The Government has acknowledged the complexity of upstream reform, saying that setting charges for upstream markets will be a complex matter and it is therefore "undertaking careful work at present to think through upstream reform."

The comments come with the publication today of the Government’s formal response to the public consultation on its proposed Charging Guidance to Ofwat which ran between 9th July 2015 and 6th August 2015.

Commenting on the upstream guidance, the Government said several water companies had expressed their particular support for the statement in the guidance that “there is no intention to introduce any contestability into the network.” The Government response says:

“Further detailed guidance on charging in upstream markets will be issued once all the different factors have been worked through with all interested parties. The high-level text in the guidance at present will be built upon once there is greater clarity over the appropriate regulatory framework for the market.”

“General consensus that all the overarching objectives were appropriate”

The draft guidance set out four overarching policy objectives for water charges as follows:

• fairness and affordability
• environmental protection
• stability and predictability
• transparency and customer focused service.

It also outlined how these objectives should be achieved in all of the main charging regimes:

• household charges
• non-household charges
• charges in the retail market
• charges in upstream markets; and
• charges for developers.

The consultation document asked 9 questions to gain views on the different parts of the guidance. Overall there was a good level of support for the government’s policy aims set out and there was consensus that all the overarching objectives were appropriate.

There were also suggestions on a wide range of different issues about how the guidance could be improved. Some of the main themes related to: surface water drainage charges, the need for charging information to be appropriate and useful to customers, cost reflectivity; and charges in the new retail market due to open in April 2017.

The Government has not opted to include a further extra objective, suggested by a new entrant, for‘cost reflectivity’ to promote effective competition. The correspondent (a prospective new entrant to the retail market) said:

‘Cost-reflectivity across the whole value chain is an essential prerequisite of competition; if prices are not set correctly at the wholesale level, there will inevitably be a distortion in competition at the retail level, with margins excessively squeezed for some customers and inflated for others’.

The Government response says that Sustainable Drainage Systems (SuDs)received particular attention, with several respondents expressing support of the role which these can play in reducing flooding. Some respondents expressed their support for non-household charging to be used to encourage the uptake of SuDs or other inventions to prevent flooding e.g.:

‘Non-household charging could be an opportunity to encourage private investment into flood alleviation, particularly through the development and maintenance of SuDs. If a company or a group of companies, benefit from an intervention then they should pay toward the intervention.”

A couple of respondents also welcomed the part of the guidance which says that SuDs maintenance costs can be recovered through surface water drainage parts of sewage bills.

Government to review concessionary surface water drainage charges guidance

The largest number of responses came from schools and other public sector organisations located in the North West of England as part of a campaign on the issue of surface water drainage charges.  Respondents pointed out the difference in levels of surface water drainage charges required across the country, quoting information from the Department for Education that schools spend £27 million per year on water and sewerage charges in the North West compared to £11 million per year in the South East.

As a result, they felt that it was “very unfair that Ofwat encourages but not requires area-based surface water drainage charging” which they attributed to giving rise to the regional differences in charges.

In response, the Government said it acknowledged the strength of feeling on the issue and in light of the feedback received, it has decided to review its Guidance to Water and Sewerage Undertakers in relation to Concessionary Schemes for Community Groups for Surface Water Drainage Charges.

Retail margins a key issue for new entrants to competitive market

The document provides further food thought as the Open Water programme set up by the UK Government to deliver the competitive market by April 2017 progresses. In response to the consultation several water companies have requested further guidance on how water companies should protect either rural non-households or small and medium sized businesses.

They also said that this section of the guidance should make sure that Ofwat’s charging rules ensure a level playing field for competition in the new market.

An issue which was of particular importance to new entrants was retail margins, with support for Ofwat to keep the retail margin under close review. One new entrant wanted the guidance on the issue to be strengthened and for Ofwat to be required to publish details over the tests it had made with regard to this.

Another outcome sought by a new entrant was that Ofwat should require wholesalers to publish wholesale charges which are clear and easily understandable to retailers who commented:

‘We note that for retailers to present the charges to customers simply and transparently, retailers will need to clearly understand the wholesale charges which form the greater part of the non-household bill.’

Large variation in tariffs and margins presents difficulties for retailers seeking a national strategy

Several respondents commented on the section of the guidance which mentioned tariffs and charging standardisation between companies. The guidance says that there may be some benefits from standardisation of some aspects of tariffs and charging between companies but this would need careful consideration due to potential risks.

A new entrant highlighted that the large variation in tariffs and margins across the country presents difficulties for retailers in being able to have a national strategy and provide unified service offerings, suggesting that they would support greater standardisation.

However, the opposite view was voiced by a water company who said that standardisation of tariffs would be difficult and warned that it could have unintended consequences, thereby giving rise to substantial incidence effects on customers.

Achieving resilience and effective competition ruled out as additional objectives

In its formal response to the main issues, the Government has ruled out adding ‘achieving resilience’ and ‘effective competition’ as further overarching objectives which was suggested by a number of respondents.

It also had some interesting points to make on the issue of cost reflectivity and cross subsidies, commenting:

“….the structure of this industry around regional monopoly companies does not easily lend itself to driving cost reflectivity across all charging regimes as a desirable outcome in its own right…….Water industry charges have always contained a range of cross-subsidies. Unwinding these can have significant incidence effects and should be approached with appropriate caution.”

The final Charging Guidance to Ofwat will now be laid in Parliament for a period of 40 days. If at the end of 40 days neither House has resolved that it should not be issued it will then be formally published in December 2015.

Click here to read the response document in full