At the start of this session, we looked at historical account of the driving forces of strong personalities and political positions that could have led to the UK water prioritization experience. We found this account to be incomplete. And instead, it also uncovered four main prerequisites in the local context of England and Wales. In the previous two videos, we've tried to assess the good news and bad news outcomes, as it were, from the UK water privatization. We found no comprehensive account taking in all the necessary perspectives across a long enough period of time up to the current date. What evidence we did find on the England and Wales water privatization case was rather mixed. In this final video for this session, we look at a further set of outcomes that don't fall into these already muddy good news and bad news categories. Here we'll look at outcomes that still seem unclear. They represent challenging questions to ask about the situation now, and about how the industry's development path may unfold in the future. First, some researchers, such as David Saal, Martin Cave and their colleagues, have tried to use certain standard economic tools to measure the efficiency trends of the England and Wales privatized water sector over time using a range of available data. In 2007, David Saal, David Parker and Tom Weyman-Jones tried to determine the total factor productivity of the industry. This is one economic measure of the efficiency of an industry. The findings by Saal, Parker and Weyman-Jones fit into our unclear outcomes category, I think. There had been total factor productivity efficiency gains before privatization in the industry, back from 1986 to 1990. But there were also gains after privatization, from 1993 to 1996. But at the same time, there were also efficiency losses after privatization, from 1990 to 1992, and again from 1996 to 2000. So there was no clear narrative there of the water industry was inefficient before privatization and became efficient after privatization. The picture is more nuanced. Separately in 2007, Fabrizio Erbetta and Martin Cave published a different kind of economic analysis. They used a Data Envelopment Analysis, or DEA approach, to look at production frontiers in the England and Wales privatized water industry. Erbetta and Cave, like Saal and his co-authors, found little evidence of significant efficiency gains up to the year 2000. However, following a one off price cap regulation intervention in 1999, 2000 where allowed prices were cut by around 10%, Erbetta and Cave did find a modest jump in efficiency levels. Erbetta and Cave claimed this showed that regulatory intervention had been successful at this time in reducing technical inefficiency in the sector. However, their analysis runs only until 2005. So it's unclear whether, over a longer period, such as that adopted by Saal and his co-authors, there would be the same cyclical behavior between short-term efficiency gains, followed by some temporary efficiency losses. In their paper, Saal and his co-authors also looked at the possible effects of scale on efficiency in the industry. This would include mergers, acquisitions, and diversification into other business areas. This graph shows their findings, again showing average total factor productivity growth rates over time. Saal and his co-authors here claimed that for the period from around 1990 onwards, this scale effect led to efficiency losses overall. Their point was that the behavior of the water company's post-privatization was not always successful here. Companies entered into businesses that were not their core area of expertise and probably lost money and efficiency as a result. This table shows amounts written off by seven of the major privatized UK water companies, stated in millions of pounds sterling from 1996 to 1999. They ranged from around the 300,000 pound level for a particular write-off in South West Water in 1999 all the way up to a 124 million pound cost for restructuring in United Utilities in 1996. Interestingly, there's also an 83 million pound write-off here by United Utilities recorded for 1996, 1997, for quoting problems with Bangkok contract. This write-off was equal to a third of United Utilities' pre-tax profits in the previous year. It was due to various contractual and construction problems, and associated with political risks in Thailand at the time. The year earlier, Thames Water had also written off around 95 million pounds due to unsuccessful overseas contracts and businesses. And after this period, most of the UK privatized water companies withdrew from much of their international water and sewage business contracts. So is this evidence bad news? Will it in the longer term be possible to recoup some of these apparent scale effect and write off losses? Or is there useful knowledge and experience to be gained from these business and contract experiments? Perhaps, after all, private businesses have to take risks. Some of these pan out, others do not. Instead, the appropriate metric here should be overall performance or return on capital. So perhaps we should not focus overly on this list of a few relatively modest commercial failures. Another area of debate is the balance between increasing capital investments to maintain or enhance service in environmental quality through the England and Wales privatized water and sewage company's activities. Or whether to be more mindful instead of the fact that water bills have risen above the UK rate of inflation for the majority of the period since privatization and may now be a risk to household in terms of water bill affordability. This table shows status quo and projected data on this capital spend and water bill balance. From 1990 to 2010, 85 billion pounds has been invested in the capital spend for the England and Wales water companies. Over the same period, average combined household water and sewerage bills have been around 300 pounds per year. With predicted future rates of capital spending of around 96 billion pounds for the period 2000 to 2030 based on 2010 estimates in this report by Martin Cave and Severn Trent Water, average household bills may rise to 400 pounds per year in the same 2010 prices. So will this be affordable? Since 2004, the official definition in England has been that a household is in water poverty if it spends 3% of its income on its water bill. According to Family Resources Survey data from 2009-2010, already around 24% of households in England and Wales were at this 3% threshold. So this is before the projected water bills increased over the next two decades. And from the same data, nearly 12% of households were spending 5% of their income on water bills. So is this projected long-term capital spending necessary for maintaining and enhancing water and sewerage services to customers, say, in the face of climate change challenges and ever rising policy, regulatory and consumer expectations around sustainability and environmental quality standards? Will there be innovations that might produce the projected bill increases and the projected capital spending, but still deliver the same desired outcomes? We'll return to this innovation aspect in our final session. But we should ask here whose responsibility is it to ensure that water bills are affordable and that more households do not suffer from water poverty? If regulators set standards for the private water companies to meet that are too high and water bills become unaffordable, does responsibility to remedy this situation lie with the water companies or with the regulator? Or should the government itself be more mindful of affordability issues and the guidance it issues to the regulators that will affect prices? And there are other issues here like welfare benefits to households and policy approaches to water metering of poor households. Should these be considered, too? Various discussions are ongoing on all of these points. But I'd say overall, the outcomes here of this affordability versus investment aspect of privatization still remain unclear or present. Another balancing act is the ratio between equity investment and debt investment in the England and Wales privatized water industry. This plot, from the economic regulator Ofwat shows Ofwat's preferred proxy measure for the market capitalization or total asset value of the England and Wales water industry. This is what Ofwat calls the regulatory capital value or RCV. We can see here that the combined RCV for all the England and Wales private water companies has more than tripled since privatization in 1989. But at the same time, the proportion of this value made up of equity or the value owned by shareholders, has remained fairly flat over time, whilst the proportion of the value constituting net debt or outstanding borrowing is increasing dramatically over time. Given the world has just been through a major global economic recession from around 2008 onwards, that was in part fueled by subprime mortgage lending, where many individuals were loaned debt they couldn't afford. Is this debt-fueled approach to the water industry's RCV growth really good news, or is it bad news? Ofwat's view on this is somewhat unclear. Ofwat seems less concerned about the direct risks of this level of debt or leverage. Ofwat, however, is concerned, is monitoring and is putting safeguards in place against what they call the risk of contagion in a case of, say, one or more water companies defaulting against their debt. So whilst you may have moral objections here to this situation, especially in our post-recession world, overall we think this is another unclear outcome of the water privatization so far. A final area of unclear outcomes concerned policy and practices toward competition in the privatizing England and Wales water industry. You'll recall that the promise of a liberalized competitive market was one of the political underpinnings of the broader privatization program. And although there was some reservations about its feasibility in a natural monopoly setting like water, this was also true for the England and Wales private water companies. As of 2014, there has, in fact, been further consolidation. The combined 39 water and sewage and water only companies of privatization in 1989 have become just 18 regional monopoly companies now. The 10 main players have remained the same, whereas the 29 smaller water only companies from privatization have now become just 8 companies. This has mainly been due to mergers and takeovers involving the water only companies. The 10 main players have been prevented from merging due to the requirements of benchmark economic regulation which we'll address in our next session. They have, however, undergone various changes of ownership. Over this time, there have also been 5 newly appointed companies and 8 new water supply licensees. In terms of the competitive ecosystem then, variety has reduced due to consolidation. However, there is still variety in terms of water company scale. Company annual revenues range from around 15 million pounds in the smaller water only companies up to 1.7 billion pounds for some of the main 10 water companies. And the overall industry annual revenue here is about 10.5 billion pounds. Some degree of competition for the non-domestic water and sewerage business has existed if only since around about 2010. This has meant that large water users, so typically large businesses, could choose their water supplier. And this is being rolled out for all businesses from around 2017 under current plans. This will mean over a million businesses and other non-household customers of water companies that are based mainly or wholly in England, will be able to choose their supplier of water and wastewater services. The information website that's been created for this change, called open-water.org.uk, notes that this newly created water market. And I quote, will be the largest retail water market in the world, delivering around 200 million pounds of overall benefit to customers and the UK economy. This competition promise has been a long time in the making due to various legal and regulatory difficulties in separating out the functions of water companies. But it's worth stating that this new market is only for the customer services and billing side of the industry. In this diagram, we can see the parts of the England and Wales water industry overall value chain that the sector's economic regulator, Ofwat, thinks are potentially contestable. The value chain here is based on modern equivalent asset value, or MEA. Parts of this we can see are a natural monopoly, mainly the water distribution and sewage collection and transport networks. In other words, Ofwat thinks it would be uneconomic to duplicate these parts of the system. However, we can see here that Ofwat also estimates the non-domestic or business retail part of the system shown here in the line in the bottom right orange box is only 0.1% of the overall value chain. So is this new competitive market mainly for retail and billing services to non-domestic customers good news if it only affects 0.1% of the value chain? For some time, there has also been discussion about domestic households one day being able to choose their water supplier, too. Say you're a water customer and you prefer to switch to a different supplier. Your decision may be based on price or customer service quality. At the moment in England and Wales, as a domestic water customer, you cannot choose your own supplier. In the future, this may become possible. Particularly based on the policy learning and precedent set by the opening in 2017 of the competitive non-domestic water market. So will this be good news? Well, we can see again here from the plot that again, the household or domestic retail portion of the overall value chain is very small. Ofwat estimates it to be around 0.2% of the overall value chain. So I'd still say this is another unclear outcome, for the time being at least. We should also consider the flip side of competition, coordination. The sustainable management of water resources in the face of a changing climate, changing demographics, and changing population trends may require more coordination across the boundaries of the ten main privatized water and sewage companies in England and Wales. Early progress on this issue has been modest. Regulation has been permitted so-called inset appointments for many years. This is where cross-border water trading can occur between the existing privatized water companies. The business case here is that a modest cross-border connection cost to supply water from one company area to another is far more efficient and sustainable and cheaper, of course, for customers and for the country as a whole than developing entirely new water resources or building new pipe networks. And yet, only a handful of these inset appointments, which again come under the purview of Ofwat, have been granted to date. To summarize, the UK water privatization case is interesting to examine. It's a rare example of a large full divestiture privatization and one that has persisted for more than a quarter century so far. It was also part of a wider British privatization program or radical experiment, to quote again the words of Mr. Privatization, John Wall. So it represents a context, a moment in time, a set of status quo conditions, and a dynamic baseline that might be hard to find again elsewhere in the world, now or in the future. The UK water privatization case has also followed a specific path, and been path dependent due to certain local specific prerequisites that were already in place before the privatization took place. This point is important for anyone considering transferring this experience to elsewhere in the world. Albeit, as Dale has already said, the willingness to do these kind of water privatizations internationally now has waned compared to the excitement about it maybe some two decades ago. The UK case also represents one where there were two overlapping changes of institutions. The England and Wales water industry was privatized. But at the same time, based on important precursor organizations, regulatory institutions were created and/or developed. We've also seen that the England and Wales water privatization involved significant political, administrative, regulatory and legal capacity and willingness. It was also a costly process, at least in the short term, and bearing in mind that we've seen mixed evidence on its good news, bad news, and unclear outcomes. We've also seen that there's still learning going on. In particular, the regulatory approach that has been necessitated by ongoing developments in the England and Wales private water companies has needed to evolve. We'll look at this specifically in our next session when we look both at water regulation issues and practices in lesser developing countries as well as lessons that might be learned from the UK's water regulation experience. Hopefully, overall, we've shown that recounting and assessing a historically detailed and institutionally complicated policy intervention such as the UK water privatization experience, is challenging. Doing so can inevitably raise new questions. Consequently, it's also a case on which opinions naturally may continue to differ. We've tried to present the available evidence as best as we can, but we leave it up to you to consider what other evidence you'd need to make perhaps a more balanced assessment here and whether that might ever even be possible. We say that because we've seen various moral obligations embedded in the UK water privatization case and lingering concerns over the sector's legitimacy in the eyes of the public, politically, and in the media. In some cases for seemingly very good reasons, like tax avoidance and fat cat salaries of certain water company executives. But here we invite you again to reflect back on our ancient instincts regarding water privatization and to consider just how deep our feelings on this subject can be, and whether we're basing them on the overall evidence and good news or not. Thanks for watching this video.
