Memorandum from the Department of the
Environment, Transport and the Regions
ENVIRONMENTAL AUDIT COMMITTEE, SEVENTH REPORT:
"WATER PRICES AND THE ENVIRONMENT"
1. The Government welcomes the Environmental
Audit Committee's report on water prices and the environment,
published on 14 November 2000. The report has made an important
contribution to the understanding and further improvement of the
process for setting water industry price limits in England and
2. The 1999 Periodic Review has provided
for an investment programme in environmental and other improvements
unprecedented in its scale and in the outputs it will deliver.
It is important to remember that investments in quality improvements
are cumulative, in that each investment scheme delivers a permanent
improvement on top of all previous improvements. So the investments
costed at some £7.4 billion will deliver further gains in
the quality of aquatic habitats, rivers and coastal waters over
and above the improvements delivered in 1995-2000. As the Committee
reports, the then Chairman of the Environment Agency said that
"by 2005 we will have reached a position where the significant
environmental damage created over the past 200 years will have
been repaired". The Government takes pride in the programme
of environmental improvements specified for water companies in
this Periodic Review.
3. The Committee concentrated on the extent
to which the process and outcome of the 1999 Periodic Review contributed
to environmental protection and sustainable development, a focus
which reflected the Committee's own remit. However, the Committee's
report fully recognises that the Periodic Review must address
multiple objectives and divergent interests. The Government welcomes
the Committee's recognition that the determination of price limits
is a complex balance that may not be driven by any single over-riding
4. The report gives due credit to the fact
that this Periodic Review in general worked well, and that it
"provides a fair and open system" (paragraph 179) and
was a considerable improvement on the process adopted for the
previous 1994 Periodic Review. The Government nevertheless agrees
with the Committee that further improvements to the process are
desirable and achievable before the 2004 Periodic Review begins.
The Committee's recommendations for improvements illuminate a
number of common themes.
5. First, the Committee calls for more direction
to be given by Government at the beginning of the Periodic Review.
The Committee believes that the Government should take a clear
lead in setting the policy "vision" for the review process.
6. There is clearly an important balance
to be struck here: between the Government being overly prescriptive,
and thus tying the hands of the independent regulators; and the
Government's proper role of setting the policy framework for the
review process. Ofwat has responsibility for setting price limits
and, as the Committee report highlights, the Government must respect
this role of the independent regulator. But the Government is
responsible for the over-arching social, economic and environmental
policies that form the context in which the Periodic Review is
conducted. So, at the outset, it is appropriate for Ofwat to consult
on and determine the mechanics and timetable of the review. But
it is for Ministers to give an indication of overall Government
policies and priorities, which provide the framework for the Director-General's
decisions. The Government accepts that it should set out this
"vision" at the earliest appropriate point, taking into
account the availability of information on external factors such
as EC Directives.
7. The document Raising the Quality
published in September 1998 largely fulfilled this function in
the 1999 Periodic Review. Its scope was not strictly limited to
the specification of the quality investment programme, but also
touched on issues such as water charging policy, asset maintenance
and service to customers. It was followed in January 1999 with
guidance on Maintaining Public Water Supplies. The
Committee's report and the evidence that they received, for example
from Water UK, recognised the improvement in the policy guidance
issued by DETR and Welsh Office compared with the 1994 Periodic
8. These views will be taken into account
when the Government examines the timing and content of its policy
guidance for the 2004 Periodic Review.
9. Second, the Committee recommends a number
of areas in which the parties should co-operate more to develop
a shared understanding of facts rather than competing claims.
The Government agrees that in advance of the next Periodic Review
there is scope for varying degrees of co-operation between different
bodies in developing approaches in a number of areassuch
as customer surveys, leakage and the strategic approach to long-term
asset maintenance. DETR, Ofwat, the Drinking Water Inspectorate
(DWI) and the Environment Agency are already working with the
water industry on a number of these issues highlighted under individual
10. Third, the Committee makes a number
of recommendations about distinguishing the roles and responsibilities
of the public sector parties. Examples mentioned include Ofwat
expressing views on planning matters (paragraph 171) and the early
DETR reference to the size of possible price cuts (paragraph 68).
The Government accepts that each of the public bodies involved
in the process has a distinct role and statutory responsibilities.
However the Government also agrees with the Committee that openness
and co-operation by all parties is one of the most important features
of the review process. As the Committee says (paragraph 3) "open
and constructive debate is more constructive and transparent than
whisperings behind closed doors" and that it is "reasonable
for Ministers to make clear, to the regulator, their political
wish to deliver both price cuts and a comprehensive environmental
programme" (paragraph 67). The Government firmly agrees that
public sector bodies should endeavour to work together in a co-ordinated
and effective fashion without undermining the independence of
the separate regulatory bodies.
11. The Director-General's price determinations
and the Periodic Review process extend to both England and Wales.
Recommendations in this report therefore have implications for
Wales. However policy responsibility for the regulation of the
water industry is devolved to the National Assembly for Wales.
This Government response therefore does not address issues specifically
concerning water and sewage undertakers operating wholly or mainly
12. The Committee has specifically invited
responses to recommendations in this report from DETR, Ofwat and
DWI. Ofwat and DWI are making separate responses to the Committee's
report and the recommendations affecting them. In view of the
Government's overall responsibility for policy on the economic
and environmental regulation of water, this is an overarching
Government response to all the Committee's recommendations as
well as to those directly addressed to DETR.
The timetable and inputs
Paragraph 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.
13. The Government shares the Committee's
view that, in general, the 1999 Periodic Review was well planned
and managed. Ahead of the 1999 Periodic Review, Ofwat consulted
early on the proposed framework and timetable for the process,
and all parties had the opportunity to comment on the proposals.
But, as Ofwat makes clear in its own response to the report, both
Ofwat and the Government will seek to learn lessons from the conduct
of the review and apply them in the future. Ofwat has consulted
all stakeholders about the way in which the review was conducted
and will work with DETR, the Environment Agency and DWI to develop
the timetable for the 2004 Periodic Review.
Assessing customer needs
Paragraph 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.
Paragraph 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.
14. The Government agrees that it would
be helpful for the regulators and water industry to reach a greater
measure of agreement on the public's views of priorities for the
next review period. In the last review, conflicting evidence was
produced from different customer surveys on the priority attached
to the standards of water and sewerage services, the importance
of environmental protection and quality improvements and the levels
of water charges. In particular, it would be helpful to move nearer
to agreement on the weightings and trade-offs that the public
attached to these, to enable a better assessment of alternative
packages. The DETR's own survey for the 1999 Periodic Review was
intended to provide evidence on these issues. The Department will
consider again before the next review what improvements could
be made in such a survey. Ofwat, the Environment Agency and DWI
too will be looking at ways of improving their assessment of customer
views to meet their distinct needs.
15. The Government does not believe that
DETR should take over customer consultation from the independent
regulators. But the Government does wish to see better co-ordination
for the next Periodic Review. In advance of the beginning of the
review, DETR, Ofwat, the Environment Agency and DWI will discuss
the content and timetable and later the findings of customer surveys.
This will not, of course, mean that further customer consultation
may not be required during the course of the review. Each water
company is properly entitled to consult its own customers directly
and indeed should do so. Local and regional issues call for local
consultations, including those undertaken by the regulators' regional
customer consultative bodies.
Paragraph 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
Paragraph 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 the key
upward pressure on prices without equally emphasising the customer
and public benefits which it delivers.
16. The Government welcomes the Committee's
recognition that it is appropriate for Ministers to give guidance
on the nature and size of the environmental programme. The Committee
also, rightly, draws attention to the need closely to co-ordinate
the work of Ofwat, DETR and the quality regulators. The Government
is responsible for determining the environmental policy framework
within which each Periodic Review is conducted. In setting quality
objectives, Ministers must also have regard to the cost implications
of the quality investment programmes. Indeed the principles of
sustainable development demand a coherent approach to environmental
and economic decision-making. In 1998 and 1999 the Department
and Ofwat worked closely together, sharing much of the modelling
work on costs and prices at national and company level.
17. The Department's press release in March
1999 therefore sought to present a balanced picture of Minster's
decisions on the quality programme. It was an important part of
that picture to indicate broadly the changes in water bills that
might be associated with the delivery of the specified investment
programme. Ofwat's Prospects for Prices
(October 1998) had already set the climate of public and customer
expectations for price cuts before the indicative average ten
per cent reduction was mentioned in March 1999. Nor was there
any question of Ministers attempting to pre-empt or undermine
Ofwat's ultimate responsibility for setting price limits. The
Government notes the Committee's concern on the appropriateness
of this announcement and will consider how best to announce its
expectations for the next Periodic Review.
Costing of the Environment Programme
Paragraph 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 Environment Programmes and also engage in a more
critical examination of their unit costs.
18. The Government agrees that the ability
to carry out economic appraisal of costs and benefits of individual
schemes, as well as groups of schemes, will be an increasingly
important function for the Environment Agency. The Agency already
has work in hand in conjunction with DETR and Ofwat, to develop
further its existing appraisal techniques. A revised approach
should be in place in good time for the next Periodic Review.
The Role of the DETR
Paragraph 94. The Committee is mindful of
Ofwat's lead role in running the Periodic Review process. However
it is important that all parties keep the overall policy objectives
in sight throughout the process. 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. 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 social and economic policy objectives.
19. The Government shares the Committee's
view that Ministers are responsible for setting both the legal
and policy framework in which each Periodic Review is conducted.
This policy framework, covering environmental, economic and social
objectives, was set out in September 1998 in Raising the Quality.
For the next Periodic Review, the Government intends to issue
a statement of its overall objectives and priorities as soon as
there is sufficient clarity over the obligations arising from
EC Directives and other factors. Ofwat will also consider in detail
with DETR how the timetable of the review can best accommodate
guidance by Ministers, and at what key stages this would be most
helpful to the process.
20. The Government accepts the Committee's
recommendation that DETR's policy statement should cover environmental,
social and economic objectives. Consistent with the Utilities
Act 2000, the Committee will note that the draft Water Bill, published
in November 2000, makes specific provision for Ministers to give
guidance on social and economic policies to Ofwat, building on
the existing powers to take decisions on environmental matters.
Paragraph 100. The Committee recommends that
Ofwat makes the full financial model as used for the Periodic
Review, including equations, publicly available.
Paragraph 101. 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.
Paragraph 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.
Paragraph 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.
The system of Reporters
Paragraph 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.
21. These recommendations, addressed to
Ofwat, concern the detailed conduct of the review, and the Director
General is responding to them in his response. However, there
are certain general principles that the Government agrees should
inform the review process.
22. Transparency is one of these principles.
The Committee rightly recognises the great progress already made
on the part of Government and the regulators towards increased
openness compared with the 1994 Periodic Review, and calls for
further steps to open up the process to be considered. It will
of course always be necessary to withhold some detailed financial
information about individual companies from general publication
because of commercial sensitivity. There is also a strong case
for publishing information at set stages, enabling it to be properly
considered and validated. Subject to these considerations, in
line with overall freedom of information policy, the Government
believes that there should be a general presumption in favour
of making information available. Both the companies and other
interested parties should have access to sufficient detailed information
to be in a position to understand the regulators' decisions. The
response from Ofwat addresses what more they are doing to address
transparency and the involvement of stakeholders.
23. Transparency should not be expected
of Ofwat alone; it should apply equally to the practices of companies.
They should make information readily available, not only to Ofwat
and to other regulators, but also to their customers and the public,
who have a legitimate interest in scrutinising the respective
public positions of companies and regulators. Legitimate commercial
confidentiality should apply only to genuinely sensitive information.
All-round transparency can only strengthen the robustness of the
Periodic Review process.
24. Ofwat's response also explains the role
of the new policy committee. This innovation is a welcome anticipation
of a provision proposed by the Government in the draft Water Bill
to strengthen the independent advice to the Director General.
25. Robust scrutiny by Ofwat of companies'
estimates of scheme costs is a vital part of the Periodic Review
process. As Ofwat explains in its response, it regards the system
of reporters as a valuable check on and link with companies. It
has not been demonstrated that the effectiveness of reporters
is affected by their employment by companies. However, Ofwat will
review the issues to ensure that the current procedures strike
the right balance and will continue to develop the value of the
Involving wider stakeholders
Paragraph 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
26. The Government agrees that it is important
for all stakeholders to be involved in the Periodic Review process.
The quadripartite forum was there for communication and co-ordination
of the intensive efforts of the parties most directly and continuously
concerned in the process. Other stakeholders have interests and
contributions that may be just as vital and valid but may not
need to be continuously involved. It is important that such stakeholders,
who include environmental and consumer groups, are kept properly
informed of the mechanism and progress of the review, and that
they understand the key stages and appropriate means by which
their views can most effectively be brought to bear. It is for
Government and the regulators to provide the maximum opportunities
and clarity to assist such contributions. In the light of the
Committee's recommendations Ofwat is reviewing how best to involve
stakeholders in the next Periodic Review process. In particular
Ofwat has followed the Committee's recommendation by joining the
Environment Council and will explore its proposals with the Council.
27. Although Ofwat has the lead role in
the conduct of the Periodic Review, and its direct consultations
and meetings are key opportunities for input, there are also other
routes by which groups can involve themselves. In particular,
environmental groups should have a clear opportunity to express
their views on programmes and priorities at an early stage to
the Environment Agency, so that they may be taken into account
in the Agency's advice to Ministers and Minister's guidance to
Ofwat. The proposal in the draft Water Bill for a Consumer Council
for Water will provide a new independent voice in the Periodic
Review process. Both Ofwat and DETR will continue to examine the
scope for further improvements in consultation procedures, including
lessons to be drawn from best practice elsewhere with a view to
developing a public plan for involving stakeholders. These discussions
will be linked with the co-operative consideration of customer
surveys (see above, under the recommendation in paragraph 52)
as means of consulting in the widest possible way, especially
on the development of the objectives to be met.
Paragraph 121. The Committee welcomes the
Environment 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.
Paragraph 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.
28. The Government agrees that the environmental
benefits derived from water company investment should be comprehensively
assessed. This is necessary not only to establish whether the
investment has delivered the environmental benefits promised,
but also to inform evaluation of future investment proposals.
In some casessuch s ameliorating low-flow in riversenvironmental
benefits will be seen soon after the investment is made. In other
cases there is likely to be a longer time delay. For example,
if phosphorous inputs to a eutrophic watercourse from sewage treatment
works are tackled, there may still be enough phosphorous attached
to the sediment to perpetuate the signs of eutrophication for
several years to come. The Government nevertheless believes that
the Environment Agency's annual report on progress in implementing
the National Environment Programme could helpfully include an
assessment of the environmental benefits delivered. It will ask
the Agency to undertake this, on an increasingly quantified basis
over time. The government, the Environment Agency and Ofwat are
not convinced that an annual stakeholder forum would improve progress.
However the Government is committed to increasing public participation
in investment decisions for the next Periodic Review.