Draft Water Services (Scotland) Bill
Consultation on Proposed Provisions
SECTION A: The Executive's policy
The Water Services (Scotland) Bill: The Executive's Policy
Introduction
A1. Scottish Water is responsible for providing all services on the public water and sewerage networks across Scotland. It was established as a public corporation by the Water Industry (Scotland) Act 2002 and is accountable to the Scottish Ministers, and through them to the Scottish Parliament, for the provision of these services.
A2. Ministers appoint the chairman and non-executive members of the Scottish Water board and approve the appointment of its executive members. They set the policy framework within which Scottish Water performs its statutory functions and determine the level of financial resources available to it by setting annual limits on its borrowing and on the total amount of income available to it from customers as a whole.
A3. The Programme for a Better Scotland, published on 15 May 2003 confirmed Ministers' commitment to retaining Scottish Water in the public sector. Ministers have set Scottish Water the task of achieving significant improvements in efficiency, so as to ease pressure on customer charges. They also require Scottish Water to continue contributing towards their public health, environment protection and social policy objectives by ensuring an uninterrupted supply of wholesome drinking water, the safe disposal of wastewater and the continuation of current charging arrangements for household customers.
A4. Scottish Water operates within a regulatory framework designed to safeguard public health and the environment and to promote the interests of customers. The framework's main elements are:
- The Drinking Water Quality Regulator (established by the Water Industry (Scotland) Act 2002) - whose functions include ensuring that Scottish Water complies with drinking water quality duties set by Ministers under the provisions of the Water (Scotland) Act 1980.
- The Scottish Environment Protection Agency (established by the Environment Act 1995) - whose functions include regulating the impact that Scottish Water has on the environment, principally by granting consent to discharges into the aquatic environment from Scottish Water's wastewater treatment works.
- The Water Industry Commissioner for Scotland (first established by the Water Industry Act 1999 and re-established by the Water Industry (Scotland) Act 2002) - who has the function of promoting the interests of Scottish Water's customers. The Commissioner's particular functions are to investigate and report on customer complaints, advise Ministers on the level of income needed by Scottish Water to perform its functions and, in light of Ministers' decisions on that point, to approve annual water charges schemes proposed by Scottish Water.
- The Water Customer Consultation Panels (established by the Water Industry (Scotland) Act 2002) - whose function is to represent the views and interests of Scottish Water's customers in their respective areas.
A5. The framework does not include any provisions for any form of competition on the public networks. The possibility of such competition has increased since 2000, when the Competition Act 1998 came into force. The draft Bill, at section B of this paper, contains provisions to update the framework to ensure that Minister's public health, environment protection and social policy objectives can continue to be met if competition develops.
Background
Scottish Water's Customers
A6. Scottish Water supplies water services to over 95% of household properties and sewerage services to over 90% of such properties. The remainder is served by private water supplies and sewerage systems, which are the responsibility of their owners, not Scottish Water. Scottish Water also provides water and sewerage services to some 160,000 other premises, including shops, offices, hospitals, schools, hotels and factories and other industrial plant. Others in these categories either provide some or all of their water and sewerage services for themselves or contract with third parties to provide the services for them. A distinction can be drawn between those services provided by Scottish Water on the public networks and all other services provided by other parties either for themselves or for third parties not on the public networks ("off-network" services). The latter are subject to separate provisions within the regulatory framework and are not affected by the proposals outlined in this paper.
The Competition Act 1998
A7. The Competition Act 1998 introduced a clearer framework for competition in the United Kingdom than had been provided by earlier competition legislation. It brought into domestic law provisions (which parallel those under European law) and introduced new sanctions for anti-competitive behaviour. It applies to the provision of all types of goods and services and is enforced by the Office of Fair Trading (the OFT). In the case of the privatised utilities, the OFT and the relevant sector regulator have concurrent jurisdiction. The 1998 Act applies to Scottish Water, but in Scottish Water's case it is applied and enforced by the OFT alone as the Water Industry Commissioner does not have the same concurrent powers as the Office of Water Services (OFWAT) has in respect of the privatised water industry in England and Wales.
A8. The Competition Act includes two prohibitions:
- A prohibition of agreements between undertakings, decisions by associations of undertakings or concerted practices which have the object or effect of preventing, restricting or distorting competition in the United Kingdom (or a part thereof) and which may affect trade within the United Kingdom (the "Chapter I prohibition"); and
- A prohibition of conduct by one or more undertakings which amounts to the abuse of a dominant position in a market in the United Kingdom (or part thereof), which may affect trade within the United Kingdom (the "Chapter II prohibition").
A9. These prohibitions, breaches of which carry penalties of up to 10% of annual turnover, affect Scottish Water in a number of ways. For example, they preclude it from seeking to retain particular customers within a customer group by offering them charges and tariffs not available to other customers in the same group and in the same circumstances. Also, the basic principle of competition legislation relating to "essential facilities" carries significant implications for Scottish Water. Where certain assets (i.e. "essential facilities") are uneconomic to duplicate, but access to, or use of, them is essential in order to compete effectively in a market, the owner of the assets may be required to provide competitors with access to them on an equitable basis. It can be argued that some Scottish Water assets, notably the water and sewerage pipe networks, constitute essential facilities. In such cases, and where safety, public health and other practical considerations make it feasible, Scottish Water might be required to make access to these facilities available to competitors. Failure to do so could leave it open to the charge of abusing a dominant position were it to be demonstrated that such a position existed in a particular case. This state of affairs could result in prospective new entrants to the market gaining access to, or otherwise benefiting from, the infrastructure vested in Scottish Water, with Scottish Water having to open parts of its networks to competitors in two possible ways that can be summarised as follows:
Common carriage - where Scottish Water would use its system of water mains to carry water treated by a competitor to the competitor's customers, or where it would use its sewers to carry wastewater from a competitor's customers to the competitor's treatment works.
Retail Competition - where Scottish Water would have sole responsibility for treatment and distribution on the public networks. It would treat water or wastewater for a competitor and would distribute it to or from the competitor's customers using the public networks. In such cases the role of Scottish Water would differ from its present role of supplier in that while it would continue physically to supply water and sewerage services, it would do so on behalf of the competitor and it would be the competitor rather than Scottish Water who would have the direct commercial relationship with the ultimate consumer of the service.
Executive policy
Risks and benefits of competition
A10. Competition can bring benefits to customers. In general, it provides choice and encourages efficiency, keener prices, greater customer responsiveness, innovation and improved standards. In the water industry, common carriage could encourage competition in the provision of water and wastewater treatment services by enabling third parties to develop new treatment facilities that relied on the public networks to supply and serve their customers. There would also be scope to use retail competition as a means of providing customers with more choice in how they pay for water and sewerage services. However, these options also pose a range of risks.
Prohibiting common carriage on the public networks
A11. In the case of common carriage the risks would be to public health and the environment. Allowing third parties to add to the public networks drinking water that they had treated, or to draw from the public sewers sewage for treatment, would mean them becoming involved in the processes by which Scottish Water manages the infrastructure as a whole to ensure continuing compliance with drinking water and wastewater treatment regulations. This involvement would necessarily complicate the process and introduce additional risks to it. In the case of drinking water, there would be the primary risk to public health from the insertion of treated water. Also common carriage would probably mean tapping new sources of water and this could impact on effective water resource management. These risks could be managed by placing strict operating conditions on the third party, but they could not be eliminated. Consequently, there would be a greater likelihood of failure within the process.
A12. Were such risks to be realised, the consequences could include contamination of the public water supply, interruption to the 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.
A13. The Executive has concluded that these risks to public health and the environment outweigh any foreseeable benefits that might arise from competition in treatment services. It has decided therefore, in the interests of safeguarding public health and the environment, that the regulatory framework should be revised to preclude the possibility of anyone other than Scottish Water using the public networks to carry out the physical supply of water or sewerage services. To this end the draft Bill contains provisions prohibiting common carriage on the public water and sewerage networks.
Prohibiting retail competition for households
A14. Retail competition poses risks for households. These risks arise from the nature, and impact on customers, of the current arrangements by which households pay for water and sewerage charges. A crucial feature of the current arrangements for charging domestic customers is the link between charges and the Council Tax band of the property served. Thus households occupying properties in Council Tax Band A pay two thirds of the charge paid by those in Band D and one third of the charge paid by those in Band H. In addition the discounts on Council Tax available to particular households are applied to water and sewerage charges too. These include a discount of 25% for all single adult households. Taken as a whole these arrangements provide that charges reflect broadly ability to pay, with those living in higher banded properties, who tend to be better off, paying more for their water and sewerage services than those in lower banded properties. However, these arrangements are dependent not only on the current link to Council Tax bands, but also on the practice of the local authorities collecting the charges along with Council Tax payments. Discounts in particular, which are dependent on the local authority applying its detailed information of an individual household's circumstances, could not be maintained were another arrangement put in place, as any such arrangement could not be given access to the local authorities' household information.
A15. Careful regulation would enable the effect of the link between Council Tax bands and water charges to be retained. However, there is no feasible means by which the range of discounts could be retained. Consequently, there is a serious risk that retail competition for households could mean new entrants to the market "cherry picking" high-banded properties, leaving low-banded properties and those attracting discounts to be served by Scottish Water. This would reduce Scottish Water's revenues, leaving it little option but to increase charges to those customers who remained with it.
A16. In light of these very particular arrangements for charging, it is unlikely that competition would develop in a manner that would benefit all customers. Indeed, the expectation would be that low income and vulnerable households, such as single parents and single pensioners, would end up being worse off as the benefit to them of receiving a discount would be lost. Accordingly, the Executive has decided that the regulatory framework should also preclude the possibility of there being retail competition in the household sector. Therefore, the draft Bill contains provisions prohibiting this form of competition.
Licensing non-household retail competition
A17. This leaves open the possibility of retail competition for Scottish Water's 160,000 non-household premises. Such competition would mean Scottish Water continuing as the sole supplier of water and sewerage services on the public network, but with the possibility of new entrants to the market providing non-household customers with services such as meter reading and billing and collection of charges. In effect Scottish Water would become the wholesaler of water and sewerage services to the new entrant, with the new entrant becoming the retailer of these services to the end user. This would encourage Scottish Water to improve the efficiency with which it provides retail services at present and also the nature of these services. In itself that would offer a modest benefit to non-household customers. Additional benefits might include billing arrangements better suited to the needs of particular customers. This could include providing the operator of many sites with a single invoice in respect of all the sites at a frequency that suited the operator, or combining retail water and sewerage services with other utility services.
A18. Customers generally could benefit through the impact that providing wholesale services to retailers would have on Scottish Water. Providing wholesale services would require Scottish Water to improve the transparency and accuracy with which it accounts for the different costs of its business. This would make it easier for the Commissioner and retailers to check Scottish Water's progress in delivering efficiency and for Scottish Water itself to identify the scope for greater cost effectiveness. Thus the development of competition in one part of the business could be expected to provide an additional spur to efficiency beyond that provided by the current regulatory regime.
A19. A key consideration for the Executive is that the pressure on wholesale charges from retailers should not result in Scottish Water offering the retailers better charges at the expense of other customers. Keener charge levels must be based on improved efficiency within Scottish Water and its benefits must be available to all customers - household as well as non-household. There is an issue therefore of ensuring that those taking advantage of competition do not do so at the expense of other customers. It is important that the regime of economic regulation is capable of ensuring that retailers and their customers contribute fairly and proportionately to the costs of the public networks on which they would still rely for the service. Accordingly, the draft Bill contains provisions to establish a regime to license the providers of retail services that deliver that outcome.
Licensing regime
A20. The Executive proposes two types of licence:
- A Water Services Retail licence - whose purpose is to establish a legal right for the holder of such a licence to enter into contractual agreements with non-domestic customers on the public networks, for the provision of water services.
- A Sewerage Services Retail licence - whose purpose is to establish a legal right for the holder of such a licence to enter into contractual agreements with non-domestic customers on the public networks, for the provision of sewerage services. This licence will apply to trade effluent services, though it will not affect Scottish Water's responsibility for monitoring compliance with trade effluent consents and agreements.
A21. Each will entitle the holder to become a wholesale customer of Scottish Water for those respective services. Only licence holders will be entitled to become wholesale customers and to offer retail services to customers on the public networks. It will be possible for a retailer to hold one or other or both licences depending on the services that they wish to offer to their customers.
The role of the Water Industry Commissioner in the licensing regime
A22. The purpose of the licensing regime is to ensure equality of treatment for all customers served by the public networks. This is a task that falls within the broad functions of the Water Industry Commissioner, as the economic and customer service regulator of Scottish Water. It is proposed that the Bill should amend the detail of the Commissioner's remit and functions to reflect the possibility of others than Scottish Water providing retail services to customers on the public networks.
A23. At present the Commissioner acts on behalf of all classes of Scottish Water's customers. He has no duties in respect of the customers of other service providers. To ensure that the Commissioner acts in the interests of all customers served by the public networks, it is proposed that his general function of promoting the interests of Scottish Water's customers should be extended to those of retailers' customers. This duty will not extend to the Commissioner being involved in regulating the charges set by new entrants for their customers. That is a matter to be settled between supplier and customer in a competitive market. However, it will extend to matters in connection with the levels of service provided by new entrants insofar as these might be specified in licences. An important part of the Commissioner's new role will be to ensure that new entrants are capable of providing the level of service that they propose in their application for a licence and that subsequently they do provide that service consistently.
A24. It is proposed that the Commissioner will administer the licensing regime on the basis of regulations made by Ministers. The regulations will be the subject of consultation before being given effect in secondary legislation. Their purpose will be to ensure that there is a transparent, fair and proportionate process by which the Commissioner considers licence applications, grants licences and subsequently monitors and enforces compliance with licence conditions.
A25. It will be open to any legal person to apply for a licence. Conditions will be attached to licences only insofar as they are necessary to enable Scottish Water, the Commissioner and retailers to perform their respective functions. The conditions will ensure that retailers meet their obligations to contribute towards the costs of maintaining the public networks. They will also provide a clear basis for the transactions and exchanges of information between Scottish Water, the Commissioner and retailers that will be necessary.
A26. In granting licences the Commissioner will be required to consider whether the applicant has the financial strength and the operational and managerial capacity to satisfy their licence conditions as a retail supplier. It is envisaged that a licence once granted will remain valid for as long as its conditions continue to be observed. Licences will be transferable only where the Commissioner is satisfied that the person receiving the licence is capable of meeting its conditions.
Charging for the provision of wholesale services
A27. A principal part of the Commissioner's new functions will be the power to regulate the wholesale charge to licensed providers by Scottish Water for its provision of water treatment and distribution services and wastewater collection and treatment services. At present the Commissioner has the function of approving Scottish Water's schemes of charges. These schemes are prepared annually by Scottish Water and set out the charges to be paid by different groups of customers so that taken as a whole they provide Scottish Water with the income that it needs in total to provide its services. In approving a scheme, the Commissioner, exercising his general function of promoting the interests of customers, considers whether it strikes a fair balance in apportioning costs to the different groups of customers. In broad terms he looks for the scheme to provide for each group of customers collectively to cover the costs to Scottish Water of the service that it provides to them.
A28. It is proposed that Scottish Water's charges to retailers, in effect Scottish Water's wholesale charges, should be included in the charges scheme. The draft Bill provides for this and provides the basis on which these charges should be set. Within the framework created by these provisions, the Commissioner will be responsible for establishing the detailed principles to be used in setting wholesale charges. The intention is that these charges should enable Scottish Water to recover from retailers a fair and proportionate share of the total network costs that can be attributed to their customers. This will offer the retailer the reassurance that they are paying no more than is justified economically for the services that they are buying from Scottish Water. It will also reassure other customers that they are not paying more for the wholesale element of the services than are those opting to be served by retailers. Scottish Water will agree with the Commissioner wholesale charges for water and sewerage service providers, including wholesale trade effluent charges, as part of charges schemes generally. However Scottish Water, in its capacity as a retailer, will be free to set the retail charges for those non-household customers that it serves without reference to the Commissioner.
A29. It is proposed that the Bill will provide for the Commissioner to charge licence applicants for the cost of processing their applications. It will also provide more generally for him to recover through levies on new entrants, the costs to him arising from regulating them, including the costs of monitoring compliance with their licence conditions. This is in the interests of fairness and also of consistency with the present arrangement, where Scottish Water, and ultimately its customers, meet the Commissioner's costs in regulating it.
Thresholds
A30. Where competition has been introduced in other utility sectors, it has been on the basis of the market being opened gradually to ensure orderly access to it. Typically this has meant beginning by issuing licences to serve the relatively small number of large customers and then progressively extending the scope of the market to other customers. This approach of applying transitional thresholds has particular merit where forms of common carriage and new sources of production are involved. These require careful physical management of assets and maintenance of constant production standards, which can be controlled more effectively if the initial volume of extra activity is limited. It is less clear that this is necessary where only new retail services are being introduced. Retail services pose no threat to the integrity of the public networks and the only issue is whether the licence holder is competent to provide a reasonable level of retail service to customers without placing an unreasonable administrative burden on Scottish Water. That is a matter for the Commissioner to consider in granting a licence and if there were any doubt on that score, he would be expected to withhold the licence.
A31. On balance therefore the Executive takes the view that a system of transitional thresholds is unnecessary in this market. Accordingly, the draft Bill makes no provision for them.
Exchanging customer information
A32. The prohibition on competition in the household sector effectively limits the retail market in water and sewerage services to all non-household customers served by the public networks. This amounts to some 160,000 premises, ranging from very large industrial premises, through commercial and public sector premises to small businesses. At present Scottish Water bills all of these customers and it will continue to do so unless they opt to use the services of another retailer. However, customers will only be able to choose another retailer if efficient and cost-effective arrangements are in place to enable information about customers to be transferred between retailers.
A33. The provision of such arrangements is a specialised business in its own right that has developed to meet the needs of those competing in other utility markets. The expectation therefore is that several firms will seek to sell their expertise to those wishing to enter the market. As the specification of these arrangements is primarily a matter for prospective retailers, the Executive would not expect to become involved in the detail of such developments. However, the Executive recognises that there might be a need at the outset for measures to facilitate agreement among retailers on issues such as common standards, and compatibility of systems. Insofar as such a need emerges, the Executive proposes that the Commissioner should play an informal role in assisting the different parties reach agreement. It is envisaged that this will be a non-statutory role. It will be distinct from the Commissioner's new statutory function of granting licences, which will require him to satisfy himself, among other things, that a retailer has systems in place to enable information about customers to be transferred effectively before granting a licence to the retailer.
Relationship between Scottish Water and retailers
A34. A licence will grant the retailer rights, principally the right to receive a wholesale service from Scottish Water. It will also impose duties on the retailer, including duties to provide the Commissioner and Scottish Water with whatever information they might reasonably require for the discharge of their respective functions and the duty to pay Scottish Water for any costs that they impose upon it. The rights granted to retailers by their licences will impose concomitant duties on Scottish Water in terms of satisfying these rights. These duties will be binding on Scottish Water.
Relationship between Scottish Water and the licensing regime
A35. Scottish Water will be able to compete with retail providers. This raises the question of whether it should be covered by the licensing regime. The Executive has concluded that it should not, in so far as it discharges its core functions as the physical provider of water and sewerage services. In that context, Scottish Water is bound by statute to perform a range of unique functions, usually to standards prescribed in statute or regulations. It would make no sense for its performance of these functions to be subject additionally to licence conditions, particularly where the range of functions to be covered in licences covers only a small part of those that Scottish Water performs.
A36. It is important, however, where Scottish Water is in direct competition with retailers, that it should not use, or be thought to be using, its position as the sole provider of wholesale activities to place its competitors at a disadvantage to it. To that end, it is proposed that Scottish Water will place its retail activities into a separate retail subsidiary with a view to the subsidiary being treated as a retailer for the purposes of the licensing regime. In this way, Scottish Water's wholesale and retail activities will be separated and accounted for separately. The retail arm will be subject to the same regulation as other retailers and will be treated by the wholesale arm in the same way as the other retailers.
A37. The draft Bill does not make specific provision for this arrangement. Instead, it is envisaged that Ministers will direct Scottish Water to undertake the separation using existing powers at section 56 of the Water Industry (Scotland) Act 2002.
Appeal mechanisms
A38. The Bill will provide that decisions taken by the Commissioner in exercise of the functions in respect of administering the licensing regime can be appealed to the Court of Session or the Sheriff Court as appropriate. In addition to these specific appeal mechanisms, decisions taken by the Commissioner that have a bearing on aspects of competition law can be raised with the UK competition authorities (the Office of Fair Trading and the Competition Commission). As many of the Commissioner's decisions are likely in practice to fall into this category, there could be merit, in terms of providing certainty and transparency, in making specific provision for appeals to be considered by the competition authorities in appropriate cases. As this is a matter that is reserved under the Scotland Act 1998, it would not be possible to include such provisions in the Bill. However, they could be given effect through an order made by the UK Government under the Scotland Act and the Executive will pursue this possibility with the UK Government.
Timetable for implementation
A39. Subject to the Water Services (Scotland) Bill being enacted, the Executive and the Commissioner will work towards the introduction of a regime to license retailers. The Executive will draft and consult on the regulations governing the licensing regime to be made under the Bill. The Commissioner will develop procedures on issuing licences and will consult on these. It is expected that these steps will have been completed by 1 April 2006, thereby enabling applications for licences to be submitted to the Commissioner from that date.