Rachel Fletcher, Chief Executive of Ofwat, has said she is “not at all convinced the water sector meets the test” of providing benefits to all stakeholders and not just rewarding its shareholders.

Speaking at Moody’s UK Water and Regulated Networks conference earlier this month, she referred to an observation by Larry Fink, founder and CEO of Blackrock which “brilliantly sums up why change is needed in the water sector”:

"Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society. Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate"

Performance - "productivity has flatlined"

The Ofwat Chief explained to the senior level audience that change was needed for to tackle issues related to water company performance and behaviours.

Commenting on sector performance, she referred to a study commissioned by Water UK which showed that productivity has flat lined, growing at an annual average rate of only 0.1% since 2009. This also sat alongside qualitative evidence that the sector lags behind others in adopting new technologies. The ongoing loss of water produced lost through leakage was 22% in 2016, “a figure which has remained pretty static since the early part of this century.”

There were also “ frequent incidents which raise questions over resilience”, including the Beast from the East last winter when 60k customers were off supply for more than 12 hours. The volume of complaints to water companies had also remained “stubbornly static over the last few years, despite incentives within the regulatory framework to improve customer service.”

On company behaviours Rachel Fletcher said:

“To many people, it looks like some companies are more focused on taking money out of the business than delivering for customers, communities and society. “

Gearing in the sector had increased since privatisation, with a number of companies close to or above 80%. However, while investors had benefited from increased returns from high levels of cheap debt, the benefits has not been shared equally with customers. Despite a challenge from Ofwat 5 years ago, some dividend yields continued to look out of step with what had been achieved for customers.

The shortcomings in both performance and behaviour had been of real concern and “the need to confront them” had been shaping Ofwat’s work, including in recent months.

She told the audience:

“This performance and behaviour have together created the perfect conditions for the debate about renationalisation to take hold.”

“I want to dispel the view that the focus on the water sector is a passing phenomenon, whipped up by the press and politicians……The criticism of the sector as a whole has struck a chord with the public. “

Water sector faces very significant future challenges

Change was also needed to address very significant challenges the sector now faces – including, climate change, population growth particularly in already water stressed areas and reduced abstraction levels. An extra 1,300 MegaLitres of water supply into the system by 2030 would also be needed, according to the National Infrastructure Commission, she added. The NIC had also predicted that if this was not achieved, the cost of water shortages could be as high as £40 billion a year.

The increased water demands would need to be met – and met efficiently so that water remains as affordable as possible.

However, she told delegates that there are signs that things were beginning to change and “there is much that is positive to build on.”

There were also some signs that performance was improving. For example In the first three years of the PR14 period:

• water supply interruptions fell by 20%; and
• sewer flooding incidents reduced by 14%.

Flagging up the fact that incentives can work, Fletcher said that these would be sharper and should drive more of the improvements and efficiencies that matter to customers in PR19.

According to the regulator, with the new challenges Ofwat had presented to the industry there had been “a seismic shift in the industry’s willingness to listen and be accountable to the people it serves.”

On corporate behaviours, there is a steady increase in the independent challenge to companies – through independent Non-Executive Directors having a stronger position on company Boards and with independent Chairs becoming the norm.

More investors such as pension funds were also coming into the sector who are targeting steady long-term returns. With Ofwat’s focus on financial resilience in PR19, and the requirement to share outperformance from high gearing with customers, some companies are taking steps to de-leverage. Company plans suggested there would be a range of policies linking executive bonus and dividends more closely to delivery for customers.

However, she went on to warn that while these were positive developments much more was needed, commenting:

“And if the industry is to truly transform, it needs to stop waiting to be challenged by Ofwat, and take bold steps of its own. I’m waiting for a company to make radical and speedy improvements before the new regulatory settlement in place. “

Too much water resource planning done by companies in isolation

The Ofwat Chief went on to say that at present too much water resource planning is done by each company in isolation, with trading between companies sitting steadily at only around 4%.

Ofwat, the Environment Agency, Defra and the companies are collaborating on a new national framework to give regional plans by groupings of the companies coherence and rigor. The overall objective was to enable the industry to seriously consider the case for inter-regional and national transfers and for new storage assets that could serve multiple companies.

Fletcher made the interesting observation that questions remained about who would commission, build and own these assets, commenting:

“ There is no obvious reason why this – or indeed any other - large discrete infrastructure should be funded through the wholesaler’s RCV. Ofwat is committed to addressing these questions, and pursuing the greater use of markets.”

Where next for water regulation?

Rachel Fletcher concluded her speech by asking what the future meant for Ofwat which had “moved a long way in recent years” with signs that new regulatory tools – outcome focused incentives and a drive to improve Board Leadership were having a positive effect.

However, she acknowledged that the regulator needed to change too and did not assume current approaches would drive the significant change needed for the future.

In parallel with concluding the PR19 regulatory settlements, Ofwat would also consider where next for water regulation and participate actively in the review the Treasury has commissioned into water, energy and telecoms regulation.