Utility Week

Utility Week 18th October 2013

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Comment Utility Week expert view Karma Ockenden "Having made the bold decision to open up the water retail market for businesses, the government should allow this to go to its logical conclusion" T he arcane subject of how utility companies should be structured seems to have developed a bizarre ability to make headlines. A Labour promise to break up the big six started the trend. The subject returned last week when SSE became the first of the big six to hike winter prices. The resulting debate (one likely to be repeated when the other winter price rises come through) strayed into causes of the hike – wholesale prices and green levies or the more sinister rip-off retail margins? – and the merits of vertical disintegration. The bold in the industry have responded: EDF Energy chief executive Vincent de Rivaz argued refreshingly plainly in a speech last week that price rises are not a result of excessive retail margins and that integration is good for customers. Interesting then, that in water, companies look set to be forced to remain vertically integrated against their better judgement. The Water Bill will introduce retail competition for all non-domestic customers from 1 April 2017. Businesses will be able to choose who supplies their water – their incumbent company, the retail branch of an out-of-area incumbent, or even a genuinely new entrant. Water companies will not, however, be able to choose not to compete in this new market by opting out of business retail altogether. The Bill specifies they must remain integrated companies. Not a problem for those willing and able to roll up their sleeves and fight for customers – those, for example, already testing out their retail offerings and capabilities in the Scottish market. Quite a problem for those who either aren't a whizz at retailing (Ofwat's service incentive mechanism report for 2011-13 out two weeks ago makes interesting reading in this context) or who don't have the time, resources or desire to slug it out in the open market. And that's probably a fair proportion of the industry. According to soon-to-be-published research undertaken by Utility Week, 78 per cent of water companies think they should have the option to exit retail. The market as proposed by the Water Bill looks overcomplicated. There will be 20-odd incumbent retailers, plus an indeterminate number of new entrants, scrapping over a handful of high-value national customers and around a million other businesses. Retail margins will probably be tight, so the onus will be on keeping service quality high but at a low cost-to-serve – which suggests economies of scale will be crucial. The government, however, has been adamant it will keep water vertically integrated. In its June response to the Efra committee's pre-legislative scrutiny of the draft Water Bill, it rejected the committee's call for functional separation of the retail and wholesale arms of incumbents and for the principle of non-discrimination to be included on the face of the Bill. It also rejected the call for provisions to allow incumbents to voluntarily exit the retail market. The government argued that functional separation would not eliminate the risk of discriminatory behaviour and would not be suited to all companies (from those too small to split down the middle, to those who already had voluntarily). Instead it prescribed a variety of regulatory controls on discriminatory behaviour. On the retail exit issue, it worried that this might lead to mandatory separation and that domestic customers (who incumbents would have to continue to supply) would lose out on crossover benefits from competition; in fact, that a two-tier system may emerge to the detriment of households. It seems the industry may have done too good a PR job on the virtues of vertical integration when it was trying to fend off the introduction of more competition. The government wryly comments: "During discussions ahead of publication of the Water White Paper [in 2011], water companies and their investors left us in no doubt that compulsory separation would be harmful to the sector." Now retail competition is definitely coming, firms have changed their tune and the government is having none of it. But that's a bit petty. Times change. And positions adopted in one set of circumstances don't necessarily hold true once another set of circumstances has emerged. Reluctant retailers won't make good retailers; but even those with the best will in the world won't necessarily have the time and resources to give as good as they get. The government should have learnt its lesson from energy and realised that accusations of discriminatory behaviour or unnecessarily high pricing would best be prevented by at least functional separation. Legal separation of wholesaler Scottish Water from retailer Business Stream in Scotland has worked well; regulatory fixes are untested. As for domestic customers, the jury is out on whether they will benefit from business retail competition anyway. The government says it has no desire to prop up inefficient retail businesses. It suggests white-labelled retail offerings might be the way forward for companies who can't compete. This is retail exit in all but name. Having made the bold decision to open up the water retail market for businesses, the government should allow this to go to its logical conclusion and let companies as well as customers exercise choices in the market. UTILITY WEEK | 18th - 24th October 2013 | 7

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