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Progress report
(Utility Week Via Acquire Media NewsEdge) Despite the early setback of new entrant Aquavitae's demise, the first six months of water competition in Scotland have been a success, and the Water Industry Commission for Scotland (Wics) is already looking ahead to the next phase of market liberalisation.
"The market is up and running, albeit with a couple of hiccups," says chief executive Alan Sutherland. "The systems work, customers can and are switching and they are getting a better deal."
The principal hiccup was the first new entrant, Aquavitae, going into administration after its parent company, Vitae Holdings, was taken over. Around 60 sites had already switched to Aquavitae, providing an earlier than expected test of the mechanisms for dealing with a supplier failure.
"When the market opened in April, a good number of customers switched very quickly, the ill-fated Aquavitae being the winner of those customers," says Sutherland. "Its demise tested the market systems much earlier than we would have liked, but the market came through it well."
Most of Aquavitae's customers saw the writing on the wall and switched supplier before the company lost its licence, leaving a dozen or so remaining when the company ceased operation, and they were reallocated under the market's supplier of last resort mechanism.
That left just three new entrants - Satec, Anglian Water's Osprey and Suez's Ondeo - competing with the incumbent, Scottish Water Business Stream.
Other operators are eyeing the market with interest, but its small size - around ?35 million a year - means some are hesitant to make the investment needed to trade in Scotland. Even those that have secured retail licences have yet to make a major impact.
"It has taken longer than expected for the bigger players coming into the market to sign up customers," says Sutherland. "On one level there's a feeling of 'let's get on with it', but really it is better that they get their strategies right and hit the ground running when they do enter the market."
Some high profile customers have switched, most notably high street retailer Debenhams, which moved to Satec. But the numbers have been small overall. Even Tesco, possibly the company that has been most vocal in favour of competition, Tesco, has stayed with Business Stream. However, Sutherland says this is largely because Business Stream has upped its game.
"There has been good progress with switching, but on the other hand Business Stream has sharpened its act and, to its credit, is unrecognisable today from 18 months ago," he says. "They have been offering discounts of up to 3 per cent to customers who pay by direct debit or sign up to notice contracts or pay earlier than before. That has allowed them to sign new agreements with 30 per cent of their customer base, who are now better off than they would have been if there had been no competition."
Sutherland has long argued that the main criterion for judging the success of the competitive market is not the number of customers who switch but the improved service and value for money they receive.
"We have always said this wasn't just about switching but for customers to be better off," says Sutherland. "Six months in, 30 per cent of the customer base are better off with their existing supplier while others have switched to get a better deal."
Looking ahead, Scotland's local authorities are said to be planning to take advantage of the market by preparing competitive tenders for their water and wastewater services.
"They have large estates and will have been getting large numbers of bills and a disjointed payment schedule," says Sutherland. "When we see big public bodies starting to tender their services, that is a recognition that the world has changed."
The market opening has also encouraged Scottish Water, the publicly-owned monopoly wholesaler, to improve efficiency and service.
"Competition has had a substantial impact on Scottish Water," says Sutherland. "Scottish Water has recognised that the market opening and the separation of Business Stream are a good thing and they have identified savings resulting from that. They can see the performance improvement at Business Stream and the new vehicle they have created to handle their non-core activities, Scottish Water Horizons, has an almost identical governance structure to Business Stream."
The efficiency improvements will be reflected in the 2010-14 price limits that Wics is finalising with Scottish Water.
"Scottish Water has published its first business plan and it talks about bringing down prices each year by half a per cent or so below the rate of inflation over the four years," says Sutherland. "Our view is that is a good positive step and their business plan was a huge improvement on anything we had seen previously. It was pretty complete and in many areas quite compelling in its arguments. That doesn't mean we are happy with all of it and we believe customers ought to look forward to prices rather better than Scottish Water is offering."
Wics is also asking Scottish Water to prepare a more detailed breakdown of operating costs in preparation for accounting separation of its functional divisions. This is essential for strengthening regulation, but would also ensure that the extension of competition into water or sewerage treatment happened only if it was economically justifiable. Sutherland knows better than anyone the potential complications of extending competition.
"One thing we have learned from opening part of the market to competition is that it sounds quite easy, but actually it isn't," he says. "With goodwill between the regulator and the regulated company, drawing an accounting and legal line between retail and wholesale activities is easy. The difficult bit is ensuring that they know exactly how they will interact with each other. So I am not going to say there will be competition across the value chain in two years because I know from experience we couldn't do it."
A thorny issue that Wics will need to consider in the next phase is common carriage. Although not specified under the current regulatory regime, carriage of another supplier's water over Scottish Water's network would still be possible under competition law. Scottish Water can refuse access but, under competition law, it cannot refuse access unreasonably.
"There is not an outright ban on common carriage, but what makes us very nervous is the opportunity for cherry picking," says Sutherland. "One of the critical insights from retail competition was that wholesale charges would be averaged across Scotland so no retailer was disadvantaged by the geography of its customer base. There was surprisingly little political concern about retail competition, probably because no customer had to pay a higher price or accept a poorer level of service as a result of the introduction of competition. If regional price variations are needed to make common carriage work, that is not good because the losers will inevitably complain."
Wics has been looking at experience in UK energy and the Australian water sector, and an alternative approach could see Scottish Water take on a role of network system operator.
"The advantage of having a network business sitting in the middle, purchasing capacity from the various water and sewerage treatment works, is that this entity could do the averaging internally and sell at a single wholesale price to the retail businesses," says Sutherland. "By price capping the network operator charges, pressure would then be passed on to the treatment works to be as efficient as possible."
Wics is also aware that the Scottish Government's plans to introduce local income tax offer the perfect opportunity to separate water bills from local taxation, making domestic competition a possibility for the first time. But even short of competition, Scottish Water could improve its household retail activities.
"It is clear from the success of Business Stream that there can and should be changes in household retail," says Sutherland. "There would be clear economies of scale for business and household retail and billing to be done together. It is also more straightforward for a business expert in retail to take on household billing than for a company that is expert at running water and sewerage. And if all retail is split off in England and Wales, it will give a Scottish retail business the scale to compete. And more legislation would be required to allow for household retail competition."
Sutherland is already looking ahead to the next review in 2013. "It's only five years way and that's not a long time in a regulatory cycle," he says. "We will have to do something very different in 2013 from what we do today. Now we rely on a series of tried and tested econometric tools and models that look at the capital spend and operating cost of a vertically integrated water and sewerage entity. While Scottish Water is no longer vertically integrated, for this price review we can recreate it because we can use 2007/08 as a base year when Scottish Water had all the customers.
"By the time of the next review it will be very difficult or impossible to do so, and we will need a new set of regulatory techniques to set prices from 2014."
This means Wics will have to collect different information from Scottish Water, because the traditional method of comparing the company with its private counterparts south of the border may no longer be straightforward.
"It is also quite possible that benchmarking against England and Wales will be difficult by 2013 because the industry there might be in a major state of flux," says Sutherland. "Our current thinking is that we may be looking in more detail at Scottish Water's costs to allow internal rather than cross-company benchmarking. We could, for example, ask why the running costs of a treatment works in Glasgow is different from a similar plant in Edinburgh." n
Copyright ? 2008 Reed Business Information - UK. All Rights Reserved.
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