Media Briefings

WATER AND SEWERAGE OPERATORS IN ENGLAND AND WALES

  • Published Date: June 2014

WATER AND SEWERAGE OPERATORS IN ENGLAND AND WALES: Internal competition hampers efficiency

An unbundling of the water and sewerage divisions of water operators in England and Wales would not significantly harm efficiency or increase costs. That is the conclusion of research by Belgian economists Laurens Cherchye, Thomas Demuynck, Bram De Rock and Kristof De Witte.

Their study, which is published in the June 2014 issue of the Economic Journal, explores whether the water operators exploit economies of scope between their water and sewerage divisions, using such inputs as general management or insights from research and development in the production of both services. They find that while there are several opportunities to share the available inputs, the divisions typically under-exploit these possibilities.

Since 1989, the water sector in England and Wales has been privatised, which means that incentives to reduce costs come from competition between companies. To foster competition further, the economic regulator of the water and sewerage sectors – the Office of Water Services (Ofwat) – has been considering the benefits of increased competition by separated companies.

In principle, both vertical separation of elements in the supply chain (for example, separating abstraction, treatment and distribution of water) and horizontal unbundling of water services companies could create a more competitive environment. But the benefits of the latter kind of separation depend on whether the water and sewerage divisions are run in a centralised or decentralised way.

In a decentralised company, both divisions have to buy services separately, which could be more costly. In the presence of economies of scope, the suggested horizontal unbundling would result in increased costs for the utilities.

Analysing public data from Ofwat, the researchers look at the past behaviour of companies and try to detect whether they are working in a centralised or decentralised way. In other words, do the companies exploit the potential scope economies between water and sewerage?

The results show that, on average, the water services companies do not cooperate internally. While there are several opportunities to share the available inputs, the water and sewerage divisions within companies seem to under-exploit these possibilities.

But there are differences depending on certain characteristics of the utilities. The authors find that the larger the proportion of the more costly river water abstraction, the better the observed production behaviour is explained by internal cooperation rather than internal competition.

Intuitively, this can be explained by cross-subsidies between the departments that are necessary to compensate for the more expensive water source or by an exchange of know-how on water purification. The larger the proportion of the cheaper (in terms of purification) ground water, the more decentralised is the way that companies seem to act. In this case, the water source is already relatively pure, and so there is less need for cooperation.

The service area explains cooperative behaviour within a company: the larger the service area, the more that companies cooperate. The more water exports, the better the observed production behaviour is explained by the decentralised model.

ENDS


Notes for editors: ‘Nonparametric Analysis of Multi-output Production with Joint Inputs’ by Laurens Cherchye, Thomas Demuynck, Bram De Rock and Kristof De Witte is published in the June 2014 issue of the Economic Journal.

Laurens Cherchye is at the University of Leuven. Thomas Demuynck is at the University of Leuven and Maastricht University. Bram De Rock is at ECARES, Universite Libre de Bruxelles. Kristof De Witte is at Maastricht University.

For further information: contact Bram De Rock via email: bderock@ulb.ac.be; or Romesh Vaitilingam on +44-7768-661095 (email: romesh@vaitilingam.com; Twitter: @econromesh).