UK - Pension funds will only invest directly in the water sector in England and Wales if regulator Ofwat adopts a model based on separation of utility and infrastructure, according to a paper published this week by economics thinktank Oxera.

The paper, called Valuing water in England and Wales in the medium and long-term, is part of a consultation launched by the regulator and posits a pricing model for the medium-term - that is, for the 10—15 years following the lifting of price controls in 2015 - the based on a bulk supply tariff as "a good first step" towards market-driven competition.

Jon Stern of the Centre for Competition and Regulatory Policy at City University - one of the paper's authors - warned that pension funds would likely only be interested in investing in an environment where regulatory control kept commercial risk to a minimum.

"Ofwat supports a move towards the kind of structure we propose, but rather more gradually than we do," Stern said, describing the regulator's proposal as "much less ambitious".

In the long-term, the paper argues, the most appropriate model would be a bilateral contract, one in which the network itself is separately owned and upstream water suppliers sells water directly to local supply companies and consumers - a move water companies have argued would increase the cost of capital.

Although Stern claimed the capital-cost impact would be mitigated by gradual implementation, he told IP Real Estate water investment should remain primarily the responsibility of private-sector water companies.

"Whether we have private or public investment makes a big difference. Assuming continued private-sector investment reliance, the investment source makes much less difference.  However, pension funds and similar investors with very long investment horizons are always likely to be a lot more interested in low-risk investments," said Stern.

"I would expect pension funds to be much more interested in investing in the network parts that would continue to have Ofwat or similar regulatory protection rather than in the competitive upstream and retail businesses where there would be rather more commercial risk."

Even if the regulator accepts the Oxera model, UK political and public attitudes could well stymie greater participation of market mechanisms in what was until relatively recently a public-sector utility.

"Little will happen there is sufficient agreement within government and unless water companies and their consumers are willing to tackle these long-term problems with the associated costs," said Stern.  "That is a major reason why I would argue for the limited and carefully designed changes in our medium-term model."
He added: "For political, public opinion and other reasons, introducing market competition and trading into the water industry strikes me as a case where the Chinese proverb 'Cross the river by feeling the stones' is clearly relevant."