Water today, water tomorrow Future access pricing in the water sector A discussion paper www.ofwat.gov.uk Future access pricing in the water sector 2 Water today, water tomorrow About this document This document introduces some of the terminology, concepts and issues we will need to consider in developing a new charging rules framework for access pricing for the water sector in England and Wales. It describes: • what access pricing is and why it matters; • some of the key issues we will need to consider around access pricing; • which costs could be considered in setting access prices; and • the lessons that we can learn from other sectors. The UK Government’s Water Bill, published in June 2013, will extend the role of competition in the sector in England. This will mean new companies will have access to the systems and services provided by monopoly water and sewerage and water only companies. The Water Bill also requires us to prepare rules that monopoly companies will need to follow in setting the prices they will charge for providing access. Contents 1. Why does access pricing matter? 4 2. What are the main issues? 8 3. Which costs should we consider? 12 4. What lessons can we learn from other sectors? 15 5. Next steps 26 6. Further information 27 3 Future access pricing in the water sector 1. Why does access pricing matter? Most people in England and And in June 2013, the UK Together these reforms will Wales receive their water Government published draft encourage: services from one of 19 licensed legislation (the Water Bill) to regional monopoly companies achieve this vision. Once the • greater competition in providing and their sewerage services from changes in the Bill become law, it certain services; one of 10 companies. Some will – among other things – allow: • the delivery of improved customers also receive services services, and lower prices to from licensed local companies • all non-household customers in end consumers; (new appointments). Only certain England to be able to choose • greater innovation; and non-household customers can their retail supplier (‘retail • increased transparency of costs choose their supplier. reforms’); and leading to more informed • new companies – called ‘new decision making around Each monopoly company entrants’ – to become licensed environmental trade-offs, in turn currently provides a ‘source to to supply particular wholesale leading to improved tap’ business in its area to services (‘upstream reforms’). environmental outcomes. household and non-household They would not have to provide customers (it is ‘vertically any retail services to end In particular, the UK Government integrated’). It controls: customers as they do under the has estimated there could be current water supply licensing overall benefits of £2 billion to • customer-facing (‘retail’) (WSL) framework. They would customers, the economy and the services such as reading water also be able to provide environment from its reform of meters and sending bills to sewerage services. wholesale services. customers; and • less customer-facing (‘wholesale’) services such as collecting and treating water and wastewater. The Water Bill Water supply licensing The Water White Paper (‘Water for Life’), which was published In 2005, the water supply licensing (WSL) framework was December 2011, described the introduced to encourage competition in water retailing UK Government’s vision for future water management in England in activities and upstream water resource activities. which: Under WSL, new companies can supply any non-household • the water sector is resilient; customer that uses more than five million litres of water a year • all water companies are more (50 million litres a year in Wales). efficient and customer focused; and Companies can only supply retail services or combined retail • water is valued as the precious resource it is. and wholesale services. So they are unable to specialise in offering particular services. This limits the scope for them to innovate and deliver lower prices or improved services. 4 Water today, water tomorrow The costs principle Access to what? Historically, the costs principle has been interpreted as If new entrants are to provide requiring monopoly companies to charge access prices based wholesale services, then they will on ‘ARROW’ costs. These are costs that, as a result of being need to interact with the existing replaced as the supplier, the monopoly company: monopoly water and sewerage companies. This may involve the monopoly companies charging • avoids; new entrants a price for using • reduces; or (‘accessing’) their infrastructure. • recovers in other ways. Access to a monopoly company’s water supply and sewerage infrastructure may include principle has been widely • principles for determining the access to: criticised as being anti- amount of any charge that may competitive and for giving little be imposed. • networks; incentive to monopoly water • storage facilities; and companies to become more Alongside charging rules, we will • treatment works. efficient. set rules in the form of codes of practice (‘market codes’), with For example, a new entrant could The Water Bill seeks to remove which all parties will have to apply for a ‘wholesale the costs principle from comply. These codes will describe authorisation’, which would legislation, and in its place give what is expected of all market enable it to introduce water into Ofwat the ability to issue new participants, which will enable the the supply system of an existing charging rules. market to operate efficiently in monopoly company. So, the customers’ interests. We set this monopoly company will charge a out in further detail in our price for moving the new entrant’s New charging rules discussion document on ‘Water water through its pipe network. market governance The Water Bill proposes that we arrangements’, which we A new entrant may also wish to should set charging rules for published in October 2013. purchase a range of other access pricing that cover: services from the monopoly company. • the types of charges that may be imposed; • the amount (or the maximum What price? amount), or methods for determining the amount (or In the past, prices that monopoly maximum amount), of any type companies could charge for of charge; access to their infrastructure have • principles for determining what been calculated by using the types of charges may or may ‘costs principle’. But the costs not be imposed; and 5 Future access pricing in the water sector Bulk supplies What should the charging Closely linked to access pricing is the pricing of bulk supplies. rules deliver? A bulk supply is a supply of water from one monopoly company to another. Bulk supplies are sometimes referred to As an economic regulator we have a range of duties. Our as ‘water trades’ as they are a way for companies to trade primary duties are to: water. • protect the interests of The Water Bill also seeks to provide Ofwat with the ability to consumers, wherever set charging rules for bulk supplies. So it may be desirable for appropriate by promoting us to consider the charging approach for bulk supplies competition; alongside access pricing, as there are many similar issues to • ensure that the companies properly carry out their be resolved across these two areas. This includes: functions; and • ensure that the companies can • sending efficient price signals; finance their functions. • encouraging environmentally sustainable outcomes; and • ensuring efficient companies can finance their functions. The Water Bill also proposes to give us a new primary duty to ensure resilience of water and sewerage services. Our secondary duties include: • promoting economy and efficiency; • ensuring that no undue preference or discrimination is The UK Government has estimated there could be overall benefits of £2 billion to customers, the economy and the environment from its reform of wholesale services 6 Water today, water tomorrow shown by companies in the around environmental trade-offs fixing of charges; (our sustainable development • contributing to the achievement duty). of sustainable development; and We will also need to ensure that • having regard to the principles the various stakeholders involved of best regulatory practice. in water and sewerage service delivery have appropriate controls We also need to have regard to and accountability on the quality the framework – and specific of water delivered to customers guidance – from the UK and and discharged into the Welsh Governments. environment. This is likely to be enforced through a combination So we will need to deliver an of market codes, licence access pricing framework that conditions, and/or other helps enable: subsidiary documents. • greater efficiency in the provision of services, leading to How will we develop new lower bills for customers (our access pricing rules? customer duty, and our efficiency duty); We plan to consult on our • more choice and flexibility in the preferred approach in due course. provision of services, leading to But we want to begin the debate greater sector-wide resilience with our stakeholders now on how (our yet to be enabled resilience to develop the best approach to duty); and access pricing, and would • greater transparency around welcome your views. costs, leading to more informed decisions being able to be made 7 Future access pricing in the water sector 2. What are the main issues? There are a number of issues we detailed information about their cause a change in their local will need to consider in costs would also place a burden costs (‘cost drivers’). But: developing our approach to on them – and ultimately access pricing. We explore some customers, who will pay these • this is provided it was more of them in more detail below. costs through their bills. efficient for companies to capture data on drivers rather One potential compromise would than their specific costs; and Preventing monopoly be for us to require companies to • producing and maintaining such abuse develop cost models based on models could still involve their average costs of providing companies using a significant The water sector in England and access, but with factors that amount of time and resources.