Select Committee on Environmental Audit Minutes of Evidence


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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