A report prepared by KPMG for Affinity Water suggests that disruptive regulatory changes, especially in the upstream and network segments of the water sector, are inevitable and will “drive new business models”.

The consultancy was commissioned by Affinity Water to identify potential new business models and new business activities that might emerge in the water and wastewater sectors now and in the future as the structure of the industry changes.

Introducing the report, KPMG said a number of new business models are already emerging as a result of legal and regulatory changes introduced recently as well as a result of business innovation.

The focus of the report is on more innovative business model and activities, many of which need to be enabled by further regulatory or legal change.

However, it also says that some new models could emerge without much further change, in which case the questions addressed in the report are whether sufficient incentives are in place for water companies to introduce them.

Structural change in the retail and upstream segments could create significant customer benefits

According to KPMG, in general, structural change in the retail and the upstream segments could create significant customer benefits, and the early experience with the introduction of retail competition is that it has, at the very least, already stimulated significant new thinking.

The report suggests that further regulatory and legislative reform and willingness from companies and investors to explore new opportunities is likely be needed to facilitate the development of new business models in the future

Simon Cocks, Chief Executive at Affinity Water said:

“Today’s report looks at what role companies like ours,  together with  key stakeholders,   could play in helping to create the future. There are a range of possibilities.  Some have been discussed previously and deserve further work and analysis -   such as the introduction of independent system operators to improve efficiency in the  use of resources – conversely some are completely new ideas for consideration.”

 “Our aim with this report is to try and bring these things together in order that we can start to really  focus on the long term and, from our position as Affinity Water, support the continued success of the water sector.  It is vital that we  plan for the future now, so that we can be in the best shape possible, to serve future generations of customers.”

 “Further regulatory changes now appear inevitable and they will drive new business models”

The report says that some disruptive changes of existing arrangements have already begun - especially the case in the non-household retail sector, but fewer changes are apparent in the upstream and network segments to date, concluding:

“Further regulatory changes now appear inevitable and they will drive new business models.”

 New models implied by the existing legal and regulatory changes include:

• abstraction licence trading;
• upstream water entrants selling to incumbents and wholesale network operators;
• upstream water entrants selling to new retailers;
• water trading between today’s incumbents;
• markets in bio-resources; and
• operators taking direct ownership of assets and activities via Ofwat’s ‘Direct Procurement for Customers’ proposals.

However, while the new business models and activities should help to tackle challenges, for example by delivering improved water efficiency, and better allocation of resources, the report says that they impact on a relatively small proportion of the total cost base within the sector and do not cover the more substantial assets, operations and ultimately the costs that make up customer bills.

The new models may be insufficient to make a big enough difference

The report suggests that “even if the challenges develop in line with central estimates, the new models may be insufficient to make a big enough difference.” KPMG have therefore considered alternative models that might complement the new emerging framework in terms of addressing the challenges, derived from observing parallel models in other sectors (notably energy) and by extrapolating trends already emerging in water and wastewater.

The report has identified a range of alternative and more innovative models and business activities, including an interesting suggestion that flood resilience could provide a source of water – new flood defences could be built that enable the collection and re-distribution of rainwater as a source of supply. The report says a new approach to flood resilience may be needed as a result of increasing incidence of serious flooding. The benefits of new flood resilience schemes could be enhanced if schemes were designed to store and re-use excess water.

Other activities include:

• Demand aggregator - a retail company aggregates demand across a range of customers and provides demand reduction as a service to network companies - a model which already exists in energy.
• Multi-utility retail consolidation - this could occur through retailers offering water, wastewater and other utility services together. It could also be extended to residential customers if the market becomes competitive.

According to KPMG, some models offer potential for better management of scare water resources and some offer more optimisation across company boundaries. For example:

• Non-potable water - incentivising greater use of non-potable networks and supplies would reduce pressure on drinking water supplies.
• Treated effluent as a source of water - re-using effluent occurs in some other countries but there may be a presumption against re-use in Britain.
• Asset and licence area swaps - companies could exchange assets to help optimise management of catchments.
• Independent System Operators - an ISO could improve the current system of allocation and use of scarce water supplies.
• Sewerage-only company -continuing divergence of the regulation of water and wastewater could allow the voluntary creation of a sewerage only company , analogous to a WoC (i.e. a water only company).

The report also says that the example of wholesale and retail separation shows that increased focus on a single business activity, driven by regulatory change, can create greater management focus.

Key findings and implications

According to KPMG,  the new business models and new activities have been chosen firstly for their capacity to help address some of the challenges faced and secondly because they are not currently directly implied under the existing framework.

However, the report warns that the majority might be challenging to implement under the current legal and regulatory framework and some may not be commercially viable today. It suggests that if any of the models are considered to provide benefits, there may need to be a ‘pump-priming’ by the regulator principally through greater regulatory incentives to encourage their development.

The report concludes:

 “Individually the models identified are capable of generating benefits but no one model is considered to address all the challenges simultaneously. The new models and activities can work in combination to reinforce each other. It is these combinations that suggest there is a case for encouraging multiple models to develop.”

“Further regulatory and legislative reform, and willingness from companies and investors to explore new opportunities, is likely to be needed to facilitate their introduction effectively in the future.”

Click here to download the report New business models in the water sector