Ofwat has said that the introduction of household competition in the water sector could deliver up to £3 billion in benefits to customers –and the regulator is calling for the government to take an early decision on the issue.

If the Government decides to give the go-ahead, the competitive residential retail market in England would be the largest competitive water retail market in the world and would affect every residential customer in the country.

The UK Government asked Ofwat in November 2015 to assess the costs and benefits of extending retail competition to residential water customers in England. The detailed 145 page report Costs and benefits of introducing competition to residential customers in England is accompanied by a raft of supporting documents.

The report says the rationale for the potential introduction of competition for residential customers in the water sector in England sits within a broader vision expressed by the government as:

“Opening up markets to new entrants promotes stronger competition and drives efficiency and innovation. The result is the creation of new and innovative products and services at lower costs, which benefits consumers across the UK… The government is taking action to open up markets to new entrants, driving greater competition and providing consumers with more choice.”

Potential benefits available of £2,917 million

According to Ofwat, if the market can be designed and regulated appropriately, the potential benefits available are significant – those the regulator has been able to quantify amount to £2,917 million.

Introducing its report, Ofwat said it believed that the introduction of competition in the residential retail market in England would be likely to result in a net benefit, on the basis that:

• new entry on the basis of innovative business models is more likely than not;
• multi-utility service bundles are more likely than not;
• technology that is emerging in other sectors is likely to help reduce customer search and switching costs; and
• new entrant business models could bring significant benefits in terms of water efficiency and wastewater management, and therefore resilience.

Some customers could be worse off

However, Ofwat has also that in competitive markets some customers get a better price and service than others, warning that it is possible that some customers could be worse off. “It is inevitable in competitive markets that some customers would secure a better deal than others, and that those who shop around are likely to do better than those who don’t,” the report says. However, it is still important to consider how wide the difference in deals might be, and who might be likely to get the better deals and the worse ones.

The regulator’s expectation is that the difference between the best and worst deals for residential customers in water to be far less than in the energy market today, with wholesale price regulation covering about 90% of the total bill in water compared to 25% in energy.

Commenting on when to open the market, the report says there is a choice between having a phased opening or opening the market for all customers at once. The first could be via a pilot phase on a geographical basis, which would have logic given the regional monopoly structure in the wholesale part of the value chain. Phased approaches were used in the energy markets and phased opening would also allow for any teething problems to be identified and remedied before they could have a wide impact, according to Ofwat. Opening to all, however, would allow all customers and companies to benefit from opportunities and face risks at the same time, the report says.

Could be significant benefits from a multi-utility market

The analysis also says that there could be significant benefits from the development of a multi-utility market.

According to Ofwat, there are a number of very significant changes expected in the energy market within the next five years which will affect both energy suppliers (some of which may consider entering a retail water market) and third party intermediaries (who may play a significant role in facilitating a multi-utility market).

The regulator says these should be considered in the market design if the decision is made to introduce residential retail competition.

Ofwat report also says that experience in the business customer market suggests that of the 17 monopoly water retailers currently supplying residential customers in England, not all of these may choose to remain in a competitive residential market.

More generally, it would be important to design and operate the market in a way that does not create barriers to entry.

Ofwat said:

“Having submitted our report, we are now ready and willing to work with the government as it decides how best to take this forward – including undertaking further analysis of the possible impacts on different customer groups to understand how to best protect their interests.”

Customers should be able to compare deals and switch easily

Customers who want to should be able to compare deals easily, and switching should be" as quick, simple and hassle-free as possible." The report refers to the potential for third-party services – such as Flipper in the energy market – to take the hassle out of comparing deals and switching supplier.

Ofwat also expects that competition would reduce bad debt levels in water, as retailers seek competitive advantage by reducing bad debt costs through better billing and debt management, commenting:

“With more bundle offers becoming available we could see bad debt level fall even further and become similar to those in other utility sectors.”

Customers unable to pay their bill should continue to receive help in a competitive market

The report says it will be important to ensure that those customers unable to pay their bill continued to receive help in a competitive market, although “the extent to which such measures create additional costs for other customers is a matter of market design and so is for the government to decide.”

Commenting on tariffs, the report says there may also be a continued role for social tariffs and there are alternatives ways these can be delivered, such as through a Universal Service Fund.

The report also refers to a suggestion by one potential new entrant to the water sector proposed regulation that enabled companies to offer different tariffs to different customers, but “only to the extent that the differences were justified by the differences in cost to serve those customers.”

In early stages of competition role of regulator might be even more important

On the role of a regulator, the report says that introducing competition to the residential retail water market would not remove the need for regulation. “Indeed in the lead-up to market opening, and in the early stages of competition, the role of a regulator might be even more important to ensure the market operated effectively and that customers were protected and their interests represented, “ the report says.

“Given the fresh set of challenges involved in preparing for and implementing a competitive market, it would be important that there is a regulator with the powers, skills, capacity and capability to carry out these functions.”

Water companies and their investors would welcome an early indication of whether competition will be extended 

With regard to timing, the report says there are two fundamental decisions for the government to take. Firstly, when to make a decision in principle on whether to open the market to competition and  secondly, when to open the market.

According to Ofwat, the water companies and their investors would welcome an early indication of whether competition will be extended to the residential retail market, as it will allow them to plan ahead and minimise cost by identifying the best approach

Reasons put forward by the regulator for recommending an early decision include:

• Ofwat is currently developing its approach to the 2019 price review and existing companies are keen to understand how extending retail competition to residential customers would affect the price review. An early decision would allow the regulator to incorporate provisions for market opening into the review methodology and give certainty to companies and their investors.
• An early decision would help existing companies and potential entrants think about their retail market strategies. For existing water companies, knowing whether the residential market would open to competition could be a material factor in their decisions on whether and how to engage in the business customer market. It would also allow potential entrants and new investors to assess opportunities.
• Clarity on any decision would provide existing retailers, wholesalers and potential new entrants the time to prepare for the opening of the market.

Following on from the assessment, “the government will work with water companies to begin the transition to retail competition before the end of this Parliament.” the paper says.

Cathryn Ross, Chief Executive of Ofwat, said:

“We are living in an age of retail revolution, but water customers are being left behind. The service offers from water companies can feel behind the curve compared to the innovation customers benefit from when buying other goods. The uncomfortable truth is that, when it comes to retail offers, water companies provide an analogue service in a digital age."

“Customers tell us they think they should have the freedom to choose and don’t understand why water is the only retail market in which there isn’t some form of competition.

“But, of course, this isn’t a one-way street.  There are significant costs to be considered, and it will be important to ensure that customers are treated fairly in a competitive market and that vulnerable customers are protected. The decision for the government to make is whether the potential benefits outweigh the costs and risks.”

The challenges surrounding the introduction of competition to the domestic water sector are considerable – not least of which is the number of customers willing to switch. Ofwat’s preliminary assessment published in the summer said if competition comes in houshold customers would expect bills to fall by an average of 25% for them to switch, a level of saving which the regulator said “is unlikely to be available.” 

GMB: introducing competition has no recognisable public support

The GMB union described the proposals as absurd, saying that Ofwat’s plans to introduce competition to the residential retail water market are removed from reality. The GMB said:

“The truth is that Ofwat are fiddling with competition and market reforms in a monopoly water industry as Britain continues to flood and consumers are ripped off. It doesn’t bear thinking about that our water supply could be put in the hands of supermarkets, banks, or any other Tom, Dick or Harry who wants to have a go at selling our natural resource with all the risks to public health that may entail.”

According to the GMB, introducing further competition into the water industry did not have any recognisable public support. “The only way to stop this rip off is to create a level playing field for consumers. This means re-nationalisation of this natural monopoly and this must be a priority for the next Labour Party election manifesto,” a statement issued by the union said.

Click here to download Costs and benefits of introducing competition to residential customers in England