Alan Sutherland, Chief Executive Officer, Water Industry Commission for
The father of incentive-based
(price cap) regulation, Professor Stephen Littlechild famously wrote that
economic regulation was required “to hold the fort until competition arrived”.
In gas, electricity and telecoms, competition has appeared to a greater or
sector, however, is quite different from other utility or asset-intensive
industries, and the scope for market pressures extremely limited. The cost of moving
water, unlike electricity, means there is little real choice about where or
what to buy. There are no powerful buyers able to exert any real influence on
the supplier. In the absence of competitive tensions, economic regulation of
the water sector is very different from other utilities and asset-intensive
What I’m about
to say may be regarded as heresy by some professional economists, but in my
experience (22 years and counting), monitoring the performance of a regulated
entity, which is also a monopoly, and ensuring that it remains accountable, is
much more important than setting prices – which is how most seem to describe
I wouldn’t want
anyone to take that comment the wrong way, however. Economic regulation does
play a vital role in setting prices at the start of any planning period.
Regulated companies do need to be given a defined financial envelope to work
within. They need, in the economic jargon, to be ‘price takers’ or to face a
hard budget constraint.
To that end,
economic regulators have to establish the scope for efficiency that may exist.
And to do so, they must indulge in some fairly painstaking benchmarking.
Information has to be collected and analysed in great (almost stifling) detail.
Economic regulators seek not just to compare unit costs, but also to reflect
appropriate differences in the operating environment, the assets operated and
the quality of the outputs or outcomes being delivered.
performance monitoring (as evidenced through that information) ensures that the
hard budget constraint is maintained. There can be no cutting of corners in levels
of service or investment delivered. Be in no doubt, this is a highly technical,
the management team of a monopoly service provider, the more need there is for
robust regulatory scrutiny. A management team will always know more than a
regulator about their business, resulting in an inevitable information
asymmetry. To compensate for this asymmetry, the regulator must draw on
benchmarks over time, across companies or even across borders. There is a lot
of devil in the detail....
So to the
regulation involves close and detailed explorations of any variances between
what was set out at the start of a planning period and actual performance. It
is a highly pro-active role.
regulators collect a lot of information. This information must be very clearly
defined and the regulator will expect commentary to support any submissions.
Regulators regularly review what they collect, why they are collecting it, and
how often it needs to be collected.
Is it difficult
and time consuming to collect? Yes. But is it also an essential pre-requisite
for a well-run and sustainable sector? Yes.
entity will often suggest that collecting this information is an undue burden,
an expensive luxury or a distraction from providing a quality service to
customers and communities. Foxes and chicken coops come to mind.
the information an economic regulator asks for is less than the service
provider needs to operate efficiently and effectively both now and into the
future. As an economic regulator, I would happily stop collecting information
where a regulated company can evidence that it does not need to know what is
On the side
of the angels!
Perhaps one of
the most important elements of this information is that which relates to
performance in delivering the capital programme. The economic regulator must
ensure that capital programmes – no matter whether they relate to asset
replacement, growth or performance/compliance improvement – are delivered. No
ifs, no buts, and no excuses.
In New Zealand
this means there should be a close partnership between the economic regulator
and Taumata Arowai. The economic regulator will have to draw on the technical
expertise of the quality regulator and the water quality information they
collect. The quality regulator will need to know whether there are any issues
with progress in delivering desired improvements.
jointly with Scotland’s water quality and environmental regulators and customer
representative colleagues, I look at how Scottish Water has progressed each
project relative to the agreed target: from detailed design to financial
approval to start on site to delivery of the output, and finally confirmation
that the desired outcome has been delivered. Where projects lag, questions are
asked, and assurances and remedial actions sought. It is this process that
ensures customers and communities can have confidence that value for money will
be delivered. In a public sector context, the owners of the water operations
also benefit from knowing that their policy ambitions are more likely to be
achieved both in the short and in the long run. Regulation substantially
reduces the information asymmetry that would otherwise exist. This means that
policy makers and owners can and should expect more for their communities.
organisation can make this reporting process easier if it is proactive in
highlighting variances in its capital delivery, and has robust explanations
about how it intends to get delivery back on track. There is no scope to wait
until a project’s due date has arrived before asking questions about what has
been delivered, or, much worse, about why it has not been delivered. Any
changes in the agreed capital programme – which should be few in number – must
be carefully reviewed.
is key – not for policy, but rather for the delivery of policy. An economic
regulator usually publishes an annual commentary on the regulated company’s
performance. The aim is to make such commentary as clear and accessible as
possible. This helps ensure that all parties, be they customers, communities,
local councils, or supply chains, can have confidence in the industry, its
value for money and its contribution in making our lives better now and into
this mean for water sector reform?
regulation ensures that information on performance is carefully monitored. For
this to happen, early progress will need to be made in improving the quality of
information on assets, on performance levels and the costs of operation. As
noted earlier, the information the economic regulator requires is only a subset
of what is required to run a water business efficiently and effectively.
Collecting this information – in all its gory detail – is a critical building
block in ensuring that any water reform will realise its full potential. There
will always be scepticism about the scope for efficiency identified in a
regulator’s benchmarking. But pursuing this proactive route of information
collection and analysis will ensure that these regulatory expectations are met.
Indeed, the history of the economic regulation of the UK water sector suggests
that regulators have consistently underestimated the efficiency the regulated
companies have been able to achieve.
look very hard at the information a regulated company provides. The
implications of this intense scrutiny are clear. The new regulated entities
will need to establish excellent systems and processes for collecting and
managing their information. They will need to understand what their information
means and its implications. They will have to learn to communicate clearly,
logically and consistently. Success will require close detailed conversations with
both Taumata Arowai and the economic regulator. Regulated water entities are
specialist delivery vehicles that have to be able to evidence their performance
and withstand detailed scrutiny. As such, accepting the need to evidence their
performance and delivery will need to be central to the new entities’
typically results in greater scrutiny, more challenge and a loss of confidence
in organisations, or in the Board or in the senior management – or in all
three. When regulated companies are unable to evidence and explain their
performance, regulators typically collect more detail, more frequently. It is
these ebbs and flows in levels of scrutiny, challenge and confidence in an
entity’s performance that generate the dynamic pressure for efficiency. We may
never dismantle the Three Waters Fort, but that does not mean that all of us,
as citizens and consumers, should not expect real value for money. Step
forward, the regulators!