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Water industry prepares for change

Water regulator Ian Byatt retired last week leaving his successor Philip Fletcher surrounded by tense speculation about the future of privatisation. Nina Lovelace explains what is happening.

Philip Fletcher took over regulation of the water industry at an unsettled time - reflected in his caution not to speak to any water companies about the future of privatisation until September.

Outgoing Ofwat boss Ian Byatt left water companies under pressure to reduce costs for customers, while continuing to improve service. He also demanded greater competition in an industry which, unlike the gas and electricity sector, does not have a competitive market.

So it is perhaps unsurprising that the water companies have put some serious thought to finding alternative streams to boost their revenue. While they must continue to produce results for Ofwat, many have decided that the only way to progress is to restructure away from the 'outdated' privatisation model.

Both Kelda, operating as Yorkshire Water, and the ailing Welsh water company Hyder have most recently hit the headlines with proposals to separate their assets from their operations.

The logic behind the process is to separate the revenue making operations side of the business from the regulated asset company - the body that holds the licence and would be responsible for service delivery. The theory allows the operations company to generate cash free from Ofwat's restrictions.

This new model would see operations companies boosting efficiency by introducing competition and tendering service contracts to other asset maintenance and management companies.

The results are, so far, an interesting set of plans. However, all are still in their early stages of development. While Byatt was keen on improving efficiency, he was concerned about whether Ofwat would still be able to protect the interests of the public. In particular, the merits of Kelda's proposed form of asset ownership and mutualisation, have caused him worries.

Mutualisation is one of three main ownership structures that have been suggested to date.

Following the asset/operations split, the assets are sold to the company's customers to create a non-profit making community company, or Registered Community Asset Model.

One of the benefits of this type of model is that the RCAM would not face the same pressures for profit growth as the Stock Market listed utility companies.

However, the RCAM would initially have to raise cash to buy the water and sewage assets from the water plc.

The second option is to franchise the asset management to a not-for-profit company, limited by guarantee and operated by a separate company. This plan was favoured by US utility Western Power Distribution in its so-far unsuccessful bid for Hyder.

The third ownership structure is to create an equity/debt mix asset company. This would include some equity to protect the asset company against possible failure of an operations company to fulfil its contractual duty.

So far, none of these options has been successfully implemented. Kelda's bid to mutualise Yorkshire was scuppered last month after Byatt became uneasy about the detail, and WPD's plans for Hyder caused enough concern for its bid to be rejected initially by the Hyder board.

But, according to analysts, these are just minor setbacks.

Restructuring of the post privatised water industry is the way forward. If water companies are to survive the 21st century, a solution that works, and one Fletcher will feel comfortable with, will not be far away.

Who's playing the water industry restructuring game?

Kelda: Operating as Yorkshire Water it approached the regulator in 1995 with a plan to mutualise its asset company into a Registered Community Asset Model and to sell its assets for around £2.4bn.

Ofwat has since rejected the plans, partially because the regulator felt that Kelda's RCAM would not provide the same incentive to be efficient as a Stock Exchange listing would.

Kelda's plan to mutualise its Yorkshire Water business has been scuppered, although it is still exploring other alternatives.

Hyder: US firm Western Power Distribution, one of two companies bidding to take over Hyder, has suggested franchising as a means to take the company forward - a move that is backed by the Welsh water utility.

Franchising involves outsourcing the day to day control of water and sewerage infrastructure to a not for profit body - in Hyder's case to its subsidiary United Utilities.

The water regulator has still to give its view on whether this is acceptable, given that United Utilities already owns North West Water, a neighbour of Hyder.

There are doubts that, without a Stock Market listing, there would be sufficient incentive for the company to reinvest in assets as often or as efficiently as possible.

Anglian Water: While confident that the old privatisation model can deliver results, Anglian is committed to finding a workable restructing model for the future.

Director Roy Pointer points out: 'Currently, some of the best minds in the business are working on Ofwat's concerns with Kelda's proposals.' It is only a matter of time before it finds an answer, he adds.

'The regulator will continue to be heavy handed towards the water companies as long as there is a lack of competition in the business.'

Wessex: Chairman Colin Skellett announced in June that the privatisation model was 'outdated' and that Wessex would be restructuring.

'We have decided in principle to separate our assets from our operations, ' he said. 'However, we have yet to decide how.'

Pennon: Operating as South West Water, Pennon has also been following Kelda's endeavours with interest with a view to following suit in some way.

'We were watching to see whether the regulator would be favourable towards Kelda's situation, ' said a spokesman.

'Nothing is ruled in or out.'

Effect of the changes on water engineers

Regardless of which form the water industry chooses to reinvent itself, civil engineers are likely to have far less job security in the future.

According to trade union Unison, which acts for the majority of those in the water sector, engineering staff will increasing be 'sold' as maintenance contracts change hands and people will be handed over as operational assets.

'Civil engineers mainly work for the operations sector, ' said a Unison spokesman. 'We are concerned that the pressures of restructuring in combination with Ofwats' push for increased competition will cause problems for employees.'

The fear is that water companies will become like local authorities, and will be forced to compete for contracts with companies outside the industry and often be taken over by them.

However, he added it was unlikely that engineers would be lose their jobs. 'It all depends on workloads and demands, ' he said.

'There may even be some scope for more work, especially in the new asset companies that will need skilled senior staff to negotiate contracts, work out specifications and enforce standards.'

Anglian Water managing director Roy Pointer is more positive about restructuring. He believes that increased competition will force engineers to become more innovative and efficient to win tenders - and continue to do so in order to keep them.

But even he conceded: 'It will not necessarily be a comfortable place for the engineer.' Measuring up to the standards set by Ofwat for public service delivery will increasingly be a challenge.

Ofwat director of engineering Dr Bill Emery agreed: 'Engineers should be concerned about these schemes (to restructure the industry) because projects need to be delivered on time and more efficiently than ever before.'

He added: 'Engineers must learn how they can work together to deliver more cheaply.'

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