entrants within a defined geographic region (16 appointments made at the time of writing)
  • The Water Supply Licensing regime, which theoretically allows water customers that use 50Ml of water a year (about 2,200 in numbers) to switch supplier, although to date none have successfully done so
When the director general of Water Services (the name of Ofwat's original head) was given a responsibility to "facilitate effective competition" this list is probably not what was intended. And, to be fair, even Ofwat acknowledges that the competition referred to above is "very limited". Clearly, significant improvements are needed if Defra's water strategy is to be delivered as the government envisages.

The situation with regard to promoting innovation in the water industry is somewhat rosier given that much has been done in this area since privatisation. However, as with the competition agenda, there is still much work to be done.

That the government sees innovation as a very high priority is not in doubt, as can be seen from the 2005 statement by Lord Sainsbury of Turville (the then Science minister) at the Innovation in Water conference as follows: "It is impossible to overstate the importance of innovation. It is one of the key drivers of productivity. It can help businesses improve the way products and services are made and delivered or introduce entirely new ones. It can reduce costs by increasing efficiency."

However, the government, in the guise of the old Department for Trade and Industry, thinks the regulatory regime in the water industry is not conducive to promotion of innovation. This can be seen from an extract from the Science & Innovation Investment Framework 2004-2014: "There is some concern the five-year price control periods typically used by the economic regulators do not give efficient incentives to undertake R&D that will reduce costs beyond the five-year price horizon." This comes as no surprise to the EIC, which has been lobbying Ofwat, Defra and the Treasury for a number of years to change the five-year investment cycle in the water industry.

Not only do these short-term horizons inhibit innovation, they lead to feast and famine years throughout the water sector and are a major cause of the current skills crisis as many people leave the industry during the inevitable downturns.

It seems, though, to achieve the government's goals, we will need to embrace a wider definition of innovation than we have in the past. As Pamela Taylor, Water UK chief executive, said last year: "We almost always associate innovation with technical or physical efficiency. But in future we'll need a wider definition." In other words, our innovation will need to be more innovative and encompass business processes and systems, the regulatory regime and other topics that may have received less attention in the past.

From the foregoing, it is clear that, in a changing world and an uncertain economy, there is much work to do to deliver the government's vision. It is also apparent that competition and innovation have vital roles to play in this process.

Let's hope then Professor Cave's review of competition and innovation will lead to positive recommendations for how we can not only deliver the Holy Grails but also have them filled with valuable and efficiently produced water. The EIC's Water Pollution Control Group will continue to engage with Professor Cave and his team to help ensure this happens.

Chris Hoggart is chair of the EIC's Water Pollution Control Group. www.eic-uk.co.uk

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