Managing Change in the Water Industry: A Consultation Paper

< Previous | Contents | Next >

F. A new statutory framework

F1. As described at Section C, the existing statutory framework is designed for a situation in which the water authorities are the sole providers of public water and sewerage services. It makes no actual provision for third parties participating in these services. The Executive believes that increased competition and the involvement of third parties requires a new statutory framework. This would address the provision of water and sewerage services in a competitive commercial environment and the essential relationship between these services and social inclusion, public health and environment protection. As such they are matters that are expected to fall within the competence of the Scottish Parliament and the Scottish Executive.

F2. The Scottish Executive sees 4 main areas in which legislation is needed to address these developments:

• Licensing to ensure only fit and proper people are involved, thus ensuring the integrity of the network so that it can continue to protect public health and the environment;
• Ensuring new entrants are also liable to criminal proceedings for supply of unwholesome water in the same way as the water authorities are present;
• Setting out clearly the water authorities’ role in protecting network integrity and acting as supplier of last resort;
• A framework for charging that is cost-reflective, ensures the network is soundly financed, and reflects the additional responsibilities placed on water authorities.

F3. In addition, the role of the Water Industry Commissioner, in relation both to licensing and to the competition legislation, needs to be addressed.

F4. As discussed above, it is also open to doubt how far current legislation actually permits the authorities to allow their networks to be used by, or on behalf of, third parties. It would be possible to remove this doubt by specifically empowering the authorities to make their networks available in a manner consistent with competition law and subject to the conditions described in this section.

(i) Establishing a licensing regime

F5. At present there is no statutory means of ensuring that new entrants to the market do not put public health or the environment at risk as a result of their activities. This a crucial issue that the Executive wishes to address. It proposes that new entrants making use of the water authorities' facilities should face the same public health and environmental obligations that currently rest on the authorities. The Executive believes that this can best be achieved by introducing a licensing regime that will apply to new entrants. The main feature of the regime would be to set common standards of technical competence and financial strength to be met by new operators in the market. This will ensure that operators are properly equipped and staffed to discharge whatever responsibilities they have taken on, and that they have the financial strength to be able to meet any claims arising from failures on their part.

F6. The case for a licensing regime is that it would ensure all suppliers meet basic requirements, protecting the public interest and providing for effective regulation. Licensing also provides a means of achieving public policy objectives with respect to charging. The Executive envisages that the legislation establishing the system should recognise that the impact of competition on the sector is bound to be uncertain. It proposes that the system should not be so prescribed at the outset that it is unable to respond to circumstances currently unforeseen.

F7. One open question is whether a new licensing regime should also apply to the 3 incumbent authorities. It is arguable that as the authorities already meet the standards set in statute this is unnecessary. On the other hand, placing the same requirements on all operators regardless of their status would help to demonstrate that all parties were being treated equally.

F8. In other utility sectors, competition has been introduced gradually, starting with the largest customers. This has helped to stimulate competition, and iron out the technical problems, on a smaller number of higher value customers. Since licences impose obligations as well as rights, there is an argument for making various classes of licenses available, perhaps on different time-scales, such as:

• licences to supply individual, large customers;
• licences to supply all customers above a certain size threshold (for example 100 megalitres);
• licences to supply all customers in an area.

F9. Where a licence extends beyond a single customer, there is a need to define the area over which the rights and obligations extend. At present, there are implicitly three supply areas, concurrent with the three water authority areas. There is a strong public policy objective for uniform domestic charging structures within supply areas. This ensures that services are available at a tolerable cost to all properties connected to the public networks.

F10. It may well be that businesses will seek to provide supply services, treatment services, or both. One option would be to make available different types of licence in each case. Under such an approach, single businesses would be able to hold licences for supply and for treatment, but these licences would be subject to separate regulation. Issues of network management (discussed at F17-21 below) underline that the licensing system for treatment facilities needs to ensure adequacy of provision

F11. The protection of the environment is a key priority. Wastewater introduced into the public sewer network must be given an appropriate level of treatment, before being released to the environment. A new entrant into wastewater treatment would have to make a long term commitment to provide treatment for wastewater collected in a sewerage district. The new entrant would need a consent from SEPA for the discharges from their works.

F12. The creation of a licensing regime implies the establishment of a licensing authority. Rather than establishing a further regulatory post, there is a strong case for adding this duty to the others already placed on the Water Industry Commissioner. Under this system, licensing would be administered by the Commissioner, subject to binding the drinking water quality regulators and from SEPA on wastewater treatment. This is considered in more detail at Section G.

(ii) Criminal liability

F13. Clearly, in light of the proposals for common carriage, careful consideration will need to be given to the circumstances that will give rise to criminal liability. The present position, where only the water authorities can be held criminally liable for providing water unfit for human consumption, would not be tenable were a number of other entrants also supplying treated water to the mains. Therefore the Executive proposes changing the law so that a new entrant can also be held criminally liable.

F14. This change would allow the Procurator Fiscal the option of mounting a prosecution against a new entrant, for example where evidence pointed to their having contaminated the public supply through a failure in their treatment systems. As a condition of access to the networks, a new entrant would need to monitor and record continually their input to the system. This would provide a body of evidence on which the Procurator Fiscal could draw in deciding whether the contamination was the responsibility of the water authority or the new entrant through their respective treatment works.

F15. The Executive recognises that there could be instances in which sufficiently robust evidence could not be obtained from the available records or other sources to establish where responsibility for contamination lay between a new entrant and a water authority. In such circumstances, the water authority could still have a case to answer for having supplied the contaminated water. In practice this could amount to it being prosecuted for having failed to detect and then avert the supply of contamination that had not been its responsibility.

F16. A balance needs to be struck in determining how open-ended an authority's liability should be in such cases. Were there to be virtually no limit on its liability, this could so colour the authority's contractual relations with new entrants as to make effective competition almost impossible. On the other hand restricting liability excessively could allow failures to go unchecked. The Executive invites comments on the extent to which liability in this area should be limited.

(iii) network integrity and supplier of last resort.

F17. Given the nature of the water industry, increased competition that depends on third parties having access to the water authorities' networks will raise complex practical and operational issues that need to be settled. Some of these issues will need to be addressed in legislation.

(a) Network management

F18. Legislation will need to provide for the water authorities as owners and operators of the water mains and sewerage networks to set common standards on water and wastewater quality and on hydraulic conditions to ensure that security and continuity of service are safeguarded. It will fall to the water authority to ensure that there is a balance between water demand and supply, and that there is adequate capacity available for the treatment of wastewater. The Executive envisages that the statutory arrangements for licensing will include provisions ensuring that any undertaker failing to meet contractual commitments, and thus causing the water authority as supplier of last resort to make good any shortfall, will be required to make penalty or compensation payments.

F19. Once a water supply area or a sewer collection system has been opened to competing suppliers of service, the manager of the distribution system will have to be empowered to schedule inputs of water or volumes of wastewater treatment.

F20. There is no national grid for water or for sewerage, and it is highly unlikely that such a development would ever be economic. It is therefore important that there is adequate capacity for water treatment in any water supply area, and adequate capacity for sewerage treatment in any sewerage collection network. Responsibility for ensuring that adequate provision is made will rest with the water authority. The cost of carrying out this responsibility will need to be reflected in water authority access charges.

(b) Supplier of last resort

F21. In Scotland, the importance of water and sewerage services has long been recognised in the policy against domestic disconnection, and in the obligation on the water authorities to supply anyone who can be supplied at reasonable cost. With the introduction of competition into supply, it would be discriminatory for these obligations to fall on any single supplier. Suppliers will have an obligation under their licences to tender for supply to all customers in a given supply area who request it , so it should only be in exceptional cases that a customer finds themselves without a supplier. In these cases, it will fall to the water authority to act as supplier of last resort to domestic customers. The water authority should be able to recover the costs of this obligation from individual customers, or, where this proves impossible or uneconomic, from all suppliers through the access charges. This will ensure that the costs of the obligation of supplier of last resort falls equally on all customers connected to the public system.

(iv) Charging

F22. Arrangements for charging are central to any new framework. Competition will work primarily through the pricing mechanism to provide a better deal for customers. But current charging arrangements in Scotland also provide a means of ensuring that the authorities can continue to serve the vast majority of households and businesses, so protecting public health and the environment. As far as domestic customers are concerned, charging schemes also provide a degree of protection for disadvantaged groups by linking charges to Council Tax bands. The latter arrangements would provide opportunities for cherry picking, by new entrants, of the most attractive customers. This brings no economic benefits, and undermines wider objectives.

F23. The framework for charging arrangements needs to address these issues.

F24. There are two closely related issues on the basis for charges:

• The basis of charges that the water authorities will levy for access to essential facilities (in the remainder of this section this is taken to mean the water and sewerage networks. Different considerations apply to treatment works, to the extent they are considered to be essential facilities).

Any conditions that should be imposed on suppliers with respect to the charges that they make to consumers in different circumstances. An example of this would be requiring each supplier to offer a single set of supply terms and conditions to all customers in its supply licence area.

F25. The objective of a framework for charges in the industry is to maintain the integrity of the whole system, in order to ensure that it can continue to serve the vast majority of households and businesses, so protecting public health and the environment. Because of the large fixed costs of the industry, almost any single customer viewed in isolation will be seen to impose a very small marginal cost on the system. However, charges have to be levied such that the total raised is sufficient to cover the costs of the system. The concept that is generally used to establish the correct charges is that of Long Run Marginal Cost (LRMC). LRMC recognises that the number of customers on a system, and the scale of their demand, must ultimately affect the necessary capacity of the system, and therefore its costs. For the majority of customers, the LRMC will, in practice, be very close to the average cost of the system with its current capacity.

F26. There is a need for a system of access charging and supply licence conditions that ensures that individual customers continue to pay towards the integrity of the system as a whole. The simplest way to achieve this would be for access charges to be set at levels that reflect the average costs of supply to customers, with charges reflecting volume (measured or estimated) but not geographical distance. This would reflect the structure of distribution charges in the electricity industry. It would mean that a new entrant to the water supply market would face the same access charge for a domestic customer irrespective of their location within the water authority’s area, and would therefore have no reason to differentiate their charges between high and low cost of supply areas. An advantage of this approach is that there need not be onerous conditions placed on licensed suppliers.

F27. Other approaches would involve access charges reflecting in more detail the different costs imposed by different customers because of their geographical location. However, it would be difficult to tie this approach to the need to ensure the contribution of all consumers to the maintenance of the system, which could lead to complicated and onerous conditions for suppliers. There could also be problems if different supply businesses had portfolios of customers with significantly different costs. Indeed, this approach to charging could create incentives for new entrants to cherry pick customers in the areas least expensive to supply. The alternative would be a need for a system of cross-subsidies between supply businesses.

F28. Our preliminary conclusion is that the medium-term integrity of the system, and thus the protection of public health and the environment, can best be secured through a system of access charges that do not reflect differences in cost due to geographical location within a water authority area.

F29. One of the most significant obligations that could be applied to supply licences is that each supplier should offer a single set of supply terms and conditions to all customers in its supply licence area. This condition would help to ensure that new suppliers did not cherry pick the most profitable and easiest to serve customers in each area. Such cherry picking would not create genuine efficiency gains from competition, and would disadvantage other customers. If the new suppliers secured the gains from cherry picking, this could undermine the ability of the industry to secure the infrastructure for the current near universal provision. However, if access charges were levied at rates that did not reflect geographical differences within a supply area, then a strict obligation of this nature might not be necessary.

F30. Current charging arrangements, through the link with Council Tax banding, reflect the value of homes and thus in many cases the ability of households to pay water and sewerage charges. This provides a significant measure of protection to many poorer customers.

F31. New entrants might wish to adopt a different approach to charging domestic customers, which could begin to undermine this feature of the system. A general move to metering could affect the protection available under the present system in a similar way. Metering is currently negligible in the domestic sector in Scotland, but, if this were to change, it might well be appropriate to introduce the sort of safeguards in place in England and Wales. These were introduced under the Water Industry Act 1999 to protect those vulnerable to hardship through having to meet high metered charges. These are identified as those receiving benefits or tax credits who have three or more children under 16 or who have certain medical conditions requiring extra water use.

F32. The planned legislation could include reserve powers in this area. Separately, the Scottish Executive is reviewing the impact of water charges on disadvantaged groups, and this may result in proposals for legislative change.

F33. The basic principles for charges that the water authorities levy for their essential services should be placed on a statutory footing. By definition, these facilities are monopoly operations. There will therefore be an ongoing need for rigorous economic regulation by the Water Industry Commissioner.

F34. Charges will also have to reflect the requirements of the Water Framework Directive, when it is implemented. In most parts of Scotland, the use of water by the public water system places minimal stress on the environment. It therefore seems unlikely that the requirements of this Directive will lead to significant changes in our charging system.

F35. It is the practice in the other utilities to put in place requirements that all market participants must meet, in respect of service provision to disadvantaged groups. The Executive envisages a similar approach in the Scottish water industry.

F36. This discussion of charges applies mainly to domestic customers, and to small and medium enterprises. Large non-domestic customers may merit special arrangements through negotiated agreements that reflect more closely the costs of the services that they receive.

< Previous | Contents | Next >