Act taps into every conscience

“No-one ever wants to pay more. Unfortunately, Scotland has been underinvesting and underpaying for the water services that were provided over many years and possibly decades. The customer will pay either today or tomorrow; either directly through charges or indirectly through taxation or foregoing other public services ........ the transition to a modern, sustainable and competitive Scottish water industry is not easy, but it will yield long term benefits to customers” [Alan Sutherland, Water Industry Commissioner for Scotland, evidence to the Water Inquiry by the Transport and Environment Committee of the Scottish Parliament, January 2001]

The announcement of the creation of Scottish Water confirmed the widely held expectation that the new Water Services Bill will herald the biggest change in the Scottish water industry since reorganisation pursuant to the Local Government etc (Scotland) Act 1994. Not only will the contents of the Bill be important for private operators wishing to enter the market and users who are seeking to obtain the most competitive service available, but also the Bill is expected to signpost the future for the new Scottish Water in terms of both its competitive activities and its statutory duties.

The introduction of the Competition Act 1998, the consultation entitled “Managing Change in the Water Industry” released in June 2000, the consultation entitled “The Water Services Bill: The Executive’s Proposals” issued in March 2001, and the Water Inquiry staged by the Transport and Environment Committee of the Scottish Parliament have all given rise to a number of questions and concerns. This article seeks to touch on some of these issues.

Where are we now?

The Scottish water industry is, of course, a different creature from the industry south of the border. In England and Wales, the water supply and sewerage services industry was largely privatised by the Water Act 1989 and is now governed by a plethora of legislation, principal of which is the Water Industry Act 1991. The English and Welsh water industry is characterised by a number of private companies, governed by the Director General of Water Services (the “DGWS”). His office is colloquially known as Ofwat.

In Scotland, the water industry’s infrastructure is owned and operated by the North of Scotland Water Authority, East of Scotland Water Authority and West of Scotland Water Authority. These were established pursuant to the Local Government etc (Scotland) Act 1994. The Water Industry Act 1999 established the Water Industry Commissioner’s post. This role is held by Alan Sutherland who was appointed with effect from 1 November 1999. His role is, principally, to promote the interests of customers. One of the core aspects of such promotion is advising the Scottish Executive on the revenue levels required by each of the water authorities. The Water Industry Commissioner’s role is very different to that of Ofwat - in essence, Alan Sutherland’s role is more advisory than executive.

Other relevant regulators in the Scottish water set-up are the Scottish Executive, which regulates drinking water quality, and the Scottish Environment Protection Agency, which regulates discharges into the environment.

On 28 February 2001, Sam Galbraith announced the merger of the three existing water authorities into one: Scottish Water.

Water and sewerage operators across Europe are well acquainted with the raft of EC environmental legislation which has required (and continues to require) much investment in infrastructure to ensure that particular environmental standards (e.g. the quality of drinking water) are met. The industry is now preparing itself for the introduction of the new water framework directive which is aimed at ensuring the overall consistency of water policy within the EC. Going forward, the European Commission expects that the water framework directive will operate as the basis of water strategy within the EC.

In parallel with this, is the introduction of the UK’s Competition Act 1998 (see previous articles on this in the Journals of February 2000 (p. 18) and August 2000 (p. 20)). The Competition Act has introduced into the UK a much stricter control of anti-competitive practices - but its relevance to the Scottish water industry was not immediately recognised. It has become clear over the last two years that the 1998 Act is having a fundamental impact in the Scottish water industry.

The most recent development has been the publication of the March 2001 consultation paper entitled “The Water Services Bill: The Executive’s Proposals”. This maps out the future for the Scottish water industry; the Scottish Executive is seeking views on its proposals. These proposals are examined in below.

What is the 1998 Act?

What is its impact?

In short (and as explained in the adjoining article “Competition Act comes of age”), the 1998 Act introduced at the UK level two prohibitions which have already existed at the EC level for a number of years. These are:

l    a prohibition on restrictive practices; and

l    a prohibition on the abuse of a dominant market position.

In simple terms, a dominant market position is most likely to exist where a business or undertaking has a 40% share or more of a particular market. Once in this “dominant” position, the undertaking in question must take care not to “abuse” that dominance. Abuse can take a number of forms, e.g.:

l    refusal to supply;

l    discriminating between customers without objective justification;

l    forcing customers to buy full ranges of products rather than just one element of that range; or

l    cross-subsidising competitive activities in another market in which the undertaking is not dominant.

So how does this impact on the Scottish water industry?

The principal relevance of the 1998 Act is the application of the

so-called “essential facilities” doctrine. A helpful summary of the issue is given in the Scottish Executive’s June 2000 consultation paper at paragraph D3:

“... the basic principle of competition legislation relating to “essential facilities” carries significant implications. Where certain assets (i.e. “essential facilities”) are uneconomic to duplicate, but 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 water authority assets, notably the water and sewerage pipe network, constitute essential facilities. In such cases, and where safety and other practical considerations make it feasible, the authorities may be required to make access to these facilities available to competitors. Failure to do so could leave the authorities open to the charge of abusing a dominant position were it to be demonstrated that such a position existed in a particular case”.

The essential facilities doctrine has already reared its head in a number of cases in EC competition case law. For instance:

l    in Sealink/B&I-Holyhead [1992] 5CMLR255, it was concluded that the port authority at Holyhead harbour, which also used the port facilities as a ferry operator, was dominant in that it owned the facilities and could abuse that dominance by arranging sailing schedules to the detriment of competing ferries;

l    in Magill (C-241 and 242/91P on appeal from cases T-69, 70 and 76/89), the European Court of Justice held that it could be an abuse to refuse to grant copyright licences of TV programme listings to those wishing to publish television magazines;

l    more recently, in Oscar Bronner (C-7/97), the ECJ emphasised that the essential facilities doctrine will only apply in situations where it can be shown clearly that it is not viable to set up an alternative competing infrastructure - in this case, the ECJ held that a home delivery service for a widely circulated newspaper was not an essential facility as it had not been demonstrated that alternative home delivery schemes could be established.
Given the size and complexity of the Scottish water industry infrastructure it has been widely accepted that this may well constitute an essential facility and that the introduction of the 1998 Act will require access to be granted to the existing infrastructure for private operators wishing to service particular customers.
Denying access to an essential facility is permissible where such a refusal is objectively justifiable. For instance, in the Scottish water industry context, a water authority might opt to refuse access to a system if a private operator cannot guarantee that a connection to that system will not compromise
environmental quality checks built into that system.
The English and Welsh Precedent
Ofwat have already remarked, in respect of English and Welsh
operators, that:
“Common carriage is possible ... the Competition Act 1998 is the catalyst to achieve its more widespread use” (Ofwat letter of 12 November 1999 to water and sewerage companies)
Indeed, in an effort to facilitate common carriage (i.e. use of the infrastructure) by competing operators, Ofwat required that the English and Welsh water companies had in place by March 2000 clear statements of the access charges payable by competing operators should they wish to connect into the water and sewerage infrastructure.
Competition is therefore somewhat more advanced in the English and Welsh sector. Experience south of the border has given some steer as to how the 1998 Act may impact in the Scottish sector.
Realisation of the potential impact of the Act (drawing on how competition has developed south of the Border) has given rise to a number of concerns, typified by statements made during the Water Inquiry staged by the Transport and Environment Committee of the Scottish Parliament.
These gave rise to the consultation paper entitled “Managing Change in the Water Industry” which was issued last year and more recently to the March 2001 consultation paper entitled “The Water Services Bill: the Executive’s Proposals”. The current consultation period expires on 13 June 2001.
A Guide to the Proposals
So what is the Scottish Executive proposing? What is in the consultation paper? In brief, the Executive makes the following proposals:
l    The creation of Scottish Water – the three existing authorities are to be consolidated into one. It is thought that this could result in savings of up to £168m each year by 2005 - 2006. The merging of the authorities into one is also expected to make the new entity better able to compete in the market;
l    Increased commercial freedom – the existing water authorities and Scottish Water itself will be given a general power to enter into commercial ventures. This power, however, will be subject to guidance from the Scottish Ministers. The guidance will therefore be very important. The Executive recognises though that the currently limited power to enter into commercial ventures under the 1994 Local Government (Scotland) Act is insufficient in an increasingly competitive market;
l    Removal of unlawful connections – an express power will be given to the existing water authorities and to Scottish Water to remove unlawful connections. This underlines the determination of the Executive that, notwithstanding the introduction of competition to the Scottish water industry, the quality of supply will remain unaffected;
l    Express power to permit common carriage and brokerage – given that the existing statutory regime does not expressly permit common carriage over the public networks, the new bill will grant such specific authority so as to avoid any suggestion that the existing Scottish authorities or Scottish Water might be acting ultra vires in allowing the public networks to be used by new entrants;
l    Clarification of the responsibility for the cost of developments – the Executive is keen to see an end to the authorities making contributions towards the costs incurred by developers in connecting into the public network. However, to encourage developments and improvements in rural areas, a contribution to costs may be permissible. The authorities are to be asked to set up network development plans in consultation with the regulators, local authorities and other interested groups to provide a framework for such development;
l    Criminal liability for the supply of unfit water and for causing harmful discharges – again, as part of the Executive’s determination to ensure that the quality of supply is not compromised, new entrants will be guilty of an offence where they are responsible for the supply of water unfit for human consumption on the public networks or causing a harmful discharge;
l    Supplier of last resort – new entrants are not to be allowed to disconnect domestic customers who fall behind with payments. Additionally, existing water authorities (and Scottish Water when it comes into being) will be obliged to be the supplier of last resort in respect of domestic services;
l    Banding of charges – the current link between domestic charges and Council Tax bands is to be placed on a statutory footing i.e. for new entrants which serve domestic customers, the charges paid to the relevant water authority would be linked to the Council Tax band of the domestic customer’s property;
l    Licensing regime – a licensing regime is to be introduced for new entrants (but not for Scottish Water). Again this is to protect the public health, environmental protection and social policy objectives which the Executive is anxious to support. Four types of licences are proposed for inserting and removing drinking water from the network and inserting and removing waste water from the sewerage system. The Water Industry Commissioner’s powers will be extended to allow him to manage the licensing regime;
l    Promotion of customers’ interest – the Water Industry Commissioner is to be given the general function of promoting the interest of new entrants’ customers on the same terms as the existing water authorities’ customers;
l    Drinking Water Quality Regulator – a Drinking Water Quality Regulator for Scotland will be created to ensure that both the new entrants and Scottish Water meet the requisite standards of drinking water quality. This mirrors the existing drinking water inspectorate function which operates in England and Wales.
It is expected that Royal Assent will be granted early in 2002.
Reflecting on some of the key issues, what are the fundamental concerns which have underpinned the proposals made by the Scottish Executive?
Cherry Picking
There is a real concern that the practical impact of the 1998 Act in the Scottish water industry will simply be the loss of the most profitable customers of each of the authorities to private operators. It is this concern which has given rise to the most sensationalist (and inaccurate) claims in the press that the 1998 Act heralds privatisation by the back door. It is also this concern which seems to have been one of the main drivers in the creation of Scottish Water.
On the one hand there is the concern of the authorities that the loss of “big payers” would load charges onto smaller consumers. This is the rationale behind the statement by Dr Jon Hargeaves, to the Water Enquirey that where “big payers” are lost to private operators, a certain amount of compensation may be recoverable through access charges in order to minimise the effect on smaller consumers’ tariffs.
On the other side of the coin is the view of business:
“The needs of business users from water and sewerage service providers are similar to our needs from suppliers of other goods or services: quality, continuity, customer services, a business-like approach and efficiency - all at the most competitive possible price.
We believe that whilst significant progress has already been made, these qualities are most likely to flourish further in an even more competitive environment and we therefore welcome the extension of competition to new players....
The CBI’s figures suggest that business charges are cross-subsidising domestic water and sewerage services, and that they are higher than charges for equivalent businesses elsewhere in the UK - higher perhaps than can simply be explained by geographical differences. This is of concern. If competition is to be developed, greater standardisation and cost-reflectivity in pricing (so that it relates ever more closely to the services provided) will be needed, and charges should inevitably fall closer in line with those of comparable water and sewerage providers elsewhere. Business users should not subsidise domestic services”. (Evidence of the Scottish Whisky Association and the Malt Distillers Association of Scotland to the Water Inquiry, 24 January 2001).
In advance of the Bill and the publication of the March 2001 consultation paper, the Scottish water authorities have, in fact, been taking an increasingly proactive approach. West Scotland Water’s Chief Executive (Ernest Chambers) told the Tranport and Environment Committee of the Scottish Parliament of a desire to secure the largest customers on long term deals. East of Scotland Water has recently announced that, together with Suez Lyonnaise, they have secured a 25 year agreement with BP to manage its water and waste services at the Grangemouth oil refinery (see Business AM, 8 February 2001).
Although these concerns have been recognised in the March 2001 consultation paper, the Scottish Executive has not proposed a “Fortress Scotland” to protect Scottish Water from such cherry picking (especially given that a limited amount of cherry picking can already take place under the existing regime). That said, the Executive has sought to redress the balance by giving Scottish Water more power to compete in the market and the ability to recover revenue lost by the departure of “big payers” through an appropriately set access charge model.
Environmental Concerns
When SEPA gave evidence to the Water Inquiry it expressed concern that:
“The management attention and resources of the authorities will be diverted to deal with issues raised by the Competition Act 1998 instead of efficiently and economically delivering a major investment programme” (statement made by Colin Bayes to the Inquiry on 17 January 2001).
The Scottish Wildlife Trust, in its evidence, adopted a more neutral stance, concentrating not so much on any proposed structure of the water industry but more about how the industry plans and delivers its environmental improvements.
One of the drivers behind the introduction of a new licensing scheme is the need for environmental protection.
It is interesting to look at the draft Water Bill which is currently under consideration in respect of the English and Welsh water sector. The consultation paper in respect of that Bill remarked on the desirability of the English and Welsh abstraction licensing scheme and, indeed, the Bill is intended to enhance and modify that scheme in England and Wales. The principle of licensing is therefore one that is recognised as workable and practicable in the water industry.
The importance of the solution settled on by the Executive is all the more important given the environmental challenges set out in the Executive’s January 2001 consultation paper entitled “Water Quality and Standards: 2002 - 2006”. The paper suggested that in the period 2002/3 to 2005/6, the overall level of investment needed to meet the standards set by regulations in the field of water and sewerage treatment could range from £1.76 billion to just over £3 billion. In the face of such investment, it is of course an absolute pre-requisite that firm yet workable controls be imposed on new entrants seeking to use existing infrastructure for common carriage.
Scottish Water as a Competitor
Sam Galbraith noted in his evidence to the Water Inquiry that:
“our job is to take on the competition and to beat it ..... we will give the authorities backing to become outward-looking organisations with a commercial bent” (statement to the Water Inquiry on 19 December 2000).
The water authorities are now generally perceived to be much more commercially minded than prior to re-organisation in the mid-90s but there is also a recognition that the authorities (soon to be Scottish Water) would welcome an ability to compete “on an equal playing field” with private operators which might seek to enter into the market.
The Scottish Ministers already have the power to approve the formation of a company by a water authority to carry out particular activities although these are governed by 1998 Scottish Office guidelines which indicate the criteria used for determining approval. The June 2000 consultation paper recognised that those guidelines are overly restrictive for dealing with the new post-1998 Act regime and the Executive acknowledged that those guidelines need to be relaxed. They will be relaxed by easing the technical and financial constraints on those activities identified as acceptable and by introducing a more efficient approval procedure. PFI/PPP schemes are already widely used by each of the three water authorities to attract private investment in the water and sewerage infrastructure. It will be interesting to see the contents of the new guidance which the Scottish Ministers will follow in authorising commercial ventures of Scottish Water.
Wrap-up
Where might the draft Water Services Bill take the Scottish water industry?
The creation of Scottish Water seems fairly clearly to suggest that the Executive is adopting a reasonably measured course. There is widespread agreement on the issues of principal concern and some of these have been touched on in this article. As ever, though, the devil is in the detail. Given that the Bill heralds the biggest change in the Scottish water industry since reorganisation, all players - authorities, regulators, private competitors and customers - would look for a system, not of free competition, but of workable competition.
Logica UK Limited, in conjunction with companies including North West Water, Southern Water and Yorkshire Water, recently produced their own model for water competition. Although proposed in respect of England and Wales, the same point was made - i.e. the desire was for “a consistent commercial and operational framework that can support the evolution of water competition”. The same applies in Scotland. The Scottish Executive recognised this early on:
“.....competition will be of advantage. That is the water authorities’ view, too. We do not want to adopt a fortress Scotland view. If we ignore competition, my great fear is that the big non-domestic users will think that we are not taking competition seriously and will go off-line.....If we go down that road, we will end up with the worst of all possible worlds. We will have a small public sector authority with huge costs and charges. Competition will help to secure the public sector” (Sam Galbraith, statement to the water inquiry, 19 December 2000).
Indeed, the Executive’s view was neatly summed up by Sam Galbraith when he announced the creation of Scottish Water on 28 February 2001:
“[The Executive is seeking to provide] … a framework so that competition will work in the interests of all customers. The purpose of the new legislative framework is to ensure that competition develops without undermining public health, environment protection and our social objectives. Crucially, the Bill will ensure that there is no scope for cowboy or rogue operators to gain access to the public networks. And it will make sure that those who are granted access are not able to cherry pick the most attractive customers.”
Richard Cockburn is an Associate in Shepherd & Wedderburn’s Competition & Regulation Group and can
be contacted on richard.cockburn@shepwedd.co.uk.
This article was compiled with the
assistance of Saltire, the parliamentary and public policy division of
Shepherd & Wedderburn.