How a catchment-based approach to regulation could lead to fairer ways of charging

Introduction

Water companies are often thought of as having one purpose – to keep peoples’ taps flowing. But they actually provide a number of different services to their customers and communities.

Most obviously, and importantly, companies will supply clean drinking water. They also take away used water from households and businesses – along with rainwater that drains into the sewer network – to treat it before safely returning it to the rivers and sea. In doing so, this helps to reduce the risk of flooding to homes and communities.

Furthermore, by connecting new properties to their network and continuously upgrading network infrastructure to meet the ever-growing demand for these services, water companies also unlock new development in their regions, and wider economic benefits associated with this. And where these network upgrades are delivered using sustainable solutions, rather than traditional, carbon- intensive methods, companies can create benefits for the local environment through improved biodiversity.

These are all things that society value and are prepared to pay for – the question is how best to do that.

How should companies be charging?

When thinking about the best way to charge for these services, it can be helpful to remind ourselves of the benefits of setting charges correctly. One well-established principle is that the price of a good or service should – subject to other important social policy objectives – reflect the full cost of providing that good or service. This ensures that users consider (and pay for) the total impact to society of their behaviour.

Where the service in question has an environmental cost, this is often known as a ‘polluter pays’ approach; in other words, those who cause environmental harm should be the ones charged for tackling this harm. This is not just a fair way to charge for goods and services. It also sends the right signals to users about the true costs of their actions, by incentivising them to take mitigating actions to avoid the environmental harm upfront, or, if the value of this service is

outweighed by the full costs involved, to restrict their usage altogether.

How do companies charge for services?

Existing charging structures in the water industry embed this ‘cost causation’ principle to a greater or lesser extent, depending on the type of service provided. For instance, around two thirds of households now pay for their water based on metered usage, and therefore face a

marginal price for each additional unit of water consumed. This is generally seen as a good thing, as it encourages users to consider whether the cost of providing that water is justified by what it is being used for – though of course when customers would be prevented for affordability reasons from paying for essential water use, companies ensure that alternative tariffs are available to allow for this.

For other services – such as removing wastewater and rainwater – cost causation is less apparent in charging structures. Scott Reid has highlighted in a previous blog that existing legislation prevents road users from paying for the costs of keeping our public highways free of rainwater, despite them enjoying the benefits of this service (and the significant costs involved).

There are other examples where charges could better reflect cost causation. There is now a growing focus on the environmental and health impacts of synthetic ‘forever’ chemicals (known as per and polyfluoroalkyl substances, or PFAS), particularly where they collect in larger concentrations on land. If regulations on PFAS limits were to tighten in future, how should companies pay for the expensive remedial work that would be required to remove these chemicals through their treatment processes?

One option would be to increase everyone’s wastewater charges slightly. But if we could create a specific charge which was targeted only at those users who introduce PFAS to the network, this would ensure the polluters pay for the costs involved.

Of course, it may be difficult to achieve this in practice, given the prevalence of PFAS in everyday products – would this mean that everyone who owns a non-stick frying pan pays this charge? An alternative approach would be to introduce a tax or levy on the sale of these products. As well as providing a source of funding for the cost of remedial work, it could also encourage users and producers of these products to look for innovative solutions which avoid the need for PFAS altogether. If successful, this would minimise the total societal cost of this issue.

Getting the balance right

The issue of PFAS encourages us to consider what is the right balance of charging between different groups, in instances where those responsible for costs may be less clear. A related question arises in the case of new housing development. When water companies connect a new property to its network, they charge developers for the direct costs of this work, as well as an additional fee (known as an ‘infrastructure charge’) to ensure the wider network infrastructure can accommodate the new demand. In practice, though, this charge only covers a portion of these costs, such as upsizing sewers, whereas the long-run costs associated with expanding the network can stretch far beyond this.

In these circumstances, should the developer pay for the full costs that a new development imposes on a water network? Cost causation would suggest so. But if society also gains from the economic benefits of the development, should the Government be explicitly helping to fund the cost of network expansion? Or is it good enough that all customers (who are ultimately also taxpayers) contribute to these costs?

Towards a different approach – SWANN

These case studies can help us to think differently about how we charge for, and deliver, services in our industry. As we can see, water companies are not just responsible for providing water – they are involved in a whole host of other services that matter to customers and to the environment. But the current legal and regulatory framework does not always allow companies to charge for these services in a way which reflects their costs. For these areas, a more joined-up approach is needed.

To achieve this, Wessex Water has been working in conjunction with industry partners to develop a new model, known as Sustainable Solutions for Water and Nature (SWANN). This model advocates for moving regulation towards catchment-based approaches to support cheaper, more innovative, more collaborative projects that more accurately reflect local priorities. This would involve defining outcomes upfront; identifying the best solution to achieve them; and then assigning the costs of those solutions to the groups who should be paying. This can incentivise more efficient delivery of environmental outcomes, potentially through more market-based approaches.

You can find out more about the SSWAN approach. It doesn’t have all the answers, but it is intended to act as a catalyst for further discussion to find a new way of working, one which strikes a better balance between fairness, environmental sustainability, and economic efficiency. By adopting more innovative and holistic approaches like SWANN, we can better align the costs and benefits of water services with those who use and impact them. This will not only ensure that water companies can continue to provide essential services, but also help to promote a more sustainable and equitable future for all.