Annex 1
BACKGROUND
1. What is Ofwat's view on the overall structure
of environmental regulation of the privatised water companies
in terms of the roles of DETR, National Assembly for Wales, DWI,
the Environment Agency and Ofwat?
Ofwat is satisfied that each of the parties
has a clear and discrete role. The role of Government (DETR and
NafW) is to decide on environmental policy and set the scope of
the environmental and quality obligations to be placed on companies.
The role of the Environment Agency encompasses setting standards
and consents to implement legislation and Government policy. The
Agency and the Drinking Water Inspectorate police and enforce
the standards for the environment and drinking water. The Director's
primary role is to set price limits that will enable well-managed
and efficient companies to finance their functions. In the context
of the AMP3 quality programme, these functions are principally
to comply with the terms of their discharge consents and abstraction
licences as well as supplying drinking water to the standards
set down in the Water Supply (Water Quality) Regulations.
2. Please describe how Ofwat interacted with
the DETR, National Assembly for Wales, DWI and Environment Agency
during the Periodic Review Process.
It would also be helpful if you could set out
the timetable for the 1999 review indicating Ofwat's actions at
each stage. For example indicating briefly when and how company
data or Government guidance was requested/assessed/processed.
The 1999 Periodic Review process spanned the
three years up to the announcement of the final determinations
in November 1999. During this time, Ofwat interacted with Government
and the quality regulators formally at all levels. So that they
might make informed decisions and understand the implications
for customers of those decisions, at key stages Government was
advised of the possible costs of the environmental and other programmes
being contemplated and impacts on household bills. This was achieved
via open letters or widely circulated reports. Such documents
were used by Ofwat to expose the principal issues and request
guidance on matters of Government policy.
Additionally, the Director and senior Ofwat
staff briefed Ministers at meetings held throughout the process.
Meetings with Government officials, EA and DWI staff were also
held at working level on an "as needs" basis. Subject
to the confidentiality status accorded to various information
provided by the companies, Ofwat shared data with other parties.
Further detail on this is given in the Overview.
Please find attached at Annex 2 a chronology
of the 1999 periodic review setting out the key actions undertaken
at each stage of the review.
THE REVIEW
PROCESS
3. Could the review process be improved? What
improvements to the process did Ofwat make in the light of its
own review of the 1994 price review? Is a report of this review
available?
At all stages of the Periodic Review Ofwat consulted
stakeholders on the process, methodology and prospective price
limits. In June 1997 Ofwat consulted on the proposed framework
and approach to the review and how it planned to involve and respond
to stakeholders. This is set out in The Proposed framework
and approach to the 1999 Periodic Review: A consultation paper
(June 1997) and Setting price limits for water and sewerage
services: The framework and business planning process for the
1999 Periodic Review (February 1998).
Ofwat is currently undertaking a review of the
1999 Periodic Review to determine what Ofwat did well and what
could have been done differently. The objective of this review
is to inform the periodic review process in 2004. The review involves
all stakeholders. A summary of the results of this review will
be published in June 2000 and copies will be passed to the Committee.
Following the 1994 Periodic Review a review
was undertaken in December 1994 on the overall approach and management
of the process. The review involved Ofwat staff, companies, Reporters,
city, media and consumer and business organisations. An internal
report setting out the key learning points from the 1994 Periodic
Review was prepared. The key learning points from this review
were addressed in the 1999 Periodic Review. A summary of these
is set out below.
— A perceived inequity between the
volume of information provided to Ofwat by the companies and explanations
provided to companies on the price limits set for them. At the
1999 Periodic Review Ofwat produced a more comprehensive publication
setting out the methodologies underlying the determinations. Each
company also received a confidential Supplementary Report setting
out the detail behind its individual determination.
— Timing and timescales—that
the process at the 1994 Periodic Review seemed rushed at the latter
stages. Ofwat set out at an early stage the timetable it proposed
to adopt for the 1999 Periodic Review. Although both the 1994
and 1999 reviews were conducted over three-year periods the time
allowed between draft and final determinations was considered
to be too short at the 1994 Periodic Review. In 1999 considerably
longer was allowed between the draft and final determinations
of price limits. So that stakeholders had sufficient time to make
considered representations on the draft determinations a period
of four months was allowed between draft and final determinations
compared to two months in 1994. In 1999 Ofwat published its draft
determinations. In 1994 this information was kept confidential.
— A perceived lack of transparency
as to how methodologies would be and were applied. Ofwat considers
that transparency is fundamental to the way in which it operates.
At all stages of the 1999 Periodic Review Ofwat described the
methodology it proposed to adopt, how it was evolving and how
stakeholders' views were taken into account. In conducting a review
a balance has to be struck between maintaining commercial confidentiality
and operating transparently.
— A perception that consultation exercises
were used by Ofwat to inform the industry rather than to engage
in a real dialogue. Ofwat set out at each stage of the 1999 Periodic
Review the issues on which it was consulting and also published
the views expressed in response and how Ofwat had responded to
the issues raised.
4. Does the present system allow sufficient
flexibility in accounting for the differing impact of quality
and other obligations by region?
Yes. The series of information submissions from
individual companies allowed Ofwat to build a picture of the impact
of the expected quality and other obligations. Both in terms of
the requirement outputs and their costs and impact upon bills,
on a regional basis from an early stage. Ofwat first provided
advice to Government on likely ranges of costs and relative bill
impacts of different drinking water and environmental improvement
programmes in the open letter, Setting the quality framework
in April 1998. Subsequent development of the National Environment
Programme by the Environment Agency, on a scheme by scheme basis,
defined the scope of the various programmes and helped companies
and Ofwat to refine the cost estimates of the required outputs
in each region.
5. At present, there is no specific legislative
provision for the quadripartite process. Do you think that the
quadripartite process should be formalised or are the roles and
remits of the participants sufficiently clear?
The quadripartite process was set up by the
Department of the Environment for the 1994 Periodic Review. It
is now managed by DETR and NafW.
Ofwat welcomes the process and the transparency
it provides. Ofwat believes the process has served customers well
for the last two periodic reviews of water prices and does not
see any reason why current arrangements should be formalised.
Indeed, in an industry which is, and likely to remain for some
time, the subject of significant structural and regulatory change
we believe there is a strong case to maintain flexibility by not
formalising the system. The current absence of constraints means
the process can be reworked as circumstances change and the relative
involvement of all parties fine-tuned accordingly.
Under the present arrangements each of the parties
to the process has easy access to the others at all levels. Ofwat's
policy throughout the 1999 review has been one of openness and
transparency. This protects the interests of all parties by enabling
them to take decisions which are fully informed. The length of
the periodic review process and the emphasis on consultation at
every key stage ensures that the opportunity to air and consider
each party's views is maximised.
6. How does the system of "Reporters"
work? Do you feel that Ofwat is able to access the quality of
the data provided by the water companies effectively?
Companies are required by the Director under
a number of licence conditions to appoint independent professionals,
Reporters, to certify and report their opinion on the regulatory
information companies submit to him. They have a duty of care
to the Director. The Director approves the Reporters' appointments
and can direct the water companies to terminate their Reporters'
contracts on the grounds of poor performance. The water companies
pay for their Reporters' work.
The Reporters' relationships with Ofwat, the
quality regulators and the water companies, including contractual
matters, are set out in the Reporters' protocol of November 1997.
The protocol also sets out the framework of the approach to the
Reporter task. During the periodic review the Reporters' process
followed that framework.
For each information submission:
— Detailed guidance was given to Reporters
on what was required of them, the priority areas for their audit,
eg areas of high expenditure, and the scope and timing of their
reports to the Director.
— Reporters produced outline audit
plans which were assessed by Ofwat for completeness of coverage
of the submission topics, suitability of reporting team members
(breadth of disciplines and depth of experience) and inputs to
be made. Ceiling costs were set commensurate with the size and
complexity of the companies.
— Workshops were held between Ofwat,
Reporters and their senior staff and the Auditors, at which they
were brought up to date with policy developments and reporting
issues.
— During their certification process
Reporters were expected to work alongside the companies, checking
that company material assumptions were exposed in their submissions,
and that Ofwat policy guidance and information definitions were
followed by the companies. This assured Ofwat of the consistency
of the companies' submissions.
— Reporters' reports were assessed
for compliance with guidance, their usefulness to the Ofwat teams
and clarity. Ofwat's assessment was fed back to them so that they
could improve their future contribution to Ofwat's analysis of
company submissions.
During the periodic review Ofwat commissioned
a joint team from KPMG and the Babtie Group (management consultants
and engineering consultants respectively) to carry out two reviews
of the Reporter process and report to the Director.
The first review was carried out in early 1998.
Its objective was "to assess the confidence the Director
and other should have in the process of using Reporters to audit
water companies' submission processes with particular reference
to the Main Quality submission".
The second review took place from late 1998
to the summer of 1999. The first part of this review was centred
on the reporting process for Submission J—the Update of
Quality Costings—for North West Water, Southern Water and
Anglian Water Services.
The team then reviewed the Reporters' process
for the Business Plan audit and report, focused upon Thames Water,
Welsh Water and Northumbrian Water. In addition to interviewing
and observing Reporters the review team also held discussions
with senior water company regulation managers.
The team's opinion was presented in reports
submitted after each stage.
The KPMG/Babtie team also produced a final report—the
Critical Overview of the Reporters' Process, which drew
together their findings over the first and second external review.
The final report was shared with the companies and Reporters in
August 1999.
The team's opinion was that the Reporters' process
is valuable to the Director in giving him an objective evaluation
of the soundness and validity of the information employed by the
water companies in the development and presentation of their Business
Plans. It concluded the Director should feel confident in relying
upon this evaluation.
7. How could companies' submissions to Ofwat
be improved?
Ofwat provides detailed guidance on the completion
of each of the submissions and requires each to be signed off
by the company's Board as well as be subject to review by the
Reporters and Auditors. This enables Ofwat to compare and contrast
the different submissions across the companies and over time.
As at the 1994 Periodic Review the companies'
Business Plans, in many cases, were bids for additional resources.
Many lacked coherent Board strategies setting out the views of
all stakeholders, including customers and showed little acceptance
of the need to make tough business decisions. For example, companies
did not generally set out an economic analysis of the options
available for maintaining serviceability for customers in considering
the need for additional expenditure to maintain assets. The Director's
panel of senior industrialists concurred with this view. The quality
of some plans was disappointing. Some companies submitted changes
at a late stage.
8. What steps has Ofwat taken to ensure sufficient
transparency of its own methodologies for processing the data
it receives and indicating how they have been applied to individual
companies?
Ofwat engaged in a three-year dialogue with
stakeholders leading up to the final determinations. A phased
process allowed timely debate of the issues and enabled stakeholders
to make informed contributions.
Final determinations: Future water and sewerage
charges 2000-05 (November 1999) set out the final decisions
on price limits. It also exposed the reasoning underlying the
Director's decisions.
In addition, each of the companies received
a Supplementary Report setting out the specific reasoning underlying
the Director's decisions at both draft and final determinations.
The Supplementary Report at final determinations also set out
the differences between draft and final determinations.
9. Does Ofwat have any in-house expertise
in environmental economics?
Unlike the Environment Agency, there is no statutory
duty on Ofwat to have regard to costs and benefits in exercising
its powers. Ofwat does not have (or, indeed, need) the resources
of the Environment Agency to assess the relative costs and benefits
of each of the several hundred environmental improvement schemes
not driven by specific legislation.
However, Ofwat has sufficient in-house expertise
to contribute meaningfully to the debate on costs versus benefits
of environmental improvements and mount a robust challenge to
discretionary schemes. This is in line with Ofwat's statutory
duty to protect customers.
Ofwat takes a close interest in the evaluation
of costs and benefits of environmental improvement schemes. Ofwat
was a sponsor, and represented on the project steering group overseeing
the production of the Assessing the benefits of surface water
quality improvements manual (Foundation for Water Research,
1996). It is active in a DETR initiative to revise the current
manual.
Within the past few years Ofwat has had representatives
on the steering groups for DETR studies into economic instruments
for water pollution control; and water abstraction; and on the
DETR Water Framework Directive economists advisory sub-group.
Suitably qualified staff also participate in periodic meetings
of the Environmental Economics UK National Forum.
10. Are you satisfied with the quality of
the various customer surveys which were carried out by interested
parties during the Periodic Review? Should there be an independent
survey to avoid the inevitable variations in emphasis which were
acknowledged in Raising the Quality (para 9)?
The quality of market research carried out into
customers' views varied. However Ofwat is satisfied that the overall
process for identifying customers' views resulted in a fair reflection
of these views in the final package of prices and service improvements.
Market research was only one aspect of the consultation
process. Companies Customer Services Committees and others also
looked at evidence such as the extent and nature of customer complaints
and other customer consultation mechanisms, some of which are
well established and not put in place simply for the price review.
Customer groups were also able to comment on company specific
information since Ofwat both required companies to put their proposals
into the public domain and published its own draft determinations
for comment.
Ofwat does not consider that an "independent"
survey was needed or would have assisted. The work carried out
by companies and others was published in full and open to public
challenge.
However, Ofwat did consider that it would be
helpful to establish principles of good practice in surveying
these complex issues and such guidance was issued to companies.
Ofwat also established a process by which CSCs were able to assess
and advise the Director on companies' customer consultation strategies.
Ofwat's approach was itself subject to consultation at an early
stage.
THE FINAL
DETERMINATIONS
11. It would be helpful if you could set out
how the final determinations differ from the draft determinations
(as published) and the reasons for any changes.
The table included at Annex 4 sets out the difference
between the draft and final determinations. The draft determinations
allowed for an industry average initial reduction in price limits
of -13.7 per cent and an average annual price limit of -2.9 per
cent for 2000-05. The final determinations delivered an industry
average initial reduction of -12.3 per cent and an average price
limit of -2.1 per cent for 2000-05.
Following the publication of the draft determinations
of prices Ofwat received over 170 representations from water companies,
environmental groups, customer representatives, trade bodies,
trade unions, MPs, local Government organisations and members
of the public.
In addition, the Director met with each of the
companies and representatives of the Customer Service Committees
in order that they could make their representations in person.
In making his final decisions the Director considered all these
representations.
The final determinations took account of some
additional quality requirements. Reappraisals were made, by the
companies and the Environment Agency, of some quality improvement
proposals.
Final determinations allowed for different rates
of take up of optional meters in some companies. In addition,
companies provided further information on specific issues which
was taken into account in some individual cases.
The final determinations also took account of
changes in the costs of business rates and the phasing of operating
expenditure arising from the previous quality programmes.
Each of the companies was provided with a confidential
report that set out the changes between its draft and final determinations
of price limits. Final determinations: Future water and sewerage
charges 2000-05 summarises the changes between draft and final
determinations (Section 1.3) and the nature and account taken
of representations (Appendix B).
Changes between the draft and final determinations
were particularly marked for North West Water. This is because
an enhanced and accelerated improvement programme was included
in price limits following final Ministerial guidance. The impact
on price limits was that over the period 2000-05 the average annual
price reduction for North West Water of -1.9 per cent in the draft
determination fell to -0.5 per cent in the final determination.
12. What is your view on the final price limit
profile?
There should be a reasonable balance between
passing efficiency savings to customers through lower bills, and
continuing to improve drinking water quality and the environment,
and improving levels of service. Customers expressed a preference
for bills not to rise above levels in 1998 and did not wish to
see significant rises after any initial reduction.
In determining the profile of price limits to
be reflected in customers' bills a balance had to be struck between
sometimes conflicting views and priorities.
The profile of price limits also takes account
of the phasing of quality and environmental programmes. In some
cases price limits have to rise at the end of the period to allow
the companies sufficient revenue to meet interest payments on
the capital they need to borrow to fund the quality and environmental
programme.
13. In Raising the Quality the DETR highlighted
the importance of stability in prices from 2000-05. The Department
reported that the respondents to its consultation on the Director's
open letter were concerned that a large price cut in 2000 followed
by real terms increases in the rest of the quinquennium would
send confusing messages to customers. The DETR asked the Director
to consider the scope for setting profiles which addressed such
concerns (p5).
How does the final price limit profile address
these concerns?
Customers indicated that they would like to
see bills fall where significant savings are possible and Ministers
indicated they would like to see prices fall in a way, which thereafter
preserves stability. In September 1998 the Government stated its
expectation that the periodic review of price limits would deliver
average price cuts to customers of around 10 per cent.
The final determinations allow for an initial
reduction of 12.3 per cent to the level of price limits to reflect
past efficiency gains and a lower cost of capital. At the industry
level this reduction is broadly sustained for the five year period;
but for a few companies average household bills will need to rise
annually because of the large capital investment requirement to
improve quality standards.
The profile of the final determination of price
limits seeks to meet Ministers' requirements. Final determinations
largely reflect an L shaped profile with price limits remaining
stable following an initial reduction to reflect past efficiency
and a lower cost of capital.
14. How do you think this profile will affect
water use by customers? Will a reduction in prices mean that customers
have less of a price incentive to use water efficiently and water
companies will have to do more to encourage efficient use? Do
the final price limits account for such a scenario?
At the national level the demand for water is
projected to fall in the medium term although many companies expect
this to reverse during 2000-05.
The majority of household customers continue
to be charged on an unmeasured basis. Their use of water will
not be directly affected by the reduction in their bill.
Regarding measured customers, in MD152, Approval
of companies charging schemes in 2000-01 (13 September 1999)
the Director instructed companies to maintain proper incentives
for the efficient use of water within the structure of the measured
tariff in 2000-01. He stated that "volumetric rates should
be set to encourage customers to use water efficiently" and
that "having regard also to the Secretary of State's draft
guidance standing charges should therefore fall by a greater amount
than volumetric rates". The current company charges schemes,
approved earlier this year, meet this general expectation.
Information collected each year will enable
Ofwat to monitor water delivered and any changes in customers'
consumption of water and sewerage services.
15. Are price increases likely to be required
in the immediate period after 2005?
The direction in which prices will head after
2005 depends on a number of factors. Downward pressure on bills
will depend on a company's performance relative to Ofwat's assumptions
on efficiencies it will make over the next five years, and Ofwat's
assumptions on the scope for continued efficiency savings beyond
2005. Countervailing upward pressures may be expected from any
further requirements for drinking water and environmental quality
improvements.
Forthcoming European and national legislation
could mean that expenditure on new quality and environmental obligations
will again be a very significant influence on water bills in the
next pricing period. European legislation that might be expected
to impact on the water industry includes the Water Framework Directive;
and revisions of the Bathing Water Directive; and the Sludge to
Agricultural Land Directive. Any further designations of bathing
waters and sensitive areas under existing directives may also
trigger the need for improvements in sewerage and at sewage treatment
works.
The Environment Agency and environmental groups
may continue to press for the implementation of improvements put
forward by the Agency in A Price Worth Paying (May 1998)
but not endorsed by Ministers for inclusion in current price limits.
This would entail improvement of the last 800 unsatisfactory intermittent
discharges; completion of the programme to achieve current river
quality objectives in the South-West; and the improvement of over
500km of rivers throughout the country which meet current RQOs
but whose quality is still categorised as poor or bad.
As explained in the Overview, the interest cover
ratios in many companies have now reached a point where further
borrowing for a significant 2006-10 environmental programme could
only be made at a considerably higher cost of capital. Analysis
of four key companies has indicated that if the 2006-10 quality
programme where to be the same size as the 2000-05 programme,
then the average household bill, for those companies, may rise
by £20-50 in the period 2005-06 to 2009-10. Accordingly,
Ofwat would caution against further significant investment on
"non-statutory" environmental improvements in the current
pricing period as this would leave less room for mandatory improvements
to be efficiently financed in the period after 2005.
16. Water companies cannot only select certain
aspects of the determination for adjudication by the Competition
Commission—would Ofwat like to see this changed?
No. The Director takes a balanced view of a
range of factors when he determines price limits. Companies have
to consider whether they can accept the package of price limits
and assumed outputs. The Commission has to set price limits. It
must therefore, take account of all relevant factors.
17. What reasons did the Environment Agency
give to Ofwat for stating (in a letter to water company managing
directors—4 January 2000) that it is not bound by Appendix
E (protocol for changes in companies' obligations and consents
after the final determinations) of the final determination document?
Was the Environment Agency consulted on the contents of Appendix
E?
The Environment Agency informed Ofwat in a letter
dated 25 November 1999 that it was unable to accept the proposed
protocol in Appendix E of Final determinations: Future water
and sewerage charges 2000-05 (November 1999). The letter stated
"the Agency cannot accept the potential restrictions on its
freedom to act to protect the environment that your protocol proposes."
In separate correspondence, copied to the Director, the Agency
state, "In several respects it would have the effect of curtailing
the independent role of the Agency Board in protecting the environment".
However, to Ofwat's knowledge the Agency has not subsequently
provided any elaboration of either statement.
Water UK responded to the Agency's 4 January
letter, on 11 February. In this letter (copied to Ofwat, DETR
and DWI) Water UK requested an explanation in more detail of the
Agency's concerns. Ofwat does not know if such an explanation
was provided.
In a reply on 6 December 1999 to the 25 November
1999 letter, Ofwat replied: "The protocol does not restrict
the Environment Agency's freedom to act to protect the environment,
but it does reflect the expected use of the appeal mechanisms,
set down in Acts of Parliament, for non-trivial changes that are
not clearly and directly linked to prior Ministerial decisions.
Of course, water companies would not need to use these mechanisms
if they were prepared to meet the additional costs without further
recourse to either current or future customers."
Ofwat did not consult the Environment Agency
on the contents of Appendix E simply because, as is clear from
the 6 December 1999 letter, the protocol has no implications for
the functions and duties of the Agency. The DETR has indicated
that it will offer a view on these issues shortly.
18. Ofwat has adopted a policy of "no
deterioration" in water and sewerage services in setting
the final price limits. Are you satisfied that such a policy will
ensure the serviceability of the infrastructure so that problems
are not stored up for the future?
Yes. The serviceability approach has been developed
over a number of years. The approach ensues that the service offered
to customers in terms of receiving a continuous water supply at
acceptable levels of pressure and at the correct quality standards
is also provided at an appropriate cost.
Under the serviceability approach the company
must carry out what it considers necessary to maintain service
to customers. Ofwat does not believe that serviceability will
suddenly deteriorate in the future.
19. How does Ofwat monitor/audit the water
companies' progress against their licence requirements?
Ofwat has an integrated approach to monitoring
each company's performance in carrying out its statutory duties
and licence requirements as well as regulatory expectations, as
part of the regime of comparative competition. In June each year
Ofwat requires each company to submit comprehensive returns on
actual progress, service levels delivered, activity, expenditure
and financial results—all set within the medium term context
of regulatory expectations. Every January each year Ofwat requires
a similar return (the Principal Statement) on the proposed tariffs
for the next financial year.
The returns are structured and must comply with
Ofwat's detailed reporting requirements to ensure comparability
both over time and between companies. The returns are subject
to detailed scrutiny by the technical and financial auditors (Reporters
and Auditors respectively), both of whom submit separate reports
to Ofwat on their findings. At the same time the Drinking Water
Inspectorate and the Environment Agency also provide reports on
their assessments of each company's compliance with quality obligations.
Additionally, the Environment Agency will be reporting to Ofwat
each year on the progress made by the companies in completing
the projects to the agreed timetables assumed in the final determination.
Ofwat reviews and analyses this information
to assess each company's performance and compliance with statutory
and licence requirements, regulatory expectations and how it compares
with its peers. Where shortfalls are identified regulatory action
follows to require the company to remedy the situation by the
earliest possible date, together with more frequent reporting
(usually quarterly) to check on progress. Ofwat summarises the
position for the sector and each company in its annual series
of reports—Financial performance and expenditure; Levels
of Service; Leakage and water efficiency; Tariff structure and
charges.
THE ENVIRONMENT
PROGRAMME
20. How did the Environment Agency demonstrate
the cost-effectiveness of the components of the environmental
programme which it recommended to Ofwat?
The Environment Agency did not recommend the
environmental programme directly to Ofwat, since decisions on
these matters rest with Ministers. The Agency proposed to Ministers
a list of improvements identified, in most cases, at scheme level.
Ministers decided which improvements should be carried out, issuing
guidance to the Director and confirming the particular schemes
to be considered when setting price limits.
Ofwat believes that customers and their representatives
should be informed how the balance is struck between environmental
concerns and the bills they are likely to have to pay. Ofwat hopes
that the joint approach that has been forged with Government and
the quality regulators will enable better decisions on new standards,
through bringing together good information on the benefits of
water quality and environmental improvements and their likely
costs.
The Agency made efforts to quantify the benefits
of components of the environmental improvement programme it promoted
for the 1999 Periodic Review, principally through the application
of the Multi-Attribute Technique (MAT). Ofwat has concerns over
certain aspects of the work undertaken to establish cost-effectiveness.
Limited attention seems to have been given to
establishing that proposed improvements offered value for money
for the environment and the customer. A decision was taken by
Ministers, however, to limit the size of the programme to achieve
RQOs in the South West Water area where customers have the highest
sewerage bills in England and Wales.
Ofwat is also concerned that limited consideration
appears to have been given to exploring whether similar environmental
benefits could be obtained at lower cost by dealing with non-water
company discharges.
Included below are three areas where schemes
were put forward and there was an opportunity to weigh costs and
benefits:
(i) Improvements to intermittent discharges
(4,682 to be improved by December 2005 at an assumed cost of £1.76
billion)
Raising the Quality stated:
"the Government wishes to see: better prioritisation
of schemes based on a sound analysis of costs and relative benefits,
using an approach which is agreed with the Departments".
(paragraph 63)
A methodology for weighing the relative costs
and benefits of the intermittent discharge programme was not developed
by the Environment Agency. With DETR's agreement the Agency ranked
the proposed projects on the basis of cost drivers, the existence
of a parent scheme and by river amenity value. Within these categories
individual schemes were ranked by estimated capital cost.
Ministers decided on the proportion of the proposed
schemes that should be included in the improvement programme but
did not set down the basis used for making these decisions.
(ii) Alleviation of adverse environmental
effects of water abstraction (low flow schemes)
In Raising the Quality Ministers commented:
"The EA has said that it will have prepared
assessments of each of these schemes by November this year. These
should set out concisely the objectives of each scheme, together
with an appraisal of the associated costs and benefits".
(paragraph 112)
and later on (paragraph 115),
". . . Schemes . . . Should be incorporated
in his [the Director-General's] price determinations, subject
to the EA assessments due in November and the more detailed guidance
that Ministers may give in individual cases thereafter".
Ministers expected schemes for inclusion to
be justified by:
— the quantified extent of the environmental
damage the scheme is to remedy;
— the extent of local concern about
the environmental damage;
— linkages to schemes for the protection
or improvement of water quality in the water body concerned;
— the effects of the scheme on downstream
water resources interests; and
— the monetary costs and (insofar as
they can be reasonably quantified) benefits of the scheme.
Cost-benefit studies for the low flow schemes
were not shared with Ofwat, and Ofwat is uncertain of the extent
of the assessments made for each of the schemes that were designed
to investigate or resolve a problem.
In the absence of such studies Ofwat was obliged
to test the Business Plan proposals against these requirements.
Not all of the proposed schemes satisfactorily addressed these
criteria. For the draft determination a number of low flow schemes
were omitted from price limits pending further appraisal. Between
the draft and final determination some schemes were reviewed,
reappraised and adequately justified for inclusion in final price
limits. Four schemes were not included in the final price limits,
Ministers confirming that further reappraisal was required.
Ofwat did not have the opportunity to examine
the studies carried out by the Agency on the environmental benefits
of implementing the low flow alleviation schemes. One company
provided a copy of a study, which was useful in clarifying the
company position.
(iii) Schemes to achieve or protect River
Quality Objectives
In 1996 a jointly funded initiative to develop
a comprehensive approach to cost/benefit analysis of surface water
quality improvements was completed with the publication of Assessing
the benefits of surface water quality improvements manual
by the Foundation for Water Research. The then DoE, the National
Rivers Authority/Environment Agency and Ofwat were represented
on the project steering group. This manual is recognised as setting
out the most comprehensive and up-to-date methodology for evaluating
water quality improvement schemes based on well-established economic
cost-benefit principles. It was not used by the Environment Agency
for testing the environmental improvements put forward for consideration
at the 1999 Periodic Review.
The Multi-Attribute Technique (MAT) was devised
and used by the Agency to rank RQO schemes according to a calculation
of the aggregate benefit they offered rather than as part of a
cost-benefit comparison. Ofwat believes there are a number of
technical problems with the methodology, which have never been
satisfactorily resolved.
The Agency did not reject any of over 700 RQO
schemes examined as not being cost-effective. All were submitted
to Ministers for confirmation, many with very low MAT benefit
values and three schemes that were assessed to offer zero benefit.
Ofwat reviewed these 700 schemes at summary
level, investigating the cost-effectiveness of the suggested solutions.
Ofwat looked at the cost-effectiveness of these schemes on the
basis of their benefit (MAT score) to cost ratio and suggested
that the most expensive schemes representing the last 5 per cent
of aggregate benefit should be reappraised. This represented 63
RQO schemes, some of which had very high unit costs, including
one where improvements were estimated to cost £10,000 per
metre of river improved. Ministers confirmed this approach, and
companies and the Agency were given the opportunity to reappraise
the schemes between the draft and final determination. Following
review one company put forward an alternative scheme (one twentieth
the estimated cost of the original scheme) which was acceptable
to the Agency.
The reappraisal of the 63 schemes, both by using
MAT and the FWR manual procedures provides the Environment Agency
with an opportunity to demonstrate the validity of its judgements.
Ofwat awaits with interest the outcome of these comparative studies.
21. The Government and energy utilities have
established the Energy Saving Trust (EST) which a non-profit distributing
company working towards the sustainable and efficient use of energy
through partnerships. In particular, the EST seeks to stimulate
energy efficiency in UK households to achieve social, environmental
and economic benefits. Energy utilities currently have an obligation,
set by the Regulator, to achieve Energy Efficiency Standards of
Performance (EESPs). These provide a mechanism for electricity
companies to invest in energy efficiency for customers as verified
by the National Audit Office. The programme is developed and overseen
by the EST on behalf of OFFER. Do you think that this would be
a useful model for promoting water efficiency?
While there are some parallels between energy
efficiency and water efficiency there are also significant differences.
For example the reduction of energy consumption is a national
issue, given the Government's commitment at Kyoto to reduce the
climatic and environmental impact of emissions. All UK citizens
will benefit from action taken to tackle global warming. By contrast
the efficient use of water is a more regional issue. The value
of water efficiency is in the reduction of water use in areas
where resources are in short supply or where existing abstraction
may be causing localised environmental damage. Water put into
public supply is not lost to the environment as a whole, but may
be returned to a different stretch of river from the abstraction
point.
Ofwat is responsible for ensuring that water
companies fulfil their statutory duty to promote the efficient
use of water by their customers. To date this has been achieved
by requiring companies to set out a water efficiency strategy
and by monitoring their activities and identifying initiatives.
The focus now is moving to establishing a more robust understanding
of the costs and achievable savings associated with different
activities. Ofwat believes that it is not necessary to set performance
targets for water efficiency. We have set out in the 1989-99 report
on Leakage and Water Efficiency the water efficiency activities
we expect companies to undertake.
| 
