Managing Change in the Water Industry: A Consultation Paper

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E. THE SCOPE FOR DEVELOPMENT OF COMPETITION IN THE WATER INDUSTRY

E1. The water authorities have effectively had a geographical monopoly on the provision of public water and sewerage services, through their ownership of networks that cannot economically be duplicated. While there is no statutory monopoly on the provision of water and sewerage services, the opportunities for owners of private systems to compete with a water authority have been limited. The cost of treatment facilities to meet water and environmental standards has proved prohibitive, as have the costs of establishing separate water distribution or sewerage networks.

E2. It is difficult to predict exactly how competition will develop in the Scottish water sector. Competitors will make decisions on which areas of the market (and, indeed, which categories of customer, domestic or non-domestic) to enter on the basis of possibilities for commercial returns. This section identifies the main segments of water authority business, and looks at how competition might develop in each.

E3. The water and sewerage operations of the Scottish water authorities can be divided into five main areas:-

Abstraction, collection and storage of raw water

Treatment services

• the treatment of drinking water for entry into the public mains network
• the treatment of wastewater collected in the public sewer network

Distribution services

• the management of the public mains network (and also of raw water transfer networks for non-domestic customers)
• the management of the public sewer network

Supply

• the supply of drinking water services to customers (and also of non-potable water to non-domestic customers)
• the supply of wastewater services to customers

Disposal

• the disposal of solid sludge from water and wastewater treatment works
• the disposal of liquid effluent from water and wastewater treatment works.

E4. These areas are currently monopolies for the water authorities, although the authorities are in partnership with private companies for the provision of large-scale wastewater treatment. In the Scottish context abstraction and collection of water is not a significant issue from a competition perspective. In areas where water is in short supply there are implications for the development of competition in terms of potential competitors being allowed access to such supplies as exist. In Scotland the combination of a relatively sparse population and heavy rainfall means that there is no real pressure on supplies and no question of the water authorities as the incumbents having a monopoly of supplies.

E5. For competition to develop in these areas, the water authorities will need to be able to distinguish clearly between two different types of activities. On the one hand are those activities that can be opened to normal competition on the basis that it is feasible for other parties to duplicate them. On the other are those activities which involve "essential facilities" in that they cannot be practically or economically duplicated and as a result have to be made available by the authorities to third parties if the third parties are to be able to compete with the authorities. Whether an asset or group of assets constitutes an essential facility will be a matter of judgement in light of the circumstances of each case, but many of the capital assets of the water authorities could be regarded as essential facilities. However, defining a facility as essential does not automatically guarantee access to third parties. Objective justifications, such as safety or lack of capacity, could provide reasonable grounds for not granting access in a particular case.

Supply

E6. Supply by new entrants could be confined to them providing customer and billing services to their customers, with the water authority actually supplying water that it has treated to these customers on behalf of the new entrant. This option might be attractive to a multi-utility, which already supplies other services. Going beyond that, with competing suppliers actually involved in the physical processes of the business, may mean granting new entrants access to elements of the authorities' treatment and distribution facilities in order to service their customers.

Distribution

E7. There is a broad consensus that the public interest would not be served by the duplication of the pipe networks, and that the management of the public mains network and the public sewer network are natural monopolies. Therefore, in practice it is likely that competition will usually be introduced into the pipe networks through opening access to them as essential facilities. This matches the separation of distribution as a regulated activity in other utility sectors.

Treatment

E8. In principle, competition can be introduced into treatment in two ways. Under the first approach, new water treatment operators could use the public water mains to service their customers by adding their treated water to the system. Similarly new entrants to the wastewater treatment business could use the public sewerage collection network to carry their customers' wastewater to their treatment works. This would enable new entrants to the supply side of the business to service their customers using their own treatment resources, through the use of the distribution network. This could bring the advantages of innovation and competitive pressure on costs to the treatment businesses.

E9. The second way of introducing competition into treatment would be to treat certain of the existing water treatment works, and wastewater treatment plants, as essential facilities. Access to the facilities would be granted to all new entrants on an equal basis. There may be an economic argument for this, where, for example, the water authority has already made investment in facilities more than adequate to service requirements in a water supply area, and a new entrant would be at a disadvantage if it were not to be granted access to this capacity. It could also be argued that it would not be in the public interest to see duplication of assets where there was already adequate provision.

E10. A factor distinguishing the water sector from some other utility sectors is that there is no national grid for water, or sewerage. Therefore water introduced into one water supply system cannot be sold in a different water supply system. Also as it requires a large amount of energy to shift liquids over long distances, it is fairly expensive to transport water or sewage. Accordingly, water supply systems are generally designed to provide water from source, through treatment and distribution to users by using gravity for the majority of the energy required. Sewerage collection systems generally collect down the hill. These practical considerations may have a bearing on the feasibility of particular cases and of whether assets constitute essential facilities.

E11. A further factor relating to treatment of wastewater relates to the Mogden formula, applied to trade effluent charges. This has traditionally been the method by which the relevant costs of receiving and treating trade effluent has been determined, in accordance with the "polluter pays" principle. It may pay large trade dischargers to explore alternative means of disposal, either by pre-treating their waste before discharge to existing sewers, or by building their own treatment plant and discharging directly to a water course or the sea. There are other options. It may be possible to consider changes to the application of the Mogden formula, to encourage innovation in such disposal, or for a new charging basis to replace Mogden.

E12. It would not be in the consumers long term interest to close off the possibility of the innovation and cost saving that could come from new entrants to the treatment business. Therefore, the potential for this form of common carriage has to be considered, with proper safeguards. However, in the short term, in the vast majority of water supply areas, and sewerage collection districts, the water authority will remain the sole provider of treatment facilities. In these cases it appears likely that new entrants into the supply market will have a case for having access to these facilities, where the capacity exists to allow this.

E13. Where a new entrant into the treatment business decides to develop new facilities in a water supply area or sewerage collection district then the supply businesses in that area will have a choice of providers of treatment services. If the water authorities own treatment facility had been deemed to be an essential facility, as the only source of treatment services available to supply businesses in the area, then it is likely that this judgement would change once supply businesses had a choice of treatment service providers.

Off-network service

E14. One area in which the water authorities are already subject to competition relates to "off-network" services. Apart from private water supply and sewage disposal services in locations where a connection to the public network would be excessively costly, some customers, mainly, but not exclusively, large users, may have the choice of private provision of either service, either by exploiting a local water source, or by discharging directly to a river or estuary. In this situation, the customers decision on whether to remain "on-network" will depend on a combination of cost and customer service considerations.

E15. The main threat to the distribution and treatment activities comes from large customers opting to make private provision off network. This reduces the economies of scale on the system, and increases the unit costs for other customers. The minimisation of water use by large customers has similar effects on a more moderate scale.

E16. Given the high fixed costs of the industry, loss of such customers means higher charges for remaining customers, and the risk of stranded assets. It is therefore important that water authorities strive to keep this business, while respecting competition legislation.

E17. Regulation of private water supplies is covered by the Private Water Supplies (Scotland) Regulations 1992. These regulations are due to be amended to implement the provisions of the 1998 Drinking Water Directive. Private dischargers are regulated by SEPA under the Control Of Pollution Act 1970.

E18. The development of competition in the water and sewerage industry should help to retain customers with large demands on the public network. These customers will know that they will have a choice of suppliers, and that the charges levied on their chosen supplier will reflect the costs that they impose on the system. This should make remaining connected to the public network a more attractive option.

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