Annual report 2002–03 >> of the Director General of Water Services Our vision << A water industry that delivers a world-class service, representing best value to customers now and in the future. Our mission << To regulate in a way that provides incentives and encourages the companies to achieve a world-class service in terms of quality and value for customers in England and Wales. How we do it << By: >> Setting price limits at levels which: – enable well-managed companies to finance the delivery of services in line with relevant standards and requirements; – provide incentives for companies to improve efficiency and service delivery; – share the benefits between customers and investors. >> Ensuring that we are aware of stakeholders’ views and priorities by consulting with customer groups, the industry and others, and undertaking customer surveys. >> Facilitating the development of competition to promote further efficiency gains and, where practicable, further choice for customers. >> Working with the quality regulators to make sure that Ministers have the information they need to set the quality improvement programme within a long-term framework. >> Ensuring that customers’ tariffs are fair and do not unduly discriminate or show preference to any class of customer. >> Handling disputes and complaints involving the companies economically, effectively and fairly. >> Monitoring the companies’ performance and taking action, where necessary, to protect the interests of customers and other stakeholders. >> Openly and transparently publishing information, which allows customers and other stakeholders to have their say in regulatory decisions. >> Making sure that Ofwat delivers best value in its regulatory role and by valuing and encouraging the development of its entire staff. >> Assessing company performance by making appropriate comparisons between the regulated companies, drawing on relevant information from other sectors and from international comparisons where available. Annual report 2002–03 >> of the Director General of Water Services For the period 1 April 2002 to 31 March 2003 Presented to Parliament in pursuance of section 193 of the Water Industry Act 1991 and to the Welsh Assembly Government. Ordered by the House of Commons to be printed 22 May 2003. HC 679 London: The Stationery Office £10.60 1 Office of the Director General of Water Services Centre City Tower, 7 Hill Street, Birmingham B5 4UA Tel: 0121 625 1300 E-mail: [email protected] Fax: 0121 625 1348 To RT. HON. MARGARET BECKETT, MP The Secretary of State for Environment, Food and Rural Affairs and RT. HON. RHODRI MORGAN, AM First Minister, Welsh Assembly Government Dear Secretary of State and First Minister I am pleased to present my report on Ofwat’s work for the year ending 31 March 2003. We are committed to openness and transparency in our work, and this report to you and all stakeholders is part of that. This year, for the first time, we commissioned an independent survey of stakeholders to consider our effectiveness and our processes. We welcomed the positive feedback from the survey and are now building on its findings. The focus of our work has been the price review – we will set prices in November 2004. We started this two-year process in October 2002 by consulting on how we will go about it. We have continued our routine but essential work in monitoring the companies’ performance. Protecting the interests of customers remains central to our role, working closely with WaterVoice. We have given advice to Government on the Water Bill, which will change the shape of economic regulation of the industry in the years to come. Philip Fletcher Director General of Water Services 2 Contents << Director’s review 4 1. Price setting 7 2. Protecting customers 13 3. Safeguarding quality and service 17 4. Companies’ finance and mergers 21 5. Price competition 25 6. The Water Bill 27 7. Communications 29 8. Resources 32 Appendices << 1. Ofwat’s milestones 2002-03 38 2. WaterVoice committees 40 3. Independent reporters and auditors 41 4. The water and sewerage companies 42 5. The water only companies 43 6. Ofwat administrative costs 44 7. Ofwat staff numbers 45 8. Ofwat structure 46 3 >> director’s review Director’s review >> The main focus of our work this year has of price competition. But it requires careful been preparing the ground for the coming consideration of the scope for further review of price limits, which will be decided efficiency and the treatment of uncertainty. in 2004. We consulted on our proposed Many respondents sought greater methodology last October, and announced incentives for companies to outperform our conclusions in the light of responses in price limits and drive efficiency further. March 2003. Many of the easier efficiency gains have We are adopting a transparent approach to been made already following privatisation the review and continue to follow the in 1989. But, although future efficiencies principles of good regulation set by the are becoming harder, we believe that there Better Regulation Task Force: transparency, is still scope for the industry to become accountability, proportionality, consistency more efficient, at a faster rate than the and targeting. economy nationally. To help us observe these principles, we This view is supported by a study we commissioned an independent survey of commissioned from Europe Economics on stakeholders’ views on our transparency the scope for future efficiency in the and how we go about our work. We industry. We are not yet drawing welcome the outcome. The survey has conclusions. We need to be sure that our usefully indicated areas for improvements. eventual proposals provide sufficient The full survey report is on our website. incentive for the most efficient companies, to the benefit of customers as well as shareholders. The next price review << In the treatment of uncertainty, we reject the option of a general contingency We remain committed to incentive-based 1 provision in prices to allow for unforeseen RPI-X is a price cap price cap regulation, using the formula that limits changes 1 risks outside the control of prudent in overall prices to RPI-X . This has demonstrated its management. But we are looking carefully inflation (RPI) plus effectiveness in driving efficiency in the or minus a factor at the changes the regulatory system determined by the privatised utility industries in the absence regulator. should provide for. 4 The companies need to be able to finance in the directions proposed by Government. their functions. Water UK’s survey of debt The Ofwat Board has been at work for a and equity investors, published in April, year. Our non-executive advisory directors provides important evidence about how add value to our decisions. And although investors view risk for the sector. We will we continue to work closely with take account of this and other studies in WaterVoice, the Council’s freedom to assessing the cost of capital. speak independently of the regulator has been strengthened. As part of the review, we joined with representatives of Government, customers, The constitutional changes in the Bill will companies and environmental groups to not take effect before April 2005, which will commission MORI to carry out our first joint enable us to complete the periodic review customer research project. The research as we began it, under the current regime. steering group is now working on the second stage of the market research, which will further explore customers’ views Changing structures << on the particular service improvements needed and the impact on bills. Since the last price review several companies have changed their capital Companies will submit draft business plans structures. Different models have emerged, by mid-August. We look to companies to but all have involved increasing the level of present well-justified plans, representing debt finance on the companies’ balance value for money for customers. The plans sheets. will inform our discussions with the companies; and we shall also use them to We believe that it is for the companies to inform Government and fellow regulators manage their own capital structures. on the decisions Ministers need to make in I welcome innovation directed at improving setting the water quality and environmental efficiency and effectiveness – an important programmes for the next five years. aim in an incentive-based regime. It is too early to say what bills for 2005-10 The most recent research presents are likely to be. The scale of the pressures evidence that, at least in the short term, to spend, including the environmental some of the new structures have the programme, means that it is unrealistic to potential to deliver savings for customers expect a reduction. We are obliged to set by reducing the cost of capital. But it also price limits that enable companies to highlights the financial risks of highly finance and carry out their functions, but at leveraged structures, including the the same time customers look to Ofwat to potential systemic risk of a number of ensure that prices are no higher than companies failing simultaneously. necessary. Progress on services << The Water Bill << Most companies continue to deliver The Water Bill was published in February improved services. Research tells us that and is progressing through Parliament. We customers believe the companies generally have worked as expert advisors with other achieve satisfactory service in relation to government departments in developing the costs. But we are not complacent. We proposals. The Bill introduces important remain concerned about Thames Water’s changes, including water-specific failure to meet leakage targets. We have legislation for competition. taken regulatory action and we expect Thames’ performance to be brought into The Bill also proposes a new corporate line with the rest of the industry by 2006-07. structure for Ofwat, and the establishment of WaterVoice as an independent Consumer Council. We are already moving 5 We continue to make progress in tackling sewer flooding.