In England and Wales, the provision of water and wastewater services was moved from the public to the private sector in 1989. This change was part of a broader government strategy, which also encompassed the telecom and energy sectors, to privatise the ownership and management of public assets.
For 16 years prior to privatisation, water and wastewater services in England and Wales were the preserve of catchment-based public water authorities. During the 1980s, water authorities became increasingly affected by limits on public sector borrowing that were imposed to contain inflation. It was challenging to fund asset maintenance and improvement. In addition, the cost of meeting water quality and environmental directives set by the European Union (EU) grew.
The government’s solution to meet the funding gap was to change the water authorities into private companies. Because 99 percent of households were already connected to the water supply network and 96 percent also connected to the sewerage system (Water Companies Association, Waterfacts, 1992), opportunities for organic growth by the new “water companies” were limited.
As a result, investment was made more attractive by the formation of holding companies that were able to undertake other forms of commercial activity and own the new water companies. Public capital was injected into the holding companies, which were then successfully floated on the London Stock Exchange. England and Wales’ 10 private water and wastewater companies were formed. There are also a number of smaller water-only companies that have existed in private ownership for many years.
New Regulatory Framework
Along with the creation of the water companies came a new regulatory framework. Ensuring drinking water quality fell to the Drinking Water Inspectorate (DWI). The Environment Agency also came into being.
The new water companies were natural monopolies. There was no competition in the market because customers were, in essence, unable to change their water services provider. As a result an economic regulator, Ofwat, was created to control water bills and set service levels. This was achieved through a system of ‘comparative competition’, central to the administration of which is the five-yearly regulatory review cycle.
Ofwat has a statutory duty to ensure companies can finance their regulated function – i.e., water and wastewater services. This is achieved through a price control mechanism. Revenue allowances are set to fund capital and operating expenditures, plus a reasonable return on invested capital. To reward efficiency and good service, the system generally allows companies to retain, for the five-year regulatory review period, savings attributable to efficiency. This creates an incentive. The existence of multiple water companies allows Ofwat to make comparisons and reward the best performers.
Changes Since 1989
The water industry in England and Wales has matured since 1989. Most water companies have undergone several changes in ownership and structure. During the past six years, a sector that was largely publicly listed has become substantially owned by institutional investors. In the first six years after privatisation, the water companies invested £17 billion. This investment is compared to £9.3 billion invested by the water authorities in the six years before privatization (The World Bank Group, Water Privatization and Regulation in England and Wales, 1997).
From 1989 to 2010, capital investment has remained high at £85 billion (Water UK, 2011). During this period, according to Ofwat, water bills were 30 percent lower than they would have been without regulation (Ofwat’s response to the Independent Review of Charging Household Water and Sewerage Services, 2011).
Water quality is high. In 2010, according to the DWI, 99.96 percent of all tests met quality standards (Drinking Water Inspectorate, Letter to Ministers, 2011). Compliance with discharge consents rose from 97 percent in 1996 to 99.8 percent in 2004 (Department of Environment, et al, The Development of the Water Industry in England and Wales, 2006).
However, these successes have not been unchallenged. Water companies have been accused by some customers and politicians of manipulating economic regulation to generate excessive profits. The progress of work to reduce leakage has been a frequent source of criticism.
Concern has also been expressed that owners of some water companies are investing insufficient revenues back into the regulated businesses. This is seen, in part, as leading to high levels of borrowing in the sector. In 2010, Severn Trent noted that water company debt had risen from zero to £33 billion between 1989 and 2010, while gearing – the level of a company’s debt related to its equity capital – over the same period had risen from zero percent to 72 percent (Severn Trent Water, Changing Course, 2010).
Competition has also proved challenging. In 1989, it was envisioned that a competitive market for large volume users would develop. This market has failed to happen to any significant degree. As a result, it is likely that measures to stimulate competition will be incorporated into future legislation.
Subject Matter Expert
Peter Martin, MartinP@bv.com