House of Commons Environment, Food and Rural Affairs Committee Water Pricing
First Report of Session 2003–2004
Report, together with formal minutes, oral and written evidence
Ordered by The House of Commons to be printed 10 December 2003
HC 121 [including HC 1240-i and –ii, Session 2002-03] Published on 18 December 2003 by authority of the House of Commons London: The Stationery Office Limited £17.50
Environment, Food and Rural Affairs Committee
The Environment, Food and Rural Affairs Committee is appointed by the House of Commons to examine the expenditure, administration, and policy of the Department for Environment, Food and Rural Affairs and its associated bodies.
Current membership
Mr Michael Jack (Conservative, Fylde) (Chairman) Ms Candy Atherton (Labour, Falmouth and Camborne) Mr Colin Breed (Liberal Democrat, South East Cornwall) David Burnside (Ulster Unionist, South Antrim) Mr David Curry (Conservative, Skipton and Ripon) Mr David Drew (Labour, Stroud) Patrick Hall (Labour, Bedford) Mr Mark Lazarowicz (Labour/Co-op, Edinburgh North and Leith) Mr David Lepper (Labour, Brighton Pavilion) Mr Austin Mitchell (Labour, Great Grimsby) Diana Organ (Labour, Forest of Dean) Joan Ruddock (Labour, Lewisham Deptford) Mrs Gillian Shephard (Conservative, South West Norfolk) Alan Simpson (Labour, Nottingham South) David Taylor (Labour, North West Leicestershire) Paddy Tipping (Labour, Sherwood) Mr Bill Wiggin (Conservative, Leominster)
Powers
The Committee is one of the departmental select committees, the powers of which are set out in House of Commons Standing Orders, principally in SO No. 152. These are available on the Internet via www.parliament.uk.
Publications
The Reports and evidence of the Committee are published by The Stationery Office by Order of the House. All publications of the Committee (including press notices) are on the Internet at www.parliament.uk/parliamentary_committees/environment__food_and_rural_ affairs.cfm.
A list of Reports of the Committee in the present Parliament is at the back of this Report.
Committee staff
The current staff of the Committee are Gavin Devine (Clerk), Fiona McLean (Second Clerk), Dr Kate Trumper and Jonathan Little (Committee Specialists), Mark Oxborough and Louise Combs (Committee Assistants), Anne Woolhouse (Secretary) and Rebecca Flynn (Intern).
Contacts
All correspondence should be addressed to the Clerk of the Environment, Food and Rural Affairs Committee, House of Commons, 7 Millbank, London SW1P 3JA. The telephone number for general enquiries is 020 7219 3262; the Committee’s e-mail address is: [email protected].
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Summary
Although this Periodic Review of water prices is at an early stage, we are encouraged by signs that it is being conducted in a transparent and mature way.
It seems likely that price limits will be raised in this Review. While it is absolutely imperative that Ofwat should rigorously examine the claims companies make about their costs, we have seen no evidence to make us doubt that it will do so.
There has been considerable debate about the scale and cost of the environmental improvements that the Environment Agency and English Nature have put forward. Water customers must not be expected to pay for every improvement to the aquatic environment, but where water companies are responsible for damage to the environment, they, and their customers, should pay to repair that damage.
The Government must urgently address the issue of how those responsible for diffuse pollution should pay for it. The water companies and Government should do more to manage the demand for water.
We are confident that Ofwat has taken note of concerns about the financial profile of water companies, and will act to address such concerns. It is important that the cost of financing investment is kept as low as possible, but the weighted average cost of capital assumed by the regulator must not be so low that it threatens the credit ratings or even the solvency of water companies.
The difficulties some consumers face in paying their water bills are a matter of great concern to the Committee. Measures to help vulnerable customers do not appear to have been effective. It is not practicable simply to lower bills across the board since to do so would jeopardise the improvements in services and quality that have undoubtedly been made in the recent past and would fail to emphasise that water is a valuable resource.
The Government should review the way poorer households are helped with their water bills and should ensure that the scale of such assistance reflects the current cost of water and sewerage in the areas in which it applies.
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1 Introduction
1. The background to this Report is the 2004 Periodic Review of water companies’ price limits being undertaken by the Office of Water Services (Ofwat). We were prompted to undertake an inquiry by the public comments of water companies and others about the level of investment required of them and the price increases which will be needed to deliver that investment. We are still at an early stage in the Review and Ministers have yet to issue their final guidance on what water and sewerage companies will be required to do between 2005 and 2010, when the price limits determined in this Periodic Review will apply.
2. Our short inquiry was intended to examine the conduct of the Review and some of the reasons for the projected price increases and to look at whether the current approach to price setting is in the customers’ best interests. We received 22 written memoranda and took oral evidence from Water UK on 29 October and from the Environment Agency and Ofwat on 5 November. We are grateful to all those to gave evidence and otherwise assisted our inquiry. In this Report we focus on two price drivers – quality improvements and companies’ ability to raise finance.
2 The price review process
3. In November 2004, the Director General of Water Services, Philip Fletcher, will set price limits for each of the water and sewerage companies in England and Wales for 2005 to 2010. The price limit is the yearly change that companies can make to bills and applies to the average bill charged by each company, so some customers will be subject to smaller or larger changes.
4. Although Ofwat alone determines the price limits, the Government determines policies and legal requirements that will have a bearing on prices. The Secretary of State for Environment, Food and Rural Affairs in England and the Welsh Assembly Government in Wales issue guidance to Ofwat and the companies on the outputs, including the scale and pace of water quality and environmental improvements, that they expect companies to deliver in 2005-10. The Environment Agency, English Nature, the Countryside Council for Wales and the Drinking Water Inspectorate advise Ministers on the choice of outputs to include in their guidance.1
5. There are a number of stages in the price review process.2 Ofwat launched this review on 15 October 2002. Ministers published their initial guidance on 21 January 2003.3 Water and sewerage companies produced draft business plans in August 2003, which set out the price limits they believe are needed in order for them to meet the requirements outlined in the initial guidance.
1 Ev 52, Summary, Ev 53, para 10 and Ev 113, para 6 2 The review process is described in detail in the memoranda supplied by Ofwat, Water UK and the Environment Agency 3 http://www.defra.gov.uk/environment/water/industry/review/jan03.htm
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6. The companies were required to set out three plans. Two were reference plans, which include defined sets of environmental and quality improvements and were based on certain assumptions about costs that were made by Ofwat and the third was the company’s ‘preferred plan’. The first reference plan, Plan A, included what the quality regulators deemed to be ‘essential and clear’ obligations, in other words, statutory requirements that must be met. The second reference plan, Plan B, set out costs for a more extensive environmental and quality programme. The preferred plan ‘allows each company to set down and explain its application for price limits’. Ofwat expected the plans to include ‘all the challenges facing the company in the price limit period 2005-10’.4 It was the publication of these plans that led to concern over the likely scale of price rises and it was at this point in the process that we conducted our inquiry. The remaining stages of the inquiry are outlined below.
Early 2004 Ministers expected to publish principal guidance April 2004 Companies publish final business plans which cost outputs identified in final guidance July 2004 Director General publishes draft price limits September 2004 Ministers issue final guidance November 2004 Director General sets final price limits
7. Ofwat provided us with the table below, which sets out the areas of expenditure in the draft business plans that are driving the proposed changes in the average household water and sewerage bill. Cost savings due to past and future increases in efficiency will not be enough to offset projected increases in the cost of maintaining base services. The proposed improvements to services, which include environmental improvements, and maintaining security of supply to all customers, would result in large price increases.
Table 1 Proposed changes in the average bill due to each area of expenditure.5 Average household bill in 2004-2005 (£) 234 Less (1) past efficiency savings and outperformance (8) (2) scope for reduction through future efficiency improvements (10) Plus (3) maintaining base services 37 of which: (a) changes in revenue 3 (b) changes in operating costs 6 (c) changes in capital maintenance 19 (d) impact of taxation 9 (4) improving services 41 of which: (a) drinking water quality 10 (b) environmental improvements 26 (c) service performance (mostly sewer flooding) 5 (5) maintaining security of supply to all customers 12 Average household bill in 2009-2010 306
8. There are marked differences in the price limits included in different companies’ draft plans and therefore in companies’ projections for household bills. These projected changes are presented in Annexes 1 and 2 to Ofwat’s memorandum.6 United Utilities’ preferred
4 Ev 53, para 3 5 Ev 53, para 11 6 Ev 56-57, Annex 1 and 2
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plan projects the largest increase in household water and sewerage charges for its customers: more than 70% increase by 2010, the end of the price review period. By contrast, Wessex Water’s plan has the smallest increase of all companies at 12%.
9. Three companies Anglian, United Utilities and Northumbrian have sought agreement to increases in bills for 2004-05 under the ‘interim determination’ procedure. If granted this would reduce the increases sought from 2005 onwards.7
Changes in the price review process 10. It is clear that this review has been less subject to the rather secretive ‘horse trading’ that characterised previous reviews. The Environment Agency and Water UK both welcomed the improved transparency of this periodic review.8 Water UK said
now the numbers are in the public domain at the very beginning of the process and that is good. It also means that there is then, quite rightly, a debate as to what it is that the companies are saying is a requirement.9
11. We welcome the introduction of draft business plans produced by the water and sewerage companies themselves and the greater scope for scrutiny and debate that this allows at an early stage in the price review process.
12. Although there may now be more opportunity to challenge the companies’ arguments for higher prices, the National Consumer Council told us that
one of the difficulties with the price setting process is the, largely necessary, complexity of the process, which makes it difficult for those outside the industry to assess the merits of companies’ plans. Regulators, industry and Government should make greater efforts to debate these issues in lay terms.10
13. In this price review, for the first time, the major stakeholders in the process agreed to commission joint customer research.11 The research was conducted by MORI on behalf of Defra, the Welsh Assembly Government, Ofwat, Water Voice, Water UK, the Environment Agency, the Drinking Water Inspectorate, English Nature and Wildlife and Countryside Link and was published November 2002. We understand that further customer research will be published in December 2003. We welcome the introduction of joint customer research, as it has limited the degree to which stakeholders have made competing and conflicting claims about what customers really want.
14. As the industry and regulators gain experience, the price review process is improving and the debate surrounding prices has become better informed. Nevertheless, Water UK said the Periodic Review process
7 Ev 53, para 4 8 Ev 36, para 24, Q 12 9 Q 12 10 Ev 75, para 12 11 http://www.defra.gov.uk/environment/water/industry/research/index.htm
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does not provide an effective mechanism for dealing with issues that are either long- term or require co-ordination with other agencies. There is a risk that it could degenerate into a system where prices have to be reset frequently.12
15. As we highlighted in a previous report, there is also some concern that the Periodic Review timetable does not match the timetable for implementation of the Water Framework Directive.13 The same is true of the Environment Agency’s review of permits that affect Natura 2000 sites14. There is therefore a risk that companies will be faced with expenses that the price review did not take into account. We recommend that Government, Ofwat, the regulators, water companies and consumers examine together ways of taking into account long-term issues for the water industry.
3 Companies’ ability to raise finance
16. Water companies have two principal sources of finance: debt and equity. Companies with stable and sizeable cash flows such as utilities can sustain higher levels of debt finance, which is cheaper than raising money through equity. Regulators of utilities have often therefore sought to encourage a higher debt/equity ratio by only allowing companies to make returns which would allow them to meet a lower weighted average cost of capital. There is, though, a limit to the extent to which companies can simply continue to increase their borrowing. Too much debt may threaten to overwhelm even the most robust cash flows, leading lenders to question a company’s ability to meet its obligations. The lenders’ response might be to lower the credit rating of the company, meaning that its cost of borrowing will go up.
17. In short, regulators must strike a balance between driving companies towards debt finance to ensure that they do not overpay for their funding, and going too far, to the extent that the company’s credit rating or even its solvency is threatened. Ofwat described two strands in its approach to the financing of water companies. One is to ensure that if a company is efficiently managed and financed it earns a return equal to the cost of capital. The second is to determine if its revenues, profits and cash flows allow it to raise finance on reasonable terms.15 Dr Dieter Helm, of New College, Oxford, has told us that in the last review the cost of capital was set too low. He argues that
the growth of debt finance and gearing has had radical consequences. Bank finance brings different incentives, constraints and managerial focus. Banks are concerned with two things: getting their money back and getting the interest paid. They do not have an interest in capital gains, and have limited ability to absorb shocks. The
12 Ev 5, para 41 13 Environment, Food and Rural Affairs Committee, Fourth Report Session 2002-03, The Water Framework Directive, HC 130-I 14 Natura 2000 sites are sites that are protected under the Habitats or Birds Directives. See Ev 93, para 5 15 Ev 55, para 30
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companies with higher gearing will tend to be more short-term in focus and less inclined to invest at the margin.16
18. The companies pointed out the risks of too high gearing. United Utilities said that it normally looked to borrow funds over 20 years: if it borrowed £1 billion then a change of one ‘notch’ in its credit rating would mean additional interest costs of £50 million.17 It described the need for a balance between equity and debt funding, and argued that the cost saving that had been achieved through greater use of the debt market and more internal efficiency “has really gone as far as it can go”.18
19. Ofwat itself acknowledges the points made by the companies. It told us that “for some companies a significant element of the price increase sought in 2005-06 is required in order to achieve what, in their view, is an acceptable financial profile”.19 Mr Fletcher told us that the
decision by Ofwat to cut prices by 12 per cent in real terms in 1999 … led to a rate of return across the industry of under 6 per cent, which is not generally regarded as a hugely generous return for private capital bearing in mind the risk it must carry … we must ensure we set the cost of capital at a point where an efficient company can expect to beat it.20
20. We note concerns about the way in which the regulator’s past assumptions about the cost of capital has forced water companies to take on higher levels of debt. We are confident that Ofwat itself has taken note of concerns about the financial profile of water companies, and will act to address such concerns. It is obviously important that the cost of financing investment is kept as low as possible, but the weighted average cost of capital assumed by the regulator must not be so low that it threatens the credit ratings or even the solvency of water companies. There is a place for equity funding, and the price limits set must reflect this.
4 Environmental improvements
21. The Environment Agency, English Nature and the Countryside Council for Wales have set out a programme of environmental improvements that will require more than 5000 ‘actions’ at about 4000 sites. Examples of such ‘actions’ include alterations to the amount of water abstracted from a water body in order to protect an important wetland, more stringent treatment of waste water to meet the terms of the Urban Waste Water Treatment Directive and schemes to enable companies to identify and prevent illegal discharges of dangerous substances to their sewerage networks.21 The Environment Agency says all
16 Ev 83, paras.5 and 6 17 Q15 18 Q15 19 Ev 55, para.30 20 Q171 21 Environmental Priorities for the Water Industry, Environment Agency, November 2003
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actions have been assessed to confirm that they are necessary and to help seek the most cost-effective option for companies to cost. It says the benefits of this programme are equivalent to a monetary benefit in the range from £5 to £8 billion.22 The final version of this advice was given to Ministers in November 2003.
22. The extent of the environment programme has been the subject of much debate. The Environment Agency told us that it was satisfied that the requirements it would like to see placed on water companies represented good value for money and would benefit customers.23 English Nature said that schemes in the programme were essential for the protection of statutory nature conservation sites,24 and the Wildlife Trusts told us that
the recent history of investment in protecting and improving the water environment has been good for wildlife, the economy and society as well as representing good value for customers and that they would like to this level of investment continue.25
23. However, Wessex Water told us that it was not yet convinced that all the obligations could be justified on cost benefit grounds and that some could be deferred until after 2010.26 Water Voice told us that it supported further environmental improvements that give value for money, but in view of what has been achieved already, it questioned whether the continuation of the present rate of expenditure was justifiable.27 Dr Noel Olsen said
while no doubt desirable in absolute terms, some of the wish list from the water quality regulators (Environment Agency, Drinking Water Inspectorate and English Nature) will, in my view, add an unjustifiable cost burden to vulnerable people and thereby create public health problems not alleviate them and expressed concern that the cost of removing nitrates would fall on water customers and not on agriculture. 28
24. The Environment Agency said that it only included environmental programmes “where the primary cause [of the problem] is coming from the water companies”.29 It said that other drivers, such as measures under a reformed Common Agricultural Policy, were necessary to reduce water pollution from other sources. A major source of water pollution that does not derive from water company activities is diffuse pollution, i.e. pollution that derives from the way land is used, for example nitrates and phosphates from fertiliser applied to agricultural land may pollute nearby water courses.30
22 Ev 36, para 16 23 Qq 87 and 89 24 Ev 91, summary 25 Ev 90, para 14 26 Ev 11, para A.7 27 Ev 65 para 14 28 Ev 104 29 Q 147 30 Qq 124,147
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25. Defra agreed that there was a need to identify the combination of action required by farmers and by water companies in order to tackle nutrient pollution of water bodies. The Department is in the process of reviewing the way in which diffuse pollution from agriculture is addressed
to identify the most cost-effective approaches to securing the reductions in diffuse pollution that will be needed, alongside action by water companies and others, to achieve compliance with the Water Framework Directive.31
26. We encourage Defra to come to an early conclusion about the best ways of reducing diffuse pollution to water bodies and how the costs of doing so will be met.
27. In its advice to Ministers, the Environment Agency contends that a number of companies have over-stated the costs of some environmental schemes, by, for example, costing full improvement schemes for sites where an investigation only is required or using unit costs that are significantly above industry standards.32 Ofwat should pay particular attention to the methods and assumptions that companies have used when calculating the costs of environmental and other improvements to ensure that only fair and reasonable charges are included.
28. The Environment Agency told us that more than two-thirds of the schemes that it had proposed stemmed directly from statutory requirements of European Directives and others stemmed from national targets set by Government, but a certain amount of flexibility remained in the choice of schemes.33
29. The environmental improvement programmes carried out by water companies have achieved a great deal since privatisation. A further large improvement programme is proposed for the period to which this price review applies – 2005 to 2010. Looking further ahead still, the Water Framework Directive will affect many activities in the aquatic environment.34 While this may ease the burden on water companies in some respects, in that it is hoped that the Directive will tackle diffuse forms of pollution, it is certain that companies will have to undertake some new projects in order to comply with the Directive. All of these programmes will tend to increase the price of water and sewerage services in the short-to-medium-term at least.
30. Whatever the final Ministerial guidance it seems clear that the price of water and sewerage services will rise and that those rises are not solely attributable to environmental improvements. If the Environment Agency and the other quality regulators have been responsible in setting out their programme, it should not be regarded as an optional extra. The National Consumer Council told us that
too often the need to invest in the water environment and developing sustainable water resources is portrayed as conflicting with the consumer interest in low water prices. It is, however, in the interest of current and future generations of consumers
31 Ev 115, para 30 32 Ev 119, para 11 33 Q 85 34 Environment, Food and Rural Affairs Committee, Fourth Report Session 2002-03, The Water Framework Directive, HC 130-I
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that water resources are developed and managed so as to be as sustainable as possible.35
31. We agree that sustainable management of water resources is in the interests of water consumers and we endorse the application of the ‘polluter pays’ principle in the provision of water and sewerage services: to the extent that water and sewerage companies cause environmental problems they – and by extension their customers – should pay for the solutions to those problems.
32. We add two caveats to this conclusion. First, where a particular problem has several causes and action by the water company alone would not be enough to significantly improve the situation, there is a case for delaying the requirement on the water company to act until the other causes are also addressed. Second, while the requirements for environmental improvements are likely to keep increasing, customers’ willingness and ability to pay ever larger bills are not. Ofwat, the water companies, the regulators and Government must begin to seek other ways of addressing some environmental problems.
5 Affordability
33. The question of how great an increase in their water and sewerage bills customers are willing to pay and can afford is a crucial one. Water Voice said “customers’ willingness to pay more for water and sewerage services should not be assumed” and that “there is high satisfaction with both drinking water quality and sewerage services and general satisfaction with the water environment”.36
34. There is a growing debt problem for water consumers. The Public Utilities Access Forum told us that between two and four million householders in England and Wales cannot afford their water charges.37 Dr Noel Olsen told us that for many people in Devon and Cornwall water and sewerage charges “have reached a point where their affordability has become a threat to public health” and that “a poor diet and social isolation are inevitable if debt is to be avoided and an excessive charge absorbed out of a standard pension income”38 There is a need for much more investigation of the level and implications of poverty exacerbated by water charges.
35. Growing consumer debt is also a problem for companies. Ofwat says
the levels of outstanding bill payments, the amount of revenue written off, the numbers of customers in debt and expenditure on debt collection by the water industry have continued to rise since 1998-99. The total household revenue
35 Ev 75, para 6 36 Ev 67, para 31 37 Ev 77, para 1 38 Ev 104
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outstanding for up to 48 months for 2002-03 stood at £781 million, an increase of £115 million (17%) since 1998-99.39
Current measures to address water poverty 36. At present, people facing difficulties paying their water bill are helped through the benefits and tax credits system, via the Vulnerable Groups Regulations and by charities. However, none of the measures intended to address water poverty has been very effective and none addresses the large regional differences in water charges.40
37. The National Consumer Council (NCC) believes that the tax credit and benefit system fails to address water affordability because the “notional element of income support intended to cover water bills has not kept pace with actual water bills … [and] the size of water bills varies hugely … yet the amount of means-tested benefit does not”.41
38. The Water Industry (Charges) Vulnerable Groups Regulations, which came into force on 1 April 2000, allow for assistance, in the form of a capped bill, to certain low-income households with water meters who need to use a lot of water for essential household purposes. To qualify, a household must be in receipt of an income-related benefit, and contain either a large family, or a person who has special water needs because of a medical condition. The current definition of a large family is three or more children under the age of 16 years, while a medical condition is defined in the regulations. The regulations only apply to companies in England.
39. The NCC criticises the Vulnerable Groups regulations for being narrowly drawn and told us “the scheme has been a failure with only a 1.4 percent take up among eligible customers in 2001/2”. The NCC alleges that the scheme costs more to administer than is paid out to customers.42
40. Defra has accepted that there may be some room to extend the scheme and issued a consultation document containing proposals for amending the regulations in February 2003.43 Defra published a summary of responses to the consultation in August 2003 and said that in would respond to the consultation in ‘due course’.44
What should be done? 41. Fixing bills at the level that the poorest in society can afford to pay would jeopardise the improvements in services and quality that have undoubtedly been made and would fail to emphasise that water is a valuable resource. But the difficulties some consumers face in paying their water bills are a matter of great concern to the Committee. Measures to help vulnerable customers do not appear to have been effective.
39 Ofwat Press Notice 34/03 of 18 September 2003 Paying for water research: Insights into how customers juggle water and sewerage bills in household budget. 40 Ev 78, para 13 41 Ev 76, para 17 42 Ev 76, para 16 43 A Consultation paper: reductions for vulnerable groups, Defra, February 2003 44 http://www.defra.gov.uk/corporate/consult/vulnerable/responses.htm.
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42. People suffering from serious difficulty in paying their bills should be helped through the benefits and tax credits system. The Government should review the way in which poorer households are helped with their water and sewerage charges. It should ensure that mechanisms to help people pay their water bills take account of the regional variation in those bills.
43. The Government should also issue its response to the Vulnerable Groups Consultation as soon as is practicable. It should advise the Committee of its response to the National Consumer Council’s charge that the scheme reached only 1.4% of eligible consumers and cost more to administer than was paid out. If the charge is correct, the Government should inform the Committee how the proposed amendments to the Regulations will resolve the problem and by what date we can expect a more effective scheme to be in place.
44. We encourage the Government and water companies further to examine ways of managing and reducing the usage of water and the leakage of water from the system
Conclusions and recommendations
1. We welcome the introduction of draft business plans produced by the water and sewerage companies themselves and the greater scope for scrutiny and debate that this allows at an early stage in the price review process. (Paragraph 11)
2. We welcome the introduction of joint customer research, as it has limited the degree to which stakeholders have made competing and conflicting claims about what customers really want. (Paragraph 13)
3. We recommend that Government, Ofwat, the regulators, water companies and consumers examine together ways of taking into account long-term issues for the water industry. (Paragraph 15)
4. We are confident that Ofwat itself has taken note of concerns about the financial profile of water companies, and will act to address such concerns. It is obviously important that the cost of financing investment is kept as low as possible, but the weighted average cost of capital assumed by the regulator must not be so low that it threatens the credit ratings or even the solvency of water companies. There is a place for equity funding, and the price limits set must reflect this. (Paragraph 20)
5. We encourage Defra to come to an early conclusion about the best ways of reducing diffuse pollution to water bodies and how the costs of doing so will be met. (Paragraph 26)
6. Ofwat should pay particular attention to the methods and assumptions that companies have used when calculating the costs of environmental and other
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improvements to ensure that only fair and reasonable charges are included. (Paragraph 27)
7. We agree that sustainable management of water resources is in the interests of water consumers and we endorse the application of the ‘polluter pays’ principle in the provision of water and sewerage services: to the extent that water and sewerage companies cause environmental problems they – and by extension their customers –should pay for the solutions to those problems. (Paragraph 31)
8. We add two caveats to this conclusion. First, where a particular problem has several causes and action by the water company alone would not be enough to significantly improve the situation, there is a case for delaying the requirement on the water company to act until the other causes are also addressed. Second, while the requirements for environmental improvements are likely to keep increasing, customers’ willingness and ability to pay ever larger bills are not. Ofwat, the water companies, the regulators and Government must begin to seek other ways of addressing some environmental problems. (Paragraph 32)
9. Fixing bills at the level that the poorest in society can afford to pay would jeopardise the improvements in services and quality that have undoubtedly been made and would fail to emphasise that water is a valuable resource. But the difficulties some consumers face in paying their water bills are a matter of great concern to the Committee. Measures to help vulnerable customers do not appear to have been effective. (Paragraph 41)
10. People suffering from serious difficulty in paying their bills should be helped through the benefits and tax credits system. The Government should review the way in which poorer households are helped with their water and sewerage charges. It should ensure that mechanisms to help people pay their water bills take account of the regional variation in those bills. (Paragraph 42)
11. The Government should also issue its response to the Vulnerable Groups Consultation as soon as is practicable. It should advise the Committee of its response to the National Consumer Council’s charge that the scheme reached only 1.4% of eligible consumers and cost more to administer than was paid out. If the charge is correct, the Government should inform the Committee how the proposed amendments to the Regulations will resolve the problem and by what date we can expect a more effective scheme to be in place. (Paragraph 43)
12. We encourage the Government and water companies further to examine ways of managing and reducing the usage of water and the leakage of water from the system. (Paragraph 44)
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Formal minutes
Wednesday 10 December 2003
Members present:
Mr Michael Jack in the Chair
Ms Candy Atherton Mr Austin Mitchell Mr Colin Breed Joan Ruddock Mr David Drew Alan Simpson Mr David Lepper Paddy Tipping
The Committee deliberated.
Draft Report [Water Pricing], proposed by the Chairman, brought up and read.
Ordered, That the draft Report be read a second time, paragraph by paragraph.
Paragraphs 1 to 44 read and agreed to.
Summary read and agreed to.
Resolved, That the Report be the First Report of the Committee to the House.
Ordered, That the Chairman do make the Report to the House.
Ordered, That the provisions of Standing Order No.134 (Select committees (reports)) be applied to the Report.
Several papers were ordered to be appended to the Minutes of Evidence.
Ordered, That the Appendices to the Minutes of Evidence taken before the Committee be reported to the House.–(The Chairman).
The Committee further deliberated.
[Adjourned till this day at twenty-five minutes past Four o’clock.
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Witnesses
Wednesday 29 October 2003 Page
Pamela Taylor, Water UK, John Roberts, United Utilities Water PLC, and Colin Skellett, Wessex Water Services Ltd Ev 16
Wednesday 5 November 2003
Baroness Young of Old Scone, and Andrew Skinner, Environment Agency Ev 41
Philip Fletcher, Bill Emery and Fiona Pethick, Ofwat Ev 58
List of written evidence
Water UK Ev 1,30 United Utilities Water PLC Ev 6 Wessex Water Services Limited Ev 11 Environment Agency Ev 34,118 Ofwat Ev 52 WaterVoice Ev 64 UNISON Ev 68 Royal Society for the Protection of Birds Ev 70 Roy Roberts Ev 73 National Consumer Council Ev 74 Public Utilities Access Forum Ev 76 Sean Creighton Ev 79 Dr Dieter Helm, University of Oxford Ev 82 Dr Neil Summerton CB Ev 84 The Wildlife Trusts Ev 88 Thames Water Utilities Ltd Ev 90 English Nature Ev 91 Northumbrian Water Limited Ev 96 Anglian Water Services Ltd Ev 99 Dr Noel DL Olsen Ev 103 Drinking Water Inspectorate Ev 105 Department for Environment, Food and Rural Affairs Ev 113
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Reports from the Committee since 2001
Session 2002–03 Eighteenth Report Conduct of the GM Public Debate HC 1220
Seventeenth Report Biofuels HC 929-I
Sixteenth Report Vets and Veterinary Services HC 703
Fifteenth Report New Covent Garden Market: a follow-up (Reply, HC 123) HC 901
Fourteenth Report Gangmasters (Reply, HC 122) HC 691
Thirteenth Report Poultry Farming in the United Kingdom (Reply, HC 1219) HC 779-I
Twelfth Report The Departmental Annual Report 2003 (Reply, HC 1175) HC 832
Eleventh Report Rural Broadband (Reply, HC 1174) HC 587
Tenth Report Horticulture Research International (Reply, HC 1086) HC 873
Ninth Report The Delivery of Education in Rural Areas (Reply, HC 1085) HC 467
Eighth Report The Future of Waste Management (Reply, HC 1084) HC 385
Seventh Report Badgers and Bovine TB (Reply, HC 831) HC 432
Sixth Report Rural Payments Agency (Reply, HC 830) HC 382
Fifth Report The Countryside and Rights of Way Act 2000 (Reply, HC 748) HC 394
Fourth Report Water Framework Directive (Reply, HC 749) HC 130
Third Report The Mid-term Review of the Common Agricultural Policy (Reply, HC 615) 151
Second Report Annual Report of the Committee 2002 HC 269
First Report Reform of the Common Fisheries Policy (Reply, HC 478) HC 110
Session 2001–02
Tenth Report The Role of Defra (Reply, HC 340, Session 2002-03) HC 991
Ninth Report The Future of UK Agriculture in a Changing World HC 550 (Reply, HC 384, Session 2002-03)
Eighth Report Hazardous Waste (Reply, HC 1225) HC 919
Seventh Report Illegal Meat Imports (Reply, HC 1224) HC 968
Sixth Report Departmental Annual Report 2002 (Reply, HC 1223) HC 969
Fifth Report Genetically Modified Organisms (Reply, HC 1222) HC 767
Fourth Report Disposal of Refrigerators (Reply, HC 1226) HC 673
Third Report Radioactive Waste: The Government’s Consultation Process HC 407 (Reply, HC 1221)
Second Report The Countryside Agency (Reply, HC 829) HC 386
First Report The Impact of Food and Mouth Disease (Reply, HC 856) HC 323
909259PAG1 Page Type [SO] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 1 Oral evidence
Taken before the Environment, Food and Rural Affairs Committee
on Wednesday 29 October 2003
Members present:
Mr David Curry, in the Chair
Ms Candy Atherton Diana Organ Mr Colin Breed Joan Ruddock Mr Michael Jack Alan Simpson Mr David Lepper Paddy Tipping Mr Austin Mitchell
Memorandum submitted by Water UK Water UK is the representative body of the UK statutory water and wastewater operators. The main objective of the water industry for the period 2005–10 is to secure the successes it has achieved on behalf of customers and the environment in the past decade. To do this it looks very likely from the draft business plans prepared by companies that the price customers pay for water and sewerage services will increase during the period 2005–10, on average by 30%. There are a number of drivers behind this likely price increase. Companies must carry out further environmental and quality improvements in order to comply with new European standards to a timetable agreed by Government. More money needs to be spent on asset maintenance. Many of our assets are over 150 years old and we need to ensure that the high level of service that customers rightly expect from the industry is not compromised. More money needs to be spent on expanding our networks to cope with population shifts and changing patterns of demand. Water UK’s submission describes the draft business plan process, the importance of customer consultation, the main price drivers and the benefits that will be seen by customers and the environment. The submission also looks at the problems with the current process which we believe is not the best approach for dealing with longer-term issues that require co-ordination with other Government departments and sectors to deliver sustainable solutions.
Evidence
Introduction 1. On 15 August 2003 water companies in England and Wales submitted draft business plans for the 2005–10 periodic review to Ofwat. This is the first critical step in Ofwat’s periodic review process leading to price limits for 2005–10, due to be announced in November 2004. The industry wishes to secure the successes it has achieved on behalf of customers and the environment in the past decade. This paper describes: — The draft business plan process. — Customer consultation for the review. — Investment requirements for 2005–10. — The need for proper asset maintenance. — What companies are saying about prices. — The key factors driving prices up. — Benefits for customers and the environment. — Unresolved issues which will aVect prices. — The weaknesses of the current process.
Draft Business Plan Process 2. The draft business plans give a broad picture to help government and the regulators to examine options for future investment, future operating costs and the level of customer bills. The plans reflect the government’s requirements for the industry set out in the initial Ministerial guidance issued in January 2003 for environmental and water quality improvement and guidance on social issues and in government’s priorities for the industry set out in “Directing the Flow” in November 2002. 9092591002 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Ev 2 Environment, Food and Rural Affairs Committee: Evidence
3. The 2004 review process is diVerent from previous reviews. In the past Ofwat has led the process, setting out costed options for Ministers in the form of an open letter. Other stakeholders have then joined the debate, before Ministers responded with detailed guidance. This time the companies and their customers have a more prominent role. Companies prepared three “draft business plans” to Ofwat, summaries of which were published by companies and put on the Ofwat website in early September. 4. The plans are draft and not final but considerable work has gone into developing them. They are the basis for further discussion and debate with stakeholders, both at national and local level. The companies, regulators and government are jointly researching the views of customers about the draft plans and customers’ priorities for action. The findings will influence government’s judgement about the environmental and drinking water quality standards the country needs. 5. Each company has produced plans based on diVerent assumptions about how much should be invested during 2005 to 2010. Scenarios A and B were set by Ofwat, in consultation with the EA and DWI. The third scenario is the company preferred plan. 6. The draft plans will help government and the regulators to examine a range of options for future investment, future operating costs and the level of customer bills. Decisions about environmental and quality requirements to be incorporated in price limits set for 2005–10 will have to be taken early in 2004, and will be issued as Ministerial guidance. Companies will send final business plans to Ofwat in April 2004. 7. All the plans were prepared within a framework specified by Ofwat designed to: — ensure that companies carry our their statutory responsibilities; and — enable companies to finance their activities. The diVerences between the plans come from the diVerent assumptions Ofwat and the other regulators have required companies to make, partly on the basis of government guidance. 8. In initial guidance issued in January 2003, Defra distinguished between three types of environmental cost driver: — Essential and clear—statutory requirements that are clearly defined and where the timing of delivery is also clear. — Essential when clarified—an expected obligation, but where timing and definition is not yet established. — Choices to be made—drivers where the government has not yet taken a policy decision. 9. Two of the plans (A and B) are based on assumptions set mostly by Ofwat. These assumptions relate primarily to the size of the environmental and quality programme. Assumptions have also been set for eYciency targets and allowed returns on investment; these are standard assumptions to ensure comparability and are the subject of discussion at the industry level. 10. Plan A assumes continuing service to customers and a mostly essential and clear quality package. 11. Plan B also assumes continuing service, but the quality package is more comprehensive. It contains most of the cost drivers in the three categories set out by Defra in January 2003, although some potentially costly items are excluded, such as the possibility of prosecution by the EU for non-compliance with discharge standards at coastal sites. 12. “Company preferred” scenarios set out the company’s view of what is realistic for 2005–10, what the quality programme should be, what needs to be achieved for customers; what is required to finance its activities; and what is feasible in terms of eYciency improvements.
Customer Consultation
13. Joint customer research (sponsored by the industry, regulators, government and key NGOs) has been a feature of the periodic review process for the first time. It has been undertaken in two stages. In 2002 customers were asked about their general attitudes to aspects of water and wastewater services. The survey established at a high level some general indicators of customers’ willingness to pay for a range of diVerent impacts including security of supply, water quality improvements, and environmental enhancement. 14. During September 2003 a second survey was carried out, based on the draft business plans. The findings will be published in December 2003 and will influence the government’s judgement about the environmental and drinking water quality standards the country needs. Some companies are carrying out more detailed company specific market research. WaterVoice, the EA and companies are also holding public meetings to discuss the draft business scenarios and priorities with customers and other stakeholders. These processes will influence the preparation of final business plans. 9092591002 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 3
What are the Plans Saying about Investment? 15. In the period 1990–2005, since privatisation, investment by the water companies has been in total about £50 billion. This has gone into programmes to improve or maintain drinking water quality, the water environment and customer service. 16. This level of spending is at a rate of just over £3 billion per annum (£3.45 billion in 2002–03)—a high level for an industry with turnover of about £6.5 billion. This reflects the capital-intensive nature of the water industry, with assets valued at just over £200 billion in current values. 17. All the scenarios show capital investment growing because: — Government has to meet higher environmental standards or risk prosecution under EU law. — Companies have to step up the pace at which they renew old water mains and sewers, or risk supply problems, rising leakage and damage to the environment. — Companies must respond to changes in the level of demand resulting from shifts in population and economic activity. 18. From the last price review in 1999, planned investment for the five years from 2000–05 is around £17 billion at 2002–03 prices. The estimated figure for 2005–10 in the Company Preferred Plans is around £20 billion, an increase of about 20%. Actual company values vary from a fall of 15% to an increase of 70%. 19. The components of this estimate show other significant changes from the current (2000–05) plan: — Capital maintenance expenditure at just over £7 billion would increase by over 20% to over £9 billion. The proposed increases vary company by company from 1% up to 50%. — Investment in meeting higher quality obligations would continue at current levels of about £7 billion in total. However company specific investment proposals vary from minus 50% to plus 50% for the water and sewerage companies. — Growth in assets to take account of higher demand—including population shifts and service improvements—would increase by over 80%, from about £2.5 billion to over £4.5 billion, that is from a much lower base than investment in capital maintenance or higher quality standards. Again there is a significant variation between company plans from minus 50% up to plus 200%. 20. So whilst there are themes here there is no one national position. There are clear diVerences between the companies’ plans and this is to be expected. The companies themselves are diVerent; they operate in diVerent parts of the country, with diVerent regional priorities. For example, in the north-west, improving the quality of the water environment will be an investment driver whilst in the south-east, improving availability of water resources whilst minimising impact of abstraction will be key, particularly to the small water only companies. And importantly the companies’ customers will have diVerent priorities that are reflected in the company plans. 21. Plan A would invest £19.5 billion, an increase across England and Wales of about 15%. 22. Plan B would invest £26.4 billion an increase across England and Wales of about 55%.
Government Requirements and Ageing Assets 23. It used to be assumed that, after the early years of high investment following full privatisation in 1990, expenditure growth would slow down, bringing a lower impact on customers’ bills. But with the government required to implement a growing number of major directives aiming at higher quality, and the realisation that after being squeezed in the last periodic review, spending on replacing essential and ageing assets cannot be delayed for ever; the price reductions of 2000 are beginning to look like a temporary blip. 24. In London, for example one third of the water mains and sewerage networks are more than 150 years old. It is a similar story for other large, older cities. If companies spend less than 1% of the total value of their assets on capital maintenance then the average life of an asset would by inference be over 100 years. During the current five year period spending has been at around 3–4%, £1.8 billion per year, with assets worth £200 billion. 25. During the current review period the industry has agreed with Ofwat and the other regulators a new forward-looking approach to capital maintenance, known as the “common framework”. This has shown a need for a marked increase in spend if performance is not to drop oV dramatically.
What the Plans say about Prices 26. To fund this investment, bills would need to rise in the period 2005 to 2010. 27. Ofwat Director General, Philip Fletcher, has said that the outcome of the price review should be bills that are as high as they have to be (to enable eYcient companies to finance their functions) and yet no more than they have to be (to protect customers of monopoly businesses). 9092591002 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Ev 4 Environment, Food and Rural Affairs Committee: Evidence
28. In April 2000, as a result of the 1999 water price review, customer bills were reduced on average by about £30. The increases in bills implied by the draft plans, relative to 1999 bills, are therefore smaller than the increases relative to current bills. The average annual increase is about £5 per year and the range from lowest to highest is £0 to £15 per year. 29. Ofwat figures drawn from Company Preferred Plans suggest that by 2010 the current average water and sewerage bill across England and Wales would be around £306, an increase of around £15 each year or £72 on the £234 average bill expected in 2004. The range of average annual increases varies from £6 to £35 though companies diVer in the profile of their increases over the five years—ie some scenarios show higher increases in the first year than in later years. 30. Plan A would give an average bill of about £305 in 2010, an increase of £70 on the 2004 average. 31. Plan B would give an average bill of about £330 in 2010, an increase of £95 on the 2004 average. 32. Most, but not all, companies would expect bills to rise by a larger amount in Year 1 (2005–06) than in succeeding years. 33. So the average cost today for a family for a 24-hour 365 days a year high quality water and sewerage service works out at about 65p per day. In 2000 the average cost was 73p. Based on these plans that would change to about 88p per day in the year 2010.
What is Driving these Price Increases? 34. The most important factors are: — Securing existing levels of service, especially by higher investment in the renewal or repair of ageing assets. — Protecting security of supply in the face of changing economic, demographic and climatic circumstances. — Declining scope for eYciency improvements as noted by Ofwat—“many of the easier gains have been made already following privatisation in 1989”. — Continuing high investment to secure the quality of drinking water and protect the environment. — Need to secure extra finance from investors. In their preferred plans some companies have used Ofwat’s reference assumptions—eg for cost of capital. Others have used assumptions based on their view of company needs. — The level of water company gearing has increased from zero at privatisation to an industry average of 59%, thus increasing the interest cost for the increased debt and reducing the scope for further borrowing to fund the capital programme without price increases to customers. — Need to fulfil existing commitments for which funding has not been available. — Increasing levels of bad debt by customers and the cost of pension provisions for employees. — Declining business customer revenue and inappropriate assumptions on meter switching at the last periodic review. — Other significant cost changes—eg in taxation, which alone could lead to an impact on average bills of around £10, energy costs, traYc management charges, increasing the costs of infrastructure maintenance and renewal and repair programmes. These costs are outside the control of the industry.
Benefits for Customers and the Environment 35. The benefits for customers will be: — Continued reliability of existing services, and compliance with quality and customer service standards. — Improved security of supply in the event of prolonged dry weather conditions, and scope for new development. — Improved characteristics of drinking water aVecting taste, smell and appearance. — Improved quality of drinking water by reducing lead “pick-up” from customers’ pipes and meeting tighter standards for lead. — Improvements to sewers reducing the risk of sewer flooding. — Better odour control at sewage treatment works. 36. The benefits to the environment will be: — Sustainable approaches to the use of water resources that protect the environment. — In many river catchments wildlife habitats will be protected or enhanced by new treatment standards at sewage treatment works. — Improved river quality by reducing the frequency of operation of certain intermittent discharges. 9092591002 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 5
Unresolved Issues
37. In practice many other potentially costly issues will be unresolved by the end of 2004, not least requirements under the Water Framework Directive. The Water Framework Directive formalises river basin management and catchment protection practices. Work to implement the directive will have to start in 2009–10 to achieve good ecological status of water bodies by 2015. The definitions of good ecological status, water bodies etc have not yet been agreed in Brussels but it is likely that these definitions will lead to an increase in standards for discharges and further constraints on abstraction. If there are extra costs after the end of 2004, but before 2010, companies may apply for interim price determinations leading to revised (increased) price limits for the remainder of the pricing review period. Revisions to the Water Framework Directive will take place on a six-yearly cycle which is a diVerent cycle from the periodic review. 38. Another example is the Habitats Directive which aims to protect specific nature sites. Certain water company abstractions are considered to be causing damage to these sites and English Nature and the Environment Agency are conducting a “Review of consents for the Habitats Directive” that has to be completed by 2012 with milestones for action at 2006, 2008 and 2010. The government is concerned about these sites and has alleged that the water industry is causing “significant environmental damage”. These costs will not be included in the November 2004 final determinations so any extra costs will be dealt with by interim determinations or at the start of the 2009 review.
39. Since the last price review 10 companies have asked the regulator for interim determinations to fund additional work that could not be costed in 1999. With the increase in the number of uncertainties facing the industry it seems inevitable that interim determinations will be a significant feature of the next review period. However, with the current process of price setting, customers should have some certainty about the price limits for 2005–10 when they are set in 2004, particularly in a climate of rising prices.
The Periodic Review Process
40. When it was started the Periodic Review was a reasonable tool to deliver what was needed: large- scale investment in infrastructure over a relatively short time period with well defined objectives. It provided reasonably predictable prices over five-year periods. It delivered significant environmental and quality improvements in an eYcient manner, with eYciency savings shared with customers. However, what is needed now is an improved mechanism to deliver long-term stability and sustainable solutions. The Periodic Review is not the tool to do this job.
41. It does not provide an eVective mechanism for dealing with issues that are either long-term or require co-ordination with other agencies. There is a risk that it could degenerate into a system where prices have to be reset frequently.
42. The UK needs to start considering the whole catchment, including the impacts of farming, transport, planning, flooding, groundwater protection and land use. New investment proposals need to be tested against sustainability criteria to find the best solution. The five-year Periodic Review as currently structured cannot do these things.
43. At some point the UK needs to protect water by changing land management practices. It is complicated enough obtaining funding for a new water treatment works, where there is a well-defined civil engineering project. The current regulatory regime, and periodic review process is not set up to cope with the idea of, for example, funding local stakeholder groups to improve land-management techniques.
44. The structure is not in place to implement holistic catchment management. And since this is the central element of the Water Framework Directive, it illustrates the major gulf that exists between the Periodic Review process and the urgent requirements of current environment policy and legislation. This gulf leads to higher prices for water customers who pick up the bill for diVuse pollution. It is an ineYcient way of managing the water cycle, but not the fault of Ofwat.
45. Members of both chambers of the Houses of Parliament, when considering the new Water Bill in committee, have drawn attention to its lack of connection with the Water Framework Directive.
46. The Periodic Review needs to be reformed or replaced with something which can support long-term objectives. The current review process cannot meet the needs of the holistic approach as required by legislation such as the Water Framework Directive.
47. In future, the plans and schemes needed to deliver long-term sustainability, as required by the directives, should be developed first to identify the investment required. This needs to be carried out by multiple agencies, well in advance, with a subsequently co-ordinated approach to providing funding for the required programme. This requires a very diVerent review process. 9092591002 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Ev 6 Environment, Food and Rural Affairs Committee: Evidence
Conclusion
48. Since 1989 the water industry and the system of regulation set in place at privatisation has delivered water improvements, 99.87% drinking water compliance, £50 billion in investment and low prices. 49. Government has made excellent progress through Defra in bringing together some of the wider influences on the water sector, and “Directing the Flow” encapsulates the new agenda, setting long-term objectives for the water industry. But the new thinking must spread out from Defra to ODPM, the Treasury, DTI and beyond. We believe that a stakeholder forum could assist with this and help to set priorities. 50. Now is the time for everyone—government, industry, NGOs and the public—to begin valuing water more and begin co-ordinating and collaborating to develop a new approach to managing the whole water cycle.
Further Information
51. Water UK has published many supporting papers on its website to explain the PR04 process. These can be accessed via http://www.water.org.uk/index.php?cat%2-256 17 October 2003
Memorandum submitted by United Utilities Water PLC 1. This is the submission of United Utilities Water PLC to the Environment, Food and Rural AVairs Select Committee inquiry into water pricing. In this submission we focus on those issues particularly relevant to United Utilities. Water UK’s submission to the Committee’s enquiry will provide the wider industry context. 2. Our draft business plan submission to Ofwat aims to set out for discussion the full range of issues aVecting the water industry in England and Wales up to 2010. We are keen to see a wide-ranging debate on these issues, involving all the industry’s stakeholders. The committee’s enquiry is a welcome contribution to that debate. 3. We know that our business plan has attracted considerable interest, containing as it does the industry’s largest investment programme and, as a consequence, its largest rises in customer bills. Whilst this draft plan is intended to set out as clearly as we can the consequences for bills, customer service, drinking water quality, and the water environment of likely governmental and regulatory decisions, it should be borne in mind that much is likely to change by the time of final business plan submissions next Easter. 4. In the remainder of this submission and in discussion with the committee we would like to bring out the following key points: — What is driving investment needs up to 2010, both for maintenance and service and quality improvements. — Why the position of the North West looks likely to diVer so much from the national picture. — The impact on future bills of the price settlement in 2000 and subsequent cost pressures. — The very much more limited scope for productivity improvements greater than those that can be achieved in the UK economy generally. — The vital need to ensure a financial outcome for the industry that is sustainable which, in our view, is only possible if equity investors are convinced they should choose to invest in the water sector.
United Utilities and the North West
5. The North West is home to 6.7 million people, around 13% of the population of England and Wales. Yet of the £50 billion invested by the water industry since privatisation, 16% has been spent in the North West. UU has thus already invested some £500 per property more than the average company, whilst maintaining bills at broadly the industry average. 6. In 2003–04 United Utilities Water plans to invest £1 billion, an investment that is equal to its turnover. This is a major challenge for any business. Figure 1 shows the scale of the investment made by United Utilities Water in the North West, in comparison to other utility infrastructure investment in the region. 9092591003 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 7
Figure 1
3
2
United Utilities
£bn Water
Air Electricity 1
Rail
Gas Local Transport
Roads 0 2001 2002 2003 2004
7. UU’s higher rate of investment than other water companies largely reflects the unique challenges we face in the North West. (a) Under-investment in wastewater treatment in the years prior to privatisation meant we faced a real catch up operation to bring the region’s waters up to standard. During the period 1990 to 2000 we successfully implemented quality programmes which delivered previously unprecedented standards of drinking water, and significantly raised eZuent discharge levels at coastal/estuarial locations such as Liverpool, the Fylde Coast, Barrow and Southport. However, river and coastal water quality still lags behind that found in other regions. The North West has a third of the poorest quality rivers in England and Wales and the greatest length of river requiring improvement or protection during the next price control period. (b) We serve a very diverse customer base, from the large rural and upland areas in the North to the major conurbations of Manchester and Liverpool in the South, with a relatively large industrial and manufacturing base. (c) Many of the water mains and sewers we inherited at privatisation dated from the Victorian era. We have worked steadily to replace or refurbish them but more needs to be done, and in the meantime these old assets are expensive to operate. (d) The region is characterised by comparatively small rivers that cross the major urban areas, with the larger watercourses in our area draining the relatively unpopulated Cumbria regions. This means that many of our large treatment plants and combined sewer overflows discharge into watercourses with limited natural base flows, requiring higher wastewater treatment to satisfy the river quality requirements.
Overall Strategy for 2005–10
8. United Utilities’ overall strategy for the period 2005 to 2010 and beyond reflects our customers’ needs and the desire of the public, government, and regulators to see a water industry characterised by sustainable, eYcient and securely financed companies. It builds on the successes of the water industry in England and Wales since privatisation, reflected in the government’s view that “the water industry has been successfully run and is firmly established in the private sector” (“Directing the Flow” DEFRA 2002). 9. The water industry has delivered significant environmental and drinking water quality improvements since privatisation in response to new legislative requirements. Price cap regulation has ensured that these have been delivered in an eYcient manner, and customers have had these eYciencies returned to them through the price cap methodology. Price cap regulation gives appropriate incentives to companies, and strikes a balance between the conflicting needs of stakeholders. 9092591003 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Ev 8 Environment, Food and Rural Affairs Committee: Evidence
10. The industry now operates in an environment that has changed considerably since privatisation. Significant investment programmes have increased debt levels, making it more diYcult to finance future increasing requirements, and as companies have moved towards the eYciency frontier, future eYciency gains become more challenging. It is in this context that UU’s plan is set. 11. UU’s plan for 2005–10 recognises the need to ensure that UU delivers its functions, and that those functions must be properly financed. For the most part our functions will be determined by decisions taken by others—notably ministers with respect to the quality enhancement programme. The process of preparing our plan for 2005–10 has revealed significant tension between meeting our responsibilities as a water and sewerage undertaker, and our desire to meet the expectations of customers. This tension manifests itself in the conflicting demands for: (a) Outputs that meet the requirements of government, the quality regulators, our customers, and wider stakeholders; (b) Finances that reflect the needs of investors and customers’ interests in stable, securely financed companies, which are able to bear those risks they are better placed to manage; and (c) Prices reflecting customers’ views as to the acceptable pace of increase and profile of bills. 12. Our plans for 2005–10 are based upon: ensuring adequate levels of investment to maintain the assets that underpin our existing activities; priority for those improvements in service that command significant customer support, particularly the reduction of sewer flooding and odour problems at wastewater treatment works; and an assessment of the improvements in drinking water and environmental quality that we think it likely we will be required to deliver in the period 2005 to 2010. 13. Over the five years from 2005–06 United Utilities’ key strategic objectives will be to: (a) Continue to deliver a value for money package of services to our customers, retaining the current high level of customer satisfaction; (b) Maintain, and in some cases improve, the current performance of our assets at an acceptable level of risk, to deliver existing service levels; (c) Maintain the supply demand balance and security of supply to all our customers; (d) Deliver the enhancements to environmental and drinking water quality required of us by Government and regulators; (e) Continue to make significant inroads into the problem of sewer flooding at customer premises, and begin a programme of work to tackle the most serious instances of external flooding; (f) Address the problem of odour at wastewater treatment works where this has given rise to the most significant customer and community concern; (g) Continue to deliver innovation and eYciency in our operations; and (h) Ensure that we maintain investor confidence by delivering acceptable returns to investors through an eYcient and sustainable capital structure.
Customer Prices 14. Table 1 below shows the K factors in UU’s draft business plan submission to Ofwat, both for the UU plan, and for Ofwat’s reference plans A and B, which are based on assumptions set mostly by Ofwat. Table 1 : K Factors UU Plan Ofwat Plan A Ofwat Plan B !12% !10.5% !13.1%
15. The UU plan results in average prices to customers that are the third highest of the Water and Sewerage Companies over the five years from 2005 to 2010, and probably equivalent to 8th highest in England and Wales overall. 16. The customer research carried out thus far for this price review shows a willingness to pay only a very modest increase over current bills. The UU plan and reference plans thus make manifest the tensions described above. There will be a huge challenge for government, regulators and companies to reach a settlement that will: meet the country’s legal obligations; satisfy aspirations for improved environmental outcomes; preserve a viable water industry in the private sector; and have legitimacy in the eyes of customers. 17. On 11 September 2003 UU made an application for an interim determination of price limits (IDoK). This application reflects the increase in construction cost inflation since 1999, and the rise in debt levels since water companies were prevented from disconnecting customers for non-payment in 1999. The outcome of that application has not been factored into this plan. If successful, this application will go some way to oVsetting price rises from 2005–06. Equally, the eVect of our recent rights issue has not been factored into our proposals. 9092591003 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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18. Our charges are required to be non-discriminatory and cost-reflective, and are approved by Ofwat. We have a vulnerable customer scheme, which currently helps those customers who have severe diYculty in paying bills. The Government is reviewing the extent of the vulnerable customer regulations at the moment, and we would welcome these customers being given additional assistance, even though their reductions will be passed on to all other customers in the form of higher bills.
Price Drivers 19. At the 1999 Final Determination UU’s allowed capital expenditure of £3 billion was the largest in the industry, and the capital expenditure allowed in order to improve quality represented more than one fifth of the industry total. Except where otherwise agreed with the quality regulators since the Final Determination, UU has delivered all of the required outputs. In addition, we have with only one exception delivered or exceeded the commitments given in our monitoring plan in relation to service performance. At the same time we have consistently improved our levels of customer satisfaction. 20. The UU planned investment in our draft business plan submission was £3.8 billion. This was based on the advice of quality regulators at the time the submission was prepared. The quality requirements are changing over time and until the ministerial guidance is issued in January 2004 they will not be definitive. Therefore this investment could go up or down between the draft and final submissions. 21. Chart 1 below shows how our planned investment is broken down between quality, maintenance, growth, and service enhancements, and the main components within the quality programme. Of the total, the largest proportion of the investment is necessary to comply with additional quality requirements imposed upon the Company. Less than a third relates to maintenance and just 8% relates to service enhancements to deal with sewer flooding, odour and improving security of water supplies to some of our customers. In other words, the great majority of UU’s capital spending will continue to be on enhancements, largely driven by legal obligations, and not funded in full in the period by customers’ bills.
Chart 1: Investment under the UU plan
Other improvements Bathing Water Directive Improving drinking Nature Conservation water quality and access
Disposal of sewage sludge Maintaining drinking water assets
Dealing with growth Urban Wastewater Treatment Directive Maintaining sewerage Improving service assets performance
22. Even though we have attempted to restrict the size of the programme included within the UU plan, average household bills will increase by 71% in real terms. UU’s average household bill over the period will be the third highest of the Water and Sewerage Companies. 23. The table below shows that without the quality programme and other enhancements to service, prices would rise by only a modest amount in order to accommodate identified cost pressures.
Table 2—Changes in customer bills (2002–03 prices) Average household bill 2004–05 243 Less Past and future eYciency savings 24 Plus maintaining base service levels 60 Drinking water quality improvements 28 Environmental improvements 90 Service performance 12 Security of supply 12 Average household bills in 2009–10 416 9092591003 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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Maintaining Services 24. The cost of maintaining base services is forecast to increase over the AMP4 period, (by £60 per average annual household bill in 2009–10). One of the more significant elements of this increase is due to changes in the way the Inland Revenue will treat certain types of expenditure for tax purposes, eVectively increasing the amount of corporation tax companies will pay. 25. UU has implemented a risk based approach to maintenance planning and intends to increase network investment by around 15% compared to that allowed in the 1999 periodic review. This is lower than the industry average increase of 23%. 26. Other cost pressures include a predicted upward trend on household bad debt and increased pension costs resulting from the recent deterioration in pension fund reserves.
Efficiencies 27. This package of price limits has been arrived at after deducting from estimated operating and capital expenditures over £300 million of future eYciencies, equivalent to a £18 reduction in bills. We have also reflected the impact of outperformance in the current regulatory period, which reduces bills by a further £6.
Quality and Service Improvements 28. Important examples of quality and service improvements that will be delivered over the period 2005–10 are: (a) To improve the quality of drinking water we supply to our customers we propose to renew or clean around 5,000km of water distribution mains. We also plan major cleaning work on 240km of our large trunk mains. (b) The long-term standard for the maximum amount of lead in drinking water is to be achieved by 2013. We propose to move towards that standard by removing some 300,000 lead communication pipes from our water system by 2010 (with another 140,000 by 2013). (c) We will tackle problems of sewer flooding in people’s homes as they arise. We expect this to require us to address incidents at 900 properties. We will also begin a programme of work to tackle the most serious cases of external flooding, addressing problems aVecting around 140 locations. (d) We propose to address the problem of odour from wastewater treatment works where this has given rise to the most significant customer and community concern. Our programme will be delivered in the first two years of the next price review period. (e) We expect to have to carry out work at 87 of our wastewater treatment works and at over 300 sewer overflows to help improve the quality of the water environment in the North West. These works treat the wastewater from the equivalent of 1.8 million people.
Uncertainties 29. United Utilities believes that the environment after 2005 may be characterised by considerably greater risk and uncertainty than the current period. There is a range of potential cost increases of a scale and variety that we have not seen in previous price review periods. This has already been acknowledged by Ofwat in their discussion of the handling of uncertainty after 2005. 30. The price limits above do not include a number of potentially significant variations to costs and revenues over the plan period. For example, price rises of the scale indicated could result in far more customers opting for a metered supply than has been UU’s experience. They could also result in more customers failing to pay their bills. 31. Other significant potential upward cost pressures after 2005, including the introduction of traYc management charges, the abolition of capital allowances and increases in non-domestic rates, have not been factored into this plan. UU expects these to be treated in such a way that they would be eligible under any interim determination that might be needed during 2005 to 2010, and consequently would further increase prices during the next price control period. 32. UU’s plan, and the reference plans, also ignore a potential additional programme of work that would be required if, as is possible, the North East Irish Sea were to be designated nitrate sensitive under the Urban Wastewater Treatment Directive. On realistic assumptions, this could add in excess of £1,500 million to UU’s investment requirements. The plans also ignore at present the very recent advice from the EA on the extent of work that might be necessary to deal with “dangerous substances” in wastewater eZuent. Meeting those requirements could add £900 million to UU’s investment programme. 9092591003 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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Financing the Plan 33. For Ofwat’s reference plans A and B companies were required to assume that the investment requirements were debt financed. For the sake of consistency and to allow comparisons, we have also made this assumption in the UU plan. 34. For a company with an investment programme the size of UU’s, eYcient financing requires a credit rating of A2. In the UU plan financial ratios are lower than we would like to be confident of securing an A2 rating. 35. However, since the submission of the draft business plan, UU has carried out the first part of a two- part rights issue. As stated in the prospectus for that rights issue, the funds raised will be used to fund the water and electricity regulated investment programmes. Therefore, we will be including that rights issue in the final business plan submitted to Ofwat next year. This can be expected to have a beneficial eVect on customer bills. United Utilities 20 October 2003
Memorandum submitted by Wessex Water Services Limited
Summary A.1 Wessex Water is consistently considered to be one of the most eYcient of the water and sewerage companies. Despite this our draft business plan suggests that customers bills need to increase by 12% over the next five years. In coming to this view we have sought to balance the interests and aspirations of consumers and investors along with the need to improve water and environmental quality. A.2 Our plan shows that it should be possible to maintain existing standards, and provide a return to investors which reflects the cost of capital without the need to increase bills. This is despite having to spend additional sums to maintain an increasing and ageing asset stock. We are able to achieve this because of eYciencies we have made over recent years. A.3 However, because of changes to Inland Revenue tax rules, customers are going to be asked to pay 2.75% more for the same level of service in the next five years. A.4 Whilst it may seem attractive to squeeze maintenance expenditure or returns to investors in order to reduce bills, neither option is sustainable. — The water industry is an integral part of the economy and society. Undue risk should not be taken with asset maintenance as this is bound to prejudice service. — Returns to investors have been somewhat below the cost of capital in recent years. This has already resulted in the exit of significant amounts of equity. Continuation of these returns in AMP4 will lead to diYculties in accessing all capital markets. A.5 Against the background of these constraints Wessex has endeavoured to prioritise investment in customer, quality and environmental improvements such that bills increase by no more than consumers willingness to pay. A.6 Joint national customer research indicates that the typical family is content for bills to rise by around 2% pa—broadly equal to increases in household disposable income. The research also indicates that investment in areas such as sewage flooding is regarded as important. A.7 Faced with this information Wessex believes it is right to challenge environmental improvements to ensure those included have clear and significant environmental benefit. We are not yet convinced that all those obligations in Packages A or B can be justified on cost benefit grounds and, as such, some could be deferred to AMP5. A.8 The Plan is however draft. If it transpires that there is a willingness to pay for improvements which goes beyond RPI!2% pa, and provided returns to investors reflect the cost of capital, then Wessex believes the quality and environmental improvement programme could and should be increased to include items in Package B.
Background and Approach to the Price Review A.9 Wessex Water set out its strategic objectives in its 1999 Business Plan. Our 2004 Business Plan will confirm these as: — safeguard public health and provide the highest possible quality of water and sewerage services; — maintain the operating capability of our assets; — balance supply and demand; 9092591004 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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— meet enhanced customer expectations; — meet enhanced environmental requirements, within the constraints imposed by customers’ willingness to pay; — deliver returns to investors commensurate with the cost of capital; — be the leading company in eYciency and service standards; and — meet all the above objectives in a sustainable way. A.10 Wessex Water has achieved these objectives in AMP3. Our record is of continuously being one of the most eYcient and profitable of the water and sewerage companies, producing some of the highest levels of service.
Wessex Water’s performance 1997–98 1998–99 1999–2000 2000–01 2001–02 2002–03
Ofwat operating eYciency band* Band A Band A Band A Band A Band A Band A Ofwat capital eYciency band Band B Band A Band A Band A Band B Band A Ofwat overall service ranking 1st 2nd 3rd 3rd 8th 2nd * Bands range from A (top) to E (bottom) A.11 These achievements provide a solid foundation on which to build a sustainable strategy for 2005–10 and the longer-term. A.12 Our approach to the 2004 price review is based upon the principle of sustainability. The definition of sustainability used by groups such as Forum for the Future is “the capacity to continue”. This definition is applied to the “five capitals”: — Social capital. — Financial capital. — Natural capital. — Human capital. — Manufactured capital. A.13 Our focus in developing our plan has been on the first three. Specifically we have tried to ensure continued: — ability and willingness to pay for services; — access to the capital markets so to allow the company to meet customer and regulatory requirements; — maintaining existing standards; and — improvement in service levels and environmental performance. Inevitably this has meant the need for compromise between the often-competing needs of each.
Forming the Plan A.14 In formulating our plan, we have sought to establish: — what our customers are prepared to pay; — the costs of meeting our existing core obligations, allowing for past and future eYciency, including the returns that are commensurate with the cost of capital; and — which customer and environmental improvements provide best value for money. A.15 This plan seeks to balance all stakeholder interests and allow us to meet our statutory obligations as we see them today. A number of issues have yet to be fully resolved, including: — the full implications of the water framework directive; — the implications of future pension shortfalls; — the extent of future electricity price increases; and — the cost of capital. A.16 Our views on these issues, and the balance between each stakeholder group, will evolve in light of new information and the feedback we receive. Next April we will update our plan and put forward final proposals for the next five years. 9092591004 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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Willingness to Pay
A.17 Unlike the last price review the industry has jointly commissioned customer research along with Regulators, DEFRA and Consumer groups. The first phase of this research established broad willingness to pay for improvements. A.18 The results show that the great majority of customers (87%) want to see bill rises kept within the range of 0% to 2% above inflation per annum.
Acceptable Bill Rises
40%
33%
30% 28% 26%
20%
13% %age of customers 10%
0% Inflation only Inflation +1% Inflation +2% > Inflation +2%
A.19 Increases around this level broadly reflect the long-term growth in the economy real disposable household income. A.20 It is however clear from the national research, and previous work, that willingness to pay does diVer between elements within society. Broadly speaking those who are willing to pay more for environmental improvements are those who either understand the benefits of the improvements and/or, have higher levels of disposable income. A.21 Wessex does recognise that by assuming willingness to pay is restricted to increases of 2% pa above inflation, we are not reflecting the divergence of views within society. Indeed we also recognise that it may be possible to find additional resources to pay for environmental improvements were it possible to charge diVerent consumers diVering amounts. However, there is a reluctance by Government and Regulatory authorities to allow companies to diVerentiate prices on the basis of willingness and ability to pay despite the fact that this may produce desirable social and environmental outcomes.
The Scope for Future Efficiencies
A.22 The current regulatory regime has been very successful at driving out the ineYciencies inherent in the water industry at privatisation. Despite the fact that the privatisation eVect itself has long been exhausted, the Board considers that there is always scope for further eYciency gains, but that three important precautionary principles should be applied when setting future targets: — first the law of diminishing returns applies to the water industry in general, and Wessex Water in particular; — second, because of the strategic and social importance of the industry, targets should be based only on sound evidence—where the evidence is weak caution should be applied; and — third, the industry works under an RPI-X based system, where the RPI already has “baked-in” to it the productivity gains of the economy as a whole. A.23 Additionally the scope for savings must be viewed against a background where: — the industry cannot change its product, uncontrollable costs are increasing and its mix of inputs are largely immovable; 9092591004 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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Trend in Operating Costs Opex Cost Structure 2002-03 Materials 100% 21% 87% 81% 80% 77% Power 13% Rates 14% 60%
40% EA 23% 19% Charges 20% 13% 7%
0% Other 1995-96 1999-00 2002-03 4% Labour Non-controllable Controllable 41%
— there is limited scope for technological advance; — the regulatory system discourages savings made through medium term capital investments; — it is unlikely under the current regulatory regime to be able to reduce costs by way of merger; — there is upward pressure on a number of costs driven by in large part by legislative changes; — there are shortfalls in pension funds; and — water industry input prices rise faster than RPI resulting in a “real price eVect”. A.24 The last point is of particular significance. The cost structure of the water industry does not reflect the make up of the RPI. For example: — labour is acknowledged as having at least a 2% RPE; — non-controllable costs, such as business taxes and EA charges, have been rising at 5% faster than RPI in recent years; and — there is a widespread anticipation that power prices will rise steeply as over-capacity in generation and supply is eliminated and transmission and distribution charges begin to rise faster than inflation. A.25 Together these changes mean that the water industry faces real price increases of nearly 1% pa before any savings can be made.
Maintaining Assets A.26 Recent experience in the transport and energy sectors clearly shows the negative eVects that utility asset failure can have on the rest of the economy. Be it concern about security of supply, public health or specific asset failure, the consequences of things going wrong in utilities is far greater than the consequences of things going right. This suggests a precautionary approach to the Price Review in general, and to capital maintenance in particular. A.27 We believe that there are three key reasons why maintenance expenditure must rise if we are to meet this objective. — Assets are ageing and their condition is deteriorating. — The post-privatisation investment in new quality obligations is moving out of its maintenance holiday period. — There are a number of extraordinary lumpy investments to be undertaken. A.28 Taking all factors together we consider that there is a need to increase capital maintenance expenditure by 17% in AMP4. However we estimate this increase in investment will only add 2.5% pa to customer’s bills.
The Cost of Capital A.29 Wessex Water has outperformed the AMP3 capital and operating expenditure targets by around 10%. This outperformance has produced financial returns that are in excess of Ofwat’s 1999 view of the cost of capital. But Water companies have been trading, and have been sold, at values well below their Regulated Capital Values for the whole of the AMP3 period. This clearly suggests that returns have been set below the cost of capital. 9092591004 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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A.30 It is unclear exactly what this discount has been but the broad consensus is that it is in the region of 5–10%. This range is consistent with the discount Wessex Water was sold for in 2002. Together this evidence suggests that the allowed rate of return in 1999 was up to 1% below the cost of capital. A.31 Setting returns at least equal to the cost of capital is vital if the industry is able to continue to attract the finance that is necessary to undertake its investment programmes. A.32 Over the last few years the reduction in equity in the UK water industry has been as a direct result of returns being below the cost of capital. Equity players have taken advantage of the availability of relatively cheap debt market to improve their returns. However, it is by no means clear that this trend can continue in the medium term. The cost of debt is already moving back up towards its long term level, and the tax advantages of additional gearing are being passed on to consumers, so making “securitisation” less attractive. A.33 It is also unclear whether the bank and capital markets will be able to finance the industry on their own. Like equity markets, debt markets also require suYcient returns before they are willing to invest and, by definition, also have limited capacity. A.34 Wessex Water’s owners, YTL, do not wish to increase the indebtedness of WWSL, and hence their return on capital employed, by moving to a highly geared, securitised, financial structure. They are comfortable with the fundamentals of the UK regulatory system and would, in principle, be prepared to consider a further investment. However the action they take post 2005 will depend upon whether the allowed rates of return reflect the cost of capital.
The Cost of Running the Base Business A.35 Because of our out-performance to date, and the scope for further eYciencies in the future, we should be able to continue to meet existing standards within existing charges. This is despite having to invest significantly more to maintain our assets and make good shortfalls in our pension fund. A.36 However, there are changes in Inland Revenue tax rules that we are unable to control. The imposition of these changes mean customer bills for the same level of service need to increase by 2.75% over five years. A.37 In addition, the continued need to invest to meet growth demands from new customers adds a further 1.25% over five years.
Meeting New Quality and Environmental Standards A.38 With this unavoidable upward pressure on costs, and customers’ desires for bills to go up by no more than 10% over five years, we have looked critically at the quality and environmental and service improvement programme. We have concluded that certain improvements represent better value for money than others, and that customers are more likely to support certain outputs than others. A.39 In particular we consider that an investment in eliminating the risk of internal sewage flooding at a cost of around £5 per customer represents a better use of funds than a number of the environmental requirements contained within Reference Plan A or Reference Plan B. A.40 Consequently, and in order to strike a balance between all our stakeholder interests, our preferred plan defers certain statutory outputs where the benefits do not exceed the costs, specific examples of this include: — Phosphorus removal is required on the Hampshire Avon but, despite a major investment the river would remain eutrophic unless diVuse pollution is also dealt with, and — Dry-weather-flow exceedence at a number of our sewage treatment works where there is a technical breach of consent which has no negative consequence on river water quality. A.41 The Board are however clear that if environmental outputs are put forward that have customer support, provided the returns to investors is adequate, it will support and carry out the necessary investment.
Bills and Price Limits A.42 Our approach to the draft business plan allows Wessex to constrain price increases below the level required by Reference Plans A or B. The detailed impact on bills in AMP4 for each of the three Plans is given in the table below. Because of the interaction of many of the influences on bills it is often diYcult to be precise as to the exact influence of each. Nonetheless, in the interests of transparency we have attempted to break out each component part—at least to an accuracy of plus or minus 0.5%. 9092591004 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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Drivers of changes to bills Company Plan Reference Plan A Reference Plan B
Passing back past outperformance "1.50% "1.50% "1.50% Future eYciency "1.50% "1.75% "1.75% Maintaining assets !2.50% !2.50% !2.50% Taxation !3.25% !3.25% !3.25% Running the existing business !2.75% 2.50% 2.50% Balancing demand and supply !1.25% !1.25% !1.25% Sewage flooding !1.75% !1.75% !2.00% Quality and environmental improvements !6.25% !7.25% !11.50% Total bill impact by 2010 !12.00% !12.75% !17.25% Average annual bill rise !2.3% !2.4% !3.2%
Although our preferred plan seeks an increase in customers’ bills by an average of 12% over five years, price limits are set to ensure the company has enough revenue to fulfil its obligations. All else being equal, revenue goes down each year, primarily as a consequence of meter options and a decline in sewerage requisition revenue. To cover these two items price limits must rise by an additional 0.6% p.a.
Summary Ensuring a sustainable outcome requires companies to balance the interests of all the stakeholder groups. Inevitably that means compromise and it is not sustainable to favour one group at the expense of another. Wessex Water believes there is natural pace of improvements which is driven by consumer’s willingness and ability to pay and the legitimate and necessary requirements of the financial markets. Current evidence suggests that willingness to pay is limited by increases in household income and that returns to the provider of capital are inadequate. However, it may be that more can be done to explain the value of quality and environmental improvement to consumers and hence alter the existing balance. 17 October 2003
Witnesses: Pamela Taylor, Chief Executive, Water UK, John Roberts, Chief Executive, United Utilities Water PLC, and Colin Skellett, Chief Executive, Wessex Water Services Ltd, examined
Q1 Chairman: Welcome to the Committee. Pamela less of an element of bargaining in that the Taylor, you are the Chief Executive of Water UK. expectation of Ofwat is that the figures you are Mr Roberts, you are the Chief Executive of United putting forward are pretty well worked through and Utilities and Mr Skellett is the Chief Executive of it is not just a bid and that your expectations are that Wessex Water Services. May I be allowed to ask you Ofwat understands what the real figures amount to a horticultural question first? When has it got to rain and that the whole thing starts to get closer to the and by how much before we get back into crisis? sensible end game than it did in the past. That may Because I need a pickaxe to dig my leeks out at the well be the case but, of course, as far as the consumer moment. Can you help me? is concerned they look at the figures and Ms Taylor: Yes, it is very diYcult at the moment. We immediately think “Ouch”. As Candy will no doubt are going to need particularly some more rain during tell us that is particularly true in the South West, but the winter months and also we are going to look, as equally elsewhere. If you wanted to tell your we go forward in terms of climate change, at better consumers this is not a game, this is serious, we do storage as well because of the diVerence in the need this money because if we do not get this money pattern of rainfall that we have at the moment. Yes, we will not be able to maintain services and there is you are quite right, we are going to need more rain a risk of going backwards, how would you explain it but we have been very grateful to our customers who to me, as a querulous consumer, without hesitation, have used water very wisely during some very deviation or repetition in one minute flat? diYcult circumstances. Ms Taylor: One of the important things to say is that Mr Skellett: The moisture deficits were 120% last we have come a long way and we are very pleased week, but do not worry about your garden, the with the progress that has been made, but obviously plants will survive all winter without watering. more progress needs to be made. What we need to do though is to safeguard the progress that we have Q2 Chairman: Very well. Yes, but I am not bothered made so far and then to build sensibly upon that at about surviving winter. It is next spring that bothers a pace and a level which makes sense. One important me. We will never get another dry spring after this thing is that there are variations. There are spring. We will have to go halfway down to variations according to geography, geology and Australia to get any damp at all. That is that history. So diVerent companies will look at the issues diversion. We have just been doing a little bit of that they have to address and then work through the teaching on this and we have been told that, with the best way in which they have to address them. Yes, as experience of past reviews, everybody has got a bit far as customers are concerned, we can be proud of more grown up. To put it in a nutshell, there is much what we have achieved so far, but we do not want to 9092591005 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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29 October 2003 Pamela Taylor, John Roberts and Colin Skellett see us going back on that. We want to safeguard and pluck a figure out of the air for this? Has it any real then to move forward so that we are fit to face the intellectual validity at all? Or is it just one of these many issues that will be coming to us down the line sort of “piss in the wind” exercises? in the form of various other directives that will be Ms Taylor: We are in a better position than we were coming our way. in the periodic review last time around where everyone was saying “My bit of research is better Q3 Chairman: Can you put that in what I might call than your bit of research”. At least this time I am “Tesco-speak” for me? In other words, what does it pleased that we have joined with the Regulators, actually mean? Are you going to say to me “If we do with NGOs and with Government in order to carry not do this, you are not going to get any water out out an agreed set of customer research. So I am of your pipe” or “This is going to happen”? Put it in pleased that we have done that but, as you say, it is concrete physical terms as to why you need the quite diYcult for customers in the abstract to say money. how much they are prepared to spend. What is more Ms Taylor: In concrete physical terms we are an relevant is that when customers see their own infrastructure based industry, so the water goes company’s proposals, it is easier for them then to through the pipes. We have got to maintain those identify with what the company is proposing and pipes. We have got to make sure that they still deliver then to have some idea about what we are really in the future. So that is one of the most important talking about. things that we need to do as we go forward. Mr Roberts: We have done our local research and I agree that it is diYcult in abstract to say to someone Q4 Chairman: Right, and if you do not get the sort “How much more would you pay for this?”, but we of money you are asking for, that is not going to are investing far more than any other company, happen? particularly in environmental improvement. We Ms Taylor: If we do not get the money that we are have invested so far, since privatisation, about £8.5 asking for, that infrastructure will deteriorate. We billion, which is a huge amount of money. If you have got to safeguard that infrastructure and then look at all the investment and all the infrastructure we have got to build on it in terms of the issues that in the North West of England, if that be road, rail, we need to face as we are going forward. We have got gas, airports, seaports, and add it all together, we to be fit to face the future and the future might have invested more than that. It is a huge amount of include issues such as climate change, it might money. The results that the customers have seen include issues such as a revised Bathing Waters though are things like the River Mersey is now Directive, it might include issues such as industry V extremely clean. It is cleaner than it has been for 300 and di use pollution and getting ourselves fit, for years. It won an award as the best river clean up. example, for the Water Framework Directive. So They have seen cleaner beaches. That whole there are many challenges ahead of us and we have Lancashire coast, the Blackpool coast is cleaner than got to make sure that we are fit to face them. it has ever been before. Similar things that we are Mr Skellett: The bulk of the expenditure following doing are not visible to the customer. We are taking privatisation for 10 years has been on meeting higher standards, meeting new standards and rebuilding lead out of drinking water. The water tastes the same treatment works. Our companies are at diVerent when it comes out of the tap, it looks the same, but stages on that and probably Wessex Water is further the reality is that it is a lot healthier for them. So ahead than United Utilities and that is why there are some of things that we do I do not think register some diVerences there. Where the expenditure now immediately with the customers as a benefit. We needs to start to focus is on maintaining the existing need to explain that to them and explain it in assets because a lot of the expenditure that has gone tangible terms, the benefits they are going to see. I do on has been at the expense of or there has been less not think it means an awful lot to people if we say we going into maintaining the existing assets. Since are going to invest X billion pounds because people privatisation Wessex Water, for example, has find it diYcult to understand what that means bought about £970 million of new assets and some anyway. We can tell them that a lot of the things that of that now needs to start to be maintained and the we are doing improve the environment and when we existing asset stock. If you look at the underground do research with our customers, if they are prepared assets on water supply we are proposing, even with to spend more on anything it is on environmental the proposal we are putting forward, we are improvements, but then, of course, when you ask replacing 0.6% of pipes each year, which are very them how much it becomes much more diYcult to long asset lives. Over time we need to gradually work get objective answers. up the investment in the existing assets, as Pamela said, to make sure that we do not now lose the advantages that we have gained over the last few Q6 Chairman: Looking at the relationship between years. consumers and shareholders, there has been a great increase in indebtedness of the water companies. Q5 Chairman: There have been a series of questions Where do you see the pain threshold beyond which about how much consumers might be willing to pay. you cannot go on that? After all, for investors you I always find these fairly meaningless exercises. If may be a safe investment, but you are a massively someone comes along to me and says “How much unexciting investment because you are a regulated would you be willing to pay for this?”, how do I framework. 9092591005 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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29 October 2003 Pamela Taylor, John Roberts and Colin Skellett
Mr Roberts: We are a low risk investment. We are shareholders are getting a nice deal out of it, but the also a very low growth investment. Having said that, poor old customer actually has to pay for what the we have this particular situation that we are re- shareholder is investing in. regulated every five years and therefore there is a risk Mr Roberts: What we are trying to do is to try and that comes in once every five years, the unknown get a balance of funding across all of our about what will come through the price review. Once stakeholders. the price review is settled, then there is clear visibility over the next five years as to what the profile of the The Committee suspended from 15.18 pm to business looks like. So to that extent then yes, it is 15.31 pm for a division in the House. low risk. As far as we are concerned in United Utilities with this big investment programme, what Q8 Diana Organ: My question was eVectively; are we are trying to do is to balance across all our customers not paying for the investment that stakeholders how that is financed. A lot of it will be shareholders are getting in that you raise the money, financed through debt. At the moment our debt to the shareholders have got these extra assets because asset base is about 55% and we would not want it to of the investment you have put in, but you are go much higher. The Regulator himself has said that actually asking the customer to pay for the ongoing he did not expect gearing to go much beyond 65%. maintenance and upgrading of that? So the customer Looking forward into the next programme, before is eVectively paying for the shareholders’ we can see another £3.5 billion or so of investment, investment. so we went to our investors in the summer with a Mr Roberts: I would tend to look at it a diVerent way rights issue and we raised £500 million from our around and think of it in terms of today’s customers, investors in September. We have told them that we broadly speaking, are paying for the assets that they intend to come back in July 2005 to raise another are using and getting the benefit that has been £500 million. So that will be a billion from our created in the past. The creation of new assets will be investors. That will strengthen our balance sheet. It Y of benefit to customers in future and is paid for by means that we can then borrow e ciently because equity and debt and the cost of that will run out into we will maintain a good credit rating and our the future and will be paid by customers in the investment needs a significant amount of debt to be future. But if you look specifically at the prices that raised to finance it and then the balance will come we are talking about in the next price review, in the from our customers in prices. So we are trying to get AMP 4 round, of the increase, the dominant element the best balance that we can. We have got to preserve is for the cost of creating new assets. Maintenance is a strong balance sheet because otherwise we do not going to rise over the whole five years by about £60 have a good credit rating and given the amount that compared to about £150 increase over the period. So we have to borrow that is very important for us. much of our capital programme is about the creation Ms Taylor: This would obviously be a judgment of new assets and therefore that is why we need to company by company where, putting it at its raise the debt and that is why we need to raise the simplest, companies have to remain attractive in additional equity so that by keeping the balance order to attract the money that they need for the sheet reasonably eYcient and having a reasonable investment programme as we go forward. We have equity component in it, we can optimise our cost of recently had independent research carried out of funding overall which means that we try and keep investors, which is the first time that this has been prices to the lowest level that we can consistent with done, and we were very pleased that Ofwat did this the amount of investment that we have to make. with us. Obviously one of the points that was made Ms Taylor: It is a bit like taking out a mortgage at back to us is that at one time water used to be a must- the best level you possibly can for your current have in your portfolio. It is not any more. So that is customers as you look forward. That is one way of why companies have to make sure that they are looking at it. suYciently attractive in order to gain the funds they need for the investment programme as we look ahead. Q9 Diana Organ: But if you take what the customer is paying for, really what they are paying for is a continuous good supply of drinking water out of the Q7 Diana Organ: As you said, Mr Roberts, you tap and they are paying for their sewage to be dealt have garnered a billion from your investors to with. improve your infrastructure and so on and that is Ms Taylor: Yes. what you were meant to do, is it not? Because I understand with privatisation all the problems that Q10 Diana Organ: I know that polling might be a we had with the lack of infrastructure and the little bit “iVy”, but what many customers would like improvements that needed to be put into the to see, of course, is a lot improvements in industry was meant to come from the private environmental issues; the quality of their beaches, investor, but if we are talking here about value for the quality of the seawater, the quality of rivers, money for the customer, is it not a little unfair that quality of lakes, quality of water that way. They are you are putting your company in order that it is not buying that when they are paying for their water attractive and low risk for the investor, for the and sewage charges, but you are wanting them to shareholder, but you are expecting the customer to pay for that. They are really only wanting to buy the actually now, with your draft business plan, pay for water or the sewage service. They want to have this all the maintenance of this increased asset? So the done but you are saying that they have got to pay for 9092591005 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 19
29 October 2003 Pamela Taylor, John Roberts and Colin Skellett this as well. So if you live in Nottingham, for have now reached a point where going forward the instance, a long way from the coast, you might never opportunities to generate further eYciencies is go to the coast. They would like to see improvement reduced. There is a limit to how much you can take in the quality and the environment as a result of what cost out of the business. We have borrowed to the water companies have been doing in the past. Why point now where we have about nearly £4 billion of should customers pay for it? Why can it not fall on debt on our balance sheet and to fund the next £3.5 the investor and fall on the company? billion that we have got to fund we will look to the Mr Skellett: It costs a certain amount of money to debt market to raise that. We have also got to raise run these businesses. If you take Wessex Water, we equities, I have already mentioned, to make sure that get less income than it costs us to run the business we have a reasonably strong balance sheet so that we and to meet the investment. These businesses are can borrow money at the best rates that we can. The cash negative, so each year we spend more than we balance now has to come from customer prices. In take in. That is why borrowings arise. On Wessex the past ten years we have had this sort of golden Water, if we just had to keep delivering what we scenario in which we have had increasing investment deliver now, so do not change things, and if there and falling prices and, to some extent, at the time of was not a tax change as well, then bills would not be privatisation the view was that after 15 years of going up. We would be in a stable situation, but it is investment we would have achieved all that we the fact that we are having to do more to meet these needed to achieve in going forward. It would all be higher standards and that means that we have to on care and maintenance, but what we see going raise more money. That money is raised from two forward are increasingly higher standards that we sources and we need to keep those sources open. We need to meet, increasing investment and the need to be able to go to the debt markets and we need capacity, certainly of my company because it has to be able to go to the equity markets. Wessex Water proportionately more new investment than anybody happens to be owned by Malaysians. They bought else, to fund that purely through further eYciency the business about a year ago and since then they and purely through debt is limited and cannot have put a couple of hundred million into the account for all of the investment that we need to business. They are saying “As the owners of make. business, we are quite happy to continue to put money into this business”, so you will raise money from the debt markets, you will raise money from Q12 Ms Atherton: Pamela, it will not surprise you the equity, from the shareholder, providing we get a that I will want to explore a little bit about the reasonable return. That is what this all about; it is regional disparities. We are coming to this when making sure that the water companies long term, customers in the South West have already been because these are long term investments that we have bearing this huge burden of 3% of the population to make, can access both the debt markets and the paying for 30% of the country’s coastline. I really equity markets and that is what United Utilities are fear when I hear that South West Water is calling for doing. They are raising money from both sources to a £10 to £15 a year increase for the next five years on fund not just the day to day running but to fund the top of inflation, compounded on top of the bills that people are already paying. There are some real stark investment programmes to deliver these higher V standards. di erences when you look at the plans that the various companies are putting forward. Can you justify those diVerences and where does the Q11 Diana Organ: But United Utilities are asking a customer come in all this? considerably large increase in this review round. Are Ms Taylor: Certainly companies will have to justify we saying then that actually at privatisation it was all their draft business plans as they go forward. As we wrong? Because the way that it was given to the know, at the moment, this is the very beginning of public at the point of privatisation was that there the process and actually the process, this time needs to be some investment in asset development around, we think, is very much better than before and infrastructure investment but that, of course, where numbers, you could say, came out of a black this would come as a result of privatisation from the sack. At least now the numbers are in the public investor. The customer did not expect to have to pick domain at the very beginning of the process and that up the bill for all of this, did they? is good. It also means that there is then, quite rightly, Mr Roberts: I do not think we are saying that it was a debate as to what it is that the companies are wrong. At the time that the industry was privatised saying is a requirement. You will also know that we a lot of investment had to be made to improve the have been asked to cost specific plans and then quality of both the environment, waste water and companies have been asked to put forward their drinking water. The industry was privatised with preferred plans into the public domain. They will virtually no debt and clearly with lots of opportunity now be expected to consult their customers to become more eYcient and take costs out of its regarding those plans as well. So it is very, very much structure. That is very much what has happened; we better than it was before. Certainly in terms of have increased the amount of debt in the business inquiries such as this Committee also helps people to and we have taken a lot of costs out of the business. explore the issues and helps companies to actually In the five years from 2000 and 2005 we are reducing have to look at the issues as we go forward. In terms our costs in our water and waste water business by in of how robust those figures are, they will need to excess of £300 million and, of course, that additional stand the test of time or not as the process progresses cash all goes towards funding the investment. But we and the independent auditors, who are independent 9092591005 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Ev 20 Environment, Food and Rural Affairs Committee: Evidence
29 October 2003 Pamela Taylor, John Roberts and Colin Skellett to the water industry in that they are under the Directive; one of the things we are being asked to do auspices of Ofwat, will be climbing and crawling, is to take more phosphorus out of the Hampshire quite rightly, over those figures as we go forward. So Avon. There is about 170 tons of phosphorus a day this is very much the beginning of a process in which going in the Hampshire Avon, it is part of AMP 3 customers will have a voice in terms of their view as period, about half of it came from sewage works. We to what it is that is being put forward on their behalf, have taken about half of ours out and we have to if you like. take more out. Even if we take all of ours out, the diVuse pollution still means that the levels of phosphorus will be above the level that is required. Q13 Ms Atherton: I do not think the people of the Y So we are saying that should there not be a South West will have any di culty in making their comprehensive plan that says this is part of dealing voice known and that is coming through loud and with the solution, rather than saying the water clear and it is going to get louder and louder. I have companies have got to do all their bit and everybody real fears about that, that in the context of people else does not do anything. I think there is a real need managing their bills, I am not quite sure how the to work together to get comprehensive solutions that customer actually gets his or her voice heard and mean that the burden is spread and it does not all fall listened to. I do not think that is what is happening. on water customers. I think people feel frustrated when they see these bills and they see these big companies giving these Q14 Mr Mitchell: I want to talk about asset big announcements that there is going to be this maintenance, but first of all I want to pursue a point massive increase and they do not see their income made by Diana while of course, on New Labour’s improving substantially to actually cover that. What behalf, carefully disassociating myself from any are the companies and Water UK’s attitude towards rampant socialism. She was right, we were told at the subsidies across the companies for where you are point of privatisation that there is a lot of work to be having such increases so that we bring them down? done, lots of investment, lots of old assets need to be Because I am sure you would agree that some of the renewed, let the investor pay this, let us raise the water companies have much smaller bills than the money on the markets so that all of it is not charged South West and I believe the North West will to the water consumer. Now you are telling us in the actually be overtaking us. next periodic review you are going to have a huge Ms Taylor: Certainly one of the things that we increase in revenue contributed by the consumer and would interested in is in terms of transparency in that this gives you the kind of return which will allow that we actually need to see who is picking up costs you to present more attractive figures to get a better and why they are picking it up, obviously in relation credit rating because you have got such a big income to customers. I think perhaps another thing that we and therefore to raise your money more cheaply and can explore here as well is that it is at the moment therefore to increase the rate of return to always the water company, perhaps because of their shareholders. Is that not what you are about? I mean history of being able to deliver, who are given the it is a nice little racket. task, if you like, of clearing up the environment and Mr Roberts: No, what we are about is looking to so on and it is then their customers who are given the fund a very significant investment programme. We task of picking up the bill at the end of it. So one of have invested £8.5 billion already. We are looking at the things that I think we need to bring into this probably having to fund between £3.5 and £4 billion debate as well is the question of who pays and where. in AMP 4. What we are trying to do is to fund that in If you look at issues such as the costs that there are Y V the most e cient way that we can so that we actually to customers on the issue of di use pollution, is it keep prices down. right that the customers of Wessex and United Utilities and the customers that you represent Q15 Mr Mitchell: Will the rate of return to should be picking up the bill? We do not think so and shareholders increase? we think that as these prices get tighter and tighter Mr Roberts: The rate of return to shareholders will in terms of what people find acceptable, we are going increase. We have factored in to our plans a rate of to have to face these issues and we are going to have return of 5.75%1. The Regulator assumed 5.7% at to face them as we look forward in issues such as we the beginning of AMP 3. So we are very consistent looked at before such as the Water Framework with the Regulator’s view of the world. What we are Directive. trying to do is to make sure that the preponderant Mr Skellett: Can I just make a couple of points? The majority of the programme will be debt funded, first is that the way that the laws are set at the money that is borrowed over a very long period. moment we are not allowed to cross-subsidise V Normally we would be raising our money over 20 between di erent groups, as you know. South West years and the whole point about preserving the has got a problem because you have got a small credit rating is if, for example, we borrow a billion customer base supporting a very large pounds over 20 years and we lose one notch, the environmental programme. One of the things that credit rating comes down one rung, the additional we tried to do in the Wessex plan is to actually interest cost will have a net value of £50 million and challenge some of things that are being asked for. I therefore what we are trying to do is to get the best think that companies look at things in a diVerent way and I fully expect that as these are draft plans 1 Note by Witness: For the avoidance of doubt, this refers to without consultation they will change. Picking up the assumed weighted average cost of capital for both debt the point about diVuse pollution and the Habitats and equity. 9092591005 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 21
29 October 2003 Pamela Taylor, John Roberts and Colin Skellett balance we can between raising funding from the When I joined United Utilities four years ago we had debt market and supporting this trend through our 7,000 employees, we now have 17,000. Those are balance sheet with equity funding so that we can profitable businesses, but I do agree we should stick overall fund these programmes as eVectively as we to things we understand. can. This year alone we are investing a billion pounds. That is the whole of the turnover of our Q17 Mr Mitchell: Thank you for that reply. Now water business. Very few companies, if any, would moving on to what the Chairman wants me to talk invest the whole of their turnover in one year. That about and that is the investment. You tell us that in is we are called upon to do and we are doing all that London many of the water pipes and the sewage we can to keep the burden to customers as low as we drains are over 150 years old and they are going to can. But, as I was explaining previously, the regional need renewing. Investment in that kind of thing is scenario that perhaps was foreseen at privatisation, something that can be brought forward or pushed that it could all come out the debt market and more back and that depends on the state of finances really. internal eYciency, has really gone as far as it can go. Does it mean that the price cuts in the last review Ms Taylor: Also, at the time of privatisation there period really meant that less was invested in the was virtually no debt in the industry in terms of their assets than should have been? gearing. Now it is around £19 billion. But also, it is Ms Taylor: Yes, and I think it is fair to say that most fair to say that privatisation, the programme that is independent commentators would say that last time now having to be implemented, frankly, was not around the amount of money that the industry was foreseen at that stage. allowed to spend on maintaining the infrastructure Mr Skellett: Just one quick comment about the was squeezed and squeezed too far. So now we are eVects of privatisation; look at the 10 years prior to actually seeing that we are needing to pay for that privatisation and the 10 years post privatisation. because it has also distorted, therefore, the type of Bills prior to privatisation about three times the rate work that companies can do in order to maintain the they have gone up since and since then we have been assets. So rather than having an improved delivering three times the level of investment. programme of replacement it has actually meant Privatisation had made a stepped change in the instead a programme of firefighting, if you like, in investment programme for these businesses. Under terms of having to stop leaks and so on and that, of privatisation the Government raised about £7 course, is not as cost eVective as it should be. So yes, billion (I cannot remember what the number was we are suVering from what happened before last now) all of which came from investors. time around.
Q16 Mr Mitchell: It would be right to think I have Q18 Mr Mitchell: You said “allowed to spend”, touched a nerve, you are all so eager to reply. It is does that mean that what you would spend on asset true the industry has not displayed any dramatic renewal and replacement is strictly limited? skill in diversification because as a consumer of Ms Taylor: It is part of the business plan proposals Anglian Water I have had letters put through the that would be agreed with the Economic box for years saying “Great new management skills. Regulator, yes. We are going to diversify. In Australia we are going to do this, that and the other” and they have all been Q19 Mr Mitchell: You mentioned earlier that the trying to diversify and generally they have made a consumer could not always see a return on muck of the diversification. They are now environmental things. Here is a great big cushion concentrating on the job of accountancy and raising underground on which you can spend as much or as money on the markets. little as you want. I thought it was an ability to fiddle Mr Roberts: The first thing to say is that we ring- the figures. fence the regulated businesses. We have to account Ms Taylor: No. for them separately and there is no cross- Mr Skellett: It is not possible to fiddle the figures and subsidisation. As far as diversification is concerned, the fact remains that it is not just over the last five I agree entirely with your sentiments that you should years. There has been under-investment in the stick to the things that you understand and we infrastructure for many years. The last five years diversify only doing two things. If you are running a made it worse. The last price review was an utility, you are doing two things; you are running a opportunity missed. Had we set stable prices, we big asset base and you have a lot of customers. So we could have started the asset improvement work have diversified in managing other people’s assets. earlier. What has happened is that in the last ten United Utilities manages Welsh Water’s asset base. years a lot of the focus has been on meeting the We have just won a contract to manage Scottish higher standards. We have got to get the focus back Water’s investment programme and we manage to the assets. When you have got assets where we are water businesses in Central Europe. Our customer only replacing pipes 0.6% per annum or 0.4% of management business manages back oYces and, of sewers per annum, it is assuming lives that just course, centres for people like the City of actually do not happen. We have got to put more Westminster, the Department of Work and money into assets. Pensions, Companies House and well known private names like Marks and Spencer. They are both, I Q20 Mr Mitchell: But it will not be the same all over think, successful businesses. Vertex is just recruiting the country, will it? Some areas will have better 1,000 people on Merseyside. It is creating jobs. assets. 9092591005 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Ev 22 Environment, Food and Rural Affairs Committee: Evidence
29 October 2003 Pamela Taylor, John Roberts and Colin Skellett
Ms Taylor: Yes, that is absolutely right. that is for extra money on assets and there is the Mr Skellett: That is why those will probably go up extra taxation, the change in capital allowances that higher in some places. puts about another 3 or 4% on bills.
Q21 Mr Mitchell: Which are the worst oV ones? Q27 Paddy Tipping: What proportion of those extra Ms Taylor: It is a question of history, so generally environmental standards is driven by European speaking inner city areas will have problems. directives? Ms Taylor: It is largely driven by European Q22 Mr Mitchell: Is there a common calculation of directives. how much spending on asset maintenance will have Mr Roberts: It is the Urban Waste Water Treatment to rise? Directive, Fresh Water Fish Directive, Bathing Ms Taylor: That is a good point in that previously it Water Directive and the Drinking Water Directive. has been a question of the water operators saying from our knowledge and understanding of our patch Q28 Paddy Tipping: What input do you have into this is what we believe is the pattern and so this is these directives? what we believe should be in the investment. Ms Taylor: We do not.
Q23 Mr Mitchell: And if we do not get it, our Q29 Paddy Tipping: Why not? performance will deteriorate? Is that the stick? Ms Taylor: If you mean what input do we have in Ms Taylor: Yes. It will not come in in time for this that do we make representations in Brussels, then particular periodic review, but this time around we yes, we certainly do. Because Water UK is only five have done a lot of work with the Economic years old and things come down the line from Regulator and with the Quality Regulator to see if Brussels that are older than five years so, as it we can come to some kind of an agreed formula, if happens now, for example, we are engaged in you like, of parameters within which we can have looking at issues to do with the revision of the these discussions which will make it improved Bathing Waters Directive. We are very active in that quality of discussion, if you like, as we go forward. at the moment.
Q24 Paddy Tipping: Bills are going to go up and you Q30 Paddy Tipping: But at the beginning of these told us that one of the things that is going to drive discussions, the people in Defra and EU say to you it up is asset maintenance. The other area where it is at the end of the day you are going to have to deliver going to go up to meet environmental standards. In this and there is going to be a charge because it is the rough terms, looking at the companies’ provisional customer basically who pays for it. Are you involved bid, what is the breakdown between them in terms in those tail end discussions, implementation of price? discussions? Mr Roberts: It varies very significantly across the Ms Taylor: It has certainly been improved since the regions. United Utilities lies at one end. The vast formation of Defra which has brought together majority of what we are doing is new build, so of the agriculture and the environment and water £3.5 or £3.8 billion investment programme about environment, so that is a great opportunity. What two-thirds is to create new assets to make further we would like to see much more of is a national improvements to meet environmental standards. framework as regards the water industry and the That is a reflection of the fact that we have got the priorities and that framework should be agreed with coastline, we have got a lot of heavy industry sitting Government and representatives of people, behind it and we have got a lot of Victorian sewers yourselves. It should involve NGOs and, of course, in places like Manchester and Liverpool that have it should involve the water sector. We should have got to be improved. far greater clarity as we look much further ahead as regards what is expected of us, when it is expected Q25 Paddy Tipping: So just put that in simple terms, and how much we are going to implement and how this is to reduce discharge basically? quickly. If we could have that kind of stability as a Mr Roberts: It is basically to reduce discharges of framework then within that you could then have storm water. It is to improve the chemical quality of periodic reviews and then periodic reviews, which waste that is discharged. That is about £1,800 are the Economic Regulator, would then be, if you million and about £500 million will be spent on the like, a check on the way to how we are doing. What clean water side which is mainly taking lead out of concerns us a bit at the moment is that the periodic the system. review is really becoming the biggest game in town and it should not be. The framework should be the Q26 Paddy Tipping: So two-thirds of your spending biggest game in town and then the periodic review or increase is around the environment? should be part of that process. Mr Roberts: That is right and I think you will find that there are other companies at the other end, Q31 Paddy Tipping: Putting that in concrete terms, like Wessex. you would want to see the periodic review running Mr Skellett: At Wessex our plan proposes a 12% against, for example, the discussions around the increase over five years. Six per cent of that is for the water framework directives so the timetables were environmental high standards and another 3% of synchronised? 9092591005 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 23
29 October 2003 Pamela Taylor, John Roberts and Colin Skellett
Ms Taylor: Exactly. struggling to get that 99 point whatever it is to 99 point something and a bit, that is a discussion that Q32 Paddy Tipping: I think, Pamela, you said to us needs to be had. earlier that at the end of the day there may be a point where the customers are going to scream and say Q38 Mr Lepper: There seems to a thing running “We cannot pay any more. We cannot deliver these” through what you have been saying; other people and I think you said somebody else is going to have put the muck into the water and you are expected to to pay. take it out. Ms Taylor: Idid. Ms Taylor: Yes.
Q33 Paddy Tipping: Tell me who this somebody Q39 Mr Lepper: How have we got into that else is. situation? Ms Taylor: I want there to be a debate about who Ms Taylor: I think probably because we have been this somebody else is because we never ever want to really rather good at it. get to the stage where our customers are saying “Whoa”. So we admit that we have a responsibility Q40 Mr Lepper: So as long as you keep on doing in terms of stimulating that debate, but we do need it— others to join us in that debate. We have got to look Ms Taylor: That is right, but we are now saying, on at where are the most appropriate interventions, if behalf of our customers, hold on. you like. Where does it make sense? Where is it most cost eVective to say that this is where we should be putting the money and this is where somebody Q41 Mr Lepper: I am glad you said on behalf of should be picking up the bill? It should be your customers. transparent. If, as we have at the moment, water Mr Skellett: Of course it is actually easy to tackle customers are going to go on subsidising farming, point sources of pollution. It is much more diYcult then fine, but let us be transparent about that and do to deal with diVuse pollution. That is why we are not at the moment do what we do, which is just saying that what you need is partnerships together to hide it. tackle this because, as Pamela says, you cannot expect water customers to keep paying for this. Q34 Paddy Tipping: So things like diVuse pollution, There is also an issue about timing of some of these one would use a CAP reform and the kind of things. Although a lot of this is driven by the instruments there to sort it out? European Union, there is some discretion on timing Ms Taylor: Exactly. And that also is an interesting and one of the problems with the five year review is point, you mentioned CAP reform, because of Environmental Regulators feel we have got to pack course if you have the periodic review as the biggest everything into the five years because we might not player in town, then some of those policy levers, such get it. What we ought to be looking at is sensible time as CAP reform, do not belong to the Economic frames that then match sensible price changes. Regulator. He cannot get his hands on those policies, so that is why we are saying that we need Q42 Mr Lepper: One of the comments that the that broader framework where all the other policies Environment Agency and English Nature have which have an impact on the bill at the end of the day made, and this refers to what you just said about that our customers are being asked to pick up. That time frames, is that the preferred strategies that the is why we need all those issues within that water companies have outlined in the proposals you framework. are putting forward would not deliver some of the environmental programmes with some statutory Q35 Paddy Tipping: Let me ask you about drinking obligations and they should be delayed beyond 2010. water quality. Have your companies collectively attempted to Ms Taylor: Fantastic. influence this by leaving out of the package, this time certainly, environmental improvements that were being driven by Europe or by the UK Government Q36 Paddy Tipping: So why are we paying even to implement? You are saying “Hang on, we cannot more? do it because that would mean pushing up the bills Ms Taylor: That is a question of what you pay for. even more”? If it is in order to maintain the pipes so that they can Mr Skellett: Certainly we have done that quite bring it to you, then that is what we are doing. So it deliberately in the case of the Habitats Directive on is a question of there are many reasons why you the Hampshire Avon, not because we do not think it would pay and you heard earlier from John that one is necessary to carry the work out, but we are saying of the things is continuing to take lead out and so on. let us be sure we have got the cost benefit right and let us be sure we have got a comprehensive Q37 Paddy Tipping: Is there a point where the programme that deals with diVuse pollution. investment is not worth putting in any longer? Because what is the point of us spending £54 million, Ms Taylor: That is certainly an issue that needs to be £2 million of operating costs, and using an extra 170 discussed, particularly as many of us are involved tons of ferric sulphate every year, adding to the next week in looking at bringing drinking water to carbon dioxide burden, if all we get at the end of the developing countries and if you look at how we are day is we have taken ours out, but it is still eutrophic 9092591005 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Ev 24 Environment, Food and Rural Affairs Committee: Evidence
29 October 2003 Pamela Taylor, John Roberts and Colin Skellett because of the diVuse pollution. All we are saying is these issues. We have been pleased that there has let us get a sensible, agreed programme that deals been a clear signal from Ministers within Defra that with the totality of it and not just with the water bit. issues such as diVuse pollution have got to be addressed. Naturally we are extraordinarily Q43 Mr Lepper: Is what you have just said included impatient for this to be done. in the 21 environmental schemes that English Nature say you have left out of the water Q46 Mr Lepper: In terms of discussions about EU programme? directives, in particular, what we have found in Mr Skellett: Not so. There are two things that we previous inquiries into other issues is that sometimes have left out at the moment. Bearing in mind, as I the companies like yours out there doing the said at the start, these are draft business plans that business of producing something or delivering are out there for consultation, I have to say we have something are not perhaps as involved as early as deliberately taken the line that we should not just say possible in discussions with Ministers about the EU “Tell us what to do and we will pass the price on to timetable that is rolling forward as they might be. customers”. We have said “Let us actually look at Ms Taylor: That was certainly the case in the past. each of these and make sure that it is going to deliver benefits to customers and let us have a discussion Q47 Mr Lepper: In the past, but it has improved? about it”. The two things that we have left out; one Ms Taylor: It is improving. is the phosphorus removal and it is left out at the moment pending getting some better understanding, Q48 Mr Lepper: In terms of you are now engaged in and the other one is that there is a technical issue a tactical thing about “We are not going to do all of about flow consents where improved information this now. We are going to decide on the timetable— about flows to sewage treatment works has shown Ms Taylor: We are not able to do that. that some sewage treatment works are technically Mr Skellett: We are not able to decide, the decision exceeding their consent. It has not changed one jot will be made by others. We are just saying before the the amount of pollution that is going into the river, decision is made, let us be sure we have asked the the river is still satisfactory. We are saying “Hang on questions and got the right answers. a minute, is it worth spending £30 million on this? Why do we not just have a look at the consents and Q49 Mr Lepper: What I was coming to is; is there make sure that it is actually having an impact on the still a stronger role for Defra to play in bringing river water quality?” So it is things like that, but together yourselves and whoever else needs to be there are not 21 items that we missed out. There may brought together to discuss these issues? be 21 aspirations that English Nature has. Ms Taylor: Yes, definitely there is a stronger role for Defra to play. Q44 Mr Lepper: Aspirations, but not things that you consider are essential to be done? Q50 Alan Simpson: A number of the environmental Mr Skellett: Not things that we are required to do. organisations that have contacted us on this have We are very happy to discuss them and we are raised their concerns about what they refer to as meeting with English Nature to discuss their “nutrient soup”, that level of pollution of fresh water aspirations. We want to get a balanced programme. and saying that much of this relates to your own The point I make is that this balanced programme discharges. In fact, the RSPB were quite specific has to have a sensible time frame that is aVordable about this; they say more than half of the polluting by customers. levels of nutrients present in our waters can be traced Ms Taylor: That underlines Colin’s point about how back to water companies’ sewage discharges. How inappropriate it often is that you have a periodic would you respond to that? review and five year chance because it means that the Mr Roberts: I think in part that really picks up the Environment Agency is often put in the position of point that we have already made about having to saying this is our chance, whereas if we were able to treat diVuse pollution, but nevertheless there is have that longer time frame, the Environment significant investment going forward in additional Agency and the others who would need to work treatment. In the case of my company, we have a lot together with Colin and his team would be able to of very dilute sewage that does contribute to rivers say “Here is the issue we need to address; what is the that are eutrophic and we have got a programme of time frame for addressing it and what is everybody’s work to remove that. What it then means, in fact, is responsibility in addressing this?” That way we that we create a lot more sludge. So then we have got could actually deal with the issue sensibly and the to make even further investment to deal with the cost to customers would not be as high. sludge that is created. But I think it is more a reflection of the waste that we have to treat rather Q45 Mr Lepper: I think you said earlier that in than being a creation. relation to EU directives that since Defra was set up Mr Skellett: Let us go back a step. River water you thought you were a little more involved in quality UK is better now than it has ever been. We discussions about these things? have made enormous progress. Yes, there is more Ms Taylor: Yes, we are certainly saying that since that needs to be done and particularly to deal with Defra has been set up and since it has brought nutrients and work is going on during the current agriculture within the remit that certainly it is very period and work will go on during the next period. much easier for us now to talk with Defra about It is again a question of the rate at which you want 9092591005 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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29 October 2003 Pamela Taylor, John Roberts and Colin Skellett to do it compared to what people are prepared to to deal with low flows. We sat in Michael Meacher’s pay and how you deal with diVuse pollution because oYce and he said “We definitely will do this” and it we come back to the point that was made about the was taken out of the programme. So yes, had you Hampshire Avon; even if you did take every bit out done everything that was wanted, prices would have from our sources, there is still suYcient in from gone up, but the Regulator chose not to do that. My diVuse sources to cause a euthrophication problem. own view is that it was a mistake because I think we Ms Taylor: The water operators in England and could have delivered even more. We could have dealt Wales are the biggest environmental organisation, if with the nutrient issues, we could have dealt with a you like, in Europe in terms of spend, in terms of lot more issues had the Regulator allowed the outcomes, in terms of success and if it were not for industry to go ahead with its planned programmes. the water industry no other environmental group or But it was not a question of scaremongering, it was the Environment Agency would be able to claim the saying “If that is what you want to do and you want successes because we are delivering them. to maintain the assets, here is the consequent price increase” and that is the same thing that is being Q51 Alan Simpson: Yes, but do you understand the said now. level of public cynicism about the industry? Last time there was a periodic review, the representations Q53 Mr Jack: I want to pursue with you the made by the industry in 1998 were that this whole question of the veracity of analysis you have done in commitment to take on board environmental clean justifying the cost increases. You deal, as an up obligations was going to be at an exorbitant cost industry, in billions of pounds which are probably for marginal environmental gain and would have to beyond most people’s comprehension. You deal in a be managed by huge price increases. Those were the massive scale of projects the engineering of which is scaremongering warnings and representations that most impressive and daunting. A lot of what you do the industry made and many of the comments that we cannot see because it is underground, it is in a we get in Parliament says that, contrary to what sewer or in a pipe. So you have to take an awful lot Austin was suggesting, you should just concentrate on trust that when you say you are going to do things on what you are good at, that is what you have been and it will cost whatever it is, that that is what it is. doing. You have been very good at identifying So give us some information as to how we can trust money for old rope. And if society wants to get you the numbers which the companies have put up to say to perform, the best thing to do is not give you this is how much it is all going to cost. money because only then can you be required to Mr Roberts: There are three points I make. First of pursue the environmental gain that we want out of all, we are looking to meet environmental standards your own resources rather than being financial that have been set for us to meet. We have not cushioned by an absolute safe as houses industry. selected those ourselves. When we then look at the People will forgo some other thing, but no-one is investments that we need to make in plant and going to turn round and say “I think we will skip equipment, those plans are independently drinking water this year”. You have everyone over a scrutinised by an independent reporter who reports barrel and you screamed blue murder at the last to Ofwat. Thirdly, the actual costs that we use in periodic review that the targets that were set could pricing out those plans, certainly in the case of my not be delivered without huge price increases. company and I am sure it is the same in the case of Ms Taylor: That is not true. Actually, to be honest, Wessex Water, are based on a database that we have the picture you paint I do not recognise. So I can of actual prices and costs that we are experiencing at only assume that you are not referring to any of us. the moment. Certainly in the case of our programme In terms of the actual outcomes that we have our independent reporter has reported to Ofwat that delivered on behalf of the environment, as I say, our the solutions that we are looking to put in place are record is absolutely outstanding and that is what we sensible, that they are robust and that they represent are saying we would like to safeguard and then current best practice sensibly build on, but we will need to do that in partnership. We cannot do it on our own. Q54 Mr Jack: Let me just ask you this; you have given a very precise answer to my question, but in Q52 Alan Simpson: I think the point that you have paragraph 4 of the evidence from Water UK you say to come back to is to say the representations made the following about these plans, which is identified by the industry in the 1998 periodic review were that to us, are worked out in great precision to standards none of the gains that you have actually delivered which other people set subject to independent could be delivered without substantial price scrutiny, costs from a database. Why then do you increases. say they are the basis for further discussion and Ms Taylor: I am so sorry. debate with stakeholders both national and local Mr Skellett: What the industry said last time was; if level? Because that gives the impression that this is you want us to do all the things that need doing and actually the opening shot to a great bargaining are being asked to be done, there are going to have exercise rather than anything else. In fact it is to be price increases. What the Regulator said was; noteworthy in United Utilities’ own evidence in we will not do some of them. So the amount of paragraph 14 where we have Ofwat Plan A, Ofwat money spent on sewer flooding was cut back, the Plan B, if you add together these two it comes to amount of money spent on asset maintenance was nearly 24%, divided by two the average is 12 and cut back. Wessex Water had a £110 million scheme remarkably the United Utilities plan comes out at 9092591005 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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29 October 2003 Pamela Taylor, John Roberts and Colin Skellett
12%. So I am just wondering if there is not a little bit Q57 Mr Jack: I was actually interested in the of horse trading built into this and it is not quite as United Utilities plan because what intrigues me is if precise as you give the impression. Plan B, which is the bells and whistles version with Mr Roberts: I do not think it is necessarily a case of the Environment Agency added in, is 13.1, one horse trading. What we have done is priced up to a might argue that you are actually getting rather set of basic common assumptions that were given to good value at 12%. You could look at that, but on us by Ofwat. the other hand there do seem to be things which United Utilities, because of for example this historic Q55 Mr Jack: Is that Plan A and B? Tell us about deficit, would like very much to do and I am not Plan A and B. quite clear whether they are included in that as well Mr Roberts: Plan A is statutory minimum that we or are there some more costs to go on top of these are told that we need to do to conform with the various plans? relevant legislation between now and 2010 and that Mr Roberts: No, there are no more costs to go on top is what is called “essential and clear”. So we know of those plans in terms of what we are seeking to do. what it is we have to do and we are told we have no The Plan A is the statutory minimum which we were choice, we have to do it to conform with all the given and, as Pamela said, we costed it on the basis relevant statutes. Plan B, if you like, starts from that of our current costs and that is the result. base of “essential and clear” that adds what, in the Mr Skellett: Can I just pick up the point about can opinion of the Environment Agency and other we delay things and can we slide things out? The quality regulators, will be additional but not answer is no because we are inspected and we have absolutely mandatory improvements. If you like to deliver things to time and if we do not deliver them they are “nice to have” rather than “essential to then we get penalised. So it is not a question that you have” where the case is perhaps not necessarily can sit there and say “Let us plan to do it now and proven. So we have priced our Plan A and that gives we will do it a few years later and save the money”. us a price increase of about 10.5%. We have priced We cannot do that. our Plan B which gives us a much higher price increase. Then we have been asked to price out our own preferred plan. In our case the discretion that Q58 Mr Jack: Let me just pursue paragraph 30 of we have exercised is not in what we are actually some evidence that the Committee received from going to do, but in the way in which it will be V Water Voice. I was very interested in John Roberts’ financed. Where we would di er between ourselves comments about the fact that from the point of view and Ofwat is that we believe that we would need of actually raising money, in the case of United slightly more robust financial indicators, financial Utilities they may have lowered the price of money, ratios in the business to enable us to maintain the but in Water Voice’s concerns they are worried optimum funding profile which is the diVerence about the range of size of companies and therefore between the 10.5 and the 12. However, can I just V make the final point, to go back to my initial the di erent costs of capital that are involved in this. observation, these plans have been put together Perhaps you would like to give some commentary in based on common assumptions that were given to us overall terms as to whether in fact the industry is V Y by Ofwat and, for example, do not assume anything raising its capital in the most e ective and e cient other than that funding. As I already explained to manner possible because clearly this does have a V the Committee, we have had a rights issue. That will significant e ect on the cost of the works that you help to reduce our prices. There are other aspects of are undertaking. this plan that are still subject to debate. Is everything Mr Roberts: I can only speak for my own company in there absolutely required in the next five years? obviously, but in terms of our funding strategy we do Could some of it be deferred a bit further out? So try to make it clearly as eYciently as we can. If we there is scope for discussion and debate and that will look at the costs in the business, interest cost is one take place over the next six months. of our biggest single items of cost, it is about £250 million a year, and everything we can do to minimise Q56 Mr Jack: But the temptation for you to put that therefore is very important. Hence, as I have already explained, we have looked to strengthen our things in there which, if you like, you could then just V ever so slightly shift to right in terms of time because balance sheet so that we can borrow as e ectively Y you are a company, you are a PLC, you are a quoted and e ciently as we can. We borrow large amounts company, the returns you make are important to of money over long periods of time. We access the your stock market rating. That rating aVects your American market, the European market and the creditworthiness and the cost of raising capital. So Japanese market and we are always looking to the temptation to sort of shove a few things in there borrow on the very best terms that we can and as which can be leeched out later on, is that something eYciently as we can. The size of the business helps that you succumb to or are these absolutely the but also the fact that it is a regulated business and necessities? therefore it is perceived—one of the greatest Mr Roberts: Those are the absolute necessities in underpinnings we have is the fact that Economic Plan A because we were told what to put in there. We Regulator has to ensure that we are capable of did not choose them. financing our functions. That of itself helps us to Ms Taylor: We did not write Plan A. We had to have a strong credit rating and therefore to fund the cost it. business as eYciently as we can. 9092591005 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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29 October 2003 Pamela Taylor, John Roberts and Colin Skellett
Q59 Mr Jack: Can you just give the Committee Ms Taylor: We have taken 25% out. I think going some kind of flavour as to the nature of those who forward that will taper oV quite significantly. I do inspect and assess what you are doing? Because they not actually have the precise numbers to mind, but if have to deal with, relatively speaking, a large you want me to we could give that to you in a written number of complex companies undertaking very submission to the Committee. complex tasks against the background of sometimes diYcult to understand directives and statutory Q65 Paddy Tipping: What about Wessex Water? requirements. It is a pretty daunting task to know in Mr Skellett: We are actually at the moment the the nicest sense to meet these requirements whether leading company on eYciency. We have taken more you are having the wool pulled over your eyes or not. out than anybody else and we are recognised by Tell us about the people who inspect and adjudicate Ofwat as being the most eYcient. We believe that on your industry. there is always the opportunity to take more costs Mr Skellett: We have essentially got two groups who out, but it clearly gets more diYcult. There is also an are actually responsible to Ofwat and they come issue that a chunk of the costs that you have got are from consulting engineers and they come from actually not in your hands; the cost of extraction auditors and those two groups together inspect what licences and rates and all of those things. So what we we do, go through the plans, go through the built in is that over the five year period we will take proposals with a fine tooth comb, make sure that another 5% of costs out. there is no fat in them, make sure that the costing is properly based, make sure those are delivered and Q66 Paddy Tipping: 1% a year? this is done in a great deal of detail. Mr Skellett: Yes, each year we will take another 1% out and we will also eat the extra 1% of cost that comes in because that cost actually rises faster than Q60 Mr Jack: For example, do you they go through RPI because of the cost structure that we have and it at random and say “I want to go and see that we will absorb that as well. So we are expecting to project” and go and have a look? continue to take costs out. Ms Taylor: Yes. Q67 Paddy Tipping: So are you telling me that your Q61 Mr Jack: There must be some inspectors real inflation costs are more than RPI? behind you, there are a lot of people nodding there. Mr Skellett: Yes. So that must be very good news. Mr Skellett: I think they are here to inspect us. Q68 Paddy Tipping: Can you drop us a note on that as well? Mr Skellett: Yes, we can. It is actually partly covered Q62 Mr Jack: It is nice to know who is going in and in our submission as well, but I will get you a note. looking down the sewers of Manchester or London or wherever. Q69 Mr Jack: I understand, again from evidence Ms Taylor: They do. that we received from Water Voice, that London Economics are producing a report for Ofwat on your Y Q63 Paddy Tipping: Can I just ask you about the e ciency which is supposed to be published later submission you make about eYciency in the draft this year. Have you made a contribution to that? Ms Taylor: Yes. plan? I think, Mr Roberts, you were saying earlier on it gets harder and harder to make eYciency savings. Q70 Mr Jack: What have you contributed to it? What did you say you were going to do in the last V period, have you achieved those savings and what Ms Taylor: O the top of my head, I am very sorry, are your projections for the next period? I cannot tell you but I can let you have that. Mr Roberts: In the present period that we are in, AMP 3 period, the target that was set for us was to Q71 Mr Jack: It would be nice to know what story Y reduce our costs by £300 million cumulatively over you are telling them about e ciencies. I presume the five years. We believe we will be ahead of that, that this document will be published before the die is probably round or about 10 or 15% ahead of that. finally cast. We will take more cost out. Going forward, we built Ms Taylor: Of course it will, yes. And I will let the into the plans further eYciencies not as great as that Committee have that. because this you are taking about 25% of our operating costs and going forward we think the Q72 Mr Jack: Just one quick question to John opportunities are limited. We still built in more Roberts. I wanted to know whether you thought the V eYciencies. If you are looking in terms of the water current tax write o situation for long life assets was bill, about 10% reduction, but then that is more than set at an appropriate level? overtaken by the additional costs. But we are still Mr Roberts: We are going to have change in the looking to try and take more costs and be more rules. At the moment we are able to expense eYcient go forward. replacement expenditure for tax reasons. In accounting terms it follows the life of the asset. That will change and that is part of the changes. I think Q64 Paddy Tipping: Could you express that in you have to really stand back and look at that in the percentage terms? much broader terms of tax policy and getting more 9092591005 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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29 October 2003 Pamela Taylor, John Roberts and Colin Skellett coherence and unification across the tax regime. I do Framework Directive. This is an issue that we raise not think I am properly qualified to tell you whether with Ministers constantly and we will do so. So in all that is the right thing to do or not. Again, it is our written submissions we raise it and we have also something perhaps we could return to by way of raised it in terms of this process which we are going written evidence. through now, namely the periodic review process. As we were saying earlier, we are very conscious that Q73 Alan Simpson: The Public Utilities Access our customers are having to pick up bills that they Forum have raised concerns with us about what they should not have to be picking up. This is something refer to as “water poverty”. If the industry were that we will continue to raise on our customers’ given approval for the price rises that you are behalf because it is not fair that they should be seeking, what assessments have you made about the doing it. numbers of households that would be thrown into water poverty? Q77 Alan Simpson: I know this sounds really dumb, Mr Roberts: Broadly speaking we think that, from but I just have to push it. I know that you say that our perspective, debt will rise broadly in parallel you raise it, what are the specific proposals that you with the increase in prices. So at the moment we are are making? looking at something like £20 million a year debt Ms Taylor: It depends on the issue that you are write oV and about another £10 million a year of looking it. For example, if you are looking at the additional costs of managing debt. We run Water Framework Directive, then what we are programmes for vulnerable customers to help them saying is that we want to see joint research involving manage their debts. We have schemes, for example, the industry as well, looking at where it would be where for every pound they pay to reduce debt we most appropriate to make those interventions put a pound in and match it as well. I could not give because at the moment we are saying that there is no you precise numbers as to what will happen to the transparency as regards cost, that what we are seeing population in terms of customers who have is that the cost is passed on, pollution is dealt with increased diYculties paying their bills, but I would and customers pick it up at the end of the day. We think that broadly it would rise in line with the rise are saying that no, we do not have the answer in prices. because nobody has the answer right now. We are saying that the research needs to be carried out and Q74 Alan Simpson: Another representation that we it will have to be carried out issue by issue, point by have had from Dr Noel Olsen suggested that there is point. At the moment it is in the tray marked “too a huge inequity in the way that the costs of diYcult”, but it has got to be addressed. obligations that you are faced with are then passed on to the consumers and specifically he says that, as Q78 Alan Simpson: I was wondering whether you a Government and an industry, we have just were going to nudge this across to John Roberts abandoned the principle of the polluter pays. Have because part of the question is to what extent would you made representations about this? the industry want to be urging an extension of Ms Taylor: Yes. responsibilities and powers to companies to develop a much more intrusive role in land management Q75 Alan Simpson: Because if the impact of those strategies? cost changes produce massive social injustice, how Ms Taylor: That is certainly an area where we have do we justify something that hits at the poor, who is also given evidence in that we have said that we the consumer, and just lets the polluter, who is by ought to be, for example, strategy consultees when it and large in a much wealthier position to be paying comes to planning and so on. We also would like to the costs, completely oV the hook. see a review of the powers as regards land Ms Taylor: Yes, that is right and that is a point that management. We have also looked at issues, for Dr Olsen has made on many occasions and with example, to do with flooding and we have which we agree. We have worked tirelessly to encouraged Government and NGOs to work with us encourage this issue to be addressed because on those issues. As a result of a recent workshop we obviously it is not an issue we can address, others did on flooding, we then came out with the raft of have to address it. We will continue to work proposals as well. So what we have tended to do, tirelessly to do that. We are going to have to because if you just say to people “Sort diVuse address it. pollution”, the mind goes “Cannot do it”, so what we have tried to do is to issue by issue. Q76 Alan Simpson: Can you be specific about the Mr Roberts: If I could add one small practical suggestions you are making? Because it seems to me observation, Chairman, because United Utilities is that neither water metering nor pricing based on one of the biggest landowners in the North West. We rateable values has anything to say about the own 140,000 acres because of ownership of the polluter pays principle and deflecting the cost impact reservoirs. Half of that is farmed by tenant farmers away from the point of water consumption and and we are working with some of them and with towards the point of pollution creation. RSPB to see if we can cut down diVuse pollution in Ms Taylor: Yes, we raised this issue. For example, the agricultural process. So we are working with Defra have just issued their third consultation on the some of our farmers to help them with techniques to Water Framework Directive and so we have raised use less pesticides, fewer fertilizers. In return for it again with part of our consultation on the Water doing that and making that investment we charge 9092591005 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
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29 October 2003 Pamela Taylor, John Roberts and Colin Skellett them less rent because we work on the basis that if milestones and a check along the way to how we are they do not pollute so much, then we do not have to doing rather than big debates should it be customers pay so much to clean the water and it works. We are this time or should the environment win this time. looking to run that across the whole of our estate. I That really does fly in the face what we are talking oVer that as a modest example that if you can get a about, which is sustainability as we go forward. bit lateral with your thinking it can be done. But we do not have the powers, and I do not really think we Q81 Chairman: I picked up from what Mr Skellet would want to have the powers, to enforce that, but said earlier that there is a concern that some of the it just demonstrates that when we get down to it environmental measures, the ratio between cost and there are ways in which we can tackle this problem. benefit, has not really been worked out eVectively. We all live in the age of the precautionary principle, Q79 Chairman: Extending the lateral thinking a bit perhaps we need a proportionality principle as well. more and joining it up, as it were, when we get so- Do you think that we already have or may be in called shallow environmental schemes under the danger of simply seeking to refine it to such a degree current proposals for agriculture, there ought that the actual volumes of money required to achieve perhaps to be a component there of farming on the a measurable or minimal result need to be borders of water courses, for example, to try and addressed? eradicate the pollution. Mr Skellett: I certainly do. Ms Taylor: Yes, that is right. We have got a joint workshop with the NFU coming up in a couple of Q82 Chairman: Is there a mechanism within the way weeks time on addressing these very issues as well that things are negotiated in Brussels whereby you and helping hard pressed farmers who, frankly, do can do that? not want to know at the moment and actually Mr Skellett: I think we can try to influence Brussels, demonstrating to them that if we can help them, they but there are also things that we can do here because can help us. there is discretion about how these things are implemented and particularly about some of the Q80 Chairman: I have one final question for you. time scales. Some of the things we cannot. Some of You said earlier on, Ms Taylor, that the present the things are absolute time scales but they are not periodic review worked well originally but now things where we do have discretion. I think we need things have moved past it and we need a diVerent to start from what can people aVord and what are mechanism. You say it does not provide an eVective they prepared to pay for and then what are the mechanism for dealing with issues which are long priorities within that. It may be that we do not do term or require co-operation with other agencies. some of the things right now, we do some of the Could you outline what mechanism you would have things later. Part of the problem is that there is this in mind which would solve this? Because the view that we have got one set of customers who are Director General of Ofwat is going to be before us only interested in price and then others only next week and I will want to ask him the same interested in the environment. Of course customers question. You might want to give the briefest outline are interested in both. They are interested in a now and perhaps a fuller one in writing. balance. That is what we need to achieve and the Ms Taylor: With pleasure. What concerns us is that regulatory system, I think, has worked extremely the periodic review was devised at time when the UK well over the last few years to deliver real benefits. was an island and the decisions were taken within the Now is the time just to say can we now bring it UK and issues were addressed within the UK but, as together more so that we have a co-operative your Committee has been exploring with us this framework to making these decisions and it does not afternoon, now the drive is for the environmentalists become this sort of five year battle between we have and just about 100% coming from directives that we got everything we can in for the environment and we are seeing coming through from Brussels. The have got to get the biggest price cut we can because periodic review process is not designed to cope with that is not helpful. the complexities of that and the time scales with that. We have got almost the crude five year pulling the Q83 Chairman: Thank you very much. You passed plant up, inspecting the roots and putting it back on three questions. So you have a written reply to Mr again and then let us see where we go from there. So Jack and also the last one for myself. So if you could what we would like to see instead is an agreed that, that would be helpful. If there is anything framework regarding the priorities of the water further which you want to let us have which you wish industry, what they should be, and this framework you had said or you feel that clarification is needed, should be agreed in consultation. It is not something do not hesitate to get hold of us because it is not that should be done quietly, it is something that Blind Date here. We are very grateful for your should be agreed in consultation involving people evidence. Thank you very much. such as yourselves, NGOs and others. Then we Ms Taylor: That is very helpful. Thank you very could use the periodic review as, if you like, much for all of your time. 9092591006 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Ev 30 Environment, Food and Rural Affairs Committee: Evidence
Supplementary memorandum submitted by Water UK
Efficiency Savings The committee asked what involvement does Water UK have in the London Economics report on capital and operational eYciencies commissioned by Ofwat and due to be published later this year [para 28 of the Water Voice evidence]. Ofwat published initial research on the scope for further eYciency earlier this year conducted by Europe Economics (see para 3.64 of Ofwat’s “Overview of companies’ draft business plans” published in October 2003). Water UK had no involvement in this work but we have published a critique of this work prepared by NERA and a letter to Ofwat on our website. Water UK has been consulted on the terms of reference for the London Economics work, and has commented on them. Water UK has a representative on the group that is steering the project. We await with interest the outcome of the research. The committee also asked for further information from United Utilities and Wessex on the issue of whether it is indeed harder and harder to achieve eYciency savings. Under the RPI-X regime the X represents improvements in addition to the productivity improvements already in RPI for the wider economy. Commentators like Europe Economics suggest that a large part of X represents a “privatisation” eVect. Water UK’s view is that by 2005, some 15 years after privatisation, this eVect will have been exhausted. The Wessex submission (para 24) indicated the extent to which certain cost drivers specific to the industry have been rising faster than RPI. In AMP4, United Utilities have assumed opex eYciency of 1% per year and capex eYciency of 4.4% over AMP4. Taken together these eYciencies will reduce costs by over £300m in AMP4. In AMP4, Wessex have assumed a target of 0.75% split 80/20 customer/company, capex eYciency of 8% on capital maintenance and 4.4% on capital enhancements.
Taxation The committee asked about the impact of possible tax changes. At price reviews, water companies forecast how much they expect to pay in corporate taxes, and these costs are funded directly through price limits. Generally water companies have paid a lower than average corporate tax rate because the huge size of the investment programme relative to taxable profit means they have been able to claim a high level of capital allowances. The benefits of this lower tax rate have been passed to customers via the price setting process. However a number of accounting and tax changes are expected to increase the eVective corporate tax rate in future. Some but not all of these have been included in the draft business plan costings [see Ofwat evidence paras 14 and 15]. Water UK has kept in close touch with Defra, HM Treasury and Inland Revenue oYcials about the impact of these changes on prices to customers. The first of these is the “deferred revenue” change stemming from the Inland Revenue’s Tax Bulletin 53 article of 1999. This article establishes the principle that the tax treatment of certain expenditures should follow the accounting treatment. It implies that some expenditure previously “expensed” [written oV 100% when incurred] would instead be depreciated by, say, a percentage figure depending on the expected life of the asset. This change eVective from April 2005 brings the water industry into line with other sectors, which have complied since 1999. As Ofwat indicates the average eVect on prices is of the order of 3%, but the impact varies between companies, ranging from close to zero to 6.5%. The second change is the implementation of international accounting standards in the UK (as described in the Accounting Standards Board’s FRED 29), with eVect from 2005. This will prevent, we expect, the continued use of infrastructure renewals accounting by water companies in preparing statutory accounts [even though Ofwat plan to continue to use it for price setting purposes]. This will imply, via the Tax Bulletin 53 principle that tax follows accounts, that expenditure on underground assets will also not be expensed for tax purposes. This has a further impact on prices that has not yet been quantified by all companies in their draft plans [Ofwat evidence para 15], but current indications are that it could also have a sizeable eVect. The third change that may have an impact on prices is the HM Treasury consultation on reform of corporation tax, the second round of which is currently under way. 9092591006 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 31
This may lead to the abolition of capital allowances altogether, and their replacement by accounting depreciation. Given that the water industry tends to invest in long lived assets, long lived relative to the implicit asset lives used to set capital allowances, a further increase in prices would result of the order of a further 3% or £200m per year. The outcome of this consultation is not yet clear, nor the timing of the change, although it is likely to occur before 2010.
Who Pays for Investment
The committee asked a number of questions about the issue of who pays for investment, including asset maintenance and environmental improvement. Water prices are set so that customers pay for the services that they receive. This includes the use of the assets that provide those services—an important element of cost since the water industry is very capital intensive. Prices include an element for the depreciation of those assets which is used to fund repair and renewal. The main policy issue here is the distribution of those costs between current and future generations of customers—the use of depreciation [rather than forecast spending] to set price limits implies little or no cross subsidy between generations. New investment to enhance services is funded by new money derived from the capital markets, and provided by debt and equity investors. Shareholders provide funds in return for dividends, and banks and bondholders provide funds in return for interest. These enhancements benefit not only this generation but also future generations, so it is right that the financing costs are also shared between generations. The capital markets are the only sources of funds in practice—there is very little element of subsidy from government, just some grants for a part of the cost of installation of national security measures. The EU provides no support for the England and Wales water industry although companies can borrow from the European Investment Bank for projects that support European policy at slightly discounted rates. This is in contrast to other European countries where public sector water infrastructure receives significant grants and assistance. Drinking water quality and environmental quality improvements are all obligations imposed by government. Since these investments are all funded through price limits set by Ofwat there is an implicit tax on water customers to pay for these improvements. Water Voice has called for part or the whole of these to be funded out of general taxation, or by polluters. Water UK does not take up a policy position on this matter, because it is for government to consider how the burden is distributed between consumers, taxpayers and polluters.
Asset Maintenance
The committee asked questions about the funding of asset maintenance. Water UK and its members believe that asset maintenance has tended to be squeezed in previous price reviews because of other priorities, notably the requirement to invest in quality and environmental improvement. In the last price review, for example, companies put forward proposals in their business plans costing about £8.3bn in 1999 prices which were reduced by Ofwat to £6.4bn allowed in price limits. The issue of whether there is suYcient allowance for asset maintenance was debated in the Environmental Audit Committee inquiry into water pricing and the environment. The EAC report published in November 2000 concluded that “This Committee believes that this approach [Ofwat’s “no deterioration” approach to assessing maintenance needs] has amounted to intellectual neglect of this problem” [para 209 of report]. Since the last price review the industry has taken the lead in setting up research conducted jointly with the regulators into developing a new “common framework” approach to assessing requirements. This approach is supported by all the regulators and has been implemented for the first time in preparing draft business plans. Water UK is pleased that Water Voice has supported maintenance of existing services as a priority for this price review. However we are disappointed that Water Voice has queried the variations between companies in proposed spending—these reflect the historic endowment of assets, geography and geology. In fact there is an error in para 11 of the Water Voice evidence to the committee; South West Water has not proposed a reduction of sewerage maintenance spend of 75%, instead the company has proposed an increase of the order of 150%. 9092591006 Page Type [E] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Ev 32 Environment, Food and Rural Affairs Committee: Evidence
Reform of the Price Setting Process The three main elements of Water UK’s proposals for reform are as follows:
Long-term view First, we believe that price setting should be placed within a long-term forward looking framework. Planning to cope with climate change, population shifts, reinforcing security of supply and implementing European Directives that have diVerent timeframes from Ofwat’s periodic reviews are just a few of the issues that require such an approach. At present, companies do submit water resource strategies to the EA and Ofwat which take a long-term view. However, the funding mechanisms currently in place do not support the strategies. Nor does the funding mechanism facilitate the development of joint resources such as a shared reservoir facility. Demand management is a vital component of these strategies but there is no funding for large-scale pilot schemes, which also might best be carried out across company boundaries. The new approach to asset maintenance under the common framework, agreed by regulators and companies, is a step in the right direction. It should be extended to all the other key elements, in particular the quality and environmental programme and the implications for financeability of investment. This is not a recommendation about the time period between price reviews, it is a proposition about the length of time over which one looks forward. Within such a framework price reviews at regular intervals serve as a regular check on progress. There are advantages and disadvantages with altering the five yearly review period, but they are not considered here.
Water forum Second, a national consensus on what the water industry is expected to deliver should be built up, particularly in terms of achieving wider social and environmental objectives. Defra’s own document “Directing the Flow” provided an excellent starting point for considering water in a wider context. We think the best way of building a consensus for the future is not on a piecemeal basis, as happens now, but by means of a stakeholder forum. The Scottish Executive has just set up such a forum to handle the Water Framework Directive. Water UK has pressed Defra for such a forum for England and Wales but with no success. The forum would need the active participation of other Government departments, as well as Defra, and the wider stakeholder base. In practice, at regional level, some water forums are already developing, particularly in water stressed regions.
Policy instruments Third, greater use of policy instruments or levers outside those available to the water sector, or to Ofwat, to influence the behaviour of those influencing the quality of the water environment. This includes better land management techniques, greater producer responsibility, as well as new taxes or charges based on the polluter pays principle. One of the most challenging issues for the water industry currently is deterioration in raw water quality, primarily through diVuse pollution. It is estimated that dealing with diVuse pollution, just from agriculture, costs £7 per customer per year. A better and cheaper approach would be to have a multi-barrier approach to water safety within a catchment. This would fit in well with the Water Safety Plans proposed by WHO. In practice this would include the use of measures such as fences to protect streams from livestock, reed-beds, weirs, up-stream testing points, and for transport; oil-traps for surface run-oV, reviews of the composition of fuels and tyres. Small actions are needed between the source and the tap by a variety of players. Many of these actions are outside the direct control of the industry and are not activities that would be funded by Ofwat. A water forum could help to agree approaches and debate how these might be funded. CAP reform and WTO policy are levers that could be used by Government to put the right instruments in place. The water industry is already involved in a number of voluntary, but unfunded, initiatives with other sectors. The Voluntary Initiative on Pesticides is co-funded by the water industry and the Crop Protection Association. It is working with farmers in seven pilot catchments across the UK to reduce the impact of pesticides from farming on raw water. A similar project will be set-up to deal with amenity pesticides, such as those used by local Councils to manage road embankments and verges. There is already an agreement in place with Network Rail on spraying trackside land holdings. Wessex Water tried to set up a scheme to control nitrates at source. They oVered to top-up the Government’s organic farming payments scheme in exchange for management contracts with farmers. This project foundered because the payments scheme ran out of funds. 9092591006 Page Type [O] 12-12-03 00:06:04 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 33
It is generally agreed that Sustainable Urban Drainage Schemes, SUDS, are in many circumstances a pragmatic and cost eVective approach to dealing with urban drainage. However, their wider take-up is hampered by a lack of policy ownership and a resulting failure to resolve a range of financial, legal, ownership and taxation treatment issues. November 2003 913063PAG1 Page Type [SE] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Ev 34 Environment, Food and Rural Affairs Committee: Evidence
Wednesday 5 November 2003
Members present:
Mr David Curry, in the Chair
Mr Colin Breed Diana Organ Mr David Drew Joan Ruddock Patrick Hall Alan Simpson Mr Michael Jack Paddy Tipping Mr David Lepper Mr Bill Wiggin Mr Austin Mitchell
Memorandum submitted by the Environment Agency
Summary The water industry periodic review is the country’s single biggest programme for enhancing the quality of the environment. It has delivered huge improvements. It has enabled the UK to meet its environmental obligations, providing social and economic benefits by improving recreation, tourism, nature conservation, and regeneration. It has enhanced the portfolio of the British water industry in international markets. But there is more to be done. The water industry relies on the environment for its raw material and for the disposal of treated waste water. New environmental standards and the need to cater for new housing have pushed up prices, and will continue to do so. The temporary cut in prices after the last periodic review in 1999 gave the wrong signal. The cut could not be sustained. The legacy is putting pressure on prices in the present review. For the present review we have set out a programme of improvements that will require action at 4,000 sites. The benefits are equivalent to a capital sum in a range from £5 to £8 billion. We calculate that companies can deliver the programme at a cost that is less than these benefits, based on an analysis of the costs of delivering schemes in the last price review. We estimate that the programme will contribute a modest portion of the average household bill for water and sewerage by 2010—no more than 50p per week. In making this statement, we acknowledge that there may be substantial variations between companies. However, in their preferred strategies, water companies have outlined programmes that for this money would only deliver some of the environmental programme, with some statutory obligations delayed to beyond 2010. The Agency is of the view that there is significant scope for challenge of the costs that some companies have put forward for the environment programme. If there was no environment programme, we calculate from water companies preferred strategies that average bills would still have to rise from £234 in 2005 to £280 in 2010. There will continue to be regional variations in the timing and size of environmental obligations and the eVect of this on bills. Increasingly we have situations where meeting common environmental standards is impacting customer bills diVerently in diVerent parts of the country. This is due to the diVerences in the size of programmes and the business and financial structures of the companies. The water industry is not the only sector that aVects the water environment. Government has recognised the need to tackle diVuse pollution, which will be needed to meet the needs of the Water Framework Directive. Our programme for PR04 only recommends action by the water industry to address problems caused by the industry. Water companies need to maintain a secure water supply for customers, taking account of the environment. But companies’ plans show that they do not plan to control demand and that leakage will rise. The plans show a lack of commitment to addressing abstractions that damage our most valuable sites of nature conservation. Meeting customer expectations is not only about price. It is also about the services customers get for their money. Customers want to see environmental improvements, but need to be told clearly how much they are costing them. The Agency is concerned about the inconsistent way companies have costed the environment programme and presented its impact on bills. 9130631001 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 35
1. Introduction 1. Since privatisation in 1989, limits on water industry prices have been determined in reviews conducted by the OYce of Water Services (Ofwat In November 2004), Ofwat will set limits on prices for the 2004 Periodic Review (PR04). It covers prices from 2005 to 2010. 2. We are the main environmental regulator of the water industry. One of our jobs is to safeguard rivers, estuaries, underground waters and coastal waters from pollution and other damage. We also have a statutory duty to make sure water resources are used wisely and to ensure that there is enough water for everyone and the environment. 3. Our role in the periodic reviews is to advise the Secretary of State on the environmental aspects. For nature conservation we do this in conjunction with English Nature. 4. Our advice covers: — environmental obligations and priorities; — the balance between water supplies and the demand for water, and plans for the development and use of water resources; and — other proposals by water companies that have an impact on the environment. 5. We prepare a programme of actions, taking account of costs and benefits. The proposal for the present review is described later in this memorandum. Once prices have been set by Ofwat, we monitor action by the companies to deliver the agreed actions and their water resources plans, issuing the appropriate discharge consents and abstraction licences.
2. What Previous Reviews have Achieved 6. The actions of water companies can have a big impact on the environment and wildlife, and on people who enjoy or depend on water. Every day, water companies supply 15 billion litres of water, taken from rivers and underground sources. After suitable treatment, they discharge most of this into rivers or the sea. 7. In doing this, companies must protect the environment, promote the eYcient use of water, and meet legal requirements. What they have to do to improve the environment is decided by ministers as part of the periodic reviews. 8. Previous periodic reviews have delivered big improvements. They have reversed the environmental impact of under-investment. They have enabled the UK to meet its environmental obligations and they have provided significant social and economic benefits by improving recreation, tourism, nature conservation, and regeneration. They have enhanced the portfolio of the British water industry in international markets. 9. Bathing waters and rivers are at their highest recorded quality. Salmon now migrate up the River Trent, and tri-athletes at last year’s commonwealth games swam safely in Salford Quays. 10. But more needs doing. Nearly 99% of bathing waters meet minimum standards, but only 78% meet “Guideline” standards. Rivers have improved since 1990, but 1 in 19 are still of “poor” or “bad” quality. This is 1 in 8 for urban rivers. 54% of rivers have high levels of phosphorus.1 Water companies are responsible for 1 in 6 of serious pollution incidents to water. 11. We have identified 2,000 intermittent (storm) discharges (around 10% of the national total) that are still unsatisfactory—they are causing pollution by sewage debris, and companies are continuing to find more. 160 protected freshwater and wetland sites (fens, bogs and grazing marsh) are at risk from licensed abstractions by water companies. The recent reversal, for some companies, of the downward trend in leakage is of concern. 12. The Water Framework Directive requires that water bodies achieve “good status” by 2015, unless a derogation is applied.2 Plans must be in place by 2009 and operational by 2012. Thereafter, objectives will be reviewed every six years. Action for the directive will influence the outcomes of the periodic reviews. The present review covers 2005 to 2010. The next would cover 2010 to 2015. If progress is not made to address unsatisfactory water bodies, then there will be a backlog of problems, which will be more problematic and impact even more on bills in the next price round.
3. Environmental Priorities for the 2004 Periodic Review 13. An investment programme must give good value for money. Customers must be able to aVord it and it must provide a reasonable return to investors. We want to help ensure that: — assets like pipelines, pumps, sewers and treatment works are kept in good order and operated so that their environmental performance is good and past improvements are maintained;
1 Phosphorus is an essential nutrient for plants but in excess it leads to an imbalance. Eventually freshwater habitats can be dominated by algae, with loss of higher plants and their associated animals. 2 The Water Framework Directive will be transposed into UK Law in 2003 and through River Basin Plans will require actions by water companies and others to meet new environmental objectives. 9130631001 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Ev 36 Environment, Food and Rural Affairs Committee: Evidence
— companies plan to provide enough water for customers, in a way that does not prejudice the needs of other water users and the environment; — the impact of abstractions and discharges on the environment is reduced; — all legal obligations are met; and, — companies complete necessary improvements at lowest cost, whilst demonstrating that they are taking appropriate account of the long term needs of the environment and society; and, — the industry gets ready for the Water Framework Directive. 14. The drivers for improvements stem from European and domestic legal obligations, and Government policies. They are listed in Defra’s memorandum to the EFRA inquiry, and in Annex 2 (not printed here). 15. The Agency, English Nature and Countryside Council for Wales have set out a programme that will require over 5,000 actions at around 4,000 sites from 2005 to 2010. The programme includes 3,200 main actions to improve sewage treatment works, abstractions and unsatisfactory storm discharges. In addition, there are 900 investigations, and about 1,000 small schemes for monitoring discharges. 16. The proposals were published in “A Good Deal for Water”. All actions have been assessed to confirm the need and to help seek the most cost-eVective option for companies to cost. They will benefit 6,500 kilometres of river and over 2,000 square kilometres of wetlands, still waters and coastal waters, equivalent to a monetary benefit in the range from £5 to £8 billion. Based on an analysis of the costs of the last review, by the Agency and Ofwat, the Agency believes that the companies will be able deliver the programme at a cost that is less than these benefits. The programme covers: 17. Discharges: action to reduce pollution further must be taken to meet the requirements of the Directives on Freshwater Fish, Habitats, Urban Waste Water Treatment and Bathing Waters, and the Countryside and Rights of Way Act. This will improve 3,500 kilometres of river and over 300 square kilometres of still or coastal water. Further action that will improve more than 3,000 kilometres of river and 1,900 square kilometres of still or coastal water is also proposed where justified by an assessment of the relative costs and benefits. 18. Abstractions: changes in the way water is abstracted are necessary to meet the requirements of the Habitats Directive and the Countryside and Rights of Way Act. These actions will ensure that more than 800 kilometres of river, and 28 wetlands have enough water to support the wildlife habitats. Other nature conservation schemes are proposed where justified by an assessment of costs and benefits.
Benefits of the Environment Programme 19. Our estimates of benefits (£5 to £8 billion) include the value for current and future generations of improvements to recreation, fishing, and nature conservation. They include reductions in illness (for example, stomach upsets) from improvements to bathing waters. The biggest benefits are for reductions in the risks to ecosystems and natural habitats. 20. We estimate that the environmental damage costs, taking account of improvements to be delivered in AMP3 (by 2005) from all discharges and abstractions is £1.2 to £1.9 billion per annum. The water industry is responsible for half. Our programme will reduce the damage costs caused by water companies by half, and take a step towards resolving issues under the Water Framework Directive. Details of how we developed the programme are in Annex 1. 21. We believe the benefits quoted above are an under-estimate. We have been unable to include the monetary value of some benefits for improvements to migratory fish in upstream stretches, reductions in local aesthetic impact from discharges in coastal waters, and economic development and regeneration associated with better water quality. The developments we have in mind are housing or commercial development in urban areas, once waterways are cleaner and more attractive. 22. A further benefit lies in meeting increasing expectations for good water quality and the security of water supplies. Good quality, with thriving wildlife, reduces risks and increases confidence that water resources are safe. The programme will provide increased safeguards at a time of uncertainty in planning for climate change. 23. We have published on our web site reports on the scope of the programme, the environmental benefits, and action required by other sectors for each operational Area of the Agency.
4. How this Periodic Review Differs from Others 24. We welcome moves to improve transparency. A Regulators Liaison Group represents Ofwat, Defra, Welsh Assembly Government, the Environment Agency, English Nature and Drinking Water Inspectorate. These, and Water UK, WaterVoice, the Wildlife and Countryside Link and Welsh Assembly Government are working jointly on market research to get the most eYcient and authoritative estimate of public opinion. The results of the first stage have been placed in the public domain. Further research is underway and will be published in December. 9130631001 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 37
25. Water companies have published summaries of their draft business plans. The Agency has reviewed draft business plans (section 5.0) and is concerned about inconsistencies, which means that information is not transparent for stakeholders.
5. Draft Business Plans
Water companies submitted their plans in August 2003. Ofwat published its overview of draft business plans in October3. We are reviewing the draft business plans and will advise ministers in November. Figure 1 shows the pressures on bills, as set out in Ofwat’s paper.
Figure 1: Price Pressures on Bills
40
30
20
10
0
Change to bills (£) -10
-20
-30
Efficiency Maintaining Security of Drinking Environment Service Savings Base Supply Water performance Services
26. Our preliminary view follows. 27. We calculate that even if there were no environment programme, overall bills would still need to rise substantially. With no environment programme, based on the companies’ preferred strategies, the average household bill would rise from £236 to £280. 28. The information about the impact on prices of elements of the business is not presented consistently. 29. A key factor for many companies is maintaining their financial attractiveness to investors. These financial costs put pressure on bills, and capital investment needed to deliver environmental improvements. These financial costs are spread across the diVerent elements of the companies’ business, but not all companies have done so in the same way. Apart from taxation, the impact of financial costs on prices is not transparent, in either companies draft business plans or Ofwat’s paper. 30. A number of companies have challenged legal and policy obligations. These include ones identified by ministers as “essential and clear”. Several companies propose delaying until beyond 2010, all improvements under the Habitats Directive. This would increase the risk of infraction by the European Commission. 31. A comparison of the costs published by companies, with estimates by the Agency and Ofwat, suggest that some companies have significantly over-stated costs. 32. The plans divide the companies’ activities into sectors. There is a risk that this, in the demanding timetable for PR04, means that companies will not look across their business to find the most cost-eVective solutions.
3 Setting water and sewerage price limits for 2005–10: Overview of companies’ draft business plans, Ofwat, October 2003. 9130631001 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Ev 38 Environment, Food and Rural Affairs Committee: Evidence
Regional Variations 33. The South West has 3% of water customers but 30% of the national coastline. Bills here have risen fastest because of requirements to improve bathing waters and provide treatment for crude sewage discharges to the sea. In the present review, United Utilities, Yorkshire Water and Severn Trent will be most aVected by new requirements to improve freshwater fisheries. 34. Initial scrutiny of company draft business plans shows evidence that because of diVerences in company customer bases and financial structures, similar environmental programmes in diVerent parts of the country could have a diVerent impact on customer bills. 35. Table 1 shows how the water and sewerage companies in England say the environment programme would aVect their customers’ bills in 2010. This information is taken from their published draft business plan summaries, as presented in Ofwat’s paper (see footnote 16). These figures need to be treated with caution as companies have made diVerent assumptions in the allocation of financing costs across the environment and the rest of their business. 36. In this price review, some companies with small capital programmes are quoting large price rises for 2005 to 2010. Although South West Water has a modest environment programme (see Table 1), it says prices for its customers need to rise by 22% by 2010. Some companies have costed programmes and solutions that go significantly beyond the Agency’s recommended programme.
Table 1
WATER AND SEWERAGE COMPANIES’ ASSESSMENT OF THE IMPACT OF THE ENVIRONMENT PROGRAMME ON BILLS4
Company Price increase for the environment by 2010 Plan A5 Plan B Anglian Water £15 £27 Northumbrian Water £5 £11 Severn Trent Water £3 £9 South West Water £8 £16 Southern Water £73 £118 Thames Water £5 £9 United Utilities £94 £165 Wessex Water £14 £22 Yorkshire Water £10 £54
6. Water Resources Plans 37. We are reviewing draft plans. These were submitted with the draft business plans. We will report to ministers in November. Our preliminary view follows. 38. The quality varies. Many require a lot of additional work before the final submission in early April 2004. 39. Many companies have not followed agreed best practice and the guidance of the Agency and ministers. This includes demand forecasts, leakage, the environment programme, and choosing options. 40. Some companies propose a rise in leakage. This is contrary to Government policy. Most propose that leakage volumes will not reduce by 2030. We believe that advances in leakage control, and pressure on scarce water resources will drive down the economic level of leakage6. 41. Most companies believe that per capita consumption will rise and that they cannot do anything about it. There is little evidence of commitment to demand management. There is an emphasis on resource development, with proposals for the construction of several new reservoirs. (The “twin track” approach intends a more balanced look at resource development and demand management). 42. Many companies have excluded schemes that deal with the impact on sites covered by the Habitats Directive or Sites of Special Scientific Interest. Even where they are included, they are programmed after 2010, beyond the agreed timescales. As noted above, this increases the risk of infraction.
4 Table complied from “Setting water and sewerage price limits for 2005–10: Overview of companies” draft business plans, Ofwat, October 2003. 5 Plan A and Plan B are the reference plans contained in draft business plan. They are based on common assumptions provided by Ofwat. For the environment programme, Plan A includes schemes for drivers, which ministers have said are “essential and clear”. Plan B includes additional schemes for drivers which ministers have identified as “choices will be made” or “essential when clarified”. 6 The economic level of leakage is the level of leakage at which it would cost more to make further reductions than to produce the water from another source. 9130631001 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 39
7. Beyond the 2004 Periodic Review At the last periodic review, investment continued, but with a cut in prices (Figure 2). The price cut was a result of operating eYciencies, a reduction in implied profit levels, and out-performance of the delivery of AMP2. We believe the cut in price sent the wrong signal about the need for long-term investment, and the cost of water. 43. The Agency questions whether it might have been possible to have more investment at the last review. The industry has questioned whether the financial assumptions were sustainable. The price cut at the last review means that there is a greater pressure on prices for this price review. 44. Figure 2 also shows the impact of the companies’ preferred strategies on average household bills by 2010, and the contribution of the environment programme to the price rise. The environment programme is only one element of the price rise, and the Agency is of the view that there is scope for further challenge of the price implications of companies’ preferred strategies.
Figure 2: changes in average household bills since 1990
Companies preferred changes to bills
Average Household Bill (£) Environment programme (see paragraph 45)
1990 1995 2000 2005 2010
45. Big issues like the Water Framework Directive, climate change, and the provision of resources for new development like the Thames Gateway, means continued investment. The industry needs a long-term view of the environmental pressures, and a sustainable financial structure for the future that will allow adequate investment in the long term. 46. The Agency is of the view that the pressures on bills cannot be solved by simply delaying environmental improvements. Annexes Annex 1: Development of the Environment Programme Annex 2: A Good Deal for Water [not printed here] 21 October 2003
Annex 1: Development of the Environment Programme We examined the risk of breaches of statutory requirements and the risk of environmental impacts. We looked at causes, and at the options for tackling the issues. This resulted in environmental requirements for each scheme, for example, limits on discharge quality. Where we were uncertain about the measures, we proposed investigations. All schemes have been assigned “drivers”7. These define the obligations the scheme would deliver. The requirements for each scheme have been identified according to national guidance developed by the Agency, with English Nature for nature conservation, and have been subject to rigorous quality assurance. The guidance has been provided to water companies and other regulators.
7 Environmental Drivers for PR04, version 3, April 2003. 9130631001 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Ev 40 Environment, Food and Rural Affairs Committee: Evidence
The drivers for environmental improvements are summarised below:
Waste Water Treatment and Storm Discharges The Directive on Urban Waste Water Treatment imposes minimum treatment requirements on sewage eZuents. The level of treatment depends on the size of the discharge and on the type of water to which it is discharged. The outcome is better water quality, particularly for rivers and coastal waters thought to be at risk from eutrophication. It also covers improvements to intermittent (storm) discharges of sewage, so reducing sewage litter in rivers and on beaches. The Directive on Integrated Pollution Prevention and Control controls activities at sewage works receiving certain discharges from industry via sewers, or where sludge is incinerated.
Wildlife and Habitats The Habitats and Birds Directives safeguard sites and threatened species that are important at the European level. The sites, Special Protection Areas and Special Areas of Conservation, form a network known as Natura 2000. Sites designated under the Convention on Wetlands of International Importance, especially as Waterfowl Habitat (Ramsar sites), are aVorded the same protection as sites designated under these Directives. English Nature and the Countryside Council for Wales notify Sites of Special Scientific Interest (SSSIs). These form the network of protected sites of national importance for conservation. Although water companies have always had a duty to conserve SSSIs, the Countryside and Rights of Way Act 2000 puts additional duties on public bodies, including Ofwat, the Agency and water companies, to further the conservation and enhancement of SSSIs. The Biodiversity Action Plan is a commitment through the Government’s signing of the Convention on Biological Diversity. The Government has stated that it will meet its duties to conserve biological diversity under the Countryside and Rights of Way Act through the England Biodiversity Strategy. This sets out work for the next five years.
Fish and Rivers The directive on Freshwater Fish protects and improves the quality of waters for fish. Some 20,000 kilometres of river are covered and Defra and the National Assembly for Wales are currently consulting on the designation of a further 11,000 kilometres of additional stretches of river and canals and 90 still waters (equivalent to an area of over 14,000 hectares). Also, 40,000 kilometres of river have River Quality Objectives. These define the water quality needed to protect fish, the use of the river for recreation and to ensure water quality for abstractions for water supplies, industry and agriculture.
Directive on Bathing Waters Sets water quality standards to protect public health and the environment.
Directive for Shellfish Waters Lays down standards for waters designated as shellfisheries and so protects shellfish and improves the marine environment. The Shellfish Hygiene Directive, sets conditions for the production and marketing of shellfish intended for human consumption.
Groundwater The Groundwater Regulations control the entry of certain substances into underground water and so protects these waters and the water supplies and rivers that depend on them. There are also cases where the abstraction of underground water may have too much impact on water quality and companies may need to develop an alternative source for drinking water. There are also cases where companies act to control the spread of historic pollution caused by others.
Sewage Sludge Regulations In most cases the best option for sludge is recycling to agricultural land. This is regulated through the Sludge Regulations. Further sewage treatment could increase sludge volumes. Restrictions could be placed on sludge disposal on agricultural land as a consequence of the Nitrate Directive,theLandfill Directive and the Groundwater Regulations. 9130631001 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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Chemicals Schemes for the Directives on Dangerous Substances cover extra treatment needed to deal with diVuse inputs of pollution to sewers and so reduce the amounts of chemicals entering the water environment. The Agency has also presented research on the feminisation of fish by chemicals in eZuent. We recommend a programme with the water industry to establish the basis for any future changes needed in sewage treatment.
Local Actions This covers improvements that are not required under other headings, but have local support and will bring environmental improvements that will not be achieved in any other way.
Water Framework Directive Action taken through the above will form a cost eVective and adequate preparation for this Directive. This heading covers additional action, specific to the Directive, where this would be more eYcient in the long run, for example stopping a discharge to groundwater that will be banned rather than spending money on treating it.
Assessment of Benefits We made a systematic assessment of the benefits, in accordance with ministerial guidance. The aim is to: — provide customers and stakeholders with justification for our proposals; and, — inform decisions by ministers for schemes where there are choices about what should be done. These assessments are based on a review of the available studies and inputs from the leading experts. The underlying methodology has been peer reviewed, and agreed by Defra, Welsh Assembly Government and Ofwat. For each scheme classified by ministers under “choices to be made” we have combined our assessment of the benefits with the companies’ estimates of the costs from draft business plans, as reviewed by Ofwat. We will submit to Defra a ranking of these schemes based on the ratio of benefit to cost, and other, non- monetised, factors. We have also assessed the environmental benefits of the overall environment programme for each company. This includes qualitative and quantitative benefits and monetary values where appropriate and possible. We will also identify where action is required in other sectors to deliver the environmental outcome.
Costs We have, with Ofwat, also carried out an assessment of the costs of our proposals using data from the last periodic review and other information. We have used this, with an analysis of Ofwat’s Final Determination of the 1999 Periodic Review, to assess the impact on bills. By 2010, the programme we propose would contribute to the average bill no more than the 50p per household per week. In making this statement, we acknowledge that there may be substantial variations between companies. We also sought advice from OXERA on the relationship between water industry investment and prices.
Witnesses: Baroness Young of Old Scone, a Member of the House of Lords, Chief Executive, and Mr Andrew Skinner, Head of Environmental Quality, Environment Agency, examined.
Q84 Chairman: We understand that Lady Young is Wales, on the environment programme for the closeted at Defra on the subject of ghost ships. We period of review. We do that in conjunction with will make suitable arrangements to have her English Nature and also CCW in Wales, because decontaminated when she arrives! We trust that she many of the aspects of the programme are dealing will not be too long in doing that. Meanwhile, Mr with nature conservation issues on which they are Skinner, you are the Head of Environmental Quality the primary adviser to Ministers. We sit with fellow at the Environment Agency. You know the regulators, including the Drinking Water background to this report and so let us begin by Inspectorate and of course Ofwat, as a group that asking what exactly is the Environment Agency’s seeks to propose a programme on which Ministers role in determining the environmental controls that can make judgments and give advice to Ofwat in water and sewage companies are forced to their stewardship of the process. undertake. Mr Skinner: The Environment Agency’s role is to Q85 Chairman: A significant amount of the provide advice to Ministers, and it is Ministers regulations themselves presumably are European because there is a parallel process operating in Union regulations? 9130631002 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner
Mr Skinner: A large proportion of the regulations course, many of the schemes in the early parts of the are European Directives. As we say in our final programme were also statutorily driven and documents, over two-thirds of the schemes which we therefore there were not the choices to be made. are proposing to Mrs Beckett for consideration stem directly from statutory requirements from European Directives; others stem from national. Targets set by Q89 Chairman: So you will be perfectly happy if, let us say, the consumers in the south-west are all up in Government through the PSA process. arms because of increases in their water bills and they are told that these increases flow from Q86 Chairman: If you are submitting them to her improvements in quality and all sorts of desirable for her consideration but they are statutory things? You are perfectly happy to go down there requirements flowing from European regulations, and say to them, “It is, and it is for your benefit”? what choice has she got? Mr Skinner: I would and we do. Obviously the Mr Skinner: The programme is not entirely nature of the geography of the country is that the statutory-driven, and so there are choices. In the environmental burdens do not fall equitably, but we jargon of the exercise, there are choices to be made, are talking about meeting environmental standards. and some of the proposals we have put forward are In fact, in the south-west the environmental ones where we believe there are environmental and programme is actually quite small, and so I could indeed social and economic benefits to be accrued and have very happily had that conversation. from doing the schemes, but those are ones on which there is no statutory driver. In the case of those Q90 Mr Jack: Let us just move on in an schemes that are statutory, the judgment is actually, examination of the rigour with which you have come in our view, about making sure that they are done in up with the programme. In paragraph 15 of the V the most cost-e ective way by the water companies evidence to the Committee you say: “The Agency, to meet the environmental objectives. Another part English Nature and the Countryside Council for of our dialogue with our partners in this process is Wales have set out a programme that will require actually helping in various ways the scrutiny of the over 5,000 actions at around 4,000 sites from 2005 to companies’ plans to make sure that, as far as one can 2010. The programme includes 3,200 main actions to V judge, they are proposing cost-e ective schemes to improve sewage treatment works . . .” and you go on achieve necessary outcomes. and on. How did you work all this out? Mr Skinner: We did that by quite a long and Q87 Chairman: Are you satisfied that all the complicated process. It starts, as we have said, from requirements laid upon companies do actually the statutory drivers that need to be met, the represent value for money? statutory obligations on the country. That leads to a schedule of schemes, which are compiled locally in Mr Skinner: I am satisfied, and I say that with V V confidence because we have done an extensive liaison between Agency sta , English Nature sta exercise to satisfy ourselves on just that point. The and water companies. That brings up a long list and that has then been put through a number of points comment has been made on previous iterations of of scrutiny: firstly, to establish whether in fact the this process that there had not been cost-benefit environmental problem is something which has been rigour applied to those situations where there were caused by the water company in the first place, choices to be made. We have done a lot to make sure because there are many impacts on the water that could not be levelled this time. We have done an environment which are not for their accountability; extensive programme of cost-benefit analysis. We secondly, to be confident that we know the answer have had our approaches assessed and peer- to the problem and therefore can specify standards reviewed and challenged. It is by coincidence that which the water companies need to meet; and today is the day that we are required to give Mrs thirdly, the cost-benefit scrutiny. Beckett our final advice on this matter. The schemes that will be in that final advice will be a smaller tranche of schemes than we started with because Q91 Mr Jack: May I just stop you there for a they have been weeded down by various processes of moment? Looking through A Good Deal for Water, scrutiny, and one of those is cost-benefit assessment. and I must compliment you on the pretty pictures, they are very nice, I was struggling really to find in this document any kind of detailed economic Q88 Chairman: Baroness Young will be able to kill analysis that would underpin the assertion that you two birds with one stone, will she not, while she is make in the conclusion of your evidence to the there! In past programmes, do you think there have Committee where you say that all of these been occasions where the incremental benefit to be improvements are only going to cost people I think gained has not been justified by the incremental cost it is on average 50p per household per week. It says in achieving it? that on page 12. We are intrigued to know how this Mr Skinner: The retrospective on the programmes in great calculations was done when A Good Deal for the past is that they have provided a huge benefit to Water seems to be an analysis-free zone. water quality and water environment. I think the Mr Skinner: The 110 pages of advice which we are programme has a huge and successful track record. giving to Mrs Beckett today contains a lot of what The retrospective analysis has not been done in every you are asking for—detailed schedules by various case, and so I cannot give you that assurance. Of environmental drivers, as we call them, various 9130631002 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner issues to be changed. That will contain also the cost- under the various directives and national benefit outcomes. All the methodology is in the programmes to improve their water quality, which public domain. appears to be the message you have told the Committee: these are the drivers of this price Q92 Mr Jack: Having produced this volume of increase. I want to know who the guilty parties are work with the rigour of the analysis, which sadly is in the column headed “Company” which might be not displayed in A Good Deal for Water, in Table 1 going over the top and, if they are going over the top, in paragraph 36 you list the Plan A and Plan B totals what are they going over the top with. for the work to be undertaken by the water Mr Skinner: Some companies have proposed companies listed. Are the figures there realistic, in schemes which are not the ones to which we have your judgment; are they over-statements or under- given priority in their programmes, and some statements of the true costs of doing all that is companies have proposed costs which we are, required to meet all these thousands of actions which through Mrs Beckett, inviting Ofwat to scrutinise you have detailed? particularly carefully. Mr Skinner: Those are figures from the water company plans, as you realise. We have made global Q97 Mr Jack: Which companies are the ones that judgments about the appropriateness of those are the goodies and which are the baddies? figures. Mr Skinner: In our own assessment, we have identified concerns about the programmes of United Q93 Mr Jack: Global judgments? I ask the question Utilities and of Southern Water. because I am interested to know the validity of this 50p per week per household. I woke up this morning Q98 Mr Jack: Could you clarify this? The increase to discover that some judgment had been made by that United Utilities, for example, were given today, Ofwat in agreeing United Utilities’ figure and one was that at the end of this process or was that other. I was not certain whether that was an interim something else? price review or whether it was the final version. We Mr Skinner: No, that is something completely have to find out the numbers because there is a diVerent. That relates to the management of the missing column from this document, and that is the existing programme. water companies’ own assessment of their figures. As you have done all this rigorous work, let us not Q99 Mr Jack: It is the existing programme. I was bit be global; let us be specific. Company by company, surprised that two had been picked out. How would who is charging the right amount and, if not, why? you classify the reasons behind United Utilities not Mr Skinner: I refer you to my colleagues who will following the programme? follow afterwards because it is their job, at the end Mr Skinner: It is partly to do with our judgments of the day, to assess those plans. Because we are about the cost necessary to deliver the programme concerned to be sure that what we are proposing is that we are asking Ofwat to scrutinise. cost-eYcient, we have done our own analysis. We can talk about the costs of individual schemes and Q100 Mr Jack: One of the things we are anxious to the schemes in the company because we have some establish is whether all of this represents to the water knowledge of that business. Translating those costs consumer good value for money. If we take the two into individual amounts on bills is a complex that you have picked out, Southern and United process, which only Ofwat can do, Utilities, notwithstanding your concerns, do they represent good value for money? Q94 Mr Jack: You say in paragraph 36: “Some Mr Skinner: There are schemes in the United companies have costed programmes and solutions Utilities’ plans which include operations relating, for that go significantly beyond the Agency’s instance, to shellfish waters, which are not in our recommended programme.” recommendations. Mr Skinner: That is correct. Q101 Mr Jack: They think it is a good idea. Just Q95 Mr Jack: The point is that I do not know which explain this to me. That is an environmental benefit. of these companies has gone beyond that. Can you Why do you think they have put that in? tell us which has gone beyond your programme? Mr Skinner: I do not know. I have not had the Mr Skinner: Various companies have dealt with this dialogue with them and so I do not know. in various ways, and most of the figures which are in the common currency are from the companies’ Q102 Mr Jack: If they took out of their programme preferred strategies. the things that were not in your list, do we know by how much it would reduce their estimates? Q96 Mr Jack: Forgive me, Mr Skinner, if it is Mr Skinner: Again, there are two points. One is the diYcult to answer the question now. I asked a simple schemes in the programme and the other the unit question: which of the companies listed in Table 1 in costs to deliver them. The draft business plan is only your evidence to the Committee have gone beyond two months old and that scrutiny has not been done. the Agency’s recommended programmes? I am trying to establish whether any of these water Q103 Mr Jack: Just to conclude, as far as you are companies are trying to raise money other than is concerned, Southern Water and United Utilities necessary to meet the recommended requirements have things in their programmes which would 9130631002 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner increase their costs beyond the Environment Ofwat saying, “This is what we would like you to do Agency’s recommended programme of activities. to follow this process”. That all has a formality right Do I therefore conclude that the rest of from the start, although of course there is an awful the companies are compliant with your lot of professional interaction of a much more recommendations? informal nature as the process goes on, and of course Mr Skinner: The two companies I have mentioned we do not always agree. have costs in their programme which we have specifically suggested to Ofwat should be subject to Q106 Chairman: We welcome Baroness Young. I their examination, though I am sure they will tell you hope you have been suitably decontaminated on they have examined all of them. I can supply a your way here and that you have sorted out the schedule, but it is actually in the material we will be problems of the ghost vessels and all of that. giving to the Secretary of State later on today, which Baroness Young: I would not bank on that, identifies which of the companies have met in Chairman, but we are a step further forward. May I various respects in the programme what we have give a profuse apology. asked for and where they have not. Q107 Mr Mitchell: I thought your defence of what Q104 Mr Drew: To be absolutely clear, Mr Skinner, is said in the paragraph where you said that some what is the process of engagement you have with the companies have gone beyond the desired level is a bit companies to know what their cost structure really is lame. What are you actually going to say to the and what their strategy is in terms of trying to make consumer because here are changes made in these environmental improvements and how do you pursuance of a European directive and your own then, when you are either satisfied or not satisfied, instructions, some of which have been added to by rebuild this back into their cost structures, in terms companies loading in other things which you say are of the prices they will then set? unnecessary. Does that not really put a Mr Skinner: I do not do that last step. The structure responsibility on you to tell the consumer that some is as follows. As I explained, at the early stages of this companies are free-loading? process, when the environmental programme is Mr Skinner: We will do so. being assembled, that is done in dialogue between my colleagues in our various regions and their local Q108 Mr Mitchell: Is that report saying, “Anglia companies. That leads to the programme, the should not be doing this and it should be doing that programme which the Agency specifies and which but it should not be doing it in the gold-plated way Ofwat asks the companies to cost according to a it is”? structure of arrangements, which leads to these Mr Skinner: The 110 pages which go to Mrs Beckett plans, A and B. That is then delivered and it was today include that information, and that is or will be delivered two months ago. From our various a public document subsequently. We have been very perspectives, we are in the process of analysing that. open about that and Barbara Young has given a Our advice to the Secretary of State lists our number of speeches in the last couple of weeks assessment of all those issues and goes into the saying just those things at various public fora. At the detail, some of which we have touched upon in the end of the day, though, the decision is with previous exchange. The process is then that the Government, who will receive our advice, and Secretary of State gives guidance to Ofwat to advice from the Drinking Water Inspectorate on instruct the companies to go through into their final other aspects of the programme, and then business plans. Our role at that stage is to advise commission Ofwat to discharge its duties within the Ofwat, answer questions and help them develop a scope of that advice. The track is for us in the public programme which meets the requirements which we domain to be very open about what we are doing and have specified and which the Secretary of State has why we are doing it, to give advice to Ministers. accepted in her guidance. It is quite a complicated process. Q109 Mr Mitchell: That is never going to reach the public, is it? Ofwat is going to come in with its usual Q105 Mr Drew: To be clear, and I understand how technical gobbledegook and coeYcients and you work with the companies, how would you percentages. The Minister is not going to produce a describe your relationship with Ofwat at the report. How is the consumer to know that he or she diVerent stages? It sounds as though you start quite is being duped because the company is over- informally with Ofwat and then you get into a charging for things that are not necessary? formal arrangement. Presumably then this has to be Baroness Young: I hope that the process in which we enforced by the two organisations. What is the are involved will in fact mean that when we get to the parallel relationship? point at which the consumer is actually faced with a Mr Skinner: The structure of the process is that we bill, we have made sure that all of the environmental and Ofwat, together with others, sit round the table schemes that are in the programme are rigorous, at what is called the Regulators’ Group, which is fully tested, least-cost options, that anything that is brokered by Defra oYcials. That means that there is extraneous and unnecessary is not in the a fair degree of formality about the process right programme, and that anywhere where costs look from the start. The instructions to the companies ostensibly too high or where the impact on bills about what they are asked to include in their plans looks higher than it ought to be, that has been go out under joint signature from the Agency and stripped out. That is the important message we are 9130631002 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner giving to the Minister in our advice. That needs to be Baroness Young: Strangely enough, in that line up very high up in the discussions between ourselves, of villains, we are probably the one they trust most. Defra and the economic regulator in the next few We have a head start, or that is what our market months, until such time as the Minister issues research tells us anyway. It is a big issue in terms of definitive advice. That goes to the end point in that. the size of increases in average bills that may result from this pressure, but we always knew that. If you Q110 Mr Mitchell: We all hope for a reasonable recall, five years ago when we were involved in this outcome. process, we were constantly saying that a big price Baroness Young: I think it is premature to say that reduction five years ago was simply going to store we ought to be winding customers up and saying up trouble now, and here it is; it is happening now. that we do not want any gold-plating. If we had had a steady price rise over that period, it would have been a steady price rise from now on in, Q111 Mr Mitchell: This is challenging stuV rather than the sort of curve that we might have to that goes significantly beyond the Agency’s see as a result of the price cut that happened five recommended programme. If some of that still years ago. What we are saying is that the market remains after going through the gobbledegook research, which we have all shared with the process, will you be telling the consumer that it customers—ourselves, Ofwat, English Nature and should not be? Government—is not saying that the customers Baroness Young: Certainly, if we felt the process was are not prepared to pay for environmental not working, we would be very clear and explicit improvement. The customers are interested in about that, but I have confidence that the process environmental improvements. will actually reach a point at which a sensible Mr Mitchell: They tell us they will pay more taxes environmental programme is part of the process. for better public services but when it comes down There are other issues that impact, of course, on to it in the polling booth, they have a very diVerent customers’ bills. I do not know whether we have position. covered that already. The totality of the impact on customers’ bills comes from a whole range of factors, some of which are in the environment Q113 Mr Lepper: Barbara, I think you are right programme, but only some of them. There are also when you say that of that line-up that Austin gave taxation issues for the companies and issues to do us, it is the Environment Agency that tends to be with wanting to dig up the roads and the cost of that. perhaps trusted more than others. It is usually the There are issues to do with their own financing Environment Agency which is telling people that arrangements. There are other elements of the they ought to see rather more rather than rather less quality programme, like the Drinking Water of something. Mr Skinner, you cited Southern Inspectorate Programme, and there are big costs Water as the other company where you thought associated with maintaining the serviceability of there were some questions to be asked about their their assets. There is a whole load of drivers that will proposals. Could you just give us one or two impact on customers’ bills eventually. We think we examples of what Southern Water have in their plans are part of a process that will really hone down at the moment that the Environment Agency feel are rigorously that environment programme to a point where it is big, and there is no doubt that it will have not perhaps absolutely necessary? an impact on customers’ bills, but that it is Mr Skinner: The issue which we are inviting absolutely rigorously tested and therefore we do not Government and Ofwat to scrutinise is not so much have to go to the customer and say, “You ought to the schemes in the programme but the way in which kick up a fuss about some elements of the those schemes are stated to impact upon the environment part of the programme”. It is only the customer bill. As has been explained by Barbara, environment part of the programme that we really there are all these various issues which come from are qualified to comment on. company structures, company pressures and taxation. We are very happy to say that the Q112 Mr Mitchell: You have all these processes but environment programme is important and will cost the consumer is faced with other bills and you are money, but we do not want it to be overstated. We blithely assuming that they will not mind paying an do have concerns from our own analysis, and Ofwat extra 50p a week, or whatever it is, for improvements can do this more thoroughly than we can, as to in beaches, water and sewage elsewhere which they whether in fact that is the right statement about the will not necessarily see at a time when the consumer impact of the environment programme on costs. is being asked for more on the rates, more on other taxes, more on other charges. This is going to produce some kind of consumer reaction, I would Q114 Mr Lepper: It sounds to me as if you are fear. At the end of the day, the consumers do not saying that what Southern Water are doing is trying trust you; they do not trust the water companies; to oZoad on to the customer—they are asking the they do not trust Ofwat; they do not trust customer to pay for some of their environmental Government; and certainly, least of all, do they trust schemes—costs which they, as a company, have to European directives. Are you not afraid that this is meet but which ought to be met from somewhere going to produce a kind of reaction with the other than the customers’ bills? accumulation of these charges? Mr Skinner: No. 9130631002 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner
Q115 Mr Lepper: Then I have misunderstood. Q118 Patrick Hall: And so in the Midlands and in Mr Skinner: There are two points. Firstly, we are the London area there is less pollution than there is merely suggesting to the economic regulator, whose in other places, which does surprise me. job it is, that he should look at these issues more Mr Skinner: You have named two regions that do closely. It is not so much whether the costs will call not have any bathing beaches, and that is quite a on the question; the question is whether it is significant driver on environmental pressures. appropriate to allocate it as a cost caused by the Although we may have this diVerences about the environment programme. numbers, there is no doubt that the programme in United Utilities is a big one, and that is, among other things, driven by coastal water quality issues. Q116 Mr Lepper: All right, and so the essential thing you are saying is that it is about questions on Q119 Patrick Hall: But it is a programme that goes Southern Water’s figures? beyond what you think is sensible? Mr Skinner: Yes. Mr Skinner: In that case, yes. Baroness Young: One of the lessons I think we have learnt from this price round, and I am sure Philip Q120 Patrick Hall: That is to clean up beaches? Fletcher will agree with this, is that there are some Mr Skinner: In that particular case we are into issues about what perhaps ought to be more shellfish waters. transparently demonstrable in the way that companies present figures. It is part of a learning Q121 Paddy Tipping: You have told us, and I think process and the refinement of the price round it is right, that most of these environmental process but I think we do need to be able to improvements are driven by European directives. disaggregate some of the financing costs more Are we at the end of the road? Are there more accurately from the elements of the environment European directives to come and, if there are, what programme. discussions are you having? Are you across there in Brussels talking about these things and giving advice and, most particularly, not just looking at the Q117 Patrick Hall: May I explore the business principles but looking at the practicalities and the about the costs to achieve the environmental end costs? improvements? You have flagged that up as being Mr Skinner: It is not the end of the road because the cost one fizzy drink per week, which I think was there is the Water Framework Directive, which we referred to earlier as 50p per week, which is £26 a discussed previously, which will increase in some year. If one looks at the evidence that you have let cases the environmental standards to be met and us have, and at Table 1, could you explain if we are place more focus on ecological issues. In our short supposed to be seeing £26 for the whole year as the version, and it is also in our long verison, we are price increase on average for all of these water suggesting to Government that there are important companies? Therefore, with Southern Trent’s Plan opportunities in this programme of improvements A of £3, which is less than 6p per week, does that to make sure that the country is prepared for those new burdens. As far as being over in Europe, the mean that there are no problems in that huge part of answer is: yes, we are there a lot and very much, in the country of Severn Trent or that that you have not the way in which you have described it, influencing set them proper standards to pursue, or that they do the guidance. Although the Water Framework not want to do that? What do these figures actually Directive is only about 30 or 40 pages, it has about mean? I really do want to know how this 50p, or 1,000 pages of guidance sitting behind it. In those whatever it is, has been arrived at, without reading pages, if wrongly constructed, are costs, and perhaps Margaret Beckett’s 10,000 page document to which even unnecessary costs to this country. The Agency, you refer. together with our colleagues in Scotland and Mr Skinner: I will try to do it simply. The £26 relates Northern Ireland, working as a UK group, have put directly to the column of figures headed Plan B, and a lot of eVort into what in shorthand we call fit for it is an average figure; i.e. it is our judgment across purpose implementation. That does not mean to say the country. The fact that some companies have low it will have zero costs but it will be what we believe numbers in here in some cases is due to the fact that to be eVective, appropriate and consistent with our there is not a large programme of need. Perhaps that previous practice. has been satisfied in previous rounds under diVerent geographical circumstances. There is a huge Q122 Paddy Tipping: The figure may be £26 for this variation from region to region and company to review but the Water Framework Directive is company, which is translated through into the bills coming on, and we have had discussions before because of the circumstances of the region. If you do about making sure these mesh together. How much the average of Plan B, you will find it is higher than more is it going to be? It might be nothing if you get £26, and so we are saying that in our judgment, and your way. we hope that Ofwat will be able to discover this, Mr Skinner: I very much doubt if it will be nothing. there is scope for the work being done more cheaply The first point to make is that the Water Framework but, because the figure is low, that does not mean to Directive cuts cross-sectorally across all polluters say that we are necessarily unhappy with the and we are only talking here about the impact on the programme. water companies but it is clear that there will be 9130631002 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 47
5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner additional burdens on water companies; the water polluters, and so they are paying in that respect. In companies’ own publications have supported this. terms of some of the water quality issues, I think we There will be successive periodic reviews and there do need to make sure that we are not paying twice, will be comparable, perhaps not as big although this and so we do need action on the Common one is smaller than the last one, increases to bear by Agricultural Policy. There is, in particular, a real water companies. window of opportunity, if the new reforms come in, to get some decent shaping of both the basic subsidy Q123 Paddy Tipping: Barbara told us earlier on that payments and the incentive payments beyond that to the public loves you all and loves you more than make sure that farmers are minimising their impact on water quality, so that they also pay in a slightly other people; you are trusted. What are they saying V V to you about bills? What is your own research? Is £26 di erent way; i.e. by doing things di erently in return for the money they get. That will also have a what people are prepared to pay? That is not what I V have heard and it is not the research I have seen. knock-on e ect to the next price round because if we Baroness Young: Certainly the research took a can reduce the amount of pollution going into rivers, lowish range of possibilities about what people were we will have to take less of it out at the other end, but prepared to pay and tested those. It did not test this we need action on both. It would be unrealistic to scale of bills. The point to make about the longer say, as some have said, that it has been the water term, however, is that one of the features of the companies who have done their bit over the last ten environment programme is that much of it has no years and it is now time for the farmers to do it, choice to it: we either have to do it or we will be in infraction under European directives or else we will Q125 Paddy Tipping: What have you said in your fail to meet the Government’s PSA targets. There is submission to Mrs Beckett about that? not a lot of discretion. You could say that you might Baroness Young: We have said exactly that. want to slow it down and pace it out a bit more but the reality is that, if we do that, that last five years of implementation of the Water Framework Directive, Q126 Alan Simpson: No doubt it is true that you are which will be covered by the next price round which more popular with the public than politicians are, is 2010 to 2015, will look like a mountain that is very but you are not likely to be the ones who cop it in the hard to climb. I think we have got to keep moving neck in the way that politicians are in respect of the through the programmes that we have now public reaction to any price rises. I do not think you identified. In terms of aVordability, you have to look will find disagreement on this Committee about the at the range. The average is a £26 increase for the need to comply with directives. The issues that we environment, but Thames only has a £3 increase; are trying to grapple with are about the most South-West Water, which currently has the highest equitable ways of meeting those costs. I would like bills, only has as £4 increase. It is very diVerential to try and pick up from some of the questions raised depending on the size of the programmes across the perhaps before you arrived, Baroness Young, and country. Also, if you look at the cost of water just put the money figures together. What exactly do compared with other utility bills, it is comparatively you expect the 50p to raise for the industry? Can we low and we have not yet put in place proper put some ball-park figures on this? measures for minimising the impact of water bill Baroness Young: We are talking now about an increases on poorer households. If we could get environment programme—and this is a moving metering programmes up, that would both reduce target because we are refining schemes all the way demand and allow smart tariVs to come in that through and basically trying to pare out anything would allow people to get a slug of water for their that is not either very clearly going to hit a real basic needs which could be diVerentiated in charge if environmental outcome and produce real impact or they were a poor household. We could find ways, cannot be justified at the cost—and so this number and also through the Social Security system, of is going down all the time. I think we are at £3.5 mitigating the impacts of bills. I think it would be a billion for the overall programme, over which the bit short-sighted in terms of the longer term need for Secretary of State has some discretion on about environmental protection if we were to pitch the bills £0.75 billion. It is £3.5 billion with about £0.75 only at a level that could be aVorded by the poorest billion where she has choices to make. That was a household. number that originally was up at about £5 billion and we have successively pared that down. In fact, I always joke with Andrew Skinner that some of our Q124 Paddy Tipping: You are saying that you think staV are now at the point of saying that we are that the only way forward really is for customers, cutting too much out. with mitigation and the kind of qualifications that you have given, to pick up the bill. What are the other things you could do? Surely the polluter ought Q127 Alan Simpson: Can I ask you to take a step to be paying all this, should he not? back from that? I am not asking you what the Baroness Young: There are several polluters around. programme will cost. I am asking you what the 50p If you take pollution in its wider sense, i.e. would raise. It seems to me that you cannot be sitting abstraction of water from viable wetlands, for there saying that the 50p will be on the bills. example, or rivers, the great British public in Actually, the figure that it draws in is going to be less drinking, irrigating their farms, filling their and less. I just want to know how much you have swimming pools or watering their gardens are the estimated. 9130631002 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Ev 48 Environment, Food and Rural Affairs Committee: Evidence
5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner
Baroness Young: Our leaflet with the can of fizzy the eVective environment programme is and to have drink was aimed at trying to help the public some sort of feel, working with the economic understand just the bare bones of what this is all regulator on the economic regulation of the about and what it would mean for them. That 50p companies, as to what that would cost if it was would have raised £4.5 billion. Now that we have the delivered in the most cost-eVective way. That is our programme heading down the way towards £3.5 job, as the Environmental Regulator, not to take a billion, that is probably under 40p, and so it is still a view about how that is funded. That is for the fizzy drink, but it is Tesco’s own brand rather than a Economic Regulator to do following the guidance Diet Coke. from ministers about the size of the environment programme that ministers are minded to see Q128 Alan Simpson: I am not quibbling about that delivered as part of that process. part. I just want to put some fairly static figures in place. On the original calculations, that would have raised £4.5 billion. For you, that was the total Q132 Alan Simpson: So would you accept that in amount that would additionally have been incurred the way that you have set out the explanation, all of as costs for the industry over this period to 2010? your presumptions would lead members of the Baroness Young: Yes, but we are now, as a result of Committee, members of the public to believe that a process that will go on right through to the final what you are saying is, “Here is the total cost of determination, reducing that figure; it is now £3.5 meeting these additional improvements and the billion. public are the ones who are going to have to pay”? That is your 50p. Q129 Alan Simpson: I understand but I want you to Baroness Young: I think you need to address that stick with me because I do not think it helps us if, question to the Economic Regulator because the every time we ask a question on a given set of figures, way in which the figures are presented means that the you try and move the goalposts to somewhere else. I costs of financing the company are spread across a think we are still trying to catch up with you on the number of these headings in terms of the way that figures that you put in. If we can accept that there costs are presented, so the costs of financing the will be improvements and savings and just stick to company will be embedded in some of the total costs this set of figures, you were saying at the time of of these schemes and that is one of the issues that I submission that 50p on average would raise £4.5 think we would be wanting to lay on the table for the billion in terms of the costs over the period. That next price round in terms of a degree more would cover the costs of those additional obligations transparency in the way in which the companies faced by the industry in that period, and so it is present their preferred business plans. about £1 billion of investment per year. Would that be on top of the investment that has been going into the industry anyway? Mr Skinner: Yes. Q133 Alan Simpson: Does that mean that somewhere in these 10,000 words that you are passing across to the Secretary of State, you will be Q130 Alan Simpson: Since 1990, about £3.5 billion spelling out that she has a choice about where the per year has gone in as investment; you would be costs are to be met and that choice need not presume talking about an extra £1 billion and so it would be that the entirety of the costs should be picked up by about £4.5 billion per year going in as investment. I the consumer rather than self-financed by eYciency am just concerned about the equity issue, about who pays, because the industry has squealed at us that improvements or dividends foregone within the these extra costs will be unaVordable. Have you industry? Are you making it clear to the Secretary of looked at the industry’s self-reward programme in State that she has that choice? terms of its dividend payment over the last few Baroness Young: I do not think it is strictly true to years? say that the Secretary of State has that choice. Baroness Young: Certainly we have been aware of Clearly it is an important issue that the Economic the fact that water company dividends have held up Regulator, in his decisions, produces a financial remarkably. framework for the companies to operate within which does not over-favour any of the recipients of Q131 Alan Simpson: In the last couple of years, benefits in the equation, but he is an independent dividends have been rising and the returns on the Economic Regulator, as I am sure he is going to tell water industry have been 58% head of the FT Share you in a few minutes, and although the Secretary of Index, and so it is hard to say that this is an industry State is able to give guidance on the environmental on its knees and unable to reward its shareholders. I programme, he is at the end of the day able to make do not have any qualms about meeting these costs. I an independent decision about the way in which the am just concerned about who you are asking to pay structure of the water companies’ financing takes the costs. place. Baroness Young: That is an issue that you need to raise with the Economic Regulator; it is his job to construct a financial framework for the industry that Q134 Alan Simpson: We will have the Economic allows them to run a satisfactory but not over- Regulator in a moment. satisfactory business. Our job is to work out what Baroness Young: He is your man. 9130631002 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 49
5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner
Q135 Alan Simpson: I am just asking whether it is Q138 Mr Lepper: You mentioned leakage as well as clear from what you are saying that it is not an an issue there and there is this issue, is there not, automatic presumption that the costs should be met about the level at which it becomes economic to do entirely by the consumer? rather more to deal with leakage than just simply let Baroness Young: Again Philip will explain the way in it continue. Are we at that level? You are suggesting which the costs are structured, but my belief is that that we are at that point where more should be done at the moment some of those financing costs are to deal with leakage. infrastructure costs for the costs of all the various Mr Skinner: The economic level of leakage is one of improvement programmes and, therefore, the costs the key yardsticks which Ofwat use and clearly there of financing are embedded right across the range of has to be a breakpoint where investment does not programmes that are delivered to the price round. produce benefits, but we believe in many cases that What you would see, therefore, if what you were that has not yet been reached and that some of the saying was that you did not want so much of the longer-term proposals of the water companies, profit to be passed on to shareholders, you would see particularly those who are actually forecasting a diminution in the cost of the environment leakage to rise, not just holding steady which in programme, so it would still be met by bills, but it many cases we think is insuYcient, could do more. would be met at a lower level of cost. The thing I The economic level of leakage of course is a bit of a think that Philip will say, and I hate to put words moving target as the environmental value of the into his mouth because we are not the Economic assets which are aVected by the abstraction increases Regulator, we are the Environmental Regulator, is and then of course the equation changes. Therefore, that whatever happens, we must end up at the end of looking forward to the Water Framework Directive, the day with a bunch of water companies that are looking at the kind of issues about the ecological capable of standing up and being financed both quality of waters and, therefore, the value which will through equity finance and through debt finance and be placed upon them, we can only see that the issue if we do not end up with that, we are all in grave of leakage is going to become one which has to be trouble if the water companies get into financial kept at. diYculties. Now, the Economic Regulator makes those decisions in an independent fashion and they Q139 Mr Lepper: Are there any companies which at are not decisions for us. the moment you feel are taking this issue as seriously as you would wish them to? Q136 Mr Lepper: There has been some mention Mr Skinner: Yes. already about managing the demand for water. The water companies say demand will go on increasing. Q140 Mr Lepper: Which are they? You talked about or mentioned Smart tariVs and Mr Skinner: There is a spectrum of performance in metering. Now, metering, the impression I have, is companies and the two companies who have got the not really very popular, but it is there and it is highest leakage projections are Severn Trent and available. Is it really practical for the water Thames, but other companies are managing it well companies to be doing more to manage demand? and managing it down. Northumbrian is an example Mr Skinner: Yes, we believe it is both by what they and that is an issue where water resources is not a themselves do and the way in which they stimulate high-pressure issue, so there are examples. choices in their customers. In parallel with the process we have just been describing which is about Q141 Mr Mitchell: I just want to ask you about the costs over the next five years, the water leakage because one engineer said to me that leakage companies are putting in proposals to us for their and investment are often alternatives. Governments long-term water resources plans and our general push companies into dealing with leakage and the view on those, which we will be publishing next performance has been quite impressive in reducing week, is that the companies, and it varies between leakage and it is now forecast to go up. You say that company and company overall, have not got Y in some cases some companies propose a rise and su cient attention to demand management and most propose that leakage volumes will not reduce water conservation issues, including such things as by 2030. Just as a layman, it could be that the managing leakage in their own systems and that they companies are sensibly deciding, “We are better are too heavily predicated towards investment in spending money on this rather than on dealing with new reservoirs. We do believe that the companies leakage”. With these two alternatives, why are you could do more and we do believe that metering could bashing the leakage argument when the question is be part of those future solutions and we also that investment could be better used for other recognise that a greater penetration of metering improvements? would make available some of these options about Mr Skinner: Well, we bash it if the consequence of choices and spreading the costs in the way that that is to bring forward the need for new water Barbara has described. resources schemes which could either mean the construction of new reservoirs or possibly risk some Q137 Mr Lepper: How widespread is metering at environmental damage elsewhere and clearly just as the moment? Can you give us a rough estimate? there is a trade-oV, as you describe, which the Mr Skinner: I am sorry, I do not have a figure. My company made, there is a trade-oV that we made in colleagues who follow will answer that question terms of the environmental pressure from new water more than I can. resources schemes. We are of the view that the kind 9130631002 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Ev 50 Environment, Food and Rural Affairs Committee: Evidence
5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner of predict-and-demand approach to water resources Q145 Diana Organ: Do you not think that, as the where you work out where it is going to be and you Environment Agency, it is your job to tackle that then go for it by new construction ought to be kind of diVuse pollution rather than saying that the balanced by, where appropriate, an attack on consumer has got to be paying the extra 50 pence to leakage. help clear up the environment? Baroness Young: Could I comment also on the issue Mr Skinner: Well, we want to do both. of timescale. We are at the moment in the midst of one of the most serious pre-drought situations I have experienced for some time. It may sound strange Q146 Diana Organ: You cannot do both though, when it has started to rain, but the reality is that if can you? we do not get 30% more rain this winter than Mr Skinner: Well, we are constrained in doing what average, we will have water restrictions in many you are asking us to do in respect of agriculture parts of the country in the spring and I think that one because we do not really have the resources and of the things about ignoring leakage, which can be a drivers in place, but there is environmental damage way of reducing water consumption, pretty well on being caused by nitrates and phosphates, an ongoing basis starting from now, as it were, and particularly phosphates coming from the water you have seen the figures, is that we can get action industry and we have plans in the programme that now, whereas if we are looking for building we have been talking about which will tackle that reservoirs, it takes at least 10 years to get all the and meet the European requirements. We, as we approvals and if they are not forthcoming at the end have said already in talking to Mr Tipping, have of ten years, we are in a worse position with climate already advocated strongly to Defra that they ought change biting harder and no visible means of to be working in parallel and to use the drivers that providing water for very legitimate uses and are possible in terms of agricultural reform. We increasing dry summers and potentially sometimes think that the chance of CAP reform is a huge lost followed on by dry winters. I think it is a bit risky opportunity to provide a mechanism whereby other quite frankly not to tackle leakage hard in the forms of water pollution are dealt with and in that current circumstances, particularly in those areas of case the land user is paying. water shortage like the south-east where quite frankly we are now drier than Syria in available water per head of population. Q147 Diana Organ: Well, you have rather ducked it Mr Mitchell: Well, this is an incredible, wonderful because you have rather said, “Oh, well, it’s not argument for privatisation, is it not? We privatise the really up to us”, but it is because you are advocating water industry and we are forecasting droughts and the 50 pence a week. How much of that 50 pence a a shortage of water next year. We privatise electricity week are consumers in certain areas having to pay to and there are going to be black-outs next year. We clean up the nitrates and phosphates? privatise the railways and they all break down and Mr Skinner: No, because we had designed the the trains cannot run. What a lovely agenda for programme and set the targets so that they are only privatisation! where the primary cause is coming from the water Chairman: To which you are not required to reply! companies.
Q142 Diana Organ: As the Environmental Q148 Diana Organ: But those programmes that you Regulator, do you agree in the principle that the are saying that only the water industry needs to clean polluter pays? up were actually challenged last week in the evidence Mr Skinner: Yes, we do. to us from the Chief Executive of Wessex Water where he said that this was not the case and they are being asked to do more than the pollution clear-up Q143 Diana Organ: On that basis then, why is it that is caused by the water industry. that we are asking the consumer to pay to clear up Mr Skinner: Well, we disagree with him and that is the environment, the nitrates and phosphates in a programme which we believe is necessary and has rivers, rather than actually taxing those that are not been included in that particular water causing that diVuse pollution to pay for the clean- company’s programme and is an example of a up? missing factor, but we are asking Wessex Water to Mr Skinner: Well, we are not because nitrates and address all the issues in the rivers of their catchment. phosphates in rivers come partly from the water We are asking Mrs Beckett, in parallel with companies and, therefore, from the people who use deliberating on this issue, to set in place the their services and from other practices largely mechanisms for a more aggressive way of tackling relative to agriculture. land-based pollution which one needs to anyway for the Water Framework Directive, so it is an issue which will face the country and since agricultural- Q144 Diana Organ: But there is substantial derived pollution has a long lead time between the evidence that agricultural activity does increase the action being taken and the improvement being nitrates and phosphates in rivers. achieved, we think that should be started, if Mr Skinner: Yes, absolutely. anything, sooner. 9130631002 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 51
5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner
Baroness Young: I should say that Defra is at the to try and get early notification to water companies moment currently preparing its diVuse pollution of schemes that they can do in the first year of the strategy which we will play a strong role in and have programme so that there is not a lag-time every time advised on, but it will be absolutely fundamental to a new five-year programme is started and also so get agriculture subsidy to direct farmers in the right that we can get a better process, and I think there is direction. still work to be done on this, on schemes that emerge during the course of the five-year review which I Q149 Diana Organ: Just on another issue of other know is a concern to water companies, that if they diVuse pollution, occasionally you will know that do schemes, they may not get the reimbursement or there is crude discharge by households into water may not get that taken into account in their funding courses which causes a real problem of pollution formula until the next price round. There needs to be into those water courses. Why does the Environment a better process for what is known as the logging up Agency not do more to enforce that this crude of those schemes that happen in an interim sense, but discharge does not continue? I suspect that it is not easy to get away from the Mr Skinner: Most of those discharges actually come periodic nature of the review other than by these through water company pipes and they are what we mechanisms for stretching. refer to as ‘intermittent discharges’. There are very few direct discharges from households into water Q153 Joan Ruddock: So basically you do not think courses and where they are, we deal with them. the regulatory regime needs to be modified? Baroness Young: I would find it quite diYcult to Q150 Diana Organ: Well, locally, I can tell you, in know what else we could put in its place, to be the Forest of Dean there are quite a lot. honest. I think in a situation where there are a range Mr Skinner: Maybe I can pursue that with you. of regulators and government all playing a role, this Baroness Young: Certainly if we were aware of a is probably as good as we can get. water quality issue that was substantially impacted on by household direct discharges, we would be Q154 Joan Ruddock: Do you think we could do taking action because we would be establishing that better within the framework? there was a real water quality failure issue. Baroness Young: It is a learning experience. We have identified some things already. I think the logging- Q151 Diana Organ: And would you expect the up process does need a bit of attention. There are householder to pay for the pollution that they had concerns about it and there is quite a big chunk of caused? the programme this time around for the habitats Baroness Young: If we discover that, for instance, regulations where we will not be able to give the they are wrongly connected so that their sewage companies suYcient clarity until quite late on pollution is going out through the wrong pipes, we towards the determination and there is anxiety that would take enforcement action to ensure that they those costs are going to be able to be taken into redirected it and got themselves repiped. account. Quite often if we identify schemes that are not actually clear enough to put in a proper project, Q152 Joan Ruddock: I want to ask a bit about the we ask companies to do investigations and again we process itself of the periodic review. Water UK in would like to see some of those schemes where their evidence to us said, “It does not provide an investigations come to fruition during the five-year eVective mechanism for dealing with issues that are period being able to be brought in as actions as soon either long term or require co-ordination with other as we know what the investigations have revealed. agencies”. I wonder if you actually agree with that So there are issues with the logging-up process, there statement and, if so, what do you think are the are issues, I think, with the way in which the drawbacks of the periodic review process for dealing company business plans are presented to allow us to with environmental issues? analyse them with the Economic Regulator more Baroness Young: I think the periodic review process eVectively and to disaggregate out some of the is like one of these things, it is the least worst of all impacts of financing costs. I am sure Andrew, the options that we have looked at so far. It does because he has crawled all over these damned plans involve a whole range of agencies, it involves more than I have, will have thoughts about the government, there are very clear responsibilities process. allocated, there is a very clear timetable, it is Mr Skinner: I was going to say on the point about reasonably transparent and it is getting better as we the long-term perspective that I think we agree with do it more often, so I think we ought not to say that the water industry that maybe the five year cycle the process is completely broken; it is far from that. needs some fine-tuning to deal with the issues I think the issue is the fact that it is a five-year Barbara has described, but the challenge is also to process. We have challenges coming out of the put the thing in the context of a long-term strategy Water Framework Directive that require us to take which the Water Framework Directive will demand a much longer look and I think that will be useful for and which all the parties involved have to find a way water companies in that they will get a feel for the of doing after the cycle is complete. sorts of environmental issues coming up over a longer timescale. I know that the Economic Q155 Joan Ruddock: Do you think the current Regulator, in the way he designed the programme, is framework will enable the Water Framework attempting to stretch it, as it were, in two directions Directive requirements to be factored in? 9130631002 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Ev 52 Environment, Food and Rural Affairs Committee: Evidence
5 November 2003 Baroness Young of Old Scone and Mr Andrew Skinner
Mr Skinner: I can see mechanisms whereby the sorry you have had a fairly charged sort of day but contribution the water industry needs to make to no doubt you have been able to deliver the document let the country deliver the Water Framework to Mrs Beckett at the same time as bailing out the Directive requirements could be accommodated ships, and we look forward to the outcome of that within something which is quite like what we do with scarcely concealed interest. If there is anything now. you want to say which you have not, please let us Chairman: We are going to have a vote very shortly know, and if we have further questions we will let indeed so I am going to suspend now so we can be you know. ready for the vote and ask colleagues to come back as soon as possible afterwards when we will begin The Committee suspended from 3.47 pm to 4.06 pm with Ofwat. Thank you two very much for coming, for a division in the House.
Memorandum submitted by Ofwat
Summary In July 2004 we will set draft price limits for the water and sewerage companies in England and Wales, for consultation, followed by our final decisions in November 2004. These will be based on companies’ final business plans, which they will submit in April 2004. We must by law set price limits that are high enough to enable well managed companies to run their businesses. But, to protect the interests of customers of these monopoly companies, prices should be no higher than they have to be. Price increases for many companies’ customers are needed simply to maintain the huge improvements made over the last 15 years. There are also upward pressures on bills at this review. These include new requirements to improve drinking water and environmental quality, and changes in taxation, capital maintenance and financing. Other potential upward pressures on bills, for example the new Bathing Water Directive and adoption of private sewers have not been included in companies’ business plans. In August, the water and sewerage companies published their draft proposals for price limits for the period 2005–10. This paper concentrates on the issues coming out of the draft plans that impact most on price limits. Average industry price limits could rise in real terms by 6% each year, more than 30% over the period 2005–10, based on the companies’ proposals. At the extreme, United Utilities has made proposals that could, if accepted, lead to an increase of £173 in the average bill for its customers. We are scrutinising the draft plans carefully. We will question each company and, where we do not consider its proposals are fully justified, challenge them. The submission of the draft plans early in the process is proving invaluable as a basis for working with other regulators and water companies to ensure we have good quality final plans next year. In January 2004, Ministers will issue their principal guidance on the quality and environmental obligations they expect the companies to cost in their final plans and deliver in 2005–10. This will follow advice from us which we will provide in December and from the Environment Agency, English Nature and the Drinking Water Inspectorate on the outputs to include in their guidance. We expect outputs to be properly costed by companies and deliver clear enhancements, in line with sustainable development principles. In making our decisions on price limits we must consider customers’ interests. WaterVoice, which represents customers’ views, will provide us with its views on future price limits. With others we are conducting joint customer research into customers’ opinions and priorities for investment. This research will be published in December. However, we know from our postbag and press coverage that customers are concerned about the future level of bills and the aVordability of those bills. Earlier research found that customers are satisfied with tap water supply, sewerage services and value for money and they see little need to improve the current service they receive. We will all need to test the priority and value of the proposed improvements and the outputs that we expect to be delivered by each company. Our early analysis shows that there will be hard choices to make if we are to limit the cost pressures faced by companies to those that can be appropriately financed, and to set price limits that are aVordable. Unless the scale and pace of the proposed outputs are changed, customers will face very significant increases in bills in order to pay for them.
Price Setting 1. Our primary duty is to enable eYcient companies to carry out and finance their functions under the Water Industry Act 1991. Our role is to set price limits that allow each company to do this while protecting the interests of customers. The approach we intend to take at this review is published in “Setting water and sewerage price limits for 2005–10: Framework and approach” (March 2003). 9130631003 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 53
2. In the New Year, Ministers will publish their principal guidance on the outputs they expect companies to deliver in 2005–10. Their guidance will be developed on the basis of advice from the quality regulators; the results of the customer research setting out customers’ priorities and what they are prepared to pay; and advice we will provide on the costs and implications for customers’ bills.
Draft Business Plans 3. In August 2003 each company submitted its draft business plan to Ofwat. The plan allows each company to set down and explain its application for price limits. We expected the plans to include all the challenges facing the company in the price limit period 2005–10. 4. Three companies Anglian, United Utilities and Northumbrian have also sought agreement to increases in bills for 2004–05 under the “interim determination” procedure. If granted this would reduce the increases sought from 2005 onwards.
Preferred Strategies 5. The price limits proposed by each company based on its preferred strategy are set out in annex 1. Annex 2 includes each company’s projections of its annual average household bills from 2004–10. The industry average increase in price limits would be 6% each year, over 30% in the period 2005–10. On average, companies project an increase of £72 in the average water and sewerage bill, taking the average bill in 2004–05 from £234 to £306 in 2009–10. Companies’ proposals cover a range of increases. United Utilities is seeking the largest with an average annual increase to its price limits of 12%, which would increase its average bills from £243 in 2004–05 to £416 in 2009–10. 6. Most companies’ profile of price limits includes a large increase in 2005–06 and smaller changes thereafter. Some companies including United Utilities and Yorkshire are seeking a more even profile of similar price limits in all five years.
Reference Plans 7. As well as setting out their preferred strategies in their plans, each company produced reference plans including a defined package of quality and environmental improvements. These were based on assumptions, set by us, about the cost of capital, the scope for future eYciencies, the level of meter optants and RPI. Companies have generally indicated that they believe our assumptions to be too severe. These assumptions are not predictions of the assumptions we will use to set price limits. All the data set out in this paper is based on the projections of costs and revenues provided by the companies. 8. The purpose of the reference plans is to give us an indication of the prospects for price limits of a range of quality and environmental outputs. Plan A, which all companies completed, resulted in similar average price limits to the companies’ preferred strategies. A more extensive quality and environmental programme was included in plan B. For the purposes of this paper our focus is on the companies’ preferred strategies. 9. Our work going forward will focus on each company’s preferred strategy. We will meet each company to discuss issues in its draft plan, so the final business plan in April 2004 provides us with the information we need to set price limits. The areas we want to explore for each company are set out in annex 1 of “Setting water and sewerage price limits for 2005–10: Overview of companies’ draft business plans” (October 2003).
Issues Arising from the Draft Business Plans 10. Ministers will give guidance to Ofwat on the scale and scope of the quality and environmental obligations they want delivered. We will work with the quality regulators to test the cost eVectiveness of the programmes proposed. 11. The table below sets out the areas of expenditure that are driving the proposed changes in the average bill coming out of the companies’ preferred strategies. This identifies the items that will have a major impact on customers’ bills and guides the issues we will be following up with companies. Proposed increases to the costs of base service levels and new quality and environmental obligations would have the biggest impact on customers’ bills.
What is Driving the Companies’Proposed Changes in Bills in England and Wales (£s)?
Average household bill in 2004–05 234 Less (1) past eYciency savings and outperformance (8) (2) scope for reduction through future eYciency improvements (10) 9130631003 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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Average household bill in 2004–05 234 Plus (3) maintaining base services of which 37 (a) changes in revenue 3 (b) changes in operating costs 6 (c) changes in capital maintenance 19 (d) impact of taxation 9 (4) improving services of which 41 (a) drinking water quality 10 (b) environmental improvements 26 (c) service performance (mostly sewer flooding) 5 (5) maintaining security of supply to all customers 12 Average household bill in 2009–10 306
Operating Costs 12. The industry is proposing net increases of nearly 8%, after taking account of eYciency improvements it is proposing to make to its operating expenditure. Pension costs are the most significant element. Many companies have also expressed concerns about the eVect on future costs and revenues of bad debt as a result of the ban on disconnections. Some include additional costs in their proposals. The section on incentives and eYciency (paragraph 32) sets out the eYciency improvements companies propose making in more detail. 13. Companies’ proposals span a wide range of increases and, where appropriate, we are challenging individual companies’ justifications. However, we expect companies to be able to make some eYciency savings in the period 2005–10, above the general improvements in the economy at large.
Taxation 14. Tax changes will lead to a step increase in the level of tax the companies pay in 2005–06 and beyond. Until now, corporation tax has not been a significant driver of the changes in customers’ bills year-on-year. However, from 1 April 2005, the Inland Revenue is changing the way it will treat certain types of expenditure. In general, the impact is larger for water and sewerage companies (equivalent to a 3% increase in price limits in 2005–06). Where the water only companies have quantified the impact, it leads to a 0% to 4.5% increase in price limits in 2005–06. 15. Another possible change is in accounting standards, which would have a knock-on eVect on the timing of tax deductions for some underground assets. This has not been included in companies’ plans.
Environmental and Drinking Water Quality Improvements 16. Although the scope of work included by companies’ in their preferred strategies was based on reference plan A, there were some diVerences in the quality enhancements companies chose to include. In total, companies’ preferred strategies include expenditure of £6.9 billion for water quality and environmental improvements. For reference plan B, which assumes a larger quality and environmental programme, companies’ proposals are £12.7 billion. The key water service and environmental improvements included in companies’ plans are set out in annex 3. 17. For comparison the determination in 1999 assumed investment of £7.9 billion (in 2002–03 prices) for quality and environmental improvements for 2000–05, the largest quality programme ever. The Environment Agency responded warmly at that time, its then Chairman Lord De Ramsey said “By 2005 we will have reached a position where the significant environmental damage created over the past 200 years will have been repaired.” 18. There are other pressures on prices that companies have identified, but not incorporated into their plans. These include estimates, for example to protect the quality of the Thames Tideway during heavy rain. Companies also suggest that planning for the implementation of the Water Framework Directive could add to their costs. Most of the costs arising from the Directive will only be incurred from 2010 onwards. The Environment Agency will be consulting on the draft River Basin Management Plans in 2007–08. Companies will need to provide information on practical measures they may need to take to implement them.
Capital Maintenance 19. At an industry level companies are seeking increases in prices to fund significant extra capital expenditure. In total, companies are seeking to spend £1.7 billion more than their current plans for 2000–05, an increase of 23% over their current base service. The main reasons given for this increase are the need to maintain serviceability (the ability of assets to maintain services to customers now and in the future); and sustain levels of services for customers. 9130631003 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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20. Companies are funded through price limits to maintain their assets to a stable condition. Our current assessment is that companies’ asset systems are stable, with the exception of above ground sewerage assets (mostly sewage treatment works) which we assess as marginal. (Our judgements range from improving, stable, marginal to deteriorating and individual company performance spans this range.) 21. There are wide variations. Some companies seek increases of almost 80%. Two, Bournemouth and West Hampshire and Portsmouth, (both water only companies), foresee reductions. Some companies have presented well-argued justifications for their proposals based on sound asset performance information, but in other cases the justifications are weaker.
Maintaining Security of Supplies 22. Overall, companies’ plans suggest almost a three-fold increase, from £1.1 billion (2000–05) to £2.8 billion (2005–10), in investment to maintain the balance between supply and demand for both the water and sewerage services. Thames Water’s plans to invest to resolve leakage and supply issues in London contribute significantly to this. Although companies expect demand for water to be broadly flat up to 2010, many argue that their revenue base is likely to be adversely aVected by metering and reduced commercial and industrial demands.
Service Performance 23. The sewerage companies have proposed investing £1.6 billion to address most of the worst known cases of properties at risk of sewer flooding and some of the worst cases of external sewer flooding.
Accounting for Capital Programmes 24. Capital expenditure is not directly reflected in price limits, and hence in customers’ bills, in the year in which it is incurred. Instead, the cost is recognised over the period the assets are used, through either current cost depreciation (CCD) or the infrastructure renewals charge (IRC), together with a return on the capital invested. 25. We expect depreciation on base service assets to remain stable over a five-year price setting period with a broadly neutral eVect on customers’ bills, although this is not reflected in all companies’ plans. Investment in new assets results in additional depreciation and hence an increase in customers’ bills year- on-year. At an industry level, companies are projecting CCD of £8.5 billion for the five years 2005–10, compared to £6.6 billion allowed in price limits for 2000–05. This contributes, on average, an increase of 4% to price limits in 2005–06 and a further increase of up to 1% per annum for the period 2006–10. 26. Infrastructure assets are not depreciated, instead infrastructure renewals accounting is used. The infrastructure network is treated as a single asset system to be maintained in perpetuity. An annual charge, the IRC, is made against profits for the annualised costs of maintaining the system. Expenditure to maintain and replace the network is infrastructure renewals expenditure (IRE). We expect the level of IRC to be broadly constant, in real terms, over the medium term, assuming networks are in a steady state. 27. At an industry level, companies are projecting IRC of £3.1 billion for the five years 2005–10 compared to £2.1 billion allowed in price limits for 2000–05; and stepped increases in levels of IRE. At an industry level this contributes an increase of 3% in price limits in 2005–06.
Cost of Capital 28. We must act in a way that allows companies to finance their functions, in particular by securing reasonable returns on their capital. The cost of capital is the minimum return investors will accept for investing in a particular company. Because it is applied to the entire capital base of each company it is a highly significant element within the determination of price limits. If it is set too low companies may experience diYculties in financing their investment programmes; too high and shareholders earn windfall returns. 29. The range of company estimates for the weighted average cost of capital (WACC), equity and debt, including all premiums for water and sewerage companies is 5.2% to 5.8% on a post tax basis. For the water only companies this range is 5.7% to 6.9%. This compares with the average of 5.0% used for water and sewerage companies at the periodic review in 1999. All of the companies argue in their draft business plans that the WACC used at the last review was too low.
Financeability 30. There are two strands to our duty to allow companies to finance their functions. One is to ensure that if a company is eYciently managed and financed it earns a return equal to the cost of capital. The second is do its revenues, profits and cash flows allow it to raise finance on reasonable terms in the capital markets: “Financeability”. For some companies a significant element of the price increase sought in 2005–06 is 9130631003 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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required in order to achieve what, in their view, is an acceptable financial profile. This is in order to allow them to maintain their view of the necessary level of financial indicators to provide assurance to investors, and allow them to secure finance to fund new capital expenditure projects.
Efficiency and Outperformance 31. We operate an incentive-based regulatory regime. Mechanisms are in place to encourage companies to innovate and become more eYcient. Companies that beat our assumptions benefit financially. Where companies fail to meet our expectations they bear the costs. We recently consulted on proposals to provide enhanced rewards for outperformance. 32. At an industry level the assumptions on operating cost eYciency in the companies’ preferred strategies would result in base operating costs reducing by around 2% each year, equivalent to an annual reduction in the average bill of about 1%. This is about half the level that we included in the assumptions we provided to companies for inclusion in the reference plans. For capital eYciency companies have, in aggregate, assumed savings of about 4% on the total capital programme for 2005–10 in their preferred strategies. The easiest gains following privatisation have now been made and companies have outperformed eYciency targets since 2000 by much less than in the 1990’s.
Public Debate 33. Since companies published their draft business plan proposals our postbag has included concerns from customers and elected members about the prospects for customers’ bills. The main focus has been on the aVordability of bills, particularly for customers that are in receipt of benefits, pensions or are on low incomes. The impact of more customers facing debt as a result of increasing water bills and the cost to other customers of managing that debt is also causing concern.
Next Steps 34. Further research is being conducted based on the proposals included in the draft plans. The results will be published in early December and will provide us with an understanding of customers’ priorities for further investment and what they are willing to pay. 35. We will be advising Ministers on the prospects for price limits and will publish a broad summary of our advice later in December. In January 2004, Ministers will issue their principal guidance on drinking water quality, environmental improvements and social issues. Based on this companies will submit their business plans in April 2004. 36. In July 2004, we will publish, for consultation, our draft determinations of what price limits should be for the five years beginning 1 April 2005. This will be followed by publication of the final price limits in November 2004. Companies can ask us to refer our determinations to the Competition Commission if they do not accept our decisions. The new price limits will be reflected in customers’ bills for the year beginning 1 April 2005. 15 October 2003
Annex 1
PRICE LIMITS INCLUDED IN EACH COMPANY’S PREFERRED STRATEGY* (%)
2005–06 2006–07 2007–08 2008–09 2009–10 Annual Average Water and sewerage companies Anglian 20.8 5.7 5.2 5.8 5.8 8.5 Dwˆ r Cymru 9.4 4.8 4.3 4.1 3.1 5.1 Northumbrian** 20.7 6.8 3.7 2.6 1.3 6.8 Severn Trent 13.3 3.7 1.6 0.7 –0.4 3.7 South West 9.5 6.6 5.5 4.0 3.5 5.8 Southern 10.7 5.3 6.2 6.2 1.9 6.0 Thames 16.6 1.1 0.5 –0.3 –0.1 3.4 United Utilities 11.9 11.9 12.0 12.1 12.3 12.0 Wessex 6.3 2.8 2.3 2.0 1.5 2.9 Yorkshire 3.6 3.6 3.6 3.6 3.6 3.6 WaSC average*** 13.1 5.3 4.6 4.2 3.6 6.1 Water only companies Bournemouth & W Hampshire 9.5 4.4 4.4 4.4 4.4 5.4 Bristol 11.0 1.0 1.0 0.0 0.0 2.5 9130631003 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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2005–06 2006–07 2007–08 2008–09 2009–10 Annual Average Cambridge 23.4 5.4 2.6 1.7 1.5 6.6 Dee Valley 15.0 1.6 1.6 1.6 1.6 4.1 Folkestone & Dover 5.8 5.8 5.8 5.8 5.8 5.8 Mid Kent 6.9 6.9 3.3 3.3 3.3 4.7 Portsmouth 6.7 3.6 2.7 1.8 –0.3 2.9 South East 22.7 2.2 1.6 0.1 –0.4 4.9 South StaVordshire 6.9 2.2 1.8 0.2 1.7 2.5 Sutton & East Surrey 17.0 2.0 2.0 2.0 2.0 4.8 Tendring Hundred 6.3 –0.3 0.6 0.9 –1.2 1.2 Three Valleys 16.5 5.0 5.0 5.0 5.0 7.2 WoC average*** 14.0 3.5 3.0 2.4 2.3 4.9 Industry Average*** 13.2 5.1 4.5 4.1 3.5 6.0
*The price limits are annual price limits for each company and are taken from the company’s preferred strategy for their draft business plans. The percentage increase does not reflect inflation.
**The price limit for Northumbrian Water incorporates the limits for the Northumbrian Water area and the Essex & SuVolk Water area.
***Each average has been weighted according to the size of each company’s turnover.
Annex 2
COMPANY PROJECTIONS OF AVERAGE ANNUAL HOUSEHOLD BILLS FROM 2004 TO 2010 (£s)
Company preferred strategy 2004–05 2005–06 2009–10 Water and sewerage companies water sewerage water sewerage water sewerage Anglian 115 162 129 198 145 234 Dwˆ r Cymru 119 156 134 173 155 195 Northumbrian 87 115 104 141 118 161 Essex and SuVolk 111 131 149 Severn Trent 110 100 123 114 128 120 South West 121 213 131 228 151 256 Southern 91 160 101 177 123 216 Thames 104 92 141 94 146 93 United Utilities 119 124 128 143 167 249 Wessex 120 144 127 152 135 161 Yorkshire 114 123 119 126 140 138 WaSC average* 110 124 126 138 143 164 Water only companies Bournemouth & 101 109 125 W Hampshire Bristol 103 114 116 Cambridge 86 105 115 Dee Valley 102 116 120 Folkestone & Dover 140 48 186 Mid Kent 123 131 152 Portsmouth 73 78 84 South East 123 151 156 South StaVordshire 87 93 99 Sutton & East Surrey 122 142 154 Tendring Hundred 152 160 157 Three Valleys 114 132 155 WoC average* 108 123 136 Industry Average* 110 126 142
*Each average has been weighted according to the size of each company’s turnover. 9130631003 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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Annex 3
THE KEY WATER QUALITY AND ENVIRONMENTAL IMPROVEMENTS INCLUDED IN COMPANIES’ PLANS
Water — Upgrades to water treatment works to comply with quality standards for nitrates (£0.75 billion). — Completion of work to replace rusty water distribution mains (£0.85 billion). — Replacement of companies’ lead pipework which supplies individual properties, with an estimated cost of between £0.3 to £1.2 billion depending on the extent of replacement. — Improving the acceptability of drinking water to customers (taste, odour, appearance and hardness) at a cost of £0.3 billion.
Sewerage The main environmental improvements include: — Dealing with environmentally unsatisfactory overflows from the sewerage system (£1.9 billion). — Improving rivers to be more favourable to fish populations (£1.4 billion). — Improving the microbiological quality of coastal and estuarial waters used for shellfish harvesting (up to £2 billion). — Removal, from sewage eZuents, of chemicals classified as dangerous (£0.3 billion). — Removing nutrients from sewage treatment works’ eZuents in order to protect nature conservation sites (£0.8 billion). — Finding alternative sources of water to replace those causing damage to nature conservation sites. The cost of this could range between £0.1 to £0.6 billion.
Witnesses: Mr Philip Fletcher, Director General of Water Services, Mr Bill Emery, Director of Costs and Performance and Chief Engineer, and Ms Fiona Pethick, Periodic Review Project Manager, Ofwat, examined.
Q156 Chairman: Technically we are not quorate so we may expect to have a new Water Services if you want to say you are not prepared to answer, Regulation Authority, Ofwat II, and that will help you are perfectly entitled to, but I know from old us think about the period. It is going to be very experience what happens when votes interrupt diYcult to make it a lot longer than five years business and no doubt the leakage will be reversed at because, as Barbara Young also pointed out, a lot of some stage. We have before us, Philip Fletcher, the demands on the industry are still being Director General of Water Services, Bill Emery, formulated even for the coming five years, before Director of Costs and Performance and Chief 2010. I personally do not believe that for the crunch Engineer, and Fiona Pethick is Periodic Review period for the Water Framework Directive, Project Manager. Can we start where we just wound 2010–15, we shall necessarily have everything lined up. The water companies said that although the up neatly in 2010 even for five years, and as it whole process of the review had got more mature, happens 2015 is, as you know, a big milestone useful and constructive, they thought we were pretty date for the Water Framework Directive well at the end of where the present process would implementation. So it is always going to be a take us, and you have just heard from the balance. It is desirable for the stability of an Environment Agency they thought there had to be a incentive-based regulatory system that you get a way in which the process was able to accommodate good platform on which the companies can perform rather longer-term perspectives and requirements. when you set the price limits, but we also have safety Where do you think it is going, Mr Fletcher? If valves, one of which Mr Jack referred to, interim somebody said to you, “You have run this system, determinations. Announcements have been made we need to know where we go in future”, what would today on changes within the period, and we need to your recommendations be? have mechanisms coming from the regulatory Mr Fletcher: I would join with Barbara Young in government end for changes that are unavoidable, saying that, like democracy, it is the least worst however undesirable, during that five-year period. system, it is a good deal better than all the others. Yes, it is not perfect, and one of the obvious things Q157 Chairman: Is that your scene-setting, or do which would be better in a long-term industry is if we you want to do some scene-setting as well? could run the periodic review for a period longer Mr Fletcher: I really wanted, first of all, to welcome than five years. We are going to review that point the Committee’s investigation, but to say it is very and all others concerned with how the process works early days. We are talking about draft business immediately after this review. That is in 2005 when plans, about a year still to go before I set price limits, 9130631004 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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5 November 2003 Mr Philip Fletcher, Mr Bill Emery and Ms Fiona Pethick and it is inevitable at this stage that there is a lot of Mr Fletcher: I think it is a highly relevant principle uncertainty which still has to be sorted out. That and yet it is a diYcult one to grasp, but it is the old does not mean the process is wrong. I think actually, problem of the times do not always match up. The without being complacent, the process is working pollution which is now aVecting some of the aquifers broadly as we in Ofwat had hoped it would at happened 20 years ago, or 200 years ago if you really this stage. We have companies’ draft preferred look at the Industrial Revolution, and, as you know strategies, something we did not have five years ago, from other investigations, it is not easy to pin that on and we have two reference plans on diVerent bases to to a living polluter. Looking forward, the emphasis give us a reasonable understanding of what changes which everyone involved is putting on diVuse when you make assumptions diVerent from those pollution and its control is going to be terribly preferred by the companies, on things like the cost of important for the acceptance by water customers capital and eYciency propositions and, one big that any increase they face is justified and it is not driver of change, the scale of the environmental them bearing the costs which ought to be borne by programme. others.
Q158 Chairman: Do you think we will come to the Q161 Chairman: You are faced with Plan A, Plan B point when we have the environment as good as we and preferred plans, how do you weigh the three of need it to be? In other words the question is, will them when you come to do price determination? there be a continual environmental improvement Mr Fletcher: This goes back to the fact we are still in continually driving up prices to the consumer, or is the early days. Before we get to the price there a point where we say, “Hang on, it is good determination we shall have seen a lot more work enough”? from the companies. We are, as they say, in dialogue Mr Fletcher: We have drinking water tests meeting with the companies at the moment; we are engaged the current standard 99.8% plus, so they are creeping in a pretty—I will not say “bruising”—constructive, up. The Government announced, with a justified critical dialogue between the two of us, meeting by fanfare, yesterday yet more improvements on meeting, which colleagues like Bill Emery take with bathing beaches, with 99.8% now fully meeting the each company, to test what they have put to us. At current standard, of course there are further the end of that we shall have learnt something, they standards to come. I think the answer is that we will shall have learnt something, and we will get, I am never be at the end of this process, there will always convinced, much better final business plans next be things which drive us to another stage. But it is April than we would have done if we had not gone important that customers should feel that what is through this draft process now. That will be the coming through is actually necessary and desirable focus, that will be what they actually want to do, in the interests of the improvement of the taking account also of Mrs Beckett’s key guidance to environment and all the other improvements they me and the water companies, hopefully in late want to see, so that they have some stake, some January, on what she wants them to do to fulfil the share, in what certainly for this five years I fear will UK’s environmental obligations. be price increases rather than price reductions. Q162 Chairman: So it is dialectical synthesis? Mr Fletcher: Yes, Chairman. Q159 Chairman: I have never yet had a constituent write to me to complain about the quality of the water which came out of the tap. I think all this is Q163 Mr Mitchell: Listening to what you have said, happening over the heads of the consumers. They there is a great deal of uncertainty about what the are being told it is good for them but they did not obligations of the water companies are going to be. think what was happening before was particularly You do not know beyond 2010, you do not even bad for them. know some of them will go into the next period. Mr Fletcher: We have done joint work—which is When does that uncertainty end? Whose side do you another improvement this time round—where we, err on? That of the companies? In other words, the Environment Agency, the other environmental giving them greater income to deal with regulators, the Government, the companies, Water contingencies which may or may not arise? Or that Voice, the customer representatives, have all done of minimalism? joint research together, and phase one last year Mr Fletcher: Probably between the two. It is showed by and large customers were, as you say, important in the context where we are going to see content with the level of service they were receiving. broadly prices going up, maybe substantially, that For that reason, the companies in their draft we are only doing properly what needs to be done. I business plans by and large are not proposing big share Barbara Young’s view that we cannot stand service improvements in terms of their own direct still just because we face price increases, we need to service to the customers. One important exception is keep going with the environmental improvements sewer flooding where they do want more to be done which are necessary. At the same time this is a long- term industry with a long-term perspective and the and where I, frankly, share their view we ought to try V and do more. environmental improvements only have e ect over a long time. In her initial guidance to me, the Secretary of State made it clear that even where there are Q160 Chairman: Polluter pays, is that a relevant statutory drivers, obviously a key point, nonetheless principle in this game? there may be choices about how and when it is done 9130631004 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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5 November 2003 Mr Philip Fletcher, Mr Bill Emery and Ms Fiona Pethick and about the synergy between various diVerent determinations does indeed take eVect next year but elements in the programme. So I hope that the that is no great comfort to customers. They face guidance, when it comes to me, will take full account ageing, and not just ageing (Bill Emery upbraids me of the point she has already made in her initial when I use the word ageing) infrastructure which guidance. needs to be overhauled and up-dated because, although it is performing perfectly well at the Q164 Mr Mitchell: It depends on who defines moment, we must not run the risk with that “necessary” and what “necessary” means, does it infrastructure of serious failure in the future. I think not? we have done pretty well so far. I think there is an Mr Fletcher: It is right that the Government of the argument which we need to listen to very hard from United Kingdom is the right body to assess what our the companies that we may need a step up for the obligations as a nation are under the international coming five years, and it is unfortunate that it agreements we have entered into, including coincides with the prospect of an environmental European directives. That is where I look for that bit programme which we will still be driving ahead at a of key guidance. rate not very far distant from the first 15 years since privatisation. Q165 Mr Mitchell: There are specific directives, and that is clear, but on a general desire for an improved Q169 Mr Mitchell: That is something you can environment you cannot define how far it is going measure, the age of the investment and when it needs to be— to be renewed, but how on earth can you measure Mr Fletcher: So it is important to pin it down, and I regional diVerences like the fact they have more agree completely with that. The directives do a lot of beaches in the South West, whereas other areas have that and the Water Framework Directive, as we all more reservoirs and a greater opportunity to supply know, will provide an overarching framework in water locally from them? These are God-ordained, which all these individual elements can be properly God-given, diVerences which you cannot really looked at. What is already clear is with hindsight we measure. have all got a lot to learn about regulatory impact Mr Emery: I think there are two ways of answering assessments. Some of the assumptions made about that. One is, in terms of trying to compare the what the directive will cost already start to look a eYciency of the companies, we try and take account little optimistic, shall we say. of the diVerent geographical situations each one faces, and use rather complicated statistical Q166 Mr Mitchell: You mean exaggerated? techniques which bring in the co-eYcients you Mr Fletcher: I mean, on the contrary, far too low. commented on earlier to try and tease out factors outside management control. Whether they are Q167 Mr Mitchell: I thought they would take the eYcient or not eYcient, and those judgments feed opportunity to whack a lot more on and blame it on into price determinations, and in terms of setting up Europe, which is a good tactic. the draft business plans we have fed our current Mr Fletcher: There is a danger in blaming Europe assessments of those eYciencies into the Reference here because, certainly with what has been done up Plans A and B. So in terms of the eYciency to now, everybody takes credit for it—Ofwat takes judgments between companies, we have a method, credit for it, the companies take credit for it, so and it is a proven method over two periodic reviews, does the Environment Agency, so does the that works well. In terms of the environment Government—which shows it has been a success and programmes, they are site-specific, discharge- actually we all, probably rightly, share some credit specific, obligations-specific, and hence if there is a for those improvements. On the Chairman’s point, gap between the environmental expectations and the the incremental benefits do start to tail oV after a current consent on this particular one, and it is a very while and it is very important to be able to persuade big works, that is why that particular company has the customers they are still worthwhile doing. a large step to make in this particular period. You can only really get a trend over a long period as to Q168 Mr Mitchell: Everybody takes credit but I whether or not there has been a significant diVerence wonder if the consumer notices. However, let us not between the companies. In terms of saying, “Why get into that. Let me move on. Why are there such are Severn-Trent not exposed?”, you have to go back marked regional diVerences in the price increases? a very long time to serving populations by inland Mr Fletcher: This may be partly because company rivers so they invested in substantial levels of boards in looking at the issues in front of them have treatment many decades ago, whereas coastal chosen to take diVerent approaches, for example, on companies did not, and they are having to aVord capital maintenance. But a large part of the that now. So in terms of the impact on bills of the variations in the companies, both the reference plans quality programme, it is down very much to the and the preferred strategy, is due to the fact that individual assets, current levels of performance and diVerent drivers have diVerent impacts on diVerent the gap in the environment performance needed, and companies. If we take the one which is right out that is why you get wide disparities between pretty well on its own at the extreme, that is United companies in the environment programme. You Utilities, which in its preferred strategy is proposing similarly get wide disparities between companies in an increase of 70% in real terms—it will be rather terms of whether or not they are exposed to less if my announcement today on interim movements in population. Companies in the South 9130631004 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs Committee: Evidence Ev 61
5 November 2003 Mr Philip Fletcher, Mr Bill Emery and Ms Fiona Pethick
East are subject to substantial needs to cater for the same time we must ensure this sector does not fall growth and change in populations, other companies through the cracks. If I could comment on Mr are not. So when you look at all the component Simpson’s earlier point, yes, the shares have parts, it is not surprising you get quite diVerent performed well over the last few years but, as so packages, and of course at the end of the day if you often in these things, it depends on your starting have a small company exposed to a large point, and the starting point was the period requirement to make the movement, then its immediately after the last review when they were customer base is small but the investment could be performing very much below the market. Partly as a quite substantial, and there is only one place where consequence of the decision by Ofwat to cut prices the funding really comes from and that is supported by 12% in real terms in 1999 which led to a rate of by customers in the long-term. return across the industry of under 6%, which is not generally regarded as a hugely generous return for Q170 Mr Mitchell: I can see that, there are lots of private capital bearing in mind the risk it must carry. So a variety of issues, but we must ensure we set the factors which you say are not measurable and I can Y accept that. In the first part of the answer, you seem cost of capital at a point where an e cient company to be saying you have devised a mathematical can expect to beat it in delivering its outputs. formula for measuring God’s legacy to diVerent parts of the country. I know a beneficent deity gave Q172 Mr Jack: What dividends are you taking a very good legacy to Yorkshire and probably a less therefore in setting that cost of capital? How are you happy one to the South West, but I cannot really determining that, bearing in mind you are looking think how you can measure those factors by any forward over a five-year period? mathematical formula, which is my real question: Mr Fletcher: We are first of all thinking about a are the companies going to be able to dazzle you with consistent structure to the industry. What we science, or bluV you with geography really, when it actually have, as you know, is a great variety of comes to saying what they need to do for their area? diVerent structures from a wholly debt financed Can you properly measure and regulate that? company limited by guarantee in Wales, to a number Mr Fletcher: They cannot blind us because we have of companies which still consider it right to have a 23 of them and we can compare one with another. very substantial tranche of conventional equity. In Yes, of course, there are all these geographical setting the cost of capital we will assume that the variations but we have been working for 15 years companies need to raise funds from a variety of with the companies to try and ensure that the special sources for safety’s sake, because the fact that debt factors can be ironed out and that we can really test is relatively cheap to raise at the moment may not the degree to which one is more eYcient than persist over time. So we are not going to look at just another, and apply appropriate pressure for the less a spot point in the market, we will be taking account eYcient to catch up with the best without doing what of all the evidence which appears to us relevant on we must avoid, which is to drive a company the immediate market position, future and historic inadvertently too hard to the point where it is trends and assume some gearing, perhaps slightly impossible for them to carry on performing this more heavily weighted towards debt in the light of long-term essential task. market developments, but still assuming an equity element as well which at the moment is a lot more Q171 Mr Jack: In paragraph 30 under expensive to raise for most companies than debt. “Financeability”, you start your evidence by saying, “There are two strands to our duty to allow Q173 Mr Jack: Bearing in mind companies come to companies to finance their functions. One is to you, as you say, after 15 years and their debt/equity ensure that if a company is eYciently managed and is what it is, they are faced with the reality of having financed it earns a return equal to the cost of capital. to satisfy, in a company that has gone down the The second is do its revenues, profits and cash flows equity route, their shareholders. It is diYcult, unless allow it to raise finance on reasonable terms in the they go through some complex things like share buy- capital markets.” Both of those are very important backs, to change the debt/equity ratios they have, statements. In the context of commenting on what therefore they are faced with a circular argument, might be deemed for a utility to be an acceptable are they not? If they do not look a good prospect in financial profile, could you comment on why you the market place, they are not going to have things think the companies’ return should simply be equal like rights issues properly subscribed to, people will to the cost of its capital? not put new capital into the company to meet their Mr Fletcher: The point about financeability is partly future obligations. Equally, if they have to go into to say, there is more than that. If they are to keep the debt-raising side of things, they have to have a investors attracted to putting money into the credit rating and therefore a performance rating industry on the scale which the current programmes which is attractive to lenders, and unless you get the require, then they need to raise capital and make a numbers right they could be in diYculties. So do you return to shareholders. Mr Simpson may have look at individual companies? The point I was questions about whether those dividends are intrigued by was, “to find a return equal to the cost acceptable or not. We do not control the dividends of capital”. Do I deduce from that what you are and try and ensure only a company which is saying is if you therefore want to pay a dividend that performing very eYciently will be in a position to is more than a number which represents the return to keep its shareholders properly rewarded. At the capital, let’s say for the sake of this discussion the 6% 9130631004 Page Type [E] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
Ev 62 Environment, Food and Rural Affairs Committee: Evidence
5 November 2003 Mr Philip Fletcher, Mr Bill Emery and Ms Fiona Pethick you mentioned, if you want a return more than that what they had made since 2000. They continued to or have capital growth of the company via the stock out-perform after the 1995 review, and the way the market, that the company is going to have to system worked and should work is that that was perform even better than it said to you it could do in taken fully into account in the 1999 review and led order to generate those extra surpluses so its to the reduction in prices of 12%, a state of financial performance looks acceptable? aVairs which benefited everybody—customers got Mr Fletcher: If I take the first part of your question reductions, the environment got a continuing large first, we do need to look at the state of the company and bigger programme, the Environment Agency at individually. For example, a company which has a the time rejoiced to see the back of the Victorian very large capital programme because it has been sewerage system and everybody was happy. I fear required of it and because we have accepted the need this magician’s wand is not available to me for the for it in the price limits, may well run into the buVers year 2004, but we can see the system working and the of various financial ratios which are essential to it if eYciencies made up to 1999 were returned to it is going to maintain its borrowing capacity, and we customers, mimicking the operation of a truly must take that into account. But we always, as you competitive market, in the year 2000 up to 2005. know, start with the need for the company to be eYcient, we are not there to bail out an ineYcient company whose credit rating or whose financial Q175 Mr Jack: We look as if we are moving into a ratios are poor in the first place, and that company position where debt costs may be rising, and it does must take its chance in the market with anybody else not look as if they are going to get any cheaper. How who is under-performing. Yes, we do look at the do you factor into your final determination of these circumstances of the individual companies. What we matters possible long-term changes of interest rates? have said so far in relation to the cost of capital is Because clearly it could have an important influence that we do not expect it to be lower than the post-tax on this equation as to what is the right number to cost of capital figure we used at the last review, which allow a company to increase its costs by if debt is 5%, and we shall be, in looking forward, taking a becomes less attractive and equity becomes more decision much nearer the time of the final price attractive part-way through the settlement period. setting on whether that figure needs to increase or Mr Fletcher: This goes back to my earlier answer. As not bearing in mind the negative cash flow position you would expect, we take proper financial advice, of the vast majority of the companies. city advice and so on, so we are properly and expertly advised, but we are not assuming all the Q174 Mr Jack: Looking back over time, what can eggs go in one basket. We shall start from the you say about the track record of companies assumption, whatever a company may actually do performing better, in terms of their eYciency and by way of structure, its eggs are properly spread to therefore their ability to generate extra returns in the spread the risk, that there is an equity element and a case of those with shares to their shareholders, than debt element, and therefore whatever changes in the they said to you at the time? If that occurred, how do market it will not be so extreme as to invalidate the you then deal with that? Because the suspicion in assumptions which underpin our price limits when your mind must be, “If they could do it once, they we come to them. could do it again”. The feeling I have, at this perhaps more malleable stage as I have been given to understand the process is, is that there is an element Q176 Alan Simpson: I am fascinated by this. Are of horse-trading. Some elements of this are not you a fisherman? exact, some you cannot put a precise number on, and Mr Fletcher: No, I am not. from the consumer’s point of view the consumer wants to be sure they are not being ripped oV, they are not trying to slide something in under the carpet, Q177 Alan Simpson: Nor am I, but if I wanted to which is where I suspect Mr Emery’s ferocious and make a start and skip the tedium of standing at the forensic gaze comes in. If you were talking not to the water’s edge for hours, I ought to start with mackerel Select Committee but to water users, how do you fishing because it is dead easy— reassure them that the companies are not pulling the Mr Fletcher: I have done that! Spinners over the wool over your eyes in financial terms and are being back! “fair” in the requests they are making in relation to the size of the financial/economic challenge which they have, which is to meet the requirements of Q178 Alan Simpson: Yes, throw the lines out, it is the Environment Agency as well as, refreshingly money for old rope, you just pull them in hand over new, the infrastructure for which they have fist. Is that not the market you are describing for responsibility? water? It is not a truly competitive market, is it? Mr Fletcher: The very bare history of this, as you will None of us are going to say, “We do not like the state recall, is that the companies greatly out-performed of the market this year, we are going to skip water expectations after privatisation, and what was consumption.” We are all over a barrel, are we not, originally intended as a ten year period very quickly as consumers? became necessarily a five year period because it Mr Fletcher: There are various diVerent markets would have been unacceptable for them to continue involved here. The people who do not have choice to make returns in many cases double the level of are us as water customers. 9130631004 Page Type [O] 12-12-03 00:08:58 Pag Table: COENEW PPSysB Unit: PAG1
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5 November 2003 Mr Philip Fletcher, Mr Bill Emery and Ms Fiona Pethick
Q179 Alan Simpson: Yes. paid for the business relative to its assessed Mr Fletcher: So there is no market there. The regulatory value. So there are proxies for equity investors in the industry have absolute choice, there besides the straightforward shares. is no need for them to hold water bonds, shares or to lend as banks to water companies, and that is one of Q183 Alan Simpson: I am still at the stage of looking the factors I have to bear in mind. Ofwat is just there at this as money for old rope. My reading is that as a proxy—never a perfect proxy—for the dividends paid out since privatisation have been operation of a true competitive market with open over £18 billion, in the last five years in a diYcult and transparent information available to all players. time they have paid themselves out over £7 billion I do not think the water business will ever be quite for half a billion new equity issues. How, on the basis like that, therefore I suspect Ofwat, or something of that, can you justify putting the bill for the like it, is going to be needed for quite a long time improvements that will take place entirely on the to come. customers and not on the shareholders? Mr Fletcher: Two quick factors on the dividends. Q180 Alan Simpson: I do not have any doubts you First of all, the dividend goes with the capital value are going to be needed for some considerable time to of the equity and the shareholder is looking for a come, but it is this role as a proxy for a perfect reward on both, so if the share prices are depressed market. I think you are also there as a proxy which (and they have been running below the regulatory protects the public interest. capital value since 1999) that is one factor. Another Mr Fletcher: Absolutely. special factor is that a number of companies have been switching from equity to debt, and have paid Q181 Alan Simpson: We accept that. I know during special dividends, which I think are included in your the break we had you were kind enough to supply figures, which are a rather special case. On your some figures about investments which had taken wider question, we must ensure that customers are place in terms of new equity issues during the last five not ripped oV, and that is where I absolutely agree years. You have just said in response to Michael with you, and for the whole of the next year Ofwat Jack that in terms of the equity element, the will be giving its best shot to ensure that customers protection of that part in respect of dividends which finish up with no more than they absolutely have to you regard as legitimate has to reflect the fact the pay while the companies can finance these very big equity element is a lot more expensive to raise at the programmes going forward. moment. As an explanation, that would make sense if people had been seeking to raise equity. Will you Q184 Alan Simpson: In that assessment you will be confirm what I think you said during the break, building in a presumption that those facing water which is in the last five years there is only United poverty ought not to be pushed over the edge in Utilities which have come up with a new share issue whatever price rises come through? and that is of £0.5 billion and another £0.5 billion Mr Fletcher: That raises a whole new set of issues to come? around the whole business of water poverty. I am Mr Fletcher: Yes, they are raising £1 billion and they very concerned about customers who find it diYcult have taken half of it in advance of the periodic to pay their bills and that is why the prices must not review and eVectively said that shareholders can be over-high, but at the same time it is equally think again when they know the outcome of the important that I stick to my statutory duty of regulator’s review next year. Yes, that is quite right, enabling companies to finance their functions and there has only been one rights issue, I believe, since do not hold prices at a completely artificially low privatisation, but that does not mean that eVectively level to the point where the stability of these equity is not being raised because the equity base of companies is at any way put at risk. the industry is still there and still eVectively growing and aVected by the prices which people will pay for Q185 Chairman: If you felt you wanted to expand the shares. on that point, perhaps you could do so in a note. I am sorry to squeeze you in between two bells, as it Q182 Alan Simpson: Let us be real about this. Once were, but I know from experience that we will not you have sold your shares, whatever market trading recover a quorum after a second vote. Thank you is taking place it is not coming back to you. very much, all three of you, for coming and we look Mr Fletcher: They have their equity base there and forward to inevitable and no doubt pleasurable they are drawing money from the debt markets. Of further contact. course if you talk to Glas Cymru they will say in a Mr Fletcher: Chairman, thank you. If there are any non-standard way they have equity too, the other written questions which members wish to put equivalent of equity in the shape of the lower price me, of course I will always try and respond to them. 902098PAG1 Page Type [SE] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 64 Environment, Food and Rural Affairs: Evidence Written evidence
Memorandum submitted by WaterVoice
Background 1. In November 2004, Ofwat will set water companies’ price limits for the five year period from 1 April 2005. This will be the third price review conducted by Ofwat since the water industry was privatised in 1989 (price limits for the first five year period were set by the Secretary of State). 2. Ofwat is conducting the 2004 review in an open and transparent manner. This is exemplified by the consultation process it has adopted and by the approach taken to market research where the key stakeholders in the water industry including WaterVoice and Ofwat, have worked together to commission research into customers’ views. The first stage of that research was published in August 20021 with the second stage due in December 2003. 3. WaterVoice benefits from a close working relationship with Ofwat. However, we have also been encouraged by the willingness of Defra, the Drinking Water Inspectorate, the Environment Agency in England and Water UK to meet with us to explain their objectives and to share information. For our part we are publishing a series of briefing notes at key stages of the price review to keep customers informed of the key issues.
Key Issues for Customers 4. WaterVoice has identified five key customer issues for the 2004 price review: addressing the backlog of asset maintenance, the scale and pace of environmental improvements, tackling sewer flooding, incentives and eYciency, and financial issues. Underpinning all of these issues is that of acceptability of the new price limits. Our views on whether water companies are meeting the aspirations of customers are set out below.
The Water Companies’Draft Business Plans 5. On 15 August 2003 water companies submitted their draft business plans to Ofwat. In addition to setting out their preferred strategies, each company was required to produce Reference Plan A which included a package of statutory drinking water quality and environmental improvements. Water and sewerage companies, and the two largest water-only companies, were also required to produce Reference Plan B which included a more extensive range of drinking water quality and environmental improvements. 6. In contrast to Ofwat, WaterVoice has, in general, had access only to the public domain summaries produced by each company. These summaries are of variable quality with some companies willing to lay their proposals open to public scrutiny whilst others have sought to guard the detail of their programme. Over the past month we have, via regional WaterVoice Committee meetings held in public, been able to obtain further details about company proposals for the next five years.
Price Increases 7. In their draft business plans companies are proposing: — An average 31% real terms increase in the average household bill, taking it from £234 in 2004–05 to £306 in 2009–10; — Real terms price increases over five years ranging up to 70% in the case of United Utilities whose bills are projected to rise from £243 in 2004–05 to £416 in 2009–10; — An average first year real terms increase of around 13% (£14) for water and 11% (£14) for sewerage; — First year real terms price increses ranging up to £48 for water (United Utilities) and up to £125 for sewerage (United Utilities). 8. Of the £20.5 billion capital programme outlined in the companies’ preferred strategies the main drivers for price increases are:
Environmental improvements £4.6 billion Drinking water quality £2.3 billion
1 The 2004 Periodic Review: Research into Customers’ Views; MORI, August 2002. 9020981001 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Asset maintenance — sewerage £4.4 billion — water £4.5 billion Security of supply £3.0 billion Service improvements (including sewer flooding) £1.6 billion
Asset Maintenance 9. It is vital to the continuity of service to customers that water companies avoid a backlog of maintenance activity. We believe that previous price reviews have provided insuYcient funds for companies eVectively to maintain their networks. For example, our analysis of Ofwat’s data on supply interruptions and mains renewal suggests a broad correlation between an increse in prolonged unplanned supply interruptions and reductions in mains replacement and relining activity. We have therefore called for an uplift in targeted asset maintenance over the next five years at least. 10. We are however, concerned about the wide variation in company proposals. For example, Bournemouth and West Hampshire propose to replace or reline just 1% of its mains over the five year period (taking total mains renewal since 1989 to just 5.5%). In contrast, Northumbrian’s proposal is for almost 10 times as much activity on their mains (resulting in renewal of one-third of their network in the 20 years since privatisation). 11. We have similar concerns about the level of activity on the sewer network where some companies, such as Severn Trent and Wessex propose a doubling of expenditure on critical sewer renewal while South West propose to reduce their already limited expenditure by three-quarters. These diVerences in approach are not entirely explained by the history of companies’ serviceability (the ability of assets to maintain services to customers.)
Environmental Improvements 12. In the 15 years since privatisation the water industry will have invested £50 billion in programmes to improve drinking water quality, the water environment and customer service. This investment has been funded entirely through customers’ bills. There has been no contribution from government grants or European subsidies. As a direct result of this investment: — Coastal bathing waters meeting mandatory standards have increased from 77.1% in 1992 to 97.8% in 20022; — Ninety five per cent of rivers were of good or fair biological quality and 94% had good or fair chemical quality in 2002 compared to less than 90% for both measures in 19923. 13. Over the past 15 years, the water industry has taken action to reduce its impact on the environment. Sewage treatment works have been upgraded to meet tighter standards for the discharge of eZuents. Most, but by no means all, storm water overflows have been decommissioned. The reduction in pollution of the environment by water companies was recognised by the Environment, Food and Rural AVairs Select Committee in its inquiry into the Water Framework Directive, when it concluded that agriculture was now the biggest polluter of the water environment. 14. WaterVoice supports further environmental improvements that give value for money but we question whether in view of what has been achieved to date, the same rate of expenditure is appropriate for 2005–10. 15. We suspect that several companies may have overstated both the need for additional environmental schemes and its associated expenditure. But we are nevertheless alarmed at the potential costs (£4.6 billion) outlined in the companies’ preferred strategies. As a corollary, we are aware that most companies have not included the costs of compliance with new designations under the Freshwater Fish Directive within their preferred strategies. Defra has estimated the water industry’s share of the cost of compliance at £700 million over the five years to 2010 (although Yorkshire Water has suggested that its costs would be £347 million alone). Furthermore, the prospect of designation of the North Sea, North East Irish Sea and the Solent, among other water bodies, as sensitive waters under the Urban Waste Water Treatment Directive has the potential of at least doubling the proposed environmental programme. 16. In September the Environment Agency stated that its “programme will contribute a modest portion of the household bill for water and sewerage—no more, on average, than the cost of a can of fizzy drink in the weekly shopping for each household”4. We question this claim as 22 million households in England and Wales each paying an extra 50p per week for five years equates to £2.86 billion, well below the current proposed expenditure on environmental schemes. Instead the costs seem to equate more to a bottle of premium lager each week.
2 Bathing Water Quality: Annual Report 2002; European Commission (June 2003). 3 River Quality: General Quality Assessment; Enviroment Agency (September 2003). 4 “A good deal for water”; Environment Agency (September 2002). 9020981001 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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17. In January 2003 Dieter Helm, Director of Oxera, suggested at an Environment Agency seminar on costing environmental benefits, that general taxation could be used to fund the wider public goods associated with bathing water, special environmental areas or other national assets. This is an idea that is worthy of serious consideration to ease the burden on customers’ bills. It is arguable, for example, that as the Lake District and the Cornish coast are areas of national importance further environmental improvement should be funded centrally by tax payers rather than locally by customers.
Drinking Water Quality 18. In the 15 years to 2005 water companies will have spent £8.2 billion on new works and processes designed to improve drinking water quality. This level of expenditure has bought its rewards. Of around three million water quality tests carried out in 2002, 99.87% met required standards. The number of water quality tests failing a standard was less than one-twelfth of that in 19925. 19. Companies are proposing to spend an additional £2.3 billion over the next five years on a range of schemes designed to maintain or improve drinking water quality. We broadly support those schemes that will tackle issues of discoloration (a sizeable portion of the complaints we receive from customers), taste and odour and microbiological contamination. Together these schemes account for around £1.5 billion of expenditure. We have yet to be convinced that proposed schemes on nitrate and pesticide removal from raw water sources (£400 million) shoud be met from customers’ bills in preference to eVective application of the ‘polluter pays’ principle. 20. We also have concerns about the extent of the lead pipe replacement programme (£160 million) and believe that a continuation of orthophosphate dosing programmes in those zones where lead pipe replacement is proposed could yield the same results for a fraction of the cost.
Tackling Sewer Flooding 21. Flooding from sewers is one of the most distresssing service failures that customers can face. Its prevention is one of customers’ top priorities—even amongst those who do not know anyone who has experienced sewer flooding. WaterVoice has called upon Ofwat to allow the funding so that companies can: — Resolve exisiting sewer flooding problems by 2010; — Address new sewer flooding problems through normal operational cycles of maintenance and improvement. 22. WaterVoice accepts it is likely that (because of severe practical diYculties or excessive cost) a residual number of properties may remain at risk of sewer flooding beyond 2010. Nevertheless, we believe that the programme of work we advocate will benefit both customers (by removing the risk of internal and external flooding from sewers) and the environment (by reducing pollution of the land and watercourses caused by sewer escapes). 23. Companies are proposing to reduce the number of properties at risk of sewer flooding by around three-quarters in the period 2005–10. This will still leave over 2,600 properties (13 per 100,000) at risk of flooding once in ten years or greater. We are pleased to note the progress being made by most companies but believe that more could be achieved by some companies, most notably Severn Trent and South West. And while the main problem of internal flooding is at last being given greater emphasis it seems likely that several decades will elapse before external flooding is properly addressd.
Security of Supply 24. Despite an increase in the number of metered households and more active promotion of water eYciency measures, demand for water is slowly rising. For those companies in the drier east and south east of England this position is exacerbated by the Government’s proposals to sanction the building of 200,000 new houses in areas where water resources are already under stress. 25. In their preferred strategies, many companies have expressed deep concern that their overriding duty to supply water to customers is being compromised by the environmental regulators’ desire to reduce or terminate companies’ abstraction licences. Several companies have suggested that they will need to extend existing or build new reservoirs to meet projected shortfalls. Folkestone and Dover is seriously considering desalination as a means by which to meet peak demand. 26. We accept that there must be a balance between customers’ needs for water and ensuring that wildlife is not adversely aVected by over-abstraction. We are, however, not convinced that the Environment Agency has explored all available options with the water companies concerned. The last price review amply demonstrated that a willingness to think laterally could deliver broadly the same results for limited cost.6
5 Drinking Water Quality 2002; Drinking Water Inspectorate (June 2003). 6 Hampshire Avon low flow alleviation scheme; Wessex Water (2000). 9020981001 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Incentives and Efficiency 27. The extent to which companies can and should achieve continuous improvement in ther capital and operational activities lies at the heart of regulation of the utilities sector. The past 15 years have seen water companies repeatedly outstrip the eYciency targets set by Ofwat. Whilst we do not doubt that savings are becoming more diYcult to achieve there remains scope to improve eYciency, particularly through technological advancement, improved procurement activities and partnership agreements. The phrase “the low hanging fruit has already been picked” is fast becoming a water industry cliche´. History has shown us that companies have been able to meet, and beat, challenging targets set by Ofwat. 28. In their preferred strategies, companies have tended to adopt a very conservative approach to setting themselves eYciency targets. The extent to which additional eYciencies can be stripped out of company operations over the next five years should be illuminated by the London Economics report on capital and operational eYciencies, commissioned by Ofwat and due to be published later this year.
Finance and Taxation 29. The water industry is a low-risk industry. The companies have licences that have recently been extended from 10 to 25 years’ notice and their prices are regulated by Ofwat which has a primary duty to enable eYcient companies to carry out and finance their functions. Conventional private sector companies do not have that level of security. It is our view that well-managed water companies should attract a cost of capital consistent with the bond/annuity end of the market. If this is achieved then it should help to keep prices down without necessarily limiting the ability of companies to deliver their commitments. 30. We have therefore been taken aback by the extent of companies’ proposals for financing their business. These include: — cost of capital—most companies have assumed a post-tax weighted average cost of capital at or close to 5.75% plus 0.95% small company premium (from the Water UK commissioned report by NERA) rather than adopt Ofwat’s reference assumption that the cost of capital is 5.0% for existing assets and 4.75% for new assets (plus 0.75% small company premium); — financeability—some companies are seeking additional revenues to bolster their financial ratios, including maintenance or improvement in credit ratings; — taxation—an additional 3% on bills because of changes in the treatment of capital allowances from 1 April 2005.
Acceptability of Price Increases 31. WaterVoice has consistently argued that customers’ willingness to pay more for water and sewerage services should not be assumed. As the joint stakeholder research undertaken by MORI in August 2002 identified, there is high satisfaction with both drinking water quality and sewerage services, and general satisfaction with the water environment. Where there is support for additional expenditure this is restricted to: — Maintaining the quality of coastal and bathing waters; — Maintaining the quality of rivers; — Protecting important areas of wildlife and plants; — Tackling sewer flooding; — Improving the taste and smell of tap water. However, customers were divided on the amount they were prepared to pay (if anything). Only 1 in 8 customers were willing to pay an extra £5 per year. 32. Against these results it is impossible to reconcile customers’ willingness to fund a modest programme of water quality, environmental and customer service improvements with the proposals outlined in companies’ preferred strategies. Even if the impact of taxation (circa £9 on the average household bill over the five years) was accepted as a fait accompli, companies are still proposing real terms price increases that, on average, amount to £12 per year, well above the amount most cusomers are prepared to pay. 33. The concept of aVordability in relation to water and sewerage charges is a real one. In September 2003 Ofwat released figures showing that unpaid bills in 2002–03 totalled £781 million, an increase on £115 million on 1998–99. Revenue outstanding, as a proportion of total household revenue, increased from 13% to 17% in 2002–03. Of this, some £432 million had been outstanding for 12 months or more7. Even in a relatively benign economic environment this is a hugh debt burden for companies to carry, with the costs being borne by the wider customer base.
7 RD32/03; Ofwat (September 2003). 9020981001 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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34. AVordability is most likely to aVect those at the bottom of the socio-economic ladder, particularly those reliant upon the social security system. A good example of this is in the South West which has an above average population of pensionable age and, in Cornwall, the lowest level of average earnings across England. But it is in the South West that the average water and sewerage charge has more than doubled from £147 in 1989–90 to £342 in 2003–04. Water and sewerage charges in the South West are now currently on a par with the average standard gas bill from British Gas and around 50% higher than the average standard domestic electricity bill.8 35. Those in the South West are not alone in finding it increasingly diYcult to make ends meet when presented with large water and sewerage bills. This was recognised by DETR in 2000 when it stated: “Water and sewerage bills have risen steeply since privatisation . . . There has been an increasing burden on customers. This is a particular problem for those on low incomes, for whom water charges represent a larger than average proportion of disposable income and who may face diYculties where payment is required in sizeable instalments’9
Conclusion 36. Customers know that they have to pay for reliable and good quality water and sewerage services, and are prepared to contribute to the cost of improving and protecting the water environment. But price increases of the magnitude seen in water companies’ preferred strategies risk being counter-productive by turning customers against the industry, against the environment and against the Government, and resulting in a further increase in debts and financial hardship. 17 October 2003
Memorandum submitted by UNISON
Summary If the outcome of the next periodic review of water charges is price increases for customers a balance will have to be struck between the needs of consumers, shareholders and the wider community (ie the environment). AVordability is a key issue especially for low-income consumers. The Government should consider whether further assistance is required for low-income domestic customers. The Government and Ofwat should also ensure that employees are not expected to provide the sole source of eYciency savings given that there is already evidence of skill shortages in the sector. A wider consideration of how water charges are levied, the role of metering and the needs of low-income families is merited.
Submission 1. UNISON is the largest trade union in the United Kingdom and represents several thousand employees of the water companies and the Environment Agency. We also represent over one million public service workers in local government, the NHS, police and education authorities, energy companies and transport. 2. The majority of our members are low paid women, many of whom work part-time. UNISON is therefore acutely aware of the need to ensure that the price of an essential public service like water is reasonable and that there are adequate measures to protect the position of low-income customers. 3. UNISON therefore welcomes the Committee’s decision to enquire into this issue. The recent indicative price rises which the water companies announced have caused understandable concern among consumer groups, MPs and others. However, as the Committee will be well aware, there are several more important steps in the periodic review process before final price increases are determined. 4. Since the water industry was privatised in 1989 unmeasured water charges have increased, excluding inflation, in England and Wales by 21% and measured charges by 21.7%, according to Ofwat’s data. These are considerable increases especially since the last periodic review reduced prices by 12% overall. 5. Despite these increases average household bills for water and sewerage charges compare favourably with other major household bills eg electricity, gas and the council tax although there are significant variations in water bills between companies and regions of England. 6. On the plus side however, the increased revenue has, according to WaterVoice, financed £50 billion of new investment in the water and sewerage infrastructure. Additionally, the Government penalised the water companies for their excessive profits with the windfall tax, which was channelled into the New Deal project.
8 Domestic Electricity and gas prices; Ofgem (September 2002). 9 Water Industry Act 1999: Delivering the Government Objectives; DETR (2000). 9020981002 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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7. This long overdue but welcome investment has helped to raise standards in the water and sewerage industry considerably. The end of discharging raw sewage into the sea, improved beaches and rivers and the highest ever drinking water standards are the result of this investment and the skill of the employees who deliver the service and protect our environment. 8. However, water companies still need to make further, major investment to meet the requirements of European regulations including the Water Framework Directive and to renew our ageing water and sewerage infrastructure despite the welcome improvement in standards already achieved. 9. They also may face additional costs for maintaining and renewing the system if the Government goes ahead with proposals to introduce lane rental charges The increased costs have to be shared fairly between the industry’s customers and shareholders. It is acknowledged that shareholders are entitled to a return on their investment, which they find acceptable or they may decide to invest elsewhere. However the rate of return should reflect the low risk nature of the water and sewerage businesses and their monopoly position. 10. Ofwat and DEFRA have to ensure that that the right balance is struck between the parties while allowing much needed investment and aVordable bills. They also need to ensure that the water companies have the right numbers of skilled staV to deliver both core services and customer service functions, like debt management. 11. Following the last review many companies reduced their workforce and began to rely increasingly on outsourcing. Dwr Cymru has outsourced all its operational, engineering, IT and customer service activities. Other companies have outsourced major functions or activities. 12. We acknowledge that there is an increasing problem of indebtedness among domestic consumers, which needs to be addressed in a humane and sensitive way. The Government was right to make disconnection from the water supply illegal and it is also right that water meters should not be installed compulsorily. However there is growing support for meters on environmental grounds, particularly concerning water resources. 13. Interestingly, the recent research by Accent for WaterVoice, Water UK and Ofwat revealed that most consumers do not know that they cannot be disconnected. This suggests that the number of “won’t pay” customers is not the major cause of the rise in debt levels. The price of the product is obviously a factor but other issues like payment methods, flexible debt repayment schemes and Government assistance are important. Perhaps this is an area where further research would be merited. 14. Accent invited water companies to examine whether they have enough appropriately trained staV to deal with customers who want to talk to someone about paying their bill. Moreover while most companies support non-profit trusts set up to help poor customers much more needs to be done to inform the public about the types of assistance they oVer. We strongly support the view that customers should be able to talk directly to a trained member of staV about their bills and hope that this requirement is not undermined by the current trend to outsource customer service work abroad. 15. It is also important that water companies recruit and maintain suitably qualified staV to their core clean and wastewater operations. In tight labour markets, the companies need to be attractive to potential new entrants to replace their increasingly ageing workforce. Good terms and conditions, regard for the employee’s health, safety and welfare, rigorous policies to achieve equality of opportunity for all staV and a reputation for ethical business practices are essential. 16. Equally important is ensuring that managers concentrate on delivering safe and secure operations. In our view outsourcing can undermine this as the experience of Rail Track/Network Rail demonstrates. The report on the October storms which lead to thousands of electricity customers being without electricity for up to 10 days in the worst cases also demonstrates what can happen when basic but essential work like pruning trees by power lines is neglected. 17. Research by the Gas and Water Industry National Training Organisation, now part of the Energy and Utilities Sector Skills Council, reveals growing skill shortages in the water sector. Filling the vacancies will not be helped if labour standards are undermined because water companies are unable to finance reasonable pay, pensions and other conditions. 18. Water UK has done some excellent work on sustainability criteria to sit alongside the key performance indicators set by Ofwat. We believe that Ofwat should submit its price determination to an employment sustainability test ie what will the eVect of our proposals have on employment. 19. All this leads us to conclude that increase in water prices have to be suYcient to ensure that the companies are able to recruit and retain suitably qualified staV. 20. We accept that Ofwat must submit the company’s expenditure plans to the most rigorous scrutiny and that they should have regard to the overall aVordability of water and sewerage bills. Perhaps some environmental improvements could be introduced over longer timescales where this is consistent with EU requirements. 9020981002 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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21. There is also a growing view among many organisations representing customers and consumers that the present system of water charges in England and Wales—based on rateable values—is not sustainable. Although metering raises many diYcult issues and is not the only alternative to rateable values, it may be the most sustainable option in the long term. Under no circumstances however should water companies be allowed to install pre-payment meters, which would undermine the ban on disconnection. 22. The key consideration with meters is the tariV structure attached to them. It is perfectly possible to design a tariV that takes into account the needs of the poorest, while at the same time providing water suppliers with important data on water consumption. This would enable water resources to be managed more eVectively and would also help to identify leakages and falls in water pressure. 23. Further measures to assist lower income households with their water and sewerage bills may be necessary especially given the low take up of existing measures. 3 October 2003
Memorandum submitted by the Royal Society for the Protection of Birds
Executive Summary 1. The aquatic environment of England and Wales is in a poor state, with over 50% of rivers and lakes suVering from excessively high levels of phosphates and 30% from too much nitrate. As a result, many plants and animals of previously healthy waters are in decline. 2. Water company investment in environmental protection and improvement will need to be an essential part of the fourth periodic review of water pricing if we are to meet the “good status” requirements of the EC Water Framework Directive. 3. Despite having “cleaned up their act” and removed crude pollution from our rivers and beaches, water companies still have a major role to play in further improving the water environment. More than half of the polluting levels of nutrients present in our waters can be traced back to water companies’ sewerage discharges. 4. The RSPB supports the programme of environmental protection and improvement put forward as part of the periodic review by English Nature and the Environment Agency. This contains nearly 500 actions directed specifically at wildlife and habitats. 5. Investing to protect and improve the environment also improves people’s quality of life, delivering new opportunities for economic regeneration and leisure activity. 6. Ofwat and WaterVoice have focused to an excessive degree on the scope and scale of the environment programme, giving far greater scrutiny to this aspect of the price review than to other major drivers of price increases. 7. Water company strategies for the review show a short-sighted approach to environmental investment, with many doing the minimum statutory requirement, and some not even achieving that, omitting legally required water quality and water resources measures. 8. We believe that the scheme costs put forward by water companies are unnecessarily and unjustifiably high in many cases. This has created hostility to the environment programme from customer representatives and some parts of the press. 9. We support innovative projects proposed by United Utilities and Northumbrian Water, and hope that their emphasis on achieving multiple benefits for drinking water, biodiversity and river water quality through influencing the management of catchment land becomes a central feature of future price reviews. Such catchment schemes are in line with the objectives of the Water Framework Directive.
Introduction 1. The RSPB works for the conservation of wild birds and their environment. We are Europe’s largest wildlife conservation charity, with over one million members. We manage one of the largest conservation estates in the UK, totalling more than 125,000 hectares, including extensive freshwater and coastal wetland habitat. Our priority wetland habitats are reedbeds, grazing marsh and estuaries. We provide advice on the management of wetland habitats, and input on a range of water policy issues including water resources, biodiversity, water quality and flood defence. 2. Water and wetlands are fragile ecosystems, dependent on the way we manage water. Whilst we have seen improvements in some aspects of water quality, particularly sewage treatment and industrial eZuent discharge, UK wetlands and water are still not managed sustainably. Many aspects of water and land management impact negatively on wetlands. Not only have we lost most of our wetlands through land drainage, but we continue to damage what remains through drainage, pollution and water abstraction. 9020981003 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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State of the Water Environment 3. Many rivers, lakes and streams remain heavily polluted. The Environment Agency (EA) reports that more than half of our rivers have high phosphate levels and more than a third have high nitrate concentrations. This “nutrient soup” has choked our freshwaters with algal blooms and had a disastrous eVect on plants and invertebrates—for example, there has been a two-thirds crash in the abundance of insect life in chalk rivers, with a serious knock-on impact on wild populations of trout and salmon. Much of this nutrient problem arises from sewerage discharges into watercourses, although the proportion varies from catchment to catchment, with diVuse pollution from intensive agriculture also making a significant contribution. However, the contribution from sewerage discharges is proportionally more significant as it is ever-present, and particularly highly concentrated at times of low flows and during the growing season. 4. Our wetland wildlife is suVering as the countryside dries out. While much of this is a consequence of land drainage and flood defence policy and practice, the role of water abstraction from surface and ground waters must not be underestimated. The amount licensed for abstraction is a staggering 35 million megalitres per year, most of which is for water company supply. There are some 500 rivers, wetlands and lakes on the EA’s register of sites at risk of damage from abstraction, and the availability of water resources is a serious limiting factor in the achievement of targets for habitat restoration and creation. Populations of breeding wading birds are a good indicator of “wetness” in our countryside, and the drastic decline of these birds outside specially managed nature reserves (60% in snipe, 40% in lapwing and 20% in redshank in lowland river valleys over the last 20 years) is a warning signal about the state of our water environment.
The environment programme 5. This periodic review is a major opportunity to deliver much needed improvements to the aquatic environment and to reverse the legacy of damage from water abstraction and pollution. The environment programme developed by the EA and English Nature would ensure that water companies contribute their appropriate share to the cost of improving the health of our water environment: for wildlife, people and the economy. 6. The RSPB fully supports the environment programme. This is the first periodic review which could see substantial investment made specifically for the benefit of designated sites and biodiversity. There are 3,200 main actions (compared to 6,000 for PR99/AMP3 in 1998), of which nearly 500 are directed specifically at wildlife and habitats. About half of the 3,200 actions are statutory, with the others being government and policy commitments open to Ministerial discretion. We consider these actions to be milestones on the way to sustainable water management and the achievement of EC Water Framework Directive targets. 7. The work outlined in the environment programme would improve more than 6,500 kilometres of river and more than 2,000 square kilometres of wetlands, lakes and coastal waters. This would bring huge benefits for wildlife and improve everyone’s quality of life. Cleaning up and improving our water environment will boost the economies of city and country alike, as clean, healthy waters oVer many opportunities for regeneration. The EA has estimated that the benefits of this programme could amount to between £5 billion and £8 billion, clearly outweighing its costs.
Water company response to the environment programme 8. Water companies recently published public versions of their business plans containing their preferred investment strategies. Any review of these plans is hampered by their lack of consistency—some water companies have outlined their investment plans in transparent detail, but others are sketchy, opaque and diYcult to interpret. 9. For the purposes of water company costing of schemes, the environment programme was split into two plans or scenarios. Plan A contained all schemes which were deemed by the EA/English Nature to fall into their “essential and clear category”, ie schemes fulfilling water companies’ mandatory duties. Plan B contained these, plus schemes which fulfilled legal and policy obligations but were considered to be “choices to be made”. These “plans” were supposed to be a guide for water companies, and a menu of options from which they could select. However, most companies have chosen one plan over the other. This is unsurprising, but unfortunate, as the total environment programme (plan A and plan B) deserves proper funding, and much of value is lost if nothing from plan B is included in companies’ preferred strategies. 10. The RSPB is disappointed by the response of many water companies to the environment programme, and we have deep misgivings over the content of their preferred strategies. 11. Most companies have included only the barest statutory minimum (plan A), and many (notably Wessex Water, Thames, Portsmouth and Southern) have failed even to do that, omitting a whole raft of legally required water quality and water resources measures. The examples which follow, quoted from the business plans, are illustrative but by no means exhaustive. There is a general reluctance across the water industry to include the full environment programme in company plans, and widespread denial of the need for it and the benefits which would accrue. Many of the plans have unfairly questioned the competence of the environmental regulators, who have followed a strict and transparent process of screening and cost- eVectiveness analysis to develop the environment programme. 9020981003 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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12. Thames Water’s preferred strategy does not include much of plan A. They have excluded any work requiring reductions in abstraction from rivers and groundwaters. They say: We have excluded a number of uncertain investment drivers—such as water sustainability reductions under the Habitats Directive. 13. Southwest Water have decided that their preferred strategy should “only carry out the environmental improvements where we have a clear legal obligation”, not including many parts even of plan A. They cost plan A at £69 million and plan B at £126 million, suggesting that non-implementation of these plans will result in a lot of good environmental work going by the wayside. They cite the need to protect customers from excessive bill increases as the reason for this approach, but their own figures suggest that plan A would only increase bills in 2010 by a further £7 and plan B by £15. 14. Wessex Water’s waste water improvement programme excludes up to £54 million of action to protect Sites of Special Scientific Interest (only £2 million of action is actually included). Within work to address low flows they have excluded up to £56 million of action (including just £6 million in their programme). 15. Southern Water’s preferred strategy does not include substantial parts of the environment programme, omitting most of the water resources schemes and much of the water quality programme. They say: The large scale of the overall quality programme has led us to challenge certain areas where we believe, as yet, the Environment Agency has not proved the economic benefit to the environment. 16. Portsmouth Water’s preferred strategy does not include reductions of 5% in abstraction demanded by the EA for the protection of Habitats Directive sites. They say: In due course Ministers will have to decide whether the benefits from these perceived environmental improvements outweigh the costs and the risks to the public’s security of supply. 17. There is a wide variation in the costs attributed by water companies to the environment programme, and we are sceptical about the basis for some of their figures. We believe that the scheme costs put forward by water companies are, in many cases, unnecessarily and unjustifiably high. This has had the eVect of whipping up hostility to the environment programme from customer representatives and some parts of the press in a way which we do not believe is justified by the programme itself. We believe that it is likely that a more comprehensive programme, incorporating many more of the schemes in plan B, could be funded if the costs cited in business plans were questioned and reduced. 18. The RSPB recognises that a balance must be achieved between environmental benefits delivered and overall rises in customers’ bills, but we are concerned that the current raft of business plans muddies the water and makes it more diYcult to arrive at this balance. It is a matter of concern that this is not the first time water companies have presented a vision of enormous price rises to fund so-called “marginal” environmental improvements. The same happened at the time of the last periodic review in 1998. However, alarmist predictions about price rises then were followed by a period in which companies delivered a full programme of environmental schemes, with no significant increases in bills. In fact, in some areas bills even fell. Our concern now is that some water companies may be exaggerating the scale of the spending needed to fund the environment programme, and that this approach could jeopardise progress towards delivering a cleaner, healthier and more wildlife-rich water environment.
Concerns about water company use of customer research 19. Understandably, water companies have sought to justify their strategies by claiming that they are representing what customers want. In doing so, they have quoted and drawn conclusions from a report published by MORI in November 2002, entitled “The 2004 Periodic Review: Research into Customers’ Views”. 20. Southern Water, for example, choose to highlight the following in their business plan: The MORI survey shows that 5% of customers within Southern Water’s area are dissatisfied with the water supply service, and 29% use a water filter or purifier. 16% of customers nationally feel that the “taste and smell” of tap water needs “quite a lot” or “a great deal” of improvement. Around 16% of respondents within Southern Water’s area gave a negative rating to the current level of service on “avoiding the risk of homes and gardens being flooded by sewage”. 17% of customers were critical of the level of service on “smells from sewage works”. A similar proportion felt that this was a “most urgent” priority for improvement. 21. Thames Water said of the research: Customers highlighted sewage flooding as a priority along with suYcient maintenance to ensure reliable supply. 22. Southwest Water claimed that their preferred strategy focused “on issues which remain of particular concern to customers. These include reducing discoloured water, taste, odour and waste water flooding problems. In the Plan we are proposing to address the issues of greatest concern to our customers”. 23. The RSPB was represented on the steering group of this research project, and we therefore fully understand the conclusions which could be drawn from the research. The report showed in its conclusions that most customers place a high value on the water environment, and are prepared to invest in it through their bills. The research demonstrated that customers felt that coastal waters, rivers and wildlife habitats were in most need of further investment (ahead of 11 other aspects of company service), were a priority for action, and an aspect of company service for which they were willing to pay. 9020981003 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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24. The executive summary from the MORI research concluded: Three aspects are considered to be in need of “quite a lot” or “a great deal” of improvement by between 21% and 30% of respondents. These are— the “maintenance of the quality of coastal, and bathing waters” (30%), the “maintenance of the quality of river waters” (26%), and the “protection of important areas of wildlife and plants” (21%). 25. Respondents tend to be consistent in their views about which aspects are worth spending money on to improve (“which may result in customers’ bills increasing”). The same three “urgent” priorities emerge. Around a third of the sample say either “more” or “a lot more” should be spent on “maintaining the quality of river waters and of coastal and bathing waters’ and/or “protecting important areas of wildlife and plants”. 25% say they would be “very concerned” if the improvements to the aspect they selected as their top priority “had to be delayed to keep customers’ bills down”. 44% would be “fairly concerned”. 26. While waiting for the conclusions of the second joint customer project to be published in December (fieldwork took place in September and October 2003), we would like water companies to consider how well their business plans reflect their customers’ clear desire for investment in the quality of the water environment. It is perfectly legitimate for water companies to quote the MORI customer research in support of their proposals, but if they do so they should give a full picture of what customers actually said. If they do not they are in danger of being accused of “cherry-picking” those aspects of the research’s findings which most suit their own business priorities.
A model for water company investment 27. The RSPB particularly supports two innovative projects which have been put forward by United Utilities and Northumbrian Water, and endorsed by most stakeholders in their local areas. These projects emphasise how multiple benefits for drinking water quality, biodiversity and river water quality can be achieved through influencing the management of catchment land. We hope that this kind of approach will be a central feature of projects across England and Wales in future price reviews. Such schemes may not fall within the category of those judged to be “essential and clear”, but they are in line with the objectives of the Water Framework Directive—with which the UK will soon be legally bound to comply—and represent the sort of bold vision which water companies should be striving to deliver, in the interests of the environment and their customers alike. 15 October 2003
Memorandum submitted by Mr Roy Roberts10 I write to you as a constituent concerned about the increased charges currently being proposed by South West Water to the water regulator, OFWAT, for the next five year period (2005–10). (I should add that I am a member of the consumer body, WaterVoice.) Under these proposals, South West Water’s charges (already the highest in the country) will increase as follows: Water—from £121 to £151–£156 (depending on which strategy is approved by OFWAT)—an increase of between 25% and 29% approx. Sewerage—from £213 to £256–£266—(again depending on approved strategy)—an increase of between 16% and 25% approx. These substantial increases are over and above the rate of inflation, ie are at today’s prices, so assuming a rate of inflation of (say) 3% pa in this period, the actual increases could well be 40–45% for water, and 30–40% for sewerage over this five year period.. In addition, it’s expected that those customers without water meters (roughly half the customer base) will face increases that are considerably higher - unmetered customers could face average total bills of over £600 pa (at today’s prices) at the end of this period, (plus of course the eVects of inflation). This group of customers will include many large families and pensioners, so these increases will involve considerable financial hardship. Bills at this level would represent a substantial portion (circa 15%) of the minimum state pension. You will be aware that the population in this area includes large numbers of pensioners and many with below-average incomes, and I am sure others have already been in touch to express their great concern at this matter. I understand that this issue of water pricing is now to be examined by the Select Committee on the Environment, Food and Rural AVairs. I would suggest that on this issue (which is generally a non-party matter), the Committee should look at the particular problems in the South West, and I hope you will feel
10 Originally a letter to Angela Browning MP. 9020981005 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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able to press the South West members, Colin Breed and Candy Atherton, to examine carefully the high increases proposed by South West Water, and the impact on the region’s population. I hope the Committee will look carefully at the extent the water companies are seeking to make economies and eYciencies in their operating costs to bring down these increases, and the balance they are taking between the appropriate level of reward for their shareholders and mitigating the impact on their customers. A major factor in the high level of water prices in the region is the eVect of the substantial investment in recent years in reducing coastal and beach pollution—the cost of this investment has fallen on a relatively small customer base in the South West, although of course the cleaner beaches are enjoyed by many thousands of people from other parts of the country who have not contributed to the clean-up. Given that South West Water customers are not permitted to choose an alternative provider (unlike gas, electricity and telephone users), I would suggest there is a case for examining the idea of equalisation of water and sewerage charges across the country, perhaps by permitting diVerential price increases between diVerent regional companies, as recognition of the problems that have been caused by the level of investment in coastal pollution measures in the South West. I would suggest that unless this is done, the issue of water charges will become an issue that is far more contentious than the current controversy over council tax increases in Devon, and will no doubt lead to even more unrest of the kind that is now evident from pensioners’ groups regarding council tax. The responsible Minister, Elliot Morley, will shortly be issuing guidance to OFWAT regarding these charging proposals and the strategy the Government would wish OFWAT to adopt in increasing the costs. I hope you will feel able to impress upon him the high degree of hardship in the South West that will be caused by permitting these increases proposed by South West Water. 6 October 2003
Memorandum submitted by the National Consumer Council
Summary 1. The current price review process is not yet giving suYcient emphasis to water consumers’ interests. In particular water company profitability needs to be openly and publicly debated, and aVordability of water prices for consumers must be a key factor in determining prices. 2. The water companies have to be able to finance their functions by raising money from customers’ bills and by securing a reasonable rate of return on their capital. The profitability of the companies has a bearing on the size of customer bills, and should be a legitimate subject for debate. A full discussion of these issues and of the movement of finances between unregulated and regulated parts of the business is essential in a transparent price setting process. 3. We would like to see Ofwat, industry and Government place far more emphasis on aVordability as a factor in price setting. High levels of consumer debt to water companies, and the numbers of people who spend an unacceptable proportion of their income on water are evidence of a growing problem of unaVordable bills. This problem will only worsen if bills do indeed increase beyond inflation as is being suggested. The solution to the aVordability problem will go far beyond the current review of the Vulnerable Groups Regulations, and requires coordinated Government, regulator and industry action.
About the NCC 4. The National Consumer Council is a Non Departmental Public Body independently championing the consumer interest to bring about change for the benefit of all consumers. We have a particular remit to promote the interests of disadvantaged consumers. NCC has a history of work on water policy dating back to water privatisation in 1991. We successfully campaigned for the ban on disconnections, and were active in promoting the consumer interest in the last price review. Most recently we have published Towards a Sustainable Water Charging Policy (2002), Lifelines—the NCC’s agenda for aVordable energy, water and telephone services (2003), as well as responding to Ofwat’s consultation on the framework and approach to the Price Review 2005–10, and DEFRA’s consultation on water bill reductions for vulnerable groups. We have lobbied for the current Water Bill to strengthen the powers of the forthcoming Consumer Council for Water, and to include considerations of aVordability for consumers.
Evidence 5. NCC welcomes the introduction in the Water Bill of a sustainable development duty on Ofwat, which will give priority to social and environmental objectives alongside economic goals. We are also pleased that Ofwat will have a new primary duty to protect the interests of consumers. This is a secondary duty at present. 9020981006 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Ofwat will also have a duty to have specific regard to the interests of consumers who are chronically sick or disabled, or pensionable age, with low incomes or living in rural areas. We also welcome the initial guidance from the Secretary of State to the DG suggesting that this price review should be characterised by due weight to the economic and social eVect of policies, especially the impact of water bills on vulnerable customers. The DG has stated that bills must be as high as they need to be in order for companies to finance their functions, but no more than they have to be, as customers are prisoners of a monopoly industry. We believe that the current price review is in danger of failing to meet the second of these objectives, as the process gives insuYcient weight to two key consumer concerns: aVordability of bills and the profitability of companies.
Profitability and financial transparency
6. Too often the need to invest in the water environment and developing sustainable water resources is portrayed as conflicting with the consumer interest in low water prices. It is, however, in the interest of current and future generations of consumers that water resources are developed and managed so as to be as sustainable as possible. We are pleased that the EU Water Framework Directive and the proposed water resource management plans move towards a long-term view of the environmental measures needed to ensure sustainable water resources. Indeed long term solutions to sustainable water resources could well provide cheaper alternatives. 7. Public statements by the industry and regulator have focused on levels of investment needed to maintain infrastructure, and to carry out environmental improvements. The DG has stated (evidence to EFRA Committee of 11 June 2003), that prices will rise because of a lack of scope for further eYciency in 8. the water industry. Whilst we defer to the DG about eYciency scope, this statement ignores another crucial factor in price setting—the profitability of the water companies. 9. We are of course aware that Ofwat regulates prices not profits, but this should not preclude a discussion of profit levels, which were a major cause of public concern in the 90’s. Consumer concern about profit levels and distrust of companies’ motivations emerges again in the opinion research accompanying the 2005–10 review (2004 Periodic Review: Research into Customers’ Views, MORI 2002). The periodic review presents a golden opportunity to set out the facts clearly on profits, which are scarcely mentioned. This avoidance of discussion seems unnecessary and to the detriment of the public image of the companies and the regulator. OFWAT has a primary duty to ensure that companies can secure a reasonable return on their capital. What is reasonable is a legitimate matter for debate. Whilst operating profits and dividends are down from the 1990s, dividends are still showing growth and the sector outperformed the FT All Share Index by 58% in the last two years (FT, 16 December 2002). Any perception that the industry is in the doldrums is based on a comparison with the high rates of return on capital employed and high dividends in the 1990s. We would suggest that an industry as monopolistic and as safe as the water and sewerage industry ought to be attracting modest returns and we therefore see the present rates as more appropriate than was the case in the past. Whatever the accuracy of our judgement, a significant segment of the public clearly shares this view. 10. Also neglected by the review are the flow of loans and dividends between regulated businesses and the parent companies. We believe that this raises questions about the need for clear reporting, not only of the core businesses’ accounts but also of the “fit” between them and the parent company accounts. Common reporting standards need to be implemented so that companies can be compared and the water aspects of large companies are properly transparent. 11. A full discussion of these issues is essential in a transparent price review. The companies have been following agreed programmes of capital investment since the 1999 Price Review, and before. The water infrastructure has therefore not been ignored, making the frequent analogies with the rail industry unhelpful. The significant investment that is likely to be entailed by the implementation of the EU Water Framework Directive is barely touched on in this price review; it will be a major issue in the review for 2010–15. We therefore remain to be convinced that proposed increases vastly above inflation can be justified. 12. One of the diYculties with the price setting process is the, largely necessary, complexity of the process, which makes it diYcult for those outside the industry to assess the merits of companies’ plans. Regulators, industry and Government should make greater eVorts to debate these issues in lay terms.
AVordability
13. Price setting is about customers’ water bills. What customers can aVord should therefore be an important factor in Ofwat’s approach to the review, but it is barely discussed. 14. Average household bills vary widely, as do proposed price increases. An average water and sewerage bill for South West Water in 2003–04 at £342 represents 12% of the income of a single person on Jobseeker’s Allowance, and 6% of the income of a single pensioner receiving Minimum Income Guarantee. The 9020981006 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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proposed price rises will increase this proportion. In the North West, where bills are currently not at the extreme, the proposed 70% increase over five years would mean a single person on current levels of Jobseeker’s Allowance would be spending a massive 15% of their income on their water bill
15. DEFRA’s own sustainable development indicator aVordability measure is 3% income threshold. DEFRA estimated that in 1997–98, 18% of households, some 4.3 million spent more than this 3% threshold. These figures exemplify the substantial numbers of water customers who struggle to pay their water bill. Currently one in five households owe money to water companies. There has been considerable debate about whether the ban on disconnection is the cause of the rise in household indebtedness to water companies. However, recent research by Ofwat and WaterVoice found that the ban on disconnections does not influence payment of the water bill with most customers convinced that they can be disconnected. Indebted customers typically have the water bill as one unpaid bill among many, and juggle which bill to pay next. NCC’s opinion is that a major cause of this indebtedness is that many consumers are spending an unsustainable proportion of their income on water and simply cannot aVord it. Against this backdrop, the kind of price increases that water company business plans suggest are extremely worrying.
16. Current provision for tackling these aVordability problems is almost non-existent. The Vulnerable Groups regulations are narrowly drawn, and are designed only to cap the bills of metered customers who for reasons of ill health or family size use a disproportionate amount of water. The scheme has been a failure with only a 1.4% take up amongst eligible customers in 2001–02. The scheme also cost more to administer than is paid out to customers. The level of the cap is at the average bill in that area, and so the scheme does nothing to tackle wider aVordability problems. The Government has made clear its view that customers struggling with aVordability should be helped through the tax/benefit system.
17. NCC believes that the tax benefit system currently fails to tackle the problem of the aVordability of water for a number of reasons. Firstly, the notional element of income support intended to cover water bills has not kept pace with actual water bills. Between 1988 and 1997 this amount of benefit fell from 80% of the average water bill to just 55%. Secondly, as highlighted above, some groups of vulnerable consumers on means-tested benefits, notably households without children, spend a far greater proportion of their income on the water bill than others. Thirdly, the size of water bills varies hugely depending on region, and yet the amount of means-tested benefit does not. Lastly, a perverse cross subsidy exists through optional metering, which leads to a situation where in some areas the diVerence between a metered bill and an unmetered bill is as much as £116. At present consumers can choose to opt for meter installation. In practice, only those who will save on their water bill do so, and the cost of installation, administration and billing is borne by all customers.
18. The Secretary of State’s initial guidance to Ofwat on the price review states that it will take decisions on its recent consultation of the vulnerable groups regulations, which will be reflected, in the principal guidance to be issued in January 2004. NCC has submitted various suggestions as to how the scheme could be improved, but we hope we have shown here that, however amended, the problem of aVordability is much wider than the scheme’s scope. Given this, strategic decisions have to be taken by Government and the regulators as to how to tackle the issue of aVordability. Government should thoroughly re-examine the assistance given to vulnerable groups and propose a strategy that will achieve aVordable water for all vulnerable consumers. NCC has supported an amendment to the Water Bill that would set a ratio of water charges to household income and require the Secretary of State to give guidance to Ofwat on addressing water aVordability above this threshold. We would like to see the principle guidance contain strong, clear and practical guidance to Ofwat on tackling aVordability. We would like to see Ofwat place far more emphasis on aVordability as a factor in price setting. The aVordability problem amongst households living on income support would be considerably alleviated if the Department of Work and Pensions were to make public the amount of income support intended to contribute towards water bills and increase it to a level suYcient to cover the bills of these households. 16 October 2003
Memorandum submitted by the Public Utilities Access Forum
Founded in 1989, the Public Utilities Access Forum (PUAF) is an informal association of organisations that helps to develop policy on the regulation of the public utilities providing electricity, gas, communications and water services in England and Wales. PUAF facilitates the exchange of information and opinions between bodies concerned with the provision of those utilities to consumers with low incomes or special service needs, such as the elderly and people with mental and physical disabilities. It draws the particular problems of such consumers to the attention of the industries, the regulators and other relevant bodies, promoting the adoption of policies and practices that cater for their needs, exchanging information about service provision and promoting research. 9020981007 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Summary 1. On a test of aVordability derived from the Government’s fuel poverty strategy, between two and four million householders in England and Wales cannot aVord their water charges. The households most aVected are those living in areas where charges are high, and those receiving means tested social security benefits. 2. A number of initiatives are in place to address water poverty or have been considered, but none has been successful. In particular, the Labour Government’s attention to benefits provision has not been suYciently redistributive to make water aVordable to all. 3. The number of households unable to aVord water would increase significantly if prices were to rise by the levels announced by companies in their draft business plans.
Evidence
AVordability 4. The UK Fuel Poverty Strategy declared that 10% of a household’s income is the maximum people can reasonably be expected to spend on fuel. Thus, for any individual household, it is possible to say whether or not they are experiencing fuel poverty—whether or not fuel is aVordable. 5. The “poverty line” for fuel was established by examining the expenditure on fuel of householders in the lowest three income deciles. At the time the enquiry was undertaken in 1988 it was found that taken together those households spent 10% of their net income on fuel. Applying this method to water charges, it has been found that the corresponding threshold for water is 3%: that is the amount that, in aggregate, the lowest three income deciles spend on water. Equipped with that figure, it can readily be ascertained whether water charges for a particular household are aVordable by expressing them as a percentage of their income. The average of all households’ expenditure on water is just 1% of income.
Number of households experiencing water poverty 6. It is not known precisely how many households face water poverty, in that that they are obliged to spend more than 3% of their income on the amenity because no relevant data are available - however, it is possible to suggest what the order of magnitude might be. The most recent statistic oVered by the Department for the Environment, Food and Rural AVairs in its assessment of water aVordability in the context of sustainable development is for 1997–98 and shows the proportion of households in Great Britain spending more than 3% of their income on water charges to be 18%, or, some 4.3 million in total. 7. In a recent study, analysis of the anonomised records of 400 households’ applications to two water charities showed that applicants needed to spend on average between 4% and 5% of their net income on water. Additional data allowed comparison of the profiles of these applicants’ water poverty and fuel poverty and similarities in the distributions of the two “poverties” suggested that the magnitude of water poverty might be of the same order as that of fuel poverty. The number of households in fuel poverty is a matter of controversy at the moment because of disagreement about the appropriate way to calculate household income: it appears that something of the order of between two and four million householders in England and Wales experience fuel poverty.
Regional variation in water charges 8. Water bills are far from standard items in household budgeting; they vary greatly depending on where people live. Twenty-four companies supply water and/or sewerage services in England and Wales and their charges vary markedly, the highest being more or less double the lowest. There has been a tendency for regional diVerences in water charges to increase during the period since privatisation.
The water poverty of social security beneficiaries 9. Wherever they live, householders’ water charges have over recent years risen faster than social security benefits. The aVordability of water for people who have a safety net social security benefit income is readily examined, in notional terms, by taking average water charges and comparing them with published benefit rates. Table 1 shows the proportion of their income that the very poorest benefit recipients in England and Wales are obliged to spend on water. It is notable that all but three of the expenditures shown exceed the 3% threshold suggested for water poverty. The table also includes categories of householder paying water bills at twice or more, and in one case four times, the threshold. This pressure on the very poorest households in England and Wales would be increased significantly were the presumed increases in the forthcoming review to come in at the 30% level indicated by the companies in their recently published draft business plans. The figures in brackets in Table 1 show the proportion of income taken by water charges increasing (except for one case) by between one and four percentage points. 9020981007 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Table 1
WATER BILLS AS A PERCENTAGE OF SOCIAL SECURITY BENEFIT INCOME, 2003–04 (%)
Minimum Minimum Jobseeker’s Jobseeker’s Income Income Allowance— Allowance— Guarantee— Guarantee— single person couple single person couple £2,841.80 pa £4,459 pa £5,309.20 pa £8,101.60 pa
Average combined bill— South West Water (highest charging company) £342 pa 12 (16) 8 (10) 6 (8) 4 (5) Average combined bill— Thames Water (lowest charging company £202 pa 7 (9) 5 (6) 4 (5) 2 (3) Average measured bill £209 (England and Wales) 7 (10) 5 (6) 4 (5) 3 (3) Average unmeasured bill £245 (England and Wales) 9 (11) 5 (7) 5 (6) 3 (4)
The figures in brackets show these percentages recalculated on charges inflated by the 30% average increase announced by companies in their draft business plans
Water debt 10. Water debt is rising. Data collected by Ofwat over the last four years show that on nearly all measures companies have been less successful in collecting revenue from domestic customers. About a fifth of householders are now in debt to their company, owing on average £150. The regulator announced in early October that two companies had asked him to undertake an interim review of their charges in part because of increasing customer debt, which has led to higher debt-collection costs and loss of revenue; following a similar process last year Ofwat increased price limits for two other companies whose claims had also included unexpected debt recovery costs.
The abolition of disconnection for water debt 11. Since 1999 householders who do not pay their water bills can no longer have their supply disconnected. Thus water “deprivation” does not arise when people cannot aVord their bills—though some with metered supplies may ration their use, and an unaVordable bill may result in other necessities being foregone. But to suggest that water poverty is not therefore a concerning issue is to confine consideration to the material aspects of water supply. In wealthy Northern societies, “poverty” is almost entirely a matter of being excluded from the mainstream of the culture than it is a question of suVering physical deprivation. It is householders’ inability to pay their way in meeting bills for essential services that is damaging—being able to aVord this most basic need is critical to social inclusion. 12. One view of rising water debt is that it is a consequence of companies’ diminished eVectiveness in recovering debt, especially since their sanction of disconnection for debt was removed. This view would be that some consumers, having been granted an unconditional “right to water”, had decided not to pay their bills. However, we cannot be sure that consumers are aware of the change in the law. Some studies have shown that consumers still think companies can cut oV their water if they do not pay their bill. But this is not to suggest that the removal of disconnection has been without consequence. People unable to aVord to pay their bills and at a loss to know where to turn may now be in a position to procrastinate for longer, all the while nevertheless fearing the worst.
Measures purporting to address water poverty 13. Five measures may be examined in considering our collective arrangements to address the aVordability of water bills and these are shown in Table 2. They are benefits and tax credits, the real-terms water price cuts implemented in 2000, charitable provision, the Vulnerable Groups Regulations, and social tariVs. Two points are to be made about these measures. First, none of them has been eVective in eliminating water poverty. Second, there is a vast diVerence in the scale of the measures listed, so much so that it is almost misleading to group them together. The assistance to people who often do not know how they are going to make ends meet has been immeasurably greater through improvements to benefits and tax credits arrangements than through the water price reductions; and those price reductions similarly dwarf charitable and Vulnerable Groups provisions. The benefits and tax credit measures are eVective—if the language may be forgiven—in redistributing the aVordability of water. But massive though they are in relation to their 9020981007 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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companion measures, they have nevertheless been insuYciently redistributive. Furthermore, none of the measures addresses the regional imbalance in water charges and last price review’s reduction was the first and seems most likely to be reversed at the next review.
Table 2
VALUE AND CHARACTERISTICS OF MEASURES TO ADDRESS WATER POVERTY
Addressing absolute or relative Measure Annual value (£) Addressing aVordability Redistributive?
Benefits and tax credits several billions income relative insuYciently redistributive Prices 0.5 billion price of water absolute not redistributive Charities 3.5 million income relative insignificantly Vulnerable Groups 0.2 million price of water relative redistributive Social tariVs nil price of water relative potentially redistributive
9 October 2003
Memorandum submitted by Mr Sean Creighton
Summary 1. This note of evidence expresses concern that the issue of “aVordability” of water as a basic essential for human life is being treated as a minor issue in the Periodic Review, and that there could be adverse eVects on aVordability if the regulator decides to allow a substantial increases in water charges to fund large scale investment in the basic infrastructure of the water supply and sewerage systems as well as environmental improvements. It also argues that the alleged rise in household water debt needs to be closely questioned to avoid unnecessary increases in water charges to make up for the revenue loss. It suggests a number of actions that would be desirable to ensure that the water regulator and the water and sewerage companies are publicly accountable for their activities and decisions in relation to aVordability of water prices and debt. 2. This note is written on the assumption that the Committee will receive more technical submissions on these issues from relevant organisations.
Affordability 3. While the issue of “aVordability” was mentioned in paragraph 7.7.1. of the “Initial guidance from the Secretary of State to the Director-General of Water Services. 2004 periodic review of water price limits” (January 2003), it was ignored as a key issue in the August joint statement by the Government and the regulators on the next stage of the Periodic Review. It has been clear for several years that the water regulator’s priorities (like those of his energy and telecom counterparts) have been dominated by economic considerations, rather than sustainability considerations which seek to balance the relevant economic, environmental and social factors. The whole thrust of the January guidance was on environmental and economic issues, downplaying social issues, including “aVordability” to a few paragraphs at the end of the document. This can be interpreted as signalling to the regulator that the Government gives a low priority to social considerations. 4. The Government says that financial support policies to low income and elderly families are lifting people out of poverty. A significant rise in water prices will be one way in which this essential advance will be eroded, especially where low income families are metered (new and renovated properties). The danger is that such families will ration their use of water lower than is necessary for personal and public health and water play for young children, which was a problem identified by low income family campaigns, Barnados and Save The Children Fund in the 1990s.
Pressure to Increase Prices 5. There is already a problem of aVordability. It is clear that the water regulator is under pressure to increase water charges. How much worse will it become if there is an increase in prices? What would a 5%, 10%, 15% increase in average prices mean in monetary terms to households on low incomes or metered households with high use of water because of medical conditions, especially given the failure of the Vulnerable Groups regulations? 9020981008 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Basic Requirements for the Water and Sewerage System 6. For the sake of the nation’s health, we need a water and sewerage system which does not burst causing flooding, and that avoids the environment and the water table being contaminated. Keeping the pipe system repaired and renewed to minimise these dangers costs a lot of money. Failure of the basic infrastructure could outweigh the environmental benefits of other types of improvement funded to-date under the Government supported requirements of European Directives. 7. The recent media coverage on the state of the sewer system clearly suggests that the companies have been negligent in keeping the system up-dated to avoid sewage flooding and to prevent leakage into the soil and water table. It will be all too easy for the companies to argue that they need large price increases in order to carry out the necessary works to improve the situation. Why should customers who have already paid large sums of investment since privatisation have to pay yet more. The companies can raise more from shareholders and by capital borrowings as an alternative to loading costs onto customers. 8. But what exactly is the situation? It does not seem to be being made clear in terms of information available to the public. How much of the responses to current surveys on consumer views are based on a lack of hard accurate information? — What percentage of the sewerage pipe system in each water and sewerage company region is: — over 100 years old; — 50–100 years old; — 25–50 years old; and — up to 25 years old? — What percentage of each category by age is considered to require replacement, strengthening or remedial work? — What is the estimate of the cost? — If spread over 5, 10 or 15 years, what would the price eVect be? — How would that aVect aVordability?
Water Demand in the South East 9. There needs to be close questioning of the problems involved in meeting increased demand for water in water stress areas of a large increase in residential building as part of the Government’s community plans for the South East. 10. Could we see large increases in prices so that the South East becomes much more expensive, like the South West? And what would that do for aVordability in the South East?
Funding Investment Through Charges or Tax 11. A portion of water charges are a form of “stealth tax”, in that domestic customers are expected to pay towards the cost of environmental and water quality improvements required under European law and by the British Government, instead of being funded out of taxation. 12. As a result water prices are higher than they would be if these improvements were tax funded. The cost burden is unfairly shared by customers across the country, most markedly in the South West where the household base is smaller. 13. Unless aVordability is treated as a major consideration in the regulator’s setting of the next phase of prices, there is a danger that the “stealth tax” element will become even higher, especially if it allows in environmental and water quality schemes, which while desirable, are not necessary to meet EU requirements.
Water Debt 14. The Secretary of State’s initial guidance noted that Ofwat had “drawn attention to increases in the level of household debt and the cost of debt recovery since 1 April 2000.” It rightly noted: “There is evidence that diVerent companies have very diVerent levels of customer debt and costs. It is unclear to what extent the variation is attributable to diVerent circumstances such as diVerences in social and economic characteristics of the customer base and to what extent it is because some companies are more eVective than others in using the debt management methods open to them. The absence of directly comparable date before 2000 or for other utilities also makes it diYcult to decide on the extent to which this is part of a long-term trend in consumer debt or is a change only in water debt.” (para 7.7.9) 9020981008 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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15. This state of ignorance is deplorable. Ofwat resisted representations made by Public Utilities Access Forum from 1998 to undertake and publish a detailed analysis of debt. Local authorities are expected to have a detailed understanding of the nature of their tenant and Council payer debt, and housing associations of rental debt. It is good practice to have robust analysis. 16. Ofwat and WaterVoice research suggests that 1:5 households may be in debt. The alleged total of household water debt is £720 million. Since Ofwat does not have robust data from the companies and the companies hide behind the argument of “commercial confidentiality”, the figure cannot be taken seriously. It is not good enough not to have robust public available analysis since companies can seek to have their current price determinations reviewed to take account of rising levels of debt. If customers are to be faced with price rises they should have the right to know the exact nature of the problem. 17. And what could the exact nature of the problem be? It is likely to be one of double-counting in the case of customers who receive their water supply from a water only company and their sewerage service from a water and sewerage company. A very large percentage of the debt could be what would be classed as “technical” arrears in local authority and housing association contexts: — customers whose cheque payments are processed after the due date; — landlords who resell water, collecting the money from their tenants, but not making payments to the companies by the due date; — water direct payments being paid late by the Benefits Agency; — customers who are withholding payments because they are in dispute with the company eg over meter readings, over a supply failure; and — debt which is subject to an agreed payment plan. 18. It may even be the case that customers who pay by monthly direct debit may be regarded as being in debt until they have completed the full year’s payment—although this should mean that the total debt figure should decrease during the course of the year. It has been suggested that the debt total includes accumulated debt from previous years, therefore representing an historical accumulation, instead of having a figure of new debt outstanding at the end of each year, as well as accumulated debt, so that the annual trends can be seen. 19. Debt can also vary according to the approach being taken by each company. There may be diVerences in the experience of debt between those on diVerent payments methods, or between those whose charges are based on rateable value and metered properties. 20. It needs to be borne in mind that debt is only one possible indicator of “aVordability” problems. Large numbers of households who experience “aVordability” problems run their lives to avoid getting into debt with the companies if this means sacrificing some other aspects of their lives because their incomes are inadequate to meet all their basic needs.
Social Exclusion
21. The issues of water aVordability and debt cannot be divorced from other aspects of the Government’s social and anti-poverty agendas, including social inclusion, regeneration and neighhourhood renewal. It may well be that a high incidence of aVordability and debt problems are concentrated in areas with a higher level of neighbourhood disadvantage, even if those areas are not included in the funding regimes under the National Neighbourhood Renewal Strategy. 22. A key component of social exclusion and deprivation is problems of access, retention and aVordability of basic services such as energy, water and telephony. Water use can also be higher than necessary because of the way in which houses and flats are designed, eg because pipe lengths mean that a lot of cold water has to be drained oV before hot water comes out the tap. In metered home, such water has to be paid for. Low income households cannot aVord the latest water eYcient washing machines. 23. It has been regrettable that addressing the issues of access to and retention of basic household services has not been regarded as a major component of the work not only of Local Strategic Partnerships and Neighbourhood Renewal. 24. In addition to analysis on the extent to which alleged “debt” is real or technical, there is a need for research on the geographic and socio-economic incidence of aVordability and debt problems to inform the way in which water charges contribute to the complexity of financial and multiple debt problems faced by low income households. 25. It may also be instructive to undertake analysis of the geographic distribution of supply and sewerage infrastructure problems to see if they are concentrated in areas of low income and neighbourhood disadvantage. 9020981008 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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What Needs to be Done? 26. The following actions would help to ensure that “aVordability” and “debt” were treated with more seriousness: — The Government should require the regulator to make the issue of aVordability a major factor in the Periodic Review. — The regulator should analyse the nature of companies’ alleged household water charges debt to ascertain the actual level of annual debt after stripping out any historic accumulation and technical arrears. — The regulator should analyse the geography and socio-economic distribution of water aVordability and debt problems within each water company area, seeking the advice of the OYce of National Statistics and the Social Exclusion and Neighbourhood Renewal Units on methodologies. — The regulator should publish: — the results of the geographic and socio-economic research and debt analysis; — details of the current percentage of water prices of each company which fund environmental and water quality improvements and infrastructure maintenance and improvements; — the companies’ proposed environmental, water quality improvement, schemes and their price implications, clearly indicating which schemes are requirements to meet EU standards and which are desirable and their likely impact on charges; and — the water supply and sewerage implications of the Government’s housing development plans, the cost of improving water supply and sewerage connections to meet them, and the likely impact on prices.
External Examination 27. The utility industries (water, energy and telecoms) have a big impact on the life and economies of the regions. Yet their regulators have resisted ensuring that their policies and proposals interconnect with the economic renewal, social inclusion, regeneration and neighbourhood renewal agendas. The Regional Assemblies and Chambers are probably in the best position to hold in-depth enquiries into the activities of the utility industries and their regulators. They should be encouraged to do so the coming months, looking as a priority at water demand and supply issues, water and sewerage infrastructure needs, environmental needs and aVordability of water prices. They should seek evidence from the relevant water and sewerage companies, the regulator, the water consumer committees, advice, anti-poverty and environmental groups, and local authorities. 17 October 2003
Memorandum submitted by Dr Dieter Helm, University of Oxford 1. The water periodic review currently under way has raised substantive issues about the nature of the regulatory regime, as well as the appropriateness of proposed price increases, and its impact on current and future customers. 2. This memorandum summarises the causes of the proposed price increases for the period 2005–10, and considers the consequences of the flight-from-equity which has followed the 2000 periodic review outcome. A number of recommendations for the conduct of the current review and the future regulation of the water industry are made. 3. The last periodic review in 1999–2000 imposed a one-oV price reduction on the industry, pruned back the capital programme on the basis of Ofwat’s assessment of “aVordability”, and limited future price increases to around the rate of inflation. The consequence was to reduce substantially the market values of the companies to below their regulatory asset bases. Notwithstanding a degree of out performance on capital and operating costs, the market values remain subdued, and returns have been low. 4. The current proposed price increases are caused by: — the operating and maintenance costs of the existing networks; — the enhancement of capital expenditures to meet environmental and water quality objectives; — the cost of capital to induce investors to provide suYcient funds to finance the industry. These continuing requirements have produced a sharp rise in prices because: — there are no longer substantial eYciency gains; — the networks require considerable maintenance and replacement investment which were pruned back in the last periodic review; — the cost of capital was set at too low a level at the last periodic review. 9020981009 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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A “roller-coaster” of volatile prices is to a considerable extent the result of regulatory failures. The prices set for 2000–05 was unsustainable: customers could not indefinitely have lower prices and higher investment. Without the price cuts imposed in 2000, the current projections for 2005–10 could have been financed by roughly constant real prices. 5. The consequence of setting the cost of capital at a level below that of the cost of equity (but above the cost of debt) has been to induce a flight from equity. 6. The growth of debt finance and gearing has had radical consequences. Bank finance brings diVerent incentives, constraints and managerial focus. Banks are concerned with two things: getting their money back and getting the interest paid. They do not have an interest in capital gains, and have limited ability to absorb shocks. The companies with higher gearing will tend to be more short-term in focus and less inclined to invest at the margin. Over time, it will become increasingly apparent that, as financial ratios deteriorate, future investment will require rights issues if the continued capital investment programme is to be financed in the private sector. 7. The flight from equity does not mean, however, that equity risk has gone away-it has been transferred to customers and taxpayers. These changes have not generally been in the long-term interests of customers, the environment or government, and eVorts should be made to preserve equity within the sector. 8. In addition to encouraging returns, which facilitate rights issues, the regulatory and political risks that remain within the sector could be further reduced. These risks arise from the discretion of governments and regulators and the way it is exercised. Examples include the ways in which the periodic reviews are determined; the treatment of IDOKs; and the interpretation of European Directives. Good regulation is typically predictable regulation. The outcome of the periodic review is far from predictable, and this uncertainty is reflected in share prices and debt premia. Ultimately these are costs, which customers will bear. 9. A particular focus of regulatory uncertainty centres on the IDOK process. The instrument was designed to take account of unanticipated changes outside the control of management. There may be rather more items which fall under this description, and the process itself could be further regularised. With more predictable elements of cost pass through, the regime could begin to evolve towards a more flexible and adaptive system, allowing a more rational approach to investment planning. 10. The periodic-review process truncates a longer-term investment and management horizon into five- year discrete periods. This is unfortunate for several reasons. It creates set-piece artificial decision points, focuses management on the short term, and encourages game playing. It would be better to take a longer- term view, comprising an overarching policy framework, ten-year fundamental reviews, and much more reliance on the IDOK process to allow flexibility within periods. 11. In the determination of capital expenditure, the original concept was that the National Rivers Authority (and now the Environment Agency (EA)) would decide these issues in consultation and under guidance from the environment department. During the 1995 and 2000 periodic reviews, Ofwat subverted this process, taking the leading role, rather than technically implementing the Agency’s decisions. Although there are substantive issues in relation to the way environmental requirements are evaluated, and it is important to respond to the willingness and ability to pay of customers, the roles of the EA and Ofwat have become confused and opaque. A reassessment of the relative powers, duties and roles with respect to the water industry is likely to improve the performance of the regulatory regime. 12. In conclusion: — a major cause of the proposed sharp price increases is the significant regulatory failures at the last periodic review in 2000, and in particular the price cut then imposed; — the 2000 price review set a cost of capital which was below the cost of equity, and induced a significant flight-from-equity; — the water sector has, consequentially, come increasingly under the influence of banks and other debt holders, with less incentives to invest and less focus on the longer-term; — the IDOK process provides a limited element of flexibility within the regime. 13. It is recommended that: — the 2005 review process raises the cost of capital to a level suYcient to reward equity and thereby facilitate rights issues; — the IDOK regime is further clarified and extended; — a longer-term framework for the sector is further developed by Defra; — the five year set piece reviews are replaced by longer periods, with greater flexibility with periods through an extended IDOK process. 17 October 2003 9020981013 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Memorandum submitted by Dr Neil Summerton CB 1. This evidence is given on my own behalf. In 1991–97, I was Director Water, and then Water and Land, in the Department of the Environment. In 1998–2002, I was Director of the Oxford Centre for Water Research and I am an Emeritus Fellow of Mansfield College. I am one of the independent non-executive directors of Three Valleys Water and Folkestone and Dover Water Services, both of which are subsidiaries of Veolia Water UK.
Summary 2. It is essential to be realistic in recognising the overall position of the industry, the urgency of present cost pressures, and the financial implications of political aspirations to improve standards of service and environmental quality. In general, the price levels in the recent draft business plans reflect these pressures. There are, too, real limits as to the extent to which price pressures can be mitigated by manipulating financial variables like the cost of capital and financial ratios, and eYciency assumptions. 3. There is reason for concern about the implications of these price pressures for some customers, particularly in some areas. But overall price decisions should not (and legally cannot) be driven wholly by such concerns. Those customers are however less protected by the charging system than they were in former times. Consideration should be given to means of assisting a wider range of customers with the prices they face. But that should be done transparently and not by artificially holding prices down across the board, nor by cross-subsidy between companies, nor by sharply increasing cross-subsidies between customers within companies.
Bases of Pricing,Cross-subsidies and Impacts on Poorer Customers
(a) Unmeasured charging 4. When networked water services were introduced in the 1800s, the basis of charging was the rateable value of the property served. While meters were increasingly introduced for larger commercial customers after 1945, on privatisation in 1989 almost all domestic customers and very many smaller commercial customers continued to be charged on the basis of rateable values last fixed in 1973. 5. The eVect of charging by rateable value is that customers with higher values meet a proportionately larger share of the company’s costs than those with lower values: those with higher values therefore subsidise the services received by those with lower values. The great majority of customers have been unaware of this eVect of the traditional charging basis. 6. Further, it was the norm for local authority rents to compound housing and water and wastewater charges. Typically, the local authority as landlord would make a single payment to the water and/or wastewater supplier (who before 1974 might have been the same authority) on behalf of all their tenants. In some cases, this arrangement continued up to 1989 and beyond. The eVect was to obscure payment for water and wastewater services. Changes in both housing and water arrangements in the last two decades have resulted in many customers, particularly in social housing, receiving water and sewerage bills direct for the first time.
(b) Area cross-subsidies 7. Up to 1974, when many water and wastewater services were in the hands of local authorities, they had the benefit of subsidy both from central and local taxpayers in various ways. The creation of the 10 large regional water authorities in 1974 brought this possibility to an end. From that point, prices became reflective of costs in the particular operator’s area. Average charges varied from region to region as costs varied (though between 1976 and 1979 there was a statutory equalisation scheme entailing transfers of funds between regional authorities). The large areas of the regional water authorities did, however, open up the possibility of cross-subsidy between customers in diVerent parts of an authority’s area: in summary, urban areas, where network costs were lower because of economies of scale, subsidised rural areas. This remains in the post-1989 arrangements. 8. The post-1989 structure does not in principle preclude subsidisation of customers and, as indicated, there is extensive cross-subsidisation of diVerent kinds within the area of each company.
(c) Drainage of highways and open spaces 9. Wastewater charges to customers include the costs of draining highways and other public space. This is in eVect a concealed tax for a public service which might more transparently be met within public expenditure. Transfer of these costs to the public purse would be a way of containing water prices. It would however increase pressure on local taxation unless means were found of passing the costs to motorists who are the main beneficiaries. 9020981013 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 85
(d) Metering
10. Since 1989, an increasing proportion of the costs of water and wastewater 11 services has been met charged by metering, as in most other developed countries. Initially, the change was driven by the need for a method of charging for new properties which did not have rateable values. Increasingly, however, the motive has been demand management, particularly in areas of water scarcity in the south and east of England, where meter penetration is rising rapidly. 11. The justification for metering is that it encourages domestic customers towards more eYcient water use, eg, in relation to garden-watering. And where meters are installed at the point of connection between the company’s and the customer’s pipe, metering encourages customers to cure leakage on their supply pipe (on average, supply pipe leakage accounts for 30% of total leakage). Metering would be the more eVective as a demand management tool if eVective means can be found of introducing peak-time tariVs aimed at peak-lopping. 12. But one by-product of metering is to increase prices for unmeasured customers because of the way in which the so-called tariV basket works. In current circumstances, it tends to be customers in higher-rated properties who opt for meters, to gain financial benefit from their relatively low usage. The eVect is loss of income to the supplier. This is recouped across all customers, thus increasing charges disproportionately for unmeasured customers. Price increases for unmeasured customers can be significantly above the K factor as a result. This may be justified overall in providing a further incentive towards metering, and it may be right that prices for unmeasured customers should increase a little faster than those for measured customers because unmeasured water usage is tending to increase more quickly than metered usage. But it does need to be borne in mind that, as metering is extended under the current policies, unmeasured customers will increasingly be the poorer customers.
(e) Protection of vulnerable customers
13. The present Administration has introduced, through the Water Act 1999, a degree of protection for vulnerable customers. The water company is required to assist large families in receipt of certain public benefits and customers with certain medical conditions which require high water use. They are charged a bill equal to the average household bill, even though their actual water use is much higher than average. This shelters them from the cost of their high water needs, but they are still faced with a significant bill. (If they occupy a low-rated dwelling, it is better for them not to apply for the protection, of course. More generally, take-up under these provisions is low.)
(f) Uncollected debt and assistance of those in diYculties
14. Another form of cross-subsidy results from non-payment of water bills. Water debt is rising sharply. Companies use a variety of methods to facilitate payment and it may be possible to do more. But at present some 1.5% of monies due are written oV annually. Paying customers bear this cost in the longer run. Some companies have created charitable trusts to assist a limited number of customers who are in severe need.
Pricing Pressures Since 1989
(a) Price increases
15. Since 1989, average household bills will by 2005 have increased in real terms by 20%. This represents an annual rate of increase of a little over 1.3%. Economic growth over the period is likely to be of the order of 2.0% a year, so water charges are currently taking a declining share of the national cake. 16. There are wide variations by area around the average—from 42% in South West Water to 9% in Anglian. This results from the diVerential demands of waste water treatment, reflecting the fact that historically, inland waters have long been protected by two-stage sewage treatment, whereas discharges to coastal waters often had no treatment at all. 17. The extent of variation between company’s prices is important as benefit rates are fixed at a single rate nationally. So water prices take a much larger slice of benefit or pension in some areas than others.
11 Wastewater services are charged for by volume, normally on the assumption that 95% of the water which is drawn by a property leaves it by the sewer and is subsequently treated. 9020981013 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 86 Environment, Food and Rural Affairs: Evidence
(b) EYciency gains 18. These price increases are seen by some as a consequence of the need to pay ”fat-cat” salaries and a profit margin to private companies. Privately-raised debt and, still more, equity funding requires higher coupons than does public borrowing. But the basic justification for private involvement is that eYciency and quality of service gains outweigh these extra costs. In the medium run, the regulator ensures that these gains, over and above the cost of attracting private operators, are captured for the benefit of customers in lower prices. 19. The industry has since 1989 made major gains in eYciency. The successive price settlements have assumed an overall eYciency gain of 24% in operating expenditure and 22% in capital expenditure by March 2005. And outperformance by the companies has enabled the regulator to make more demanding assumptions price review by review.
(c) Reasons for price increases 20. The main reason for rising prices in real terms since 1989 has been the cost of investment to raise standards of performance in a number of ways: — Improvements in drinking water quality, in particular investment to deal with nitrates, pesticides, lead and parasites such as cryptosporidium. This investment has been necessary to enable regulatory standards to be met. This has also entailed extra operating costs. — The costs of protecting the environment in two ways: — Dealing with the eVects of abstractions, including improving flow in low-flow rivers and protecting and enhancing wetland habitats; — Reducing environmental impacts of sewage discharge and sludges. Here, a very wide range of regulatory requirements have had to be met, ranging from the bathing waters directive, the freshwater fish and shellfish waters directives, and the urban wastewater treatment directive. These requirements have been exceptionally heavy. — Costs of raising quality of service in a variety of ways—nothing equivalent to levels of service requirements existed under the previous nationalised regime.
Prospects for the 2005 Review 21. At privatisation, there was a tendency to regard extra investment as a hump that could be surmounted within a decade or so. Thereafter, it was expected, cost pressure would reduce, allowing water prices to fall back to a pattern of RPI " X rather than the RPI ! X needed in the first phase. It is already clear however that this happy position will not be achieved in the next review.
(a) Continuing cost pressures 22. There continues to be a wide variety of pressures requiring further new investment, pressures which will also result in new operating costs. Among the more important are: — Achieving the requirements of existing EU directives. — The Water Framework Directive. — Protection of SSSIs and other EU and domestic environmental areas. — Climate change and water scarcity, coupled with rising demand from domestic users. — Leakage control. — Ending sewer flooding. — Eliminating lead from drinking water. — The requirements of the Security and Emergency Measures Directive. Beyond this, is the risk of newly-perceived health threats resulting from water re-use. There is also a variety of other variables over which neither the industry nor regulators have any control, such as levels of business rates after the next revaluation, tax and NI changes, the prospect of statutory lane rental charges for works in the highway, abstraction charges, pensions costs, energy costs, general insurance costs, and so on.
(b) Replacement and renewal 23. Additionally, replacement and renewal cannot continue to be neglected. Water companies have to invest in replacing underground networks and above ground plant. At replacement cost, the total value of water assets now exceeds £204 billion. While the life of some categories of this investment is long, it does not and cannot last for ever. That provided in former generations varied in quality through time and 9020981013 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 87
geographically. Some old networks need surprisingly little maintenance; others do not last as long or otherwise need replacement in order to provide a good standard of service and reduce maintenance costs. In general, above ground plant needs replacement more frequently than networks. 24. Adequate levels of replacement are essential if customers of the future are to receive good service. Assets worth over £200 billion presuppose an annual replacement cost in excess of the current peak rate of £1.7 billion, if an appropriate spread of asset lives is assumed. As noted by the Environmental Audit Committee in 2000, there was a tendency in earlier reviews for OFWAT to neglect this aspect of investment. Since 1999 there have been improvements in the system for identifying these needs. It is important that regulators should recognise the implications for investment levels.
(c) Implications for prices 25. These investment requirements are not well understood by the public. Nor is it appreciated that, while there is no charge for water as a raw material, the costs of networks and treatment plants and operating them are inevitably substantial. Price pressures derive from the extra costs of the service rather than from profits per se, though the costs of capital must be met (as they would have to be met in a publicly-funded service). 26. Many of the price pressures are on the wastewater side. What is of particular concern to water suppliers is the possible temptation to achieve environmental improvement at the expense of investment in water supply, and replacement and renewal generally—that the needs of the clean water sector will be crowded out by the wastewater side. The regulator must discharge his statutory duty company by company and he must guard against the possibility of successful appeal to the Competition Commission if he were to allow the needs of the wastewater side to cloud his judgment about those of water suppliers. But it is possible to contain pressures by taking a narrow view of the functions of water suppliers.
Financial and Efficiency Variables 27. Prices also depend on assumptions about a number of financial and other variables. Here again there are limits to the regulator’s room for manoeuvre. . . 28. First, the economic regulator has statutory duties which cannot be ignored and have implications of price levels: — To ensure that water companies carry out their functions; there is little room for manoeuvre to manipulate interpretations of those functions. — To ensure that these functions can be financed, particularly but not exclusively as regards the cost of capital. This is determined by the markets. If eVorts are made to squeeze margins below the level that the markets deem acceptable, they will react accordingly. This is in essence what happened following the 1999 price determination. 29. Since 1999 there has been extensive revision of the financial structure of companies, increasing levels of debt finance and reducing equity. To some extent, this has been in the longer-term interests of customers, that is, if the level of equity exceeded that necessary for entities with the risk-profile of water companies. However, the result of squeezing returns may have been to cause a reduction of equity beyond the level that is wise. Equity capital in water companies represents a buVer which protects customers from unforeseen or miscalculated risks. If equity has been reduced to below the “right” level, risks will have been increased for customers. These considerations need to be borne very carefully in mind in the present price review, especially in considering the temptation to keep down prices by manipulating financial variables in the face of unavoidable investment pressures. 30. A further variable which may be prayed in aid to keep prices down in the face of other pressures is assumptions on the eYciency gains which companies can be expected to make in the next price period. Insofar as private companies can be expected to be more eYcient than nationalised companies (or than the former statutory private companies), the period since 1989 ought to have been suYcient to enable the implicit step change to have been completed. Henceforth, it is questionable whether water companies can make greater eYciency gains than private sector companies generally. In this context, two points need to be borne in mind: — The RPI subsumes the underlying rate of eYciency gains across the economy as a whole. If there was no extra investment and prices were restricted to the increase in the RPI, companies would need to achieve at least the average eYciency gain across the economy as a whole. The RPI " X formula therefore requires regulated companies to achieve an additional eYciency gain over and above the underlying average. — As in the case of any company, water companies have costs that they can control and costs (like tax, rates and so on) which they cannot control or even influence. The ratio of controllable to uncontrollable costs is roughly 80:20. EYciency gains must be concentrated in the area of controllable costs. This means that if the regulator’s eYciency assumption is 4% overall, water 9020981013 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 88 Environment, Food and Rural Affairs: Evidence
companies must actually achieve a gain of 5% on controllable costs. This point is of significance if the level of uncontrollable costs is comparatively high compared with the activities which the regulator uses as the benchmark. 31. All this emphasises the need for the Committee to be realistic both about the cost pressures on the industry and the extent to which there is freedom nevertheless to hold down prices in the face of these pressures.
The Protection of Poorer Customers
32. It is important that the means of assisting poorer customers should not be general action which jeopardizes either the UK’s obligations as a member state of the European Union to achieve environmental and drinking water improvements which are required by European law, or the need for asset replacement and refurbishment, or the financial stability of companies as the deliverers of essential services. 33. The question arises whether it is necessary to widen support for poorer customers. The provisions in respect of vulnerable customers are comparatively narrow. They do not cover poorer customers in general, on whom the cost of water and wastewater services can be expected to bear more heavily. That they are experiencing diYculty already is evident from the growing incidence of non-payment of water bills. 34. It is possible to imagine that with ingenuity ways could be devised of supporting such customers at the expense of other customers. This might be tempting for the Government since it avoids implications for public finances. Those on benefits might be charged a comparatively low flat fee for water and waste water services. Or, more elaborately, tariVs might be altered to provide an initial block of water for a flat fee, with additional water being charged for by volume (possible only for those on meters). But it would be more transparent to provide public help rather than to increase confusing cross-subsidies from other water customers.12 35. DiVerential cost pressures between regions may also reach unsustainable levels. In that case, the mechanism of assistance should be public help to reduce prices for hard-pressed customers in the particular company, not extensions of cross-subsidies between companies and therefore customers. Alternatively, particular environmental improvement measures could be financed through public subsidy. This would however be objectionable because it infringes the “polluter pays” principle (domestic customers do not see themselves as polluters, though they are). Moreover, all consumers would benefit from support for particular types of investment and this is not necessary. Mechanisms to assist poorer customers specifically could automatically deal with the pressure of regional diVerentials on those customers. All such measures would need to bear in mind alsothe requirements of the Water Framework Directive on cost-reflective pricing. 36. The eVect of the tariV basket rules in transferring the financial consequences of metering to unmeasured customers could also be looked at (see paragraph 12). This will become more important as metering penetration increases and unmeasured customers become more and more the poorer customers. 17 October 2003
Memorandum submitted by The Wildlife Trusts
Introduction
1. Thank you for the opportunity to comment on this important topic. As you may be aware The Wildlife Trusts are a unique partnership of 47 local Wildlife Trusts covering the whole of the UK and the Isle of Man. The partnership campaigns for the protection of wildlife and invests in the future by helping people of all ages to gain a greater appreciation and understanding of nature. 2. Collectively The Wildlife Trusts have approximately 420,000 members and manage almost 2,500 nature reserves, covering more than 76,000 hectares of land, ranging from inner city urban sites to the UK’s finest wildlife areas. We also oVer advice and encouragement to other landowners to help them manage the wider countryside for the benefit of wildlife and people. 3. We have a long history of working in partnership with the Water Industry and their investment decisions are of keen interest because of their impact on our landholdings biodiversity and throughout the catchments in which they operate.
12 In New South Wales a rapid introduction of metering with demand management objectives was facilitated by providing a state subsidy to the public water operator, to provide rebates to a substantial minority of customers. 9020981014 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 89
AMP and the Environment 4. The AMP process was devised to control the costs of a newly privatised water industry as it was asked to deliver a massive investment programme to achieve mandatory domestic and European quality targets and indeed recent water quality statistics released by DEFRA show that there has been a real success in tackling the gross point sources of pollution. 5. However our fresh and coastal waters still suVer significant pollution from nitrates and phosphates. These excessive nutrients reduce the diversity of plant life and, at their most disastrous, cause algal blooms that choke plant life and strip water of oxygen, killing invertebrates and fish. 6. The UK now faces a new challenge to restore the ecological balance of rivers, lakes and coastal waters by fully implementing the Water Framework Directive (WFD). This will require action to tackle nutrient pollution from all sources including nitrates and phosphates from sewage treatment works.
Comments on the PR04 Process 7. The Wildlife Trusts pleased to see that, for the first time, that the environmental drivers identified for the spending review included biodiversity. However with some notable exceptions, such as United Utilities, it seems that the water companies are reluctant to take such schemes forward in their preferred plans despite consumer concerns about the environment identified by the joint MORI research (see below). 8. We are also pleased to participate in joint customer research into customer views on spending through our membership of Wildlife & Countryside Link. However we are concerned that selective reporting of the findings of the initial report by WaterVoice and elements of the water industry have distorted the clear message that the environment remains at the top of the public agenda. To quote from the executive summary: “The least well rated aspects [of water company service] are ‘maintaining the quality of coastal and bathing waters and of river waters’.” (paragraph A1.6.) and “Respondents tend to be consistent in their views as to which aspects are worth spending money on to improve (‘which may result in customers’ bills increasing’). The same three ‘urgent’ priorities emerge. Around a third of the sample say either ‘more’ or ‘a lot more’ should be spent on ‘maintaining the quality of river waters and of coastal and bathing waters’ and/or ‘protecting important areas of wildlife and plants’”.—paragraph A4.1 9. In light of this support we are increasingly frustrated that water companies and WaterVoice continue to attack the environmental investment programme as if it is some kind of unnecessary and unpopular burden. In many company plans the environmental programme under Scenario A or B accounts for only a fraction of the predicted price increase yet all the attention on price rises seems to fall on what would appear to be the most popular area for investment.
Water Company Plans 10. Interpretation of the draft plans presented by the water companies has been complicated by a lack of consistency both in presentation and detail. We are very concerned that a number of water companies draft business plans include fewer schemes under the environmental drivers than Ofwat proposes under its reference Plan A scenario which we understand to be the minimum required to achieve statutory compliance. We would single out Wessex Water, Thames, Portsmouth and Southern as being of particular concern. 11. We are also concerned about the scale of the costs reported in the draft plans. There is an inherent incentive for water companies to exaggerate costs in the AMP process and thereby generate extra profits through “eYciency savings” after the price determination. Any inflation of the costs reported in the draft business plans will act to raise concerns amongst customers about the predicted price increases. This has the potential to skew perceptions about the aVordability of environmental improvements both amongst customers and aVect the outcome of cost-benefit analysis and the identification of contentious schemes. 12. Experience has shown that the final determination of previous AMP rounds by Ofwat has generally reduced initial cost estimates and, therefore, the increases in water bill passed onto the customer. In particular the draft plans presented by Southern Water and United Utlities seem completely out of kilter with the other water and sewerage companies.
The Environment Agency, CCW and English Nature 13. The Wildlife Trusts support the environmental programme presented to the public in “A good deal for water” and the supporting documents. The research suggests that the benefits to the public could range between £5 and £8 billion and outweigh the costs of delivery. 9020981014 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 90 Environment, Food and Rural Affairs: Evidence
Affordability and Non-payment
14. The Wildlife Trusts believe that the recent history of investment in protecting and improving the water environment has been good for wildlife, the economy and society as well as representing good value for customers. We want to see this investment continue but recognise that aVordability can be an issue with vulnerable groups.
15. However we do not believe that issues around aVordability should simply be tackled by minimising the unit cost of water. This does nothing to reinforce the message that water is a valuable resource or encourage conservation amongst those customers for whom the water bill represents a small proportion of income. It would also fail to capitalise on the benefits which a clean, healthy environment can bring, improvements that (from the MORI research) the public seem to support.
16. Instead we would encourage a more imaginative approach to tackling real water poverty such as rising block tariVs for metered customers, support for those in real poverty and the introduction of a water savings trust which could help promote water eYciency amongst consumers.
The Future of AMP
17. As mentioned above the AMP process was designed for the control of the post-privatisation water industry. Whatever merits or problems the system has it is clear that implementation of the Water Framework Directive brings with it a new set of challenges.
18. Not least the Directive should herald a new approach that looks at holistic wider catchment approaches to pollution control, resource management and drinking water protection. While there is much still to be done to tackle the remaining point sources of pollution under AMP4 The Wildlife Trusts believe that this should be the last round of investment in its current format. We would urge the Government to look at new ways of integrating the needs of the environment, wider countryside policy, consumer/public interests and water industry investment. This could bring huge economic eYciencies benefiting wildlife, people and the rural economy. 17 October 2003
Memorandum submitted by Thames Water Utilities Ltd
Background
1. At Privatisation a 10-year period of increased investment was envisaged that would deliver service, drinking water quality and environmental improvements. Customers’ bills would rise as a result, although partially oVset by increasing eYciency. Investment has been made, improvements in service and environmental performance and eYciency have been delivered but further substantial increases in investment were required in AMP3 and are being signalled again from 2005 onwards.
2. These are being driven by a need for increased asset maintenance, a continued and (in the case of some companies) a very substantial further quality programme and a need to address financial and accounting issues arising at the last price review or since. Thames Water has a particular need to invest to meet the challenge of London’s ageing infrastructure and growth in demand for services. These require increased investment in the next 2–3 AMP periods. As yet unconfirmed environmental obligations may add further to prices.
3. Current uncertainties may eventually contribute to further price rises, as well as to instability of prices between periodic reviews. There are also financing issues for companies as a result.
4. European environmental and drinking water quality legislation continues to develop. The Habitats Directive is a current example where there is uncertainty and conflict with Thames Water’s other priorities. The Water Framework Directive is another example that is insuYciently well understood for there to be explicit provision in our draft plan. It is hard to envisage this situation changing, yet it is not sustainable. 9020981015 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 91
Key Issues—for this Price Review and Beyond
Adequate funding of asset maintenance and service enhancements 5. Necessary asset maintenance must be fully addressed if service is to be maintained, as should service enhancements supported by customers. Environmental improvements should be demonstrably necessary.
Determining the scope and pace of further environmental improvements 6. This review does not explicitly address the requirements of the Water Framework Directive (WFD) and raises the broader issue of the “escalator” of rising standards and the challenge of sustainability. Extracting further increments of environmental improvement from water companies requires increasing and possibly disproportionate cost, as well as imposing environmental cost, from increased energy consumption for example. A consistent, long-term (10 years!) policy setting framework which can examine the costs and benefits of improvements across all sectors and diVuse impacts is a much needed pre-cursor to water price reviews, which are not the appropriate process to address these wider issues.
Reducing uncertainty 7. There are many uncertainties at this review. Ministers are required to give guidance on the extent and timing of many environmental obligations to be delivered. This is due towards the end of the process, later than is ideal. The guidance must be on time, specific and unambiguous, recognising that increased obligations means higher bills for customers. Other uncertain obligations will not be clarified in time for final business plans. These will fall into the ambit of price-correction mechanisms.
Price correction mechanisms 8. There are a number of concerns with the mechanisms in place to deal with costs arising from changes to our obligations between Periodic Reviews. Legitimate expenditure above regulatory assumptions to maintain service may be disallowed, and companies may bear financing and other costs forever. We have set out our proposals for improved mechanisms in our draft business plan.
Preserving incentives to reduce bills in the future 9. A major success of the current regime has been the delivery of eYciency resulting in lower bills than would otherwise be the case. Incentive mechanisms and eYciency assumptions must encourage this to continue, if the twin objectives of attracting investment and further savings for customers are to be achieved. 10. Our draft strategic business plan sets out our priorities and is available on our web site at http:// www.thameswateruk.co.uk. We would be pleased to make further information and detail available to the Committee if required. 17 October 2003
Memorandum submitted by English Nature
Summary 1. AMP4 is particularly important for the protection of statutory nature conservation sites. Schemes are needed to address statutory requirements for protection of SSSIs and the Natura 2000 series of international sites, to achieve Defra’s PSA target for 95% of SSSIs by area to be in favourable condition by 2010, and the requirements of the EU Habitats and Birds Directives. Other schemes are needed to meet commitments under the UK Biodiversity Action Plan (BAP). 2. Variation in the extent to which some water companies have proposed schemes to address water quality in designated sites, and in particular failure to address the risks and impacts of water abstraction, is of great concern. 3. A catchment-based approach has been proposed for a few schemes in this AMP round. We support these as examples of a more integrated and sustainable approach that more schemes should follow in future rounds. 4. Parallel action is necessary to tackle diVuse sources of pollution aVecting nature conservation sites, in order to ensure that full benefits are realised from the AMP programme. 5. There is a need for a more reliable approach than the current logging up process, to secure funding for schemes identified within AMP periods. 9020981016 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 92 Environment, Food and Rural Affairs: Evidence
1. Introduction English Nature is the statutory body that champions the conservation and enhancement of the wildlife and geological features of England. We work for wildlife in partnership with others, by: — advising Government, other agencies, local authorities, interest groups, business, communities, individuals on nature conservation in England; — regulating activities aVecting the special nature conservation sites in England; — enabling others to manage land for nature conservation, through grants, projects and information; — enthusing and advocating nature conservation for all and biodiversity as a key test of sustainable development. We have statutory responsibilities for nationally-important nature conservation sites: Sites of Special Scientific Interest, the most important of which are managed as National Nature Reserves. Through the Joint Nature Conservation Committee, English Nature works with sister organisations in Scotland Wales and Northern Ireland to advise Government on UK and international nature conservation issues.
2. English Nature’s Role in the AMP4 Programme 2.1 English Nature has provided advice to Government and to the other Regulators on the investment programme needed to deliver necessary benefits for nature conservation. We are a member of the Regulators group for the AMP4 process and so have been involved in the development of advice to water companies on the preparation of their draft business plans and preparation of public statements and consultations on the Periodic Review process. We are part of the working group that has designed and commissioned surveys of customer opinions in 2003 and 2004.
3. The Importance for Nature Conservation of the AMP Process 3.1 The previous Periodic Review was the first in which substantive consideration had been given to schemes for the protection of nature conservation sites. Although the AMP3 investment period (covering 2000–05) is not yet complete, and the majority of nature conservation schemes are scheduled for completion towards the end of that period, there have been successes already which are illustrative of the benefits sought on a larger scale from the AMP4 programme. 3.2 These include schemes to: restore flow levels to parts of the River Eden, Cumbria, a Site of Special Scientific Interest (SSSI) and Special Area of Conservation (SAC) under the EU Habitats Directive, which have enabled fish to migrate through one of the major tributaries; restoration of water levels in parts of North Dartmoor SAC and SSSI which have improved habitats for brown trout and valley mire vegetation; removal of phosphates for sewage treatment works discharging into Bure Broads SSSI and SAC in Norfolk, Woodwalton Fen in Cambridgeshire, and Looe Pool lagoon SSSI in Cornwall. 3.3 Despite these improvements, there is still need to tackle point source pollution and abstraction aVecting SSSIs and Natura 2000 sites. As at August 2003, approximately 60% of wetland SSSIs were considered to be in unfavourable condition. In the case of rivers, a high proportion is due to point source pollution leading to excessive nutrients, principally phosphorus, whilst around 160 freshwater and wetland sites were identified during preparation for the PRO4 process as aVected by or at risk from abstraction.
4. Scope of AMP4 Programme for Nature Conservation 4.1 Initial Ministerial Guidance placed emphasis on the importance of AMP4 for nature conservation. It identified as key drivers compliance with the Countryside and Rights of Way Act—in particular enabling achievement of Defra’s PSA target for 95% of SSSIs to have reached favourable condition by 2010—and achievement or maintenance of favourable conservation status for sites designated under the EU Habitats and Birds Directives (SACs for habitats and Special Protection Areas (SPAs) for birds—collectively known as Natura 2000 sites). Ministerial guidance requires that where such schemes are identified at a high level of certainty, action must be taken to cease or modify discharges, and that funding must be made available where abstraction licences need to be varied or revoked to ensure favourable conservation status. Because of the PSA target for achieving favourable condition on SSSIs, and the risks of infraction proceedings for non-compliance with the Habitats and Birds Directives, it is essential that the necessary schemes receive funding during this periodic review. In addition, a small number of nature conservation schemes which are not linked to statutorily protected sites have been included where they are required to contribute to meeting UK Biodiversity Action Plan (BAP) targets for habitats and species dependent on an aquatic environment. 9020981016 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 93
5. Process for Selecting Schemes 5.1 Schemes which are needed to address problems with water quality or water resources in SSSIs and Natura 2000 sites, were determined in close collaboration with the Environment Agency. The level of certainty with which schemes were proposed for specific sites was determined jointly with Environment Agency, based on jointly agreed criteria for (a) degree of risk to or impact on a site and (b) strength of association with water company activity.
6. Scale of Nature Conservation Programme Required 6.1 A summary of the environmental programme has been published in “A Good Deal for water”. A list of schemes was submitted to water companies for costing at the end of May 2003. Annex 1 shows tables of numbers of schemes submitted by nature conservation driver. 260 schemes to tackle water quality problems at 64 statutory nature conservation sites, were identified at higher levels of certainty. Similarly, schemes are needed at 53 sites to deal with water abstraction problems. A further 124 site investigations also require funding under the AMP4 programme. Guidance to water companies required inclusion under Reference Plan A for those statutory schemes with high levels of certainty, others (including BAP schemes) under Reference Plan B. Guidance on what to include under company preferred schemes steered companies towards including statutory schemes but was not prescriptive. Costings were also required for investigations where there was a measure of uncertainty—the results of these investigations may lead to further schemes being identified which need completion during the AMP4 period. 6.2 For water resources schemes, it is diYcult to identify schemes without further options appraisal (eg of water availability or use within a catchment) even though impacts on or risks to sites (and hence need for action) from water abstraction were clearly recognised. Hence, where water resources schemes could not be proposed at this stage, the Environment Agency recommended to water companies the use of a “sustainability reduction” approach, to enable an estimate of the scale of compensatory water provision that would need to be made in order to protect sites. Estimates based on sustainability reductions should also have been included within draft business plans for schemes with high levels of certainty.
7. Diffuse Pollution 7.1 The Environment Agency and English Nature wish to see measures introduced by Government to reduce impacts by other sectors in parallel with action on the discharges and abstractions made by water companies. Nutrient pollution, especially from phosphates, causes changes in aquatic plant communities and eventually can lead to algal blooms. Both point and diVuse sources contribute in diVerent ways to this problem and both sources must be tackled together. DiVuse water pollution from agriculture (DWPA) is a major source of nutrient enrichment in many freshwater SSSIs and Natura 2000 sites and English Nature has recently identified those sites most at risk. We expect Defra to be consulting on its DWPA proposals this winter, and it is important that swift action is taken following the consultation. Such action in parallel with action under the periodic review is important in ensuring proportionate action by other sectors in tackling water quality impacts on SSSIs.
8. Response of Water Companies 8.1 Company Draft Business Plans were produced in early September and are still being analysed. We expect to give our advice to Ministers in November, but our initial views follow. 8.2 Some water companies have included the full water quality environmental programme in their preferred strategies, which we applaud. However several have not included all “essential and clear” water quality schemes aVecting nature conservation sites in their preferred strategies, even though these fall under statutory drivers. We have particular concerns that one company has not included 21 schemes to remove phosphates from a number of nationally and internationally designated river systems in its preferred strategy. Another has also excluded six nitrogen or phosphorus removal schemes from its preferred strategy, and another has excluded six phosphorus removal schemes from its preferred strategy. 8.3 Many companies have not followed agreed best practice, and the Agency’s and Ministerial guidance, in developing their plans. We are particularly concerned that many companies have failed to include schemes to deal with the impact of abstraction at Habitats Directive sites and SSSI’s. A number of companies have not included these schemes in either their preferred strategy, or Reference Plan A. Even where they are included, water resources schemes are programmed in some cases for completion after 2010: beyond the agreed timescales and raising the potential for infraction proceedings. 8.4 The process of estimating “sustainability reductions” within water resources plans is an important way of accounting for water abstraction schemes that have been submitted at high levels of certainty, but where details for schemes cannot be identified until a fuller options appraisal has been carried out by the company. At this stage it appears that water companies have widely failed to adopt “sustainability reductions” and we refer you to the Environment Agency evidence on this point. 9020981016 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 94 Environment, Food and Rural Affairs: Evidence
8.5 A few water companies have included schemes to tackle some water quality issues at catchment level, by proposing that land management actions, such as reductions in livestock stocking density and tackling moorland gripping, be funded through the AMP4 process. We support these proposals both as schemes or investigations for funding under AMP4, and as an objective for future AMP rounds, as a more integrated and sustainable approach to managing inputs. 8.6 The Countryside and Rights of Way (CRoW) Act requires the Environment Agency, Ofwat and the water companies to conserve and enhance SSSIs in carrying out their functions. This duty on all parties must be reflected in their response to the proposals put forward to protect nature conservation sites during AMP4.
9. Dealing with Uncertainties in this and Future AMP Rounds 9.1 Some uncertainties will remain over the schemes necessary to tackle water abstraction impacts on SSSIs and Natura 2000 sites due to the lack of information at this stage on alternative resources, and of the options available to allow for changes in water resourcing. Where possible, water companies should carry out options appraisals to enable improved costing of schemes which should then be included in final business plans. However, it is important that where schemes are known to be necessary but costs at this stage uncertain, sustainability reduction estimates are used in final business plan, to ensure that resources are made available to fund such schemes once the final costs are known. 9.2 A key concern for AMP4 is uncertainties for water companies in costs and timing of new obligations from the EU, in particular the Habitats Directive. The Habitats Regulations require the Environment Agency to demonstrate that permissions, for example those for discharges and abstractions, do not adversely aVect a site of European importance, alone or in combination. If this cannot be demonstrated, the permission has to be modified or revoked unless a case can be made of over-riding public interest, and there is no viable alternative. 9.3 The Environment Agency and English Nature have given a priority rating to the action needed to tackle activities controlled by permits issued by the Environment Agency and which aVect Natura 2000 sites. The condition of the site, the risks posed by permit conditions, and the complexity of the site determined the ranking of priorities. The timetable, agreed with Government, for this review is to complete assessments for high, medium and low priority sites by 2004, 2006 and 2008 respectively, with any necessary revocations or variations in permits identified and planned within two years of these dates, ie by 2006, 2008 and 2010. This timetable does not match that for the price review. This means that some investigations to determine which discharges or abstractions are adversely aVecting Natura 2000 sites will not be completed in time for this price review. 9.4 Similarly, a number of investigations have been identified for funding by the water companies under AMP4 (see Tables 1 and 2, Annex 1), where it is not certain whether schemes, or what type of schemes, are needed to achieve favourable condition of SSSIs. In order to ensure that the PSA target for SSSIs is achieved, it is likely that investigations funded in this price review will lead to a need to take remedial action before the next review. 9.5 Some companies may therefore face changes to costs (either additional schemes, or removal of schemes from the programme) between this price review and the next. The licences by which water companies operate provide for changes in price limits between reviews, where extra costs arising from new obligations exceed a particular threshold related to the turnover of the company (IDOKs arrangements). Where the net additional costs do not exceed the threshold, the company must carry these costs until new price limits are set out the next review (logging up arrangements). 9.6 It is likely that a great many of the additional nature conservation schemes will be insuYcient to trigger the IDOKs threshold for changing price limits. However the uncertainties associated with the logging up procedure have led to reluctance on the part of water companies to rely on this procedure for bringing forward nature conservation schemes in the past. We think that measures should be put in place to give companies confidence that funding (including financing costs up to the next price limit period) will be made available for schemes that are justified under the CRoW Act and Habitats Directive drivers outside the timetable for the price review. There is a need for full assurance to be given to water companies that Government will support claims for schemes that are shown to be necessary to meet statutory drivers, and that necessary provision for funding will be made available 9.7 Part of the problem here is due to the mismatch in timetabling between the AMP4 process and other policy processes (such as the Review of Consents) which have implications for water company spending programmes. A process which is less dependent on a fixed timetable and more responsive to changes in policies which have implications for water company funding, should substitute for the current AMP approach. In order to avoid mismatches in timetable, the AMP timetable should be reviewed and a process established that will enable better alignment with the reporting cycles for other major drivers for water policy such as the Water Framework Directive. 17 October 2003 9020981016 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 95
Annex 1
Schemes and investigations submitted by EA/English Nature for AMP4 funding under nature conservation drivers, by water company
The following data were extracted from the EA/EN AMP4 database submitted to Ofwat and Defra on 13 June 2003.
HD refers to Habitats and Birds Directive sites, LoC refers to the Level of Certainty with which a scheme has been identified.
A “scheme” is where one asset (sewage discharge or abstraction point) needs improvement. Several schemes may benefit one designated nature conservation site.
Table 1
WATER QUALITY—NUMBERS OF SCHEMES AND DESIGNATED SITES BY WATER COMPANY
No. of schemes No. of schemes Total LoC 1–3 LoC 4–6 Investigations Sites Schemes Sites Schemes Sites Schemes Sites
Anglian HD 74 14 14 3 15 3 17 Water SSSI 0 0 0 0 2 2 2 Total 74 14 14 3 17 5 19
Dwr Cymru HD 4 1 1 1 1 1 3 SSSI 0 0 0 0 0 0 0 Total 4 1 1 1 1 1 3
Northumbrian HD 0 0 4 2 3 2 2 Water Ltd SSSI 0 0 0 0 0 0 0 Total 0 0 4 2 3 2 2
Severn HD 17 3 1 1 1 1 4 Trent Water SSSI 33 11 8 8 8 8 19 Total 50 14 9 9 9 9 23
Southern Water HD 13 7 40 18 8 4 20 SSSI 42 9 8 6 16 8 12 Total 55 16 48 24 24 12 32
South West Water HD 6 3 6 1 7 1 3 SSSI 0 0 3 2 3 2 2 Total 6 3 9 3 10 3 5
Thames Water HD 4 2 6 3 0 0 4 SSSI 7 1 7 7 7 7 8 Total 11 3 13 10 7 7 12
United Utilities HD 17 5 87 13 101 13 13 SSSI 13 3 0 0 0 0 3 Total 30 8 87 13 101 13 16
Wessex Water HD 18 2 0 0 1 1 3 SSSI 4 2 0 0 2 2 4 Total 22 4 0 0 3 3 7
Yorkshire Water HD 7 1 1 1 1 1 2 SSSI 1 1 3 3 4 4 5 Total 8 2 4 4 5 5 7 9020981016 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 96 Environment, Food and Rural Affairs: Evidence
Table 2
WATER RESOURCES—NUMBERS OF SITES BY WATER COMPANY
Region Habitats Directive SSSI LoC 1–3 Loc 4–6 Inv* Total Sites LoC 1–3 LoC 4–6 Inv* Total Sites Anglian Water 3 13 14 29 0 3 6 9 Bournemouth & 1 0 2 3 0 0 0 0 W Hants Cambridge Water 0 1 2 3 1 2 2 5 DwrCymru011 2 0000 Essex and SuVolk 1 4 4 10 0 1 1 2 Water Mid Kent Water 0 1 0 1 0 0 1 1 Portsmouth 2 0 0 2 0 0 0 0 Water Severn Trent 0 5 1 6 5 0 0 5 Water South East Water 4 0 1 5 0 1 1 2 South StaVs02022002 Water South West Water 0 0 0 0 0 0 0 0 Southern Water 5 2 0 7 0 0 1 1 Tendring 0 1 0 1 0 0 0 0 Hundred Water Thames Water 9 0 1 10 1 1 3 5 Three Valleys 0 1 2 3 0 0 0 0 Water United Utilities 10 0 8 14 1 0 1 2 Wessex Water 4 0 9 13 1 0 1 2 Yorkshire Water 2 0 2 3 1 0 1 2 Total 41 31 47 94 12 8 18 36
*Inv% Investigation
Memorandum submitted by Northumbrian Water Limited
1. Executive Summary 1.0 Northumbrian Water Ltd (NWL) is pleased to have the opportunity to comment on the subject of water prices at a time when the whole of the water industry in England and Wales is working towards Ofwat’s 2004 Periodic Review of prices. Each company submitted its Draft Business Plan in August, and Final Business Plans will be issued in April next year, following feedback from Ofwat and stakeholders on the draft versions. 1.1 Since privatisation investment has substantially increased compared to the prior period under public sector ownership, services have improved greatly, and major advances in companies’ operational eYciency have paid for a significant part of the service improvements and increased investment. As a result customers in England and Wales benefit from generally lower prices and better water services than their neighbours in Scotland, where services have not been privatised. 1.2 However, the water industry in England and Wales will not be able to sustain investment at the current high levels beyond 2005 without significant increases in water prices. Most of the possible eYciency gains have already been made, as Ofwat now acknowledges. Companies have already borrowed heavily to finance investment and they cannot increase borrowing indefinitely. It will be possible to introduce new equity only if the allowed returns are adequate. The forthcoming price review in 2004 (PR04) is therefore crucially important to the future of the industry. 1.3 This response is in two parts. First we consider the pressure on the level of prices. Second we consider some issues relating to the incidence of water charges 9020981017 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 97
2. Upward Pressure on Prices
Water prices and financing investment
2.0 Commentators often overlook the fact that all the water company profits—and more besides—are ploughed back into the industry in the form of capital investment. It is important to consider the industry’s cash flows (which include capital investment) as well as profits (which do not). In only one year since privatisation has the industry’s cash flow been positive. In every other year, the industry has been forced to spend more than it was receiving in revenues. Increased borrowing has made up the diVerence. 2.1 The amount of debt carried by a company as a percentage of its total of debt and equity investment is called its gearing. As a company’s gearing increases, its credit rating deteriorates and the cost of further borrowing increases. Eventually, it will not be possible to raise additional finance at economic interest rates. 2.2 In recent years companies have benefited from historically low interest rates and have financed investment through borrowing since debt was cheaper than equity. Gearing is now approaching maximum sustainable levels. It is possible to reduce gearing by raising new equity (ie issuing new shares). But this can only be done if the returns available are suYcient to attract equity investors. This requires the regulator to allow companies to remunerate equity, as well as debt finance, appropriately. 2.3 Strongly negative cash flows cannot continue indefinitely, either costs must be reduced, or income increased. If a continuing high level of capital investment cannot be avoided, then the prices paid by customers must increase if the necessary finance is to be raised.
Decisions on future investment aVect customers’ bills
2.4 The water industry is very capital intensive. Most of the industry’s costs are associated with providing, maintaining and operating the extensive networks and treatment facilities needed to deliver water services. However, for the last decade and a half the industry has additionally been required to invest heavily to satisfy the requirements of European Directives. Many of the required improvements have been desirable, but they do not come free. It is unlikely that those in Brussels legislating for the improvements considered very deeply the impact they would have on customers’ bills. 2.5 Unfortunately customers, who sooner or later must pay for environmental improvements, are not allowed any choice over which improvements they would prefer to pay for. This is partly a consequence of the way in which the industry is regulated. When prices are reset every five years at periodic reviews, the economic regulator, Ofwat, consults the Environment Agency, English Nature and Drinking Water Inspectorate over the content of the industry’s investment programme for the next AMP (Asset Management Plan) period. The environmental regulators have a tendency to see this as a once in five years window of opportunity to maximise environmental gains. By contrast Ofwat tends to view the environmental aspirations as obstacles to the lowest possible prices for customers. Ministers are left to decide the correct balance. The companies face a real risk that they will be expected to deliver more environmental improvements than have received adequate funding. 2.6 These regulatory tensions could be reduced if a more collaborative and less adversarial framework were to be adopted. We consider that a legal requirement for the regulators to collaborate in the long-term interests of the industry and its customers would be beneficial. 2.7 It is essential that preparations for compliance with the Water Framework Directive are undertaken on a true catchment management basis with improvements required from polluting industries and agriculture rather than focusing simply on end of pipe solutions from the water industry. 2.8 Many commentators have noted the deficiency in the regulatory regime with regard to capital maintenance. If too little investment in maintenance is made, assets will deteriorate and a backlog of maintenance investment will be created. Present customers will then be benefiting at the expense of future customers. However, it is not easy to calculate the level of capital maintenance that will hold overall asset condition constant, and it takes a long time before it becomes obvious that deterioration has occurred. 2.9 An opportunist economic regulator may be tempted to cut the allowance in the price cap for capital maintenance, leaving the problem for his successors. Environmental regulators may in the past have preferred to see direct investment in quality improvements and viewed capital maintenance as a competing investment area. 2.10 We are pleased to note that the EA has started to recognise that asset maintenance is vital to securing the environmental improvements achieved to date and the industry and Ofwat have worked together to develop a more robust framework for assessing capital maintenance requirements. What is clear is that any service failing due to poor maintenance will be regarded as the company’s responsibility. 9020981017 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 98 Environment, Food and Rural Affairs: Evidence
Areas where economic regulation must improve 2.11 Too often in the past economic regulation of the industry has been characterised as short termist. Ofwat cut prices to the bone at PR99 and it was clear at the time that this was not sustainable. Significant price rises in PR04 now look inevitable, but they need not have been so significant—and in some cases may not have been needed at all—if price setting in 1999 had been conducted with due consideration for the longer term. 2.12 In its insistence on setting prices in 1999 as low as possible, Ofwat adopted lowest rather than central forecasts of many items and excluded some drivers, such the Cryptospridium Regulations, which could have been foreseen. Consequently, this AMP3 period has been characterised by interim determination applications. Northumbrian Water is one of 10 companies having made such applications. In our case we have not only had to fund obligations that were not included in the price cap set in 1999, but in addition our revenue is well below the level assumed by Ofwat. Ofwat’s PR99 assumptions have proved far too optimistic. If our application is successful, it will mean prices rising in 2004–05, but this will simply bring forward part of the price rise otherwise necessary in 2005–06. 2.13 The lessons of PR99 are clear. The last review prompted an exodus of equity from the water sector because Ofwat set the allowed rate of return to equity investors too low. This needs to be rectified in PR04 if the industry is to finance the required capital investment. 2.14 Ofwat’s proposed methodology for the review looks little diVerent to that used in PR99 and we believe this is a missed opportunity. But much depends upon the application of the methodology. This must be applied in a more even-handed fashion and with greater regard to the sustainability of the industry. Ofwat is now operating in a much more transparent manner and the Director General’s statements to the eVect that “prices will be what they need to be” give cause for cautious optimism. But the acid test will be the outcome of the periodic review. The legacy of PR99 is that PR04 will be an exceptionally diYcult price review for the regulator and it is easy to see why Ofwat has already concluded that “hard choices will need to be made”. 2.15 The right balance needs to be struck at the review. This should then signal the start of an intensive and inclusive dialogue on how the regulatory framework should evolve to avoid the recurrence of such “make or break” price reviews in future.
3. Incidence of Charges 3.0 A long-term industry such as water must adhere to the concept of sustainability. Sustainability has a social as well as an economic dimension, and this is particularly relevant for water pricing. From this perspective, it is not only the level of water prices but also the incidence of water charges that is significant.
Bad debt is a burden on customers who pay 3.1 In common with most other water companies, Northumbrian Water has experienced an increasing problem with bad debt ever since 1999, when the ban on disconnection of household water supplies for non- payment came into eVect. Despite an increased focus on debt collection, and improved systems and procedures, NWL’s bad debt situation has become progressively worse, and we have been forced to include this factor in our recent application for an interim determination. 3.2 Whilst there is some debate over the extent to which customers are generally aware of the ban (our evidence suggests that the poor payers are), there is no dispute that company collection procedures have been forced to change, as they are no longer able to use the threat of disconnection. Those customers who would previously have reacted to the threat, either by settling their bill if they are able to pay, or making partial payments by arrangement, are no longer faced with that decision. Water company costs in pursuing those that can, but won’t, pay have unfortunately increased dramatically. The result is that customers who do pay are increasingly subsidising those who don’t. 3.3 For those who can’t pay there clearly needs to be a support mechanism, but we believe this should be a social security issue.
Some cross-subsidies are socially desirable 3.4 Whilst most cross-subsidies have been eliminated from charges some social cross-subsidy persists. The most significant remaining cross-subsidies in water industry charges are 1) between urban and rural customers and 2) between high rateable value and low rateable properties. 3.5 The costs of providing water services to rural customers are significantly greater than the costs of supplying urban customers, yet the tariV framework is the same irrespective of location—charges are set on a regional average basis. However, there are far more urban than rural customers, so although urban customers would pay slightly less if the cross-subsidy were to be removed, rural customers would pay 9020981017 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 99
considerably more (in parts of our area more than double). It is generally accepted that this particular cross- subsidy is socially desirable. One of the problems associated with competition in water, especially if domestic competition were to be introduced, is the potential unwinding of such socially desirable cross-subsidies. 3.6 The other cross-subsidy, between high-RV and low-RV customers, is currently being unwound by introduction of the free meter option, introduced at the same time as the ban on domestic disconnection. Part of NWL’s loss of revenue in the last five years stems from Ofwat’s under-estimation of the potential eVects of the free meter option at PR99. Although there have been fewer meter optants than Ofwat assumed, these have been high-RV/low consumption customers, who have the most to gain from switching to a metered supply. The revenue loss per meter optant has been far more than Ofwat made allowance for. It is reasonable to assume that high-RV/low consumption meter optants have a higher income than low-RV/high consumption households, so the free meter option is progressively unwinding the existing cross-subsidy that exists between rich and poor in the unmetered customer grouping. The impact oV meter optancy on unmeasured bills needs to be considered, particularly as the number of optants could increase with the general increase in bills expected from 2005.
4. Conclusions — Water prices are artificially low. Price cuts imposed at the 1999 price review were focused on the short term and it was always clear they were not sustainable. — The large gaps between companies’ revenues and their mandatory investment have been plugged by increased debt, but this cannot continue forever. In fact, PR04 needs to signal the end of the line for negative cash flows and the associated heavy borrowing. It is clear that water prices need to increase significantly in 2005 and that returns must be suYcient to attract both debt and equity investment. — How much prices will increase in the future partly depends on how much longer the sustained period of heavy capital investment, experienced by the industry since privatisation, is expected to continue. Much of this requirement emanates from Europe, but not all. — The water industry is a long-term industry. Its assets are long-lived, it invests for future generations as well as the current generation, and competent stewardship by a water company requires it to focus on maintaining those assets properly. A similar long-term focus is also required on the part of the industry’s regulators who also need to work together and with the industry more eVectively to generate a more integrated framework. — It is essential that proper allowance for maintenance is not squeezed between the demands for further environmental investment and a desire to minimise price increases. — Capital investment is not the only factor driving prices. The bad debt resulting from 1999 legislation to ban domestic disconnection is playing its part, as is the free meter option. Other significant costs drivers include changes in government taxation. — Leaving some drivers of investment out of PR04 and then bringing them in mid AMP4 to be dealt with by interim price adjustments would be to continue a short-termist approach creating damaging uncertainty and instability. A more sustainable longer-term focus is required. — As a result of the ban on disconnection customers who choose not to pay are imposing an increasing burden on those who do pay. This issue is likely to increase in significance and may become politicised. — Some existing cross-subsidies in water charges are significant and socially important. They need to be managed with care. Northumbrian Water Ltd 17 October 2003
Memorandum submitted by Anglian Water Services Ltd
Summary Pressure for price increases comes from a number of sources including: — Components of operating costs; — Current prices suppressed below sustainable levels by the previous price review; — The reducing scope for further eYciency gains; — The large scale of the investment programme. Anglian Water’s aggregate investment proposals are the third highest in the industry. This is due to our relatively high investment needs across all four of Ofwat’s cost categories and is the prime reason why the price increases arising from our proposals are the second highest within the industry. 9020981018 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 100 Environment, Food and Rural Affairs: Evidence
It is timely to review refinements of the price control methodology, especially with a view to alleviating cost pressures. The context in which regulation is applied has changed markedly since privatisation: the scope for further eYciencies has declined, whilst the capital to be remunerated continues to grow. In our view, the continued application of aggressive eYciency targets would carry a number of potential concerns: — Companies cutting spending with consequent impacts on performance; — Companies encountering financial diYculties with possible knock-on eVects such as disruption during business takeover; — A rise in risk feeding through to the cost of capital and, hence, prices given the capital intensive nature of the industry and the need for ongoing new finance. At the same time, companies should continue to be incentivised to outperform. And customers must continue to participate quickly in eYciencies achieved during the price control period. Our business plan proposals deliver these potentially competing regulatory objectives by: — Adopting a cautious approach to the forecast eYciencies built in to price control targets; — Sharing achieved outperformance with customers on a year-by-year basis rather than with a five year lag. We believe this innovative approach will better serve the interests of customers by combining a reduction in regulatory risk with more frequent return of eYciencies to customers.
Introduction 1. The EFRA select committee has announced that it is conducting a review of water pricing. The focus of its review is on: — The level of investment required; — The price increases necessary to deliver that investment; — Whether the current approach to water pricing is in the best interests of customers. 2. Water UK is making a submission on behalf of the industry as a whole. We understand that Water UK’s submission will describe the periodic review process and some of the generic issues facing the industry. The purpose of this submission is: — To apprise the committee of issues which are of particular importance to Anglian Water Services Ltd (AWS); — To recommend a refinement of the price control process which we believe is better suited to current circumstances and designed to deliver a more favourable outcome for customers. 3. We have restricted our comments to our company preferred strategy.
Price Increases and the Level of Investment Required 4. Like most companies, we have substantial confirmed and potential upward pressures on operating costs from a number of sources including: — Tax changes. — Pensions. — Customer debt. — Security. — Power. 5. The level of the price increases required can be explained by three further key factors: — The unrealistically tough settlement at the last review (PR99) with the consequence that prices are currently suppressed at unsustainable levels; — The scale of companies’ investment plans; — The declining scope which companies have to oVset these cost pressures through further eYciencies. 6. We acknowledge that our price increases (averaging 8.6% pa) are the second highest proposed by the industry. This is primarily due to our total investment plans being the third highest in the industry. We estimate that, in absolute terms, the size of our investment proposals range between second and fourth in each of Ofwat’s four categories for the reasons set out below. 9020981018 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 101
Base (maintaining existing assets and service levels) 7. We have a wide range of statutory obligations, principally regarding the quality of our drinking water and discharges from our sewage works. Maintenance investment has been persistently underfunded at past reviews. This is reflected in the implied asset lives shown in the table below. At AMP3, we were allocated the third lowest capital maintenance allowance in terms of £/property. 8. In the past, we have been able to maintain service performance through smarter operational methods. However, these techniques are now being used to their fullest extent. Applying new forward-looking risked based techniques endorsed by Ofwat, all other regulators and the water industry, our business plan demonstrates that, if standards are not to deteriorate, substantially more expenditure will be required than allowed at PR99, reflecting a degree of catch up.
Table
INVESTMENT LEVELS AND IMPLIED ASSET LIVES
Av. Yearly Capital Maintenance PR04 GMEAV Investment Proposed Implied Asset Life (£million) for AMP4 (£million) (Years) Water Infrastructure 4,924 51 96 Non Infrastructure 1,347 30 45 Wastewater Infrastructure 11,308 28 403 Non Infrastructure 4,219 71 59 Total 21,798 180 121
9. AWS has submitted a request for capital maintenance (CM) expenditure of £1,134 million. This is driven by a number of circumstances specific to our region: — AWS has the largest geographic area and a dispersed rural population. Consequently, we have one of the longest water mains networks in England and Wales. — The disproportionate proportion of PVC mains which have shown themselves to have relatively short lives. Unless we start replacing these mains at a faster rate, problems of bursts including flooding, supply interruptions and level of leakage will rise unacceptably. — AWS also has an extensive sewerage network infrastructure. We believe that there is a need to substantially increase the current rehabilitation rate from 6 km/annum to, at least, 40 km/annum given our current marginal assessment of the serviceability of this network. — AWS has more than 50% of its customers on a water meter (the highest number of metered customers in the industry). In our dry and environmentally sensitive region, this is a key part of our water resource conservation strategy. We are now at the point where many of our meters are at the end of their lives and need replacing. — Our region has a high proportion of raw water abstracted from surface sources in catchments dominated by arable production. These tend to have high concentrations of nitrates and phosphates and, as such, require more extensive treatment. Much of the complex plant installed in the 1990’s now requires extensive refurbishment or replacement.
Maintaining the Supply/Demand Balance and Security of Supply 10. Demand from industry is projected to decline, oVset by increased demand from new households. Our region has been identified by the ODPM to absorb a significant proportion of the housing growth required in the south of England. At the same time, we are required to curtail abstractions in some parts of our region for environmental protection reasons. (We have the highest concentration of SSSIs of any water and sewerage company (WASC).) 11. To accommodate the combination of these factors and to achieve Ofwat’s target for supply security, we will need to invest both in large scale mains to transfer water from zones of surplus to deficit zones as well as additional treatment capacity where we already have adequate abstraction licence quantities. This is illustrated in Appendix 1. 12. On sewerage, we are following Ofwat’s new approach which aims to project and provide for emerging issues rather than react after the event. Inevitably, this will result in greater expenditure for AMP4. In particular, we aim to ensure growth does not exacerbate foul flooding by providing adequate sewerage capacity. However, we believe this is entirely consistent with the growing public attitude to sewerage issues. 13. Consequently, we assess a need for £524 million of capital expenditure to meet the supply/demand driver for AMP4. 9020981018 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 102 Environment, Food and Rural Affairs: Evidence
Quality Including New Legal Requirements 14. Our company preferred strategy reflects the minimum legal requirements we think will apply, similar to Ofwat’s reference plan A. Even so, there are some legal obligations which we have recorded which are not accounted for under plan A. We are disproportionately aVected by the obligation to provide first time rural sewerage services under section 101A of the Water Act 1991. 15. We estimate the total cost of quality enhancements to be in the region of £863 million—(the second highest WASC expenditure after United Utilities).
Service Enhancements 16. In our business plan for the period 2000–05 (AMP3), we proposed to make substantial progress at reducing sewer flooding. At the time, Ofwat rejected our initiative, but has since supported a revised set of proposals to make substantial progress during the current period. We have made further proposals to substantially eradicate internal flooding during AMP4 and to address the worst cases of external flooding. These proposals are strongly endorsed by WaterVoice Eastern. However, the cost of resolving problems increases markedly as we approach the rump of more intractable cases. 17. In addition, we have proposals to tackle known sewerage odour problems and where we anticipate issues could arise from new housing which is programmed for our region and from greater public sensitivity to this issue. 18. As a result of these two initiatives, our capital expenditure proposals under this driver show a 200% increase from the amount allowed by Ofwat at AMP3 to £206 million.
ANew Approach to Price Control 19. In view of the pressures noted above, we believe it is timely to consider what can be done to mitigate them. Ofwat’s proposed approach for AMP4 (published March 2003) closely follows the RPI-X approach applied at the previous reviews. Key features of the approach are: — Aggressive prospective cost reduction targets (crudely the X in RPI-X). — Allowing companies to retain the benefits of outperformance for five years. 20. This approach was appropriate to the circumstances which prevailed in the early years of privatisation. Aggressive targets ensured customers benefited immediately from the substantial eYciencies available. At the same time, allowing companies to keep the benefits of achieved outperformance for five years encouraged companies to seek even greater eYciencies from which customers also ultimately benefited. 21. The drawback to the approach is that it exposes companies to relatively high regulatory risk, namely that they will not be able to achieve the aggressive targets. The risk is magnified if, as is now the case, the scope for eYciency gains declines markedly. Regulatory risk is inevitably reflected in the cost of capital. This will have a relatively severe impact on costs if, as is the case in the water industry, there is a high capital value to be remunerated and a high investment programme to finance. 22. We believe that the time has come to update regulatory techniques. Unfortunately, as noted above, there is little evidence that this is in prospect. And, despite evidence that the rate of eYciency improvements is slowing down, Ofwat’s consultants have factored in a continuing “privatisation” eVect in their initial assessments of prospective eYciencies. In our view, the outcome would be counterproductive because the adverse eVect on the cost of capital would outweigh the benefits. Other risks arising from overly aggressive eYciency targets might include: — Companies cutting back on spending with consequent impacts on service performance. — Financial diYculties with consequent impacts on cost and performance and possibly dislocations whilst businesses are transferred. 23. Ofwat itself has recognized these sorts of risk at paragraph 89 of its consultation on incentives (MD187). Although these concerns clearly apply to water companies, most other regulated industries are also capital intensive and also, increasingly, now have large investment requirements.
Recommendation 24. Our business plan proposals reconcile the competing regulatory objectives by complementing a cautious approach to prospective eYciencies with more frequent sharing of actual outperformance. We advocate sharing of achieved operating cost outperformance on an annual basis in addition to the five yearly recalibration of the baseline. 25. Companies are still incentivised to outperform. Customers receive a share of achieved outperformance more quickly. And the reduced regulatory risk translates into a lower cost of capital. We believe this approach is in the best interests of customers. 17 October 2003 9020981018 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 103
Appendix 1 FLOW TO CAISTOR INCREASE ALTON WATER COLCHESTER NORWICH - E44 AYLSHAM - E34 IPSWICH - E57 SHERINGHAM - E30 HOT SPOT: Increase flow to Alton Water Strategic main Alton - Colchester Source Works Existing Infrastructure Proposed Infrastructure STRATEGIC LYNG - E37 BURY ST. EDMUNDS FOULSHAM - E33 Strategic Schemes HOT SPOT: Increase supply from Thetford/Ixworth MID/NORTH NORFOLK TRANSFER FAKENHAM - E31 COLCHESTER - E63 WATER SUPPLY/DEMAND BALANCE RESOURCE & BEETLEY - E42 HOT SPOT: Extensions to Stoke Ferry WTW Strategic Main BURY ST EDMUNDS - E50 BRAINTREE - E60 HAVERHILL - E54 EXTNS FEERY STOKE LINK 2015 SKEGNESS - L18 LINCS/CAMBS FENLAND MARCH - E98 HOT SPOT: Transfer water from Wing Wing WTW Extensions TRANSFER BOURNE - L21 LINK LINCOLN TRANSFER RUTHAMFORD (WEST) WADDINGHAM - L5 HOT SPOT: Transfer water from Elsham New Trent Source (FUTURE) TRANSFER LINCS TRUNK MAIN COMPLETE CENTRAL HOT SPOT: Wing WTW Extensions Duplication of existing trunk mains LINCOLN - L13 GRANTHAM - L19 DUPLICATE BOOST TRENT SOURCE MILTON KEYNES - R93 MURSLEY - R91 WING EXTNS TOWCESTER - R96 RAVENSTHORPE - R80 GRANTHAM Trunk Main (post AMP5) BUCKINGHAM - R90 DAVENTRY - R89 HOT SPOT: Membrane plant at Saltersford Long Term: Complete the Central Links Andy Wain - 11 July 03
Memorandum submitted Dr. Noel D.L. Olsen, MSc, FRCP, FFPHM.
WATER AND SEWAGE CHARGES—A FAILURE OF SOCIAL JUSTICE Over the last couple of years I have chaired WaterVoice in the South West, where average water and sewage charges are currently around 10% of a state pension. For negligible public health benefit and questionable environmental benefits water customers are again destined to see their bills rise substantially over the next five years. As a public health doctor I have been involved professionally with the links between poverty and health for many years, and I felt that I should add a personal contribution to the formal evidence you will be receiving from WaterVoice and others on the impacts of high water charges on poor, vulnerable people. I am particularly concerned at the inequity caused by current Defra and Ofwat policies and the resultant adverse eVect on social justice. 9020981019 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 104 Environment, Food and Rural Affairs: Evidence
For many people in Devon and Cornwall water and sewage charges are a nightmare. They have reached a point where their aVordability has become a threat to public health. Unlike fuel poverty, the government has failed to set a target level for reduction of “water poverty” and there has been no public funding for programmes to alleviate the resulting hardship in areas with exceptionally high water and sewage charges. There has been a failure to recognise that some costs are cumulative on very poor people. If avoiding falling into debt is to be achieved, a concern amongst many elderly, vulnerable people, water, energy, council tax, some basic transport facilities and housing costs have to be paid before any residual income can be used for food and other priorities. In all other policy areas government makes some social welfare or public spending provision for high unavoidable costs. For example, railways and roads are massively subsidised from the public purse. Our heritage is respected and partially supported; museums and art galleries in London are supported by taxation but beaches in Cornwall, another national asset are not. Fuel poverty has been a major concern of government and is the subject oV major initiatives. But water customers are expected to pay all the water company costs and the eVects of regulation and quality improvements even if they are not aVordable. State pensions and other benefits are paid at a standard national rate which does not reflect local costs, leading to major problems for those with far higher but unavoidable costs such as water and sewage charges in Cornwall. A poor diet and social isolation are inevitable if debt is to be avoided and an excessive charge absorbed out of a standard pension income. In the “illustrative case histories” appended the impact of water charges on living standards are shown. Cornwall has the lowest wage economy in England, the highest charges for water, and a high proportion of the population are not on mains gas so there is an added component to fuel poverty. Public transport infrastructure is poor and for many people in rural areas there is no choice but to run a car, leading to the permanent residents running some of the oldest and most ineYcient vehicles in the UK. Because of the superb environment the area is attractive to second home owners so house prices have been pushed to levels unattainable to the local population. The people with second homes come to enjoy the tremendous environmental benefits of the region, make great use of the surfing beaches, and tend to use their homes at peak (high cost) times. This uneven use has required higher capital investment in water and sewage services so that peak summer use can be met. In eVect occasional metered summer residents receive a subsidy from local pensioners and others for sewage infrastructure and the resultant clean beaches and rivers because Ofwat’s (and Minister’s?) policies do not distribute the cost of the vast capital infrastructure in an equitable way. For bureaucratic convenience Ofwat have decided that the cost of capital infrastructure, (48% of the total bill in Devon and Cornwall) should be apportioned either by rateable value or on the basis of the metered volume of water used. There might once have been some social justice or relevance in rateable value, but the system is now flawed and out of date. Volume going through a meter is not a valid proxy for cost on its own without a substantial standing charge which Ministers and Ofwat have repeatedly rejected. Added volume through the sewerage system does add some marginal costs, but as with owning a car or a house many of the costs are fixed and extra use comes at marginal cost provided the infrastructure is adequate. With about half of the total water and sewage cost due to infrastructure capital costs, those who enjoy the amenity of a connection and the clean rivers and beaches but use relatively little metered water end up paying little towards the benefit. Thus an added burden falls inequitably on others, particularly families who inevitably consume a lot of water and pensioners who would usually be well advised to go onto a meter. Many old people while sparing in their use of water are unaware or afraid of meters and have not shifted over. If they all did there is cause for concern that the shift might bring forward the collapse of the financial systems of the water industry which are already stretched. This is demonstrated in the enclosed “illustrative case histories” to try to simplify some of the issues. “Objective one” status has recognised the economic problems of the region, but unlike the rest of Europe, this money has not been used to fund water and sewage infrastructure because technically these assets belong to a private company as a result of water privatisation. Lack of imagination on all sides has meant that solutions have not been sought, for example, the investment could be funded by Europe, the facility “owned” by a public sector organisation and then operated on a cost plus basis by South West Water. When water was privatised the SW peninsula was given far less than its fair share of the “green dowry” to fund the necessary infrastructure. While this is a fundamental cause of the present diYculties, I recognise that no Chancellor will now intervene to correct that historic injustice. A sustainable approach requires a concern for current aVordability and some sense of social justice. While no doubt desirable in absolute terms, some of the wish list from the water quality regulators (Environment Agency, Drinking Water Inspectorate and English Nature) will, in my view, add an unjustifiable cost burden to vulnerable people and thereby create public health problems, not alleviate them. In terms of DALY’s (disability adjusted life years—a WHO method for assessing the economic benefit of health procedures), removing nitrates to the level now being proposed is not justifiable on public health grounds. Yet the cost of removing them will fall on water customers, not on agriculture which is responsible for most “diVuse” pollution. This is a failure of the “polluter must pay principle”. Methaemoglobinaemia in babies, the major public health justification for reducing nitrite levels, is not a risk even at current levels—there have never been cases at these levels. Indeed the only cases (?2) over many decades in the UK have come from unregulated private water supplies at vastly higher levels. Compare these “public health benefit” costs and their DALY’s with the probable knock on eVects on nutrition, and particularly fruit consumption, caused by high water bills and you see the fallacy of the so called DWI “public health justification” for action. Public 9020981019 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 105
health, like politics, requires a balancing act over priorities. I am not aware of any public health organisations or significant sources of balanced public health argument that would see further reductions in nitrate levels justifiable if much of the cost has to be borne by the poorest in the community with resulting increase in the health eVects of poverty. Many would question if there is any value at all. Our long and beautiful coastline is enjoyed by people from all over the UK, but 3% of the population have to fund 30% of the nationally recognised “bathing water directive” beaches. Tourism is a major and important driver to the economy, but it brings few benefits to most pensioners surviving on state benefits. Indeed in many aspects it detracts from their standard of living. What is needed is a change of policy. There are a number of ways in which greater social justice could be achieved. At national level, a top-up voucher system could be introduced so that pensioners and/or all those on benefits could be subsidised to the level of the average water bill in the UK. If paid to water companies rather than to the beneficiaries it could be cheap to administer. The winter fuel payment is another precedent. The cost could either come from a redistributed national water levy or from general taxation. In view of the strong regulation that Ofwat exerts, the eVect on company profits and eYciency and therefore shareholder value could be at whatever level the Chancellor decided. It would at least introduce a measure of equity to those on the lowest income who are dependent on state welfare alone. At a local level Ofwat could also change its policies. It would be entirely feasible to add a standing charge to reflect the proportion of the cost which is attributable to infrastructure and pay at a marginal additional rate for the water consumed. Alternatively, the standing charge could fund the average annual water requirements of a pensioner or pensioner couple, and all those using more would pay at an appropriate additional rate. Managing change would be diYcult and those who have done well out of the present system would be annoyed. But to take no action is to continue an inequitable system for ever and sooner or later there is a danger that water charges will become the focus of “poll tax like” resentment. That can be in nobody’s interest and the eVect could be devastating on the water companies. The charging structure is largely imposed on them by Ofwat and they have little room for manoeuvre but it is demonstrably inequitable, and water companies have to take most of the blame from consumers. I am sending a personal copy of this paper to those MPs representing SW constituencies and to Phillip Fletcher, the Director General of Ofwat. I would be happy to expand on any of the issues and provide any further interest you would like. 18 October 2003
Annex: Illustrative case histories—Three water customers Mr Smith is a wealthy Londoner who works in financial services. In 2001 he paid nearly a million pounds for a house on a virtually private beach adjoining a surfing beach in Cornwall. Although on a low rateable value reflecting its size and value many years ago, the house has been extensively rebuilt and expanded over recent years. It was connected to mains sewerage at some considerable cost to SW Water customers collectively at the time the “Clean Sweep” programme closed down raw sewerage outfalls on the surfing beach. He was paying £490 a year for water and sewage based on his (historic) rateable value. His family only use the house during the summer holidays and for surfing. Earlier this year he changed to a metered water supply and because of relatively low water use averaged over the year he now pays just under £100 per annum. As such he pays a minimal contribution to the infrastructure cost incurred by providing him with treated water and sewage services. Mrs Jones and Mrs James are twin widowed sisters in their late eighties. One lives in Portsmouth and the other in Plymouth. They live in very similar houses with identical rateable values. Neither has significant savings nor a pension other than the state pension. Both live frugally, but Mrs Jones in Portsmouth pays £243.31 per annum on water and sewage, while Mrs James pays £490.70 in Plymouth. In view of the smallness of their income, the £5 per week extra Mrs James has to pay leads to a devastating diVerence in their standard of living. Neither are financially astute nor particularly well informed. Both have had neighbours change over to meters but they are afraid of change and worried by variable bills. Nobody has ever tried to inform them of the possible benefits of metering and neither is able to read the small print on the back of their water bills. They trust “the water board” and assume that if money could be saved, somebody would come and talk to them about it. In fact as Mrs James is a frugal water user her metered bill would be around £150 per annum, a saving of £7 per week. This amount is in eVect a subsidy from Mrs James which helps reduce the costs to the more financially astute Mr Smith.
Memorandum submitted by the Drinking Water Inspectorate 1. The 2004 Periodic Review [PR04] has a significant strategic importance for drinking water quality, as we approach the end of the post-privatisation provision for large quality-driven programmes of work to meet current and future standards. The water industry is making the transition to water company-driven strategic maintenance programmes to maintain water quality. The Drinking Water Inspectorate will seek assurance from the PR04 process that water companies will have the managerial and financial flexibility to act proactively to maintain drinking water quality during the APM4 period and beyond. 9020982001 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 106 Environment, Food and Rural Affairs: Evidence
DWI’s Role 2. DWI is responsible for identifying requirements for drinking water quality, and for agreeing specific drinking water quality programmes of work with individual water companies, which are then funded through the PR04 process.
Objectives 3. For PR04, DWI objectives are to: — meet current and future drinking water quality standards; and — facilitate the transition from large quality-driven programmes of work as the typical post- privatisation model to a water company-driven strategic maintenance programme to achieve agreed minimum levels of service, using mechanisms such as Distribution Operation and Maintenance Strategies (DOMS) and the Capital Maintenance Planning Common Framework methodology.
Drivers 4. The main drivers for drinking water quality for PR04 are as follows: — completion of the 20 year distribution mains improvement programme. This applies to mainly to five companies whose renovation programmes will run through most of AMP4; — improvements to water treatment facilities where necessary to meet current and future standards; — programmes of strategic lead pipe replacement to meet revised lead standards; and — improving the acceptability of water to consumers, by reducing consumer complaints of discoloured water, and addressing taste and odour issues. To gain support from DWI, and thus inclusion in business plans, any scheme proposed by a water company has to demonstrate justification of need, and have a mechanism to demonstrate the benefits that accrue to consumers.
Guidance 5. To date DWI has issued a number of Information Letters13, 14, 15, 16, 17 to companies, outlining expectations and requirements for PR04. This guidance is in the public domain. We have liaised with individual water companies throughout the process, as well as other Regulators and interested parties.
October 2002 Preliminary Assessment of Requirements 6. Water companies submitted their preliminary assessment of drinking water requirements in response to Information Letter 13/02. After an initial challenge by DWI, the costs were used to gauge the potential size of the drinking water quality programme and any areas of diYculty.
June 2003 Submission of Proposals 7. Water companies submitted detailed proposals for each individual scheme in June/July 2003 in response to Information Letter 4/03. DWI carried out a preliminary assessment of the schemes and issued Preliminary Opinion Letters (PoLs) setting out whether DWI was minded, or not, to provide technical support for the schemes to be included as quality programmes in water company draft business plans. PoLs were circulated to other stakeholders for comment. A summary of the programme is provided in Annex 1. Detailed assessment and technical audit of these schemes is in hand, with a view to providing water companies with a Letter of Support (LoS), or otherwise, for them to include the schemes in their business plans to be submitted to Ofwat in April 2004. LoS will take account of Ministerial guidance on the quality programme.
13 IL 13/02—The 2004 Periodic Review of Prices and AMP4—Initial Guidance. 14 IL 14/02—The 2004 Periodic Review of Prices and AMP4—Confirmation of Initial Guidance. 15 IL 15/02—Distribution Operation & Maintenance Strategies—DWI Requirements & Expectations. 16 IL 4/03—The 2004 Periodic Review of Prices and AMP4—Further Guidance. 17 IL 5/03—The 2004 Periodic Review of Prices and AMP4—Appraisal Methodology for Water Company Proposals for Drinking Water Quality Improvement Schemes. 9020982001 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 107
Water mains renovation 8. The area of greatest cost within the drinking water quality programme is provision for completion of the strategic distribution system mains renovation programme. This programme renovates the pipework used to supply water to consumers, primarily to prevent dirty water events caused by corrosion of old cast iron water mains. Work outstanding is for the last five years of a 20 year programme. Work is concentrated in five water companies—United Utilities, South West Water, Northumbrian Water, Yorkshire Water and Dwr Cymru/Welsh Water. All other companies will have substantially completed their programmes by 2005. Requirements were identified at the 1999 Periodic Review, and assessment now is a fine-tuning process.
Nitrates 9. Rising nitrate concentrations in source waters caused by run-oV from agricultural areas are a concern. Schemes to reduce nitrate concentrations will be supported by DWI if the need is justified. The steps to be taken are likely to be a mix of blending and treatment solutions. In parallel, we support the need for steps to mitigate future pollution, although these steps will not alleviate the need for action to provide blending and treatment solutions now for contaminated sources.
Other treatment requirements 10. Treatment improvements are also required for a variety of other causes, including pesticides, trihalomethanes, turbidity, cryptosporidium, iron and manganese. These schemes generally arise from a combination of deterioration of source water quality and new or revised quality standards.
Lead 11. The EC Council Directive 98/83/EC [the Drinking Water Directive], which came into force on 25 December 1998, requires an interim standard for lead of 25 Vg/l to be achieved by 25 December 2003, and a final standard of 10 Vg/l to be achieved by 25 December 2013. These requirements have been transposed within Regulations for England and Wales, and delivery of the requirements are in hand using two complementary approaches. 12. The first element is to put in place plumbosolvency measures of control by treatment whenever there is a risk that water at the consumer’s tap will contain a lead concentration in excess of 10Vg/l. Where plumbosolvency treatment is required, it will have to be maintained whilst there are significant numbers of properties supplied through lead pipes owned by property owners, irrespective of whether the water company has replaced all of its lead pipes. This element will be substantially completed within the AMP3 period, and evidence to date suggests it has been eVective and eYcient in reducing lead concentrations. Most areas of England and Wales now meet the interim standard due to plumbosolvency measures alone, and many areas may achieve the final standard as well. 13. The second element will be to replace water company lead communication pipes (the communication pipe is that part of the service pipe owned by the water company, which runs from the water main to the boundary of the property; the length of service pipe beyond the boundary is owned by, and is the responsibility of, the property owner). Where plumbosolvency measures do not achieve the required standards, the water company will be required to deliver a strategic programme of lead pipe replacement of some or all of its lead pipes in the area of supply that is not likely to meet the new standards. As time is required for the benefits of plumbosolvency measures to be established, it has been agreed to estimate likely requirements for lead pipe replacement during the AMP4 period on a best endeavours basis and to allow a financial provision within water company business plans for these potential costs where applicable. Cost estimates made to date vary significantly across water companies, but in general are substantially less than originally envisaged.
Acceptability of water to consumers 14. Intermittant discoloured water events are an irritation and concern for some consumers, and DWI is likely to support schemes proposed by a number of water companies to reduce consumer complaints arising from these events. The actions proposed are relatively low cost solutions such as flushing and cleaning.
Maintaining drinking water quality 15. DWI has chosen to not promote within PR04 significant quality programmes of work under regulation 17(1) of the 2000 [English] and 2001 [Welsh] Water Supply Regulations [i.e in addition to the need to act on failure, there is a new regulatory duty to act if a failure is likely to occur]. Instead we have: — Encouraged development of relevant Serviceability Indicators. 9020982001 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 108 Environment, Food and Rural Affairs: Evidence
— Supported the development and adoption of the Capital Maintenance Planning/Common Framework for estimating maintenance requirements more accurately. — Encouraged water companies to reappraise how they manage their delivery of service by moving from reactive failure-tolerant customer service to proactive preventative management of water supplies. To date, DWI has promoted this approach through the development of DOMS [Distribution System Operation and Maintenance Strategies]. — Promoted making provision for maintaining drinking water quality through the Capital Maintenance Planning /Common Framework, to be used by all water companies as a common basis for estimating maintenance requirements, instead of using the powers in the Water Supply Regulations. 16. We believe this to be the most cost eVective and coherent long-term approach to take to maintaining drinking water quality, but it assumes that water companies will make a reasonable estimate of maintenance requirements, that Ofwat will allow funding for those requirements, and that water companies will deliver on what is funded. If not, there is a risk that drinking water quality may deteriorate.
Customer Consultation 17. DWI was a contributor to stage 1 of the joint water industry research into customers’ views on water and sewerage services in England and Wales. The research work was wide ranging, and among its main findings was a desire by customers for improvements in the following areas: — maintaining the quality of coastal and bathing waters; — maintaining the quality of river waters; — protecting important areas of wildlife and plants; — avoiding the risk of homes and gardens being flooded with sewage; and — improving tap water taste and smell. 18. On drinking water quality issues the survey noted: — the willingness of customers to pay more for improving the reliability of supply, tap water safety and infrastructure maintenance; — customers’ support for further improvements in drinking water taste and smell; and — the high satisfaction level with drinking water quality. 19. DWI is participating in stage 2 of the research, which will explore customers’ views on more localised water related issues and the impact this would have on their bills.
Drinking water quality programme summary 20. A summary of the current status of the potential drinking water quality programme is provided in Annex 1. 13 October 2003 9020982003 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 109
Annex 1
DRINKING WATER QUALITY PROGRAMME, ENGLAND
374 schemes in total, submitted to date
120
100
80
60
40 Schemes submitted to DWI 20
0 SVT SST FLK YKY SES PRT TVN BRL NES THD TMS SRN MSE ANH MKT CAM SWT NWT WSX BWH
Water Company
DRINKING WATER QUALITY PROGRAME, WALES
16 schemes in total, submitted to date
20
15
10
Schemes submitted to DWI 5
0
DVW WSH
Water Company 9020982003 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 110 Environment, Food and Rural Affairs: Evidence
PROGRAMME BY DRIVER, ENGLAND
90 80 70 60 50 40 30 20 10 0
. . . te s ) l. R ) .) b S e to rb n r) o O c r) M trib p u e s P & e ro is itra id ry T /M th o d is th ic O N tic C e b a D D s e t. (T M e r. (o m L p t. (D t. (o P r. (F te lu e p p te e P c ce e e c c cc D A A A r D w te a a R W w a R
PROGRAMME BY DRIVER, WALES
10 9 8 7 6 5 4 3 2 1 0 ) n ) . s . r) l. R .) r) . S te e to /M e o O c e b p rb e th s P & is ro M trib itra id u o d th O is ry T b a ic D N tic C e t. (T M D s r. (F r. (o m L p t. (D t. (o e te lu e p p P te e c e e e P c c c D A c c r D w A A te a a R W w a R 9020982003 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 111
SCHEMES GIVEN PRELIMINARY SUPPORT,ENGLAND (294 FROM A TOTAL OF 374 SCHEMES SUBMITTED) 90 80 70 60 50 40 30 20 10
0 ) ) r ) ) r) . e s . n e l. d O c. . S ib t e to b h o a e b tr a p r M t s & is th ro M itr id y u / o o e T D O is ic r T e .( b L .( .( (O ic D N st C (F r t t t. M D e . te m p p p r e lu ce e e P te D P c c c e A c c D w A A r a te R a W w a R No Schemes submitted No Schemes supported
SCHEMES GIVEN PRELIMINARY SUPPORT, WALES (13 from a total of 16 schemes submitted)
6
5
4
3
2
1
0
. s . ) r) l. ) .) ) . te e to b n e o d O c r b ib a p r s a is e o S tr id y u /M th o e & th r M is itr r T e o b L T D ic O D N tic C F .( t.( t.( O M s r m p p t.( D e r. ( te lu p P e e ce e te P cc c c e D A A c D w A r a te a R W w a R
No Schemes submitted No Schemes supported 9020982003 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Ev 112 Environment, Food and Rural Affairs: Evidence 00 00 00 00 00 Acceptability DRAFT PR04 COMPANY SUBMISSIONS Company Raw water distribution ! (NSY)TVW04010020110011116 (E&S)NES1004000010100077 ! ! ordshire V (MSE)MSE100030001070001212 lCmais98332283622371217203810406390 Wessex Water ServicesYorkshire Water Services Ltd (York)YKY1602011101061002927 AllCompanies Supported WSX 1 9 8 0 71 3 30 13 20 0 31 0 19 0 20 12 1 17 1 12 0 30 0 2 0 35 1 0 29 23 307 Sutton & East Surrey WaterTendring Hundred Water ServicesThames Water SESUtilitiesThree Valleys Water United Utilities THD TMS NWT 0 0 0 0 1 0 0 6 1 0 0 24 2 1 0 1 2 0 0 10 0 0 0 6 0 0 0 2 1 0 0 12 0 0 1 1 1 0 0 1 0 0 0 12 0 0 0 0 0 0 0 36 0 1 1 0 0 107 0 2 12 104 1 11 Southern Water SRN 0 3 1 1 4 0 0 0 1 0 0 0 0 0 10 9 South East Water ! South Sta WaterPLCSST0000000010000011 South West Water SWT 1 2 0 7 0 13 10 0 0 5 1 0 0 1 40 26 Northumbrian Water l MKT0100100010130074 Mid Kent Water plc Portsmouth Water ServicesSevern Trent SVT PRT 0 1 18 4 2 3 1 0 2 0 2 0 0 0 0 0 1 1 4 0 1 0 2 0 0 0 0 1 33 10 21 9 Folkestone & Dover Water ServicesHartlepool HPL FLK Included in ANH 0 0 0 0 0 0 0 0 1 0 0 3 3 1 8 1 DwrCymruWSH100210401511001613 CholdertonDee Valley Water DVW CHO Nil Return Nil Return Cambridge Water CAM Nil Return Bristol BRL 0 3 0 0 0 0 4 0 1 2 3 0 0 0 13 2 Bournemouth & West Hampshire BWH Nil Return AlbionAnglianWaterANG1260410301150004230 ALB Nil Return Company name code Distrib Nitrate Crypto Pesticides Turb Mn/Fe Other Plumb LPR T&O Disc Other Micro cont DOMS Total Supported 9020982003 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
Environment, Food and Rural Affairs: Evidence Ev 113
Memorandum submitted by the Department for Environment, Food and Rural AVairs
Introduction 1. The Government’s objectives for the water industry are: — to protect public health; — to protect and improve the environment, ensuring that industry can continue eYciently to finance and deliver continuing water quality and environmental improvements with minimum impact on customers’ bills; — to meet the Government’s social goals, including aVordability of water supplies for households, protecting vulnerable groups, the interests of customers in rural areas, and for the disabled and for pensioners; and — to safeguard services to customers, by sustaining an industry that can provide water eYciently with the highest levels of customer service; and with an eVective emergency and drought regime to ensure that supplies are always available when needed. 2. A strong water industry with a secure future, coupled with a robust, clear, predictable and stable regulatory and policy framework is essential for delivering public policy objectives on water. 3. Every individual and private sector body operates within a framework of law that constrains decisions. The extent of that regulation is set so as to balance individual freedom of choice against the interests of others. Water is a more regulated industry in this respect than some others. 4. The water industry’s prices are directly regulated, and there is a price limit on the changes companies can make in their overall charges. There is some room for companies to decide on the distribution of the charges among their customers, and they have the freedom to charge less than the limit specified by Ofwat if they want. Although heavily regulated, water has the advantage of being a low risk investment with the price review process providing stability for investors.
Respective Roles of Government and Regulators in England
Government’s role 5. The Government’s role is to determine policies that may aVect price limits. It is for Government to inform Ofwat and companies of relevant policies that will apply in the review period, including those relating to drinking water and environmental programmes. 6. In taking decisions on policies aVecting price limits, the Government has regard to advice from Ofwat, the Drinking Water Inspectorate, English Nature, and the Environment Agency and to the cost to consumers. Representations on issues such as sewer flooding, water quality and environmental improvements are also taken into account. The potential benefits and cost-eVectiveness of proposals has to be weighed against the cost to customers and the ability of the industry to finance additional investment. 7. There are measures that must be implemented to meet EU directives and there are measures which are optional but desirable and which Ministers would like to support. A balance between these diVering objectives must be struck in the final Ministerial guidance to Ofwat.
Ofwat’s role 8. The independence of the economic regulator is essential both for the proper operation of the mechanism and for preserving the confidence of investors. The Director General of Water Services has sole responsibility for setting price limits as a condition of water companies’ appointment. The Government, the Environment Agency and the Drinking Water Inspectorate assist and inform Ofwat in that task. 9. Ofwat designs and leads the periodic review process and in setting price limits, must meet its primary statutory duty of ensuring that companies carry out their statutory functions and that they are able to finance those functions. Ofwat also has the important statutory duty to protect the interests of customers. 10. The purpose of Ofwat’s role in the Periodic Review process, in essence therefore, will be to establish with suYcient certainty what the functions of companies will be in the five years under review (2005–10), what the costs of carrying out those functions eYciently will be and what will be in the best interests of consumers in terms of price limits and service.
Environmental and Water Quality regulation 11. Both the Environment Agency and English Nature are responsible for advising Ministers’ on policy issues. In the light of Ministers’ policy decisions the Government then looks to provide the regulators, to the companies and to Ofwat, as full, early and as certain a picture as is feasible of what requirements water companies will have to meet and by when. 9020982003 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Environment Agency’s role 12. One of the purposes of the Environment Agency is to protect from the risks of damage all rivers, streams, lakes, estuaries, underground waters and coastal waters. In doing this it aims to protect, now and for future generations, wildlife, fisheries, recreation, and water supplies and water resources. And it helps ensure compliance with national and international laws and agreements. 13. The Agency’s role is to: — advise Ministers on environmental obligations and priorities; — assess companies’ plans for water resources, and advise Ministers on the balance between supply and demand (the supply-demand balance); and — prepare programmes of schemes to deliver these requirements. Once prices have been set, the Agency must set discharge consents and abstraction licences which will deliver the outcomes. It also monitors the delivery of the programme, jointly with Ofwat.
English Nature’s role English Nature is the statutory body that champions the conservation and enhancement of the wildlife and natural features of England. Its role is to advise Ministers on nature conservation obligations and priorities and to work with the Environment Agency in preparing a programme of schemes to deliver these obligations.
Quality regulation 14. Drinking water quality in England and Wales is regulated by the Government through the Drinking Water Inspectorate (DWI), which was set up in 1990 after the water industry was privatised. DWI advises Ministers on policy decisions in relation to mandatory drinking water standards imposed by EC Directives. They also carry out a technical review of drinking water schemes in company submissions for the Periodic Review, and advise Ofwat as to whether the schemes are technically justified. Full details of the DWI process are available on their website.
The Views of Water Customers 15. Customers’ interests are at the forefront of our approach to regulation. Clarity, consistency and transparency are important in the case of all regulated industries and, none more so, than water because it is essential to health and to life. Customers need to understand what they are being required to pay for and why. 16. Defra, the regulators and the water companies take into account the views of customers in a number of ways. 17. For example, following the previous Periodic Review, on the recommendation of the Environmental Audit Committee’s report18, major stakeholders in the water and sewerage industry agreed to co-operate on a joint customer research project. 18. The research was commissioned jointly by: DefraWelsh Assembly Government Ofwat WaterVoice Water UK Environment Agency Drinking Water Inspectorate English Nature Wildlife and Countryside Link 19. The results of this research are intended to provide key stakeholders and the Government with a better understanding of customers’ views of the water industry and their priorities for the scope and pace of improvements to the water environment, drinking water quality, sewerage services and customer services. It is being carried out in two stages. The first stage has been completed and paragraphs 32 and 33 below explain the principal findings. 20. The second stage of this research is underway. This is designed to explore customers’ views on the need for particular improvements to the various aspects of water and sewerage supply. The report from this the second stage is due in December.
18 Environmental Audit Committee “Water Prices and the Environment” November 2000 (597-I and 597-II). 9020982003 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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21. Customers can also make representations through WaterVoice, including on price increases, methods of charging and levels of service and performance. The WaterVoice committees inform Ofwat of important issues that aVect customers. They work closely with Ofwat and hold their meetings in public. 22. The Water Bill currently before Parliament will introduce provisions aimed at putting the consumer at the heart of the regulatory process, and making the process more transparent and accountable.
The Ministerial Guidance
Contribution to company business plans 23. The Secretary of State’s guidance to Ofwat is also intended to inform companies as to the relative priorities the Government wishes to see companies address in their business plans. The guidance is not addressed to companies as such; it is for Ofwat to ensure that Ministers’ views are taken into account. But in the sense that it informs the debate and draws attention to specific drivers, statutory or otherwise, it fulfils a role in focussing attention on, for example, new policy measures on which water companies may have to incur costs during the period covered by the review.
Timing of the Guidance 24. Defra will be issuing three sets of guidance to Ofwat over the course of the Periodic Review. The Interim Guidance was published on 21 January 2003, Principal Guidance will be published in early 2004 and the Final Guidance will be published in September 2004.
Basis of the Guidance 25. The Guidance in each case is based on information and advice Ministers receive from Ofwat, the Environment Agency, English Nature and the Drinking Water Inspectorate, as well as information drawn from the joint customers’ surveys and the views of stakeholder interests such as WaterVoice, other consumer groups, environmental groups and the water companies. The Government is keen to ensure that there are opportunities for contributions of views from all stakeholders. 26. Defra work very closely with all the regulators to establish the required levels of investment in environmental and drinking water improvements, for the Periodic Review period. These priorities are articulated in scheme-specific investment programmes for individual companies. 27. These comprise statutory schemes, very often those required in order to ensure UK compliance with EC Directives, and prioritised lists of discretionary schemes. 28. EU and domestic obligations play a large part in determining the size, scope and pace of the overall quality programme. There are a number of key EU drivers, the most prominent of which are listed at Annex II. The Government is committed to full implementation of its European obligations. In addition, there are a number of domestic policies, for example PSA targets, which have an impact. 29. An important consideration is the Water Framework Directive. The Directive is an extensive piece of legislation which will bring substantial benefits. It will take to a new level the integration of the management of the water environment. Water bodies will have to reach good status by 2015. The Department has issued two consultation papers already and it is out to consultation on a third, which includes the draft transposition regulations. Annex I explains the future obligations of the Water Framework Directive, insofar as they will aVect the water industry. 30. The timetable for transposition is a demanding one and the Directive will become increasingly significant in planning investment. It is clearly important that any investment decisions taken now look ahead to the likely future requirements of the Directive, in as far as they are known. However, the action that will be required by water companies to contribute to compliance with the Directive will generally not be clear in time to be included in the current Periodic Review. This is because work to assess the status of waters has yet to be completed, and because for some pollutants a combination of action will be needed to address the range of pollution sources. For example, nutrient pollution originates both from sewage treatment works and from agriculture, and river basin management plans will need to identify the combination of action required by farmers and by water companies. We are currently undertaking a review of diVuse pollution from agriculture, to identify the most cost-eVective approaches to securing the reductions in diVuse pollution that will be needed, alongside action by water companies and others, to achieve compliance with the Water Framework Directive. 31. However, the Periodic Review process is designed to allow flexibility to accommodate changes that arise in between formal reviews, so as work on implementing the Water Framework Directive progresses, if this raises implications for investments schemes in the pipeline, there is suYcient flexibility in the system to cope with this. 9020982003 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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32. The Government also aims to ensure that decision-making for the Periodic Review process embodies wider Government policy principles, such as sustainable development. It does this mainly through Ministerial guidance documents. It is for Ofwat to decide how to give eVect to this guidance but clear, positive and achievable statements of the importance the Government attaches to its wider policy aims are a part of that process.
Results of Customer Research 33. As explained in paragraphs 16 to 19 above, the first stage of the Joint Customer Survey took place in 2002. The findings revealed a broad level of satisfaction with water and sewerage services but also showed that there is some demand for further improvements and a limited willingness to pay for this through higher water bills19. Customers’ views on the “scope and pace of potential improvements” do include some desire for improvements. 34. However, respondents were divided on the degree of improvement needed, the amount they were prepared to pay (if anything) and on the urgency of any improvements.
Companies’Draft Business Plans 35. At the time of preparing this written evidence, the Department has yet to receive full details of the companies’ draft business plans and Ofwat. However, now summaries have been published, it is apparent that there is wide variation between the companies both in terms of scale, make up and cost of their investment programmes. For example, some companies’ estimates of the costs of the environment and drinking water programmes—and the impact on customers’ bills—are relatively modest compared to other cost drivers. In the case of other companies, their proposed environmental and drinking water investment programmes are larger items. It will be important that there is proper understanding of the reasons for such variations and the advice from Ofwat and the other regulators will be vital in this respect. The Department looks to Ofwat and the other regulators to fully interrogate all aspects of those plans to challenge costings where appropriate and to provide advice based on that further analysis. 36. Ofwat requested companies to prepare reference plans as well as their preferred strategies. The reference plans are intended to ensure consistency of approach and oVer comparison with the preferred strategies. Ofwat has stated that the reference plans will form the basis of their advice to Ministers.
Conclusions — The Government’s view is that the current regulatory processes are sound. The overall process is inclusive and allows all the principal parties to make their views known at key stages of the process. — To address previous concerns about the opportunities for stakeholders to make their views known. there has been the joint statement which not only indicated when to whom comments could be sent, but also flagged up some of the key questions. This is illustrative of the level of co-operation between the diVerent parties. — The Government will issue its principal guidance in early 2004. It will be important that the draft business plans are thoroughly examined and that both costs and proposals for additional expenditure are subject to proper scrutiny. The draft business plans showed substantial variations between companies on cost drivers, including the environmental and water quality programmes, which will require proper explanation. — In issuing its guidance, the Government will take into account the ability of the industry to deliver proposed programmes including the financeability of programmes. — The Government is interested in the views of other main stakeholders and the views of the Committee on these very important issues, which will be taken into account in future planning and decision-making. 27 November 2003
Annex I
Future Obligations of the Water Framework Directive WFD requires all inland surface and coastal waters and groundwaters to reach “good status” by 2015. Specific quality criteria have yet to be set but the Directive will set demanding environmental objectives, including ecological targets, to be met by 2015. Article 9 of the Directive aims to ensure that pricing policies improve the sustainability of water resources and requires water pricing policies to perform the following functions by December 2010:
19 Joint Statement “Results Of First Ever Joint Industry Research Into Customers’ Views On Water And Sewerage Services”. http://defraweb/environment/water/industry/research/pdf/cust statement.pdf 10 9020982003 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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— Take account of the principle of the recovery of costs of water services, including environmental and resource costs. — Embody the “polluter pays” principle. — Provide adequate incentives to use water resources eYciently. — Ensure that water use groups (separated into at least industry, households and agriculture) make an adequate contribution to the recovery of the costs of water services. Article 11 requires a series of measures to be in place to meet the environmental objectives in article 4 of the Directive. Generally we already have many of the statutory measures in place that are necessary to deliver what the Directive requires. This includes the current discharge consent system. The more demanding and wide-ranging water quality objectives in the Directive mean, however, that many existing consents will need to be reviewed. Some minor changes will be needed to the current arrangements for licensing abstraction of water, in addition to proposed measures contained in the Water Bill. As part of implementation, the Government also proposes to introduce a new power to control sources of diVuse pollution, to the extent that controls are needed to meet the river basin water quality objectives of the Directive. For point sources, water and sewerage undertakers would be directly responsible for meeting the costs of improvements to their point source discharges and would be likely to contribute a large share of the measures to improve river habitats and to alleviate low flows. The costs of improving other point source discharges would be the responsibility of the industries concerned; but they might meet some of this cost by paying increased trade eZuent charges to undertakers. Annex II Existing EU Directives with Major Impacts on the Water Industry
Directive purpose Impact of Directive
Habitats Directive Water abstraction licences and discharge consents are being reviewed and amended, unless they can be shown to have no adverse eVect on the habitats the Directive is designed to protect. Freshwater Fish Directive Further designations under this Directive are likely to lead to a continuing steady improvement in water quality for fish. The Directive will be repealed in 2013 under the Water Framework Directive. Shellfish Waters Directive We have developed a good understanding of water quality of designated waters by intensive sampling and of pollution sources by investigating the source of all failures to achieve the required water quality standard. Groundwater Directive The Directive has resulted in a tighter regulatory control over those who dispose of listed substances to land, or direct to groundwater, and over those who carry out other activities which could result in groundwater pollution. Urban Wastewater Treatment Directive Secondary treatment (generally accepted as the normal standard of protection for the environment) was provided at 98% of sewage treatment works serving over 15,000 people at the end of 2002. In England and Wales, 112 Sensitive Areas (Eutrophic) have been identified under the Directive, and more stringent treatment (reduction of phosphorus and/or nitrogen) has or will be provide at qualifying sewage treatment works. By the end of 2005, we expect secondary treatment to be the minimum standard of treatment for almost all treatment works serving over 2,000 people. Bathing Water Directive The quality of most of the 406 English bathing waters has been transformed to comply with the Directive’s mandatory standards. The Directive is subject to revision by the EC at the moment. Surface Water Abstraction Directive Between 1999 and 2001, the number of occasions of mandatory SWAD standards being exceeded was halved, the majority stemming from the determinands for colouration, dissolved iron and phenols. Drinking Water Directive The Directive has led to significant improvements in drinking water quality by setting compulsory chemical and microbiological standards. 9020982004 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Supplementary memorandum submitted by the Environment Agency
1. Introduction 1. At the hearing by the Committee held on 5 November, the Environment Agency gave evidence that draft business plans of water companies fell short of meeting environmental expectations. The Committee expressed interest in receiving further detail. 2. Since providing its written and oral evidence to the Committee, the Agency has submitted two documents to Ministers to inform decisions on the 2004 Periodic Review. These documents provide: — The joint views of the Environment Agency, English Nature and Countryside Council for Wales20, on the environmental priorities for the water industry; — The Environment Agency’s advice to Ministers on the draft water resources plans submitted by water companies as part of the 2004 Periodic Review.21 3. Both reports are available on the Agency’s website. The supplementary evidence in this paper is drawn from those reports.
2. Commentary on Draft Business Plans 4. Water companies submitted their plans to Ofwat in August 2003. Included in their plans were costs for the delivery of the a programme of environmental improvements specified by the Environment Agency, in partnership with English Nature on nature conservation issues. 5. Ofwat published its overview of draft business plans in October.22 We submitted our advice to the Secretary of State on the Environmental Priorities for the 2004 Periodic Review. In that advice we set out the results of our review of the draft business plans. 6. In their draft business plans, the water and sewerage companies, and largest water only companies, have provided information on bills for three scenarios: — company preferred strategy—setting out the company’s view of what should be delivered; — Reference Plan A—a specified list of planning assumptions, which includes the “statutory” elements of the environment programme; — Reference Plan B—a specified list of planning assumptions, which includes the “statutory” elements of the environment programme and those parts of the environment programme for which Ministers have choices. 7. Table 1 shows the Agency’s assessment of the companies’ preferred strategies in relation to delivery of their environmental obligations, and for the water and sewerage companies, our assessment of the impact of the environment programme on bills.
Table 1a WATER AND SEWERAGE COMPANIES— SUMMARY OF PREFERRED STRATEGIES IN DRAFT BUSINESS PLANS
Environment Programme fully addressed in company preferred strategies Disproportionate impact of Improvements to Improvements to restore environment programme on Company water quality sustainable abstractions bills (see paragraph 8)
Anglian Water ª| Welsh Water || United Utilities ªª | Southern Water23 |ª | Severn Trent || No environment South West Water | programme required
20 Periodic Review of Water Industry Prices—2004. Environmental Priorities for the Water Industry. An update of advice to ministers from the Environment Agency, English Nature and the Countryside Council for Wales on priorities for England and Wales, November 2003. http://www.environment"agency.gov.uk/business/444304/444643/425378/425401/425415/?lang% e. 21 Securing water supply. The Environment Agency’s advice to Ministers on the draft water resources plans submitted by water companies as part of the 2004 periodic review. November 2003 http://www.environment–agency.gov.uk/subjects/waterres/ 590165/?version%1&lang% e. 22 Setting water and sewerage price limits for 2005–10: Overview of companies’ draft business plans, Ofwat, October 2003. 23 For Southern Water and water resources schemes the information was extracted from the draft water resources plans. 9020982004 Page Type [O] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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Environment Programme fully addressed in company preferred strategies Disproportionate impact of Improvements to Improvements to restore environment programme on Company water quality sustainable abstractions bills (see paragraph 8)
Environment Thames Water | programme excluded Wessex Water || Yorkshire Water ||
} Minimum statutory environment programme fully addressed in company preferred strategy. | Minimum statutory environment programme not fully addressed in company preferred strategy.
Table 1b WATER ONLY COMPANIES
Environment programme excluded Environment programme partially included in full Portsmouth Water Folkestone and Dover Portsmouth Water South East Water Cambridge Essex and SuVolk Water (Northumbrian Water) Tendring Hundred Environment programme partially included Companies with no environment programme required Bournemouth and West Hampshire Water Cholderton and District Water Mid-Kent Water Sutton and East Surrey Water South StaVordshire Water Bristol Water (has no statutory schemes) Three Valleys Dee Valley
General comments 8. There are two water and sewerage companies, United Utilities and Southern Water, for which, although they have significant environment programmes, the share of the increase in price allocated to environment improvements in the company’s public summary looks disproportionate to the size of the programme. This may arise for a number of reasons: — exaggerated estimate of capital costs of the environment programme; — schemes not completed in 2000 to 2005, which must now be delivered in 2005 to 2010. It is also possible that the company’s financial modelling has allocated other costs to the environment programme, for example, any extra financing costs, in a manner that is disproportionate, to the part of the bills dealing with environmental improvements.
Water quality 9. Companies have challenged legal and policy obligations in their company-preferred strategies. Table 1 shows that only three water and sewerage companies included all of the sewerage improvements identified by ministers as “essential and clear” in their preferred strategies. 10. Some companies have included environmental schemes in their preferred strategies, which are not sought by the Agency, apparently taking preference over some “essential and clear” schemes. 11. We have also used our experience of regulating the water industry and of previous Periodic Reviews to provide an overview of the cost-eVectiveness of companies’ draft business plans. We have identified that a number of companies have over-stated the costs of some schemes, and in one case, many schemes in the environment programme. Examples of these additional costs include: — Costing full improvement schemes for sites where an investigation only is required, for example for Habitats Directive requirements; Schemes where high unit costs, significantly above industry standards, have been used; for example, schemes to remove sewage debris from storm sewage discharges, small works which need improved treatment to meet Urban Waste Water Treatment Directive (UWWTD) standards, and schemes to improve microbiological quality of shellfish waters; 9020982004 Page Type [E] 12-12-03 02:02:30 Pag Table: COENEW PPSysB Unit: PAG1
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— One company proposed an alternative sludge strategy at significant additional cost and allocated full costs to environmental schemes to protect water quality. 12. We have been liaising with Ofwat to address these concerns.
Water resources 13. Many companies have excluded schemes that deal with the impact of abstractions on sites covered by the Habitats Directive or Sites of Special Scientific Interest. Even where schemes are included, they are programmed to be implemented after 2010, beyond the agreed timescales for the Habitats Directive or to meet the Government’s PSA target for action at SSSIs. As noted in the Agency’s Memorandum, the delay on work at Habitats Directives sites increases the risk of infraction legal challenge 14. As a result of the mismatch in timetables for PR04, the review of consents process required under the Habitats Regulations, and the delivery of many investigations funded under the last review (AMP3), there is uncertainty over the final size of the water resources programme. With the exception of a small number of schemes the actions required to restore and protect sites will not become clear until the results of investigations become available. Many investigations will not be completed in time for the costing of implementation of solutions to be included in the Final Determinations of prices. Definitive costing cannot be carried out until investigations have been completed. 15. The Environment Agency developed a method for estimating the water that would need to be remedied to help companies to estimate the potential costs. Not all companies used this approach. Some companies made insuYcient allowance for environmental improvements. These issues may have resulted in companies under-estimating the cost of this element of environmental improvements. 16. The lack of clarity of cost information provided by companies in their draft business plans for water resources is disappointing. 17. We are concerned that some companies have taken the view that certain schemes will be subject to claims of over-riding public interest (OPI) and have excluded them from company preferred plans on this basis. Matters such as OPI are for Ministers. Other companies have not made any allowance to implement any of the results for any of investigations for statutory schemes in their preferred strategies. 3 December 2003
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