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Competition and EconomicRegulation in Water

The Future of the European Water Industry

Tony Balance and Andrew Taylor

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Published by IWA Publishing, Alliance House, 12 Caxton Street, London SW1H 0QS, UK

Telephone: +44(0)20 7654 5500; Fax:+44(0) 20 7654 5555; Email: [email protected]

Web: www.iwapublishing.com

First published 2005

C© 2005 IWA Publishing

Copy-edited and typeset by TechBooks, India

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concerning reproduction outside the terms stated here should be sent to IWA Publishing at the

address printed above.

The publisher makes no representation, express or implied, with regard to the accuracy of the

information contained in this book and cannot accept any legal responsibility or liability for errors or

omissions that may be made.

Disclaimer

The information provided and the opinions given in this publication are not necessarily those of IWA

or of the editors, and should not be acted upon without independent consideration and professional

advice. IWA and the editors will not accept responsibility for any loss or damage suffered by any

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ISBN: 1 84339 049 3

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Contents

1 Introduction 1

2 Water industry fundamentals: the rationale for regulation and thescope for competition 42.1 Key issues in natural monopoly regulation 42.2 Potential for competition in water services 92.3 Are there any successful models of water competition? 172.4 Water as a natural monopoly? A few conclusions 18

3 A framework for evaluating different models of water industryregulation 203.1 Sector performance criteria 213.2 Regulatory process performance criteria 243.3 Institutional design criteria 27

4 England & Wales: private ownership and independent regulation 294.1 Overview of the water and wastewater industry in

England & Wales 294.2 Water sector regulatory institutions 324.3 Key issues in economic regulation in England & Wales 354.4 Strengths and weaknesses of the regulatory regime for water

in England & Wales 544.5 Directions for future reform 74

5 France: competition for the market and contract-based regulation 825.1 Overview of the French water and wastewater industry 825.2 Structure of private sector participation 855.3 Distribution of water sector regulatory authority 875.4 Regulation of private sector participation in the water sector 89

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5.5 Strengths and weaknesses of the regulatory regime for waterin France 94

5.6 Direction of future reforms 105

6 Germany: public–private partnerships and multi-sector utilities 1086.1 Overview of the German water and wastewater industry 1086.2 The role of the Stadtwerke: multi-sector utility enterprises 1116.3 Models of private sector participation 1126.4 Distribution of regulatory authority 1146.5 Economic regulation 1156.6 Strengths and weaknesses of the regulatory regime for

water in Germany 1166.7 Direction of future reforms 119

7 Developing water sector regulatory frameworks in lessdeveloped countries 1217.1 Regulation ‘by contract’ 1227.2 Contracts, institutions and regulation 1237.3 Conclusion 126

Appendix 1: The legislative framework for the water industryin England & Wales 127

Bibliography 135

Index 143

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1

Introduction

In the past 25 years there have been radical changes in the approach to public policyfor infrastructure industries worldwide. Issues of natural monopoly, competition,regulation and the appropriate role for the public and private sectors, have beenrethought leading to extensive industry restructuring and privatisation, and often,the establishment of new regulatory agencies.

The telecommunications industry led the way in these developments as newtechnologies, and the competition they made possible from new entrants into thesector, rendered past policies redundant. The electricity sector followed closelybehind with governments unbundling their publicly owned, vertically integratedutilities to promote competition in generation and retailing, while providing formore effective regulation of the natural monopoly components of the sector intransmission and distribution. Similar developments were also seen in the gassector. In Europe, the European Commission played a major role in promoting andinstituting these reforms in its member states, and the accession states, throughthe formulation of directives at the European level that would require industryunbundling and the licensing of new industry entrants.

The water sector in Europe, and internationally, has not been untouched bythese developments. However, unlike the telecommunications and electricity sec-tors, where there is a large degree of consensus among sector policy makers andexpert advisers regarding the desirable degree of industry unbundling, arrange-ments for promoting competition, the role of the public and private sectors, andthe institutional arrangements for industry regulation, there is nothing like thesame degree of consensus in the water industry.

C© 2005 IWA Publishing. Competition and Economic Regulation in Water: The Future of the European Water

Industry by Tony Ballance and Andrew Taylor. Published by IWA Publishing, London, UK. ISBN: 1 84339 049 3.

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2 Competition and Economic Regulation in Water

Different countries in Europe have pursued different models of organisationin the water sector, and unlike in the telecommunications and electricity sectors,the European Commission is yet to involve itself with these issues, limiting itselfto developing directives concerned with water and environmental quality and thebroader regulation of water resource use rather than the narrower issue of waterutility regulation.1 There is clearly much here that is of interest to industry observersand policy makers. Why have different countries developed different models ofindustry structure, regulation and private sector participation?

In writing a book to address these issues we have also sought to fill an obviousgap in the literature on infrastructure regulation and reform. While there are manybooks on telecommunications and electricity sector competition and regulation,we are not aware of any that address the same issues in the water sector.

This book starts by examining the fundamentals of water sector organisation,in the light of the developments in thinking regarding natural monopoly and com-petition that have been so influential in the telecommunications and electricitysectors, to assess the feasibility of introducing competition into the water sector. Itthen goes on to look at how water sector regulation has developed in three majorEuropean countries: England & Wales, France and Germany. We finish by drawingconclusions for water sector reform in other countries based on the experience ofthese three countries.

In undertaking our review of water sector regulation in England & Wales,France and Germany, we have sought to use a common framework for assessingthe strengths and weaknesses of these regimes. We set this intellectual frameworkout in the chapter preceding our country reviews. Our review of the water industryin each of the three countries follows a similar structure but differences in substan-tive issues of industry organisation and regulation make for variation as well. Alsocontributing to the variation in these case studies is the extent to which empiri-cal data on industry performance are available. This varies substantially betweencountries and is, indeed, part of the story of regulation in these countries.

We selected the water industries in England & Wales, France and Germany asthe subjects for this book on fairly straightforward grounds. The water industriesin England & Wales and France are the industry models most commonly referredto in public debates in many countries regarding the appropriate model for watersector reform. This no doubt reflects the extensive private sector participation in thewater industry in France over a long period of time, at a time when many countrieshave been considering how to introduce the private sector into their own waterindustries, as well as the relative stability of that structure. In the case of England &Wales, it reflects its experience as a first-mover in water sector reform with the

1 This is not to say that the European Commission will not play a larger role in the structure of the watersector in the future. The report on Internal Market Strategy Priorities 2003–06 had identified the watersector as an area for further action. This could potentially lead to a requirement for all municipalauthorities to conduct competitive tenders for water services, including those currently under publicmanagement. However, in 2004 the European Parliament passed a resolution that the water sectorshould be exempt from internal market rules. This resolution means that the Commission’s actionsto liberalise entry into the water sector in the near future are somewhat less likely.

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Introduction 3

privatisation of the water industry in 1989 and the establishment of an independentwater industry regulator in Ofwat. The international scope of activities of Frenchand English water companies has also contributed to the international interest inthe domestic industries that have produced these companies.

There has been less focus internationally on developments in the German watersector. However, this has been changing gradually with the growing internationalprofile of German water utilities. Further, as water sector reformers in other coun-tries have become more familiar with the experience of water sector reform inEngland & Wales and France, they have started to look further afield for alterna-tive approaches to water sector reform that can inform their own policy making.The joint venture model between municipal authorities and private companies thatis a feature of private involvement in the German water industry has already beenadopted in a number of jurisdictions.

The choice of these three countries as the focus for this book is not to say thatthere have not been interesting and important developments in the water indus-tries of other European countries. Portugal has established its own national waterindustry regulator and is seeking to promote greater industry efficiency, while ac-commodating different policy and operational responsibilities at the national andmunicipal level. Italy continues to pursue industry consolidation and increasedprivate sector participation, while the Netherlands remains committed to a modelof public service provision through corporatised water utilities. In Scotland, theindustry remains under public ownership but with a significant level of contractingout to the private sector and is overseen by a relatively independent water industryregulator. In some countries though, reforms are still at too early a stage for prof-itable analysis to be undertaken and conclusions drawn regarding the strengths andweaknesses of these industry models.

Our book does not seek to draw definitive conclusions regarding the superiorityof any one particular model of industry organisation over another, or the mostappropriate direction for the European water industry, but rather to provide acontribution to public debate. Hopefully, in writing this book we will encourageothers to respond with their own analysis and conclusions regarding the waterindustry not only in the three countries we have included here but also in the otherEuropean countries, which the constraints of time and space did not allow us toexamine here.

This book has grown out of a number of research projects that we, the authors,have undertaken and articles we have written over the past few years. These in-clude an earlier review of water industry regulation in England & Wales, France andGermany written in 2000, articles written for Water 21, the magazine of the Interna-tional Water Association, in 2002 and 2003, and a further review of water industrydevelopments in England & Wales in 2003. Over this time our thinking in relationto many of the issues that we discuss in this book has developed as we have benefitedfrom the comments of various readers of our work. We would like to thank all thosewho have provided feedback on these earlier articles. In particular, we would like tothank our colleagues Dr Scott Reid and Ms Lisa Sayer for their invaluable help andinputs. Responsibility for the contents of this book, of course, remains our own.

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Isbn1843390493 Contents