APPENDIX 2
Correspondence from Pamela Taylor, Chief Executive, Water UK to the Chairman of the Committee
I am writing to you regarding the NAO Report: Pipes and Wires. I understand that you will be holding a hearing on 8 May.
We were very glad to be consulted about this work; the NAO surveyed our members and invited us to participate in the work of their expert group. The report contains a lot of helpful material drawn from the survey and other sources.
The report indicates that the regulated industries have reduced their prices and improved quality of service, and that price cap regulation has helped to deliver these benefits. It is important to recognise the achievements of the past, but it is equally important not to be complacent about the future. Our concern is with the impression that is given that regulators are doing enough to address the risks identified in the report that are rightly judged in need of mitigation.
We think the regulators should be challenged to do more. Our detailed comments on the NAO's conclusions are attached (Annex A). We hope that the PAC will press the regulators to do more.
Our most important concern relates to the handling of long term investment. We think that a much more effective approach to long term business planning is required than is proposed in the NAO Report, involving all stakeholders including government and regulators, and ensuring that the expectations of customers are adequately satisfied in the long term.
We support the Environmental Audit Committee's Report on Water Prices and the Environment published in November 2000, which concluded "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."
We are actively working with government and the regulators to try and persuade them to put processes in place that achieve these objectives.
We look forward to seeing the PAC's Report in due course.
Pamela Taylor
Chief Executive
Water UK
April 2002
Annex A
|
Risk |
NAO remedy |
Comment |
|
Strength of incentives |
Variations in strength over price review period are adequately dealt with by Ofwat by use of a five year rolling period [but not by some other regulators] |
Only looks at one aspect of "strength". Does not ask whether five year retention of out performance provides sufficient incentive or not [issue is covered in NERA papers for 1999 water price review] |
|
Decisions on levels of investment on basis of inadequate information |
Report recommends regulators "should consider publicly identifying the improvements in outputs and outcomes that they are willing to allow companies to invest in" |
A weak conclusion. One problem here is that five year horizons are too short for industries investing in long term assets. Para 3.11 reports companies' views that a long term approach is needed, but this is not picked up in the conclusions.Another problem is the ability of the regulator to exercise discretion, enabling the regulator to ignore customer preferences and expectations, and double guess company business plans. Important that decisions on outputs and investment levels should be widely supported by stakeholders |
|
Distort incentives relating to investment |
Recommendation is for regulators to get companies to prepare risk management models |
Report says that companies regard the incentive to invest as a serious concern, but completely fails to recommend actions by regulators, or improvements in regulatory processes to improve predictability and certainty, which is what companies are most concerned about. |
|
Allow insufficient or excessive returns |
Set cost of capital on a transparent and consistent basis |
Report fails to draw attention to key concerns such as differences in methodology of different regulators, policy consistency over time, and whether pre-commitment of regulators to a clear methodology would help |
|
Investors may perceive regime to be uncertain |
Regulators to set out principles and assumptions underpinning price review decisions and share financial model |
Recommendations are helpful but do not go far enough. No discussion of what should happen when regulators get their assessments of the cost of capital wrong so that share prices collapse [as happened following the 1999 water price review] and market values fall below regulated asset values |
|
Excessive demands on companies |
Specify clearly and in advance what information is needed. Regulators to evaluate completed price reviews |
Notes that excessive information demands is a key concern for companies but no discussion of whether regulators have gone far enough in seeking to reduce information demands. The Competition Commission also felt Ofwat's price setting methods should be simplified, no assessment is provided as to whether this has happened.Cites Ofwat's evaluation as a model, but fails to point out that Treasury guidance recommends that evaluation should be independently conducted —the Ofwat evaluation was not independent [the Environmental Audit Committee report on Water Prices and the Environment is the best available evaluation report on the 1999 water price review] |
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