Executive Summary

Europe’s water industry is grappling with six major issues in 2006
that present often-conflicting interests and that may need new
and different approaches to running a water business in order to
meet regulatory and stakeholder expectations.

• The Environment: U.K. and European legislation governing
  the quality of drinking water, rivers and bathing waters, and
  effluent discharges is becoming increasingly stringent and is
  the major driver of water industry investment across Europe.
• Resources: Population movements, demographic changes
  and greater use of water-consuming household goods,
  coupled with higher standards of living, mean that water use
  is increasing while water resources, not only in drier southern
  Europe, but in northern Europe and in Britain, are coming
  under increasing pressure. With environmental issues around
  the building of new reservoirs and the over abstraction of
  water from rivers, the water industry has to look to demand
  management, conservation and leakage initiatives.
• Customers: Customer expectations of what they expect
  from their water supplier have risen, particularly where
  privatization and competition have affected and upgraded
  other utility provision such as electricity, gas and telecoms.
• Investment and finance: Increasingly the public sector in
  Europe has been unable to afford to finance a water sector
  facing increased environmental and customer obligations,
  and the private sector has been playing a greater role. Private
  water companies have operated water franchises in France
  for many years, while privatized water companies in England
  have been a success story in terms of the amount of
  investment they have delivered since 1989.
• Asset management: Increased environmental obligations
  and customer expectations have led to an increase in the
  sheer amount of water and wastewater infrastructure in
  Europe – the bathing water, urban wastewater and
  framework directives have necessitated the building of many
  sewage treatment plants across Europe, for example. This,
  and the need to look after clean water mains in order to
  address leakage in times of water scarcity, means that asset
  management, always a mainstay of water industry policy,
  has become even more important.
• Structure: The water industry in Europe has traditionally
  been municipality based, but as new obligations have
  necessitated greater private sector financing, so the industry
  has been forced to look at new ways to organize itself, be
  that through privatization, franchises, public–private
  partnerships, consolidation or outsourcing.

Introduction

The water industry in Europe is a sometimes-contradictory mix of
public sector, municipal control and private sector finance and
investment. The prevailing model is one of municipal control with
increasing private sector franchise operation, a model pioneered
in France but now expanding across the European Union. The
exception is Britain, where regional water authorities based on
river basins were privatized in 1989 and where today private
sector water companies operate.

Whatever the ownership and structural model, a number of
policy and operational issues drive the European water sector.
These are the environmental agenda and resources, especially the
European Water Framework Directive, customer obligations,
investment and finance, asset management, and structure.

The Environmental Agenda

Water has to be taken from the ground or from rivers and after
use be treated and returned to rivers or to the sea. It is therefore
subject to a raft of environmental legislation that exceeds that to
which other utilities such as energy have to submit.

In Europe, a number of European Commission directives provide
legally binding parameters within which water undertakers must
operate. These are primarily the European Drinking Water
Directive, which controls the quality of water from European
customers’ taps; the Urban Waste Water Directive, which
controls the quality of effluent from sewage treatment works;
the Bathing Water Directive, which controls the quality of
effluent discharged at coastal sites; and the Water Framework
Directive, the newest and biggest piece of legislation, which
brings all these under a strategic umbrella.

Member states that fail to meet the standards set down in these
directives can, and are, prosecuted and fined.

The Drinking Water Directive
Environmental legislation next examines the quality of potable
water. The Drinking Water Directive is the strictest legislation in
the world in terms of the parameters it sets out restricting the
number of substances permitted in the water consumed across
Europe. The parameters cover a range of around fifty substances
from lead to potassium, from iodine to chlorine, but also cover
aesthetic issues such as color and odor.

Water companies and authorities can and do devote much of
their investment and technology toward ensuring that their
water treatment works produce drinking water that complies
with the Drinking Water Directive – and are prosecuted if they do
not. This is even though only about 3 percent of the water
treated at treatment works and that issues from customers’ taps
is actually drunk.

Cryptosporidium
One specific challenge the water industry faces on the drinking
water front is the cryptosporidium. This is a parasite originating
from farm animals that leaches into aquifers, that is extremely
difficult to detect and eliminate from water, and that causes
stomach upsets.

Much investment has been made in filtration and monitoring at
water treatment works to deal with this issue.

Diffuse pollution
A wider issue of diffuse pollution of water aquifers from
industrial, urban runoff and agricultural sources is an increasing
challenge for the water industry across Europe.

While it has been possible to control more obvious pollution of
the water environment using the so-called end-of-pipe solution,
diffuse contamination of aquifers and rivers from, for example,
agricultural pesticides, has been less easy to manage.

Diffuse pollution is usually something water companies have no
control over, yet they are obliged to remove its impact from the
water they treat. The Water Framework Directive is partly
designed to embrace this issue and provide a holistic policy for
the whole water environment to ensure that all stakeholders and
participants, from industry to agriculture to recreational water
users to water companies, meet their obligations toward a
cleaner and uncontaminated water environment.

Dirty water
Potable water, whether drunk, used for cleaning or washing
purposes, flushed down toilets, or used by industry or for
agricultural use, then becomes wastewater. It is collected in
drains and sewers and for the most part arrives at wastewater
treatment plants for treatment before it is returned to the water
environment, either to rivers or to the sea.

The Urban Waste Water Directive regulates the quality of water
discharged to rivers or seas near towns and cities. The Bathing
Water Directive specifically regulates the quality of effluent
discharged anywhere near where people might swim or surf in
coastal areas.

Over the last fifteen years, the parameters laid down in these
directives have again driven water industry investment in
treatment and monitoring. Where once untreated sewage might
have been discharged into the sea via short pipe (outfall), for
example, the strictures laid down in these directives have now in
many cases meant that the water industry across Europe has
increasingly had to install primary, secondary and even tertiary
(often ultraviolet) treatment along with long sea outfalls.

The result of this environmental legislation has been an
unprecedented ramping up of investment in wastewater
treatment and a corresponding improvement in the quality of
Europe’s rivers and coastal waters. Much is still to be done in this
area, especially in the newer EU members in central and Eastern
Europe, where a legacy of industrial and agricultural pollution
and a relative lack of wastewater treatment and infrastructure
has still to be addressed in terms of its effect on the
water environment.

The last part of the water cycle is the disposal of sewage sludge.
While treated wastewater effluent can be safely returned to
rivers or to the sea, semisolid sludge, which has to be disposed
of, remains.

If effectively treated, it can be used as fertilizer or can be reduced
to pellet form for landfill. In some instances, it can be incinerated
and in some instances be used for the generation of energy.

Resources

Resources are the first step on the path of water environmental
legislation. Water companies and authorities are limited in terms
of how much water they can abstract from surface water, in
particular before they start to damage the water environment.
European directives prohibit water companies from over
abstraction, which in turn provides an incentive, if one were
needed, to implement demand management in times of water
stress, such as hot summers and peak demand.

Clean water
At the start of the water industry cycle, water has to be taken, or
abstracted, from surface water, rivers and lakes, or groundwater,
underground aquifers. The first issue to address is therefore the
availability and sustainability of water resources.

Here geography and climate are the key issues. In northern
Europe rainfall has always been thought to be relatively plentiful,
while in southern Europe the climate is assumed to be generally
drier. However, the resources issue is not that simple.

There are climatic issues that are not always generally realized.
For instance, London actually has less rainfall than Istanbul.
Northern Europe may be colder than the South, but rainfall is not
that much higher than in many southern European countries –
the pattern is just different. Winter rain in southern Europe is also
more useful than summer rain in the North.

The other major factor dictating the resources issue is where
people live. Major cities, relatively affluent urban areas and
industrial activity put pressure on water resources, whatever the
availability of resources.

The Customer Agenda

Unlike other utilities, water remains a monopoly for all but the
largest industrial customers. Bringing choice and competition, as
has happened with electricity and gas, has not been possible in
water and is unlikely ever to happen.

But this does not mean that customer expectations have not
risen over the past two decades nor that regulatory pressure for
the water industry in Europe to improve the service it provides for
customers has not increased.

The water industry in Europe finds itself increasingly having to
bridge the gap between customer expectation and service
delivery. If environmental legislation means that water quality is
increasingly addressed, there are still issues around enhancing
service at all points of customer contact, including, crucially, the
customers’ bills. The importance of customer confidence is also a
key to the means for growth.

Service in the water industry is typically driven by regulators.
Service has historically been poor, as has been the case in many
monopoly industries with a history of under-investment, but is
improving, especially in countries with a high level of private
sector involvement, such as Britain and France.

Key service areas are better-quality water, better pipes, consistent
pressure, hours of opening for inquiries, responses to letters and
calls, and improvements to sewers and wastewater treatment.

Traditionally, the relationship between the water industry and the
customer has been identified by a “suits us” arrogance,
insensitivity and an asset-focused approach.

Although many water customers care little about their water
suppliers, there are still areas where customers have contact with
their water companies and may have cause for dissatisfaction.
These are outbound mailings, product use, roadwork, meter
reading and other operational contacts. In Britain alone this adds
up to 100 million experiences every day.

But what does a negative or positive customer experience matter
to a monopoly? Increasingly, water companies and authorities
have to answer to a number of challenges. These are regulated
targets; differentiation with comparators, which can influence
the ability to invest; the ability to raise prices; and reputation in
the market, which again can influence the ability to invest or
attract good-quality people.

Challenges affecting customer management
The water industry across Europe faces a number of specific
challenges affecting customer management and billing. That is
notwithstanding the fact that in many places customers are not
yet billed specifically for their water, or when they are, they are
not yet billed on a metered basis for the water they use –
although the tide is moving toward water billing based on usage.

The water industry faces challenges in terms of aging technology,
financial pressure, more demanding customers and
shifting regulation.

Aging technology is exemplified by legacy IT, some of it
becoming increasingly unsupported. There is often poor
functionality, leading to manual processes that are often costly
and inefficient. This leads to inflexibility, with a corresponding
high cost of change, while high maintenance costs develop
associated with costly mainframe technology.

Financial pressures stem from huge levels of capital investment
that are required, often as a result of the parameters laid down
in European directives – these add up to £16.8 billion over the
next five years in the U.K. alone – and the limited amount water
companies and authorities can demand for price increases.

Regulators also rightly demand greater efficiencies from the
water industry. Another financial pressure is customer debt –
water bills are often low on a customer’s list of priorities, and in
most instances, water companies and authorities cannot
disconnect customers who do not pay.

In terms of demanding customers, expectations are being driven
up across Europe by the development of a consumer culture. This
is fueled in markets like Britain where there is competition in
other traditional utility sectors, such as electricity, gas and
telecoms, and where this has driven other utilities to develop
new and better service offerings.

Customers are also getting used to “channel expectations” –
being able to use Internet and self-service payment options,
for example.

Levels and quality of regulation for water vary across Europe,
with Britain, with its early privatization, probably the best
example. Regulators, where they exist, demand cost savings,
making process efficiency key. There is also a focus on relative
performance between different monopoly water businesses and
a move toward more qualitative measures in this respect.

Faced with these challenges, a water utility needs a customer
management and billing approach that contributes to
dramatically reducing the cost to serve, is flexible and able to
adapt to future developments, provides an improved customer
experience, and can be realistically delivered with the least
operational risk.

Across the range of customer service experience, there are plenty
of opportunities to reduce costs and improve customer service.
These are bill consolidation, billing and payments consolidation
of multiple bill platforms, IT infrastructure, credit and collections,
call center operations, meter reading and field force services.

Enhanced water customer service could manifest itself as
increased first-time resolution of questions and complaints,
efficient resolution of these questions and complaints, tailored
billing for industrial and commercial customers, the ability to
study a bill online, and integrated – and accurate – billing.

Investment and Finance

The water industry in much of Europe remains a publicly
financed, municipally administered business. However, the
private sector and private capital are playing an increasing role,
albeit more on the French franchise model than the British fully
privatized model.

Where the water industry is fundamentally in private hands,
whether through full ownership or franchise, it is seen by
investors as a safe sector, with predictable earnings and cash
flow. Water is seen as lower risk than other corporate sectors and
utilities and also lower risk than other regulated businesses,
perhaps with the exception of electricity transmission.

Compared with other sectors, water in Europe is generally cash
flow negative, with ongoing borrowing requirements for the
foreseeable future, and subject to changes in nation state
regulation and environmental standards from European
Commission regulation.

Private sector water businesses therefore have to focus on
delivery, preparation for the next price review and future
borrowing needs. On delivery they have to reach OpEx and
CapEx efficiencies and try to operate as close as they can to the
frontier of regulatory expectation. In readiness for future price
reviews, they must maintain credit quality and improve their
profile in terms of financeability. And they must match future
borrowing needs with access to the financial markets and
credit ratings.

For private sector water businesses in Europe, the challenge is to
ensure adequate financing and incentives for long-term capital
investment. This is not always helped by the regulatory cycle – in
England and Wales there are issues around balancing the fiveyear
investment cycle arising from the five-year price review with
long-term environmental targets.

The England and Wales price review allows for future legislative
changes and gives guidance regarding European environmental
standards. But in other areas the five-year horizon presents
potential conflicts of interest.

Asset Management

Regulated private sector water utilities in Europe are faced with
the challenge of managing and maintaining their capital assets,
water and wastewater treatment works, water mains and
sewers. This is often undertaken with a number of suppliers and
contractors, under pressure to provide services at the lowest
possible cost.

Regulators set tough targets for savings on capex and opex,
along with an imperative to manage assets in a safe, secure and
sustainable way.

Taking the U.K. as an example, legacy asset and work
management systems have often not been designed to meet the
increasingly complex information requirements of today’s water
industry. Leakage has become an increasingly potent issue, with
water companies under pressure to radically remedy their
leakage problems before being allowed to develop
new resources.

Water companies in the U.K. and across the rest of Europe often
find that their asset information is, where it exists, fragmented,
making optimal asset performance difficult.

An additional pressure for water industry asset managers is the
increased attention being paid to streetworks activity. In some
countries, such as Britain, water companies can now incur
penalties if they spend too long on a streetworks job or dig up
the wrong piece of road because of inaccurate information as to
where an asset was.

Structure

Although there have always been some private sector water
companies in Europe, the majority have been state or
municipality operations. That is changing.

England and Wales underwent privatization of its water
authorities in 1989. Few other European countries have chosen
to go down this route, but many have sought to emulate the
French option, where a municipality retains ownership of its
water assets but franchises out the operation and maintenance
of those assets to a private company on a fifteen-to-twenty-year
concession basis.

The number of private sector players in Europe’s water scene is
fairly small. France has Veolia, Suez and Bouygues. Spain’s
biggest water company is Agbar, partly state owned. Britain has
ten water companies, but the biggest, Thames Water, is
currently owned by German energy giant RWE (though soon to
be sold), and while the next biggest, AWG and Severn Trent,
remain independent, others have different ownership – Wessex
Water is owned by Malaysian conglomerate YTL, for example.

The likelihood is that Europe’s water industry, from an
operational viewpoint, will come to be dominated by French (and
perhaps English-based), Spanish and German (Berlinwasser)
players – but operating on a franchise basis rather than outright
ownership. Who buys Thames Water, whether it remains intact
and whatever strategic direction the new owner takes, it will be
a crucial part of the future European water jigsaw.

Conclusion

Europe’s water utilities are among the most efficient in the world
and indeed many, from Thames Water to Veolia to Águas de
Portugal, have exported their operations to North and South
America, Africa and elsewhere. But ever-tightening
environmental standards, rising customer expectations,
regulatory pressure, and the rigors of environmental
contamination and shortages of the natural resource itself mean
that Europe’s water industry will have to find innovative ways of
managing, financing and structuring itself – coupled with
innovative use of IT and technology – to overcome the challenges
of the future.

That means working with the private sector and working in
partnerships with other organizations that can bring specific skills
to bear on areas of water industry operations, such as asset and
workforce management, which present unique challenges, will
be important to meet the expectations of regulators,
shareholders and customers.

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