Water sector regulator Ofwat has launched a new consultation on price and non-price protections for business customers in the water retail market.

Around 1.2 million business customers in England have been able to choose their retailer since the business retail market opened in April 2017.

To protect business customers who have not actively negotiated and/or agreed new contract terms with their retailer and remain on 'deemed' contracts with their existing supplier, the Retail Exit Code (REC) sets out requirements for price and non-price terms in the default tariffs offered to these customers.

The price and non-price protections currently set out in the REC were last reviewed by Ofwat in 2018-19 – a consultation paper sets out the regulator’s initial thoughts on its approach to reviewing the REC protections.

Introducing the review, Ofwat said it will have a key objective of promoting the interests of current and future business customers using competition and/or regulation as appropriate, alongside

the following four objectives:

• promote efficiency and innovation;
• simplicity and clarity;
• proportionality;
• improve resilience.

"Business retail market not yet functioning as efficiently or effectively as it could"

The consultation paper says:

“Based on evidence from our market monitoring….the business retail market is not yet functioning as efficiently or effectively as it could. Some of the market frictions we identified in earlier reports (in particular poor quality data) continue to impede delivery of improved customer outcomes.”

According to Ofwat, larger customers continue to be more aware, more engaged and have higher incentives to engage in the market, reaping greater benefits from competition. In contrast, smaller customers are less engaged and have much weaker incentives to engage in the market.

Business customers are currently classified in three separate groups according to consumption categories:

• Group One (0-0.5Ml)
• Group Two (0.5Ml-50Ml)
• Group Three (>50Ml)

In Ofwat’s view, continued REC price protections of some form are required for both Group One and Group Two business customers.

For Group One customers Ofwat is proposing that price protections are more closely aligned to efficient, forward looking retail costs of serving such customers. The regulator therefore proposes to retain the net margin approach to specifying price caps for Group One customers.

Price caps for Group Two customers are specified as a maximum price per customer set by reference to wholesale charges, uplifted by a gross margin. Ofwat is proposing to retain a gross margin approach to specifying price caps for Group Two customers. “We see greater activity and engagement among medium sized customers, who have greater incentives to seek out and achieve better deals from a competitive range” the paper says.

Ofwat intends to base any revisions of REC price caps for Group One customers on its view of the forward-looking costs of serving customers in the business retail market that an efficient retailer might incur, including the extent to which the costs may differ materially between customer size and type.

The paper says:

“Since market opening, the form and extent of actual costs for retailers operating in the market should have become clearer. However, we note that retailers have influence over several costs, including many of those relating to market data quality and other market frictions, so our assessment of efficient forward-looking costs would look to exclude such costs and build in plausible and challenging cost efficiency improvements, possibly taking account of external benchmarks.”

Ofwat intends to retain the existing non-price protections set out in the REC to afford protection for customers who have not actively negotiated and/or agreed new contract terms with their retailer in their current form, noting that “competitive pressures are not adequately protecting the interests of all customers.”

The regulator introduced an explicit 'no worse off' condition in April 2020 which prohibits retailers from unilaterally altering non-price terms that would result in business customers being materially worse off (financially or operationally) compared to their position at market opening.

Improving quality market data quality "crucial to facilitating improved levels of water efficiency in the business retail market"

Ofwat has ruled out strengthening incentives on retailers to deliver water efficiency savings in the business retail market, commenting:

“We do not consider that our review of the REC provides an opportunity to strengthen incentives on retailers to deliver water efficiency savings in the business retail market. We consider that, alongside exploring strengthened incentives for wholesalers via PR24, Market Performance Framework reform provides an appropriate opportunity to explore strengthening incentives for retailers.”

The paper says the regulator also notes that improving the quality of market data is crucial to facilitating improved levels of water efficiency in the business retail market.

Ofwat expects to consult on more specific proposals in summer 2022 and plans to publish its decision by the end of 2022 with the intention of any revisions taking effect from April 2023.

Deadline to submit responses to the consultation is 5pm on Monday 31st January 2022.

Click here to download the consultation paper Business retail market: 2021-22 review of the Retail Exit Code – a consultation