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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