Memorandum from Water UK
SUMMARY
The periodic review process is of crucial importance
to the water industry, its customers and regulators. It is the
mechanism which set priorities, investment and prices for the
whole water sector.
The periodic review process is not idealit
is too convoluted and onerous, and needs clearer stronger management,
more data sharing and a common vision from all participants. The
process should result in a clear definition of outputs and the
timescale for implementing them.
The 1999 review was designed from the outset
to deliver a one-off price cut which is unsustainable in the medium
term, we believe that prices will rise above inflation in the
future to make up the deficit. Indeed there is still confusion
among regulators about what is part of the programme and what
has been left out.
The overall outcome of the review is extremely
tight for companiesrisk has been increased, so reducing
the capacity of companies to carry out discretionary environmental
work, and is leading to a restructuring in a number of companies
to deal with the challenges of meeting the targets set by regulators.
Our main concerns are:
The early view taken by both Ofwat
and DETR that price cuts and additional environmental improvements
could be achieved without squeezing other parts of the companies'
activities too hard.
A lack of joined up regulation.
A failure on the part of DETR to
take a stronger lead.
An Ofwat driven timetable that others
struggled to keep up with.
A heavy burden of form filling that
went well beyond what was really needed.
It is important to companies to have clear well
defined obligations, with sensible timetables for delivery, and
which are fully funded within realistic price limits. It is also
important not to have "regulatory creep", the imposition
of extra new obligations between reviews that are not properly
funded.
The remedies that might help to improve the
process in future include the following:
DETR to take charge of the quadripartite
process, adopt a stronger lead.
More joined up regulation.
Agreed roles and remits for all players.
Agreed timetable and set of principles
at outset of process.
More resources for DWI to assist
them to fully participate in the process.
A reduction in information requirements.
Companies to take the lead in preparing
strategic business plans.
Sharing of Ofwat's financial model.
1. INTRODUCTION
Water UK represents the United Kingdom water
industry, comprising private companies in England and Wales, the
three publicly owned water authorities in Scotland and the Northern
Ireland Water Service, except Mid Kent.
The UK water industry is a key player in delivering
environmental improvements. Over the last 10 years, the industry
has invested £12 billion in environmental work.
Over the next five years we will deliver a further
£7 billion worth of environmental improvements including
902 schemes to improve waste water quality, 75 schemes to meet
bathing water standards, 24 schemes to protect the water environment
by reducing abstraction, and 487 schemes to improve river water
quality.
The industry manages hundreds of SSSIs, and
many of those sites covered by the Habitats Directive rely on
our careful management of water abstractions for public water
supply and treated waste water discharges. We play a lead role
in protecting and promoting UK biodiversity and the industry is
the national sponsor of the otter.
Water is a long-term industrymanaging
part of the water cycle for human use requires careful planning
and management to meet a number of objectives. Historically the
industry has been able to plan to meet these objectives. But following
the outcome of the 1999 periodic review there will be increased
financial pressures and increased risks which will force the industry
to put greater emphasis on short-term objectives.
The price cuts imposed by the economic regulator
are damaging to the management of a long term industry with key
public health and safety duties. They are not sustainable in the
longer term, further price increases to fund future environmental
improvements and other objectives are inevitable before 2005.
The industry is a long-term businessand there is a need
to improve the decision making on the balance between environmental
improvement and price reductions.
2. BACKGROUND
The industry supports fully the basic principles
behind medium-term, incentive-based regulation. Three independent
regulators ensure that the industry in England and Wales delivers
outputs in terms of price and value, drinking water quality and
environmental protection.
Whilst it is essential that each regulator maintains
independence, it is essential also that policies and intended
outputs are complementaryin current terminology regulation
must be "joined-up". The industry, along with other
commentators, is concerned that this is not the case. Even after
the 1999 final price determination, there is still confusion between
regulators about which elements of the environmental programme
have been allowed for.
It is relatively easy for regulators and other
parties to agree on the high-level broad principles of the activities
that need to be carried out, but in this agreement needs to continue
through to the technical definitions of projects. Technical definitions
are extremely important, as they affect costs in a major way.
For instance cost drivers for wastewater improvements were differently
defined by EA and Ofwat; this would be a simple administrative
point to improve, through sharing agendas between the regulators
at an earlier stage.
3. REVIEW PROCESS
(a) Roles of Players
Overall the 1999 review process didn't work
as well as it should, either in terms of the timing of inputs
from the industry or the weight the inputs were then given by
regulators.
Whilst supporting the need for independent regulators,
the periodic review process requires strong management and we
believe that DETR should take a stronger lead in this process,
in terms of timing, clarity of obligations and full funding.
DETR took a more direct role in the 1999 review
than the DoE took in 1995, and we suggest they should play an
even stronger role in the future, ensuring the process goes smoothly
and providing opportunity for inputs from the different parties.
A major lesson from this review has been that timing is crucial
in terms of inputs to process and decisions.
We do not consider there is a need for legislation
to manage the process, but it would be helpful if the roles and
remits of the players were formalised, and a timetable and set
of principles agreed between all parties at the beginning of the
process.
The industry, as a whole and individual companies
input to the process by responding to consultation papers, representations
at one or two general meetings, bilateral meetings with Ofwat,
and through a total of fourteen highly detailed and complex information
returns (Annex 1).
Despite this the quadripartite process did not
work well because of a lack of realism about how much environmental
improvement was genuinely compatible with reduced prices, and
a lack of early consultation by Government on its proposals, leading
to last minute decisions.
In the spirit of open government, obligations
need to be clear, properly funded and no policy documents should
be issued without full sign-up from all regulators and DETR. Furthermore
the process needs to be completed earlier, so that companies can
implement the new pricing structure effectively and with minimum
disruption.
(B) DATA
REQUIREMENTS AND
COLLECTION
The volume of data required by all regulators
(but principally Ofwat) is huge.
A common data collection exercise for all three
regulators would help, with one set of data being agreed on and
provided to all regulators by companies. The system became almost
inoperable due to the issue of untested and inappropriate data
collection systems by Ofwat. These required many corrections and
amendments by Ofwat while the industry was completing them, and
were costly and difficult to complete to the required dates. The
data collection methodology was flawed as the spreadsheets did
not link up between regulators (and even parts of regulators),
so much more thought needs to go into this. The industry would
welcome the opportunity to contribute to the development and testing
stages for data collection systems in the preparation for future
reviews.
Indeed the whole Strategic Business Planning
process collapsed under data requirementsso much detail
was required that plans couldn't be strategic. We suggest that
in the future companies should build their own plans, perhaps
on a rolling basis. Regulators would then examine the gaps and
ensure that their regulatory requirements were being met.
Whilst companies were required to share information
on the most detailed aspects of their operations, Ofwat did not
share its own information, particularly on its financial model.
We fully supported the constructive process
of certifying data, but remain concerned that much of this data
were ignored by Ofwat. Using Reporters as technical auditors in
a sensible method of validation, but regulators should either
trust them or drop them. In our experience, Ofwat were extremely
selective in the use of reports, and transparency in the way that
the process works would help prevent regulators quoting selectively
from the work of independent Reporters.
(C) TIMETABLE
The timetable for the review was set out by
Ofwat in its Framework paper of February 1998 and is attached
as Annex 2.
In principle the timetable seemed reasonable,
but actual practice has fallen short of ideal, as Ofwat set the
timetable and others had difficulty keeping up. DETR were supposed
to respond to the Director General's open letter by July 1998
but their response slipped to September 1998. The EA tried to
recapture some ground during the process but were unable to. In
reality it was Ofwat's process, Ofwat's review and Ofwat's outcome.
The industry was alarmed at the under-resourcing
evident in the Drinking Water Inspectorate for the periodic review,
and the way that the water supply quality issues were put at a
lower priority than the environmental agenda. The DWI appeared
unable to get its agenda included properly, contributing to extensive
under-funding for water supply improvements. It is likely that
this imbalance will need to be corrected at the next price review.
(D) PREDICTING
THE OUTCOME
We are concerned that in the 1999 review, the
Director General appeared to have decided the outcome of the review
at the outset. The process needs clear leadership which doesn't
prejudice the outcome, with a clear timetable, clear inputs and
clear data requirements. A number of wider issues need to be examined
such as rolling AMP process, greater transparency about who pays,
and the use of polluter pays principle.
Of more immediate concern to the industry is
that not all obligations are properly funded, for example, £900
million has been left out of the final settlement without any
proper explanation by the regulator.
(E) CUSTOMER
RESEARCH
The industry's overall feeling is that customers
have been cheated by the regulator who has largely ignored their
opinions.
The review was informed by many different customer
research studies. We believe that in general the national studies
by DETR, Water UK, EA, and DWI were all well conducted. In particular,
the studies carried out by DETR and Water UK were complementary.
In addition all companies did their own surveys which provided
a great deal of local detail.
Such customer research is essentialin
itself it has a high value, but it is equally crucial that regulators
and decision-makers listen to, and act on the research findings.
For instance, sewer flooding was recognised as important to customers
according to all of the research carried out during the review
process, but it was not considered an obligation in the final
determination. Furthermore, research must be carried out before
the expected outcome of the review in the public domain. In the
1999 review, research was geared to proving/disproving Ofwat's
policy intention of price cuts.
Almost everyone is a customer of the water industry.
Customers are electors and citizens. Research needs to be focused
on long term expectations, not only from "customers"
views but from society's view of what is required from the industry
over the longer term.
We are not convinced of the need for an independent
customer survey to inform future reviews, although there may be
benefits in more joint surveys, and exchanging views on the questions
to be asked. We suggest that a framework survey could be developed
with accredited questions which companies and regulators could
then adapt for their own circumstances.
4. THE ENVIRONMENT
PROGRAMME
(a) Timetable
The environment programme is challenging, and
the timetable for implementing the work is ambitious, and some
companies expressed concern which led to last minute changes by
DETR.
Nevertheless all companies will deliver their
obligationsmost of the obligations arise from Europe, and
are necessary to meet new legislation. But it is a myth that our
programme is simply driven by European standards. The detail of
the environment programme is driven by the DETR and government's
interpretation of relevant directives and the implementation programme.
Often these are over and above the requirements of the Directives
themselves, and reflect national objectives for improving receiving
waters.
(b) Prioritising the Programme
Regulators should ensure that they have carried
out Cost Benefit Analysis or equivalent to ensure value for money
on behalf of society before publishing the programmes for companies
to deliver. After these decisions have been made, companies develop
cost-effective ways of achieving the objectives, given the incentives
under price cap regulation.
In this review the industry and others were
not clear how the EA identified priorities for its programmes.
Also it seems that the EA is not keen on costing the programme
and expects the industry to deliver it, no matter what the cost.
The water industry is a major player in helping
deliver environmental objectives. However we are one of many players
in helping protecting and improving the water environment, and
we are concerned that the EA should apply similar levels of energy
to address diffuse sources and small private polluters.
(c) Delivering the Programme
In some respects companies act as environmental
contractors, delivering those improvements Government regard as
appropriate. But we also deliver what our customers tell us they
want and sometimes there are conflicts between the two (for instance
rates of improvement in protection from sewer flooding, mentioned
earlier).
There is no discretion about outputs regulators
expect to be deliveredcompanies have to appeal against
those if they are not happy. However companies can choose combinations
of inputs such as the type of plant invested in, as long as these
deliver the required outputs.
Companies are keen to take a precautionary approach
to environmental protection and improvement, but often this is
impossible because of lack of funding, and a failure by regulators
to take a precautionary approach eg deteriorating water quality.
Regulators may regard environmental risks as business risks, and
use the threat of prosecution as the main incentive mechanism.
(d) Monitoring
Targets for implementing the programme are set
out in monitoring plans, and companies report annually through
extensive June/July returns to Ofwat. This includes progress on
environmental matters.
However we believe that the industry is best
placed to manage the process of delivering the programme. Government
and regulators should not get involved in the delivery of projects
within each five year periodonly set out what is expected
by the end of the period. Flexibility for the delivery of projects
is essential to allow companies to take flexible and efficient
approaches.
The balance between spending on quality improvements
and maintenance is crucial. Schemes are vital to improve environmental
quality but the overall network needs to be maintained in order
to avoid further problems. Whilst the quality side of the equation
has received priority in the final determination, maintenance
cannot be overlooked at the next review.
(e) Water Saving Trust
Water efficiency is of major importance to the
industry as a whole, and in the last five years huge efforts have
been made to educate customers in the wise use of water. All companies
have water efficiency plans in place which provide a framework
for education campaigns, provision of advice on water efficiency
and free or subsidised water efficient devices.
However water efficiency differs from energy
efficiency as there is a regional/local dimension in water resources.
In some areas where resources are tight, it must take a high profile,
in other areas without a resource problem the need to promote
efficiency needs to be considered alongside other priorities.
Setting up a trust implies more bureaucracy
and the centralisation of decisions best taken at the regional
and local level.
5. FINAL DETERMINATIONS
(a) Stability
Stability is key for the industry and for customerswe
need certainty in the projects that need to be delivered and their
costs to customers. The financial capacity of the companies is
much less than previously and this will effectively prevent new
obligations thought up after 2000 from being implemented before
2005, without price increases.
In the 1999 review, the industry had looked
towards an "L" profile, with small price cuts followed
by stable regime. The regulator's initial price cut will lead
to price rises above inflation in later yearsessentially
a "V" profile. Water industry consultation for the periodic
review confirmed that customers preferred price stability to a
short-term price reduction with increases later on, but this consensus
view was not accepted by the regulator.
We therefore believe the review outcome is short-term,
as it is inevitable that prices will rise in the future. We would
have preferred an outcome closer to stable prices over the whole
of the five-year period.
(b) Prices and Water use
Ofwat's view is that water demand is falling,
because of large reductions in industrial use over the last 10-15
years due to a decline in heavy industry. This has offset increased
demand from domestic customers. However there is a geographical
splitsavings due to lower industrial use have been made
in the north and west of the UK. Domestic demand for water increasing
due to population growth in the south and in East Angliawhere
was resources are under greatest pressure. There has been no analysis
of the likely effect of price reductions on overall demand for
water. Previous studies have shown that demand for water is relatively
inelastic to price, although metered customers typically use less
water than those charged on a non-measured basis.
There is a need to distinguish between effects
of bills and effects of volumetric charges. We believe that the
fall in bills generally will not encourage water conservation
and careful use by customers. However Ofwat has encouraged companies
to reduce standing charges rather than volumetric charges to limit
the negative effect of lower prices on consumption.
(c) Appeals
The industry would prefer a shorter, issues-specific
appeals process, rather than having to open up the whole determination.
Whilst the Competition Commission is a new and different body
to the MMC, there is a feeling that as it is part of the Government,
it is unlikely to go against a decision by the regulator, implicitly
supported by Government.
Of major concern is the timetable for the appeals
process, in particular the short time between the announcement
of the determination and its implementation. Earlier determinations
would allow a process of reflection and for companies to prepare
appeals.
Furthermore the appeals process is expensive
and onerous, outcome is uncertain, and this is reflected in the
attitude of the City to those companies which launch an appeal.
(d) Interim Determinations
Companies would prefer the certainty of funding
within the final determination of price limits to carry out all
the work required in the review period, to avoid the cost and
uncertainty arising from interim price adjustments. In practice,
as is clear from the recent past, there is "regulatory creep",
extra new obligations are imposed between prices reviews that
are not funded in price limits.
Many political and regulatory risks are not
accounted for in the 1999 price determinations, including new
obligations and more competition. Some of these items may be picked
up in interim price increases, but there is very little financial
headroom within companies to cope with logging up (which is a
mechanism that makes allowance for the extra costs at the next
price review). There is a likelihood that companies will have
to resist/appeal new obligations simply because they don't have
the capacity to fund them.
(e) Maintenance
The industry's biggest concern for the longer
term are cuts in maintenance spending. Water UK doesn't believe
that Ofwat has successfully achieved its claims of "no deterioration".
Our concern is that asset condition will worsen, building up problems
which will have to be tackled in the future.
Independent work carried out by Professor Chris
Binnie reinforces this point and a copy of the executive summary
is attached as Annex 3.
The industry is concerned that Ofwat relied
on poor quality capital maintenance efficiency models, and operated
them in a non-transparent way. This has contributed critically
to under-funding of asset maintenance for the new period, and
risks of poor performance. A collaborative approach between the
regulator and the industry to improve shared understanding of
asset condition and maintenance should form part of the preparation
for the next price review.
(f) Job Losses
Whilst companies are seeking to avoid job losses,
they have been an inevitable consequence of the one-off price
reduction. Indeed companies and independent commentators had predicted
even greater job losses that have materialised to date.
The industry is determined that cuts in manpower
should not compromise public health and the safety of remaining
employees. However risks will have been increased.
Manpower was significantly reduced in the 1980s,
when government set manpower reduction targets for the water authorities.
Much of these savings were made by the introduction of new technology.
In fact much of the technological advances in the industry are
20 years old. New systems are generally replacements, so that
additional manpower savings are not gained by their introduction.
The HSE is surveying accidents in the industry
to see whether they may be caused by manpower reductions.
6. CONCLUSIONS
The review process is not idealthe process
is too convoluted and onerous, it needs clearer stronger management,
more data sharing and a common vision from all participants. The
process should result in certainty for companies, including clear
definition of outputs and the timescale for implementing them.
The 1999 review was designed from the outset
to deliver a one-off price cut which is unsustainable in the medium
term, we believe that prices will rise above inflation in the
future to make up the deficit, and to fund any new environmental
improvements that Government wishes to implement in future.
The overall outcome of the review is extremely
tight for companiesrisk has been increased, so reducing
the capacity of companies to carry out discretionary environmental
work, and is leading to a restructuring in a number of companies
to deal with the challenges of meeting the targets set by regulators.
To summarise our main concerns are:
The early view taken by both Ofwat
and DETR that price cuts and additional environmental improvements
could be achieved without squeezing other parts of the companies
activities too hard.
A lack of joined up regulation.
A failure on the part of DETR to
take a stronger lead.
An Ofwat driven timetable that others
struggled to keep up with.
A heavy burden of form filling that
went well beyond what was really needed.
It is important to companies to have clear well
defined obligations, with sensible timetables for delivery, and
which are fully funded within realistic price limits. It is also
important not to have "regulatory creep", the imposition
of extra new obligations between reviews that are not properly
funded.
The remedies that might help to improve the
process in future include the following:
DETR to take charge of the quadripartite
process, adopt a stronger lead.
More joined up regulation.
Agreed roles and remits for all players.
Agreed timetable and set of principles
at outset of process.
More resources for DWI to assist them
to fully participate in the process.
A reduction in information requirements.
Companies to take the lead in preparing
strategic business plans.
Sharing of Ofwat's financial model.
May 2000
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