Select Committee on Environmental Audit Minutes of Evidence


Supplementary memorandum from the Environment Agency

  The Environment Agency welcomes the opportunity to provide supplementary evidence to the Committee on the forward planning elements of the Periodic Review of Water Company Prices. The Committee has rightly recognised the key linkage between the environmental planning process and the Periodic Review of Prices. We believe that the further development of these processes and a fundamental review of the linkages between them could provide additional certainty and transparency of objectives to all stakeholders. In addition, it could minimise the stop start approach to planning and investment which is an inevitable consequence of the current simplistic five year review.

1.  ENVIRONMENTAL PLANNING

  Long term planning for water quality and water resources are in essence a continuous process and normally undertaken at the catchment level. Environmental monitoring data provides information on the state of the environment and an understanding of the pressures acting upon it. Monitoring programmes are designed to provide adequate certainty over the causes and effects of pollution to allow plans for protection and improvement to be developed. These plans can be drawn up to meet the requirements of a number of water quality and water resources objectives, which may be derived from EU Directives or as a result of UK policy. All environmental objectives are set in the context of sustainable development and are determined by the Secretary of State, following advice from the Environmental Agency. For the purposes of AMP3 the open letter from the Secretary of State, entitled Raising the Quality set out these objectives.

  The Agency continues to develop these water quality and water resources planning methodologies and aspires to provide a long-term view of the actions needed to maintain and improve the water environment. The Agency's consultation document, Creating an Environmental Vision (June 2000), will provide a high level overview of the aims for inland and coastal waters.

  The requirements for individual catchments are developed using the LEAPs process. This provides the forum to involve local stakeholders in the planning process and informs the local authority planning process. The LEAPs have been the focus of local consultation on options for catchment improvement and have produced Action Plans detailing the remedial measures required. These have informed the AMP3 improvement programmes where water industry discharges are known to be impacting on the achievement of water quality objectives.

  From April 2001, the Agency will commence the development of Catchment Management Abstraction Strategies (CAMS) which will complement LEAPS. Each CAMS will, following local consultation, describe the water resources position and set out a strategy to deal with the pressures on water resources within each catchment. As CAMS are produced they will provide a detailed basis for information on local water resources status, issues and actions to feed back into strategic planning and catchment management.

  The catchment planning approach has been the basis for water quality improvement in England and Wales over the past 20 years. This philosophy will be consolidated by the new EU Water Framework Directive, which is expected to be adopted formally this year. This sets out a long term approach to integrated "river basin management" taking into account water quality and water resources requirements of river basins. This will set out a plan to achieve "good ecological quality" through the adoption of a "programme of measures" with a six year review of progress. The process will consolidate the current approach and add a degree of strength through statute.

2.  CURRENT PERIODIC REVIEW PROCESS

  The periodic review process is an economic tool developed by the Director General for Water and administered by Ofwat in order to review water company financing in the light of the monopoly position of the industry. In order to set water prices the Director General has evolved a complex formula to take into account the key components influencing the company costs. The five yearly periodic review is conducted over a three year period, which creates arbitrary stop/start planning. It generates potentially unmanageable peak workloads and demanding timescales, particularly for the scrutiny of cost estimates and cost effective solutions.

  For the purposes of this discussion the two primary influences on costs need to be separated.

1.  The costs of new obligations on the company.

  These are derived from the requirements for environmental improvement, identified in the environmental planning processes above, and endorsed by the Secretary of State; (but may also be derived from the requirements for improvements to drinking water quality set by the Drinking Water Inspectorate or other obligations outside the companies' control).

2.  The base costs of operating, maintaining and renewing the existing assets

  This includes the costs of operation, maintenance and replacement of all the company assets and the borrowing required to finance it. It excludes the new obligations above, but would include improvements made by the company voluntarily and should also take account of additional services to meet population growth.

  During the AMP3 determination the public debate failed to distinguish between these elements and in many cases the impact of the large asset maintenance costs distorted the debate on the new obligations. There was also considerable blurring of the edges on issues of growth, base operations and head room which should have been clearly assigned to one or other categories.

  When opinion polls were taken by the DETR and the Agency the public expressed a willingness to pay for environmental improvement, providing excess profits were not seen to be passing to the company or its shareholders. The separation of the above elements could have overcome these fears.

  In AMP3 the environmental improvements required to overcome historic under investment and recent environmental obligations were relatively large. In future years the proportions may change and the base costs of asset maintenance are expected to be relatively large. Separation of these could lead to a smoothing of the investment cycle, as the asset maintenance costs should be more predictable and similar to the normal business risks carried by non monopoly companies. It is essential that the state of assets is fully understood and that asset maintenance is adequately funded.

3.  PROPOSED CHANGES

  The Agency would propose that the environmental programme should be "ring fenced" and funded separately from existing base obligations. The environmental planning base should be developed over a longer timescale to enable cost scenarios, including best engineering solutions to be clearly quantified at an early stage. Ofwat should be required to ensure that certified costs are available during the process so that a fully costed and prioritised plan could be assembled and tested against national and international obligations. Scenarios should be developed progressively on a rolling basis with the full involvement of stakeholders. We would suggest a three year lead period for this process. This would spread the work more evenly and ensure that decisions are made on good quality data for both costs and environmental benefits.

  To ensure that companies continue to have an incentive to make efficiency savings within the environmental programme, we would propose that efficiency savings realised through better implementation should be split two ways, between the company and the environment. This would be achieved by bringing schemes forward from the next three year period as funds from efficiency savings became available. Companies should have an opportunity to make further savings by integrating the new environmental improvement programme with their ongoing asset renewal plans. Finding revenue rather than capital solutions could make additional savings. Within this partnership approach, we believe that more cost-effective schemes would be achieved and innovative solutions such as those developed under the Sustainable Urban Drainage (SUDs) research and development programme could flourish.

  With regard to the base costs of operating, maintaining and renewing assets the Agency would recommend that the Director General consider a rolling review, allowing the water companies to make a reasonable return on their investment. The planning cycle for this sector of business should be on a long-term basis. Allowances for growth in population served and trade effluent should be factored into this element of the costs. Demand management objectives involving leakage could be dealt with in this way.

  In much of England and Wales, we believe that, in the longer term, further progress on leakage control is necessary and appropriate. The economics of leakage control will change over time. It is not possible to predict how the economics will change, but a technically proficient level of leakage has been identified which reflects best practice in the water industry today, together with a few additional technological improvements that are known to be under development now. It is recommended that this technically proficient level of leakage should be seen as a long-term target in most of England and Wales.

  This long-term approach should significantly smooth the overall nature of the process and reduce the impact on expenditure and prices. The Agency re-iterates the need for adequate asset maintenance in order to protect the environment from infrastructure failure and inadequate supervision.

  In summary, the Agency believes that the above proposals could significantly improve the process. Additional development of these principles, for instance, to allow cross linkages between the environmental programme and the base costs, could provide further opportunity to promote cost effective solutions. The Agency would be happy to work with the Department of the Environment, Transport and the Regions, the Director General and the water industry to improve the periodic review process. We trust that this answers the supplementary questions posed by the Committee.

August 2000


 
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