Narrow window to improve regulation and secure better environmental outcomes from the water sector

Posted by Guy Thompson on 10th August 2021

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Guy Thompson is Group Director of Environmental Futures at Wessex Water and a former founding Executive Director of Natural England and Executive Director of Green Alliance. In this piece he explores how policy can support water companies to accelerate ambitious action on the environment

The water industry in England, its regulators and the government are all in furious agreement: water companies need to raise their game on the environment. The industry is signed up to a vision to become globally recognised environmental leaders by 2050  and recent government and regulatory consultations have set out an exciting template, focusing on the long term and delivering greater environmental and social value.

The game-changer since the last Water Price Review is the government’s 25 Year Environment Plan. As place-based long-term stakeholders with a core purpose to improve public health and the environment, water companies can make a major contribution to the government’s environmental targets, in particular the recovery of nature within a generation.

However, the devil will be in the detail. Wessex Water’s experience on the ground is that inflexible EU environmental regulation currently inhibits the ability of the private sector to innovate. The 25 Year Environment Plan’s goals require finding new ways of incentivising businesses to deliver environmental improvement. Whilst all parties are committed to making the step-change in the water industry, the real question is how and how fast this can be enabled.

Move from prescriptions to outcomes

Through the programme of regulated expenditure drawn up by the Environment Agency (the so-called WINEP – the Water Industry National Environment Programme), the current approach to regulating water companies on the environment prescribes inputs and outputs, focused almost exclusively on investments in physical infrastructure to improve water quality. This approach has worked well historically, having raised billions of pounds of private investment to clean up rivers and beaches. However, it can lead to perverse outcomes, such as increasing carbon emissions through the energy consumption of the assets. Investment in catchment solutions in general – and nature-based solutions in particular – can achieve substantially more for the environment at a lower cost.

To make a greater contribution to the government’s environmental targets, water companies need more flexibility to innovate their service delivery to customers and communities. Instead of prescribing inputs, water companies should be incentivised to focus on environmental outcomes at a catchment scale, aligned to the relevant national targets on the face of the Environment Bill: nature, water, and climate mitigation and adaptation.

Incentivising for nature-based solutions

Regulators need to incentivise water companies to find the right balance between grey and green infrastructure solutions. This can be achieved without radical regulatory reform:

  1. Long term outcome targets for the environmental improvements required by the 25 Year Environment Plan, such as phosphorus reduction in rivers, biodiversity improvements and carbon reduction, should be set and cascaded to a catchment level, with milestones along the way.
     
  2. A robust system of monitoring, accreditation, and validation should be established through a system of tradeable permits and credits like the UK Emissions Trading Scheme. To encourage collaboration with other actors and increase investment certainty, an approach would be needed, underpinned by the latest environmental science, which estimates the expected outcome of particular actions (in terms of the number of permits and credits generated), so that companies would have greater confidence that paying others to carry out particular actions will be recognised.
     
  3. The regulatory incentives need to adapt to support and enable companies to deliver in this way. Ofwat needs to unlock these efficiency gains for society by adjusting its approach to economic regulation.

These aspects would not necessarily require primary legislation and would deliver substantial efficiency gains with relatively small policy changes and no additional cost to the government. Indeed, Wessex Water is already demonstrating how it can be done by working with the Environment Agency and Natural England to develop Catchment Markets in nature-based solutions. They would also help the water industry make a much bigger contribution to the levelling up agenda in its regions and enhance the social value it creates for the communities it serves.

Using the water industry as a testbed for private sector delivery of the 25 YEP

There is a narrow window of opportunity to get these incentives right. Alongside the Environmental Land Management Scheme, the Water Industry National Environment Programme (WINEP) is the most significant mechanism for delivering a swathe of the government’s environmental targets - worth £5 billion in the current regulatory period. Decisions taken on this over the next six months will define how quickly companies can begin to transform. Get this wrong now and we’ll be waiting until 2030.

The direction set out in the Environment Agency’s current review of the WINEP published recently is sound, but weak in its application for the next regulatory cycle. There are some encouraging words in the consultation about an outcome focus, but the outcomes are then narrowly defined as everything beyond a company’s regulated obligations. This misses the point entirely. Better regulation, according to the principles set out above, is what will unlock the innovation and investment needed from the private sector to deliver the 25 Year Environment Plan.

These questions permeate beyond the water industry. As a highly regulated, relatively homogenous, place-based sector, the water industry is ideally positioned to act as a testbed for a new approach to local delivery of the government’s environmental targets. Water companies are uniquely well placed to raise finance in nature-based solutions and innovate with market mechanisms like EnTrade. Incentivising the water industry differently on the environment is the bold step the government needs to take towards nature recovery.