Ofwat puts dampener on merger hopes

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The water regulator Ofwat yesterday ruled out mergers between suppliers to help the industry meet the huge environmental bill it is facing over the next five years.

Philip Fletcher, the director-general of water services, said "bigger is not necessarily better" as he published new research showing that in the some cases the larger the water company the higher its unit costs.

The research, carried out by the consultant Stone and Webster, found no clear evidence of economies of scale in the water industry.

On the contrary it concluded that there were "significant dis-economies of scale", with costs rising in proportion to size.

The publication of the research will dash industry hopes of a softening in Ofwat's opposition to mergers in the run-up to the setting of new price controls from next year.

The industry is proposing a £20bn capital investment programme between 2005 and 2010, of which £13bn stems from new environmental requirements relating to water quality and sewage. This could result in a £75 increase in the average domestic bill to £409 by the end of the period. Water companies have argued that the increase in bills could be kept to a minimum if suppliers were allowed to save on costs by merging.

But the Ofwat-commissioned research, which looked at the experience of water companies both at home and overseas, showed that there were no cost advantages in merging. It also found that no overall cost savings were achieved by the same company providing both water and sewerage services.

Mr Fletcher promised that Ofwat would continue to look at different structures for the industry with an open mind. But he emphasised that the sector remained very largely monopolistic, suggesting that there will be no move away from the regulator's preference for having a large number of "comparator" companies to help set efficiency targets within the industry.

A further finding is that the structure of the industry, based on integrated river basin management, is not the best way of organising it. But the report cautions that to tear this structure up and introduce a new one would involve "significant costs".