An idea full of leaks

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Privatisation is not valuable in and of itself – it is competition that counts. Although it has worked elsewhere, it has not and will not work in the water industry, because there is no scope for competition.

It is satisfying to be proved right when everyone tells you that you are wrong. The trouble is that it clouds your future judgement. So Napoleon, after many victories, invaded Russia. Caesar failed to beware the Ides of March. Mrs Thatcher refused to be deflected when her advisers told her that it was impossible to reduce the power of trade unions, or to privatise state industries. She also refused to be deflected when she was told that the poll tax would not work. But on that occasion her advisers were right.

The government’s white paper on competition in the water industry comes from a similar vein. It is driven by 10 Downing Street. The objective is to bring to water the same kind of competition that is changing the face of other utility industries. That competition was introduced in the face of ferocious opposition. They said that only a BT monopoly could provide an advanced, integrated, national telecommunications network. But competition has brought better services and lower prices. We were told that the lights would go out if the electricity industry were broken up. It was broken up and the lights stated on. Or the country would be racked by gas explosions if the British Gas monopoly were disturbed. It was disturbed and our buildings are still intact.

So it is easy to see why there is scepticism when the same sort of arguments are presented to explain why it is impossible to have competition in the water industry. As in telecoms, gas and electricity, there are those in the industry who rush to explain that the present structure is not only the best of all possible worlds, but the only one that can protect us from contaminated water. That argument is as fallacious as all the others.

But there is, nevertheless, a difference. Surprising though it seems to many people, it really is possible, and desirable, to introduce competition into telecoms, gas and electricity. In the water industry, however, the common sense instinct that having competing water suppliers is daft is perfectly correct.

The basis of competition in gas and electricity is to split off the natural monopoly elements is (national transmission and local distribution), from the potentially competitive components (production and supply). So we broke up the electricity industry by separating the National Grid and London Electricity from companies like National Power and Power Gen – and now several others – who run power stations.

And in future you will be able to buy your gas or electricity from anyone – it could be British Gas, Marks & Spencer or Barclays Bank – who wants to provide service, billing and account management. As with any other form of retailing, these companies will buy in the services they need, manufacturing and distribution – to bring the goods to you.

So why can’t the same thing happen in water? Just as in electricity and gas we can have competing suppliers putting power into the system and selling it to final customers, we could have a national water grid, and River Thames Water could compete, on taste, price and service, with Farmoor Reservoir, Highland Spring and Perrier piped across the channel.

The first difference is that the clear cut separation between resources and distribution, which is key to the new structure of gas and electricity, simply doesn’t exist in water. You could supply much of the country’s needs from Kielder Water, a huge lake in Northumberland which was built to cater for a North of England manufacturing industry that closed down, at the cost of piping it all the way across England: or you could use more expensive local resources at lower distribution costs. In water the monopoly element distribution is in direct competition with the possibly competitive element, resources, and that makes regulation much more complex.

Still, you could probably overcome that if it wasn’t for a second problem, which is that water is so cheap. The government sold the assets of the water authorities for around a tenth of what it is estimated it would cost to build these assets now. Many of them were built by our Victorian forefathers. So the replacement cost of assets is mostly irrelevant. But it is not irrelevant to potential competition. That is what it would cost someone who was providing a new source of supply to do it.

Now at the moment there is massive and arbitrary averaging of the costs of water supply. Tariffs that vary considerably across different water companies, but hardly at all within individual water company areas. But there are no more than a handful of customers across the country who are paying more than it would cost a new entrant to supply them, once proper account is taken of the opportunity cost of the water resources and the replacement cost of distribution assets.

That means that there is no possibility of competition based on superior efficiency. However efficient you are, you cannot under cut current prices and make money, unless you cross-subsidise your sales from somebody else. And that is what will happen. Something that the government can call competition will emerge. Large customers will ask for discounts, and they will get them.

The reasons they will get them will have – can have- nothing to do with the long run cost of supply, which is already above what they are paying, and everything to do with the fact that they can ask, and the government is encouraging them to ask. Domestic users can’t ask, and won’t get. Mostly they will just have to meet the cost of discounts for other people. Perhaps that was what the government had in mind. Or perhaps they just hadn’t thought it through.

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