At Shepherd and Wedderburn we have been watching regulatory and political developments in the water sector closely. We think the regulatory framework has the potential to be in for big changes, and not in ways that many expected at the start of Ofwat’s Water 2020 programme.
Water industry governance – under attack?
Recent media coverage on corporate governance in the privatised UK water sector has focused on customer trust and industry performance. Spats between key stakeholders and companies like Thames Water got acrimonious, with current and past regulators, politicians and others lining up to criticise industry practices and performance as a result. Severe disruption of roads and residents in London, and indeed across the country, attributable to water companies over the winter has put operational performance under the spotlight and in the eyes of politicians. Media outlets including the FT and Guardian have given a sustained critique of various parts of the industry over many months, and this is now bubbling to the surface of the political environment.
Result? Many in the industry respond by simplifying corporate structures (including Thames and Yorkshire Water), Ofwat reacts by making late additions to the PR19 business planning process (reactive, because Water 2020 has been in development for many months), and a parliamentary Committee is set up to scrutinise whether the current regulatory framework is fit for purpose. Key figures in Ofwat have also been making the point that their regulatory policy is not in fact driven by headlines. Meanwhile, the National Infrastructure Commission publishes a report highlighting the fragility of England’s water supply resilience (and casts doubt on measures such as water trading as being an adequate response). Further, DEFRA has published a consultation on the future of environmental regulation in a post-Brexit world, which has the potential to disrupt and influence further, albeit more likely in the longer term.
Ofwat and the industry as a whole have been developing the next price control for some time. But all of the above happened (or was announced/published), more or less in the months of April/May. All have the potential to significantly disrupt and influence water industry business planning and the regulatory framework itself. While Ofwat’s expectations for water companies in PR19 have been generally regarded as ‘tough’ and will push companies to outperform, these recent developments will push both the companies and the regulator to prove their legitimacy in being entrusted to operate in this vital industry. This all seems to be shaping up to be a very different picture for water stakeholders than that which was envisaged in the early stages of PR19 planning.
The expected and unexpected
So, what could happen next in evolution of the regulatory framework? This is hard to say, but there are some key issues that are likely to gain traction. The National Infrastructure Commission’s report calls for a more strategic approach to water networks, suggesting something needs to be done at a ‘level above’ the geographic boundaries of the existing incumbents – which is something that could blur the lines around the ownership and operational responsibilities of UK water companies as currently drawn. This has echoes of Helm’s proposals on the ‘System Operator’ model, a model which reimagines the delivery of water services – a key feature of Helm’s work which has also featured heavily in his Cost of Energy review. Whether this means a greater focus on Ofwat’s current proposals and expectations on their Direct Procurement model (where water companies tender out the design, build and operation of key strategic assets), or greater intervention or ‘reworking’ of current proposals will remain to be seen, but this is surely an issue which the Parliamentary Committee won’t ignore.
Water companies can probably also expect further scrutiny and intervention on their corporate governance and financing arrangements from both independent regulators and politicians. Much of this is not new to ‘networks’ businesses, particularly those which have been subject to enforced business separation of their operations in various forms including those in the Telecoms, Energy and more recently in the EU, Card Payment Systems sectors. But this could mark a further step in the regulation of water companies.
One key overriding point cuts across all of this which is that the current state of independent economic regulation of utilities, such as water, (and the benefits these stable frameworks can bring) can not be taken for granted. The inherently political and emotive nature of this vital resource, water, means that the control if this resource is subject always to the potential for political intervention in unexpected and disruptive ways.