Select Committee on Environmental Audit Minutes of Evidence

Memorandum from the Office of Water Services (Ofwat)

Response to the Environmental Audit Committee's Seventh Report, Water Prices and the Environment


  Ofwat welcomes the recognition in the Committee's Report that the 1999 Periodic Review achieved "a clear forward programme with sufficient consultation (para 39) and that the review process provides a fair and open system for determining water price limits and thus provides valuable incentives for water companies to reduce operating costs and to search for innovative ways of designing and operating new schemes" (para 179).

  Ofwat accepts that the process can be improved by further refinements. It needs to be both transparent and flexible. It must provide opportunities for Government, regulators, customers, environmental interests, the water companies themselves and others to play a full part and ensure that their views are heard. It is, as the Committee recognises, for Ofwat to lead the process (para 94), within the policy framework set by Government.

  In looking forward to the 2004 Periodic Review, Ofwat accepts that particular attention should be given to the development of the basis for determining future capital programmes, including the extent of further environmental improvements; and investment in maintaining the infrastructure. Its intention will be to achieve the optimum balance between necessary new investment, charges to customers, and the ability of water companies to continue to finance their functions within a framework that maintains pressure for continuing efficiency gains.

  Further comments on detailed recommendations are set out below.

The timetable and inputs

  39.  The Periodic Review is a complex and necessarily iterative process which needs to be efficiently planned and managed. It is therefore important that the Director establishes a clear forward programme with sufficient consultation. The Committee believes that this was achieved in the 1999 Periodic Review, despite Water UK's concerns, and that all relevant parties were given the opportunity to make the case for an alternative timetable if necessary.

  Ofwat welcomes the Committee's confirmation that Ofwat established a clear programme for the 1999 Periodic Review and that all parties were given the opportunity to set out the case for an alternative timetable.

  This was confirmed by the consultation exercise that Ofwat undertook to ask all stakeholders about the way in which the Review was conducted, although many respondents considered that the review process was too long. Ofwat will work with DETR, EA and DWI to develop the timetable for the next review in 2004. Work on developing the methodology for the review is already underway.

  Preparation for the 2004 Periodic Review was a key issue at the meeting on 16 January 2001 with stakeholders to discuss the draft Ofwat Forward Programme. Stakeholders sought greater involvement in the planning of the next review, early clarity on Ofwat's approach and methodology and careful consideration of the timing of announcements. Ofwat will be considering these points and will incorporate them into the final Forward Programme to be published in March 2001.

Assessing customer needs

  50.  The Committee agrees that, like any sensible company, water companies should be constantly undertaking the necessary market research to assess their customers' views and needs. However, such work does not obviate the need for a comprehensive and independent survey of public opinion focussed on the particular issues relevant to a given Periodic Review.

  Ofwat agrees that market research undertaken by companies in order to understand their customers' views will need to be supplemented. There are likely to be issues of wider relevance, which would not necessarily be addressed by companies, or issues thrown up by companies' work which warrant further investigation. For example, during the last price review Ofwat undertook quantitative research into customers' views on how efficiency savings should be allocated between further investment and lower bills. This work also explored customers' attitudes to different possible bill profiles which were emerging from Ofwat's analysis.

  52.  The confusing plethora of customer surveys produced throughout the 1999 Periodic Review was not constructive. The Committee recommends that, in future, comprehensive and independent surveys should be commissioned by the DETR. These should seek to establish the public's expectations as water customers and citizens within the five-year Periodic Review timescale (including their attitudes to and preferences for environmental improvements). They should also seek views on longer-term policies which impinge on the environment. The structure and content of this research should be discussed within the quadripartite group so that there is common ownership of the survey and its findings.

  Ofwat agrees that for the next Periodic Review there should be much more co-operation between the parties to reach agreement on the scope and nature of the research needed. Although attitudes to environmental improvements will, as in 1999, be a key issue it will be just as important to understand customers' views on a range of other issues relevant to the next Periodic Review. In developing research proposals for the next price review Ofwat expects to involve the DETR, DWI, the EA and the water and sewerage companies, in co-ordinating and sharing details of research.

  It is important when designing and interpreting such research, to take account of the impact that regional priorities and bills have on customers' views. It is also possible that issues will arise during the formal Periodic Review process which would benefit from closer examination. National surveys will therefore not necessarily obviate the need for regional surveys.

  Ofwat takes seriously the need to understand customers' views and priorities. We are committed to carrying out a range of research projects over the next four years to explore customers' attitudes. The Ofwat Forward Programme 2001-02, on which we are currently consulting stakeholders, outlines the first major project looking at customers' views on various aspects of the service provided by water companies.

Early predictions

  68.  The early statement by the DETR regarding the possible size of the environment programme was helpful and appropriate. However, the Committee recommends that in future Ministers should respect the role of the independent regulator, Ofwat, to determine price limits and not influence customer and public expectations by publicly announcing its own price expectations.

  69.  In turn, the Committee recommends that Ofwat seeks to ensure that its own statements do not "demonise" environmental and quality investment by portraying it as key upward pressure on prices without equally emphasising the customer and public benefits which it delivers.

  While the Government determines the quality and environmental programme it is part of Ofwat's role to challenge proposals in order to clarify the costs and benefits of quality and environmental expenditure. In so doing, Ofwat seeks to ensure that capital investment in improving the quality of drinking water and the environment is used optimally.

  The 1999 Periodic Review delivered a £7.4 billion capital investment programme, for the improvement of drinking water quality and the environment. These quality and environmental programmes account for the lion's share of the capital investment programme. Investment to improve water quality and the environment also needs to be reviewed alongside other calls upon investment to improve service to customers, including expenditure to alleviate sewer flooding. Ofwat will continue to aim for a measured and balanced approach to the issues, not least in its public statements.

Costing the Environment Programme

  90.  The Environment Agency must develop and strengthen its capacity to assess and demonstrate the benefits of the schemes which it proposes for inclusion in future National Environmental Programmes and also engage in a more critical examination of their unit costs.

  Ofwat welcomes this recommendation. The methodology must be in place in time for the next Periodic Review. Ofwat has been invited by the EA to take part in developing that methodology. The protocols should be developed soon to appraise the benefits of environmental improvements for inclusion in the next Review. Ofwat will also work with EA to provide the complementary information on the costs of carrying out improvements. These costs must be reviewed alongside the environmental benefits, to ascertain the cost-effectiveness of these proposed improvements.

  94.  The Committee is mindful of Ofwat's lead role in running the Periodic Review process. However, it is important that the overall policy objectives are kept in sight throughout the process by all parties. It is the Government which provides the policy framework within which the Review operates and the Committee would like to see the DETR take the lead in bringing the overall policy "vision" to the fore more vigorously within the quadripartite process. The Committee recommends that, in future reviews, the DETR presents a short, overall statement of existing policy to the quadripartite members at the outset. As well as key environmental protection goals this should encompass relevant and economic policy objectives.

  Ofwat agrees that the regulation of the water industry necessarily involves a number of stakeholders:

    —  The Government which sets the overall framework and standards.

    —  The National Assembly for Wales (NAFW) in respect of Wales.

    —  Ofwat the economic regulator which sets companies' price limits.

    —  Drinking Water Inspectorate which enforces drinking water standards.

    —  Environment Agency which enforces environmental standards and requirements.

    —  Companies that provide water and sewerage services.

    —  Customers the consumers of water and sewerage services.

    —  Consumer and environmental groups which set out their preferred outcomes from price reviews.

  Careful articulation of their respective roles is critically important to successful regulation. Clarity of Government policy is essential in setting the context for regulation. But, as the Committee recognises in acknowledging the lead role of Ofwat, regulation must give primacy to the statutory framework and duties. Ofwat is a non-Ministerial government department; it is established by Parliament as the independent regulator and is accountable to Parliament for its performance.

  Within the constraints of the statutory framework, Ofwat agrees that economic and quality regulators, Government departments, the NAFW, the companies and other stakeholders each have an important role to play. In the same context, clarity of Government policy on the relevant environmental, economic and social issues guides the regulatory process. Ofwat recognises that Government policy may evolve during a Periodic Review and will take such developments of policy properly into account.


  100.  The Committee recommends that Ofwat makes the full financial model as used for the Periodic Review, including equations, publicly available.

  Ofwat recognises the emphasis which the Committee placed on this recommendation.

  In October 1998 (RD32/98) Ofwat published a detailed Rule Book of the financial model (known as Aquarius 2) which was to be used in the 1999 Periodic Review. An appendix (on floppy diskette) contained the equations performed in the financial model; but the software in which Aquarius 2 was encoded omitted. The Rule Book explains what the financial model does and how it does it. Deloitte and Touche audited the financial model. Their opinion statement confirmed that the Rule Book was consistent with it and that they both fairly interpreted the Director's proposals in setting price limits for water and sewerage services. Ofwat considers that this represented a sufficient explanation of the financial model for the companies and other stakeholders to assess the price determinations.

  However, Ofwat will look at the issue again in the context of its development of a new financial model, building on the existing price setting arithmetic. Ofwat will publish a detailed Rule Book (including all the equations) of the new financial model. An independent audit of the financial model will be commissioned and the opinion statement published. When the new model is in place, Ofwat will consider carefully whether the companies should also have access to the new software.

  101.  Water UK also felt that Ofwat had been rather opaque in relation to the independent business advisers which Sir Ian appointed in 1998 to address Ofwat's lack of a business understanding. Their appointment was clearly announced in an Ofwat press release in January 1998 and their terms of reference are available from the Ofwat Library. However, the advisers' reports have not been published and although the Director did refer to their advice throughout the Final Determinations this was mainly to reinforce his decisions and it is not clear where the panel may have held different views. The Director recently established a policy committee consisting of four independent advisers and the Ofwat senior management team. The Committee would welcome clarification of the role of the new policy committee, its role and relationship with the Director, and its implications for Ofwat's access to independent business advice.

  Ofwat's Regulatory Policy Committee (RPC) was established in the spring of 2000. It formalised and replaced the long-standing arrangements whereby the regulator sought confidential advice from a small panel of business experts. Its role is to advise the Director General on the broad range of issues affecting the industry. It consists of the Ofwat Management Board, chaired by the Director General and, at present, three independent members. They were appointed on the basis of their knowledge and experience of relevant business issues. It bears some similarity to proposals in the recently published consultation paper on a draft Water Bill for the appointment of a Water Advisory Panel. However, the RPC is non-statutory; its members are appointed by the Director General rather than the Secretary of State.

  The Director also seeks advice from a wide range of people and organisations, both within and beyond the water industry, in carrying out his regulatory duties as necessary.

  102.  Although Ofwat has made efforts to address its transparency since the last review, as acknowledged by the water industry and the Environment Agency, the Committee believes that the regulator has not yet struck the right balance between commercial confidentiality and operational transparency.

  Ofwat welcomes the Committee's recognition of its efforts to address the transparency with which it conducts reviews. It has continually striven to improve the transparency of its decision making. Very much more information was published at Periodic Review 1999 than at Periodic Review 1994, most significantly the draft determinations of price limits. Ofwat's intention is to be transparent about its activities and place information in the public domain where it does not breach commercial sensitivities.

  In considering its approach to Periodic Review 2004 Ofwat will take into account stakeholders' comments on the conduct and transparency of Periodic Review 1999. However, companies also need to play their part and make more of their submissions publicly available. Ofwat recognises that finding the right balance between transparency and commercial confidentiality is a delicate matter, but has to take account of the confidentiality markings that companies place on their submissions.

  104.  Ofwat must make further efforts to involve the full range of stakeholders beyond the quadripartite forum during the periodic review process in a more effective way. The Committee recommends that, in considering the merits of various means to achieve this, Ofwat gives effect to best practice in this area such as the Environment Council's stakeholder dialogue methods.

  Ofwat has joined the Environment Council and will explore with it its proposals for developing dialogue with stakeholder groups as a component in the management of environmental issues.

  Ofwat agrees that good stakeholder dialogue is an essential part of good decision-making and welcomes proposals for effective means to improve that dialogue. Consultation exercises are a valuable means of determining stakeholders' views and in planning for Periodic Review 2004 Ofwat will consult on its planning. Stakeholders were uncertain at Periodic Review 1999 at what stage of the process it would be helpful for them to make representations. Ofwat will endeavour to provide more clarity at Periodic Review 2004.

Data provision

  109.  The Committee welcomes Ofwat's continuing work to ensure that the data it requires from companies is proportionate to the regulator's needs. In view of the potential burden (in both time and money) that such data requirements present, the Committee recommends that, as a matter of regulatory best practice, Ofwat accounts for the data which it demands. Companies should be left in no doubt what data and analysis is required from them and why.

  Since 1989 Ofwat has established a tried and tested annual process of information capture from the regulated companies in England and Wales. This information, in the form of the annual June Returns, has been central to monitoring the performance of the industry and taking any necessary regulatory action. In addition to the special submissions that are required for price setting, the information collected in the June Return also plays an important part in the Periodic Reviews of price limits.

  Ofwat published a consultation paper in May 2000 setting out the proposed requirements of the Annual Return from June 2001 to June 2005. The information collected annually was updated to reflect Future Water and Sewerage charges 2000-05 and Water Industry Act 1999. Ofwat's review of June Return 2000 aimed to reduce the burden of data capture. The new information requirements also took into account the separate monitoring carried out by the quality regulators.

  Overall, the information required in June Return 2001 represents a reduction on the information requirements set out in the June Return 2000, even after taking account of new information needed arising from the Water Industry Act 1999 and Periodic Review 1999. For each data item in June Return 2001 there will be a descriptor for each data item explaining the primary purpose of the information collected.

  The same principles will apply to the special information submissions that are collected at price reviews. Ofwat will consult on the information submission requirements in advance of Periodic Review 2004.

The System of Reporters

  115.  The Committee recommends that Reporters should be engaged and paid directly by Ofwat rather than the water companies and that Ofwat regularly monitors its arrangements with its Reporters to ensure that:

    —  there is effective scrutiny and audit of the estimated costs of schemes

    —  water companies identify least cost solutions to meet environmental standards which take into account the whole life costs (capital and operating) and the environmental as well as economic costs of a scheme or programme of schemes.

  Building on companies' licences Ofwat and the water industry have developed the present system for appointing and paying Reporters over a number of years. Ofwat believes that it works well. Ofwat is in control of the appointment decision, but the water companies have a strong say in the process. Both should therefore have confidence in the professional ability and integrity of those appointed. Ofwat benefits from the technical audit and scrutiny of the companies' plans and annual returns, providing objective views on the quality of the companies' regulatory information. But it is for the independent Reporter to decide the level of audit necessary and plan how the audit programme will be executed.

  Ofwat discussed these issues at the stakeholders meeting on 16 January with companies and Reporters. Ofwat is, therefore, not persuaded that the present accountability and payment arrangements should be changed. It will continue to seek to develop the value of the Reporter system, for example through guidance, workshops and the assessment of each individual Reporter's performance and by encouraging companies to maximise the value to them of the process and outcomes of their Reporter's audit work.


  121.  The Committee welcomes the Environmental Agency's proposal to publish an annual report on the progress of the water companies in implementing the National Environment Programme. The Committee recommends that the Agency also takes steps to monitor and report upon the environmental benefits derived from water company investment.

  122.  The Committee recommends that a stakeholder forum is held annually to facilitate the presentation and discussion of progress on the delivery of the environmental and quality programme.

  Ofwat also welcomes the EA's proposal to publish information setting out companies' progress in implementing the National Environment Programme. Ofwat will also continue to publish companies' progress in its series of five performance reports, but considers that a stakeholder forum in addition each year is unnecessary.

The price profile

  128.  The Committee believes that roller coaster prices confuse consumers as to whether their valuable water resources are being carefully managed by the industry and how far they themselves should be bothering about water efficiency. As metering becomes more widespread, there will be an increasing price incentive to be water-efficient and clear pricing signal will be needed.

  Ofwat agrees that price fluctuations should not be greater than necessary. Prices should give clear signals to customers about the costs and benefits of the service concerned. Where customers are charged according to the volume of water they use, price provides an important incentive for efficient use of water. In 1999-2000 only 17 per cent of households were on metered charges. Ofwat agrees that clear price signals to customers are needed, and in approving companies' charges schemes required companies to apply a greater proportion of the reduction in price to standing charges, rather than volumetric rates, to underline this point.

  However, the sharp initial reduction in bills was in Ofwat's view essential if customers were to share fully in the efficiency gains delivered by water companies since 1994. An alternative of a smaller initial price reduction would have lead to companies retaining money that rightly belonged to customers.

  As part of its market research for the periodic review Ofwat asked customers in a survey of 1,200 customers whether they would prefer a sharp initial reduction, followed by a gradual increase (V shaped) or a smaller initial reduction followed by stable bills (L shaped bill profile). Over 60 per cent of customers, in each of the four regions surveyed, said they would prefer a V shaped profile, with prices, after the initial reduction, rising gradually to pay for improvements as they are made. But only a quarter of customers said that they would be upset if their preferred profile were not chosen.

Size and nature of the environment programme

  139.  The Director should seek to ensure that the Final Determinations document makes clear how far changes in key factors such as the cost of capital have influenced the final outcome during the review process.

  Ofwat agrees that its documents should clearly state the key factors affecting the outcome of the Periodic Review process. It sought to do so in the last price review and will endeavour to do so in future reviews.

  Ofwat considers that it did clearly explain changes in the key factor cost of capital. In Prospects for Prices (October 1998), Ofwat had a wide range (4.0 per cent to 5.5 per cent) for the pre-tax cost of capital. For the purposes of producing illustrative price limits and average bills the value of 5.25 per cent (towards the top of the range) was used. A letter from the Director to the companies (MD145) sent in March 1999 clearly stated that market conditions had returned to more normal conditions and that the cost of capital had moved closer to the mid-point of the Prospects for Prices range as the range itself had also narrowed to 4.25 per cent to 5.25 per cent. No further changes were made to the cost of capital assumed by Ofwat after MD145.

Accommodating new obligations

  151.  The Committee is concerned that there is a lack of clarity in the present arrangements for dealing with the timely introduction of those environmental schemes which were approved within the National Environment Programme for 2000-05 but which are currently subject to re-evaluation and not included in the price limits. The Committee recommends that Ofwat reviews this process before the next periodic review.

  The Minister set out his expectations for dealing with the projects requiring re-evaluation at the time of the Periodic Review, both in his parliamentary answer on 25 November 1999 and in his letter of 24 November 1999 to Sir John Harman, Chairman of the Environment Agency. Ofwat is closely involved in the process.

  Once the most suitable solution for delivering environmental benefits has been identified and confirmed to the satisfaction of Ministers, Ofwat will (having assessed an appropriate cost) make the necessary financial agreements. If the costs of projects are such that this will make a material difference to financing the functions of the company, the company can ask for price limits to be reset at an interim determination. The calculations for dealing with this are set out in the Licence of Appointment. This process also applies to other obligations, for example, if any of the projects investigating the environmental impact of water abstraction demonstrate that remedial action is required, these will also be subject to a similar process for companies to be remunerated. The process by which the projects put forward by companies are assessed for eligibility is set out in Appendix E of Future Water and Sewerage Charges 2000-05 published by Ofwat in November 1999.

  The interim determination process has recently been applied for a number of companies. One of the schemes in Wales, Llangefni in Dwr Cymru's supply area, has been reviewed and the revised project confirmed by the National Assembly for Wales. Financial provision for this work is included in the interim determination of price limits for this company.

  If the additional costs are not material, the company has the opportunity to ask for these additional costs to be incorporated into price limits at the next Periodic Review. The process is well established. Over the last 10 years over £1 billion of additional capital expenditure and the associated operating costs have been recognised and incorporated into price limits to remunerate companies for such changes between price settings.

Tackling different sources of pollution and ensuring the polluter pays

  159.  The Periodic Review is an effective mechanism for dealing with point source environmental problems caused by water companies. However, the Committee is concerned that the DETR and the Environment Agency are disproportionately relying on the Periodic Review mechanism and the water companies as the key means to achieve compliance with water quality and environmental protection objectives and not sufficiently tackling pollution from diffuse sources.

  160.  The Committee welcomes the DETR's intention to encourage the Environment Agency to focus more regulatory effort on diffuse sources. The Committee recommends that the Department acts swiftly to ensure that the Agency can demonstrate an overarching enforcement strategy for dealing with diffuse sources of pollution.

  Ofwat welcomes the Committee's support for the DETR's intention to encourage a greater focus on diffuse pollution. Any further significant investment by water companies should be tested in costs versus benefits terms against dealing with underlying diffuse pollution.

Interface with planning process

  171.  As well as the attitude of local planning authorities, the Committee was made aware of concerns regarding Ofwat's interference with planning matters as expressed in Appendix E of the Final Determinations document. The Director suggested that decisions on whether to impose stringent planning requirements on works necessary to meet quality improvements "should rest with government rather than local planning authorities and water companies" (only the cost of reasonable requirements had been allowed for in PR 99). Local planning authorities are already subject to Government advice regarding the application of conditions and CIWEM (the Chartered Institution of Water and Environmental Management) in particular, felt that this sought to undermine the role of local planning authorities. However, the DETR confirmed that it remained the Government's policy not to interfere with the jurisdiction of local planning authorities unless it was necessary to do so. The Committee believes that the Director's statement in Appendix E was inappropriate and his remit in this area, or lack of it, should have been made clear.

  172.  Overall, the Committee is satisfied that there is a suitable framework in place which should provide the necessary interface between the planning system and the required outcome provided for by the Periodic Review. However, this framework is not being utilised as it should be in all cases.

  173.  The Committee is concerned that evidence indicates that local planning authorities (LPAs) do not always seem to recognise the importance of the statutory obligations faced by the water companies and the extent of the National Environmental Programme which needs to be delivered with their co-operation. The Committee recommends that the Government provides the LPAs with a clearer guidance which is also relevant to the Government's international commitments.

  Ofwat accepts that it is not its function to interfere with local planning authorities in carrying out their duties. Its concern is that water companies should not simply be able to pass through to the customer any costs that may arise, however extreme, in relation to obtaining planning permission. There should continue to be an incentive for each company to achieve the most cost-effective solution consistent with environmental and other requirements. It is also concerned about the need for planning authorities to ensure that local considerations are fully and fairly balanced with national and regional considerations in particular cases and with considerations about the time and costs involved in planning decisions.

  National and regional planning guidance and the operation of the appeal and call-in system provide the context within which those issues may be resolved.

Economic cycles versus sustainability

  179.  The Committee believes that the current Periodic Review Process, operated by Ofwat, provides a fair and open system for determining water price limits and thus provides valuable incentives for water companies to reduce operating costs and to search for innovative ways of designing and operating new schemes. However, we recommend that the DETR, companies and the regulators ensure that the five year investment programmes of the Periodic Review are set in a comprehensive, clear framework of longer term, policies and goals including those relating to water resources and environmental quality and serviceability goals. In turn, these five year programmes should be seen as contributing to the achievement of these goals.

  180.  The Committee believes that the DETR should take the lead in setting out the policy framework and environmental future at the outset of the periodic review process as recommended in paragraph 93.

  See comments in response to paragraph 94.

Ofwat's "no determination" approach

  198.  It is this "failure" based approach which concerned our witnesses most. Water UK believed that, if Ofwat's method was followed, only recent failure would allow a company to spend more money than had been spent previously. However, companies were anxious not to fall short of the serviceability criteria and incur the resulting penalties of breaching licence conditions. They therefore wanted to secure funds for precautionary spending. Ofwat, however, argues that companies can choose to spend more if they think it is necessary—by allocating additional spending out of their profits. The Committee accepts that ultimately this option is open to the companies to avoid licence breaches. However, efforts should be made to ensure that Ofwat's methodologies for determining funding levels incorporate more forward-looking elements.

Developing a new approach

  208.  Water companies need to manage and renew their sewers and water mains in order to develop appropriate levels of service to their customers on a sustainable basis. The Committee is not satisfied that Ofwat's "no deterioration" approach to the maintenance and renewal of underground assets (sewers and water mains) is a logical or acceptable means of assessing the amount of investment which water companies need to meet these requirements. The Committee believes that this approach has amounted to intellectual neglect of this important problem.

  209.  The Committee therefore very much supports the initiative of the DETR, and the agreement by Ofwat, to develop a new approach. This approach should be forward-looking and should enable companies to adequately prepare to renew and repair the cohorts of sewers and mains which will come up for renewal/rehabilitation simultaneously as a result of historical peaks in building activity.

  210.  It is imperative that the new approach is in place in time for the next Periodic Review, with water industry support and assistance. The Committee acknowledges Water UK's recent initiative to develop an agenda for assessing capital maintenance needs. This is a key area of responsibility for water companies and the Committee hopes that the industry will now continue to make a pro-active and positive contribution to developing new methodologies.

  The majority of water industry assets, particularly infrastructure, have long service lives. Provided that there are no dramatic changes in maintenance activity, rates of change in the serviceability of the assets—their ability to continue delivering the outcomes sought from them—are likely to be gradual. In recent years, the serviceability of above and below ground assets has been stable, and in some companies, improving. This situation is set out in the context of a doubling of investment in capital maintenance since privatisation.

  Ofwat's staged framework for assessing future capital maintenance needs (see Annex 1) has been developed to test company projections against recent experience, the changing state of the asset systems, economics and relative performance of other companies. We accept that insufficient attention has been paid to developing a complete and intellectually robust framework and that Ofwat has a role to play in its development, but the main responsibility for developing the substance of the approach lies with the water companies. Ofwat set down in its letter to Managing Directors (MD161—April 2000) its forward-looking agenda for capital maintenance and the areas where progress needed to be made by water companies prior to the next review of price limits in 2004.

  Meanwhile the current Ofwat method already allows for the funding of higher levels of capital maintenance activity even without a full economic justification where the trends in serviceability delivered to customers are deteriorating or appear to be likely to deteriorate. In the recent periodic review three companies were funded for increases in capital maintenance activity because of unsatisfactory trends in serviceability.

  As part of its work on developing a complete and intellectually robust framework, Ofwat recognises that there is a need to improve the indicators it currently uses so that they may better reflect the level of serviceability to customers and the environment. For water supply assets, this need is being addressed initially by a current joint initiative between Ofwat and the Drinking Water Inspectorate. Consultants have been appointed to undertake a study and will produce their initial findings at the end of February 2001. The aim of the study is to refine and develop a set of robust serviceability indicators for water treatment, supply and distribution to measure water company performance in maintaining serviceability of its water supply assets. Once a trend in these indicators has been established then they will be used to inform judgements of future capital maintenance needs.

  A similar joint initiative is planned with the Environment Agency to review serviceability indicators for the sewerage service.

  In addition, Ofwat is co-operating fully in a parallel study being undertaken by consultants for UKWIR. Separately, Ofwat has recently met with UKWIR to discuss future research and development needs of the industry and has accepted an invitation to participate in an UKWIR led management team to consider the research needs in this area.

  In developing its approach to capital maintenance Ofwat will have strong regard to the Secretary of States views set down in Raising the Quality as well as taking proper note of the views of the Competition Commission in its determination of price limits for two water companies. Ofwat looks to take the issues forward and has in its letter to Managing Directors (MD161) sought the participation of water companies in the process.

  211.  The Committee recommends that the DETR moves rapidly to commission work in this area and examines the suggestions put forward by Water UK and OXERA regarding the necessary elements of new methodologies . . .

  Ofwat does not consider that DETR should necessarily take the lead in commissioning this work, but does believe that it should work closely with Ofwat in its role as the "standard setter". Ofwat will continue to discuss with DETR the work that is required. We consider it essential that projects and studies be co-ordinated to ensure they are complementary so maximising the value of the work programmes.

  211.  . . . It is imperative that water companies and Reporters are fully engaged in the processes of developing and implementing any new approach and that the latter receive appropriate training.

  Ofwat agrees that it is essential that Reporters fully understand the overall framework and the approaches to assessing appropriate future capital maintenance needs developed by the Regulator and the water companies. Each Reporter must be clear about the way in which the company on which he reports actually implements the framework and its approach.

  Ofwat will ensure that Reporters participate with industry and Ofwat staff as the standard framework and acceptable approaches are developed, and include staff with skills in the relevant disciplines in their teams at the appropriate time. Ofwat will seek to take advantage of the expertise and experience of Reporters by fully involving them in the consultation process when company information reporting requirements are being drafted.

  212.  In future Ofwat must make clear exactly what data and analysis it expects the companies to provide with respect to their capital maintenance needs.

  Ofwat accepts the need for clarity on the data required. However, flexibility is also needed. Reporting requirements cannot anticipate every aspect that a company may wish to address in its business plan. Ofwat would not want a company to withhold information relevant to its business case simply because it was not set out in the reporting requirements. In their 1999 Business Plans companies provided considerable and helpful information that was not specifically requested in support of their proposals. Ofwat nonetheless believes that there is room to improve the presentation of business cases and will work with the companies to achieve this.

Setting the right framework

  220.  The Director General of Ofwat should be directly accountable for ensuring that Ofwat makes a positive contribution to the Government's sustainability agenda. The Committee recommends that, in line with the Government's own commitment, the Director General should have a specific duty to have regard to sustainable development.

  Ofwat has played an appropriate role in contributing to sustainable development as the economic regulator by incorporating the largest programme of work yet expected to improve drinking water and environmental quality within price limits. Ministerial guidance set out the overall quality and environmental standards to be achieved at the review.

  It is for the Government to decide overall sustainability strategies. Integrated guidance from Government would facilitate the attainment of sustainable development throughout the industry. The current process in which Ofwat requests guidance from Ministers on the assumptions to make on future water and environmental quality, and related issues, has established the roles of the Government, the quality regulators and Ofwat. A provision for Ministers to issue social and environmental guidance which Ofwat must have regard to is set out in the draft Water Bill. This combined with Ofwat's duties under section 3 and 4 of the Water Industry Act 1991 would allow Ofwat, and the companies, to continue to make an appropriate contribution to the attainment of sustainable development without the necessity for an additional duty.

Water efficiency

  225.  The Committee acknowledges and welcomes the number of water efficiency initiatives being undertaken by the water industry. We believe that companies do not have significant incentives to promote water efficiency and that there would be merit investigating the feasibility of setting company-specific targets for domestic water use, once a robust methodology for efficiency measurement has been agreed. This would help to focus efficiency efforts and drive the markets for water efficiency and innovation.

  Companies have incentives to meet customers' demands for water by the most cost-effective means. As knowledge of the costs and savings of water efficiency measures improves, Ofwat and companies will be better placed to consider what level of water efficiency activity is economic for each water company. Ofwat is working with the EA, DETR and companies to establish robust methods for investigating these issues and to promote best practice.

  230.  The DETR has set up a tripartite group looking at leakage and water efficiency to facilitate the exchange of information between itself, Ofwat and the Environment Agency. The water companies are concerned that they have not been consulted on this tripartite work. However, the DETR confirmed that the companies would be involved in the Tripartite Leakage Study which has been commissioned and funded by the group. This study is investigating the environmental and economic justification for further, long-term reductions in leakage (amongst other topics). The DETR is keen that this study retains its independence from commercial interests as it will inform future policy on leakage reduction. The Committee looks to this new study to clarify how water companies are to investigate the ELL taking account of both economic and environmental costs and exactly what information in this regard needs to be provided to Ofwat.

  While the water companies were not involved in the process that framed the terms of reference for the tripartite study they are heavily involved in the delivery of the study objectives. The industry has been invited to workshops to share and comment on the progress made with the study, and the appointed consultants are working closely with the industry to establish current best practice.

  231.  The Government should spell out its long-term aims for leakage reduction in the context of water resource policy and clarify in particular whether it wants companies to reduce leakage below their economic levels. If it does, it should explain its reasons.

  In pursuit of the duty to promote economy and efficiency in carrying out their water supply functions companies are expected to maintain leakage at levels which maximise economic benefits to customers and the environment. In Ofwat's view, to seek to reduce leakage to levels that were not economically based would result in customers paying unnecessary higher bills and would divert resources from environmental and other investment.

  232.  Ofwat should make clear what information it requires to assess where each company stands at present in relation to its economic level of leakage.

  Ofwat has explained to companies what is necessary to demonstrate a robust appraisal of the economic level of leakage. As a result 17 of 24 companies were able to demonstrate a robust assessment of the economic level of leakage this year.

  Ofwat has provided all companies with formal guidance on the information required to establish leakage levels. Guidance on how to make and present an appraisal of the economic level of leakage was in RD16/98, and in instructions for completing Periodic Review Information Requirement E and the Periodic Review Business Plan.

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2001
Prepared 4 April 2001