Ofwat consults on ditching falling block tariffs to promote water efficiency

Ofwat is consulting until 1 October on scrapping falling block tariffs and potentially removing all wholesale charge discounts large business customers enjoy, in light of water scarcity.

The consultation cited in explanation the looming 5bn litre a day water shortfall forecast by 2055, and the Government’s growth mission, which depends on addressing water scarcity. In addition, Ofwat cited Recommendation 38 from the Independent Water Commission, that "Tariff structures should be changed to incentivise water efficiency. This could involve removing falling block tariffs for non-household consumption.”

The regulator said: “Our current view is falling block tariffs are no longer appropriate given the water scarcity challenges we face. Charging structures with falling marginal costs for higher consumption send the wrong signal about the value of efficient water usage. Although only one company currently has a falling block tariff in place, removing the use of falling block tariff signals the importance of taking actions to address water scarcity.”

It has invited views on whether other discounted charges for large users should continue or not. For 16 of the 17 wholesalers, these discounts currently take the form of a discounted single rate tariff structure, where all volumetric charges for larger users are lower than the equivalent volumetric charges for other business and household customers, while the fixed charges are higher. At the extreme, one company offers a volumetric rate to large users that is 56% lower than the standard rate offered to its household customers. Ofwat noted: "These discounts have been in place for decades, and were introduced based on the principle that larger users do not use the smaller distribution network and are therefore cheaper to serve than household customers or other smaller business customers.”

The consultation noted removing discounts from large users could increase their costs and therefore chill growth, may raise concerns about cost reflectivity, and would affect other user charges under the price control (lowering the amount of revenue to be collected from households). On the flip side, it said continuing with discounts could undermine water efficiency efforts and therefore hinder growth long term.

As a result of this conundrum, the consultation pondered whether discounts for large users might be restructured to keep prices down but provide better price signals for water efficiency. Two options were presented but alternatives also welcomed: 

• Fixed charge discount: All business customers would pay the same volumetric rate as charged to households, regardless of how much water they consumed, but would receive a discount on fixed charges. The discount could be proportionate to the volumes consumed, or could be the same irrespective of volumes consumed. 

• Rising block tariff: Lower unit rates would be applied to lower blocks of consumption. As customers use more water, the volumetric rate rises for each subsequent block. Ofwat said: “We consider that rising block tariffs could provide a strong incentive for large users to reduce their water use. This could be introduced alongside discounts in fixed charges to recognise the differential use in network assets between larger and smaller consumers. However, a rising block tariff structure could be perceived to be penalising the largest users of water, particularly those that have little ability to significantly to reduce their water use.”

Elsewhere, the consultation considered two further elements. First was possible changes to Ofwat's wholesale charging rules under the Water Industry Act 1991 to promote greater water efficiency. It said these did not restrict company choices but are sometimes perceived to do so. It listed the following options, alongside doing nothing:

• Change the weighting given to cost-reflectivity in conjunction with other charging principles.

• Widen the scope for when different charges can apply to different types of customer, by including benefits to society and the environment.

• Introduce a new rule to require companies to set charges that incentivise water efficiency.

• Introduce a new rule to require companies to set charges that incentivise water efficiency but at the same time remove the charging rule that sets out how differential charging is justified on the basis of cost differences of different physical characteristics.

Second, the consultation considered how wholesalers and retailer incentives to support water efficiency could be more aligned. At present, wholesalers have price control drivers but retailers’ revenues are tied to volumes sold. Ofwat offered some examples for consideration – including a Thames Water incentive for business retailers that intervene and enable non-household customers to reduce their demand; and a community sharing mechanism, such as the £30 bill credit for households offered by South West Water in 2022 if customers in Cornwall helped save water and contributed to the partial refilling of the Colliford Reservoir.