What price regulating?

Earlier I saw a BBC story on the depressing news that household energy prices in the UK look set to continue to rise above inflation for the next 17 years. This is according to a new report by the National Audit Office. (NB. The full NAO report looks generally at the impact on household bills of the estimated £310 billion budget needed to implement the 2012 update of the Government’s 2010 National Infrastructure Plan.)

This all started me thinking about the UK water sector’s long-term household water bills. Looking back of course the trend has been largely upward. For England and Wales there’s been above-inflation increases from 1989-2000, a one-off cut in 2000, a decade of further rising prices, and now more or less flat pricing (NB. this is 2009 data with projections; if I manage to find an updated chart I’ll put it here instead):

Picture: Average household bills for England and Wales 1989-2015. Source: Ofwat.
Picture: Average annual household bills, England and Wales, 1989-2015 (not adjusted for inflation). Source: Ofwat.

Looking ahead, short-term we’ve heard strident calls both by the coalition and Labour for action on rising water bills and worsening affordability – coinciding with the ongoing Thames/super sewer/blocked 8% price rise fiasco (more on that in another post!).

Probing out a bit further signposts of future price directions can also be found in the post-2009 Price Review, ‘strategic direction statements‘ water companies are now required to produce (these ‘provide a 25 year context for the companies’ five-year business plans‘, state the objectives of water companies’ ‘long-term charging strategies’, and address ‘how they plan to achieve these and the implications for bills‘). Quickly going through a few of them, for the bigger companies – and noting this was hampered by dead links on the Ofwat page and lousy searching functionality on water company websites – hunting around for the word ‘bills’ (comes up a lot!) reveals some of the following outline visions of future water pricing:

  • Anglian state an aspiration ‘to deliver our strategy while limiting bill increases to an average of one per cent above inflation over the long-term‘ – that is, unless ‘major investment‘ becomes needed ‘to adapt to the impacts of climate change.’
  • Severn Trent (whose statement is under revision it seems) loosely propose they’ll ‘keep costs and bills no higher than they need to be‘ but then helpfully do separate out potential cost increases by 2035 – i.e. from water quality improvements (+£3 on bills by 2035), avoiding supply interruptions (+£15), leakage reduction plans (+£5), increasing the rate of metering (+£3), water efficiency plans (+£1), increasing supply capacity (+£9), added costs of supply pipe adoption (+£8).
  • Thames look decidedly defeatist/pessimistic in this company, bleakly stating that, ‘in order to meet future challenges, we will have to make substantial additional investments, which will mean that bills will need to increase‘ (their position may be shifting on this!). At the same time they do address affordability, suggesting that ‘[t]hroughout our 25-year plan, water charges are expected to remain below 1.5% of disposable income on average.’
  • United Utilities present a rather vague, non-binding strategy to ‘strike the right balance between keeping bills affordable whilst ensuring our water and wastewater infrastructure receives the investment it requires.’
  • Wessex also are non-committal in their aim to ‘demonstrate to our customers and others that we are playing our part in improving resilience and keeping bills down … at the level customers are in general willing to pay.’
  • Yorkshire only talk about ‘[p]roviding the lowest possible prices‘ and instead focus on their proud claims that ‘[t]arget-setting and innovation have been the building blocks of our success in keeping price increases to no more than inflation in respect of our expenditure on operations and capital maintenance‘ whilst laying blame at the door of ‘[i]ncreases in tax and essential environmental legislation as ‘key drivers of above-inflation price increases for our customers in the past.

Delving beneath these – largely vague – statements about future price directions, I’d like to talk about another perhaps significant factor. This is the as yet unknown impact of the recent departure of Regina Finn from Ofwat. I baulk, of course, at focusing too much on particular, individual personalities. I’m also aware Ofwat changed from a Director General-model to a board structure in part to mute this aspect (and to, no doubt, bring in more and fresher views into high-level decision-making). Nevertheless, after being thoroughly unimpressed with Ofwat for many years, I find myself realising that it was during Ms Finn’s tenure as chief exec that arguably the most significant moves towards regulatory reform and better longer term planning have been started. I see this period very much in the same vein as set out in Ms Finn’s own words, from her resignation press release, as being when Ofwat began to lay ‘the foundations for a new model of regulation in which water companies have to listen to their customers and deliver a step-change in their performance‘.

We’ve got long-standing concerns of course about the heavily entrenched culture of conservatism and incrementalism across the UK water sector. Above and beyond any actions by Ofwat alone, much will no doubt rest on whether a new customer-focused, more proactive culture actually materialises in the coming years. Sadly, scanning through reported opinions during the build up to, and in the wake of Ms Finn’s resignation, I think there remains cause for concern.

What do I mean? First, a few caveats. For starters, it’s not uncommon in regulated utility sectors to have emphasis upon – and even demonisation of – individual personalities. It’s a price one pays leading a regulatory body, and sadly some vilification comes with the territory. Second, honestly I can’t accurately assess the veracity of reported internal goings-on in Ofwat, including how its staff perform and how its working environment operates. I’m on the outside looking in, including when I read rather stark remarks about 49% of staff reporting in an internal survey that they had no confidence in Ofwat’s executive team, and only 19% reportedly confident (compared to a 39% civil service sector average).

I can only look externally then at what I see as processes and principles at work. To do so, a recent paper on regulatory capture by Ms Finn (and Simon Less) actually proves very handy. Specifically, when I read criticisms that proposed regulatory reforms involved too much ‘uncertainty’ and ‘risk for investors’ that would increase the cost of capital and drive up household water bills, I hear a clear call for the regulator ‘to take decisions that are biased in favour of the interests of the industry they regulate rather than the customers or wider society on whose behalf they regulate‘ – i.e. regulatory capture by industry, as Finn and Less define in their paper (where this quote is from). And yet it’s not a linear causal link between regulatory reform and eventual household bills. We know, there’s a lot that water companies could do to innovate to mitigate various cost pressures. And they are, largely, not doing innovating to do so. Against this known background then, lazily citing ‘risk to investors’ risks sounding simply like carefully crafted scaremongering.

When regulatory staff though, again as quoted in Utility Week, also apparently appear unwilling to accept uncertainty as an inherent part of regulatory reform, to my eyes, they risk misrepresenting an essential regulatory role – i.e. to provide a strong, independent challenge to the vested interests and power of a monopoly sector. I mean, come on, will I really live it up to water companies and their investors to offer independent scrutiny and to have my best interests at heart, above and beyond shareholder returns? No, the regulator has a crucial role to play here, on my behalf. And if its independent challenge process takes several rounds of heated to-ing and fro-ing between regulator and regulated, and involves at least some risk exposure for investors that have been largely used to milking a ‘cash cow’ in deference to the sector’s laggard climate change resilience and sustainability performance (and ‘industrial scale’ tax avoidance), then so be it!

I must reiterate again though that I don’t know if independent challenge has been the motivation or whether, again as quoted in UW, there has been a seemingly petty ‘desire to win a fight with the water companies rather than wanting what is best for its stakeholders‘. All I can say is that I expect the regulator to challenge vested interests and business-as-usual practices. The UK water sector is notoriously inward-looking. It largely isn’t exposed to competition or to best practice challenges from other countries or other sectors. If its regulator(s) provides no challenge, who’s left? If a regulator falters to me it broadcasts that it’s itself become ‘captured’ – this time in ‘its own historic way of doing things‘ and ‘particular regulatory processes that it has spent time and effort honing‘ – and may not be asking itself if ‘[w]hat may have worked in a previous period is not necessarily best approach today‘? (Quoting Finn and Less again here.)

With much of the new regulatory framework already in place, perhaps my pessimism is unwarranted. Regina Finn herself, now departed from Ofwat, but just a few days ago having joined new regulatory and policy consultancy, Lucerna Partners (and other utility-related things) may also not just give up on the promise of a more innovative, sustainable and customer-focused UK water sector. Being outside of Ofwat I also don’t yet know where new chief exec, Cathryn Ross may aim to take matters (as an aside, it’s heartening to see another high-level female appointment in a largely male-dominated industry here).

Returning to where I started, and thinking about long-term water price directions, sadly I’m still not optimistic. The resurgence of entrenched, almost vitriolic resistance to change around regulatory reform and Regina Finn’s resignation have not been edifying. For now then, who can predict the direction of long-term water pricing in the UK. Perhaps it will, like energy, be locked into many years of above inflation price increases?

Duncan Thomas

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