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Valuing every dropHow can we encourage efficiency and innovation in

water supply?

Water today, water tomorrow

www.ofwat.gov.uk

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Valuing every drop how can we encourage efciency and innovation in water supply?

This is one of a series ofoccasional focus reports.

It highlights the work we

are doing on a particular

policy area, with the aim of

encouraging wider debate

and discussion.

Contents

1. Serving customers, protecting the environment 3

2. Identifying the problems 8

3. Tackling root causes a long-term strategy 13

4. The immediate next steps 20

5. Further information 23

2 Contents

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Serving customers, protecting the environment 3

1. Serving customers, protecting the environment

Water supply is an essentialservice. We depend on it in our

daily lives. So, we need to be able

to rely on it. By and large, the water

sector in England and Wales has

delivered a reliable service. For

example, in the 23 years since

privatisation in 1989, 12 companies

have not imposed a hosepipeban at any time. And no individual

company has had to impose a ban

more than three times.

We expect that the sector will

continue to deliver a reliable

service in the future. But our

water resources are coming under

increasingpressure. We

need new

solutions to

make sure that,

while delivering

a reliable

service, the sector also protects the

environment and keeps customersbills as low as possible.

The water sector has delivered

signicant environmental

improvements since privatisation.

For example, it has carried out

investigations and actions at

more than 200 sites to reduce the

damaging impacts of abstraction

(the process of taking water out ofthe environment). This has helped

to improve river quality. Under the

Environment Agencys General

Quality Assessment, 72% of

English and 88% of Welsh rivers

are now rated good or excellent,

compared with 55% and 79%

respectively in 1990. We challenged

the companies we regulate to

make sure that they made these

improvements while providing value

for money. So, customers bills are

about a third lower on average than

they would have been without our

regulation.

But we must all do better in the

way that we plan for, source and

use water. Some of our rivers are

already running dry. Climate change

will alter our weather patterns,

which could leave us with even less

water where and when we need it

in the future.

By and large, the water sector in

England and Wales has delivered

a reliable service

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4 Serving customers, protecting the environment

Water resources in the south-east

The Water Resources in the South East of England (WRSE) Group

currently comprises the Environment Agency, Ofwat and seven water

companies operating in the region. Other licensed water companies

are also eligible to join. Defra, the Consumer Council for Water and

Severn Trent Water all have observers on the group.

It aims to identify and assess options to balance water supply and

demand in the south-east. It takes account of the potential to deliver

better outcomes for customers and the environment by sharing

resources and trading water. Companies in the region can then

consider these options when they develop their own water resource

management plans.

The groups 2010 report suggested that water companies in the

south-east could save about 500 million over the next 25 years

by developing shared rather than independent solutions.

Earlier reports identied a case for connecting water distribution

networks so that four of the companies in the region could trade

water. The companies implemented these proposals, securingsupplies more sustainably and bringing some cost savings for

their customers.
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For example, since autumn 2010we have experienced by and large

a prolonged dry spell. As a result,

some water companies have been

granted drought orders and permits

for parts of eastern and south-east

England.

Population growth and changinglifestyles could increase demand

in some regions, exacerbating the

problem. Projections from the Ofce

of National Statistics show that the

population of England and Wales

could grow from about 55 million

in 2010, to more than 63 million by

2030 an extra 8 million people.

The south-east of England alone

could see 1.4 million more people

over the same period.

We describe the problems in detail

in The case for change reforming

water abstraction management inEngland, a joint report from the

Environment Agency and Ofwat,

published in December 2011.

Even without these challenges,

evidence suggests that we do not

Being more efficient with water

at every stage of the value

chain would help protect theenvironment and make better use

of customers money

always make thebest use of our

water resources.

For example,

we could move

more water from

areas where there is a surplus to

those where it is in short supply.In Harnessing upstream water

markets whats to play for?, which

we published in March 2010, we

estimated that trading water could

save 960 million, compared with

the cost of developing new supplies.

There is also scope for many of

us to use less water. In the east

of England, Veolia Water Easts

customers use fewer than 120

litres of water per person each

day on average. By contrast, the

average across England and Wales

is about 150 litres per person eachday. Consumers can use less

water without giving up the health,

business and recreational benets

they enjoy. They just need to waste

less. Waterwise, an independent

authority on water efciency,

provides a wealth of information on

its website to help household and

non-household consumers use

less water.
http://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdf

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6 Serving customers, protecting the environment

The water companies needto control leakage effectively.

Consumers rightly expect their

suppliers to minimise leakage.

It sends the right signal about

valuing water, and promotes

positive attitudes towards using

this precious resource wisely. So,

while the companies have reducedleakage signicantly since the

mid-1990s, they need to maintain

this momentum as water becomes

increasingly valuable.

Being more efcient with water

at every stage of the value

chain from resources, through

delivery, to the water that we

all use would help protect the

environment and make better use

of customers money (see text box

on page 7). Improvements would

make a difference now. They are

also essential if we are to meetfuture challenges most effectively.

We need new solutions from

Government, from regulators,

from thecompanies,

and from us as

customers as

well.

Traditionally,

Government

and regulatorshave responded

to individual

problems, such

as leakage,

with individual

solutions including leakage

targets. This has often led to a

detailed regulatory approach,

which can stie innovation and

distract regulated companies from

delivering the best outcomes for

customers. It makes more sense to

nd sustainable solutions that tackle

the root causes of any problems.

In this document, we discuss what

those root causes might be, and

how we need to change to achieve

the best outcomes for customers

and the environment.

The UK Governments Water White

Paper, Water for Life, published

in December 2011, sets out some

possible solutions for England. The

Welsh Government is expecting to

publish its own strategic policy for

water during 2012. Everyone has arole to play. This document is mainly

about Ofwats role.
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Understanding the water value chain

Abstraction

We get most of our water from sources like rivers, reservoirs and underground aquifers

(or groundwater). To take water out of the environment (to abstract it) the companies and

other water users like farmers and industry need to have a licence. They must also

pay the Environment Agency an administration fee for these licences. Collectively, we

take about 55 billion litres of fresh water out of the environment each day. We use about

16 billion litres of this for public supplies. The rest is mainly used by the energy sector,

farming and other industries.

Treatment, storage and distribution

The water we use each day is treated to a high standard, stored, and pumped through

more than 338,000 km of pipes to where it is needed. To make sure that we can rely

on these supplies, each company maintains and updates a 25-year water resourcemanagement plan. It selects a range of solutions that will secure water supplies at the

best value for customers and the environment. These can include developing or trading

water resources, and managing demand by installing water meters or xing more leaks.

Consumption

Each of us uses about 150 litres of water a day on average in our homes. We also use

water at work, in our public spaces and places of leisure. As well as supplying water andtaking away wastewater, the companies are responsible for:

reading our water meters (about 40% of households have one);

sending us bills;

providing us with water efciency advice; and

responding to any complaints or enquiries we have.

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8 Identifying the problems

2. Identifying the problems

If we are to deliver improvements,

rst we need to identify any

problems with the current

arrangements. Then we need to

decide how best to tackle them.

We describe some of the key

issues below.

Over-abstractionThe Environment Agency considers

that river ows in England are

potentially too low to support a good

standard for local plants and wildlife

in up to 11% of rivers and lakes.

And 35% of groundwater sources

are over-stretched.

Unused licences

Environment Agency research

in 2008 found that licence

holders abstracted only 40%

of their licensed volumes in

England. Leaving this water in the

environment could obviouslyhelp where the environment is

already under stress. And some

abstractors have good reason

to keep their unused licences as

valuable back-up. But holding on to

licences could be inefcient if the

water would have more value to

other users.

Missed opportunities to share

resources

At the moment, only about 4%

of the public water supply is

transferred between company

regions. Why do the companies not

trade more? The cost of transferring

water in bulk is certainly one factor.

Yet the analysis we carried outfor Harnessing upstream water

markets whats to play for? took

account of these transfer costs,

and still found signicant potential

savings from redistributing water

from areas of surplus to areas

where it is in short supply.

Inefficient investment in new

resources

Missed opportunities to share

resources are one example of

inefcient investment. But there are

other reasons to question whether

the companies are investingefciently. Some stakeholders

have argued that the companies

suffer from a bias towards

schemes that require signicant

capital investment reservoirs, for

example. We considered this in our

discussion paper on Capex bias in

the water and sewerage sectors in

England and Wales substance,

perception or myth?. We found that

our regulatory incentives may cause

the companies to prefer either

operating or capital expenditure

unduly, depending on their

individual circumstances. And we

identied other possible sources of

bias including a company culturethat favours engineering solutions

and low risk.

Concerns about leakage

Leakage is often regarded as

synonymous with waste. Yet it is

actually wasteful to reduce leakage

when the costs of doing so are

greater than the costs of increasing

supply or reducing demand by other

means. We want the companies

to manage leakage down to levels

that are neither wastefully high nor

wastefully low. But in the early 1990s

when they were free to manageleakage as they saw t many

allowed levels to rise unacceptably.

Since 1997, we have set targets that

have seen total leakage fall by more

than a third. We are considering

whether leakage regulation and

management need to change to

deliver further improvements.
http://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdf

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Water efficiency targets

We have set the companies targets for the work they must do to help

consumers save water. They comprise:

an annual target for each company to save at least one litre per

property a day, on average, by promoting water efciency;

a requirement to provide information to consumers on how to use

water wisely;

a requirement for each company to improve the evidence on how

effective water efciency measures are likely to be; and

an additional company-specic target to promote water efciency

as part of a best-value solution to securing reliable supplies.

We set targets for the period from 2010-11 to 2014-15. In their rst

year, we required the companies to save 24 million litres a day by

promoting water efciency. They actually saved 35 million litres a day,

nearly 50% more than the target amount and two-and-a-half times the

amount they saved in 2009-10.

Using water inefficiently

Households and businesses use

water wisely when they get at

least as much value from using

it as it costs to supply the water.

But that does not always happen.

Sometimes consumers use water

even when the benet it gives them

is less than the cost of supply.

We do not know the total value

that households and businesses

get from using water, and we can

only estimate the total cost of

supply, including wider social and

environmental costs. So, we cannot

say how much water we waste.

We do know that the nancial

incentive to use water wisely does

not reect the full cost of supply,

including environmental and

social costs. And we know that as

consumers we are unlikely to takeaccount of these environmental

costs. Defras report on Public

understanding of sustainable

water use in the home, published

in September 2009, found that

consumers are not very aware

of the environmental impact of

using water. We provide more

information on these issues in

Push, pull, nudge how can we

help customers save water, energy

and money?, which we published in

March 2011.

Customers paying the priceUltimately, it is customers who

pay the price for these problems.

They pay for any inefcient

investments. They pay for wasted

water whether or not they waste it

themselves. And they bear the risk

of higher prices or more frequent

water use restrictions if supplies

become unsustainable in the future.
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Identifying the causes

a new approach?

It makes sense to nd solutions

that tackle the root causes of any

problems. But what are those root

causes?

Poor price signals

One of the key issues is that

price signals do not reect the

value of water to the environmentor to other users. Abstraction

charges set a price for water at

its source. They are based on the

costs to the Environment Agency

of administering the abstraction

licensing system. They take little

account of local environmental

conditions. And because there is noeffective market to trade licences,

Traditional responses to finding

solutions to water resources

issues can discourage innovationFinding solutions atraditional approach

Traditional responses to these

issues are often prescriptive

telling companies and consumers

what to do. This can discourage

innovation. Instead of addressing,

anticipating or even inuencingtheir customers needs and wants,

the companies may concentrate on

responding to the regulator.

For example, the companies

use an activity-based measure

to report progress against their

water efciency

targets. They

multiply water

efciency

activities by the agreed savings for

that type of activity. If they wish to

do something new to promote water

saving, we require them to provide

evidence that it is effective. As aresult, some companies may rely

on established activities, instead

of innovating and trying out new

solutions that could be much better.

Even if we can develop incentives

that would work in isolation, it is

another challenge to make them

work collectively. If regulation

becomes complex, the companies

will respond to incentives in

unforeseen and counter-

productive ways.

Detailed regulatorysolutions also tend to

be self-perpetuating

because they treat the

symptoms, not the causes

of the problem. Leakage

targets are an obvious

example of this. They have

helped to reduce leakagesignicantly. But we are still not

Identifying the problems 11

condent that the companies would

manage leakage effectively if we

stopped setting targets because the

underlying causes remain. We need

to improve our overall approachto regulation to provide better

incentives.

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demand on to their customers

through higher bills.

Limitations of regulation

The main role of the economicregulator is to provide incentives

for monopoly companies to act as if

they were in a competitive market.

But regulation has its limitations.

For example, regulated companies

have more information than their

regulators. That can make it hard

to set appropriate incentives. One

solution is to try to obtain more

and more information. But that

encourages detailed regulation, and

we have already discussed how

that can cause problems of its own.

So we need to nd more effective

ways to regulate that do not rely ondetailed information.

Effective long-term solutions must

tackle these root causes. In the next

chapter, we describe our strategy

for doing just that.



bills need to

increase. It

means that

we need to

look beyond nancial incentives

to encourage people to use water

wisely.

Monopoly powerIn competitive markets, companies

must remain efcient in order to

survive. If they provide poor service

or charge too much, customers

will choose another supplier. By

contrast, monopolies have less

incentive to keep prices down

and service standards high. For

example, there is not necessarily

an incentive for them to nd more

cost-effective ways to source water.

Also, household customers

cannot choose their water

supplier, while choices for non-household customers are currently

limited. And, in the absence of

regulation, monopoly companies

have no incentives to help their

customers manage their water use.

Unregulated companies can simply

pass the rising costs of meeting

It makes sense to find solutions

that tackle the root causes of any

problemsthere is no price to reect the value

that other users place on water.

Abstraction charges typically apply

to the total amount of water that a

licence holder is allowed to abstract,

rather than the amount that they

do abstract. An abstractor could

damage the environment by takingall of the water it is allowed to,

and doing so at a peak time. Yet it

would pay the same price if it chose

not to take any water from the

environment at all.

At the other end of the value

chain, about 60% of households in

England and Wales do not have a

water meter. Unmetered customers

pay a xed fee, but then pay nothing

at all for each unit of water they

use. So they have little nancial

incentive to use water wisely. Even

metered customers pay less thanthe full costs of supply. Metered

charges reect only the companys

costs, which cover some but not

all of the environmental costs of

supplying water, and removing and

treating wastewater. This does not

automatically mean that customers

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Tackling root causes a long-term strategy 13

3. Tackling root causes a long-term strategy

Our strategy is based around the

concept of sustainable water. We

want a water supply system that is

environmentally, economically and

socially sustainable. Using water

resources inefciently is a barrier

to that. Tackling the root causes of

that inefciency is likely to be the

most effective way forward. So ourapproach involves:

bringing price signals more

closely into line with costs;

introducing more choice; and

developing improved regulatory

incentives for the companies

to choose options in the best

interests of customers and the

environment.

Better price signalsWe want price signals that reect

more closely the value of water to

the environment. At the start of the

value chain, that means developing

better price signals for raw water.

Reforming abstractionDefras Natural Environment White

Paper, which was published in

June 2011, recognised a need to

reform the way that people and

businesses in England can obtain

water abstraction rights. Water for

Life provides more detail on the

UK Governments plans, which we

welcome. It sets out the objectives

for a new system, which are to:

give clear signals and regulatory

certainty on the availability

of water, to drive efcient

investment to adapt to climatechange and meet water

needs;

better reect the value

of water to customers, its

relative scarcity, and the

value of ecosystem services

to ensure all our water sources

are protected;

reect the benet of discharges

to river systems;

drive efciency in our water use,

using market forces and smart

regulation to lower costs and

reduce burdens;

be fair to all abstractors, taking

into account current licences; be exible and responsive to

changes in supply and demand,

including providing greater access

to water when more is available;

and

meet our water needs at least

cost to bill payers, and to the

consumers of other products and

services which depend on water.

Some changes are already under

way. For example, the Environment

Agency is taking steps to reduce

barriers to trade in abstraction

licences. Trading can help toallocate resources more efciently.

It reveals the value of water to

different users, and allocates it to

those that value it most. Water for

Life notes that a new abstraction

system should encourage more

trading.
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14 Tackling root causes a long-term strategy

Defra will develop detailed reform

options by 2013. It will establish

a national advisory group of keystakeholder representatives to

guide this process.

We are working with Defra,

the Welsh Government, the

Environment Agency and other

stakeholders on these longer-term

reforms. They are essential if we

are to improve the process for all

abstractors. In the meantime, we

are exploring mechanisms thatOfwat could apply now to improve

the companies decisions about

potentially damaging abstraction.

We are developing an abstraction

incentive mechanism (AIM), which

would use price limits to reward

or penalise regulated companies

for the impact of some of their

abstraction decisions. This would

complement other incentives that

we are developing to encourage

the companies to trade more

water (see page 17). The incentive

would penalise the companies for

abstracting more than a specied

(or baseline) volume of water, ifthat abstraction was likely to cause

environmental damage. It would

also reward them for abstracting

less than their specied volumes in

those cases.

Penalties and rewards would only

apply in cases where there was

a material risk of environmental

damage. They would vary according

to the degree of potential damage.

We would administer rewards

and penalties through our regular

reviews of the companies pricelimits. We would set higher price

limits for those companies that

abstracted less than their specied

volumes, and vice versa. The

objective would be to minimise

the impact on customers bills

of protecting the environment. It

would provide an incentive for

We want prices signals to reflect

more closely the value of water to

the environment

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How much do we

really value water?

Sometimes we only appreciate

the value of something when

we no longer have it. That is

exactly what some people in

parts of rural Shropshire found

when they ran out of water

in the summer and autumn

of 2011. After months of low

rainfall, the private springs and

bore holes that supply them

nally ran dry.

Living in remote locations,

they had no mains water tofall back on. So residents had

to travel for miles to get water

from relatives or friends. The

BBC interviewed one couple

who had spent about 170 on

containers, which they lled

by travelling to family 50 miles

away. They commented: We

feel a bit bereft really. Its so

essential, isnt it?

the companies to deliver better

outcomes for the environment in the

most cost-effective way.

The AIM is not a substitute for

more fundamental reforms that

would apply to all abstractors. It is

a practical, short-term step that we

can take until longer-term solutionsare in place.

The mechanism is targeted at

improving decisions about existing

abstractions, rather than inuencing

the companies decisions about

future investments. The existing

water resource planning process

already requires the companies to

take account of the environmental

impacts of abstraction. Water for

Life reinforces the need for them to

demonstrate that they have done

that. At the same time, we are

working with the UK water industryresearch body (UKWIR), the

Environment Agency and Defra to

review the guidance on assessing

these environmental impacts.

Paying for what we use

At the other end of the value

chain, metering can help align

individual household bills broadly

with the costs of delivering water

and sewerage services. That can

send an effective signal to us as

customers to use water efciently.

We carried out work to look at

some of the costs and benets of

metering over different time periods.

We published our initial ndingsin October 2011 in Exploring the

costs and benets of faster, more

systematic metering in England

and Wales. This report showed

that faster rates of metering could

be benecial for customers and

the environment under certain

conditions such as when water

resources are under pressure.

The policy framework for metering

is a matter for the UK and Welsh

Governments. Water for Life

explains that it is for each water

company in England to decide onan appropriate metering strategy for

its region, taking account of impacts

on water demand and affordability.

The UK Government expects

companies in water-stressed areas

in particular to consider the role that

metering might play in managing

water demand.
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Introducing morechoice

Introducing more choice, wherever

it is in consumers interests, would

help to address the problem of

monopoly power.

In Water for Life, the UKGovernment announced its

intention to introduce more

competition for non-household

customers in England. By changing

legislation, it has already allowed

non-household customers that

use ve million litres of water

a year or more to choose their

supplier. Choice was previously

restricted to customers using

more than 50 million litres a year.

The Government will reduce the

threshold to zero in a future Water

Bill, which will allow all non-

household customers to choosetheir supplier.

It has also proposed several

reforms designed to encourage

more new companies to supply

water services and so deliver

more choice to customers. These

include:

establishing a new, regulated

approach to market entry that

allows licensed suppliers to

compete for eligible customers

across England, Scotland and

Wales;

introducing a new licence so that

new companies can specialise

in providing wholesale waterservices, retail services or both;

and

extending access rights to allow

alternative suppliers, such as

landowners or farmers with spare

water, to input water into any part

of a water companys network (for

example, directly into a reservoir).

We think that changes such as

these will help create market

incentives for the companies to use

water resources more efciently.

Some water companies are alsolooking at ways to improve the

existing market and regulatory

framework. In its 2010 report,

Changing course delivering a

sustainable future for the water

industry in England and Wales,

Severn Trent Water proposed

several reforms to encourage more

trading of bulk water supplies. For

example, it suggested that Ofwat

and the Environment Agency could

require the companies to consider

options for bulk supplies in their

business plans.

Introducing competition in retail

services could generate benetsthroughout the value chain. For

example, the threat of losing

customers would provide a clear

incentive for retailers to keep their

costs down so that their prices

remain competitive.

Customers could also expect a

wider choice of tariffs and tailored

retail services. The environment

should benet too, with retailers

providing water efciency advice

to help customers minimise

their bills. One of the benets of

retail competition in Scotland isthat it has resulted in business

customers using less water. For

example, Scottish Water Business

Stream helped Tesco to reduce

consumption in its stores by 8%

using smart meter technology.
http://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdf

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Developing betterincentives

What is a bulk water

supply?

A bulk water supply is the

supply of water from one

licensed water company to

another. Companies draw

up a contract (a bulk supply

agreement) that sets out

the terms and conditions of

a bulk supply, including the

price. If the companies fail to

reach agreement, they can

ask us to make a decision (a

determination) on the terms

of the bulk supply agreement.

Regulatory incentives can have an

impact on the companies decisions

about their options to balance

water supply and demand. We

want to provide incentives for the

companies to choose options in thebest interests of customers and the

environment.

Incentivising water trading

A 2010 report for Defra,

Assessment of regulatory barriers

and constraints to effective

interconnectivity, identied various

barriers that prevented water

companies from trading bulk

supplies with each other. One was

that prices for untreated water do

not reect the value of water to the

local environment, which we discuss

above. Other issues fell into twobroad categories. The rst covered

different types of risk. The second

was about regulatory incentives.

It should be possible for the

companies to allocate and price risks

appropriately in the contracts that

they agree between themselves. We

are helping the water sector achieve

this for example, by helping to

develop model contracts. The issues

around regulatory incentives clearly

fall to us to address.

We are considering options to

incentivise bulk water trading. One

would be to deregulate it. Bulksupplies would still be subject

to the usual water quality and

environmental regulation. But we

could allow the companies providing

bulk supplies to keep the full return

from this activity for as long as it

continues.

By contrast, we currently only allow

them to keep the full return for ve

years. We could also allow the

companies receiving bulk supplies

to keep any excess returns. In itself,

this would tilt the playing eld in

favour of bulk supplies, and againstother options to balance supply and

demand. But by helping to offset

other barriers to bulk supplies, it

should result in better outcomes

overall.

Another option would be to continue

to regulate bulk supplies, but to

increase the returns that we allow

for regulated companies. We could

allow those providing bulk supplies

to keep any excess returns forlonger than ve years. And we could

allow bulk supply recipients to keep

some of the saving they would

make from taking a bulk supply

rather than developing a higher-cost

scheme of their own. At present,

customers would receive all of this

saving. But they only benet if their
http://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdf

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suppliers choose the best value

options. We want to make sure that

there are sufcient incentives for

them to do so.

In Future price limits a

consultation on the framework,

we sought stakeholders views on

these options. We ran a workshopon water trading in January 2012,

and we will be holding a series of

industry working group meetings.

We will then consider the comments

we receive, and the relative merits

of the options. We will publish our

conclusions in autumn 2012 in our

consultation on the methodology for

the next price review.

Avoiding regulatory bias

The Defra report also described

concerns that the way we regulate

could make a water company

nancially worse off if it chose totake or provide a bulk supply. One

argument was that our regulation

provides a stronger incentive to

invest in capital schemes, while the

companies have to classify bulk

supplies as operating expenditure.

We want to provide incentives for

the companies to choose options

in the best interests of customersand the environment
http://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Download

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20 The immediate next steps

4. The immediate next steps

Maintaining secure water supplies

at an efcient cost is a signicant

challenge. In this document,

we have described some of the

changes that we need to make

to the way that we regulate. Our

strategy will shift the focus away

from detailed regulatory solutions,

such as specic targets. Instead,we want to tackle the root causes

of problems that prevent the water

sector from delivering best value to

customers and the environment.

We are working on the long-term

solutions that we described in

chapter 3. But we recognise that itwill take time to implement them,

and more time before they take full

effect. We will continue to develop

short-term or interim measures,

which can start to make a real

difference now.

Better price signals

In November 2011, we published

our consultation on the framework

for setting price limits in the

future. It described our proposed

approach to the overall package

of incentives for the companies.

Key features include:

separate price limits for

the wholesale and retail

components of the business;

incentives to trade water; and

a focus on requiring the

companies to deliver outcomes

rather than outputs.

The consultation also described

the approaches we are

considering to assess and

recover costs. In the past, we

have assessed the companies

requirements for capital and

operating resources separately.

Going forward, we are looking

at the companies overall

expenditure. We are also

exploring how to incentivise the

companies to invest in the most

sustainable solutions. We want to

remove any perverse incentives

In December 2011, Defra reduced

the threshold at which non-

household customers are eligible

to choose their supplier. This

means that ten times as many

customers will be able to switchtheir water supplier. In preparation

for this, we have revised the retail

market code and contract. This

followed extensive consultation

with the industry. Our aim is to

make sure that the water supply

licensing system works well in the

new expanded market.

We are developing an abstraction

incentive mechanism along

the lines that we described in

chapter 3. Our future price limits

consultation described this in

outline, and asked for initial views.

We will explain it in more detail

in autumn 2012 when we consult

on our methodology for the 2014

price review.

Working with the Environment

Agency and Defra, we are

supporting a proposed UKWIR

project to improve the waythat the companies calculate

the environmental impact of

abstraction. This will explore how

best to value the impact it has on

the long-term sustainability of a

water resource.

Using market forces

Future price limits

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The immediate next steps 21

We are working with Defra and

the Environment Agency to update

the guidelines on water resource

for them to favour solutions that

do not deliver best value for

customers.

planning. This is the guidance that

we expect the companies to follow

when they prepare their plans to

balance water supply and demand

over the following 25-year period.

We want to improve this guidance

in several ways. For example, we

want to encourage the companies

to integrate their water resource

planning with other areas of

their business. This should lead

to solutions that provide better

overall value for customers. With

the Environment Agency and

Defra, we will publish a revised

joint draft for consultation early

in 2012.

Other work

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22 The immediate next steps

You can help

We welcome views on the issues we have raised in this document.

We would be particularly interested in your views on:

whether the changes we have suggested will deliver the

improvements we seek to water resource use, leakagemanagement and support for customers to use water efciently;

the timeframe over which you think these changes will take full

effect; and

whether there are other, potentially more effective things that we

and others could do.

Please contact Paul Hope, Head of Water Resources (paul.hope@

ofwat.gsi.gov.uk) if you would like to contribute to the debate.

Jointly with the Environment

Agency, we provided input at

the early stages of the current

UKWIR review of the economics

of balancing supply and demand.

This is the technical guidance

that sits below the policy

guidance in the water resource

planning guidelines. Along withthe Environment Agency, we are

members of the steering group

for this project. UKWIR plans to

publish a revised document in

winter 2011-12.

We are reviewing our approach

to regulating water companyleakage. We will publish a report

that explores options to improve

our current approach to leakage

target setting, and considers more

fundamental longer-term reforms.

In 2012, we will review what

incentives would be appropriate

for the companies to promote

water efciency once the existing

targets have expired in 2015. We

will consider how water efciency

ts within the wider framework of

incentives that we set out in our

future price limits consultation.

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Further information 23

5. Further information

Ofwat publications

Harnessing upstream water markets whats to play for?, Ofwat, March

2010

Waste not, want not making the best use of our water, Ofwat, June 2010

Push, pull, nudge how can we help customers save water, energy and

money?, Ofwat, March 2011

Capex bias in the water and sewerage sectors in England and Wales

substance, perception or myth?, Ofwat, May 2011

Exploring the costs and benets of faster, more systematic water metering

in England and Wales, Ofwat, October 2011

Future price limits a consultation on the framework, Ofwat, November2011

Related information

Changing course developing a sustainable future for the water industry

in England and Wales, Severn Trent Water, April 2010

Water Resources in the South East Group Progress towards a shared

water resources strategy in the South East of England, Summary report,

October 2010

Assessment of regulatory barriers and constraints to effective

interconnectivity of water supplies, Defra, 2010

The natural choice: securing the value of nature, Defra, June 2011

Water for Life, Defra, December 2011
http://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_demand.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/customers/metering/pap_tec201110metering.pdfhttp://www.ofwat.gov.uk/future/customers/metering/pap_tec201110metering.pdfhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_summary_paper_Final.pdfhttp://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_summary_paper_Final.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://www.defra.gov.uk/environment/natural/whitepaper/http://www.official-documents.gov.uk/document/cm82/8230/8230.pdfhttp://www.official-documents.gov.uk/document/cm82/8230/8230.pdfhttp://www.defra.gov.uk/environment/natural/whitepaper/http://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_summary_paper_Final.pdfhttp://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_summary_paper_Final.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.ofwat.gov.uk/future/customers/metering/pap_tec201110metering.pdfhttp://www.ofwat.gov.uk/future/customers/metering/pap_tec201110metering.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_demand.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdf

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Ofwat(The Water Services Regulation Authority) is a non-ministerial

government department. We are responsible for making sure that the water

and sewerage sectors in England and Wales provide consumers with a goodquality and efcient service at a fair price.

Ofwat

Centre City Tower

7 Hill Street

Birmingham B5 4UA

Phone: 0121 644 7500

Fax: 0121 644 7699Website: www.ofwat.gov.uk

Email: [email protected]

Photographs Environment Agency, Getty Images,

iStockPhoto, WWF-UK

Printed on 75% minimum de-inked post-consumer

waste paperFebruary 2012

ISBN 978-1-908116-19-2

Crown copyright 2012

You may reuse this information (excluding logos) freeof charge in any format or medium, under the terms of

the Open Government Licence. To view this licence,

visit http://www.nationalarchives.gov.uk/doc/open-

government-licence/ or email psi@nationalarchives.

gsi.gov.uk.

Where we have identied any third party copyrightinformation, you will need to obtain permission from the

copyright holders concerned.

Any enquiries regarding this publication should be sent

to us at [email protected].

This document is also available from our website atwww.ofwat.gov.uk.

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Ofwat 2012