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‘(2) In that subsection, after paragraph (e) there is inserted—
“(f) to secure the provision of services by licensed water suppliers and licensed sewerage suppliers in a manner that is not detrimental to the exercise of the functions referred to in subsection (2A)(b) above.”.’.
Thank you, Mrs Riordan. It is a pleasure to serve under your chairmanship again this afternoon. It is good to see that so many hon. Members have come back from their lunch to join us.
This is a technical but crucial pair of amendments. I will speak to them together, because they fit together. “No detriment” is a phrase that we use a lot in the water debate, so it is perhaps worth me spending 30 seconds explaining it. “No detriment” clauses ensure that the wholesaler is no better or worse off as a result of water efficiency measures undertaken by retailers. The idea is that, at each price review, the regulator sets a fair cost to the wholesaler, bearing in mind the activity of the previous five years.
Perhaps I can look—with your permission, Mrs Riordan—down the road at why that is important. The Government are rightly committed to ensuring that the water industry is resilient against the twin threats of population growth and climate change, but there is not enough work in the Bill to ensure that there is not an accidental and unintended consequence. We have seen significant savings in water usage with the Scottish model. Historically, the debate on retail competition has been on bringing down the cost of water usage to businesses, charities and the public sector, but it is right that we also bear in mind the abstraction benefit. In the figures I have seen, which take in the larger part of the sector, the introduction of competition creates a saving of something like 6% or 7% on water usage. Clearly we would all welcome that, particularly given the debate we have had on abstraction challenges.
The Bill, however, provides a perverse incentive that could reduce that potential saving. Some customers might benefit if we allow retailers to supply from a new water source that is cheaper than the current company’s regional average cost, but that might not add resilience or be efficient and might, at least partially, strand incumbent company assets. As we discussed this morning, that would simply increase costs for all other customers, including those in households.
“The Scottish experience has demonstrated the range of benefits business and public sector customers can get from more customer focused suppliers with an incentive to improve the services they offer. While some have simply looked to reduce their bills through simple measures such as discounts for direct debits or aggregated purchasing; others have benefitted from improved information on their water use which has enabled them to benchmark against others and introduce changes which cut operating costs significantly. Other organisations have been helped by their retail supplier to introduce more innovative measures such as rainwater harvesting.”
That goes back to the points made previously by the hon. Member for Tiverton and Honiton. We agree with the White Paper’s aspiration and think it is admirable. It also states:
“We want to see the market develop so that water suppliers work with their business and public sector customers in England to get the same benefits from a competitive market that Scottish customers already enjoy.”
Labour Members absolutely support that, but the problem is that there is no measure in the Bill sufficient to ensure that we do not get the stranding of assets and the forcing up of costs to customers.
Although I have been in favour of holding the water companies’ feet to the fire when appropriate, it is right that we do not disincentivise wholesalers working with retailers to reduce consumption. The reality is that only new entrants are affected. If Business Stream, for example, were to enter the market in England and found that it could access a cheaper source of water more than that from a current wholesaler, for example Northumbrian Water—I am conscious of not using South West Water as an example all the time—it will want to offer that reduced price to its customers. We all recognise that that is a good idea; it is one of the points of the market. However, there is no incentive to do much better than the incumbent on service or to innovate more generally, which means there is no incentive to provide tailored water efficiency advice, for example, which is beneficial to the customer, but might involve an up-front cost for either the retailer or the customer. That is an obvious discrepancy and we want to work with the Government to tidy it up.
As discussed on Second Reading and in previous debates, the supply of water and sewerage services is predicated on an understanding that such assets have an extremely long life—in some cases, of more than a century—because of the scale of investment required and, if the Committee will pardon the pun, the sunk costs. If the volume of water supplied or treated falls, the costs of maintaining the overall structure are forced up, leading to a lower return on the investment. That creates a disincentive for investment in the market, which is in no one’s interest. The Opposition believe that maintaining appropriate investor confidence is crucial. The Minister has had representations from the experts he brought in from Scotland and many investors have flagged up that live concern. When he responds, I would be grateful if he could explain why the Government have until now—I am sure he will be persuaded after my eloquent speech—not included in the Bill a measure like the amendment.
Scotland has been the base model for this work. One benefit of the Scottish model is that the retailers are free to focus on providing the best service and advice possible to their customers, both on water efficiency and on how to reduce wastage. Business Stream has a contract with East Dunbartonshire council—the local authority of the Under-Secretary of State for Business, Innovation and Skills, the hon. Member for East Dunbartonshire (Jo Swinson)—and is a good illustration. It put meters into all the high schools in that area—seven or eight—and found that six out of seven high schools had fairly standard water usage. However, the usage in one was off the scale. Business Stream was able to say to the local authority, “We think there’s a leak somewhere.” It put a little bit of money into sourcing the leak and fixing it, which saved a significant sum of money in the long term for the local authority, which was good for the taxpayer, and reduced the water requirement.
There is no incentive in the Bill for the retailer to offer such advice. We would therefore be grateful if the Minister looked carefully at the amendment. It is designed to help the Government. I hope we have a shared value in trying to bring people together. We surely want a system in which the retailer and the wholesaler work collaboratively and not in competition. I would be grateful if the Minister took the advice of his independent experts and the representations of the investor community and made this small change to the Bill.
I thank the hon. Gentleman for his amendments. Amendments 140 and 141 would amend a general duty in clause 23 regarding undue preference and discrimination in the sector. They would add a duty on the Secretary of State and Ofwat to secure that the provision of services by licensees does not have an impact on a separate duty on the Secretary of State and Ofwat to secure that incumbent water companies properly carry out their functions.
Amendment 131 would remove clause 23 entirely—I assume the hon. Gentleman has the aim of replacing it with amendment 141.
I am grateful to the hon. Gentleman for putting that on the record. Clause 23 provides the Secretary of State, Welsh Ministers and Ofwat with a general duty to ensure that incumbent water companies do not exercise undue preference to themselves or their own retail businesses, associated licensees or other incumbents, to the detriment of new entrant licensees, inset appointees or other incumbents when providing wholesale services.
Undue preference might be demonstrated by an incumbent water company prioritising inquiries or service requests from its subsidiary licensee over those from other licensees, inset appointees or incumbents—for example, a request for a new connection from its own retail business or subsidiary licensee might go to the front of the queue ahead of a request from a licensee or an inset appointee.
The clause introduces the same duty on Ministers and Ofwat to address undue discrimination in the delivery of services by incumbents to licensees, inset appointees and other incumbents. That might involve, for example, an incumbent placing different water quality standards from those it would place on its own suppliers or contractors on unassociated licensees or incumbents, over and above those required by the law. It is essential that those that enter the water supply and sewerage markets have confidence that incumbent water companies act appropriately within those markets and do not use their dominant positions to enable their own retail businesses and associates to undercut their competitors by giving preferential treatment or subjecting them to fewer burdens or lower costs.
The clause complements an existing provision that requires Ministers and Ofwat to exercise their functions under the Water Industry Act 1991 in a manner best calculated to secure that no undue preference or undue discrimination is shown when it comes to the fixing of charges. The new duty will sit underneath the wider duty for Ministers and Ofwat to promote competition in the provision of water and sewerage services where that is in the interests of customers. With the other provisions, clause 23 ensures that Ministers and Ofwat have the tools they need to ensure that new and existing markets work well for customers, and that there is a level playing field in which market participants can operate.
The new duty proposed by amendment 141 would instead require the Secretary of State and Ofwat to ensure that licensees act in a manner that ensures there is no detriment to incumbent water companies when carrying out their functions. We are not sure how that would sit alongside the general duty for the Secretary of State and Ofwat to secure that licensees meet their statutory obligations and the conditions of their licences, given that those will be set by the existing duties on Ofwat and Ministers, as well as the new duty in clause 23.
The proposed new duty would not add anything, but I note that there is a similar duty on the Water Industry Commission for Scotland to secure that its licensees act in a manner that is not detrimental to the exercise of Scottish Water’s core functions. We looked at the explanatory notes of the Scottish legislation to see what that means. They link the duty to market opening and suggest it could possibly be used as a way to require licensees to use a central mechanism to facilitate the exchange of information required when a customer switches to another licensee. The Open Water programme is developing that policy and we are satisfied that it can be delivered through licence conditions and codes, which we have debated.
We have looked at briefing material used by WICS. WICS implies that the “no detriment” duty would prevent licensees’ water efficiency activities impacting on incumbents’ profits. In England and Wales, both incumbents and licensees are under a duty to help their respective customers to conserve water. We are not willing to undermine the market for water efficiency services if that, indeed, is the desired impact. If the amendment were to have such wide or further unforeseen implications, we could put licensees at a competitive disadvantage if a similar duty were not placed on the retail side of the incumbent’s business. Why should licensees be kept under a duty that potentially curbs their water efficiency activities while an incumbent’s retail business is allowed to operate without that barrier?
The brief is based on the explanatory notes that accompany the legislation, so I guess we have a difference of interpretation. Given the broad interpretation of the corresponding provision in Scotland, as suggested by the explanatory notes, the amendment creates too much uncertainty and there appears to be scope for it to be applied in a way different from what was originally intended in Scotland, where it originated. We consider that the clause, along with the other existing duties, provides the market in England and Wales with the protection it needs.
I will try to pick up on a couple of the questions posed by the hon. Gentleman. Licensees will operate in only 10% of the overall market, so I would need convincing that the no detriment duty will have a practical effect other than potentially protecting the revenue of incumbent water services. The hon. Gentleman is clearly concerned about asset stranding, but we believe that such concerns are overstated. As I said, only up to 10% of companies’ assets by value will be subject to competition. The changes we made to the Bill after pre-legislative scrutiny are acknowledged by investors and companies as helpful in that regard.
Incumbent water companies will benefit from provision of water efficiency services, because they will not have to invest in new resources. The hon. Gentleman gave the example of Business Stream seeking to provide information because it would be incentivised to do that. In evidence, it said that part of its customer relationship was to pass that information on, and it would seek to work with customers to ensure that they are being efficient.
Essentially, we believe that competition will encourage water efficiency in England and Wales. The system is different in Scotland, and given our different circumstances we do not believe that we have to copy every aspect of that system slavishly and make our system a carbon copy. We are having discussions in the Open Water programme about taking the best of what worked in Scotland and applying that in a relevant way in England and Wales. We feel that we have got that balance right.
I am quite disappointed that the Minister or his officials seem to have made up their mind. They are not listening to the clear advice that they were given. I bring the argument back to his regional company. Both WICS and the investors have warned his officials that without the amendment there will be no provision for a shared understanding of and agreement on how the costs will be met. There will be a bizarre situation in which, if an efficiency on water usage is made, which we would all commend, the wholesaler will be left to pick up the additional burden. The amendment would ensure an equitable arrangement and that the wholesaler is not penalised, because whenever a wholesaler is penalised, that penalty is passed on to its domestic customers and to other customers with the new entrant retailer.
I urge the Minister to look carefully at our amendment. It is offered as a helpful piece of advice. It worked in Scotland and is one of the key reasons why the Scottish market works. If the Minister is unable to listen to the advice of investors and WICS, then I regret that I shall have to divide the Committee.
With this it will be convenient to discuss the following:
New clause 26—Separation of retail and wholesale activities—
(a) retail activities, and
(b) wholesale activities within one year of Royal Assent of this Act.’.
The Minister has known this debate was coming since he was put on the Front Bench team. It is fundamentally about how we avoid incumbent water companies operating as a cartel to stop the effective functioning of new entrants, and it goes to the heart of the successful operation of the retail market. We heard compelling evidence in the session last week from Dr Kenway in particular, but from others as well, about the 25-year head start that the incumbent water companies will have on any of the new entrants.
Because it is always the right place to start, I will talk about Scotland in just a moment, but first let me say that idea of separation did not just come from the Select Committee, although it is important to remember that the Select Committee recognised its importance. It goes right back to Martin Cave and the Cave review that took place under the previous Government, which first floated the idea of retail competition. It was Martin Cave who recommended the legal separation of the retail arms from the incumbent water companies.
What do we mean by separation? What we need is confidence among both new entrants and customers that the incumbent water company is not giving itself an unfair advantage over new entrants. Let us think about the way the energy market works, taking Scottish Power as our example: its generation arm is held separately from its retailing arm and its grid ownership arm—that is, those who generate electricity are not allowed unfairly to give information to those in the national grid structure and those who sell it on to the customers at the point of the plug. Unfortunately, for reasons that the Select Committee never understood, officials in the Department for Environment, Food and Rural Affairs rejected that obvious approach to the retail market. Actually, I think I do know why they did that, but I will come to that in a second.
In Scotland, given that Business Stream and Scottish Water had an historical, inbuilt advantage, they did not just legally separate their functions so that Business Stream—the wholly owned entity of Scottish Water—put up firewalls; they went a step further and moved their premises out of Dunfermline and across the Forth into Edinburgh. If the Minister has not had a chance to visit Business Stream headquarters, I recommend that he comes to Scotland for a warm Scottish welcome and to see Business Stream and Scottish Water and how they have functionally separated.
Ideally, we would have functional and legal separation, but at this stage I would settle for legal separation, to put provisions in. I suspect that, because the Minister’s civil servants have not changed in the past couple of years, the usual examples will be trotted out about the costs of setting it up and how it is a bit of a pain for the water companies. After all, the water companies only made £1.9 billion pre-tax profits last year, so it would be terribly unfortunate to ask these destitute companies to bear a little bit of cost. Water UK has successfully lobbied DEFRA officials repeatedly on this over a long period. My great frustration with organisations such as Water UK, is that it is not interested in putting the customer first and protecting the new entrants; it is only interested in protecting incumbent wholesale water companies.
The Select Committee debated this matter at some length. The Minister and the hon. Member for Tiverton and Honiton will recall that a key area of contention among the Select Committee members was how we deliver confidence. As I said in the previous debate, we all want a successful, vibrant retail market, but there has to be investor confidence in that. Without the separation of retail and wholesale company arms, it is difficult to see how investors could have the same of level of confidence.
Without statutory separation, officials tend to say, “It’s a bit difficult. Let’s punt it to the regulator to sort out.” The Minister knows that the regulators have urged him to provide for separation and that Scottish Ministers have flagged it as a specific concern. He has been asked to do it, not just by the regulators, the investors and the new entrants, but by Scottish Ministers as well, yet he continues to resist. Even some water companies are now calling for separation. I should be grateful if he reflected, once again, on why, despite that overwhelming wall of representations, he has allowed his officials to be captured by Water UK and a handful of water companies, which, funnily enough, find that it is not in their interest to have good competition, because they got away with poor practices for years.
The Minister’s officials have included cost savings in the document, but WICS calculates that full retail separation could achieve net benefits of between £760 million and £2.5 billion for England and Wales in the first 30 years’ operation. That is real money that could be put back into public services from the public sector, or help small and medium-sized businesses. If we are to make the market work, we have to give people confidence. We cannot have a situation in which the wholesale arm sits on the same floor of the same building as the retail arm, without statutory provision to provide safeguards for the customers.
I hope that the Minister will reflect on this and remember the deliberations of the Select Committee when it came to its conclusions.
It is, as always, a pleasure to follow the hon. Gentleman in his reflections on what the Environment, Food and Rural Affairs Committee had to say. In fact, my recollection is that it talked about functional separation, not legal separation, so he is talking about going a stage further.
I thought the Minister was listening to what I said. I said that the Select Committee had said functional, but I was suggesting that as a first step we should go for the legal rather than the functional.
The hon. Gentleman did make that clear, but the position he advances with his amendments is not the same as that of the Select Committee. That is what I was seeking to emphasise.
New clause 26 would require licensed water suppliers operating under the existing water supply licensing regime to set up legally separated entities for the retail and wholesale parts of their business. I suspect that the intention is to place a requirement to legally separate on incumbent water companies, rather than on the eight new entrant licensed water suppliers. Under the Bill, new entrant water supply licensees will be wholesale customers of the incumbent water companies, so there is no need for them to legally separate.
I could have misheard, but I think the Minister said eight new water entrants. If that is so perhaps he could explain where he could the figure eight from.
Perhaps I will return to that later in my remarks. The figure was passed to me at some point.
Legal separation is generally raised as a way of combating discrimination, but it is by no means the only way. What the amendment might be proposing for incumbent water companies is that two bodies must be created under the single existing statutory appointment and probably under the same ownership. That is already possible, as demonstrated by the joint venture set up by Wessex Water and Bristol Water. The legally separated company provides the customer-facing services while Wessex Water and Bristol Water provide wholesale services.
Ofwat will need to use its regulatory or concurrent competition powers smartly to prevent and discourage incumbent companies from discriminating against new entrants in favour of their own retail businesses, either through the prices they charge or by other non-price forms of anti-competitive behaviour. The Government expect Ofwat or other competition authorities to take firm action where there is evidence of discriminatory pricing or behaviour. The tools at its disposal include the power to require undertakings from market participants to address anti-competitive behaviour; that could include but not be limited to structural changes—in other words it could happen subsequently.
Is the Minister absolutely convinced that what we are putting in place is robust enough to ensure that where a water company has both a retail and a wholesale arm, it does not cross-subsidise the retail with the wholesale, which would not be possible for any potential new entrant?
My hon. Friend is obviously concerned that we get this right and, as he has been at pains to say throughout, that we are going far enough to do that. The way the Bill has been developed based on what we said in the water White Paper ensures that we have the ability to do that through the regulator. The hon. Member for Dunfermline and West Fife characterises that as, “It’s too difficult. Shove it over to the regulator.” An alternative way to say that is, “We are giving the regulator the powers to do this and we trust them to do it.”
Perhaps the Minister could tell us whether Ofwat asked for that power, or if it asked for a legal separation provision in the Bill.
I suspect that the hon. Gentleman is not entirely wedded to everything that Ofwat has asked for. When we come to sustainable development duties, there might be some variance. Sometimes we take a different view from the regulator about what we are asking them to do, and I suspect he does too.
Water companies and their investors told us that there would be considerable risks to future investment if structural reform was imposed on the sector—I am talking about the consultations on the White Paper. That risk has also informed our approach to retail exits, which the hon. Gentleman also carries close to his heart, whereby a power for an incumbent to exit could be used by a competition authority to require companies to separate only where it finds individual cases of discrimination. We do not want to take risks with a successful model, given the challenges we face in building the resilience of the sector.
In clause 23, we introduce a wide power for Ministers and Ofwat to take steps to address undue discrimination and preference in incumbent water companies’ dealings with other market participants and their own retail businesses and subsidiaries. The hon. Member for Dunfermline and West Fife was keen that we remove that and replace it with his own option. We have now moved on from that. Legal separation helps to address issues of discrimination in competitive markets, but it does not eliminate them altogether; only ownership separation could begin to do that. Given investors’ concerns and the relatively small size of the competitive market, we thought it would be better for Ofwat to work with the incumbent water companies and the licensees on the best way to minimise the risk of discriminatory behaviour.
We do not have representation from Water UK on the Committee, and it has come in for a bit of a hammering from the hon. Gentleman and some of his colleagues, but I think it would be fair to say that it is a representative body, and new entrants are now engaging with it and becoming part of what it does. I suspect that we will see Water UK increasingly representing a range of positions—people who are new into the sector as well as incumbents. The hon. Gentleman seems to feel that it speaks only for the incumbents.
Ofwat has produced a document that lays down the challenge to incumbent water companies to make plans to address discrimination within their businesses. These plans will be tested with at least two licensees. We think that this process deserves to be seen through without imposing irreversible structural changes on the sector.
The figure which the hon. Gentleman was keen to probe during my remarks, that of eight companies, relates to new entrants which currently hold licences. More may emerge and enter the market before April 2017. There are 21 incumbent water companies, and this debate is more about the incumbents. The amendment refers to licensees, and we were pointing to the fact that the drafting of the hon. Gentleman’s amendment would pick up the eight licensees as well as the incumbents, on which he was focusing.
Clause 23 allows Ofwat to address discrimination in favour of an incumbent retail business and subsidiary licensee, which relates to the issues raised by my hon. Friend the Member for Tiverton and Honiton. We believe that the clause we have just discussed provides the powers to address these concerns. On that basis, I urge the hon. Gentleman not to press his new clause to a vote.
I am grateful for that explanation. Perhaps I might offer my opinion that Water UK has been adequately represented in parts of this Bill Committee over the last few days. If I may, first I will pick up on the point about the position of the Select Committee on Environment, Food and Rural Affairs. This is perhaps one of those issues on which I say “potato” but you say “potahto”. The Select Committee actually said that while its preference was for legal separation, if that was not possible, it wanted functional separation.
The Minister will recall that the Committee was actually quite innovative, and said that we should have a lighter-touch regime for companies that voluntarily chose to provide some separation. Before I sit down, I wonder whether the Minister has had any inspiration on whether he is minded to ask Ofwat to consider that approach. It would mean that the hand of Ofwat was lighter on the shoulder of those companies that went down the route of functional or legal separation than on the shoulder of companies that refused point blank to do so. I am disappointed that the Minister is not prepared to listen to not only Ofwat or the Select Committee, but Scottish Ministers, WICS and investors.
I note in passing that from the few occasions when I have seen the hon. Gentleman engage with Scottish Ministers on the Select Committee, it seems that he does not always hang on their every word and seek to deliver whatever they want.
As the Minister knows, I am quite a consensual sort of player. When the Scottish National party very occasionally gets something right, I do not hold its badge against it. In the same way, when the Minister occasionally gets something right, not only will we sit down in shock, but we will help to get the Bill through. This is why we have not opposed every single one of the clauses the Government have put forward. The reality is that Scottish Ministers, as the Minister knows, have made representations and said that this is an area of danger for them because of the impact on industry.
I am disappointed that the Minister has not addressed the investor representations—made directly either to him or to his predecessor, and certainly to his officials—which flag up the need for confidence. This is a fundamental point of disagreement. We want the market to work, and for that there has to be investor confidence. If investors and regulators are asking for something and only a handful of water companies are not in favour of doing it, then I know which side of the argument I want to be on. I will therefore press the new clause to a Division.
On a point of order, Mrs Riordan. I do not intend to cause any trouble at all, but I would just like, for information, to understand the procedure we have just gone through. The Committee clearly voted for clause stand part. Can I be illuminated as to whether or not it formally ought to have been asked of the Government parties whether they were content to take that vote again? I am merely seeking an answer for information purposes, not to disrupt proceedings.