Water Utility Competition: Lessons from the Electricity Sector

Water utilities are considered to be natural monopolies. Economic theory holds that in industries where long-run average cost decline as output expands, a single producer will be able more efficient in delivering services than multiple providers. But are water utilities natural monopolies?

In this paper, we sketch a scenario for a competitive landscape in the urban water industry and provide some thoughts on how to respond strategically to the threat of new entrants in the municipal water market.

Water Utility Competition

Marketing guru Theodore Levitt prophetically wrote in 1960 about the problems currently facing electricity utilities: “Who says that the utilities have no competition? They may be natural monopolies now, but tomorrow they may be natural deaths.” Levitt sketches a future where “fuel cells, solar energy, and other power sources” threaten the sustainability of the centralised electricity distribution system. Half a century after these words were written, they are becoming a reality.

Who says that the utilities have no competition?

The electricity grid is being inverted and is moving from a centralised monolith to an active decentralised network driven by consumer demand for green energy self-sufficiency. The ongoing development of electricity generation and storage technology will drive this decentralisation even further.

A similar scenario is unfolding in the water industry. Competition does not originate in large-scale third party access but in fragmentation of service delivery assets over multiple service providers. Developers are interested in decentralised service provision, seeking independence from publicly owned infrastructure.

Reviewing the concept of public utility in more detail reveals it to be an absurd one

The usual response of utilities is to move into defensive mode. Water utilities place themselves in a different category than other service providers. Utilities point out the unique qualities of water as a life-sustaining product considered the most essential of all services. But reviewing the concept of ‘public utility’ in more detail reveals it to be absurd. Every good is useful to the public, the fully commercialised food industry being a case-in-point. Water utilities cannot rely on a preference status within the gamut of service providers to mitigate the risk of competition.

How can water utilities respond to the entry of new service providers to the market? Three scenarios can be sketched. The least productive response is to keep our head in the sand and wait for the hype to blow over. The experiences in electricity show that this is not an acceptable proposition.

Secondly, water utilities could revert to their powers as water authorities and create a regulatory burden on developers that minimise the likelihood of these proposals coming to fruition. The current discourse in this area is focused on the risk of becoming the Provider of Last Resort. In this scenario, an independent, decentralised utility would no longer be able to meet its obligations, forcing publicly-owned utilities to inherit the assets and liabilities. This situation is indeed not theoretical. In Europe and much of the United States, this is precisely the mechanism of how large vertically integrated public utilities came into existence. This blocking of innovation is certainly not conducive to maximising the public good overall.

Don’t fear becoming provider of last resort. Become the provider of first preference.

The most productive way to manage the risk of becoming the Provider of Last Resort is to ensure that we become the Provider of First Preference. Instead of focusing on their perceived special status as a service provider, utilities should focus on understanding why communities are seeking self-sufficiency. Can incumbent water utilities become more entrepreneurial and provide a suite of services that would make developers not see the need for taking risks in becoming a water utility themselves?

The electricity experience may be instructive. The three big power ‘gentailers’ in Australia are players in the renewable energy market but are not big enough to avoid competition, for example from the South-Australian wind. This case suggests water utilities should prepare for such a possible future by further developing contribution arrangements, as well as considering approaches to managing the risk of third party access, including insurance, options and guarantee arrangements.

Acknowledgements

This paper has been written with the help of Jon Anstey and Megan Kreutzer and was presented at the VicWater conference in Melbourne on 12 September 2014.

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