Graeme Young, EU & Competition Partner at Dundas & Wilson LLP, looks at the proposed Government reforms to the existing inset regime contained in the draft Water Bill which is currently making its way through Parliament.

Introduced in the early 1990s, as something of an afterthought to water privatisation, the 'inset regime' is generally regarded as the only existing viable route to providing competition in the water market in England and Wales.  Until recently network competition, with one vertically integrated water company replacing another for specific sites, looked like the only game in town.  So why is the Government proposing to remove it and what it being proposed in its place?

On one level the answer is quite straightforward…  The Government is replacing the inset regime with a vertically unbundled cousin, the new 'retail infrastructure authorisation'.  To understand this more fully one needs to take a short walk back through the evolution of the inset regime and how those currently engaged in this market will in the future engage with housing developers and other customers under the arrangements proposed in the Draft Water Bill.

The inset regime

Under the existing inset regime, a company can apply to replace the existing appointed water and/or sewerage company for a specific geographic area if:

• the relevant area is currently 'unserved';
• the supply is to a 'large user' (a customer which uses at least 50 ML of water a year, or 250ML in Wales); or
• the existing appointed company agrees to transfer part of its area to that company.

The company must apply separately for each new appointment on a site by site basis.  Multi-utility providers are generally attracted to developments of new unserved areas where they can provide energy and telecoms infrastructure as well as water (and negotiate a bulk supply of water from the local incumbent).  Large users present a slightly different proposition, for example often involving companies seeking to use their own skills and resources (such as bore holes or other solutions) to service heavy users of water such as power stations.  The third criterion has tended to be used to facilitate cooperation between neighbouring incumbent water companies.

Whichever criterion an inset is established under, the inset appointee effectively becomes the incumbent water company under regulatory arrangements that are very similar to those governing the incumbent water companies. 

One important feature of these arrangements is that, while the new appointee is not subjected to price control Ofwat requires the appointee to satisfy them that customers will be 'no worse off' as a result being served by them and as opposed to the incumbent water company.

The new 'retail infrastructure authorisation'

The Water Bill does away with the failed water supply licensing regime introduced in 2003.  It seeks to replace it with a set of new 'authorisations' and market codes covering separate activities in 'upstream', 'wholesale', 'infrastructure' and 'retail' markets.  One of those new authorisations is the 'retail infrastructure authorisation'.

The introduction to the Draft Water Bill explains that this new authorisation will:

"Enable the holder to provide the so called “last mile” infrastructure which will connect eligible premises to undertakers’ water supply systems (for example the licensee will own and manage the mains, pipes, meters etc. the undertaker would otherwise have provided for a new development).  This will initially enable new entrants to provide such infrastructure to supply commercial and industrial sites in line with the other new authorisations, but the draft Bill includes a power for Ministers to enable those holding a retail infrastructure authorisation to own and operate retail infrastructure for household premises in order to completely replace the inset regime for unserved areas and large users" (para 63).

Conclusions

While there will be some devil in the detail when it comes to drafting the new set of authorisations and the accompanying market codes, the current inset regime would simply not have worked under the new legislative framework.

On balance, the new retail infrastructure authorisation presents potentially significant benefits for developing "last mile" infrastructure solutions:

• There will be no need for separate 'appointments' for each site and companies will be able to operate on the basis of a single national authorisation from Ofwat;
• Companies can decide whether or not they want also to provide retail services – they could make arrangements with a retail-only provider or an incumbent water company;
• The 'large user' requirement is to be abolished and a company will be able to compete for all premises which are not household premises (being those in which, or in any part of which, a person has his home); and
• The introduction of regulated wholesale pricing should make it easier to obtain bulk supplies to service customers (when not using own water resources).