Current monopolies on water provision are harming the environment by not encouraging firms to innovate to find new and more sustainable sources, according to an independent review of UK water markets, which also claims that licenses to extract water from unsustainable sources are too easy to obtain.

Professor Martin Cave, who was commissioned by the Department of the Environment Food and Rural affairs (Defra) to undertake the review, said that greater competition should be introduced between water suppliers to business customers as part of a programme designed to enhance service levels and limit the sector's environmental impact.

He also called for a tightening of regulations governing the sourcing of water designed to address potential shortages in areas such as the south east.

"I am concerned that the current abstraction licence and discharge consent regimes fail to reflect the true environmental, economic and social costs of abstraction and discharge," he said, adding that as a result water is being allocated, used and discharged inefficiently - a problem that will only be exacerbated by global warming.

An EU Water Framework Directive was brought into force in the UK in 2003 with the aim of preventing the deterioration of aquatic ecosystems, promoting the sustainable use of water and ensuring progressive reduction of groundwater pollution.

But the report found that many water boards in the UK will not achieve the " good ecological status" standards that the directive requires them to meet by 2015. It claims that a failure to invest in the identification and exploitation of new sources has led to existing sources being over used - as result water tables have fallen and concentrations of pollution have risen.

The report also warns that population growth and industrial expansion will only serve to make the problem worse, and claims that the market should be opened up to competition and regulations tightened as a means of accelerating the exploitation of new water sources.

In addition, the report signalled support for proposals currently being reviewed by industry watchdog Ofwat that would see a water efficiency target imposed on utilities requiring them to reduce demand from the properties they serve by one litre per property per day each year over the period between 2010 and 2015.

Alan Sutherland, chief executive of the Water Industry Commission for Scotland, (WICS) welcomed the report's recommnedations.

"We applaud Cave's findings in favour of the introduction of competition for non-domestic water customers in England and Wales and believe it will encourage much needed innovation and bring wide-ranging environmental and cost-saving benefits," he said.

The report came a day after industry group Water UK published a report yesterday which found that while some companies are embracing techniques for enhancing water efficiency, the industry could do more to tackle wastage.

Hilary Benn, secretary of State for Environment, Food & Rural Affairs said the industry must move to address water shortages and waste as a matter of urgency.

"We have a growing population and more houses to build, and we are living more water-intensive Lifestyles," he said. "All these challenges need to be addressed, and in a sustainable way."

The Water UK report also identified another significant problem - the water industry is responsible some one per cent of carbon emissions and this is expected to double by 2030 because of the rising population and more stringent treatment standards.

Both reports welcome the Carbon Reduction Commitment – an emissions trading scheme effective from 2010 that will require firms that spend more than £500,000 a year on energy to take part – as a good way of incentivising water companies to reduce emissions.

Jacob Tompkins of charity Waterwise said there are a number of measures the water industry can take to cut its carbon footprint, including cleaning pumps' blades, installing technologies for the gasification of sewage sludge and increasing renewable energy use.

He also urged utilities to do more to incentivise customers to reduce their water use. "Some five per cent of UK energy use goes on water use in the home - showers, kettles and baths," he said. "We'd like to see energy companies and water companies given incentives to team up and reduce this huge slice of energy use in people's homes."