UK Water Competition: Water Supply Licences

Publication Date	March 2006
Publisher	Datamonitor
Product Type	Report
Pages	15
ISBN Number	not applicable
Product Code	DAT00471

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Summary

Introduction

While the remit of Ofwat is currently to promote competition, which it has chosen to do through the mechanism of Water Supply Licenses, there is considerable debate about how successful they can potentially be. The contention is largely around the pricing mechanism supported by Ofwat and how this shields incumbent water utilities from potential efficiency advantages of entrants.

Scope

Outline of the mechanics of the WSLs and how they are designed to operate.
Description of the pricing structures that Ofwat has introduced and how this will affect competition.
Debate on some of the technical issues that this raises for the industry
Coverage of the legal challenges that the WSLs and pricing structure currently face.

Highlights

While Ofwat has introduced Water Supply Licences to allow entrant water retailers access to the UK market, there is considerable debate about how successful they can be.

The current pricing mechanism chosen by Ofwat protects incumbent water utilities from the potential greater efficiency of entrant suppliers as they can price on a "retail-minus" basis.

The WSL scheme is under considerable pressure from a court case involving a paper mill in Wales which is currently before the Competition Appeal Tribunal. The precedents set in this case are likely to be extremely important for the future direction of competition.

Reasons to Purchase

Review progress of competition in the UK water industry
Quantify the retail margins that entrant WSL holders currently have to work with
Understand the technical issues that WSL holders face when entering this market

Content

Catalyst
Summary
Methodology
Analysis
- Ofwat has introduced Water Supply Licenses (WSL) as a mechanism to open the large volume end of the market to competition.
- The focus of competition in the Water Industry is now on Water Supply Licenses (WSL).
- A Water Supply License (WSL) comes in two basic forms, a "retail-only" or a "combined" supply and retail licence
- There are three different ways in which an entrant can use a WSL to retail to major water users.
- WSL holders may purchase excess water from a neighbouring network, establish a link and pay common carriage.
- Ofwat has currently allowed incumbents to set prices on a "retail-minus" basis effectively shielding them from new entrant threats.
- The "retail-minus" pricing structure protects the incumbents' margins by starting with the original retail price.
- The wholesale discount available to WSL holders from indicative access prices is on average less than 1%.
- A retail-minus costing strategy makes assumptions about the likely costs involved in serving entrants.
- WSL holders would like to see the costs set by the suppliers reflect the underlying costs of abstraction and distribution.
- While there are other costing mechanisms aside from "retail-minus", Ofwat has not chosen to support them.
- Technical issues exist for WSL holders, however there is less debate than surrounds pricing
- There are costs for the incumbent supplier in the provision of service as the "supplier of last resort".
- In addition to supply constraints between regions, internal restrictions are also common.
- While competition should drive entrants to innovate, the best water sources are likely to have gone already.
- Water quality is both a serious legal and technical issue for water companies.
- The WSL pricing structure is being challenged in the Competition Appeal Tribunal by entrants Albion Water and Aquavitae
- A key case is still before the Competition Appeals Tribunal that contests the validity of a "retail-minus" costing structure.
- Albion claims that D?r Cymru is currently making a substantial margin on the supplies to Shotton.
- Any substantial margin for Shotton that exists has the effect of subsidising other customers of D?r Cymru.
- While the Shotton case may be resolved mid-2005, any changes to the WSL pricing structure will take much longer.
Appendix
Further reading
- Ask the analyst
List of Tables
- Table 1: Table of indicative access prices published by Incumbent water utilities
List of Figures
- Figure 1: An entrant can purchase wholesale water supplies from the incumbent and retail to its customers.
- Figure 2: If the entrant has their own wholesale water supplies, they can use the incumbent's network.
- Figure 3: WSL holders may purchase excess water from a neighbouring network, establish a link and pay common carriage.
- Figure 4: Supplying water from regions that are not immediately adjoining the consumer's region is not allowed under the Act.
- Figure 5: Schematic of a "retail-minus" pricing approach (relative proportions are merely demonstrative)
- Figure 6: Schematic of a "unbundled" pricing approach (relative proportions are merely demonstrative)
- Figure 7: It is possible to have multiple water networks within the same region
- Figure 8: Existing Supply Arrangements for Shotton Paper Mill
- Figure 9: Albion's supply proposal schematic