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Valuing every dropHow can we encourage efficiency and innovation in
water supply?
Water today, water tomorrow
www.ofwat.gov.uk
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Valuing every drop how can we encourage efciency and innovation in water supply?
This is one of a series ofoccasional focus reports.
It highlights the work we
are doing on a particular
policy area, with the aim of
encouraging wider debate
and discussion.
Contents
1. Serving customers, protecting the environment 3
2. Identifying the problems 8
3. Tackling root causes a long-term strategy 13
4. The immediate next steps 20
5. Further information 23
2 Contents
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Water today, water tomorrow
Serving customers, protecting the environment 3
1. Serving customers, protecting the environment
Water supply is an essentialservice. We depend on it in our
daily lives. So, we need to be able
to rely on it. By and large, the water
sector in England and Wales has
delivered a reliable service. For
example, in the 23 years since
privatisation in 1989, 12 companies
have not imposed a hosepipeban at any time. And no individual
company has had to impose a ban
more than three times.
We expect that the sector will
continue to deliver a reliable
service in the future. But our
water resources are coming under
increasingpressure. We
need new
solutions to
make sure that,
while delivering
a reliable
service, the sector also protects the
environment and keeps customersbills as low as possible.
The water sector has delivered
signicant environmental
improvements since privatisation.
For example, it has carried out
investigations and actions at
more than 200 sites to reduce the
damaging impacts of abstraction
(the process of taking water out ofthe environment). This has helped
to improve river quality. Under the
Environment Agencys General
Quality Assessment, 72% of
English and 88% of Welsh rivers
are now rated good or excellent,
compared with 55% and 79%
respectively in 1990. We challenged
the companies we regulate to
make sure that they made these
improvements while providing value
for money. So, customers bills are
about a third lower on average than
they would have been without our
regulation.
But we must all do better in the
way that we plan for, source and
use water. Some of our rivers are
already running dry. Climate change
will alter our weather patterns,
which could leave us with even less
water where and when we need it
in the future.
By and large, the water sector in
England and Wales has delivered
a reliable service
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Valuing every drop how can we encourage efciency and innovation in water supply?
4 Serving customers, protecting the environment
Water resources in the south-east
The Water Resources in the South East of England (WRSE) Group
currently comprises the Environment Agency, Ofwat and seven water
companies operating in the region. Other licensed water companies
are also eligible to join. Defra, the Consumer Council for Water and
Severn Trent Water all have observers on the group.
It aims to identify and assess options to balance water supply and
demand in the south-east. It takes account of the potential to deliver
better outcomes for customers and the environment by sharing
resources and trading water. Companies in the region can then
consider these options when they develop their own water resource
management plans.
The groups 2010 report suggested that water companies in the
south-east could save about 500 million over the next 25 years
by developing shared rather than independent solutions.
Earlier reports identied a case for connecting water distribution
networks so that four of the companies in the region could trade
water. The companies implemented these proposals, securingsupplies more sustainably and bringing some cost savings for
their customers.
http://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_Joint_report_Final.pdfhttp://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_Joint_report_Final.pdf -
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Water today, water tomorrow
Serving customers, protecting the environment 5
For example, since autumn 2010we have experienced by and large
a prolonged dry spell. As a result,
some water companies have been
granted drought orders and permits
for parts of eastern and south-east
England.
Population growth and changinglifestyles could increase demand
in some regions, exacerbating the
problem. Projections from the Ofce
of National Statistics show that the
population of England and Wales
could grow from about 55 million
in 2010, to more than 63 million by
2030 an extra 8 million people.
The south-east of England alone
could see 1.4 million more people
over the same period.
We describe the problems in detail
in The case for change reforming
water abstraction management inEngland, a joint report from the
Environment Agency and Ofwat,
published in December 2011.
Even without these challenges,
evidence suggests that we do not
Being more efficient with water
at every stage of the value
chain would help protect theenvironment and make better use
of customers money
always make thebest use of our
water resources.
For example,
we could move
more water from
areas where there is a surplus to
those where it is in short supply.In Harnessing upstream water
markets whats to play for?, which
we published in March 2010, we
estimated that trading water could
save 960 million, compared with
the cost of developing new supplies.
There is also scope for many of
us to use less water. In the east
of England, Veolia Water Easts
customers use fewer than 120
litres of water per person each
day on average. By contrast, the
average across England and Wales
is about 150 litres per person eachday. Consumers can use less
water without giving up the health,
business and recreational benets
they enjoy. They just need to waste
less. Waterwise, an independent
authority on water efciency,
provides a wealth of information on
its website to help household and
non-household consumers use
less water.
http://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdfhttp://publications.environment-agency.gov.uk/PDF/GEHO1111BVEQ-E-E.pdf -
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Valuing every drop how can we encourage efciency and innovation in water supply?
6 Serving customers, protecting the environment
The water companies needto control leakage effectively.
Consumers rightly expect their
suppliers to minimise leakage.
It sends the right signal about
valuing water, and promotes
positive attitudes towards using
this precious resource wisely. So,
while the companies have reducedleakage signicantly since the
mid-1990s, they need to maintain
this momentum as water becomes
increasingly valuable.
Being more efcient with water
at every stage of the value
chain from resources, through
delivery, to the water that we
all use would help protect the
environment and make better use
of customers money (see text box
on page 7). Improvements would
make a difference now. They are
also essential if we are to meetfuture challenges most effectively.
We need new solutions from
Government, from regulators,
from thecompanies,
and from us as
customers as
well.
Traditionally,
Government
and regulatorshave responded
to individual
problems, such
as leakage,
with individual
solutions including leakage
targets. This has often led to a
detailed regulatory approach,
which can stie innovation and
distract regulated companies from
delivering the best outcomes for
customers. It makes more sense to
nd sustainable solutions that tackle
the root causes of any problems.
In this document, we discuss what
those root causes might be, and
how we need to change to achieve
the best outcomes for customers
and the environment.
The UK Governments Water White
Paper, Water for Life, published
in December 2011, sets out some
possible solutions for England. The
Welsh Government is expecting to
publish its own strategic policy for
water during 2012. Everyone has arole to play. This document is mainly
about Ofwats role.
http://www.official-documents.gov.uk/document/cm82/8230/8230.pdfhttp://www.official-documents.gov.uk/document/cm82/8230/8230.pdf -
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Water today, water tomorrow
Serving customers, protecting the environment 7
Understanding the water value chain
Abstraction
We get most of our water from sources like rivers, reservoirs and underground aquifers
(or groundwater). To take water out of the environment (to abstract it) the companies and
other water users like farmers and industry need to have a licence. They must also
pay the Environment Agency an administration fee for these licences. Collectively, we
take about 55 billion litres of fresh water out of the environment each day. We use about
16 billion litres of this for public supplies. The rest is mainly used by the energy sector,
farming and other industries.
Treatment, storage and distribution
The water we use each day is treated to a high standard, stored, and pumped through
more than 338,000 km of pipes to where it is needed. To make sure that we can rely
on these supplies, each company maintains and updates a 25-year water resourcemanagement plan. It selects a range of solutions that will secure water supplies at the
best value for customers and the environment. These can include developing or trading
water resources, and managing demand by installing water meters or xing more leaks.
Consumption
Each of us uses about 150 litres of water a day on average in our homes. We also use
water at work, in our public spaces and places of leisure. As well as supplying water andtaking away wastewater, the companies are responsible for:
reading our water meters (about 40% of households have one);
sending us bills;
providing us with water efciency advice; and
responding to any complaints or enquiries we have.
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Valuing every drop how can we encourage efciency and innovation in water supply?
8 Identifying the problems
2. Identifying the problems
If we are to deliver improvements,
rst we need to identify any
problems with the current
arrangements. Then we need to
decide how best to tackle them.
We describe some of the key
issues below.
Over-abstractionThe Environment Agency considers
that river ows in England are
potentially too low to support a good
standard for local plants and wildlife
in up to 11% of rivers and lakes.
And 35% of groundwater sources
are over-stretched.
Unused licences
Environment Agency research
in 2008 found that licence
holders abstracted only 40%
of their licensed volumes in
England. Leaving this water in the
environment could obviouslyhelp where the environment is
already under stress. And some
abstractors have good reason
to keep their unused licences as
valuable back-up. But holding on to
licences could be inefcient if the
water would have more value to
other users.
Missed opportunities to share
resources
At the moment, only about 4%
of the public water supply is
transferred between company
regions. Why do the companies not
trade more? The cost of transferring
water in bulk is certainly one factor.
Yet the analysis we carried outfor Harnessing upstream water
markets whats to play for? took
account of these transfer costs,
and still found signicant potential
savings from redistributing water
from areas of surplus to areas
where it is in short supply.
Inefficient investment in new
resources
Missed opportunities to share
resources are one example of
inefcient investment. But there are
other reasons to question whether
the companies are investingefciently. Some stakeholders
have argued that the companies
suffer from a bias towards
schemes that require signicant
capital investment reservoirs, for
example. We considered this in our
discussion paper on Capex bias in
the water and sewerage sectors in
England and Wales substance,
perception or myth?. We found that
our regulatory incentives may cause
the companies to prefer either
operating or capital expenditure
unduly, depending on their
individual circumstances. And we
identied other possible sources of
bias including a company culturethat favours engineering solutions
and low risk.
Concerns about leakage
Leakage is often regarded as
synonymous with waste. Yet it is
actually wasteful to reduce leakage
when the costs of doing so are
greater than the costs of increasing
supply or reducing demand by other
means. We want the companies
to manage leakage down to levels
that are neither wastefully high nor
wastefully low. But in the early 1990s
when they were free to manageleakage as they saw t many
allowed levels to rise unacceptably.
Since 1997, we have set targets that
have seen total leakage fall by more
than a third. We are considering
whether leakage regulation and
management need to change to
deliver further improvements.
http://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdf -
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Valuing every drop how can we encourage efciency and innovation in water supply?
10 Identifying the problems
Water efficiency targets
We have set the companies targets for the work they must do to help
consumers save water. They comprise:
an annual target for each company to save at least one litre per
property a day, on average, by promoting water efciency;
a requirement to provide information to consumers on how to use
water wisely;
a requirement for each company to improve the evidence on how
effective water efciency measures are likely to be; and
an additional company-specic target to promote water efciency
as part of a best-value solution to securing reliable supplies.
We set targets for the period from 2010-11 to 2014-15. In their rst
year, we required the companies to save 24 million litres a day by
promoting water efciency. They actually saved 35 million litres a day,
nearly 50% more than the target amount and two-and-a-half times the
amount they saved in 2009-10.
Using water inefficiently
Households and businesses use
water wisely when they get at
least as much value from using
it as it costs to supply the water.
But that does not always happen.
Sometimes consumers use water
even when the benet it gives them
is less than the cost of supply.
We do not know the total value
that households and businesses
get from using water, and we can
only estimate the total cost of
supply, including wider social and
environmental costs. So, we cannot
say how much water we waste.
We do know that the nancial
incentive to use water wisely does
not reect the full cost of supply,
including environmental and
social costs. And we know that as
consumers we are unlikely to takeaccount of these environmental
costs. Defras report on Public
understanding of sustainable
water use in the home, published
in September 2009, found that
consumers are not very aware
of the environmental impact of
using water. We provide more
information on these issues in
Push, pull, nudge how can we
help customers save water, energy
and money?, which we published in
March 2011.
Customers paying the priceUltimately, it is customers who
pay the price for these problems.
They pay for any inefcient
investments. They pay for wasted
water whether or not they waste it
themselves. And they bear the risk
of higher prices or more frequent
water use restrictions if supplies
become unsustainable in the future.
http://randd.defra.gov.uk/Document.aspx?Document=EV0503_8291_FRP.pdfhttp://randd.defra.gov.uk/Document.aspx?Document=EV0503_8291_FRP.pdfhttp://randd.defra.gov.uk/Document.aspx?Document=EV0503_8291_FRP.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://randd.defra.gov.uk/Document.aspx?Document=EV0503_8291_FRP.pdfhttp://randd.defra.gov.uk/Document.aspx?Document=EV0503_8291_FRP.pdfhttp://randd.defra.gov.uk/Document.aspx?Document=EV0503_8291_FRP.pdf -
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Water today, water tomorrow
Identifying the causes
a new approach?
It makes sense to nd solutions
that tackle the root causes of any
problems. But what are those root
causes?
Poor price signals
One of the key issues is that
price signals do not reect the
value of water to the environmentor to other users. Abstraction
charges set a price for water at
its source. They are based on the
costs to the Environment Agency
of administering the abstraction
licensing system. They take little
account of local environmental
conditions. And because there is noeffective market to trade licences,
Traditional responses to finding
solutions to water resources
issues can discourage innovationFinding solutions atraditional approach
Traditional responses to these
issues are often prescriptive
telling companies and consumers
what to do. This can discourage
innovation. Instead of addressing,
anticipating or even inuencingtheir customers needs and wants,
the companies may concentrate on
responding to the regulator.
For example, the companies
use an activity-based measure
to report progress against their
water efciency
targets. They
multiply water
efciency
activities by the agreed savings for
that type of activity. If they wish to
do something new to promote water
saving, we require them to provide
evidence that it is effective. As aresult, some companies may rely
on established activities, instead
of innovating and trying out new
solutions that could be much better.
Even if we can develop incentives
that would work in isolation, it is
another challenge to make them
work collectively. If regulation
becomes complex, the companies
will respond to incentives in
unforeseen and counter-
productive ways.
Detailed regulatorysolutions also tend to
be self-perpetuating
because they treat the
symptoms, not the causes
of the problem. Leakage
targets are an obvious
example of this. They have
helped to reduce leakagesignicantly. But we are still not
Identifying the problems 11
condent that the companies would
manage leakage effectively if we
stopped setting targets because the
underlying causes remain. We need
to improve our overall approachto regulation to provide better
incentives.
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demand on to their customers
through higher bills.
Limitations of regulation
The main role of the economicregulator is to provide incentives
for monopoly companies to act as if
they were in a competitive market.
But regulation has its limitations.
For example, regulated companies
have more information than their
regulators. That can make it hard
to set appropriate incentives. One
solution is to try to obtain more
and more information. But that
encourages detailed regulation, and
we have already discussed how
that can cause problems of its own.
So we need to nd more effective
ways to regulate that do not rely ondetailed information.
Effective long-term solutions must
tackle these root causes. In the next
chapter, we describe our strategy
for doing just that.
Valuing every drop how can we encourage efciency and innovation in water supply?
12 Identifying the problems
bills need to
increase. It
means that
we need to
look beyond nancial incentives
to encourage people to use water
wisely.
Monopoly powerIn competitive markets, companies
must remain efcient in order to
survive. If they provide poor service
or charge too much, customers
will choose another supplier. By
contrast, monopolies have less
incentive to keep prices down
and service standards high. For
example, there is not necessarily
an incentive for them to nd more
cost-effective ways to source water.
Also, household customers
cannot choose their water
supplier, while choices for non-household customers are currently
limited. And, in the absence of
regulation, monopoly companies
have no incentives to help their
customers manage their water use.
Unregulated companies can simply
pass the rising costs of meeting
It makes sense to find solutions
that tackle the root causes of any
problemsthere is no price to reect the value
that other users place on water.
Abstraction charges typically apply
to the total amount of water that a
licence holder is allowed to abstract,
rather than the amount that they
do abstract. An abstractor could
damage the environment by takingall of the water it is allowed to,
and doing so at a peak time. Yet it
would pay the same price if it chose
not to take any water from the
environment at all.
At the other end of the value
chain, about 60% of households in
England and Wales do not have a
water meter. Unmetered customers
pay a xed fee, but then pay nothing
at all for each unit of water they
use. So they have little nancial
incentive to use water wisely. Even
metered customers pay less thanthe full costs of supply. Metered
charges reect only the companys
costs, which cover some but not
all of the environmental costs of
supplying water, and removing and
treating wastewater. This does not
automatically mean that customers
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Water today, water tomorrow
Tackling root causes a long-term strategy 13
3. Tackling root causes a long-term strategy
Our strategy is based around the
concept of sustainable water. We
want a water supply system that is
environmentally, economically and
socially sustainable. Using water
resources inefciently is a barrier
to that. Tackling the root causes of
that inefciency is likely to be the
most effective way forward. So ourapproach involves:
bringing price signals more
closely into line with costs;
introducing more choice; and
developing improved regulatory
incentives for the companies
to choose options in the best
interests of customers and the
environment.
Better price signalsWe want price signals that reect
more closely the value of water to
the environment. At the start of the
value chain, that means developing
better price signals for raw water.
Reforming abstractionDefras Natural Environment White
Paper, which was published in
June 2011, recognised a need to
reform the way that people and
businesses in England can obtain
water abstraction rights. Water for
Life provides more detail on the
UK Governments plans, which we
welcome. It sets out the objectives
for a new system, which are to:
give clear signals and regulatory
certainty on the availability
of water, to drive efcient
investment to adapt to climatechange and meet water
needs;
better reect the value
of water to customers, its
relative scarcity, and the
value of ecosystem services
to ensure all our water sources
are protected;
reect the benet of discharges
to river systems;
drive efciency in our water use,
using market forces and smart
regulation to lower costs and
reduce burdens;
be fair to all abstractors, taking
into account current licences; be exible and responsive to
changes in supply and demand,
including providing greater access
to water when more is available;
and
meet our water needs at least
cost to bill payers, and to the
consumers of other products and
services which depend on water.
Some changes are already under
way. For example, the Environment
Agency is taking steps to reduce
barriers to trade in abstraction
licences. Trading can help toallocate resources more efciently.
It reveals the value of water to
different users, and allocates it to
those that value it most. Water for
Life notes that a new abstraction
system should encourage more
trading.
http://www.official-documents.gov.uk/document/cm80/8082/8082.pdfhttp://www.official-documents.gov.uk/document/cm80/8082/8082.pdfhttp://www.official-documents.gov.uk/document/cm80/8082/8082.pdfhttp://www.official-documents.gov.uk/document/cm80/8082/8082.pdf -
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Valuing every drop how can we encourage efciency and innovation in water supply?
14 Tackling root causes a long-term strategy
Defra will develop detailed reform
options by 2013. It will establish
a national advisory group of keystakeholder representatives to
guide this process.
We are working with Defra,
the Welsh Government, the
Environment Agency and other
stakeholders on these longer-term
reforms. They are essential if we
are to improve the process for all
abstractors. In the meantime, we
are exploring mechanisms thatOfwat could apply now to improve
the companies decisions about
potentially damaging abstraction.
We are developing an abstraction
incentive mechanism (AIM), which
would use price limits to reward
or penalise regulated companies
for the impact of some of their
abstraction decisions. This would
complement other incentives that
we are developing to encourage
the companies to trade more
water (see page 17). The incentive
would penalise the companies for
abstracting more than a specied
(or baseline) volume of water, ifthat abstraction was likely to cause
environmental damage. It would
also reward them for abstracting
less than their specied volumes in
those cases.
Penalties and rewards would only
apply in cases where there was
a material risk of environmental
damage. They would vary according
to the degree of potential damage.
We would administer rewards
and penalties through our regular
reviews of the companies pricelimits. We would set higher price
limits for those companies that
abstracted less than their specied
volumes, and vice versa. The
objective would be to minimise
the impact on customers bills
of protecting the environment. It
would provide an incentive for
We want prices signals to reflect
more closely the value of water to
the environment
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Water today, water tomorrow
Tackling root causes a long-term strategy 15
How much do we
really value water?
Sometimes we only appreciate
the value of something when
we no longer have it. That is
exactly what some people in
parts of rural Shropshire found
when they ran out of water
in the summer and autumn
of 2011. After months of low
rainfall, the private springs and
bore holes that supply them
nally ran dry.
Living in remote locations,
they had no mains water tofall back on. So residents had
to travel for miles to get water
from relatives or friends. The
BBC interviewed one couple
who had spent about 170 on
containers, which they lled
by travelling to family 50 miles
away. They commented: We
feel a bit bereft really. Its so
essential, isnt it?
the companies to deliver better
outcomes for the environment in the
most cost-effective way.
The AIM is not a substitute for
more fundamental reforms that
would apply to all abstractors. It is
a practical, short-term step that we
can take until longer-term solutionsare in place.
The mechanism is targeted at
improving decisions about existing
abstractions, rather than inuencing
the companies decisions about
future investments. The existing
water resource planning process
already requires the companies to
take account of the environmental
impacts of abstraction. Water for
Life reinforces the need for them to
demonstrate that they have done
that. At the same time, we are
working with the UK water industryresearch body (UKWIR), the
Environment Agency and Defra to
review the guidance on assessing
these environmental impacts.
Paying for what we use
At the other end of the value
chain, metering can help align
individual household bills broadly
with the costs of delivering water
and sewerage services. That can
send an effective signal to us as
customers to use water efciently.
We carried out work to look at
some of the costs and benets of
metering over different time periods.
We published our initial ndingsin October 2011 in Exploring the
costs and benets of faster, more
systematic metering in England
and Wales. This report showed
that faster rates of metering could
be benecial for customers and
the environment under certain
conditions such as when water
resources are under pressure.
The policy framework for metering
is a matter for the UK and Welsh
Governments. Water for Life
explains that it is for each water
company in England to decide onan appropriate metering strategy for
its region, taking account of impacts
on water demand and affordability.
The UK Government expects
companies in water-stressed areas
in particular to consider the role that
metering might play in managing
water demand.
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16 Tackling root causes a long-term strategy
Introducing morechoice
Introducing more choice, wherever
it is in consumers interests, would
help to address the problem of
monopoly power.
In Water for Life, the UKGovernment announced its
intention to introduce more
competition for non-household
customers in England. By changing
legislation, it has already allowed
non-household customers that
use ve million litres of water
a year or more to choose their
supplier. Choice was previously
restricted to customers using
more than 50 million litres a year.
The Government will reduce the
threshold to zero in a future Water
Bill, which will allow all non-
household customers to choosetheir supplier.
It has also proposed several
reforms designed to encourage
more new companies to supply
water services and so deliver
more choice to customers. These
include:
establishing a new, regulated
approach to market entry that
allows licensed suppliers to
compete for eligible customers
across England, Scotland and
Wales;
introducing a new licence so that
new companies can specialise
in providing wholesale waterservices, retail services or both;
and
extending access rights to allow
alternative suppliers, such as
landowners or farmers with spare
water, to input water into any part
of a water companys network (for
example, directly into a reservoir).
We think that changes such as
these will help create market
incentives for the companies to use
water resources more efciently.
Some water companies are alsolooking at ways to improve the
existing market and regulatory
framework. In its 2010 report,
Changing course delivering a
sustainable future for the water
industry in England and Wales,
Severn Trent Water proposed
several reforms to encourage more
trading of bulk water supplies. For
example, it suggested that Ofwat
and the Environment Agency could
require the companies to consider
options for bulk supplies in their
business plans.
Introducing competition in retail
services could generate benetsthroughout the value chain. For
example, the threat of losing
customers would provide a clear
incentive for retailers to keep their
costs down so that their prices
remain competitive.
Customers could also expect a
wider choice of tariffs and tailored
retail services. The environment
should benet too, with retailers
providing water efciency advice
to help customers minimise
their bills. One of the benets of
retail competition in Scotland isthat it has resulted in business
customers using less water. For
example, Scottish Water Business
Stream helped Tesco to reduce
consumption in its stores by 8%
using smart meter technology.
http://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdf -
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Water today, water tomorrow
Tackling root causes a long-term strategy 17
Developing betterincentives
What is a bulk water
supply?
A bulk water supply is the
supply of water from one
licensed water company to
another. Companies draw
up a contract (a bulk supply
agreement) that sets out
the terms and conditions of
a bulk supply, including the
price. If the companies fail to
reach agreement, they can
ask us to make a decision (a
determination) on the terms
of the bulk supply agreement.
Regulatory incentives can have an
impact on the companies decisions
about their options to balance
water supply and demand. We
want to provide incentives for the
companies to choose options in thebest interests of customers and the
environment.
Incentivising water trading
A 2010 report for Defra,
Assessment of regulatory barriers
and constraints to effective
interconnectivity, identied various
barriers that prevented water
companies from trading bulk
supplies with each other. One was
that prices for untreated water do
not reect the value of water to the
local environment, which we discuss
above. Other issues fell into twobroad categories. The rst covered
different types of risk. The second
was about regulatory incentives.
It should be possible for the
companies to allocate and price risks
appropriately in the contracts that
they agree between themselves. We
are helping the water sector achieve
this for example, by helping to
develop model contracts. The issues
around regulatory incentives clearly
fall to us to address.
We are considering options to
incentivise bulk water trading. One
would be to deregulate it. Bulksupplies would still be subject
to the usual water quality and
environmental regulation. But we
could allow the companies providing
bulk supplies to keep the full return
from this activity for as long as it
continues.
By contrast, we currently only allow
them to keep the full return for ve
years. We could also allow the
companies receiving bulk supplies
to keep any excess returns. In itself,
this would tilt the playing eld in
favour of bulk supplies, and againstother options to balance supply and
demand. But by helping to offset
other barriers to bulk supplies, it
should result in better outcomes
overall.
Another option would be to continue
to regulate bulk supplies, but to
increase the returns that we allow
for regulated companies. We could
allow those providing bulk supplies
to keep any excess returns forlonger than ve years. And we could
allow bulk supply recipients to keep
some of the saving they would
make from taking a bulk supply
rather than developing a higher-cost
scheme of their own. At present,
customers would receive all of this
saving. But they only benet if their
http://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdf -
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Valuing every drop how can we encourage efciency and innovation in water supply?
18 Tackling root causes a long-term strategy
suppliers choose the best value
options. We want to make sure that
there are sufcient incentives for
them to do so.
In Future price limits a
consultation on the framework,
we sought stakeholders views on
these options. We ran a workshopon water trading in January 2012,
and we will be holding a series of
industry working group meetings.
We will then consider the comments
we receive, and the relative merits
of the options. We will publish our
conclusions in autumn 2012 in our
consultation on the methodology for
the next price review.
Avoiding regulatory bias
The Defra report also described
concerns that the way we regulate
could make a water company
nancially worse off if it chose totake or provide a bulk supply. One
argument was that our regulation
provides a stronger incentive to
invest in capital schemes, while the
companies have to classify bulk
supplies as operating expenditure.
We want to provide incentives for
the companies to choose options
in the best interests of customersand the environment
http://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Download -
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Valuing every drop how can we encourage efciency and innovation in water supply?
20 The immediate next steps
4. The immediate next steps
Maintaining secure water supplies
at an efcient cost is a signicant
challenge. In this document,
we have described some of the
changes that we need to make
to the way that we regulate. Our
strategy will shift the focus away
from detailed regulatory solutions,
such as specic targets. Instead,we want to tackle the root causes
of problems that prevent the water
sector from delivering best value to
customers and the environment.
We are working on the long-term
solutions that we described in
chapter 3. But we recognise that itwill take time to implement them,
and more time before they take full
effect. We will continue to develop
short-term or interim measures,
which can start to make a real
difference now.
Better price signals
In November 2011, we published
our consultation on the framework
for setting price limits in the
future. It described our proposed
approach to the overall package
of incentives for the companies.
Key features include:
separate price limits for
the wholesale and retail
components of the business;
incentives to trade water; and
a focus on requiring the
companies to deliver outcomes
rather than outputs.
The consultation also described
the approaches we are
considering to assess and
recover costs. In the past, we
have assessed the companies
requirements for capital and
operating resources separately.
Going forward, we are looking
at the companies overall
expenditure. We are also
exploring how to incentivise the
companies to invest in the most
sustainable solutions. We want to
remove any perverse incentives
In December 2011, Defra reduced
the threshold at which non-
household customers are eligible
to choose their supplier. This
means that ten times as many
customers will be able to switchtheir water supplier. In preparation
for this, we have revised the retail
market code and contract. This
followed extensive consultation
with the industry. Our aim is to
make sure that the water supply
licensing system works well in the
new expanded market.
We are developing an abstraction
incentive mechanism along
the lines that we described in
chapter 3. Our future price limits
consultation described this in
outline, and asked for initial views.
We will explain it in more detail
in autumn 2012 when we consult
on our methodology for the 2014
price review.
Working with the Environment
Agency and Defra, we are
supporting a proposed UKWIR
project to improve the waythat the companies calculate
the environmental impact of
abstraction. This will explore how
best to value the impact it has on
the long-term sustainability of a
water resource.
Using market forces
Future price limits
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Water today, water tomorrow
The immediate next steps 21
We are working with Defra and
the Environment Agency to update
the guidelines on water resource
for them to favour solutions that
do not deliver best value for
customers.
planning. This is the guidance that
we expect the companies to follow
when they prepare their plans to
balance water supply and demand
over the following 25-year period.
We want to improve this guidance
in several ways. For example, we
want to encourage the companies
to integrate their water resource
planning with other areas of
their business. This should lead
to solutions that provide better
overall value for customers. With
the Environment Agency and
Defra, we will publish a revised
joint draft for consultation early
in 2012.
Other work
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Valuing every drop how can we encourage efciency and innovation in water supply?
22 The immediate next steps
You can help
We welcome views on the issues we have raised in this document.
We would be particularly interested in your views on:
whether the changes we have suggested will deliver the
improvements we seek to water resource use, leakagemanagement and support for customers to use water efciently;
the timeframe over which you think these changes will take full
effect; and
whether there are other, potentially more effective things that we
and others could do.
Please contact Paul Hope, Head of Water Resources (paul.hope@
ofwat.gsi.gov.uk) if you would like to contribute to the debate.
Jointly with the Environment
Agency, we provided input at
the early stages of the current
UKWIR review of the economics
of balancing supply and demand.
This is the technical guidance
that sits below the policy
guidance in the water resource
planning guidelines. Along withthe Environment Agency, we are
members of the steering group
for this project. UKWIR plans to
publish a revised document in
winter 2011-12.
We are reviewing our approach
to regulating water companyleakage. We will publish a report
that explores options to improve
our current approach to leakage
target setting, and considers more
fundamental longer-term reforms.
In 2012, we will review what
incentives would be appropriate
for the companies to promote
water efciency once the existing
targets have expired in 2015. We
will consider how water efciency
ts within the wider framework of
incentives that we set out in our
future price limits consultation.
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Water today, water tomorrow
Further information 23
5. Further information
Ofwat publications
Harnessing upstream water markets whats to play for?, Ofwat, March
2010
Waste not, want not making the best use of our water, Ofwat, June 2010
Push, pull, nudge how can we help customers save water, energy and
money?, Ofwat, March 2011
Capex bias in the water and sewerage sectors in England and Wales
substance, perception or myth?, Ofwat, May 2011
Exploring the costs and benets of faster, more systematic water metering
in England and Wales, Ofwat, October 2011
Future price limits a consultation on the framework, Ofwat, November2011
Related information
Changing course developing a sustainable future for the water industry
in England and Wales, Severn Trent Water, April 2010
Water Resources in the South East Group Progress towards a shared
water resources strategy in the South East of England, Summary report,
October 2010
Assessment of regulatory barriers and constraints to effective
interconnectivity of water supplies, Defra, 2010
The natural choice: securing the value of nature, Defra, June 2011
Water for Life, Defra, December 2011
http://www.ofwat.gov.uk/publications/prs_inf_up.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_demand.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/customers/metering/pap_tec201110metering.pdfhttp://www.ofwat.gov.uk/future/customers/metering/pap_tec201110metering.pdfhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_summary_paper_Final.pdfhttp://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_summary_paper_Final.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://www.defra.gov.uk/environment/natural/whitepaper/http://www.official-documents.gov.uk/document/cm82/8230/8230.pdfhttp://www.official-documents.gov.uk/document/cm82/8230/8230.pdfhttp://www.defra.gov.uk/environment/natural/whitepaper/http://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://archive.defra.gov.uk/environment/quality/water/resources/documents/wt0921-technical-report.pdfhttp://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_summary_paper_Final.pdfhttp://www.environment-agency.gov.uk/static/documents/Business/100401_WRSE_summary_paper_Final.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.stwater.co.uk/upload/pdf/STW_Changing_course_web_pdf.pdfhttp://www.ofwat.gov.uk/consultations/pap_con201111fpl.pdf?download=Downloadhttp://www.ofwat.gov.uk/future/customers/metering/pap_tec201110metering.pdfhttp://www.ofwat.gov.uk/future/customers/metering/pap_tec201110metering.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/future/monopolies/fpl/pap_tec1105capex.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_pushpullnudge.pdfhttp://www.ofwat.gov.uk/publications/focusreports/prs_inf_demand.pdfhttp://www.ofwat.gov.uk/publications/prs_inf_up.pdf -
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Ofwat(The Water Services Regulation Authority) is a non-ministerial
government department. We are responsible for making sure that the water
and sewerage sectors in England and Wales provide consumers with a goodquality and efcient service at a fair price.
Ofwat
Centre City Tower
7 Hill Street
Birmingham B5 4UA
Phone: 0121 644 7500
Fax: 0121 644 7699Website: www.ofwat.gov.uk
Email: [email protected]
Photographs Environment Agency, Getty Images,
iStockPhoto, WWF-UK
Printed on 75% minimum de-inked post-consumer
waste paperFebruary 2012
ISBN 978-1-908116-19-2
Crown copyright 2012
You may reuse this information (excluding logos) freeof charge in any format or medium, under the terms of
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Where we have identied any third party copyrightinformation, you will need to obtain permission from the
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Any enquiries regarding this publication should be sent
to us at [email protected].
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