Examination of Witnesses (Questions 200
- 219)
THURSDAY 6 JULY 2000
SIR IAN
BYATT AND
MR KEVIN
RIDOUT
200. As the review continued, the Government
made a statement in September 1998 that there would be a major
expansion of environmental works, a programme totalling about
£8 billion. Did this cause problems for you given that you
had already made your statement that you envisaged significant
price cuts? How was the tension between your policy of price cuts
and the Government's policy of massive expansion of the environment
programme resolved?
(Sir Ian Byatt) I think ministers wanted to see lower
prices as well as an environmental programme, and they had their
own issues to resolve and I cannot really help you with how they
did that. As far as I am concerned, there was of course a large
environmental programme in the period from 1995 to the end of
the century, and the issue was how big a programme would continue.
What we did during the spring of 1998 was to send an open letter
to ministers where we had costed what was then on the table. In
the light of that costing, and of course in the light of where
we had got to on such assessments of efficiency as we had been
able to make at that stage, ministers looked at that and made
their decisions which they published in Raising Quality
at, I think, the end of September 1998—it might have been
early October but I think it was the end of September—when
they had resolved their own views about trade-offs.
201. But is not this tension between price cuts
and the environmental improvements still there? Does this not
explain why there is still a question mark over certain parts
of the environmental programme with individual companies who have
complained that they are not clear whether such and such a programme
is to be included in the programme or not?
(Sir Ian Byatt) To take the second half of the question
first, if I may, there is now complete clarity about what is in
the programme, and if you have been told anything to the contrary
by anybody else I think they are incorrect. There is now complete
clarity.
202. Yesterday, we were told by North West Water
there is not complete clarity. It would be very helpful if you
could—
(Sir Ian Byatt) I will ring up North West Water as
soon as I get home. There is clarity certainly as far as costs
are concerned. I do not want to avoid a situation where for the
same money something different could be done. It would be foolish
to try now to set in concrete, if that is the right word, everything
five years ahead. There has to be some flexibility in projects.
That seems to me entirely desirable. But as far as financing is
concerned, as far as the money which has been allowed for and
the programmes which ministers wish to be carried out now, that
is absolutely clear. You ask me about tensions between the environment
and customers' bills, of course environmental improvements cost
money and of course customers ultimately are paying that money,
and so in some sense there must always be some tension, some trade-offs,
as we find in our own private lives. We have been fortunate in
the last few years, certainly culminating in this price review,
in being able to have, so to speak, our cake and eating it. So
thanks to the efficiency of water companies which has accumulated
since they became private, customers have been able to see lower
bills and a better environment, but of course in the future there
may well be some thinking to be done about how the money is spread.
There is always a balance, I think.
203. Does that mean you do not think we can
carry on having our cake and eating it in the future, and that
post-2005 prices will start to rise again if we want to continue
the environmental programme?
(Sir Ian Byatt) I think that must depend on how the
efficiency pans out over the next five years, and I am going to
leave that to my successor to look at. Also it depends on the
size of the environmental programme and that is very unclear.
The water industry will almost certainly continue to invest heavily
after 2005, they have a capital stock to maintain in a serviceable
state and have to continue to maintain serviceability to customers.
We allowed something like just over 6 billion—I think it
was 6.4 but I am subject to correction on my decimal places—
(Mr Kevin Ridout) 6.2.
(Sir Ian Byatt) —6.2, thank you, for capital
maintenance. Who knows whether that will go on at exactly the
same level or whether it will become more efficient or whether
problems will be found. So the spending will carry on in that
way. Then, on supply and demand, we allowed 1.7 billion capital
expenditure, a lot financed through infrastructure charges but
still there, and we are currently in the situation where the demand
for water is not rising. If the demand for water were to start
rising again, that would be a bigger number. So how much scope
there is for an environmental programme depends on those factors
as well as on environmental demands, but even those two things
I have talked about could lead to expenditure which was greater
than was going on in the 1980s.
204. So the likelihood is that bills will rise
from 2005?
(Sir Ian Byatt) No, no, I did not say that.
205. That was the underlying substance of what
you were saying.
(Sir Ian Byatt) No, I am sorry, I did not mean that.
I think there is always efficiency on the one hand and the scale
of the quality programme on the other, and you cannot know what
the balance is going to be until you have done quite a lot work
on both, and it would be much too early to talk about that.
206. If I could just ask about the phasing of
the programme over the next five year period, we have received
some criticism that the phasing has been such that the majority
of the environmental works will come at the end of the programme.
Could it not have been arranged in such a way that it was more
evenly spread out over the five year period?
(Sir Ian Byatt) We have to think about two factors
there. One is the efficiency with which the companies can carry
out their capital programmes. If you rush a capital programme,
then you are not always able to find the efficiencies you could
find if you had a little more time. Some of the capital programmes
I believe in the early 1990s were rushed. I think part of the
reason why South West Water's bills went up by so much was they
were rushed. Maybe it was right to rush them, because you do get
the outputs, but you have to pay the penalties in terms of the
costs or the inability to find the same efficiencies. So we have
to think carefully about the planning ability of the companies
and then also we have to think carefully about the financing of
these programmes, because a company in order to borrow cheaply
in the market has to maintain a particular financial position,
and in particular above all it has to keep an interest cover in
its accounts which is adequate. In the price review we looked
at a number of financial indicators and they are set out in this
document (Final Determinations: Future Water and Sewerage Charges
2000-2005). The financial indicators we chose, which all have
long and complicated names, are the ones which are conventionally
used in the city because we do a lot of work in the city and we
spend a lot of time talking to the providers of finance, because
billions have to be borrowed for this programme, in order to set
the price limits so that we can maintain a good financial profile.
If you rush things, of course, then you find you run up against
your financial covers. In some cases, for example in North West
Water, particularly because of the discussions which I had with
the Minister for the Environment between July and November, bills
were coming up again because of the need to meet these financial
covers.
207. I do not see the logic of the bills rising
at the end of the period. Would the same objective not have been
achieved had the bills remained stable throughout the period in
the case of North West Water, for example?
(Sir Ian Byatt) In the case of North West Water, you
have a perfect example of our arithmetic because in the draft
determinations of July you will find a reduction in the bill and
then a fairly flat bill thereafter, and then in the final determinations
the bill starts to come up again. The reason for that is essentially
that in the draft determinations we assumed that the environmental
obligations were all completed by the end of 2005, by December,
in line with EC obligations, and the Environment Minister discussed
with me bringing them forward. I explained if we brought them
forward and so had a more concentrated capital programme that
could cause problems with the financial indicators. He accepted
that but decided nevertheless that was what he wanted to do. So
you will see the differences there and that was a timing issue.
208. So when the bills of my constituents go
up at the end of the next five year period, I can blame it on
the Minister and not yourself?
(Sir Ian Byatt) It is not a question of blame. Decisions
were consciously taken by the Minister.
Chairman
209. That does not really answer the question
of whether a more incremental approach to price increases would
have been wiser in the medium term, both in terms of the financial
effect on the companies, which have now lost a lot of value on
the stock market and therefore also on their ability to bring
forward the capital programme, rather than this dramatic cut which
you made. I can see the appeal of that but a more incremental
approach might have been wiser, might it not?
(Sir Ian Byatt) No, I do not think it would. You mean
having a more gentle price change?
210. Yes.
(Sir Ian Byatt) That would have left the companies
with a lot of profit in the early stages. I did do some consultation
with customers and particularly asked the customer service committees
on this and they were not very fond of the idea of paying the
companies a great deal of extra profit in order to make their
financial position slightly easier towards the end of the period.
211. But not just their profit, money for their
capital programme.
(Sir Ian Byatt) You have to be sure that money is
maintained for the capital programme and not paid out in dividends.
We did have a glide path, as it is known in the trade, a more
gentle adjustment of prices in the 1994 review, and the companies
responded by increasing their dividends very substantially. I
warned them several times about that and I resolved that was not
a sensible position to repeat.
Chairman: You have mentioned customers,
I know Christine Russell wants to come in on the question of customer
services.
Christine Russell
212. Good morning, Sir Ian. One of your key
roles of course is to protect and represent the interests of customers,
and in your opening remarks you placed quite an emphasis on the
priority that you gave to consultation during the review period.
In the evidence that we have heard so far it is quite obvious
that there were some very different conclusions to the customer
surveys that were carried out. We were made aware of the Environment
Agency and in their survey they said that 95 per cent of customers
would prefer water bills to remain the same providing there were
environmental improvements. The DETR survey had over 50 per cent
saying that customers would actually prefer to pay more for priority
improvements. Yet your National Consumer Council concluded that
what customers really wanted was price reductions. I wonder if
you would like to comment on the different conclusions of the
customer surveys which were carried out?
(Sir Ian Byatt) Indeed. I regard all these customer
surveys as extremely valuable and I am delighted they are carried
out. Of course, you always have to look at how the questions were
asked, and there is an art in this as well as a science. The conclusions
I draw are that customers did not want to see any deterioration
in the quality of the commodities and services, the drinking water
and the environment they receive. They were quite clear about
that. They did not want to see lower bills if it meant lower quality.
Then there was the question of what was the balance between getting
higher quality and lower bills, and I regret those surveys which
did not indicate to customers that they could have both in those
particular circumstances which became evident in the way I described
in my answers to Mr Chaytor before these surveys were carried
out. In Prospects for Prices where we do set out our views
on the customer research, we say that the national Water UK Survey
results indicate that on average customers would like to see approximately
half of possible efficiency savings used to reduce their bills.
That is exactly what happened. Nobody has challenged our assessment
of that. The research done by the Ofwat National Customer Council
was a very specific piece of research designed to fill a gap in
the evidence, and it particularly concentrated on low income customers.
The conclusion I drew from that was that when it comes to how
much do you want better quality and how much do you want lower
bills, the lower income customers tended to be more concerned
with keeping their bills down, but it is quite clear that they
did not want to see deterioration in quality, and of course they
will not see any such deterioration.
213. Was that the tiny survey of only 48 households?
(Sir Ian Byatt) Yes.
214. What surveys, in addition to that very
small sample, did you actually carry out?
(Sir Ian Byatt) We did not.
215. You did not do any. If you did not do any
but DETR did, the Drinking Water Inspectorate did, the Environment
Agency did—
(Sir Ian Byatt) And the companies.
216. —could I ask, Sir Ian, what your
views are perhaps in the future on having a totally independent
survey done?
(Sir Ian Byatt) It is interesting you ask me that
because we did think about that at the time and we decided the
water companies' customers were the water companies' customers,
and that I would like to see the water companies take the responsibility
for asking their customers what they wanted. That is not the way
things worked in the old days and I have been trying to encourage
them in all kinds of ways, and this is just an example, to ask
their customers and communicate with their customers and listen
to their customers. I decided that was the best strategy and then
we had other pieces of work done by the Environment Agency and
by the DETR which were very valuable. We did also do a survey
ourselves of a sample of people in four regions in early 1999
which tended to test what we had found out here. I felt we had
found out enough in order to do our job adequately at this price
review from the material which we analysed and reported in Prospects
for Prices. I think I can only leave my successor to decide
whether he believes that a national survey by the regulator is
better than the companies doing it. I would suggest to him, in
thinking about this—provided he asks me of course—that
there is an important point about the responsibility the water
companies have to their customers. They are their customers, not
my customers.
Joan Walley
217. Good morning, Sir Ian. In the evidence
you have given to our Committee you specifically say that you
do not believe that serviceability will suddenly deteriorate in
the future, and here I am talking about asset maintenance. You
are very confident that it is not going to deteriorate in the
future, what are you basing that confidence on?
(Sir Ian Byatt) We have a number of indicators of
serviceability and we think we have focused on the key indicators,
which are both delivery to customers and a combination of the
questions of pressure and interruption of supply and flooding
from sewers, and much more immediate indicators such as bursts
in water mains and collapses of sewers. We now believe we have
a longish run of information—and we publish this information,
as you know—and we think it is unlikely that there will
be any sudden change in a system which has a very large number
of pipes and a very large number of sewers, where if deterioration
takes place it usually takes place slowly, and we do measure what
is happening. There is a gap in our information, and that gap
really comes from the fact that the water companies are not I
believe doing the job I would like them to do in assessing the
economics of capital maintenance. I was disappointed in the plans
that they sent to me because they did not link very clearly the
condition of the assets to future serviceability. My business
advisers were also disappointed in those plans and, as I think
you know, we wrote a letter to the water companies, MD161 if I
remember the number correctly, explaining how we would like this
to be done. So I do not think we have come to the final conclusions
on all this. It is a very important subject and I know your particular
interest in this and I hope I have provided satisfactory answers
to your letters. I can assure you that serviceability has to be
maintained, there is no question about that.
218. Yes, but I do not feel that maintenance
serviceability is something which features in the review we have
just been through. It may well appear in the future, but I do
not believe that you have really addressed it. The crux of it
is in a way your response to my colleague Mrs Russell that this
is really all about whether or not there is going to be money
for the capital programme or money paid out in dividends. I want
to see money for the capital programme but I am not satisfied
that anybody has actually assessed what the extent of that capital
programme should be, particularly when it relates to the underground
infrastructure.
(Sir Ian Byatt) We have measured what is happening
to serviceability and we have related that to the amount of money
which has been spent, so what the companies have been doing in
the past has maintained serviceability. We do not believe there
is any evidence that serviceability is about to decline dramatically,
on the whole it is, if anything, improving at an overall level.
We keep a very close eye on serviceability and if we see evidence
of poor performance on, for example, the pressure indicator or
the interruptions of supply, I can assure you the companies get
letters and several companies have had letters about that. What
I think still needs further work is the exact relationship between
future spending and future serviceability, and we assume that
if you continue doing what you have been doing and that has been
satisfactory in the past, it will be satisfactory in the future.
We also have asset stock surveys every five years, and the asset
stock survey we believe confirms our view that serviceability
is being adequately maintained and there is not a sudden deterioration
in the assets. But I agree with you that I would like to see more
analytical work in that area.
219. You say that now but that did not feature
until April 2000. The view you are putting now, about needing
to look at this in the future, was not really part and parcel
of the current review which has just been completed.
(Sir Ian Byatt) Yes, it was, because we indicated
in our methodology papers that we would look at serviceability
not only as it has been in the past but how it would be in the
future, and we challenged the companies to provide information
which would show how expenditure in the future would relate to
serviceability in the future, and it was the answers to those
questions which disappointed me. So it was certainly a part of
the review.
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