Ofwat Chairman Jonson Cox has said that the upcoming PR19 Price Review “may offer very significant headroom either to improve the resilience of the service customers receive, or materially to cut their bills, or both.”

However, Cox also went on to describe water companies as having been slow to look for new ways to serve customers, ineffectual in tackling bad debt and how passive, rather than restless to push the frontiers, saying:“One asks if steering the ship has been a steady cruise for those enjoying their monopoly position.”

The Ofwat chief was delivering the Regulatory Keynote Speech at last week’s Water UK annual City conference which brings together industry leaders, regulators and government bodies alongside investors, analysts, ratings agencies and city institutions.

Commenting on competition, Cox said that although Ofwat was seeing an increasing role for markets and opening some markets to competition, in some cases they would never be truly competitive in the traditional sense - water resources or direct procurement may be cases in point.

However, the regulator would be trying to make market forces work as well as possible, for example by reducing transaction costs, by making it easier to trade and by more transparent cost information.

He described the process of getting ready for next month’s opening of the retail market to competition, as “a long term, herculean, effort”, saying it also had been a big effort for companies and success was not yet guaranteed. On customer data in the new marketplace Cox added that retailers in competitive markets “won’t stand for being messed around by data or system inadequacies of previously monopoly incumbents.”

While there was speculation about the extent of change that will come and whether it will justify the cost of introducing competition, he was confident the sector will see innovation for customers e.g. in services, credit terms, bundling and billing administration. Whether it was by changing legislation or through economic incentives, Ofwat was giving companies choices at various points in the supply chain which will drive efficiency.

Water companies “slow, ineffectual and passive”

On the possibility of residential competition, Cox said Ofwat had been asked to conduct a study a year ago by the Government to look at the prospects of extending retail competition to residential customers after 2020, commenting:

 “The study opened my eyes to how slow water companies have been in looking for new ways to serve customers; how ineffectual they have been in tackling bad debt, how passive they have been, rather than restless to push the frontiers. One asks if steering the ship has been a steady cruise for those enjoying their monopoly position rather than the challenging voyage of the choppy seas that customers and competitive businesses face in their daily life.”

While the Government’s decision on residential competition is still awaited, some companies and investors have accepted that it may well happen in some form over the next decade, he said.

Price Review 2019 has potential for very material level of headroom on prices

Emphasising that his views on the 2019 Price Review were “personal views at this stage and stated in a hypothetical sense”, Cox said:

“I perceive the potential for a very material level of headroom on prices which could be delivered for customer’s benefit through service improvement, infrastructure investment, system enhancement or price reduction.” The factors that created headroom included a step change in efficiency (including the introduction of Totex to see what additional productive efficiencies could be found), segregation of the value chain, opening up of markets, innovation and record low financing costs

However, Cox declined to attribute water company underspend by in 2015/16 to Totex savings, saying:

“It would have excited me about the potential efficiencies we were seeing, if I were not inclined to put more weight on this being late spending more than large efficiency. I have to say it doesn’t speak well of the business planning process by companies that they take money ahead of needing it and seem unable to phase expenditure in accordance with their business plan – something we shall be more watchful about going forwards.”

Nevertheless, Ofwat has great expectations for Totex; smarter approaches, such as catchment management, would enable large capex-heavy costs to be avoided and postponed, benefiting customers. The regulator will take account of actual and projected evidence of efficiency gains from AMP 6 at PR19, using and projecting the limited data available by 2018.

Bioresources market could be better thought of as an energy business

Cox also had some interesting comments on the nascent bio-resources market, saying:

“Maybe this element of the value chain is better thought of as an energy business, rather than as a disposal problem. Bio- resources may well be a stand-alone commercial energy business in its own right.”

While separate price controls would bring some increase in complexity, it would also put a sharper emphasis on companies’ efficiency at different points in the value chain. “Incidentally, this may well lead to further steps of companies divesting areas they don’t see as core to their business, while they concentrate on their regulated monopoly networks.” he added.

Innovation - supply chain says UK water sector one of slowest adopters of new approaches in the world

On innovation, Cox said Ofwat would also be considering and forming a view on the scope for innovation in the sector, saying that as much as any management in the sector, he could talk about many innovations that have been made. He questioned:

“But I wonder how truthful those claims really are, especially when the supply chain to the water industry repeatedly tells us that the UK water industry is one of the slowest adopters of new approaches in the world.”

Ofwat recognises there could be requests for further investment in infrastructure

Commenting on financing, Cox said lower returns for incoming investors would increase their focus on the potential return for operating and performance on service and efficiency. This would be complementary to Ofwat’s focus on companies striving for the frontier, and create more alignment of interest, if investors played their part in holding companies to frontier performance.

On headroom, Cox told the audience that Ofwat would be looking at the potential for a material reduction in prices to customers and would expect to see companies consulting their customers for their views on opportunities.

However, price reductions were not the only use of headroom and there could very well be further investment in infrastructure required to deliver an ever more resilient sector. “We recognise that there may be considerable expenditure for “hard” infrastructure for new water transfer schemes, for flooding resilience, for service continuity  .. (and) … that there will be requests to fund more infrastructure, such as, for example, intercompany transfer schemes,” he added.

System operator for SE England with powers to force efficient allocation of water?

He also raised the interesting prospect of whether Ofwat would look for more consideration of what the resource position might be if the 12 companies in the south and east of England were subject to an independent system operator who was able to determine how water be shared across companies.  

Cox added that at this stage he was not proposing that Ofwat should set up a statutory system/operator, but the regulator was looking at and interested to see what a system operator would do if they had the powers to force an efficient allocation of water.

Describing his speech as a set of personal views as to where, given conditions today, Ofwat might take the price review, he concluded by setting out the following four key themes for PR19:

• Outstanding service to customers showing real innovation, high reliability and responsiveness.
• A strong recognition of customers’ views on affordability particularly given the conditions – if the same in 2019 as they are today – offer the scope for material price reductions if that’s what customers want.
• Resilience in the round; resilience of the infrastructure, of corporate structures, the resilience of the relationship with customers, operational resilience and asset resilience – all underpinned by companies operating at the frontier of efficiency
• A a step change in innovation.

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