A new consultation launched by Ofwat on setting licence fees in the new retail market has flagged up the potential for higher costs and uncertainties surrounding the early stages of the competitive market which opens in April 2017.

The new retail business customer market in England will introduce a new Water Supply and Sewerage Licensing regime (WSSL) in April 2017 for those incumbent water companies planning opted to take part in the market and also for new entrants.

Ofwat said one of its primary concerns is to provide as much certainty as possible to the new WSSL licensees.

“Many are new organisations, with uncertain turnover and potentially small margins associated with retail activity. To maximise the benefits to customers of competition, we want to avoid the WSSL licence fee becoming a barrier to entry, especially in the formative years of the new market,” the consultation paper says.

The second key factor is that Ofwat currently has no data on which to estimate customer numbers or turnover by WSSL licensee.

Ofwat has estimated that the total cost of regulating the new market will be £0.725m in 2017-18, allocating 50% of the costs to the WSSL licensees and 50% to the undertakers. This gives a total estimated cost to the WSSLs for 2017-18 of £0.363m.

WSSL licensees will be obliged under condition 9 of the standard conditions of water supply and sewerage licences to pay an annual licence fee for “the regulatory cost for that year of the Licensee’s water supply licence”. This means WSSLs funding Ofwat’s costs in relation to the WSSL regime, and similarly their share of CCWater’s costs in relation to the WSSL regime.

The new market will also see the removal of the current 5ML per year usage eligibility threshold in England, while in Wales the eligibility threshold will remain at 50ML- the Welsh Government has a different policy position from the UK Government in respect of the market for business customers. Ofwat also wants to ensure that there is no cross-subsidisation of the business market in England by Welsh customers.

The annual licence fee is currently adjusted to take account of any under- or over-estimate of the costs of regulating the WSSL regime for any earlier year. At the moment Ofwat is predominantly funded through the licence fees paid by the incumbent water companies (undertakers).

Introducing the consultation, Ofwat says that the costs of regulating the WSSL regime are uncertain and are likely to be higher than the previous WSL regime because the regulator expects the WSSL regime to be significantly more effective than the WSL regime in enabling entry to the market.

Calculating regulatory costs for WSSLs is also complicated both by arrangements to allow incumbent companies to amend their licences to exit the non-household retail market (which means that some undertakers will not retain their business customers) and the fact that the full WSSL regime will not extend to Welsh undertakers who should not be required to fund the costs of the full WSSL regime.

Turnover unceratin until market opens and cash flows uncertain "for some time"

The consultation paper states:

“In considering the model for setting licence fees for WSSLs, we are conscious that turnover is uncertain until the market opens and that cash flows will be uncertain for some time. We need to set fees in a way that minimises uncertainty, encourages market entry and enables Ofwat to recover its costs associated with regulating the WSSLs.”

The scope of the consultation excludes the future fees for processing applications, which is subject to a separate flat fee. It also does not consider any wider arguments about whether the current licence fee mechanism set out in Condition N of undertakers’ licences will remain fit for purpose as markets develop within the water and wastewater sectors.

For WSSL licence fees, Ofwat is proposing that the most appropriate basis of charging combines a flat fee per licensee with the bulk of the costs allocated through a variable element based on market share. The regulator says a fixed fee would enable Ofwat to recover costs from all licensees including those with a very low or minimal customer base and if set at a low level, this should avoid the fee becoming a barrier to entry.

Ofwat is proposing that 10% of  budgeted costs for overseeing the WSSL regime will be allocated to the fixed fee element, then divided equally between the licensees. The other 90% of the fee will be allocated to licensees on a variable basis based on their market share, calculated by wholesale charges paid rather than turnover or retail customer numbers. Ofwat said this means that the bigger licensees meet the majority of the costs in line with their share of the market.

For year 1 (2017-18) of market operation, the regulator is proposing to delay the annual invoice until October and use data from the market operator to allocate the variable elements based on wholesale charges paid as at 30 September 2017.  From year 2 (2018-19) of market operation onwards,Ofwat will issue an annual invoice early in the financial year. WSSLs supplying eligible Welsh customers will be charged on the same basis as WSSLs operating in England.

An estimated 1.2 million business customers in England and Welsh customers of undertakers wholly or mainly in England will be eligible to choose their water and sewerage retail supplier from April 2017.

Ofwat says that after the market has been operating for two or three years, it expects to have good data about customer numbers, turnover and market share.

Deadline for submissions is 11^th November 2017 – click here to access the consultation paper.