The Untapped Potential report, written by Dr Simon Less and published by Policy Exchange (apparently one of David Cameron’s favourite think tanks) on Monday this week is outstanding. It goes to the heart of many of the problems the UK faces in balancing increased water use with the need to maintain a sustainable environment. It makes some really creative suggestions as to how the problems may be overcome with organisational changes rather than the massive capital plans to which the water companies normally turn.

It is not often that a report of this type gets such a rave review, particularly from me. But I strongly believe this is a report that goes to the heart of many of the difficulties being experienced and how aspects of our existing financial and environmental legislation are exacerbating the situation. (In addition, even as a former Director of Ofwat Dr Less has, where appropriate, not spared the blushes of his former colleagues at Ofwat – or those of the Environment Agency.)

The Report tackles many headline-grabbing topics – particularly with respect to over-abstraction from rivers causing unsustainable pressure on the UK’s water resources and damaging the environment. The situation is aggravated by water companies using the ‘cheapest’ sources rather than the most environmentally-sustainable ones. The Report indicates that the present abstraction license system brings a level of future uncertainty that actually encourages water companies to hoard their licenses and to use them without regard for the environment.

The highlight of the Report for me though is that it deals with one of the subjects that has concerned us for many years – i.e. the ‘cathedral building’ bias of water companies:

‘Problems with current water supply regulatory arrangements

 

Some aspects of current water supply regulatory arrangements are a legacy from a period when the options were simpler for developing new water supply sources and infrastructure, and were generally cheaper. A simple regulatory approach focused on scrutinising different capital supply projects put forward by the monopoly water company was acceptable.

 

Such a process is now insufficient to identify and select the best ways to bear down on the costs of matching water supply and demand. The regulatory framework needs to deal with greater complexity of options and information, including options for dealing with the peak versus average demand shortfalls, comparing demand- and supply-side options, operational expenditure versus capital expenditure solutions, new sources versus greater interconnection and promoting innovation.’ [p.60]

The Report also points out an incentive for water companies to prefer a capital solution:

 

‘Bias in favour of capital-intensive supply side solutions

 

Monopoly water companies have their prices regulated by Ofwat. The process for establishing prices incentivises companies to try to maximise their Regulatory Capital Value (RCV) on which Ofwat allows them to earn a regulated return. Companies grow their RCV by securing Ofwat agreement to new capital investment. Ofwat’s approach to price regulation also incentivises companies to become more efficient by minimising operational expenditure, a further incentive for companies to choose capital over operational expenditure. […]

 

Other, non-regulatory, factors may also contribute to a capital bias. Companies may be culturally more comfortable with their traditional role of building supply infrastructure (largely unchallenged by competitors), investors may have become used to the size of the RCV being shorthand for a company’s value, and companies may prefer to have ‘control’ of their own supply rather than enter into contracts for bulk supplies with others. (Regulation may also be a factor driving the latter.)’ [p.61]

 

The Report deals with many other specific aspects of the problems faced by over-abstraction, related long-term problems, and how these will best be addressed. But I believe these three short paragraphs sum up the problems the UK faces in terms of its water regulatory framework (not only for water supply but also for wastewater treatment).

Surely a system that so encourages capital spending and minimizes operational expenditure is well past its ‘sell-by date’? If only we had come to these sorts of conclusions earlier perhaps the UK would not be saddled with such a heavy long-term debt from the water utilities. We also might have a system more able to cope with the vagaries of climate change and increased demand.

Update (15/11/2016): Revised link added for report; featured image from report added.

Roger Ford

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