How a regulatory system works in practice
A Water Services Association case study

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Page 2: The need for regulation

Water Services Association 3 Image 2In order for the privatisation process to be successful, it was necessary to make sure that the public interest was protected. In the production of something as important as gas, electricity or water, it is essential to ensure that these services are run in the best interests of the whole community. While most of these utilities were to benefit from operating as private sector companies in new competitive markets, it was necessary to make sure that the activities of the new privatised utilities would be regulated in the public interest. In simple terms, the newly created privatised companies had to work within certain limits and regulations.

This case study focuses on regulation in the water services industry in England and Wales and shows how the Office of Water Services (OFWAT), the Department of the Environment, the Environment Agency and the Drinking Water Inspectorate, play a crucial role in regulating the industry in this country. In particular, the case study focuses on the role of the Director General of Water Services in establishing a periodic review of price limits for the water and sewerage companies in England and Wales.

Today, we live in a society in which there is a pressing demand for rises in environmental standards e.g. in the production of clean water and the reduction in industrial effluents and discharges. These improvements come at a cost and with this in mind, water companies have been allowed to increase their charges to pay for some of these improvements. However, limits - price caps - have been set on these price increases in order to protect consumers.

The price cap for the water industry is represented by the formula RPI + K, where RPI is the retail price index and K is known as ‘the K factor.’ K is a charging limit which represents the amount by which average water charges can rise above the retail price index in any one year. K is made up primarily of two parts, the -X factor and the +Q factor. -X is the amount by which water prices should be reduced due to efficiency improvements within the business and +Q is the amount by which prices may rise to allow for quality improvements in water services. +Q and -X currently combine to produce a positive K factor. This means that the water companies are allowed to raise prices by more than inflation although the amount varies from company to company.

The three principal regulators

Water Services Association 3 Image 4The government holds the key role in maintaining a water services industry which serves the public interest. The Secretary of State for the Environment and the Secretary of State for Wales appoint companies to take responsibility for water and sewage, as well as appointing the Director General of the Office of Water Services (OFWAT), members of the Environment Agency and the Drinking Water Inspectorate.

  1. The Director General of Water Services. His key role is to ensure that the water companies are able to run their businesses in a financially viable way, whilst meeting public expectations in terms of quality of service and other requirements. The Director General must also make sure that the interests of customers are protected.
  2. The Environment Agency. The Environment Agency ensures that sufficient water is provided for water companies to meet the needs of their customers, while at the same time ensuring that the interests of the natural environment are protected. It is also responsible for protecting the natural environment from the effects of contaminated waste water.
  3. The Drinking Water Inspectorate. The Inspectorate’s role is to ensure that water companies meet the very strict quality and health standards with which water supplied for public consumption must comply.

Water Services Association | How a regulatory system works in practice