Economic regulation at a crossroads

Alan Sutherland, Chief Executive of WICS considers the limitations of the traditional regulatory approach and highlights a way forward that may put the water industry in a stronger place to face future challenges, including climate change.

The sector in Scotland has come a long way since Scottish Water was created in 2002. Current generations have benefited from the prudent investment of previous generations, with Scotland having invested more per person per year than any other part of the UK since it was created (£135 compared with around £105).

Large efficiency gains have been delivered. Our targets to reduce operating expenditure have resulted in Scottish Water’s average bills being around 20% lower than they would otherwise have been. Scottish Water is also playing its part by becoming ever more efficient in improving the way it manages its assets, and its service levels have increased markedly.

But the challenges of the future are different. When we consider both embedded and operating carbon, the importance of the government’s ambition to achieve net zero emissions by 2040 is difficult to overstate.

At the same time, many of Scottish Water’s assets, such as pipes and sewers, are ageing and need to be replaced. And we must address these challenges whilst maintaining the high levels of service customers enjoy today.

This requires a new focus on the long term.

The traditional regulatory approach is limited in this regard. It focuses on the short term (at best a regulatory control period) – no regulated entity can make confident plans where payback extends beyond the next price setting exercise. This is because it is a sine qua non of economic regulation that, de facto, a hard budget constraint underpins any regulatory incentive framework.

There is, I would suggest, an alternative approach. This is for the regulated entity to ‘own’ its performance. No more “we can’t do this because we are not funded to” and no hiding behind other stakeholders. The onus is on the utility to establish and maintain the trust of society, communities and its customers. So, what might this look like?

The future could be bright! So start dreaming!

It is the year 2035. Scottish Water proudly announces that it has met its obligations to achieve net zero emissions five years early.

It is the most trusted service provider in Scotland. It has won the confidence of its regulators and is trusted to be open and candid about its successes and shortcomings.

Even the best customer focused retail companies now want to consult with what was previously regarded as a boring old utility. They want to learn about how Scottish Water is able to tailor its performance to the needs and expectations of the wide range of customers and communities that it serves.

Customer and community complaints reflect small and genuine human errors. There are no systematic issues that could be identified by a review of customer and community contacts.

So how did this transformation come about?

Scottish Water took critical steps in the early 2020s that facilitated its transformation both as to how it sees itself and in how Scotland’s communities and customers view it.

Building on an industry vision set out in 2019, Scottish Water established an effective conversation with the customers and communities that it serves. These conversations allow all interventions – whether operational or in terms of capital expenditure – to have fully embedded the views of the customers and communities that will be impacted. There is a recognition that sometimes there will be negative effects for some but these are compensated for pro-actively by Scottish Water. No intervention happens without this customer view having played at least an equal role to the vital technical engineering input. When Scottish Water advances projects for discussion with government and its regulators, the customer and community view of what should be done is already fully embedded.

Scottish Water reports performance regularly and transparently. It sets out clear expectations of what it will achieve in the short, medium and long term. It more than meets the needs of its regulators when it comes to the completeness of the information it provides. The context and explanation of this information is also exemplary. The regulators are able to see consistent, evidenced trends of improved performance.

The trust of regulators, customers, communities and Scottish society more widely grew and acted as a further confidence builder for the whole Scottish Water organisation as it took the difficult steps required to take full ownership of everything that it does and build and maintain confidence in all that it does. Scottish Water further builds on this trend by developing a transparent internal assurance process, which shares its conclusions (initially warts and all) with all who are interested.

Taking comfort from the assurance and the easier to analyse information, the regulators have the time and space to understand broader trends across the industry – to act as occasional coach, or as the conscience to Scottish Water as it seeks to improve its performance each year – despite the more challenging circumstances arising from having to adapt to climate change. Regulatory input is seen as a benefit not as a hindrance. It is regulation, not de facto control.

Scottish Water has taken ownership of its performance to a transformative level. In this future world, it becomes hard to imagine that its regulators ever felt the need to be so critical. This is my dream! What’s yours?

Alan Sutherland | Chief Executive