A decision by the Competition and Markets Authority (CMA) will force major energy buyers in the water sector to take a more active approach to managing their energy costs.

Energy represents 9% of water company costs and, according to Veolia,  the sector is responsible for 1% of the UK’s carbon dioxide emissions. The companies have tools to manage their energy costs, so they should not automatically be able to collect extra revenue to cover rising prices, the CMA said in its provisional determination on four companies – Northumbrian Water, Yorkshire Water, Bristol Water and Anglian Water – which are all disputing the regulator’s determination of their business plans for the next five years.

The water companies say their plans should be automatically adjusted to allow for changes in energy prices (known as a ‘real price effect’, or RPE, adjustment) although not all companies asked for RPE on water costs. Similar adjustments are considered for cost items such as labour or chemicals.

To qualify for RPE treatment costs had to  track differently from the CPIH inflation index used (which already allows water revenues to rise), be volatile or be largely outside management control, CMA agreed.

The CMA noted arguments that energy prices have often been volatile and have departed significantly from CPIH – and that analysis showed that “historical BEIS forecasts have often failed to estimate energy prices accurately”. But it decided water companies’ energy bills were partly covered by the inflation index and partly under management control.

Ofwat had said in its determination that, among other options, companies could use fixed energy tariffs to minimise their exposure to price fluctuations, or reduce energy costs through increased energy generation, production of biofuels, using energy during off-peak times and improving efficiency. In addition, companies’ work towards targets of net zero carbon emissions could have a substantial impact on energy usage in the sector and therefore mitigate real price effects. The CMA decision – currently provisional and out for consultation – will send the companies back to these options as they will have to manage their energy costs more actively and continue to find new ways of reducing their energy bills.

The four disputing companies argued that energy costs were not fully reflected in the inflation index. Bristol Water said that management had options to protect against short-term fluctuations but not the long-term trend of rising energy prices,while Northumbrian Water said that it had the industry leading approach to demand flexibility, energy production from sludge and procurement of energy, so it had less scope for further improvements.

Read the CMA’s provisional ruling on the water companies’ determination here