Ofwat is moving ahead with its work to establish a competitive market for water resources set out in proposals in its May paper Water 2020: Our regulatory approach for water and wastewater services in England and Wales.

Key elements of Ofwat’s proposals include:

• Using the regulatory framework to promote markets in water resources.
• Requiring incumbent companies to make key data available on supply/demand deficits and water resource costs in a consistent format which should be available on company websites
• Each incumbent company required to publish a bid assessment framework setting out its policies and processes for assessing bids from third party providers of water resources and leakage/demand management services.
• Development of a new access-pricing framework for England to help third parties enter the market if they can provide new water resources as efficiently as incumbents. This will be implemented with a combination of cost-based charges for network plus services and a compensation payment that reflects the incumbent’s forward-looking incremental water resource costs.
• Introduction of separate binding price controls for water resources and network plus.
• Regulatory capital value (RCV) protection to be provided for efficient expenditure up to 31 March 2020.
• Requiring RCV allocation to enable the separate water resources price control - each company to propose its own allocation to the water resources control to Ofwat for review.
• Requiring incumbent companies to bear some under-utilisation risk for investment in new water resource capacity from 1 April 2020.
•  System operator functions will be carried out by incumbent companies and other market participants, with a broader role to be played by markets.

Ofwat has now published the minutes of the first meeting of the Working Group set up to look at the design of the new market, alongside a separate document which brings together a range of presentations made at a meeting of the Group on 25 July to explore options for a potential market information platform.

Concerns felt by incumbent water cos over increased risk as result of more competitive market

Ofwat’s own update at the July meeting which included a summary of responses to its consultation on Water Resources W2020 revealed the concerns felt by incumbent water companies over increased risk as a result of a more competitive marketplace. In response to a question on whether the price control arrangements for increases in water resources capacity should, at least in some circumstances, expose an incumbent water company to some degree of market-wide demand risk, the majority of respondents disagreed.

As of 21 July Ofwat had received 15 responses on this question  - 11 from the water companies and 4 from other stakeholders). The majority of the respondents (10 out of 15) did not agree that new capacity should be exposed to some market-wide demand risk. Respondents said that further discussion and more evidence was required to make a full assessment – comments included:

“There are further issues that need to be explored in more detail if the proposal is to be implemented without adverse impacts on resilience.”

“In general it is appropriate for companies in a market to be exposed to risk of demand fluctuations. There are, however, a number of issues which arise from making returns on resources investment variable with changes in demand.”

Challenges flagged up by a number of respondents included the fact that demand side risk is not completely diversifiable and that it could also lead to an unnecessary increase in the cost of capital.

Three potential price control approaches under consideration

The Ofwat paper also assesses the impacts of three potential approaches for the form of price control in terms of achieving its objectives:

1. Unit cost approach

• Exposes incumbents to full market wide demand risk
• Does not fit well with the objective of protecting the pre-2020 RCV

2. Asset based approach

• Protects customers from bilateral market entry
• Does not expose incumbents to market wide demand risk through form of control
• Protects pre-2020 RCV
• Will distort company optimisation decisions in favour of newer assets over older ones

3. Adjustment based approach

• Does not expose incumbents to market wide demand risk through form of control
• Protects the pre-2020 RCV
• Protects customers from bilateral market entry

Commenting on the role of brokers in the marketplace, Ofwat has separately flagged up the US-based information platform Waterlitix™ -  the largest and most comprehensive database of water right price and sales information in America.

The Waterlitix™ platform currently provides access to over 15,000 (and growing) sales records across all water asset types and market regions. To ensure data integrity, Waterlitix™ reports individual transaction information including price, water volume, and deal terms that are all verified through interviews with buyer and seller and cross-referenced with regulatory filings.

Potential barriers for third party entrants

An interesting paper presented by South East Water at the July meeting flagged up the following potential barriers which could be faced by third party schemes:

• Regulatory incentives and biases
• Preference for ‘build over buy’ –due to capex bias or concern over control and risk management
• Disproportionate bias against options with greater uncertainty (demand management)
• Trading incentives may be insufficient
• WRMP process -  the complexity and detail of process may bias against third party options and there could be concern about the degree of control over third party options
• Information failures  - third parties providing insufficient data on costs and risks of options and third parties’ lack information of company demands and potential prices.

Possible solution would require firms to publish data on costs of their own proposed demand/supply schemes

The SEW paper set out a proposed solution for creating a marketplace for water resources would involve the creation of an information exchange or marketplace, the objective being to eliminate many of the search costs and enable efficient transactions to be identified.

The water companies would provide data on their projections for demand, supply and deficits, data on the costs of the companies’ own proposed supply / demand schemes, together guidance and templates on the information that companies need in order to evaluate third party options.

Potential third party suppliers could then respond to the company data to offer potential solutions that meet company requirements and with the specific information that companies’ need. They would also have greater visibility over the level of national demand –particularly relevant for possible demand management or leakage reduction options. Third parties could then provide information on potential innovative options for further development with interested companies.

There are three further meetings of the group planned for 2016. Click here to download the July meeting prsentations document