Competition is needed to "prevent water customers being left behind in a retail revolution", Ofwat said, in response to a November 2015 report by the UK government which asked it to look at the costs and benefits of competition.
A more open water market could bring new offers such as water efficiency services and leak detection, and multi-service bundles where customers could, for example, combine energy and water services, Ofwat said.
Ofwat is cautious in its proposals, saying that "there can be no guarantees of how successful introducing competition to the residential retail water market would be. But the evidence from our assessment suggests that a net positive outcome is more likely than not." However, it believes that are "significant potential benefits worth around £2.9 billion over 30 years".
While competition is unlikely to reduce water bills significantly in the short term, lower bills may become possible as retailers achieve efficiencies and challenge wholesale prices, Ofwat said,
The proposed market would be "competitive, not unregulated", Ofwat said.
"As in the business customer market, requirements will be needed to ensure public health and safety is maintained, and that customer protection is in place to ensure all customers are treated fairly. Appropriate assistance would, in particular, need to be in place for vulnerable customers and those struggling to pay their bills," Ofwat said.
The water market was privatised in 1989 and competition introduced for the non-residential market in 2014.