UK: Scottish Water Merger Whets Appetite for Change

On Monday, 1st April, the three existing Scottish water authorities, ESWA, WOSWA and NOSWA were abolished, and the new Scottish Water was created. From its headquarters in Dunfermline (a compromise location unlikely to have pleased many within the new organisation) it took over the assets and functions of the three former water authorities and assumed responsibility for the country's water services. Other significant new legislation for the water industry is in the pipeline, and this is a time of great change within this industry north, and indeed south, of the border.

But what will the new Scottish Water do? Is the creation more than just a merger? Will it end up in a messy divorce? Is this a case of a public sector calf being fatted for privatisation? Is the "Fortress Scotland" approach seemingly being taken by the Scottish Executive misguided? Who will be the April fools? So many questions.

Briefly, the background to the water industry in Scotland is that it remains in public ownership, i.e. the shareholders in Scottish Water are the Scottish Executive. Compare the position in England, where the water industry has been wholly privatised, with the statutory undertakers in the various parts of the country constituted as PLC's.

The pre-existing tripartite Scottish water industry had been predicated on a belief that devolved control of the industry would be a more effective answer to Scotland's water infrastructure needs than the centralised model that now obtains. The logic now seems to be the projected economies of scale and streamlining of administration flowing from the link-up.

Ross Finnie, the Minister for Environment and Rural Development, tells us that "the creation of Scottish Water is more than just a merger." That is certainly the case, although not perhaps in the way that the Minister would prefer us to believe. An analysis of the new and forthcoming law in this area is instructive.

The Water Industry (Scotland) Act 2002 of the Scottish Parliament received Royal Assent on 1st March and makes provision for the establishment of Scottish Water, the transfer to Scottish Water of the functions of the water authorities established by the Local Government etc (Scotland) Act 1994 and the dissolution of those authorities. On 1st April, all the functions and assets of the three existing Scottish water authorities passed to Scottish Water. The Act also draws wide the commercial freedom of Scottish Water and provides welcome clarification on its vires regarding commercial ventures. It is understood that detailed guidance on the procedure for Scottish Executive approval of major Scottish Water projects will be forthcoming in the near future. Along with the Act, this will remove the doubts of all but the most sceptical lawyers over the statutory powers of the new body to enter into significant capital projects, complex service agreements and the making of bulk water supplies.

Leaving aside the provisions of the new Act dealing with the creation of water customer consultation panels (aimed at domestic customers) and the creation of the post of Drinking Water Quality Regulator, the elements of the new Act discussed above will be welcomed by all those who intend to do business with Scottish Water. Scottish Water is now the fourth largest water services provider in the UK. It will play a key role in the Scottish economy over the next 4 years purchasing an estimated 50% of the total contracts in the construction and engineering sector to deliver a £2billion investment programme aimed at compliance with increasing European and National standards.

The Water Environment and Water Services Bill is currently in its second round of public consultation. The Scottish Executive expect to introduce a draft Bill into the Scottish Parliament in the very near future. On review, the Bill will be more interesting in strategic terms for what it leaves out than for what it includes.

In the Bill will be provisions implementing in Scotland the European water framework directive: various technical and managerial provisions to improve water quality and protect the water environment in Scotland and to define SEPA's (the Scottish Environment Protection Agency's) role and powers in regulating the water environment north of the border. It is expected that the legislative position on these matters will be developed from 2005 to 2012 using a substantial amount of secondary legislation. Sadly, the new Bill will abolish one of the more appealing idiosyncrasies of the Scottish statute book, introducing English-style provisions for compulsory abstraction licensing for those extracting amounts of water in excess of a statutory threshold. The prevailing wisdom, that Scotland was so wet that no such regime was required, has therefore passed into history.

Previous consultation papers for the new Bill had included relatively detailed provisions relating to the introduction of full competition into the Scottish water industry, by means of the introduction of common carriage of water and a licensing regime to regulate new entrants to the market. It had been anticipated that these provisions would be further fleshed out in the new Bill, with a view to providing a fully thought out statutory framework for the introduction of competition and the inevitable explosion of the existing Scottish Water monopoly that now exists. We now understand from the Minister that whilst "there remains the need for such a framework….further consideration of some complex issues is necessary and as a result the Executive has decided that provisions relating to the framework should not be included in the Bill". Thus is revealed why the creation of Scottish Water is more than just a merger. It is a cornerstone in shoring up the Scottish market from the risk of English privateers engaging in border raids in search of profit and market share.

Perhaps the "Fortress Scotland" approach is not what is intended. Time will tell, but a comparative study of how similar questions are being answered south of the border is helpful in this context. Large-scale water users in England and Wales are to benefit from greater competition in terms of the proposals announced at the end of March by the Environment Minister, Michael Meacher. If the Westminster Parliament approves the proposals, new entrants to the English water industry will be able to use the existing statutory undertakers' network to supply premises using more than a specified threshold of water per year (50 megalitres as currently drafted – around 200,000 baths). Whilst no-one wants to be the guinea pig, Scotland is facing the risk of being left behind in terms of securing the greater innovation and efficiency that increased competition would undoubtedly bring. The speed with which the Water Industry (Scotland) Act was taken through the Scottish Parliament, along with the ability of key stakeholders to influence its provisions, has shown that the Scottish Parliament can be quick and effective when it wants to be. There will therefore really be no excuse for falling behind England in opening the market up to competition.

So what lies in store for the Scottish water industry in the future? Will Scottish Water go through a messy divorce? The likely answer to this is No. The trend is, given the change in the water industry over the last 10 years first from local authority control, through the tenure of the three water authorities to the new Scottish Water has been a trend of centralisation. Provided that the central belt can adequately cross-subsidise the rural parts of the country there would seem little reason to split Scottish Water up in the future. Indeed if it is to be a serious player UK-wide, as the Scottish Executive proposals contemplate, it will need to stay big to compete. On the "fatted calf" analysis, the larger entity would surely provide a more attractive flotation offer in the (currently unlikely but these things do change) event that Scotland feels ready for a significant privatisation.

One palliative for potential new entrants to the Scottish market who are straining at the leash is the significant outsourcing programme that Scottish Water is understood to be contemplating with regard to the capital and operational investment required to reach the new standards to which it aspires. It may be that English players successful in securing work in the outsourcing programme can rapidly leverage these jobs into a wider assault on the Scottish market. Timing is of course crucial too. Too long a period without any movement and the English privateers will surely be reaching for their copies of the Competition Act!