Examination of witness (Questions 1-19)|
TUESDAY 30 JANUARY 2001
1. Can I welcome everyone to the first hearing
of the Environment Sub-committee into the draft Water Bill, and
can I just draw to your attention that we have published all the
memoranda that we got in, I think, on time, and they are available,
rather pricey, I think, at £13.60, but for those of you who
want to save money they should be on the web by now. Can I ask
you to identify yourself, as the first witness, for the record,
(Dr Helm) My name is Dr Dieter Helm.
2. Do you want to say anything, by way of introduction,
or are you happy for us to go straight to questions?
(Dr Helm) I would like to make just one, very short
remark, and go straight to the questions thereafter. The scale
of the challenges facing the water industry are large, and there
are four key question areas which the Bill would need to address
if it was to set a stable basis for the industry going forward.
They are proper utility regulation, competition, the sustainable
development and climate change agenda, and, very importantly,
the new restructuring proposals that are coming from some members
of the industry. It is my view that the Bill, as it is currently
drafted, does not address adequately any of those four core questions.
3. So you would give it nought out of ten, would
(Dr Helm) As a consultation document, it is extremely
helpful; but if this particular version of the Bill was to go
into legislation I suspect your Committee would be considering
another Bill quite shortly afterwards, to address some of these
questions more comprehensively.
4. So a missed opportunity, if it goes ahead
in this form?
(Dr Helm) Yes; it is much better if it is revised.
And I would draw attention to the scale of revision that was necessary
to the Utilities Act, because some of that perhaps was not as
well thought through as it might have been.
Chairman: Thank you very much.
5. Would you tell the Committee how significant
a contribution to the development of the water sector this present
draft Bill represents?
(Dr Helm) In each of the four areas I have indicated,
it makes a number of helpful suggestions, and some suggestions
which actually may make matters worse, but in no way is it adequate
to the sorts of challenges. And if I could elaborate, just slightly,
upon that, the Utilities Act came out of a utility reform proposal,
which was intended to provide consistent regulation across the
utility sector; it ended up being essentially an electricity trading
arrangements Bill, plus merger of the regulatory offices Bill,
for the energy sector, and this Bill would need to take forward
substantially that utility reform agenda. There is no plan in
this Bill for competition, and no clear vision of how competition
might work. The Bill does not explain how the marriage between
the climate change agenda and the investment requirements, on
the one hand, and the concerns about poorer customers and bills
might be married up, and the Bill takes general powers to address
just some of the issues which would come up if the industry was
allowed to restructure along some of the plans that are put forward.
So I think it does not really get us very far forward, as it stands.
6. You certainly appear to concur with certain
of our witnesses who have commented on the absence from the Bill
of provision relating to the introduction of competition in the
water sector. So I take it then you do agree with these witnesses,
who have suggested that it is impossible to consider the draft
Bill in its proper context without proposals on competition?
(Dr Helm) Competition has to be addressed through
legislation. The draft Bill puts competition in the `further work'
box, and, if I might suggest, `further work' is a very, very big
agenda. Competition does not happen in isolation in these kinds
of industries, you have to define the access terms, the property
rights, the safety, drinking water type requirements. And, very
importantly, the lesson from the electricity and gas industries
is that a reasonably well thought out vision of where you are
going, some timetables, some phased introduction of competition,
to allow the process to be managed, but most of all a timetable,
is essential to take this forward. And that seems to me to be
wholly absent, not only from this draft Bill but also wholly absent
more generally from the Government's thinking about where competition
will go. And that leaves the industry and customers and competitors
uncertain, they do not know whether to invest in taking this forward,
or whether, in fact, it will be just one of those things which
bubbles along for several years before anything happens.
7. What other measures then do you believe should
be in the Bill to ensure that it makes the necessary contribution
to the development of the water sector?
(Dr Helm) I think there should be a clear plan as
to how competition is to be introduced, and there are many problems
in the electricity and gas sector but in both industries there
was such a plan, with deadlines, a phased introduction, and then
the Bill should effect that plan and that transition so that the
changes can be taken forward. But this is the wrong way round;
you do not start with a piece of legislation then think what you
are going to do, you start the other way round, which is to think
what you want to do with competition, what sort of competition,
because there are lots of different kinds of competition, what
sort of competition you want, and then you have legislation to
effect it. This draft Bill goes exactly the other way round, and
it seems to me to be not correct, and I would have thought it
is many months of hard work to come to proper conclusions on that,
it is not something that can simply be a few draft provisions
for the Bill and off we go.
8. Is competition a good idea?
(Dr Helm) Some sorts of competition would be, I think,
very desirable in this industry, but I stress the point there
are many different kinds of competition; the industry already
has quite a few elements of competition, there is contracting,
there is an element of competition through comparator efficiency.
But what I would caution against is going for a full-blown, complete
commodity-type industry very quickly; the key here is to learn
through a process of gradual, timetabled and set reforms which
gradually open up the market, so no risks are taken on the environmental
side, no risks are taken on safety, and we learn as we go along.
And the point of competition is not that it follows some path
we can predict, if it did, we would not need it, perfect planners
could arrive at the solution; we will learn as we go through this
process. So a gradual, step-by-step evolution towards more competition,
with lots of opportunities to reassess where we have got to along
the way and consider how further steps might unfold.
9. I am not very happy about the idea of buying
electricity from different companies, but I can accept that the
electricity that comes into my house is identical, whichever company
it comes from, but water is almost bound to be different, if it
was really genuinely being bought from different companies, is
it not? In practice, it will all come from the same supply, but
how can you really have competition? If I chose to buy water from
a company that operated primarily in a limestone area, primarily
it would be supplying hard water, would it not? So you could never
get that hard water to my taps in Manchester?
(Dr Helm) I think there are lots of examples, across
many markets, in which competition of the form you describe might
take place; but the key distinction is whether you are competing
to have different people trying to deliver that service to you
better, or whether you are trying to choose different services.
Now, in the water case, it is very unlikely that you will be choosing
different sorts of water, although lots of people, surprisingly,
do go into supermarkets and pay very large premiums for different
kinds of water, but you are unlikely to do that; but there is
no reason why you should not choose whether an alternative company
could provide that more efficiently to you. And, essentially,
that is what happens in the electricity and gas industries in
the UK, and now increasingly in other countries. It is the same
gas, it is the same electricity, but some companies can buy and
sell it at better terms than others and offer you a better customer
service, and you, the customer, can then choose which one you
10. Yes, but there are essential differences,
obviously, between gas and electricity, you buy your gas, you
buy your electricity, you use it, you pay for what you use; with
water, it is fairly cyclical, you can buy it coming out of the
tap, but then it has to go somewhere else. So would you have competition
with the water supplier and then competition with the waste disposal
people, or would they be the same; it is an extremely complicated
(Dr Helm) I agree with that entirely, and I think
it is very helpful to draw analogies with other industries. I
was not trying to suggest that it was identical to those. But
I think this clearly illustrates that, unless those issues are
properly thought out and one sorts out what sort of competition
one actually wants, for what sort of functions, over what time
period, it is very hard to draw up legislation to effect it; and
I think this discussion illustrates exactly the point that I was
trying to make. But these issues have not been properly thought
through, and, without a plan of how to go about it, the idea that
this Bill could be suddenly and quickly amended, with a few extra
powers to solve this problem, I think that is just not likely
11. Would the measures of this Bill increase
costs to the water companies, and, if so, would those costs necessarily
have to be passed on to the customer?
(Dr Helm) I think there are aspects of this Bill which
may increase, in fact, the degree of regulatory risk that the
companies face, and I think may have some upward pressure on the
cost of capital; and the cost of capital is incredibly important
in this industry. When you are an investment industry, spending
perhaps some £40 billion, just 1 per cent on the cost of
capital each year is a very, very large sum of money; it is not
like electricity and gas where investment is quite low and one
is interested in just the operating costs. Now how might the risk
be effected; well, I have tried to argue, over a long period of
time, that there is a connection between regulatory risk and cost
of capital, and that the regulatory risk derives from two sources.
One is that the powers are invested in the individual, and that
leads to personalisation of regulation, and that one is always
at risk that the regulator may have different views from his predecessor,
or her predecessor, and may use that discretion in different ways;
that makes for uncertainly. Secondly, the duties of the regulator
are very general, and, indeed, this Bill makes them even more
general, they just have to look after consumers. What does that
mean? How are the balances to be struck between all the different
components? That is left at the discretion of the regulator, subject
to guidance. But those two things, to me, increase the regulatory
risk, and in that regard I advocate, first, that there should
be a board and not a Director-General, following the model of
Ofcom, as proposed in the consultation paper and the new Gas and
Electricity Markets Authority. And, secondly, if these duties
are to be made so general then the companies must have a clearer
view of what financing the functions means, which is the protection
they have, that if a regulator increases the burdens on them investors
will have some degree of protection. And the Bill, as it stands,
weakens the finance and functions duty, by making it one amongst
several, and so investors, who have already reacted very negatively
to the last price review, are going to reflect that in their cost
of capital going forward. And cost of capital going up is a bill
that, in the end, we all will have to pay; and the example I have
in mind is that the regulator in the rail industry has now had
to agree an 8 per cent cost of capital for the rail industry,
in order to sustain investment in that industry. These are very,
very large sums, and we need to try to bear down on the cost of
capital, not bear up on it, and this Bill, I think, does not help
us solve that core problem. And that was the core problem at the
heart of the Utilities Reform Green Paper and was not properly
carried through in the Utilities Act 2000.
12. Is it inevitable that increased costs of
capital, which may come about because of increased regulation,
have to be borne by the consumer, is that something inherent in
a privatised industry?
(Dr Helm) Absolutely. In the very short run, you can
raid shareholders; if you could drive the share price down to
one pence for each company. The share prices of these companies
are already below the value of the regulatory asset base, at least
for a significant number of them. But, in the end, if the Government
wants investment to be carried out by the private sector, if it
is doing what I call inventing a private sector borrowing requirement,
it is using private companies' balance sheet rather than the Treasury
to finance these investments, then that comes with a price. You
cannot force investors to invest in these industries. And if the
cost of capital is driven up, and this risk is measured every
single day in capital markets, you can look up the share price
every day and see how people react to the risk that is there,
if that price goes up and if people want the investment, and if
the Government is not going to do it itself, then that price,
in the end, will be borne by customers.
13. So they have the choice of either paying
through their taxes or paying through their bills, but either
way the people pay for it as opposed to those who are making profit
out of it?
(Dr Helm) The question might be turned back onto the
first ten years of the industry.
14. I know the questions, Dr Helm; what interests
me are the answers?
(Dr Helm) Yes, I was going to answer it, if I may,
please, by virtue of illustrating your point about profits. In
the first ten years, this industry, arguably, made higher returns
than was strictly necessary to finance its functions, but they
did make those returns and that has now happened. But, looking
forward, if you want the investment, you cannot extract that from
previous shareholders, what you have to do is to say, is it the
case that the sums of money required in this industry can be raised,
and at what cost, from the market; and, by looking in the Financial
Times every day, or whichever you like to look at, you can see
the price that investors are demanding to invest in these shares.
And it turns out that the market value of these companies now
looks to be less than just the value of the regulatory asset base,
and that tells you that investors do not think these companies
are going to make abnormal profits in the future; on the contrary,
what the current price of shares tells you is that investors think
that the profits will be less than the cost of capital they have
15. So the question could possibly arise whether
privatisation is a suitable vehicle for the public utility which
meets regulatory standards which are required by the public?
(Dr Helm) I think it is a very good question, and
it seems to me to turn on this. It is true that the public sector
could, in principle, borrow at lower rates than the private sector.
We know the Treasury can borrow at virtually the riskless rate.
But we also know that the Treasury, in the past, has not been
prepared to borrow, and that privatisation is a process by which
the Treasury has shifted very substantial borrowing requirements,
for the rail industry, the water industry, etc., to the private
16. In theory.
(Dr Helm) Now if it has transferred those thing to
the private sector then it is not unreasonable to say that if
it goes to the market and asks for that capital it will have to
pay the price the capital market offers, investors have lots of
choices of where to put their money. Now if the response to that
is to say, "The price is too high, we ought instead to do
it through the state," then there are costs to doing it through
the state, and the past performance of the industry and its investment
is put in that frame. What I am trying to argue is that this Bill
should try to lower the regulatory risk the companies face, in
order to lower the price that we, as a society, have to pay private
investors to carry out this investment. And my argument is, this
Bill does not address that question. We ought to be able to borrow
from the private sector at pretty low costs of capital, because
these ought to be pretty low-risk businesses; after all, they
are monopolies, lots of their activities are in that form, and
likely to continue in that way for some time to come. This Bill,
to an important extent, not a massive extent but an important
extent, goes in the wrong direction in not lowering that regulatory
17. Would you say that the various regulatory
authorities are co-ordinated, in any way, under the provisions
of this Bill, or are they likely to be in conflict with one another?
(Dr Helm) I think this Bill is a step in the wrong
direction, in as far as many people argued, myself included, in
the mid 1990s and thereafter, that what we needed was consistency
between the regulatory bodies, and that required a fairly common
approach to calculating things like costs of capital, asset values,
lots of the technical components of regulation, and the Utilities
Bill was a major attempt to create that cross-utility consistency.
What we have instead now is a series of sectoral Bills, a Transport
Bill, a Communications Bill, a Water Bill, and the Utilities Act
itself was, in fact, an Energy Bill; that is a step in the wrong
direction. Now it is argued, in the draft Bill, that this Bill
takes forward consistency; it does not, the other bodies are having
boards, not director-generals, for example. Nobody else is having
an advisory panel; it is proposed in this Bill that the water
industry should have an advisory panel. These sorts of issues
ought to be addressed in a consistent fashion, and it seems to
me important that where there is a deviation from the pattern
that is being adopted elsewhere, and where it works elsewhere,
there ought to be a good explanation of why to do it, and there
is no explanation in the draft Bill as to why an advisory body
is better than a board, for example.
18. Dr Helm, your evidence so far has been very
refreshing and very clear. How long do you expect to be Chairman
of the Department of the Environment's Academic Panel, given the
fact you appear to have taken ...
(Dr Helm) I have always expressed my views in a clear,
I hope, and independent fashion, and my views to this Committee
are expressed in my capacity as a Fellow of New College, in Oxford.
The Academic Panel is nothing more than a panel to discuss a variety
of largely economic issues that come up in the environmental area,
and I think it would be a great disservice to the Department if
its Panel was comprised of people who were not prepared to set
out their independent views.
19. I quite agree; it does credit to the Department
that it has you as the Chairman of the Panel. I hope that that
position will be sustained. I just wonder why, in framing the
Bill and the consultation, they appear to have taken no notice
of your views at all?
(Dr Helm) The Academic Panel meets, I think, three
times a year, it has a very general agenda, we do not discuss
all the issues in relation to the DETR, and indeed we have not
discussed this one. But I think it would be fair to say that I
try to make whatever views I have on utility regulation, which
I have formulated over the last ten years, as widely known as
I can, and I am sure they are aware of what those views are, and
I have published them on a number of occasions, so there is no
new departure in my evidence to you from anything I have already
put in the public domain.