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Introduction
Good morning.
I compliantly accepted the topic which Water UK gave me – 'regulation – the future'.
In the year 2001, futurology is back in fashion. It strikes me that, like Space Odyssey itself, such visions, or nightmares, tend to be a reflection of current preoccupations, from Nostradamus onwards.
So what are my visions of the future for 2001?

Vision 1 – No More Regulation?
Regulators are not the flavour of the month. Regulation can be a dirty word – clogging the arteries of commerce. We can all agree that economic regulation has drawbacks compared with the transparent operation of a wholly free competitive market, subject to whatever constraints a free democratic society considers are necessary to achieve social or environmental objectives.

But there are other dirty words; 'monopoly'; 'high prices'; 'poor service'. How many markets do achieve that state of perfection? Water, of all utilities, is likely to retain some monopoly characteristics, and we have a long way to go before competition is fully developed.

Across the world, preserving water as a precious resource is very high on the political agenda. In England and Wales, the water industry is the instrument for delivering a set of key environmental quality objectives, through a massive programme of capital investment.

I suspect that the country which led the way in privatising the provision of water and sewerage services is likely to see the need for some form of economic - and quality - regulation for as long as we are around to worry about it.

That doesn't mean that things won't change. Vision 2 is a bit more humdrum.

Vision 2 – An Efficient Regulated Industry?

Progress So Far

It is a tribute to the privatised water industry – and to the success of environmental and economic regulation over the last decade – that so much has been done in England and Wales:

• By 2005 we will have seen £50 billion worth of investment to improve drinking water, protect the environment, and ensure supply meets essential demands.
• An impressive 99.8% of drinking water samples now pass rigorous tests – and those last few percentage points are still being pursued.
• Customers can take tap water safety for granted - unlike a quarter of the world's population.
• Security of supply has greatly improved and leakage has been cut by a third since its peak levels 5 years ago.
• Overall levels of service to customers have shown significant improvements; and
• Efficiency gains per household of £60 over the 1994-99 period - shared equally between customer and shareholder for 2000-01 – brought an average 12% cut in household bills this year. (I will come back to the issue of further efficiency later.)

I believe that Ofwat's key contributions to the industry have been twofold:

• to set prices and provide a regulatory framework within which industry can succeed; and
• to provide a proxy for market competition in the shape of good comparative data, providing real incentives for efficiency, and rewarding companies that demonstrate good practice.

The targets were indeed challenging. They were also achievable. I pay the industry my second tribute and make my second prediction of the day; they are beginning to show themselves on course to meet the challenge.

No one pretends that efficiency gains are easy. They demand difficult decisions on systems, processes, manning levels and procurement. But our most recent report on unit costs and relative efficiency offers a picture of the companies' relative operating and capital maintenance efficiency for the last year of the five-year price-limits period of 1995-2000. It shows that all companies have improved their efficiency substantially.

What's more, our early analysis for the first half of 2000-01 reveals that many companies are beating the efficiency assumptions set in PR99. This trend is being confirmed by the reduction in operating costs as shown in companies' half-year results.

The full picture will not emerge until the end of this financial year but the half-yearly snapshot is promising - for customers, for the industry, and for shareholders. I do not believe that the industry would have made as much progress as it has, certainly in the absence of full market competition, without the challenge of the periodic review to push them forward. But there is further to go, which brings me to:

Vision 3 – A Restructured Industry?

It is important that we don't lose sight of the gains that comparative competition and incentive-based regulation has brought over the past 10 years. And it is equally important that we do not now endanger those benefits.

That is why the issue of retaining incentives to efficiency has been at the heart of Ofwat's thinking when companies have proposed restructuring their businesses.

In our consultations on both the Kelda and the Glas proposals - for Yorkshire and Welsh Water respectively - we have made clear that any new structure must contain benefits for customers. And these benefits, along with any new risks, must be properly explained to them. We have also made it clear to companies and their prospective financiers that we would continue to regulate on a level playing field – no favouritism for new structures or old.

In our consultations on both proposals, the key points that we needed to be satisfied about were similar.

They included:

• Without shareholder pressure, do the plans provide enough incentives for a continuing drive for efficiency?
• What benefits are offered to customers and are they protected from any new risks should the company run into difficulties?
• Can the management still ensure environmental protection and drinking water quality in the light of proposals to out-source operations?
• Are the Drinking Water Inspectorate and Environment Agency still able to regulate the company effectively particularly if it fails to meet its obligations?
• Do the proposals include adequate consumer consultation given the new model of company proposed?
• Are the boards of the new companies fully independent and able to negotiate at arm's length from the outset?

Other companies have said that they are considering the possibilities of restructuring. The current shareholder-owned model has worked well. It is delivering efficiency gains for the benefit of customers and shareholders whilst the water companies have been carrying out their greatly expanded capital expenditure programme. A company needs to have good reasons to change that model - and I will assess any proposals on the criteria I outlined above.

Most of the proposals which have been canvassed involve the separation of ownership of the assets from their operation. This makes it essential that the owner should have a clear procurement plan and the skills to let and manage the contracts effectively. He must never lose sight of his overall responsibility for the safe and efficient delivery of services.

This is no easy option. Poor contract management would not be rewarded by the Regulator "passing through" the additional costs to customers.

Such companies will still be expected to perform fully as effectively and efficiently as their equity-based comparators. One of the issues is whether the transparency of contract letting and competition between suppliers for the owning company's business offers opportunities to do better than the in house operations, or whether these opportunities are offset by the risks of loss of control. That question is at the heart of the consideration I am giving to the Glas proposals, and to any similar proposals in the future. I stress again that all companies, whatever their structure, will continue to be subject to firm comparator based regulation. The one factor that might in due time make a difference is Vision Number 4;

Vision 4 – A Competitive Industry?

As yet, the Government is not ready to indicate the outcome of its consultation on competition issues, undertaken last summer. This makes for a large gap in its proposals on a draft Water Bill published shortly before Christmas. Until the gap is filled, it will be very difficult to weigh the balance of the proposals overall.

The water industry is not the same as gas or electricity. There are barriers to potential entrants. In relation to its sale price, water is expensive to move around. The massive capital investment needed to provide the networks for supplying drinking water and for safe wastewater disposal means that it makes little economic sense for them to be duplicated.

There is no "national grid" for water supply or wastewater disposal. Competition must not endanger security of supply. We have to be able to continue to meet essential demands for water throughout England and Wales.

But above all, safety comes first. No development in competition can be allowed to put public health at risk.

That said, competition initially for the business of large water users, has begun. I am convinced that it has a long way to go. How much further will competition develop? The question used to be: "will competition develop in the industry?" I think it is changing to: "How fast will competition develop?" But the companies and potential new entrants - and their customers - must lead the way.

The Government's consultation on a draft Water Bill proposes a further change to my remit. If enacted, Ofwat will set out to protect consumers by "promoting" competition rather than "facilitating" it. Is the difference just playing with words? I do not think so.

I must pay attention to my statutory remit from Parliament. Facilitate: to make easy; is not as powerful as To Promote. Either way they require me to pay close attention to the opportunities that competition may bring and the impact it may have on the industry and customers. I should welcome the stronger remit, which takes me on to …

Vision 5 – A Reconstructed Regulator?

I said at the start that I doubted whether it would be practicable to abolish Ofwat in the near future. Certainly, the Government's draft Water Bill proposals continue to envisage a single economic regulator. I welcome the retention of an independent regulator (naturally!). The proposals will not work as well as they should unless I continue to have access to a wide variety of expert advice. The Government proposes to establish a Water Advisory Panel, appointed by the Secretary of State for that purpose. So far, I am not persuaded that it has been fully thought through.

This is because the paper contains no guidance on how the panel would operate, what issues it will deal with, or its accountability. I would not want to risk the panel restricting channels of communication with the Regulator or confusing accountability. Any increase in regulatory uncertainty can lead to a higher cost of capital for companies that, in turn, could push up prices for customers. At Ofwat, we already have a long-standing practice of taking advice from a panel of senior industrialists on economic and regulatory issues. We have an established Regulatory Policy Committee, which includes independent external members alongside Ofwat senior management, who provide regular advice on our work.

Ofwat is already moving in directions proposed by the draft Bill, for example towards an independent Consumer Council for Water. We are freeing-up the 10 regional customer service committees and the national committee to speak and act more independently, because I believe these are the right things to do.

We see some risk of overlap between the duties of the new proposed independent water customer council and the regulator. A separate voice is welcome but it should go hand in hand with separate statutory functions that are clear and different from the Regulator's. Neither should impose additional, unnecessary costs on customers.

There are a number of areas in the bill that could contribute to regulatory uncertainty and need further thought before emerging as firm proposals. Thus whilst I welcome the ability to impose fines on companies I also recognise the risk this brings for companies and customers of increasing the cost of capital. The suggestion within the Bill that others should determine companies' performance standards could also contribute to regulatory uncertainty.

We will be responding to the consultation on these and other issues.

No More Visions – The Day Job

These are some of the many challenges facing Ofwat and the industry in England and Wales. In the meantime, we must also manage the daily round of regulation. We are:

• making preparations for the next Periodic Review, which takes effect in 2005 (refining and discussing our approach on issues like capital maintenance);
• considering such major proposals as the RWE merger with Thames. We have just concluded a public consultation on licence modifications for this;
• undertaking casework under the 1998 Competition Act; and
• actively monitoring each company's performance and compliance with its statutory duties, taking regulatory action where necessary ;

My statutory primary duty is to act in the manner I consider is best calculated to ensure that the companies carry out their functions and can finance them. But the purpose of that is not only to ensure shareholders get a reasonable return – it is also to encourage the industry to put its customers first. With sound, transparent and stable economic regulation, I am confident they will do so.

Yesterday, I hosted a stakeholders conference on our draft forward work programme for 2001-02 - some of you were also present. The draft work programme gives us the opportunity to revisit our objectives. We have used it to spell out Ofwat's vision of how we wish to regulate and what we would like to see the water industry of England and Wales achieve.

Ofwat's vision is to help ensure that we have a water industry in England and Wales that delivers a world-class service to its customers in terms of quality and value.

We will regulate in a way that provides incentives and allows the water industry to achieve this world-class service. That is what the customer - and the investor - would expect.

Thank you.