Ofwat has today published a major paper setting out its regulatory approach for the 2019 Price Review and beyond - including far-reaching proposals which will bring about fundamental changes for the UK water sector.

Ofwat is now seeking comment on the  detailed and  lengthy 231 page document Water 2020: our regulatory approach for water and wastewater services in England and Wales which is accompanied by a separate set of detailed appendices, evidence  and analysis.

Introducing the paper, Ofwat said the major reforms would help boost resilience and secure a better deal for water customers, the environment and wider society.

Describing the proposals as pro-market, the regulator said it would use its tools to align the interests of investors and companies with those of customers, using market mechanisms to deliver benefits for everyone.

The regulator has announced it is backing new markets in bioresources – the term it is now using to describing treated sewage – and water trading, which together could be worth £1.6 billion. Forecasts suggest the bioresources market could produce benefits of up to £780 million and the potential benefit from smarter water use through trading could be worth £800 million.

Ofwat has also announced it is stepping away from the use of the RPI measure of inflation, towards a CPI measure.

Commenting on bioresources, the regulator said that given the financial and environmental benefits, it wants to empower markets to unleash innovation and efficiencies, bring in third parties and promote the trading of bioresources. Bill payers could also benefit with the cost of water services being reduced by these new markets.

Ofwat has also put forward proposals to  encourage further water trading, saying that setting conditions to encourage water companies to trade between themselves and with third parties could see a smarter use of water reserves.

Following  consultation, Ofwat has today also confirmed that it will phase out the use of the RPI measure of inflation and move towards a CPI based measure, in line with government and Office of National Statistics advice. RPI has lost its status as an official statistic and is increasingly an index which customers do not recognise, with CPI more commonly in use.

The paper says that in relation to bioresources, evidence shows there is scope for increased optimisation of activities across the companies – and, looking further ahead, greater participation from firms operating in wider waste markets. In relation to water resources, trading is below its optimal level, and taking steps to reduce identified barriers to this could result in significant benefits for customers.

 Again, looking further ahead, there is also scope for participation from third parties, both in terms of selling water into the public water supply, and in negotiating directly with water retailers as the retail business market develops in line with the Water Act 2014.

Information platforms to be set up for new bioresources and water trading markets

Ofwat’s proposals include the introduction of  an information platform for bioresources markets with the aim of making information available that will enable others to offer services if they can provide them at a lower cost and/or of a higher quality than the existing companies.

The information will include, in the short term, details of location, contract duration and successful bids and, in the longer term, cost/pricing information.

Ofwat also wants to introduce an information platform for water resources markets which will make information available that will stimulate conversations between potential buyers who have supply-demand issues to address and those with water resources or demand management services to offer.

Ofwat is proposing to require companies to make available data on supply-demand deficits and water resource costs in a consistent format. Incumbent companies will also be asked to publish a bid assessment framework setting out its policies and processes for assessing bids from third party resource and demand management service providers.

Separate binding price controls for bioresources and water trading in PR19

The regulator is also proposing to introduce separate binding price controls for sludge/bioresource treatment, transportation and recycling/disposal and water resources for PR19, saying:

“ This will inform, enable and encourage an effective market by revealing improved information that will help us to set better targeted incentives; supporting company decision-making; mitigating cross-subsidy concerns; and helping to foster a more commercial culture and focus within companies in relation to these activities.”

For water resources, this control will apply to companies in England and in Wales, last five years, and take the form of a total revenue control with a mechanistic within-period adjustment mechanism that depends on the scale of bilateral market entry.

For bioresources, the control will apply to companies in England and in Wales, last five years, and take the form of an average revenue control.

Ofwat is also proposing to allocate parts of the RCV to bioresources and water resources- a measure it says is necessary to ensure a level playing field within these markets and wider markets), to avoid the over-recovery of costs and to maintain consistency between charges and cost recovery.

Service Incentive Mechanism under review

Ofwat introduced the SIM in 2010 as a means to provide companies with an incentive to provide more than a basic level of service to customers in the absence of true competitive pressure.

Ofwat has already committed to continue using the SIM - in its current form - for the current price control to ensure customer service remains at the core of companies’ focus. However, the paper says there are a number of reasons for considering changes at PR19 for the 2020-25 price control period, including:

• companies (and Ofwat) are in a different place from when the SIM was first introduced;
• SIM scores are beginning to converge; and
• customer expectations continue to evolve.

Ofwat says it is investigating how it can ensure the SIM (or a variant thereof) remains relevant following this current price control and reflecting any decision taken by the  UK Government whether to introduce competition into the residential retail market in England.

Long-term commitments – decisions today have impacts well beyond 5 year price reviews

The regulator is also consulting on one outcomes issue in the paper – that of long-term commitments, saying it wants to incentivise companies to focus on their customers over the longer term, rather than concentrating their effort around five-year price reviews.

The paper states:

“The water sector is a long-term business, with long-lived assets and intrinsic links to ecosystems. Decisions made today can have impacts well beyond the five-year price control.”

Ofwat said it plans to engage further on this area via the outcomes workshop in June and its November consultation and is now seeking stakeholders’ views on its current preferred long-term commitments option. – one of four options set out in the paper.

Direct procurement for high-value infrastructure projects of £100 million-plus

Ofwat is also proposing to incentivise companies to use direct procurement for customers (DPC) for high-value infrastructure projects - the paper says:

“DPC takes place when a water company procures services, particularly infrastructure projects, on behalf of customers, including the project’s financing. It promotes the use of markets for projects which would otherwise be provided by the water company.”

“DPC can generate savings from project costs and cheaper financing. It can also encourage companies to take a long-term view of projects, bringing long-term savings.”

The paper says Ofwat will evaluate companies’ proposals for DPC as part of its risk-based review of company business plans at PR19 and will expect companies to use DPC for projects valued at more than £100 million.

Ofwat will also support sustainable improvements in the environment through a long-term view of investment and risk management that encourages companies to plan over multiple price review periods rather than one. “This helps companies develop whole-of-life solutions and use the most effective mechanisms to deliver environmental outcomes such as payment for ecoservices.”, the paper states.

Cathryn Ross: "where there's muck there's brass"

Commenting on the proposals, Cathryn Ross, Ofwat Chief Executive, said:

“The challenges posed by climate change and population growth mean we need bold, creative and innovative action to ensure we have reliable access to resilient, affordable water services in the future. Today we unveil a package of reforms to help set the sector on the path to secure that goal.”

“As the old saying goes, ‘where there’s muck, there’s brass’. We think there is something in that idea. The trading of bioresources could be a real breakthrough – economically and environmentally. By kick-starting this market, we could develop reliable, domestically sourced low-carbon energy generation and reduce water bills.”

“While some may be squeamish about this, it is an industry we ought to support because it is safe, green, sustainable and economically attractive.”

Click here to download Water 2020: our regulatory approach for water and wastewater services in England and Wales in full