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Retail competition: The story so far, the journey to come1
Retail competition: The story so far, the journey to comeNovember 2011
www.watercommission.co.uk
Retail competition: The story so far, the journey to come2
Companies, investors and customers stand to benefit from an Anglo-Scottish retail market if we build appropriately on Scotland’s experience.
• Weneedtothinkbigtoaddresstheclearchallengesthatlieahead;thereisaneedtoimprovebusinessflexibilityandefficiencyandallowspaceforinnovation.
• Achievingthiswillrequiremuchmorecollaborationbetweencompanies,moretargetedregulationandrealengagementbetweencompaniesandtheircustomers.
• Measured,smallstepswilldeliverprogressandavoidalienatingeithertheinvestororthecustomer.
• Whyshouldacustomerhavetodealwithupto20+suppliers?
• Whyshouldmoretailored,un-regulatedvalue-addingservicesnotbeavailable?
• InScotland,customerchoiceencouragedinnovation,ledtomoretailoredservicesforalltypesofbusinessandthe publicsector,and,eventhreeyearslater,continuestoreducecosts.
• Environmentalbenefits,includingwaterandeffluentmanagement.
• Costreductionsinretailactivitiestothebenefitofcustomersandinvestors.
• Implementationcostskeptlow.
• Investorsworrylessaboutregulatoryrisk.
• Implementinganymarketframeworktakestime.
• AbespokemarketforEnglandcouldincreasecomplexityinitsimplementationanditsoperation.
• Ourapproach,basedonpracticalexperienceandinvolvingmanyinterestedpartiesinScotland,wouldsimplifyandde-riskimplementation.Itwouldbesupportedbycustomers,somecompanies,manyinvestorsandtheScottishGovernment.
Collaboration not rivalry
Businesses want choice
An Anglo-Scottish market(building appropriately on Scottish experience)
Tried and tested implementation
Retail competition: The story so far, the journey to come3
• Collaboration not rivalry
• Businesses want choice
• An Anglo-Scottish market
• Tried and tested implementation
➜
Retail competition: The story so far, the journey to come4
Economic regulation of the water industry has been very successful. Our success in Scotland results directly from the framework put in place by Government at the privatisation of the industry in England and Wales.
• Ofwat’sregulatoryframework,whichweadoptedinScotland,hadanumberofusefulincentiveproperties. TheseincentivepropertiesencouragedScottishWaterto:
• Reducecosts;
• Investtoimproveservices;and
• Improveservicelevels.
* Review of Ofwat and consumer representation in the water sector,Defra,July2011,page63.
** Financial performance and expenditure of the water companies in England and Wales 2009-10,Ofwat,November2009,page5.
*** Future water and sewerage charges 2010-15: Final determinations,Ofwat,November2009,page96,Figure11.
Scotland
£105lowerthantheywouldotherwisehavebeen
£4.3billionsince2002-03,or£220perbilledhouseholdperyearonaverage
35%reductionfromlevelsin2002
Averagehouseholdbills
Capitalinvested
Operatingcosts
England and Wales
£110lowerthantheywouldotherwise havebeen*
£90billionsince1989**,or£190perbilledhouseholdperyearonaverage
Broadlyflatinrealtermssince1989***
Retail competition: The story so far, the journey to come5
But there are now new challenges facing the water industry.
• Industry financing:Thereisanongoingneedtofinanceinvestment,butcompanybalancesheetsarenowstretchedand, inScotland,availablepublicexpendituremaybemorelimited;
• Walker Review (2009):Affordabilityandlegitimacyofhouseholdwaterchargingisagrowingissue.Upwardpressuresonbillsbecauseofstretchedbalancesheetsarelikelytoreinforcethisissue;
• Climate change and carbon mitigation:UKcommitmenttoreducecarbonemissionsbyatleast34%by2020andatleast 80%by2050*(InScotland,42%by2020and80%by2050**);
• Pitt Review (2008):Floodingandresilienceofthewaternetworkneedsattention;and
• Cave Review (2009):Innovationandcompetitioninwatermarketsshouldbeapartofthesolutionbycontributingto efficiencyandmoresustainableoutcomes.
*DECCwebsite,availableathttp://www.decc.gov.uk/en/content/cms/emissions/carbon_budgets/carbon_budgets.aspx.
** Low Carbon Scotland: Meeting the Emissions Reduction Targets 2010-2022: The Report on Proposals and Policies,ScottishGovernment,March2011.
Retail competition: The story so far, the journey to come6
And there is a continuing need to improve outcomes delivered to customers and our environment. It is not the once and for all challenge that was originally expected.
• “Investment will remain high in the second half of the 1990s, it could revert to more normal levels in the early years of the next century”*
• Investmentinpublichealthandenvironmentalimprovementshascontinuedat highlevels**
Expectation
Reality
• Challengesaroundimprovingresilience,reducingcarbonandmeetingtheWaterFrameworkDirectivewillfurtherstretchbalancesheetsandputanupwardpressureoncustomercharges.Sustainableoutcomesrequirenewapproaches.
Future challenges
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➜
* Future charges for water and sewerage services: the outcome of the Periodic Review,Ofwat,July1994,page24.
** Future water and sewerage charges 2010-15: Final determinations,Ofwat,November2009,Figure9,page67,Figurein2007-08prices.
Retail competition: The story so far, the journey to come7
The financing constraints on the industry have the potential to alienate customers and/or investors.
• Equityfinancemaybeneededtohelppayforfutureimprovements.Overtimecompaniesmayconsideritprudenttoreducetheircurrentlyhighleverage.Thiscouldputanupwardpressureonbills.
• Agreaterportionofcapitalinvestmentwilllikelyneedtobefinanceddirectlyfromcustomerbills(particularlytopayforthegrowingcapitalmaintenanceburden).
• Politicaland/orcustomerpressuretokeepbillsdowncouldleadtheeconomicregulatortoviewthecostofcapitalasaneasyshorttermpalliative,oralternatively;
• Pressuretomaintainreturnscouldforcepriceincreasesthatwouldlikelyhaveanegativeimpactonwillingnesstopay forfutureimprovements.
• Allowing the company to earn a higher return within a lower cost envelope (e.g. from initiatives such as asset rationalisation that reduce the overall cost base).
• Engaging customers in price setting to improve legitimacy and willingness to pay for environmental improvements.
• Committing that all NPV positive projects will be allowed to meet their planned payback.
Potential undesirable responses that could occur
But the regulator can mitigate this risk
Retail competition: The story so far, the journey to come8
• Customers(andotherstakeholders)arenotsufficientlyengagedinpricesetting.
• Pricesettingisablackbox;
• Lackofcustomerinvolvementinpricesettingraisesconcernsaboutthelegitimacyofwatercharges;and
• Defacto,regulatorsdecidewhatcustomerswant.
• Thefixedfiveyearpricecontrolanddeliverycyclemaybebothtooshortandtoolong:
• Tooshort:Initiativeswithlong-termpay-backs(pay-back>lengthofthepricecontrol)areunlikelytobeimplementedbecausesavingswouldbelikelytobepassedtocustomersbeforetheinvestmentreachedpay-back;
• Tooshort:Largecapitalprojectsareunlikelytodivideneatlytofitthefiveyeardeliverycycle–whichcouldlead toinefficientprocurementandexacerbatethestop-startdeliverycycle;and
• Toolong:Flexibilitymayberequiredifprioritieschangewithinthefiveyears.
• Thereisaninherent,defacto,biastowardscapitalsolutionsandtheremaybeabiasagainstpotentiallymorecreative andinnovativesolutions.
• Potentiallylowercostorlowercarbonsolutionsmaybecrowdedoutbecausereturnsareearnedonlyoncapitalinvestment;and
• Regulationcanseekriskelimination;itshould,however,rewardeffectiveriskmanagement.
• Settinganaveragecostofcapitalmayleadtosub-optimaloutcomes.
• Weneedtorecognisethatifwewantcompaniestobemoreinnovativeorpursuelonger-termbenefitsonbehalf ofcustomersandshareholderstheywillrequiredifferentreturnsoncapital;
• Timehorizonsofinvestorsareunlikelytomatchthelengthofthepricecontrol.Re-estimatingthecostofcapital everyfiveyearsincreasesregulatoryriskandthecostofcapital;and
• Themarginalcostofcapitalmaybehigherthantheaverage–particularlyforlargeorinnovativeprojectsoropportunitiesforassetrationalisation.
We believe regulation needs to evolve to meet these future challenges.
Customers
Investment
Finance
Retail competition: The story so far, the journey to come9
To meet these future challenges, we are introducing a number of evolutionary changes to the regulatory framework in Scotland.
• CustomerForumestablishedtonegotiatedirectlywithScottishWater,andmaketrade-offsanddecisions withinthepricesettingprocess;
• Simplifypricesettingtoopenuptheprocesstocustomersandotherstakeholders;and
• Liberalisedmarketfornon-householdshasdeliveredlowerbills,tailoredservicesandmoresustainableoutcomes.
• Focusontotalcosts;removingdefactobiasesarisingfromthedifferentialtreatmentofoperatingandcapitalexpenditure;
• Focusonagreedoutcomes,notonthewaysinwhichtheseoutcomesmightbeexpectedtobedelivered;
• Initiativesshouldearnareturnforthefullperioduntiltheprojecthaspaidback–withinandacrossregulatorycontrolperiods;and
• Rollinginvestmentreviews(separatefrompricereviews)tospecifyinvestmentoutcomesmorefrequently.Thisshouldprovidegreaterflexibilitytorespondtourgentand/orchangingprioritiesandprovidegreaterforwardvisibilitytoplanforlong-termimprovements.
• Introduceanincentiveandmonitoringframework,basedonfinancialreturns,tobuildconfidencethatareasonablereturnwillbeavailableforareasonablelevelofperformanceoverthelong-term.Thiswouldincludeamechanismtoshareexcessreturnswithcustomers;and
• Acceptthatahigherreturnmaybeearnedoninnovativeapproaches,providedtheoverallcosttothecustomerislower.
Customers
Investment
Finance
Retail competition: The story so far, the journey to come10
• Collaboration not rivalry
• Businesses want choice
• An Anglo-Scottish market
• Tried and tested implementation
➜
Retail competition: The story so far, the journey to come11
Experience from Scotland is that choice has improved legitimacy and service. Business customers in England are now demanding the same. They want to exercise choice to have a stronger voice and receive more tailored services.
• AstudybyCCWaterfoundthat84%ofbusinesscustomerssupportedcompetitioninthewaterandsewerageindustry.*
• Thesamestudyalsofoundthatnearlytwo-thirdsofbusinesscustomersthoughttheywerelikelytoswitchifgivenachoice.
• Similarly,Accentfoundthat69%ofSMEbusinessesthoughttheprincipleofcompetitioninthewaterindustrywaseither agoodorverygoodthing.**
• AtarecentsessionofOfwat’sBusinessCustomerForum,therewas“unanimoussupport”forthecreationofasinglecompetitiveretailmarket.***
• Customergroups,suchastheMajorEnergyUsers’Council,havespokenoutontheirdesireforacompetitivemarket tobeestablishedandthebenefitstheyseefrombeingabletochooseoneortwoUK-widesuppliers.****
*Setting Strategic Direction: Competition Research with Business Customers,ConsumerCouncilforWater,June2007,pageiii.
** Small and Medium Business Customer Views on Competition in the Water and Sewerage Industry,Accent,June2010,pagei.
*** Business Customer Forum meeting note,Ofwat,14April2011.
**** Water Competition Action Group,MEUC,4August2011.
Retail competition: The story so far, the journey to come12
Retailers in the Scottish market are providing new and improved services.
• Retailersarenowtailoringtheirservicestomeetthespecificneedsoftheircustomers.Retailersdesigntheirservices aroundtheinterestsoftheircustomersandnotthewholesaler.
• Forexample,retailersworkaroundtheircustomer’sscheduletoavoiddisruptingtheircustomer’sbusiness.
• Satecarrangesforleakstoberepairedandmeterstobereplacedatnightinordertominimizetheimpactontheir restaurantcustomers.
• Retailersareincentivisedtoworkwiththeircustomerstoreduceconsumptionanddischargesinawaythatvertically integratedcompaniesarenot.Retailersmustrespondtotheircustomers’needsorrisklosingthemtoacompetitor.
• Aimeraprovidesregularmanagementinformationthatidentifiesusagetrendsandanyanomalies.Byproactivelyprovidingthisinformation,itscustomersareabletocatchandquicklycorrectanyunexpectedincreasesinconsumption,suchasleaks,andavoidrunninguplargebills.
• Aimerameetswiththeircustomerstoidentifyadditionalwaystoreducebillsandlowerconsumptionthroughservices suchasmeteringunmeteredproperties,fixingleaksanddrippingtaps,andinstallingrainwaterharvesting.
• WithAimera’sassistanceandtheinstallationofrainwaterharvesting,alargecaravanparkwasabletoreduce itsconsumptionby20%.
• Albion,apotentialspecialistlicenceholderinScotland,isworkingwithdevelopersonawater-efficientcommercialandresidentialdevelopment.Thebuildingswillbefittedwitharangeofwatersavingdevicesincludingintegratedgreywaterrecyclingsystems.
Retail competition: The story so far, the journey to come13
Business Stream – the Scottish Water subsidiary – has had not just to sharpen its pencil but to become much more customer focused.
• BusinessStreamisnowproactivelyofferingcustomerswaterefficiencyandconsumptionreductionservicestailoredtothecustomer’sneeds.Theyestimatethattheseserviceshavesavedtheircustomersover£13million,saved7.4billionlitresand reducedCO₂emissionsby8,025tonnes.
• BAESystemswillsaveinexcessof£300,000overthecourseoftheconstructionofthenewaircraftcarriersfromBusinessStream’sleakageandefficiencyservices.
• BusinessStreamoffersallofitscustomersconsolidatede-billing.Thissavescustomersadministrativecostsandmakes itmucheasiertocompareandreduceconsumptionacrosstheirsites.
• ASDAestimatesitsavesover£80,000peryearasaresultofconsolidatede-billing.
• Sinceseparation,BusinessStreamhasintroducedawiderangeofnewservicesandproductsthatitdidnotofferinthepast–fromautomatedmeterreadingstotariffoptimisationandcarbonefficiencyadvice.Someoftheseserviceshavebeenintroducedatthecustomer’srequest.
• Aspartofitswinningbid,BusinessStreamisprovidingfreeautomatedmeterreadingservicestotheScottishpublicsector.
• BusinessStreamhasintroducedagainshareschemewhereitfundswaterefficiencyimprovementsandsharesthesavings withthecustomer.
• GlasgowCityCouncilestimatesitwillsave£1millionayearasaresult,withouttheneedforup-frontcapitalexpenditure.
Retail competition: The story so far, the journey to come14
In England there is potentially even greater scope for an improved customer experience because many non-household organisations have to interact with more than 20 water and sewerage providers.
• Thisisnotuncommon.Forexample:retailers,restaurantgroups,hotels,thePostOffice,otherutilities,banksand governmentorganisations.
• Evenorganisationslocatedinjustonegeographicareacouldhavetodealwithmanywaterandseweragesuppliers.
• InKentaloneitispossibletobeservedbyfivedifferentcompanies(Southern,SouthEast,VeoliaWaterSoutheast, ThamesandSutton&EastSurrey).
• EssexCountyCouncilwouldhavetodealwithfivesuppliers(Anglian,Thames,EssexandSuffolk,VeoliaWaterEast, VeoliaWaterCentral).
• Ifacustomerwantstotrysomethinginnovativetosavemoneyorbecomegreener,suchasinstallingsmartmetersat allofitslocations,notonlywilltheyneedtoworkwithmorethan20companiestomakeitpossible,buttheyareunlikely toseeanyconsistencyinapproach.
• Eachwatercompanyhasitsownprocessesandproceduresforcustomerfacingactivities.
• Thiscreatesadditionaladministrativecostsforcustomersastheymustuse20+processestointeractwiththeirsuppliers.
Retail competition: The story so far, the journey to come15
• Collaboration not rivalry
• Businesses want choice
• An Anglo-Scottish market
• Tried and tested implementation
➜
Retail competition: The story so far, the journey to come16
Our experience in Scotland is that retail competition has created value.
• TheCommissionspent£5.7m(fundedbygrant).
• TheScottishWaterGroupspent£13.6m.Thiswascapitalised.
• CMAsetupcostswere£3.2m.
Set up costs
• Regulator’slevyof£1.2m.
• CMAcostsof£2.5m.
• Extracostofcapitalof£0.7m.
Ongoing costs
• AssumingBusinessStreamwouldhaveimprovedatthesamerateasScottishWatersince2006-07,ithasfurtherreducedcostsby£8.1mperyear.
• NosavingsachievedbyScottishWaterhavebeenincluded.
Current savings
achieved
• Incrementalretailefficiencies(1%peryear).
• Incrementalwholesaleefficiencies(0.05%peryear).
Savings from dynamic efficiency
PV of cash spent & savings already
realised
PV of all costs & savings if no
further efficiencies
PV of all costs & savings with
dynamic efficiency
-£22m -£22m -£22m
-£9m -£119m -£119m
+£18m +£279m +£279m
+£110m
+£85m
-£13m +£138m +£333mNPV
Retail competition: The story so far, the journey to come17
The introduction of retail competition in Scotland pays back in 7 years.
Pays back in 7 years
NPV = £333m➜
➜
Today
Retail competition: The story so far, the journey to come18
Adjusted by non-household revenue, Scottish Water’s retail costs were already lower than those of most companies, but after separation, Business Stream achieved further savings.
* Source:InformationforEnglandandWalesisfromJune Return 2009-10,Ofwat,2010,table21b(operatingcostsanddepreciation)andtable23(revenue).CostinformationforBusinessStreamisfromRetail competition in Scotland: An audit trail of the costs incurred and savings achieved,WaterIndustryCommissionforScotland,April2011,tables13 and17.RevenueforBusinessStreamisfromAnnual Report and Accounts 2009-10,BusinessStream,2010.
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
YorkshireWater
SouthWestWater
/nite1/2li2es
AnglianWater
SouthernWater
ThamesWater
DŵrCymru
AverageWASC
S=o>shWaterbaseline
WessexWater
SevernTrent
BusinessStream
NorthumbrianWater
!on$householdre-./lo0er.1n23os-s/n3lud/n2de0re3/.1on.s.0er3en-.2eo4non$
householdrevenue*• PriortoseparationScottishWater’scostsalreadycomparedwellwithmanywatercompanies;
• Nevertheless,BusinessStreamfoundsignificantcostsavings;
• Northumbrian’sleadingpositionmaybeexplainedbyitsparticularmixofindustrialcustomersanditsownershipofEssex&SuffolkWater;
• SevernTrent’slowcostsappeartoresultfromitallocatingonly12.5%ofretailcoststonon-households(industrynormis17-23%);and
• WessexWaterhasajointventurewithBristolWater(setupin2001)forretailactivities,withafocusonreducingbaddebt.
Retail competition: The story so far, the journey to come19
Similar benefits could flow to customers in England from opening up the retail market to competition.
Present value of all costs and savings without dynamic
efficiency
Present value of all costs and savings
with dynamic efficiency
-£182m -£182m
-£529m -£529m
+£1479m +£1479m
+£988m
+£734m
+£768m +£2.5bnNPV
• Assumenomergers.
• Assumeonaveragecompaniesachieve2/3rdsofthesavingsachievedbyBusinessStream.
Ongoing cost reductions
• Incrementalretailefficiencies(1%peryear).
• Incrementalwholesaleefficiencies(0.05%peryear).Dynamic efficiency
Set up costs
• Assumeconservativelythatcompaniessouthoftheborderincursamecostsper non-householdcustomer:• Noallowanceforcodesalreadyworking.• Noallowanceforexperiencealreadyearned.
• AssumeCMAtobefitforpurposeforpan-GBmarket:£10mnewexpenditure.• AssumeOfwatcoststoimplementframework:£8mnewexpenditure.
Ongoing costs
• AssumeCMAoperatingcostsincreaseto£10mperyear–a£7.5mincrement.
• AssumeextracostsforOfwatof£2mayear.
• Assumeextracostsofcapitalallowanceof£6mayear.
Retail competition: The story so far, the journey to come20
Based on costs incurred in Scotland, introducing retail competition in England could have a positive NPV of £2.5 billion and pay back in 7 years.
Pays back in 7 years
➜
NPV = £2.5bn➜
Retail competition: The story so far, the journey to come21
Following the Cave review, a number of consultants, hired by the water industry, have published reports on the costs and benefits of introducing retail competition in the industry.
• Deloitte (February 2011)*
• Deloitte’sanalysisofthecostsandbenefitsofretailcompetitionreliedonestimatesofcostsratherthantheobserved evidencefromScotland.
• Oxera report for UKWIR (June 2011)**
• OxeraquestionedtheassumptionsusedintheCaveReview’scostbenefit.
• OxeraformallyretractedcommentsmadeinthereportandissuedanapologytoProfessorCave.
• Deloitte (September 2011)***
• Deloitterecentlyissuedanupdatetotheirpreviouspaperwhichclaimedtherewouldbenobenefitfromintroducing retailcompetitioninEngland.
* Lessons for the water and sewerage industry from retail competition in the utility sector,Deloitte,February2011.
** The cost-benefit analysis knowledge base,Oxera,June2011.
*** Competition vs regulation?,Deloitte,September2011.
Retail competition: The story so far, the journey to come22
In its most recent article, Deloitte compares non-household retail costs by customer between companies to suggest that retail competition on its own will not bring benefits.
1.Deloitte’scomparisonincludesBusinessStream’sfinancingcosts,whicharenotincludedinthecompanies’numbers–overstatingBusinessStream’scostsby£28.2.DeloitteappearstouseanoutofdateestimateofthenumberofcustomersservedbyBusinessStream–overstatingBusinessStream’scostsbyafurther£8.3.TheDeloitteanalysisincludesthecostsofprovidingnewadditionalbilledservicesnotprovidedinEnglandandWales.4.BusinessStreamincurscostsinacquiringandretainingcustomersandindevelopingitsbrand.5.BusinessStreamalsoincurscostsofcompetitioninScotlandandcostsinseekingnewcustomersinEnglandandWales.
However, this article includes a number of errors.
➜
Retail competition: The story so far, the journey to come23
Given that it incurs the extra costs of operating in a competitive market, Business Stream is a clear market leader. It is the benchmark which other companies will have to match.
• BusinessStream’scostsarearound40%lowerthantheaveragelevel,whenexpressedasaproportionofrevenue, comparedto25%,whenexpressedpercustomer.
*Thecostsofwateronlycompaniesareincludedwiththeirrespectivewaterandseweragecompanies,inlinewithDeloitte’smethodofcomparison.TheresultsforAnglianWaterandNorthumbrianWaterreflecttwodifferentpossiblewaysofmakingacorrectiontoDeloitte’sanalysis.
Retail competition: The story so far, the journey to come24
Based on these comparisons, the companies in England and Wales only have to achieve between and third and a half of the savings made by Business Stream to cover all the costs of introducing retail competition. Before account is taken of the potentially substantial benefits...
Retail competition: The story so far, the journey to come25
There are many such potential benefits which we have not included in this cost analysis.
• Moretailoredcustomerservice;
• Theavailabilityofnewservices,includingtargetedwaterefficiency;
• Improvedsatisfaction;
• Additionalcustomerlegitimacy;
• Theopportunityfornon-householdcustomerstoswitchsupplier;and
• Thepotentialforanimprovedandlessbureaucraticregulatoryregime(ashasresultedinScotland).
Retail competition: The story so far, the journey to come26
A competitive market in England will benefit both customers and companies.
• ASDAestimatesconsolidatede-billingsavesitover£80,000peryearonadministrativecostsinScotland.Ifthiswasavailable UK-wide,theycouldsavebetween£500,000and£600,000.
• ScalingthesavingsachievedbyASDAtothe5largestretailersintheUKleadstoestimatedsavingsofaround£10mperyear inprocessingandadministrationcosts.
• B&QwasabletoreduceitsannualwaterconsumptionatitsScottishstoresbyover£20,000withthehelpofBusinessStream. IfitmadethesamesavingsUK-wide,itcouldsaveover£200,000worthofwaterperyearandreduceitscarbonfootprint.
• BasedonsavingsachievedbyB&Q,theother4majorDIYretailerscouldstandtoachieveestimatedsavingsofaround£700,000.
• PolicyExchangealsocitesexamplesofhowcustomersbelievetheycouldbenefitfromacompetitivemarketinwater*:
• Havingoneortwosupplierswouldbring“electronicbilling,assignedpointsofcontact,awillingnesstoresolveissues withoutthethreatofdisconnection,lesstimespentdealingwithqueries.”
• Acustomernotesthatwithanationalsupplier“therewouldbeloweradministrationcostsandeasierco-ordination, thesupplier’sobjectiveswouldbebetteralignedwiththecustomer,and‘gainshare’dealsonimprovingleakageand waterefficiencywouldbeeasiertoarrange.”
*Water retail services competition in England and Wales: Still Hobson’s choice?,PolicyExchange,July2011,pages7and13.
Retail competition: The story so far, the journey to come27
• Collaboration not rivalry
• Businesses want choice
• An Anglo-Scottish market
• Tried and tested implementation➜
Retail competition: The story so far, the journey to come28
There were three important lessons that we learned from establishing a retail framework in Scotland.
1. WorkingcloselywithScottishWater,itsnewretailsubsidiary,potentialnewentrantsand otherinterestedpartieswasessential.
2. Theremustbeaworkableplanthatminimisescostsandrisks.
3. Thereneedstobeacleardatesetformarketopening:thisisessentialsothatallparties maintainasingle-mindedfocusondelivery.
Retail competition: The story so far, the journey to come29
Based on our experience in Scotland, it would take time for the retail market to be fully opened in England.
Ourpricereviewidentifiedopportunitiesandthreatsofcompetitioninthewaterindustry
ConsultationbyScottishExecutiveandpolicy development
Resourceplandeveloped
WaterServices(Scotland)Act
FinalDeterminationfor2006-10
WholesaleServicesAgreementandOperationalCode
DevelopmentoftheCentralMarketAgencyandmarketcode
Wholesalechargesschemedefined
Marketopening
2001
2002-03
2004
2005
November2005
Summer2006
2006-07
2007
April2008
➜
England appears to be at this stage
➜
Retail competition: The story so far, the journey to come30
Some of the activities that need to be completed before market opening are complicated and time consuming. Since there are limited opportunities to complete them in parallel, a constructive dialogue needs to be maintained.
Companies(lead),regulator
Regulator(lead),companies
Regulator(lead),companies
Regulator
Companies,regulator
Regulator(lead),companiesandpotentialentrants
Allmarketparticipants
Developoperationalcodesandtemplatewholesaleservicesagreement
Developgovernanceandmarketcodes
EstablishCMAandpopulatemarketsystems
Setrevenuerequirementforretail
Preparewholesalechargesandsetdefaulttariffs
Developandfinaliselicensingprocesses
Systemstesting
Year 1 Year 2 Year 3 Year 4 Year 5 Market opening
Activity Organisations involved
➜1 year
➜1 year
➜1 year
➜2 years
➜½ to 1 year
➜3 years
Retail competition: The story so far, the journey to come31
However, building on our experience could simplify and de-risk implementation and minimise costs.
• TheScottishexperienceisbothscalableandadaptabletothechallengesthatmayariseduringthecreationandoperation ofanEnglishmarket.
• KeyteammembersinvolvedinestablishingthemarketinScotlandwouldbeabletoassistinthecreationofasimilarmarket inEngland(e.g.thelegalteam,CommissionstaffandtheCMA).
• TheexperienceofestablishingtheScottishmarketprovidesanexampleofhowtogettheregulator,theincumbentwholesaler,potentialretailersandotherstakeholdersboughtintotheprocess.Allofthepartiesworkedtogetherconstructivelytoopenthemarketonschedule.
• TheWholesaleChargesSchemewasdevelopedbyScottishWaterandtheCommissionworkingtogethertounderstand ScottishWater’swholesalecosts.
• TheMarketCodeandOperationalCodewerecreatedinconsultationwiththeLicensingFrameworkImplementationGroup,whichincludedpotentialmarketparticipantsandotherstakeholders,suchassomeoftheEnglishcompanies.
• TheCMAwascreatedonscheduleandatalowercostthanmanypotentialsuppliersbid.
Retail competition: The story so far, the journey to come32
The Scottish experience presents an opportunity to reduce the risk and cost of operating a retail market.
• TheproceduresoftheScottishmarketaretriedandtestedandhavebeenshowntoberobustenoughtoworkeven throughtwoveryseverewinters.
• TheScottishmarketframeworkensuredthatnocustomerlostmoneywhenoneearlyentrantfailed.
• TheScottishmarkethasalreadyidentifiedandresolvedmanyoftheday-to-dayissuesanEnglishmarketwouldface.
• TheCMA’sTechnicalPanel,whichScottishWaterandtheLicensedProvidersaremembersof,providesthemwith theopportunitytoproposeandapprovesolutionstomarketissuestheyhaveidentified.
• TheOperationalCodehasbeentestedbythreeyearsofactualwholesalerandretailerinteractions.
• TheCMA’ssystemshaveprovencapableofmaintainingtheregistryofsome140,000waterandseweragecustomers andprocessingthesettlementforthem.Settlementhastoberegionalbecausewholesalechargesareregional, butthesettlementsystemsshouldbewithintheoneorganisation.
• TheScottishmarkethasshownitworksforallnon-householdcustomers,fromlargeurbancustomerstosmallremote ruralones.
Retail competition: The story so far, the journey to come33
Investors in the English water industry agree that reforms along the lines of the Scottish experience could benefit companies and their shareholders.
J.P.Morgannoted: “Our impression... is that a restructuring of the England and Wales water sector in line with Scotland could create opportunities for the companies to realise value from their retail businesses which under current regulation are just a cost centre.
• The key building blocks of the reform (the Scottish experience) were:
• The RCV was not subdivided, it all went with the wholesale business;
• The WACC was not changed;
• The retail providers pre-pay the wholesale charges (hence taking the bad debt risk)...”
Liberum Capital noted: “Many thanks for coming [to] our investor lunch yesterday. I have had some very positive feedback from the meeting. The clients included some large investors in the water industry including Fidelity, Barings, UBS amongst others and I think you might have helped in convincing them that the introduction of competition is not necessarily a bad thing…”
Retail competition: The story so far, the journey to come34
Based on our experience and dialogue with companies and their investors, eight principles seem to be important.
1. Government,theregulatorandthecompaniesneedtoworktogethertointroduceretailcompetitioninalowrisk,practicalway.Therealsoneedstobemovementtowardsmoreconstructiveengagementbetweencompaniesandtheircustomers.
2. Thetimelineformarketopening,includinganytrialorshadowoperation,needstobalancemovingquicklywithensuring thatthearrangementsarerobust–ittookusaroundfiveyearstocompletetheprojectfromfirststepstomarketopening inApril2008.
3. TheRCVandassociatedreturnsofthewatercompaniesshouldbeallocatedinfulltothewholesalesideofthebusinessandfuturewholesalepricesshouldbeadjustedtoensurethattheimpactofretailcompetitiononthatbusinesswillbeNPVneutral.
4. Thereshouldbeanadditionalreturnoncapitalavailabletotheseparatedretailbusinesstoreflectitsriskandallowittostandaloneinthemarket.
5. Theretailbusinessshouldbeartherisksassociatedwithbaddebtsandreceivablesbecauseitisbestplacedtomanagethem.
6. Theretailbusinessshouldpre-paythewholesalerwherethewholesalerconsidersthattobenecessary,makingiteasiertolicensenewentrantsandavoidingtheriskthataninferiorcreditreplacesatop-notchcreditintheexposureofthewholesalebusiness.
7. TheplayingfieldshouldbedemonstrablylevelwithregulatedaccesstothenetworkandaGovernanceCodecoveringeachincumbent’sretailandwholesalebusinesses;thecontentsofeachGovernanceCodebeingdependentontheextenttowhichtheregulator,otherentrantsandcustomerscanbesatisfiedthatalevelplayingfieldexists.
8. Theretailbusinessmustbeabletobenefitfromtheeconomiesofscaleinherenttosuchoperations;inEnglandthiswouldmeanallowingmergersbetweenretailcompanies.
Retail competition: The story so far, the journey to come35
Building on what has been created in Scotland, and adapting appropriately for a larger market, could minimise costs and risks and reduce lead times.
• ThewaterindustryinScotlandisdifferentfromtheindustrysouthoftheborderonlyinitsownership:inotherrespectsitsactivitiesaresimilartoothercompaniesinotherareasofGB.
• Retailcompetitionispartofapackageofregulatoryreformstoempowercustomers,enhanceincentivesandencourageinnovationtothebenefitofbothcustomersandinvestors.
• Retailcompetitioncan,ifpursuedjudicially,bothreduceriskinthewholesalebusinessand createvalue.
• Offeringnon-householdcustomerschoicewillincreasethelegitimacyofwaterchargesand reducepoliticalandregulatoryrisk.
Water Industry Commission for ScotlandFirstFloor,MorayHouse,ForthsideWay,StirlingFK81QZE:enquiries@watercommission.co.ukT:+44(0)1786430200
www.watercommission.co.uk
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