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Draft Water Services (Scotland) Bill
Consultation on Proposed Provisions

SECTION E: Partial Regulatory Impact Assessment

PARTIAL REGULATORY IMPACT ASSESSMENT

E1. This partial regulatory impact assessment (RIA) assesses the likely impact of the provisions contained in the draft Water Services (Scotland) Bill

Issue

E2. Is the current regulatory framework for the provision of public water and sewerage services adequate to protect the Executive’s objectives given the possibility that competition on the public networks might develop?

E3. The current regulatory regime applies only to Scottish Water as the sole provider of water and sewerage services on the public networks. It makes no clear provision for the regulation of services provided by third parties using the public networks. Until recently, this was an acceptable state of affairs. However, the Competition Act 1998, which came into force in March 2000, opens up the possibility of other parties seeking various forms of access to the public networks. The Executive proposes therefore that the Water Services (Scotland) Bill should revise the legislative framework to ensure that its public health, environment protection and social policy objectives continue to be met as competition develops.

E4. Scottish Water is regulated by several different regulators (WIC, SEPA, DWQU, and HSE — see paragraph A4 of this consultation paper for further details). Due to the complex nature of this regulatory regime and the difficulty in predicting how a competitive market will develop and behave, the assessment of costs, benefits and risks included in this partial RIA is mainly qualitative.

E5. In RIAs it is good practice to distinguish between policy and implementation costs. Policy costs refer to the costs that can be directly attributed to the policy goal whereas implementation costs are those that can be attributed to the ‘red-tape’ burden of regulation. The situation under consideration here is what form of competition, if any, should be allowed. Therefore it is about opening up a market rather than imposing additional burdens. In general therefore there will be benefits to businesses rather than additional costs. Hence the analysis below does not mention costs, except in specific instances where they are thought to be significant for particular businesses.

Objectives

E6. The Executive has business and public policy objectives for Scottish Water. The public policy objectives are for it to contribute to:

• Public health - by providing a constant public supply of drinking water, which satisfies drinking water quality standards and by the safe and effective removal of wastewater.

• Environment protection - by providing for the treatment and disposal of wastewater that meets environment protection standards.

• Social policy - by maintaining the link between domestic water and sewerage charges and the Council Tax system, which results in domestic charges that reflect broadly customers' ability to pay for the services that they receive.

E7. The Executive wishes to ensure that the revised regulatory framework continues to support Scottish Water's contribution to the delivery of these objectives.

Risk Assessment

E8. The Competition Act 1998 came into force in 2000. It opened up the prospect of competition on the public water and sewerage networks developing on the back of challenges brought under the Act by third parties wishing to enter the market and compete with Scottish Water through the shared use of parts of the networks. This competition could take two main forms:

• Common Carriage - where a new entrant to the market competes with Scottish Water, to provide water and sewerage services on the public networks. This is on the basis of the new entrant adding water that they have treated to the public networks for distribution to their customers on the networks, or drawing wastewater from the public sewers for treatment in their own wastewater treatment works. In both cases the new entrant is providing a treatment service, which they can only deliver through the public networks that the incumbent owns and operates.
• Retail - where the incumbent continues to provide all the treatment and distribution functions and the new entrant's role is confined to offering billing and other customer services in competition with the incumbent.

E9. As matters stand, either form of competition would mean new entrants to the market operating beyond the scope of the regulatory framework that is applied to Scottish Water. This could pose risks to the Executive's stated objectives on public health, environment protection and social policy.

Preferred Option

E10. In February 2003, Ross Finnie MSP, Minister for Environment and Rural Development outlined the Scottish Executive’s policy for addressing the possibility of competition on Scotland's public water and sewerage networks. He said that the Executive would amend the present framework of water and sewerage regulation by legislating to:

• Protect public health and the environment by prohibiting common carriage on the public networks.
• Safeguard the Executive's social objectives by prohibiting anyone other than Scottish Water from serving household customers.
• Establish a licensing regime to regulate the provision of retail services to non-household customers.

E11. The Executive believes that this option strikes the right balance between the need to safeguard its public policy objectives and the desirability of capturing the benefits that can be expected to flow from competition. In terms of the former, the restriction of competition to the non-domestic sector will ensure that the link between the Council Tax system and domestic charges is retained. In terms of the latter, it will clarify the legal framework, which will assist prospective new entrants to the market by providing them with certainty as to the application of the Competition Act. It will ensure that wholesale charges are published, so that there is a level playing field for new entrants to compete with Scottish Water in the supply of retail services. By assisting businesses that wish to enter the retail market to compete with Scottish Water, the Bill will benefit businesses generally by encouraging the development of choice for the 160,000 premises in the sector. This can be expected to stimulate keener charges and better services.

E12. A licensing regime for retail competition in the non-domestic market will impose some costs on the companies that currently supply retail services to non-domestic customers. The Executive is only aware of a very few such companies and it is expected that the cost to obtain a license under the new proposals will be relatively minor. The cost of running the license regime will be recovered by the WIC from all license holders.

Alternative Options Considered

E13. The following alternative options were considered:

Alternative Option 1: No change to the existing legislative framework
Alternative Option 2: Prohibit all forms of competition on the public networks
Alternative Option 3: Allow retail competition for all customers
Alternative Option 4: Allow common carriage

E14. The section below considers the costs, benefits and risks of each of these options.

Costs, Benefits & Risks of each Option

Alternative Option 1: No change to the existing legislative framework

E15. If the present legislative framework is not revised, there is a risk that competition will develop on an ad-hoc basis. This would pose risks to Ministers’ public health, environment protection and social policy objectives. (See below on the options for retail competition and common carriage.)

E16. As well as posing risks, ad-hoc development of competition, probably as the result of legal challenges against Scottish Water, would be an inefficient and ineffective way forward. It would mean considerable uncertainty existing for many years both for water users and for those firms wanting to compete with Scottish Water.

Alternative Option 2: Prohibit all forms of competition on the public networks

E17. The Executive considers that for legislation in this area to fall within the competence of the Scottish Parliament, it should not go beyond the minimum necessary to safeguard its stated policy objectives. It has concluded that prohibiting all forms of competition would go beyond what is required. Further, such a prohibition would prevent potential suppliers unnecessarily from entering the market and would prevent non-domestic customers from obtaining the benefits that competition could bring them.

Alternative Option 3: Allow retail competition for all customers

E18. In the Strategic Review of Charges 2001, the Water Industry Commissioner estimated that the size of the retail segment of Scottish Water's business as a whole was around £75m in 2000-01.

E19. By 2006, when competition would be introduced, Scottish Water is expected to have cut its operating costs by approximately a third. If it achieves this then the potential net benefit from retail competition is estimated to be around £5m a year. These net benefits would accrue to customers in the form of keener prices and to new entrants in the form of profits.

E20. The above estimate of the potential benefit from retail competition does not capture any dynamic efficiency gains that might result from increased competition, although these are thought to be small. Nor do they capture any benefits that may result to businesses having a choice of supplier, such as improved service levels. The cost of the regulatory regime that would be required to administer the competitive regime and the data transfer system would reduce these benefits.

E21. Against these benefits have to be set the risks posed by retail competition to Ministers’ social policy objectives. These objectives are delivered through the current charging arrangements for domestic customers. First, charges are averaged across the country so that customers resident in expensive to serve areas pay for their services on the basis of the same tariff structure as those in relatively cheap to serve areas. Secondly, local authority billing and collection of domestic charges is conducted on the back of the Council Tax billing and collection system. Thus domestic customers across the country pay for water and sewerage by reference to the Council Tax band of their homes and where they receive a discount on their council tax, they also receive the same discount on their water and sewerage charges.

E22. It does not appear possible to retain the current charging arrangements and introduce retail competition in the domestic sector, as the arrangements are dependent on the local authorities applying their detailed information of individual household’s circumstances, which could not be made available to other parties. The Executive judges that the potential net benefits that may result from retail competition in the domestic sector are not sufficient to offset the higher charges that would result for many of the most vulnerable (such as single parents, single pensioners and the disabled) if the current charging arrangements were undermined.

Alternative Option 4: Allow common carriage

E23. Allowing common carriage would create a larger contestable market compared to the retail competition only options. Taken at face value, this could imply there is greater scope for efficiency savings in the industry, which would feed through into benefits for businesses and domestic customers.

E24. The critical issue here is that in the Executive’s view common carriage poses an unacceptable risk to public health and the environment. Anyone wishing to add water or draw water from the public networks would be committing themselves to running a continuing process, relying on the performance of managerial and operational functions to a constant and demanding standard. Such processes would inevitably carry with them the risk of standards not being met at all times. Were such risks to be realised, the consequences could include contamination of the public water supply, interruption to supply and damage to the public infrastructure - all of which would threaten public health. Similarly, on the wastewater side, there could be pollution, including sewage flooding, interruption to the supply and again damage to the public infrastructure - threatening public health and the environment.

Consultation with Small Business: ‘The Litmus Test’

E25. The proposed reforms should not involve any additional costs to small businesses — rather they should benefit water users by providing them with a choice of retailer. They should also benefit potential small retailers by providing clarity on the legal framework.

E26. Small businesses and their representatives are specifically invited to respond to the consultation questions.

Compliance & Enforcement

E27. The Executive proposes that the Water Industry Commissioner should be responsible for administering the licensing regime: considering licence applications, issuing licences and monitoring compliance with the terms of the licences. It proposes that the Commissioner's actions in this respect should be subject to appeal to the Courts and, in respect of competition matters, to the Competition Commission.

Results of consultation

E28. This RIA is part of the Executive’s consultation on the draft Water Services (Scotland) Bill and the results of the consultation exercise overall will help inform the full RIA.

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