Examination of Witnesses (Questions 280
- 299)
THURSDAY 6 JULY 2000
SIR IAN
BYATT AND
MR KEVIN
RIDOUT
280. What about the timetable? You said at the
beginning of your remarks, "There has been a three year timetable".
Again, the water companies in their evidence said they felt the
timetable was Ofwat-driven. You would not want it to be not Ofwat-driven.
You published a consultation paper right at the start of the period.
You wrote to the managing directors setting out the possible timetable.
What was the arrangement right at the beginning, not only for
the water companies but the other stakeholders we have been talking
about, to feed into the nature of that timetable? Did they have
any views on it? Was it very much a timetable set by yourselves,
one that you are going to drive forward because you are in the
driving seat on this?
(Sir Ian Byatt) I believe we had to set a timetable.
I believe it is highly desirable to set a timetable because then
people know when they can contribute. Without that, the consultation
process makes much less sense. We did consult on that timetable
initially.
281. Had you already set out the timetable?
(Sir Ian Byatt) We had set out a provisional timetable,
yes. If people had said that was a ridiculous timetable then,
of course, we would have had to think again about the timetable,
so we did consult on the timetable and on the information—
282. Any criticisms of that timetable are in
hindsight, they were not made at the start?
(Sir Ian Byatt) We are reviewing the 1999 Review.
We have had a lot of material coming in and we have done a number
of surveys about stakeholders, to see what they thought about
the process. The results are now in and they are currently analysing
them. The obvious thing, so far, is that the water companies did
not like the answers so, perhaps, that is why they say they did
not like the process. Some messages I am getting are that the
process might have taken too long. Of course if we accelerate
the process then we have the problem of consultation. It is a
balance to be struck. I think we will put out our views on the
consultation, the views that we have collected, and then that
can be thought about for the next review. This is an area where
I think innovation and development is highly desirable as we make
the whole thing much, much more participative, so that the water
issue, so central to people's concerns, can be something they
can have their say on.
283. That is very important. Transparency in
the process is equally important. You cited transparency as one
of the key learning points from the 1994 Review. You obviously
feel it has been addressed in this review. I think it is fair
to say we still receive some evidence that some aspects of the
decision-making process are not sufficiently transparent. To give
an example, and to ask you to respond to it, Water UK claim 930
million have been left out of the final settlement, without an
adequate explanation of where that money is going to come from.
(Sir Ian Byatt) Are we back to the 62 schemes?
284. No, I do not think we are. We are at the
assumption of capital enhancement that out-weighed the schemes
and a need to have the new obligations which may arise during
the period of 700 million. We do see the impact of water abstraction
on 110 million.
(Sir Ian Byatt) Which may materialise.
285. They are outside the pricing regime you
have set in place.
(Sir Ian Byatt) That 700 million, of course, that
can be allowed for through the logging-up process or the interim
determination mechanism.
286. You would not see it as a lack of transparency
at this stage?
(Sir Ian Byatt) I think we are explaining what we
are doing. There are things which are new obligations which may
arise. When they arise then we will look at them carefully, and
they will be put into the process if they are the right costing
for those new obligations.
287. How will they link into the price limits
which you already set? Not on the basis of these figures, they
outweigh those figures?
(Sir Ian Byatt) If they pass a materiality threshold,
then there is an interim determination of prices, the price limits
have changed. That happened in the last review period in the case
of Northumbrian Water, who asked for an interim determination
because of changes in the waste water schemes associated with
the Urban Waste Water Treatment Directive. We did allow an increase
in prices to finance that. If it is below the materiality threshold,
then we logged up. In other words, we record the obligation and
when we come to the next price review it would be allowed in the
overall price limit. There is certainly a mechanism for doing
that. It seems to me very strange to describe that as something
that has been excluded without explanation.
288. Those were the words. You have put on record
your explanation for that now. Within your own determination internally
you obviously use some financial model for working out the different
cost limits, is that financial model open to public scrutiny?
Do the companies know what model you are using?
(Sir Ian Byatt) Yes, we published a very detailed
book which sets out how we have done it. What we have not done
is publish every equation. I think there are good reasons for
not doing that. We have published this document which has been
audited by a firm of accountants who certified that the equations
in the model do exactly what they purport to do.
289. It is a model that could, in theory, be
used by a company themselves to test out your assumptions and
their own assumptions.
(Sir Ian Byatt) What the companies can do is build
their own models. There is a consultant's model around which gives
almost exactly the same answers as our model.
290. In this particular review process you set
up an advisory panel with five senior industrialists, how did
you find that? That seemed to have been a private panel to report
to yourself?
(Sir Ian Byatt) Yes.
291. How did that work within the periodic process?
I appreciate it was private. Were there terms of reference for
the panel in the way they reported? How could people be clear
about any undue influence that the panel may have had on the process?
(Sir Ian Byatt) The panel was there to help me carry
out my statutory duties. The way we worked was that I would raise
things with them where I was uncertain on issues and they would
advise me on those. One of the things they did was to read two
of the business plans. They read them through carefully. These
are people who are quite used to reading business plans. They
told me what they thought of those two business plans. Also, when
we are thinking about the cost of capital and how the financial
market might respond—because the cost of capital work is
essentially identifying what is going on in the financial market—we
do not set the cost of capital, the financial market do that,
and we have to read the signs properly. They helped on that as
well. They also helped on efficiency. They were an interesting
group of people including—
292. Have you published their names?
(Sir Ian Byatt) Their names are well known and have
been put in our annual report, they cover engineering, finance,
some indulge in the public sector and private industry. I have,
from time to time, mentioned their advice in the final determination
document. There is not, so to speak, a published separate report
from them.
293. Earlier on in your evidence, I am not sure
to which member, you gave evidence about taking advice from city
analysts, was that this panel?
(Sir Ian Byatt) No, no that was different. We have
a corporate finance adviser, David Rees. He spent a great deal
of time talking not only to city analysts but, perhaps, more importantly,
to the providers of finance. He presented—having gathered
together earlier thoughts—to city analysts, to institutional
investors and so we believe and he believes that they were all
part of the process of deciding what this most important matter—the
cost of capital was, not only the cost of capital but the whole
role of financial indicators in determining whether people could
raise money. One of the really big lenders is the European Investment
Bank, who are extremely helpful to the UK water industry and lend
money at good rates. David and I went to see the bank in Luxembourg
to talk about this future programme, not about the details of
financing it, but the whole broad picture. The bank is geared
up to dealing with this very big environmental programme, or their
part of it.
294. Going back briefly to the early remarks
about the financial model, on reflection what you said in answer
to me there was that—I think I asked you whether the water
companies could use that model—there was a consultant's
model which gave much the same results that they could use and
the equations of the new model were not published. Why are those
equations not published? Would it not be more transparent if that
model was fully—with every equation in place, not that every
member of this Committee could understand it but the water companies
could use that to more closely model their own predictions—directly
linked into the periodic review processes with yourselves?
(Sir Ian Byatt) That is a point we will obviously
consider because it is a point being made to us, but my provisional
answer is that we have provided ample information for the companies
to do their modelling and to understand what is going on. Both
at the draft determination and the final determination stage we
sent them a supplementary report which contains all the inputs
of the various expenditure lines that went into that model. So
I do not believe that they are, in fact, disadvantaged in any
way. One of the characteristics of water companies, to share the
interesting aspects of doing this particular job, is that they
spend a lot of time explaining that I ask for much too much information,
it is a tremendous burden, and costs an enormous amount of money
to provide. Then whenever I make a decision they bring in (metaphorically)
a forklift truckload of more information which disputes the fact
that the decision is the right decision. So their approach to
information is not yet fully mature.
Mr Sawford
295. Could I return to the issue of leakage
and leakage reduction where I felt we had left one aspect of it
unanswered, Sir Ian, when Mr Keetch raised this. I believe you
said you have not looked at to what extent leakage is or could
be contributing to rising water tables. You referred to the costs
to industry of particular problems with relation to London Underground.
You rightly suggested that this is a wider than London issue.
Birmingham is slowly sinking, or whatever. Is this something you
feel Ofwat might need to look into in the future or ought to look
into? Do you feel there is a need to investigate or monitor this
whole issue because it clearly is one that is not likely to go
away, and I felt that you indicated that you had not really looked
at the whole problem of the extent to which leakage may be contributing
to the water table issue.
(Sir Ian Byatt) I would be surprised if it made a
material contribution but that is not based on full knowledge.
We will go away and we will think about this matter because quite
a lot of the leakage from pipes may not get right down into the
water table. Although people tell me that a certain number of
trees are no longer as well-nourished as they used to be. So it
is quite a complicated business and I do not know exactly what
the contribution of leakage to the rising water table is. But
I will go away and ask for some advice on it.
Mr Chaytor
296. One of the continuing themes of our inquiry
has been this argument about information and discrepancies over
information. One of the main tools by which you assess what the
companies are saying to you is through the system of reporters.
I would just like to ask a little about the reporter system because
in the submission you gave to us you explained that you reviewed
this on two occasions and then employed consultants KPMG to do
an analysis of the reporters' process, and they concluded that
the reporters provided an objective evaluation and a soundness
and validity of information from companies and concluded that
the Director should feel confident in relying upon this evaluation.
The water companies from their side also commissioned a consultant
who comments that you effectively rejected the companies' asset
management plans even when these had been assessed and certified
by the reporters. How do you explain this dichotomy? On the one
hand, you are being praised by your consultants for the quality
of the reporters' work and you are recommended to accept them
almost without qualification and, on the other hand, you are being
criticised by the companies for selectively quoting from the reporters'
reports or just ignoring them.
(Sir Ian Byatt) There is an issue about how we use
the reporters. We do not use the reporters to say that is the
right answer, that is a proper and good management plan and we
should just tick it off. We never thought that was a sensible
way to do it. If anybody is suggesting that is what we should
do, I do not think that is a sensible thing to do. What we use
reporters for primarily is to make sure that the information which
we have got is properly comparable across all the companies and
that the uncertainties in the information are properly exposed.
Then when we have this comparable information we can draw our
own conclusions about the effectiveness and the costs of different
companies. That turns out to be a very powerful tool, but not
always popular of course with the companies who are discovered
to have high costs.
297. What you are saying is that the reporters
are not entirely objective in their assessments because you are
reserving the right—
(Sir Ian Byatt) No, we only use them in a certain
way and we use the reporters on the quality of information issue.
We do not use the reporters to tell us whether the whole asset
management plan is right or wrong. That is not their function.
298. The reporters are engineers not accountants.
(Sir Ian Byatt) The reporters are primarily consultant
engineers but they do employ such financial analysts as they need
to do their job.
299. If they are primarily consulting engineers
and they are making engineering judgments as well as financial
judgments, in some circumstances you are overriding their engineering
judgments.
(Sir Ian Byatt) We are not overriding their judgments.
We use reporters in order to make sure that the information is
well-founded and a lot of this information is engineering information
on the costs of doing things which our engineers can then look
at and also to ensure that all uncertainties in the information
are properly exposed. So that if the scheme could cost this, this
or this, that uncertainty is exposed. The word "certified"
is the wrong word. We are not asking them to certify that the
companies have got a good asset management plan.
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