MD 154

TO MANAGING DIRECTORS OF
WATER AND SEWERAGE COMPANIES
AND WATER ONLY COMPANIES

12 November 1999

DEVELOPMENT OF COMMON CARRIAGE

1.   Introduction

The Competition Act 1998 (the Act) is an important milestone for the water and sewerage industries in England and Wales. From 1 March 2000, I will have stronger legal powers to remove barriers to competition. Within this new legal framework there are significant opportunities for market competition to develop. In particular, the Act opens up the scope for market competition through shared networks, ie common carriage.

Common carriage, when one company supplies water or sewerage services to its customers by using another company's network, may include the shared use of a pipe network, treatment works or storage capacity. Common carriage is possible now, but few companies have pursued it, despite having much of the experience and knowledge required to implement it as a result of the treatment and transport operations they carry out within their areas. The Competition Act 1998 is the catalyst to achieve its more widespread use.

This letter sets out how I envisage the development of a coherent common carriage framework. It provides guidance on what companies should do, and by when, and the principal elements that they should address in deciding how to operate shared use of their networks. This letter also sets out the legal position as I see it, and builds on the information set out in the consultation guideline on the application of the Competition Act 1998 to the water and sewerage sectors.

2.   The Legal position

Each company should be ready by 1 March 2000 to respond positively and substantively to enquiries and requests to share the use of its infrastructure. It should have ready a statement of principles that would govern this shared use. Any company that is not in this position may be subject to complaints from potential competitors.

If a company unreasonably refuses to share its infrastructure, or offers unreasonable terms, it may be abusing a dominant position. If I receive a significant and well-documented complaint about this type of behaviour, or I suspect that a company may be abusing a dominant position, I will use my powers under the Act to investigate. If I find that a company has infringed the Act, I will direct it to change its conduct and, if appropriate, impose financial penalties. You do not have to submit your statement of principles to me for approval, but if I receive a complaint or suspect an infringement of the Act, I will require you to furnish me with the relevant information.

My decision on a complaint about sharing infrastructure for common carriage will depend in part upon whether access to the network facilities is essential to competition. A facility is essential if access to it is necessary in order to compete in a related market, and duplication is impossible or extremely difficult owing to physical, geographic or legal constraints (or is highly undesirable for reasons of public policy).

Where my investigation shows that access to a facility is essential, but the incumbent refuses to share it, the incumbent must prove that its refusal has an objective justification. If the incumbent cannot show this, it is likely to be found to have abused its dominant position. If access is not essential, however, then an incumbent's refusal to share its use with a competitor is less likely to be an abuse of a dominant position.

In deciding whether a facility is essential, I will consider whether it is needed to compete in the relevant market, and the ease and cost of its duplication. To favour new entrants by interpreting the concept of essential facilities too widely would damage long-term incentives to invest or to develop competing facilities that might be more efficient. I will be careful to strike a balance, such that market competition and common carriage is facilitated, but not forced or distorted.

3.   Principal elements of common carriage

It is not my role to prescribe, in advance, how each company should govern the shared use of its network. You should set out the prices and operating conditions, ensuring that they are properly related to costs and are consistent with comparable components of your company's charges. Each company will be required to comply with the quality regulations set out by the Drinking Water Inspectorate (DWI) and the abstraction and discharge regime controlled by the Environment Agency. 

Common carriage will require careful management. The incumbent and the entrant will need to agree how to cover important factors such as monitoring and control of water quality, allocating responsibility for managing emergency procedures and security of supply to customers. Incumbents should be able to draw on their experience in managing many of these risks in their day to day operations (such as mixing different types of water) when implementing common carriage agreements. Incumbents and entrants should be able to agree these matters without regulatory intervention.

Underlying any common carriage agreement should be a commitment by the incumbent to equal, fair treatment of entrants and their customers. I will not expect the incumbent to finance the entry of a competitor to the market, but neither will I allow the incumbent to frustrate entry by setting unreasonable terms for shared use. For example, an incumbent can expect to recover the reasonable costs of operating an essential facility on a non-discriminatory basis - ie to treat entrants on the same basis as it treats itself.

Equally, the direct costs of entry to the market should be borne by those likely to benefit directly from competition, not spread across the entire customer base. I will not allow common carriage to lead to unsatisfactory levels of service or jeopardise the incumbents' ability to finance and carry out their functions.

Each company may have its own views on how it would implement a common carriage arrangement, based on its own circumstances. There are, however, a number of important issues that each company should take account of when deciding how to operate the shared use of its network. These issues are set out in the Appendix. Incumbents and entrants should be able to agree these matters between themselves, without regulatory intervention. It would be prudent, however, for them to agree upon a mechanism for the resolution of disputes after common carriage has been implemented.

4.   Access Pricing

To work effectively, companies will have to charge for common carriage in a way that broadly reflects the costs incurred in using the system. There will also be costs involved in connecting to the network, which the entrant should bear. If additional water is being sent through the network, some network reinforcement may be required. The cost of such reinforcement should be borne by the entrant. The incumbent should not use common carriage as an excuse to make the entrant pay for network reinforcement that would have to be undertaken anyway, nor should the incumbent set high connection costs as a way of deterring entry. 

Companies will need to develop, and publish, costings of elements in the provision of network services. A transparent picture of the costs involved in different parts of the network is an important factor to the development of common carriage. We are considering how best to achieve this, which may involve a revision to our Regulatory Accounting Guidelines. Such transparency in the way each company allocates its costs will facilitate access to existing networks. How a company will price the use of its network is one of the principal issues that each company should set out in its statement.

5.   Next steps

The Appendix sets out the principal issues that each company should address in deciding how it will implement common carriage. You should set out by 1 March 2000 how you will take account of these issues. This statement should be made available to anyone who requests it.

Ofwat's competition team welcomes discussions with each company on the development of its statement of common carriage principles. The Appendix is not an exhaustive list and may be revised in the light of company responses. Comments on the issues, including whether there are errors of omission, are welcome. These should be submitted by Friday 17 December 1999.

I C R BYATT

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APPENDIX – PRINCIPAL ISSUES FOR COMMON CARRIAGE

 Underpinning the development of access codes should be the willingness of both parties to reach agreement. Each party should recognise that standards of service to existing customers should not be jeopardised. The incumbent should treat the entrant and its customers fairly. Where appropriate, there should be an element of reciprocity in common carriage agreements. Each company should have regard to the following important factors when implementing common carriage.

1.   Quality

Common carriage must not lead to increased risk of unsafe water being supplied. The incumbent can expect the water entering its system to comply fully with the water quality regulations. The entrant will be responsible for ensuring its water inputs meet the statutory standards. This requirement must include some parameters which would impact on compliance at customers' premises. There is also a need to check that mixing of waters will not cause any deterioration in water quality reaching customers.

The entrant should expect to bear the costs of monitoring and sampling the quality of its inputs to the incumbent's system. These costs could be a part of the access charge. However, the monitoring requirements imposed on an entrant should not be any more onerous than a prudent incumbent normally carries out elsewhere in the course of its day to day operations. The entrant could be given the choice of arranging its own sampling and monitoring procedures, perhaps by an independent party. DWI will provide guidance on checks to be made on the quality aspects before entering into a common carriage agreement and the elements which should be included in a common carriage contract.

2.   Liability

Under current legislation, incumbents are responsible for the water supplied and enforcement action is taken by DWI to deal with failures. If water unfit for human consumption is supplied, incumbents are criminally liable. Incumbents cannot contract out of this, but they have a defence if they took all reasonable steps and exercised all due diligence to secure that the water was fit for human consumption when it left the incumbent's pipes. DWI has made it clear to us that it will take action against undertakers in the event of quality problems, and stresses the importance of contracts containing penalties for entrants if their water gives rise to problems

3.   Emergency procedures

The incumbent is likely to retain primary responsibility for managing emergency procedures. In practice, the incumbent may want to address emergencies as part of a network strategy. There should be provision within the agreement for each party to offer full assistance and co-operation to the other in the event of an emergency. The parties should agree the types of emergency where this arrangement would apply, particularly if it involves the inability of one party to supply its customers.

 4.   Security of supply

The entrant will need to ensure that its inputs are matched by its customers' demands. In terms of how these inputs are delivered in to the system (such as pressure and flow rates) the incumbent is likely to manage the entrant's inputs as a part of its overall network strategy. It may be necessary in some cases for the incumbent to control how much water the entrant inputs, to allow it to balance the network, as long as the entrant's customers are still able to take supplies. Where the incumbent causes problems of reliability of supply, such as mechanical breakdown, the entrant could expect to receive compensation from the incumbent or have the incumbent make alternative arrangements to supply the entrant's customers.

The entrant is responsible for ensuring that its water resources are sufficient to provide a sustainable supply to its customers, particularly its household customers (bearing in mind the restriction on interrupting supplies for households). However, the incumbent retains the duty to provide supplies to all customers in its Area of Appointment (within the circumstances defined in the Water Industry Act 1991). Therefore, if the entrant fails to make enough water available to supply its customers, then the incumbent is obliged to provide a supply if requested. The incumbent should receive adequate payment for being left automatically to supply the entrant's customers. This might include the provision of a bond or other form of financial security.

5.   Access charges

Deciding upon the charges for the shared use of the incumbent's network should be an integral part of each company's statement of principles. I expect each company to charge entrants as it would charge itself.

It is important that access charges allow incumbents to recover reasonable network costs and capital maintenance charges, without over- or under-recovery. This might be on the basis of average costs, where appropriate, or long run marginal costs. Charges should be non-discriminatory. Distance-related charges may not be appropriate, unless the incumbent charges its own customers in this way.

6.   Metering

Metering will be required to measure the entrant's inputs and the demand from its customers.

7.   Leakage

Leakage and sewer infiltration are common problems. The incumbent and entrant should agree how to recognise these factors in calculating the amount of water taken or effluent discharged by the entrant's customers. Several factors are material to this, including the fact that there may be leakage upstream of the entrant's input point, and that water is used by the incumbent in keeping the system running satisfactorily.

If the entrant is required by the incumbent to input water additional to the amount taken by its customers, then this allowance might be equal to the incumbent's published leakage figures or its leakage target, appropriate to the part of the system involved. Once figures were agreed, the incumbent ought to make up any excess leakage deficit. If the entrant provides its own new pipes, then one could expect that these are less likely to leak, at least in the short-term, so leakage allowances might not be necessary.

8.   Other terms

Terms such as duration, termination and notice provision will need to be agreed between the two parties. It may be prudent for both parties to agree upon a time-limited contract or one where proposals that allow the terms to be re-examined after, say, five years.

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