Water regulation and Ofwat

What is Ofwat?

The Water Services Regulation Authority, better known as Ofwat, is the independent economic regulator of the privatised water and sewerage industry in England and Wales. Prior to April 1st 2006 its functions rested with the Director General of Water Services. The framework for the changeover was outlined in the Water Act 2003.

As the economic regulator, Ofwat is responsible for setting limits on pricing and protecting customer interests, encouraging competition and adequate investment within the industry, and administering and enforcing the licensing regime for water and sewerage companies set out in the Water Services Act 1991.

Ofwat is not a quality or environmental regulator for water: these responsibilities lie with the Environment Agency, the Drinking Water Inspectorate, English Nature and the Countryside Council for Wales.

Like other independent regulators, including Ofsted, Ofcom and Ofgem, Ofwat is a non-ministerial government department.

The current regulatory framework for water is set out by the Water Services Act 1991, as updated by section 39 of the Water Act 2003.

This requires all water and sewerage companies to submit to regulation by Ofwat as "water undertakers", and to provide and maintain an "efficient and economical system of water supply", and to improve and extend its network of coverage. The Act and regulations under it also set out standards of service that companies must meet: if they do not, Ofwat is empowered to issue "enforcement orders" against them, which can include fines. In extreme circumstances, Ofwat can seek High Court approval to appoint administrators to take over the company until the terms of the Order have been complied with.

Ofwat's main function is to conduct five-yearly price reviews. These aim not only to keep prices for customers to a minimum, but also to permit water companies to make an adequate return on capital (permitting investment into the water infrastructure), while encouraging efficiency savings. Ofwat sets its price frameworks on a company-by-company basis, reflecting their business plans and projected revenues, and determines a maximum level above which prices may not rise.

Price limits were set in 2009 for customers' bills for each year between 2010 and 2015.

Background

Ofwat was created by the Water Act 1989, which privatised the ten public water authorities, creating ten regional water companies in their place. Prior to 1973, water services were provided by a mixture of local authority and private undertakers. The Water Services Act 1973 created the structure that survived to privatisation.

Privatisation was first mooted in a 1986 white paper and was consulted on in 1987. The privatisation was motivated by the desire of the Thatcher government to improve efficiency and performance by introducing private sector disciplines to public sector utilities, to spread share ownership, and to raise money from the flotation (which took place in November 1989). In order to meet EU water standards and to make the sale more attractive, the Government wrote off £5 billion in the industry's debts and provided a "green dowry" of £1.6 billion for environmental investment.

It followed the model of previous sell-offs of nationalised natural monopolies: recognising that full competition would not be immediately possible, and that private sector monopolies or oligopolies would tend to exploit their positions at the expense of customers, an independent regulator was created to approximate competitive conditions and to protect the interests of customers. Water privatisation was one of the most controversial of all the Thatcher and Major governments' de-nationalisations, with many astonished at the notion of "privatising water".

One of the first duties of the new director general was to appoint ten independent regional Customer Service Committees (which have been known as WaterVoice committees since 2002) to represent the interests of consumers.

The Water Industry Act 1991 consolidated previous legislation and established the current system of regulation, bringing sewerage into the regulatory framework. The Environment Act 1995 created the Environment Agency as a water quality regulator (replacing the National Rivers Authority) and put Ofwat under a duty to promote efficient water use by customers. In 1998, the ten major water companies joined together to form Water UK to represent their interests.

With the election of Labour in 1997, the regulatory system was put under scrutiny in a major Utilities Review. The Competition Act 1998 bolstered the role of the Office of Fair Trading and the regulators in ensuring the maintenance of competition. This was followed by the consumer white paper, "Modern Markets: Confident Consumers", which proposed a new structure for the regulators. This proposed that the regulators' primary duty should be consumer protection, and undertook to increase the independence of consumer representation.

The subsequent Water Services Act 1999 increased Ofwat's powers by giving the director general the right to approve companies' charging schemes, and it pursued the consumer agenda by reducing companies' powers to disconnect customers and to require water metering. The utilities bill (subsequently the Utilities Act 2000) would have introduced the new regulatory framework across gas, electricity, water and telecommunications, but due to a lack of parliamentary time, the elements relating to water and telecoms were dropped.

In November that year, the Department for Environment, Food and Rural Affairs (Defra) issued a draft water bill for consultation, which would also put the regulator under a duty to promote (rather than facilitate) competition, to reform abstraction licensing and promote water conservation. Consultations concluded in 2002, and the subsequent bill became the Water Act 2003.

Controversies

Opponents of privatisation have long argued that the need for economic regulators demonstrates that it is a fallacy that privatisation generates competitive gains for consumers. The substitution of price regulation for competition in the immediate aftermath of privatisation, after important concessions had been already made in order to make flotations attractive, permitted profits and shareholder returns to flourish in many industries.

It is widely agreed that the water industry has been pressed hard by Ofwat. Many argue that the stringency of the Office's regime has contributed to a lack of willingness to invest in water. Indeed, in 2000 proposals were put forward to transform Welsh Water into a debt-financed company, taking it effectively out of the private sector.

The National Audit Office warned that the use of an RPI-x price control model had some considerable potential to distort investment in the industry, whilst additionally acting as a disincentive to water providers. The NAO also criticised the number of demands put upon the industry by Ofwat. As such, it recommended a simplification of the price review process.

Throughout the preparations for the November 2004 pricing review, the industry insisted that considerably higher water prices were required to permit it to maintain the increasingly antiquated network of mains and sewers. In 2003, Water UK warned that companies would need to raise an additional £50 billion to carry out 25 per cent of the necessary repairs.

For the 2009 pricing review, Ofwat said there had been a greater focus on setting price limits within the context of the long-term future of the water and sewerage sectors. The Environment Agency described the 2009 price review decision as "a good deal for water customers and the environment."

In August 2010 the Government announced that a review would be carried out into Ofwat itself, to ensure that the regulator still offered good value for money and that it was well prepared to tackle future challenges such as climate change. The review is due to report back in early 2011.

Statistics

In 2010-11, prices will decrease by 0.8%. This includes inflation of 0.28%.
Average water bills range from £88 for Portsmouth Water to £205 for South West Water, with an overall average of £165.
Average sewerage bills range from £114 for Thames Water to £282 for South West Water, with an overall average of £174.

The price limits above also apply to:
non-household customers using less than 50 million litres (Ml) of water a year;
companies operating wholly or mainly in Wales using less than 250 Ml a year.

If you use more water than this, your bill increases will be broadly similar to those for household customers, but the price limits do not apply. However, you may have a choice of water company under arrangements for competition.

Source: Ofwat - 2011

Quotes

"Ofwat has been successful in holding down household bills while water companies invest in their infrastructure. But we need to make sure the regulator is in good shape to help the industry prepare for a changing climate and a growing population, at the same time as keeping bills affordable
"It's important to reassure water companies and bill payers that Ofwat provides good value for money by carrying out its duties without unnecessary red tape."

Environment Secretary Caroline Spelman announcing the proposed review of Ofwat - 2010

"Resources and environmental systems such as water, land and air are under increasing stress. Sustainable development is about understanding the true value of our resources. It is also about joining up economic, social and environmental goals."

Ofwat - 2011