Water Bill

Lord Moynihan Excerpts

Tuesday 4th February 2014 Lords Chamber

As it stands, it is bizarre and does not gel with any concept of a market that most of us understand. I believe that if the safeguards are there, the Government will eventually come round to doing this. I hope that they come round to it during the course of the Bill, rather than finding themselves in a situation in a year or two where it becomes obvious that some of the players in the market ought to get out and that the consumer experience would be better if they did so. The Government should think again. I hope that the Minister will have better news for us on this. I beg to move.

[Lord Moynihan (Con)]

My Lords, I shall speak to Amendments 107 and 132 in my name. I also support Amendment 98 in the name of the noble Lord, Lord Whitty. I have listened to him over the past 10 minutes and there is now no doubt in my mind that his amendment—and, indeed, this group of amendments—is the jewel in the crown of all the amendments that have been tabled so far to the Bill, and that is for a very good reason.

The Bill provides for the opening up of water retail services to competition. That is welcomed by some of the leading water companies and by the regulator, and the concept of exit is welcomed by both. Exit is welcomed north of the border and it has been welcomed by the Defra Select Committee. That is a rare alliance indeed. However, as the noble Lord, Lord Whitty, has stated, it is also welcomed by the investor community. Brought together, they are powerful voices in support of exit in the retail services market.

I shall concentrate my remarks on a number of the points raised by the noble Lord, Lord Whitty, and then summarise, as I see them, the key areas of opposition to date that the Government have put forward and offer some reflections on them.

The first and most fundamental point is that for an effective market there needs to be an ability for new entrants to enter and for existing market players to exit. Customers benefit from more effective and efficient suppliers replacing poorer performing businesses. Allowing incumbent water and sewerage companies to exit from retail services would help ensure successful development of the new retail services market and thus benefit customers. Successful entrants could more quickly acquire critical mass by buying the customers of the less successful or committed incumbent retailers. There appears to be plenty of scope for customer benefit if high-performing companies were to take on the customers of other companies.

Ofwat data have suggested that one water and sewerage company can spend up to twice as much as another providing retail services to each domestic customer. Ofwat reports significant variations between companies’ customer service standards. Simon Less, the senior visiting fellow on regulatory policy, has done some outstanding work. He has clearly made the case at the Policy Exchange that where a company considers its strength is in wholesale water activities, allowing it to sell its retail business would enable its management to focus on wholesale. Water wholesaling and retailing have quite different sets of risks. Exiting retail services would reduce a wholesaling company’s risks from, for example, bad debt. The sector would, overall, be able to access investors with a wider range of risk appetites. Allowing exit from retail services would enable mergers between retail businesses, with benefits from increasing scale and scope.

Not only is the group that I have outlined in favour of exit; let us also reflect for a moment on the Bill. This Bill principally came from Martin Cave’s review—80% to 90% of the Bill was based on this review. He, too, is supportive of this principle. It does not go as far as separation, which does concern many noble Lords. It allows, as the noble Lord, Lord Whitty, has stated, no compulsion, simply an option to exit the retail market. I mentioned that the market itself is supportive of this proposal. It is interesting that Moody’s has come out in support of the proposal. Not only Moody’s, but Macquarie Equities Research has recently published a telling and impressive review of retail exit, in which it states:

“We … see a consolidation of retail functions as positive for both consumers and shareholders. Companies will be under no obligation to exit, but will hold the option to do so … Consumers benefit as ultimately all cost synergies are passed to consumers”.

In placing a value on this, Macquarie concluded that synergies through exit could be worth up to £40 million to just two companies alone. Let me quote its overall conclusion on this:

“Under retail competition, given the size of their bills and the services they require, non-households are the area where”,

you would,

“expect to see greatest activity in providing new, tailored services for customers. Figures from Scotland, where there has been non-household retail competition since 2008, show that customers have saved £35 million.

We estimate that NPV savings for customers in England and Wales could be c. 10x that in Scotland, or £350mn.

This estimate tallies with a cross reference estimate. Total annual costs in household retail is c.£800mn and that non-household is roughly 1/2 that of household: i.e. £400mn. With a 15-20% cost reduction through consolidation we would expect to see total annual savings of c.£60-80mn per annum. If we assume that half of this is shared between consumers and companies, then the benefits of consolidation could be c.£30-40mn per annum, or c.£400mn value. …

Under current proposals, water suppliers will need to hold a ‘licence of last resort’, meaning that if they exit their retail division, they are still potentially liable to provide retail services if the new owner of the retail customers goes into administration.

This means … that water companies are unlikely to exit their retail divisions if they need to maintain the capability of running the infrastructure systems needed in case their customers need to return.

This causes two problems … : firstly in the non-household retail division, the water companies that lose market share, will end up with rising costs relative to their revenues and could potentially see losses increase and continue, and secondly in the household retail area, there can be no cost synergies between the existing 18 water and water and sewerage companies”.

Macquarie’s is a powerful voice in this debate, but I would argue that Ofwat is an even stronger voice. Cathryn Ross, at the Water Bill Committee on 3 December, said:

“Our view is that retail exit for incumbents is a critically important element of a functioning, effective retail market. Particularly important is the fact that if we do not allow incumbents to exit, essentially we are mandating inefficient retailers’ remaining in the market. That will basically be baking in cost that customers will have to pay for, which we can easily avoid”.—[Official Report, Commons, Water Bill Committee, 3/12/13; col. 7.]

What would my amendments do? They would enable incumbent water and sewerage companies to transfer their retail businesses to third parties. They would also secure the benefits of such transfers by ensuring a level playing field and consequently maximising the benefits that could flow to non-household customers. It is important to repeat that this approach does not require or compel incumbents to transfer any or all of their non-household customers. It is an option and, as the noble Lord, Lord Whitty, said, it would be subject to the approval of the Secretary of State and a restriction on its use by the competition authorities, and nothing more.

I said that in closing I would try to answer the issues which, as I understand it, underpin the Government’s position at present. The first was referred to by the noble Lord, Lord Whitty: allowing retail exit could unsettle the investment climate. I hope that the noble Lord, Lord Whitty, and I have demonstrated from both sides of the Committee that that is not a strong argument when investors and companies are actively seeking this change, suggesting that they are far from unsettled by it. As I mentioned, the rating agency Moody’s had previously suggested that this would be a positive change, and the Australian bank Macquarie, as I have quoted, also supports the change. Similarly, a recent research study report entitled “Ready for Retail?” published in Utility Week, which I have gone back to—it was quite wrongly maligned by my noble friend the Minister in his summing up at Second Reading—is a good assessment and is worth looking at closely. It highlights that of those companies that were approached, 76% supported amending the Bill to allow retail exit, so I am not convinced that allowing retail exit is going to unsettle the investment climate.

The second point put forward by the Government is that allowing only non-households to exit the retail market would create a two-tier market where householders could be left stranded with a water company that has signalled a lack of interest in providing customer service. To the extent that there is a concern here, it would be addressed entirely by allowing retail exit for all customers rather than just the non-household element. However, even if only non-household retail exit was facilitated, again this appears to be a weak argument when companies have been forced to provide these services in any event since privatisation. Since companies have no choice but to provide retail services because the licence they signed up to at privatisation requires them to provide an end-to-end, source-to-tap service, we really have no idea about whether they are interested, or not, in providing them now—absent retail exit. Indeed, there is a wide variation in the quality of customer service provided by companies, with some of them improving but still some significant gaps at the moment. This argument is really an argument against the status quo. If we have been comfortable with the current arrangements for the past 20-plus years, it seems odd to start criticising it now.

The third point is that if the Government were to go further and allow retail exit for all customers, households could be passed to a new retailer about which they knew nothing and, unlike business customers, they would have no option to switch if they were unhappy with the quality of the service they received. This point, which has been made by the Government, is true on the face of it, but it is rather a xenophobic one. First, customers have never had any choice over who provides these services because they have simply inherited their local monopoly provider. Again, why is this a concern now? Secondly, while the local branding of companies—Thames Water, Severn Trent Water and so on—gives us a warm sense of local provision by local companies, of course they are not local at all. Most of the companies are owned by Canadian or Australian pension funds, and that ownership changes hands regularly with customers none the wiser about the process. Generally the process is very positive for customers because competition in capital markets brings new investment into the sector, and investors put pressure on the management of these companies to keep costs, and therefore bills, down for customers. Surely the key point is that customers want the lowest prices and the best service, and allowing retail exit provides that most effectively. Poor performers are moved out of the market and good performers can grow their market share, even if they are not the “local incumbent”.

The fourth point mentioned by the Government is that introducing retail exit would require a change or create problems with Ofwat’s price controls. I hesitate to say it, but I think that is a redundant argument. The current price control arrangements apply to regionally specific companies and licences. Ofwat is setting both household retail and non-household retail price control. Allowing this change would be easily accommodated within Ofwat’s price control arrangements; in fact they have been designed for that purpose.