What to make of a Gray watery outlook

A few weeks after I stopped following it the Gray Review of Ofwat and consumer representation was finally released. This was back in July. It may well have been picked up in the trade press, but I had other things on my mind at that time (namely preparing papers and presentations on some of our fascinating work on publicly-funded researchers who have potential to do pathbreaking/frontier research, from our EURECIA project, to take to conferences in Italy and the US).

After looking at the role of Ofwat and its interaction with key stakeholders, the main conclusion in the press release of the Gray Review was this:

‘[R]egulation in the water sector has worked well since privatisation … major change is not needed to the statutory framework or regulatory landscape; but … to achieve continued success, Ofwat needs to see through the changes it has embarked on to reduce the burden of regulation it imposes on the water industry and work constructively with the other organisations in the sector.’

What a predictably bland, unambitious and narrow outcome! It’s all fine but Ofwat should reduce the paperwork a bit. I’m flabbergasted there wasn’t anything more constructive to say!

Two small saving graces for the Review were its mentions of innovation and renewable energy. As we know, these are both long-standing, significant challenges for the UK water sector. The recent Martin Cave and Severn Trent report pointed this out quite emphatically (the full report is here). On innovation, the Gray Review largely relies on the earlier Cave Review’s findings, and says:

‘Concerns about the lack of incentives for innovation were raised in responses to our call for evidence … in the sense that the regime is seen as suppressing R&D activity …’

‘…companies will tend to see R&D expenditure as an easy area in which to cut costs, particularly if there is no strong driver for innovation at the time or if the potential returns are not clear…’

‘…it is not necessarily true that the water companies are best placed to pursue R&D activities. This may be a more natural activity for supply chain companies who may have a wider national and international market in which they can benefit from innovation in design of equipment etc.’

‘To the extent that specific R&D investment is required, the Cave proposals (on a new R&D vision, research body supported by funding, and excluding R&D expenditure from comparative efficiency tables) seem to be an appropriate response.’ (p. 47)

The Review then goes on to hold out hope in Ofwat’s move to more outcome-based regulation and less micro-management of inputs and outputs.

Addressing the third quote above – i.e. whether water companies or suppliers are best placed to do R&D – this is a strange and rather dated, linear view of innovation (that it moves from basic research through a chain to application). Our UKWIR work on innovation in the UK water sector rejected this picture. We considered innovation as a shared activity – and a common responsibility. All parties take part in the development, helping to tailor it to specific needs. All have something to bring to the table. Without this joined-up approach, many inventions fail to get adopted as innovations. Without a shared vision for the sector, priorities and strategies are all over the place and there is significant wastage. I had thought these points had diffused through the sector. Evidently I was wrong.

On renewable energy, the Gray Review has this to say:

 ‘…there is considerable scope for a wider range of renewable generation on sites owned by the regulated companies. … such generation is already incentivised quite separately through the Renewables Obligation … 

It is not obvious that such investment needs to be incorporated within the RCV [Regulatory Capital Value] of the water and sewerage companies with the added protections that would entail. This appears to be another example of the risk-averse nature of the companies and their distrust of the regulatory regime. It would be understandable if the owners of the companies saw an unregulated generation business as a high risk activity to enter into; but the risks could be mitigated, for instance by way of a joint venture with a renewable generation specialist. Part of their reluctance to do this seems to be related to uncertainty over how the interface between such schemes and the regulated business will be treated by Ofwat in the future.’ (p.44)

There is really quite staggering scope for a better treatment of energy efficiency overall, and renewable energy in particular, in the UK water sector. If the water companies have failed to do this – through lack of regulatory and commercial pressures – shouldn’t there be action to remedy the situation? According to Gray, no. Ofwat should simply keep its approach ‘under review’. Marvellous.

The Review also has an extremely cursory treatment of Ofwat’s sustainable development duty, recommending it does not move up from a secondary to a primary position (pp. 52-53). About the only constructive point made here concerns:

‘…how the commitment to sustainable development is turned into individual regulatory policies and decisions. The essence of many of the criticisms … seems to be that, at the decision stage, Ofwat is driven too much by a desire to introduce market mechanisms and by cost-benefit analysis which focuses on the ratio of quantified benefits to quantified costs, and does not take into account the unquantifiable benefits considered under a broader impact assessment and the longer-term policy goals these might contribute to. Ofwat might usefully consider whether it properly takes such wider impacts into account in its analyses.’ (p.53)

I imagine this superficial, hands-off understanding and practice of sustainable development in the UK water sector will have to change before long. Looking at some results of water supply and demand under future climate scenarios from our CREW project there is simply no way the current system can continue unaltered. Demand will simply outstrip supply without efforts in both mitigation of climate change and better adaptation to it.

Two other aspects of the Review caught my attention. First, the Review considered the role of the supply chain and impacts upon them from the cyclic nature of investment in the UK water sector (pp. 49-51). Similar to our UKWIR work, the Review noted that skilled people are retiring but not being replaced, that staffing levels are hard to maintain from investment peak to peak (a feast or famine situation), and that there are ‘hidden costs and intangibles such as maintaining facilities for peak staffing levels and the permanent loss of sector expertise to more stable industries’ (p.49). The Review offered no real solutions. But at least these important points were raised.

Second, the issue of the value for money of Ofwat was addressed. This revealed Ofwat cost 17 million GBP to run in 2009/2010 (p. 62). It also shed some light on a claim I’ve been seeing here and there, about customers’ bills now being a third lower than they would have been without Ofwat’s efficiency drives since privatisation in 1989:

‘Ofwat … [looks] at the effect of the efficiency challenges it applies in the price review process … to strip out the effect of overbidding and assess the impact of the ongoing efficiency improvements required by Ofwat relative to the companies’ own plans. On this basis Ofwat estimates that customer bills are now, on average, £110 lower than they would otherwise have been. The equivalent cumulative savings for customers since privatisation would be about £2.5 billion. 

Ofwat also noted that its enforcement action had delivered £385 million of net benefit to consumers since April 2005 (when it was given powers in this area). These are helpful indicators, but they do not provide an assessment of the effectiveness of the organisation in achieving these benefits for consumers.’ (pp. 63-64)

The last sentence is the real killer here. The indicators do not causally attribute any of these savings to actions by Ofwat. If this can be done, I would really like to see the details – methodology, data, the lot. What’s the control group in this instance? What other alternative scenarios are considered to compare to? E.g. a far more innovative water sector since privatisation? A far more sustainable one? One with actual competition? (I’ve asked Ofwat about this point, and hope to hear back soon.)

All in all though, the Gray Review is a weak, unchallenging input for the forthcoming Water White Paper (which Defra has now committed to publish next month, December 2011). The Gray Review paints a picture – inaccurate though we think it is – of a UK water sector in good health, in need of only incremental tinkering. And yet some people were expecting ‘the most radical overhaul of the UK water sector since privatization in 1989’ from the imminent White Paper that will use the Review as an input.

With such insubstantial Gray Review ‘evidence’ hot-off-the-press, can a ‘radical overhaul’ be justified with recession, unemployment, national strikes, the Euro and the like grabbing headlines? Sadly, as much as it is sorely needed, I think Defra will conclude it cannot…

Update (15/11/2016): Featured image added from this source.

Duncan Thomas


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