Aquanomics Update: UK Consumer Distress a Boon for Investors

British consumers may soon feel the pinch of higher water rates. Between 2010 and 2015, British water utilities claim they will need to make £27 billion in infrastructure investments to comply with the EU-wide Water Framework Directive, which requires water utilities to comply with new water conservation and pollution standards aimed at adapting to climate change-related water shortages. Ofwat, the UK’s water regulator, received the proposals Monday amid criticism from British consumer groups who claim ratepayers are having trouble coping with similar rate increases for gas and electricity service. British Gas, for example, raised its service rate 44 percent this month.

The rate increase will go to pay for efficiency improvements aimed at driving individual use down from 150 liters per day to 130 liters per day. The highest rate applications have come from Bristol Water and Southern Water, which collectively serve seven million customers. Bristol Water has proposed an infrastructure improvement plan that will raise average annual rates from £149 to £187 next year, representing a 26 percent increase over inflation. Southern Water’s 23 percent rate increase will raise annual bills to £426 by 2015 to pay for investments worth £2.6 billion. United Utilities, another large water provider, has asked for a 2.7 percent annual increase over five years to fund a £4 billion investment plan aimed at creating annual efficiency gains of around 1.5 percent. All companies have said the rate increases are necessary to comply with the new EU conservation and pollution standards.

While the rate increases understandably create distress for consumers, they represent an interesting opportunity for water-focused greentech companies and investors. The efficiency-focused infrastructure improvements will require water technology far more advanced that what is currently deployed. While some of this technology is deployed already in places like the water-conscious United Arab Emirates, much of it has yet to move from the prototype phase. Nothing will help that more than £27 billion worth of RFPs, especially when the issuers’ other choice is to face a hefty EU fine. While Ofwater will probably accept rate increases smaller than those proposed, driving down the amount of total investments, the work required to meet this demand will drive further innovation in water technologies. As far I’m aware, the improvements to be made in Britain between now and 2015 represent the largest concerted effort to rebuild a water industry anywhere in the world. If done correctly, as with all things greentech, the high initial capital expenditures will result in long-term cost savings as resource efficiencies drive down operating costs and service rates. Greentech VCs would do well to get some of their water companies in front of the British utilities.

This brings up a related point. Electricity and gas rates have increased in recent years as a result of constrained power supplies, demand levels rising above forecasts, and structural shifts in the natural gas industry. The proposed increase in water rates also stems from use and resource constraint issues. In the power, heat, and water supply industries, however, increasing rates have played a large role in moving green technologies further into the mainstream. But just who should bear the cost of this? Passing costs onto consumers is a common practice in regulated industries. Companies in these sectors are required to negotiate tariffs, and rates of return are strictly supervised by regulatory authorities. This helps (sometimes) to keep rates down and preventing utilities from taking advantage of their natural monopoly status. However, as markets move, utilities are forced to renegotiate, often with undesirable consequences for consumers.

But if utilities were unregulated and rates were set to monopoly pricing, wouldn’t this drive down demand (or drive up efficiency and conservation)? So maybe regulators should pay. After all, they’re the ones who force utilities to keep costs down, though often with limited success. They also force utilities to keep the water on for people who can’t or won’t pay their bills. And the utilities themselves? Faced with a set of perverse regulation-based incentives, utilities do their best to keep investments and improvements at a minimum. Anything else would raise the ire of shareholders.

The answer is a combination of all three. The EU follows the polluter pays principle, which means utilities should bear a considerable portion of the investment burden. Regulators, however, in sticking with their mission of public service should view the infrastructure improvements as a investment in future conservation and insurance against water shortages and drought. Consumers increasingly need to come to grips with their legacy of overuse. When water is in short supply, demand becomes relatively inelastic. Hang out in the desert for a bit with a box of Fiji Waters and you’ll see what I mean. Or just ask the Gulf Arabs, who must desalinate more than 95 percent of their drinking water and still face a potentially devastating shortage. GE has found one of their biggest growth opportunities in that market. The UK’s water situation represents a similarly significant opportunity for companies developing even newer, more innovative technologies. Perhaps the British Government will use this opportunity to build their own water tech industry. The demand is certainly there.