Memorandum submitted by the Office of
Water Services (J25)
INTRODUCTION
1. Ofwat is the independent economic regulator
of the licensed water and sewerage companies in England and Wales.
We were created in 1989 when the industry was privatised. The
regulated companies provide water and sewerage services to the
majority of the population. They will be directly affected by
the implementation of the Water Framework Directive.
2. Our primary duties include ensuring that
the companies carry out their functions, as specified by the Water
Industry Act 1991, and that they are able to finance these functions.
We also have a duty to protect customers. We do this by ensuring
that customers' bills properly reflect the costs of supplying
clean water and disposing of wastewater. We set price limits for
each of the companies, which limit the revenue that efficient
companies can collect from their customers to finance the provision
of services.
3. We last set price limits in November
1999 for the five charging years from 1 April 2000 to 31 March
2005. We will next do so in November 2004 for the period from
2005-06 to 2009-10. In setting price limits we must take account
of the outputs that the companies are required to achieve, including
those required under EU Directives. Ministers, in conjunction
with the quality regulators, tell us what quality and environmental
outputs the companies must achieve. It is our job to make sure
that efficient companies can finance them.
THE PURPOSE
OF THE
DIRECTIVE
4. We welcome the goal of the Directive
to establish a framework to protect inland, coastal and groundwaters.
National governments within the United Kingdom must take adequate
measures for all water bodies, such as rivers and lakes, to achieve
"good water status". This has not yet been fully defined.
Broadly it means good ecological and chemical status of surface
waters, and good chemical and quantity status for groundwater.
5. Achieving these goals will place substantial
obligations on all water users and our direct concern is the impact
this Directive will have on the customers of the water companies.
Customers of the water companies should only bear their fair share
of the costs of implementing it. Those who abstract water, or
affect the quality of water within a river catchment, including
farmers, motorists and local authorities, should pay their proper
share of the costs of compliance, in line with the polluter pays
principle. We recognise that allocating the responsibility is
difficult, and applying the polluter pays principle is also complex.
There are opportunities to consider the development over time
of market instruments to achieve the most efficient application
of the polluter pays principle.
6. We believe that the regulatory regime
provides a sound basis for the private water sector to deliver
its obligations arising from the Directive. England and Wales
have already made substantial progress towards meeting the principles
of the new European Water Policy underpinned by the Water Framework
Directive. With integrated river basin management in place since
1974, and the separation of regulatory functions in 1989, we have
the structure to identify and enforce compliance with the Directive.
7. The water and sewerage industry has delivered
major improvements to reduce its impact on the aquatic environment
since privatisation. Compliance with mandatory standards for bathing
waters has risen from 66 per cent in 1988 to 97 per cent in 2001.
The percentage of "good" quality rivers has risen from
84 per cent in 1990 to 94 per cent in 2000, with most of the balance
being due to diffuse pollution.
8. These improvements have been expensive,
and water customers are paying for them in their water and sewerage
bills as permanent stepped increases in prices. Overall capital
investment in the 15 years since privatisation (1989-2005) will
be almost £50 billion. This capital investment has maintained
the existing assets, as well as enhancing them to deal with increasing
demand from customers, tighter quality standards, and improving
customer service. For the sewerage service, around £15 billion
of the £28 billion capital investment has improved assets
to meet new environmental standards, driven mainly by Government
requirements agreed in Europe. The capital investment programme
for the combined water and sewerage services for 2000-05 included
around £7 billion on improving drinking water and environmental
quality. In 2004-05 the average household customer, without a
meter, will pay about £30 more per year for the improvements
agreed by Ministers in 1999. Water customers will continue to
pay for these improvements for ever.
9. Investment since 1989 has dealt with
the major environmental impact of sewage collection and disposal.
These investment programmes have mostly been in response to European
Directives based on meeting defined standards for the quality
of wastewater returned to rivers and the sea. The current investment
programme will deliver, by 2005 the largest ever programme of
asset improvements.
THE WATER
FRAMEWORK DIRECTIVE
10. Hitherto, water customers have borne
through bills the main share of the cost of the big improvements
in the quality of the water environment. But instead of just looking
at fixed emissions from specific processes, the Water Framework
Directive requires the analysis of water management across the
whole river basin. We endorse this approach and fully support
the principles behind integrated river basin management. The principle
that the polluter pays means that all those activities contributing
to deficiencies in water quality and quantity should share the
responsibility and the costs. This may involve direct discharges
from factories, abstraction and effluents for/from fish farms
and power generation, and run-off from agricultural land and highways
as well as the public water supply and return of treated sewage.
11. We welcome the emphasis in the Directive
on using economic analysis to inform decisions on identifying
and meeting environmental goals. However, this is the first time
that such analysis has been part of a Directive affecting the
water environment. Developing robust economic methods of analysis
will be time-consuming and require considerable resources. It
will not be easy to apply it in a consistent way, for example
assessing the impact of agriculture, forestry, highway drainage
and the discharge of sewage effluents equitably.
12. We note that the Directive requires:
— an economic analysis of different
water uses within the catchment;
— an analysis of all the possible measures,
their potential costs, risks and effectiveness to inform the selection
of a package of cost effective measures to achieve compliance
with the environmental objectives in a cost effective way; and
— analyses of the benefits accruing
from environmental improvements to compare with cost effective
solutions to inform decisions on the extent and the timetable
for delivering measures.
13. All these analyses will contribute to
the goal of sustainable use of water within the catchment. The
majority of this analysis is new and has yet to be developed and
tested.
14. We collect, review and publish some
of the information needed to inform and carry out these economic
analyses. For example, information on the pricing policy of water
services and the costs of water companies carrying out improvements.
Information held by others such as the Environment Agency and
DEFRA complements our economic expertise. We suggest that the
Secretary of State takes the lead in assigning responsibilities
for providing the economic analyses required to implement the
Directive, particularly those set down in Annex III. This will
enable the economic and environmental regulators to contribute
to carrying out these economic analyses under the guidance of
the Secretary of State.
15. This analysis is required to inform
the decisions on the measures to take. This may include identifying
and defining investment programmes to control point sources, and
also controls over diffuse pollution. These measures may affect
many areas of the economy.
16. The analysis necessary to identify the
environmental objectives and to assess the relative impacts of
the polluters will take time to develop. For example, investigations
on the environmental impact of water abstraction take several
years and require a variety of weather conditions to evaluate.
17. Initial estimates by the WRc for the
Government indicated that the total costs of compliance with the
Directive may be up to £9 billion. Time and resources are
needed to carry out thorough investigations and analysis to determine
the appropriate levels of expenditure and where it is made.
18. The large river basin districts identified
each comprise several river catchments. Under the timetable set
in the Directive these all require detailed local investigations
by 2004:
— to characterise surface and ground
water;
— to assess the environmental impact
of human activity; and
— to carry out an economic analysis
of water use.
19. These studies are central to defining
and identifying any remedial action, whether investment or recommending
changes to government policy. The analysis necessary to identify
the environmental objectives and to assess the relative impacts
of the polluters could take time to develop. It is essential that
all of us carrying out these analyses have sufficient guidance
to be able to work consistently, and also sufficient time and
resources to complete them to the very constrained timetable.
It may be tempting to trade-off thoroughness to meet the timetable.
However, insufficiently robust analyses at this stage run the
risk of promoting poorly justified improvement measures. Guidance
on work programmes and duties must be clarified as soon as possible
to allow this first stage to be completed in the next two years.
IMPLEMENTING THE
WATER FRAMEWORK
DIRECTIVE
20. The Department for Environment, Food
and Rural Affairs and the Welsh Assembly Government are in the
process of consulting on the transposition of the Directive into
national legislation. The scope, timing and eventual costs of
implementing the Directive inevitably hinge on the detail underlying
the legislation transposing this Directive.
21. Defining the goal of "good water
status" is central to the drafting of the river basin management
plans. Clarifying this definition and other criteria, such as
the status of wetlands, is essential to orderly implementation
in order to avoid misdirected investigations and poor investment
programmes.
THE TIMETABLE
22. The United Kingdom must transpose the
Directive by the end of 2003. The first major piece of analysis,
the characteristics of the surface and groundwaters for each river
basin distinct is due in 2004, and others follow before the draft
river basin management plans in 2008. The first deadline for delivery
of environmental objectives is 2015.
23. Decisions on delivering the environmental
objectives depend on comprehensive, thorough and balanced information
on the factors affecting water status in the river catchment.
This timetable for the first round of river basin management plans
(RBMPs) is tight. The first round of studies characterising the
water bodies, and the economic analysis of water use precedes
the drafting of RBMPs.
24. We suggest that the emphasis should
be on obtaining sound information and developing good methodologies
to use during the implementation process. Achieving the environmental
goals of the Water Framework Directive is a long-term objective
based on sustainable water use. The measures to be taken need
to be fully justified by economic analysis. The flexibility allowed
in the Directive, to determine routes and timescales for compliance,
should be used so that sustainable cost-effective measures can
be identified and if necessary given time to be effective. A measured
approach, consistent with the Directive will, we suggest, benefit
both the environment and the economy—including water customers—in
the longer-term.
THE POSSIBLE
COSTS TO
WATER CUSTOMERS
25. The WRc report for the Government on
the draft Directive showed highly provisional estimates of total
costs between £2 billion and over £9 billion for implementation.
About half these costs could fall to the water companies and could
be incurred over a 10-15 year period. Any costs incurred by the
water companies will need to be passed into price limits on a
basis which assumes that the companies carry out the work efficiently.
Based on the impact of the National Environment Programme in the
1999 periodic review, and other things being equal, the average
unmeasured water and sewerage bill could be £5 to £20
higher, than it would otherwise need to be, (ie about 2.5 per
cent to 10 per cent higher) for total costs of between £1
billion and £5 billion, by the time this implementation programme
is complete. The current estimates of implementation costs are
very uncertain and we understand the Government will revisit the
regulatory impact assessment next year once there is more clarity
about transposition of the Directive. In practice, many other
factors will also affect water bills including pressure on financing
costs, the need to maintain the existing infrastructure, and the
scope for further efficiencies. And in practice, the scale of
costs will be affected, and hopefully reduced by the development
of sound methodology to:
— understand the benefits of proposed
improvements;
— identify cost effective solutions;
and
— compare the two to inform decisions
on work programmes.
26. A robust framework will be important
both for its own sake and to demonstrate value to those bearing
the costs of improvements.
27. The Directive assumes a dynamic approach
to managing the environment. Discharge consents will be based
more on delivering environmental outcomes, than on meeting emission
standards, as in, for example, the Urban Waste Water Treatment
Directive. Over time there will be technological advances and
the public's view of the value of environmental improvements may
change. These changes can be incorporated into the economic analysis
supporting the RBMPs. For example, developments in farming practice,
vehicle technology and use, and sewage treatment processes, are
all likely to change the costs of implementing measures. The choice
of the cost-effective solution and therefore the overall cost
of implementation will change over time. Such changes may complicate
the estimation of potential costs in a regulatory impact assessment,
but we believe this dynamic and flexible approach is a sensible
way of managing uncertainties from plan period to plan period.
PROPORTIONAL IMPACT
ACROSS THE
RIVER BASIN
28. "Polluter pays" is an underlying
principle of the Water Framework Directive. At first sight this
seems straightforward. However, the provisions of the Directive
may be difficult to apply fairly and consistently. At present
water companies treat sewage before returning it to the environment.
This is as it should be. However, water customers are also paying
the continuing costs of the large investment programme in the
early 1990s to remove pollutants such as pesticides and nitrate
from sources of water used for the public water supply. Water
customers pay both to clean up their water before use and also
after use, before its return to the environment.
29. As we understand the Water Framework
Directive principles, all sectors should play a role in achieving
the environmental objectives in proportion to their impact on
the river catchment. This involves an appropriate balance between
diffuse and point sources of pollution. Water customers should
pay only their fair proportion. Decisions will not be easy. For
example, requiring large projects to reduce nutrient levels in
rivers from such point sources as sewage treatment works may be
much more straightforward than achieving the equivalent benefits
at much lower costs from changes in agricultural practice. But
the complication should not preclude adoption of whatever is the
best practicable, and sustainable, option. Any arguments about
impracticality need to be subject to full scrutiny.
PUBLIC CONSULTATION
30. We fully support the extensive public
consultation planned on the measures and environmental outcomes
included in the river basin management plans. Involving representatives
of water customers from WaterVoice, alongside representatives
from other sectors and stakeholders, in the river basin management
planning will help sensible decision-making. In due course, it
could also improve the overall acceptance of the costs of compliance,
whether these costs are ultimately paid in higher costs of manufacturing,
food production, or in customers' water bills.
WATER PRICING
POLICY
31. Article 9 requires that the principle
of recovery of the costs of water services is adequately applied.
The pricing policy for water services provided by the licensed
companies in England and Wales recovers the costs of providing
these services from customers. There are no Government subsidies
and customers pay the costs of maintaining, operating, enhancing
and financing the public water distribution system and wastewater
treatment and disposal. Customers will also pay, in their bills,
for any asset improvements identified and justified by the RBMPs
to reduce the environmental impact of water company activities.
We believe that the current framework for setting and paying for
water services complies with Article 9.
EFFICIENT USE
OF WATER
32. Article 9 states that water pricing
policy should provide adequate incentives for users to use resources
efficiently. The current pricing policies offer incentives for
metered customers to be efficient in their use of water, and we
seek to ensure that companies' charges are consistent with their
statutory duty, to promote efficient use of water by customers.
The majority of business users are metered, and can make savings
by being efficient in their water use. Under the Water Industry
Act 1999 domestic customers can ask for a water meter, without
installation charge. Currently only 21 per cent of domestic customers
are metered and this is increasing slowly year by year. The rest
pay by reference to the rateable value of their home. The Act
restricts severely water companies' ability to insist on metering
domestic customers. At present, customers opting for a meter may
do so to reduce the cross subsidy, but once installed permanently
there will be an incentive for them to conserve water.
33. We believe that metering is the fairest
method of charging for water, as it relates charges to the amount
of water used or sewage discharged. By 31 March 2003 we expect
23 per cent of households in England and Wales to have metered
supplies.
THE WATER
FRAMEWORK DIRECTIVE
AND THE
PERIODIC REVIEW
TIMETABLE
34. The periodic review timetable provides
for the setting of price limits for the water companies in 2004
for 2005-10 and in 2009 for 2010 onwards, and this review period
may be for longer than five years. The preliminary analysis required
suggests that few schemes specific to the Water Framework Directive
will be sufficiently advanced to include in the capital programmes
from 2005. However, much of the quality programme required for
other purposes, including other directives, is likely to contribute
to the eventual implementation of the Water Framework Directive.
35. The integration of the 2009 periodic
review with the Water Framework Directive timetable will depend
largely on the timetable for consultation and decisions surrounding
the river basin management plans in 2009. Work programmes driven
solely by the Water Framework Directive will not be identified
until 2009, after the public consultation on RBMPs. If Ministers
confirm that schemes have been fully justified and meet the criteria
for compliance by mid-2009, we will be able to consider them when
we set price limits. There must be time for us to examine the
companies' proposals and challenge both the options chosen and
the costs. To include speculative allowances in price limits to
fund schemes which had not yet been justified or costed would
tend to remove the challenge for companies to carry out works
efficiently. Any excess provision would, without requiring companies
to perform efficiently, simply yield a surplus for the shareholders.
Customers would be paying more than they should, without any benefits
for the environment.
36. If improvement schemes are not justified
in time for price setting the regulatory regime can deal with
changes between reviews. This will not prevent companies starting
work on delivering outputs between price reviews. The price setting
timetable will not, in our view, impede delivery of compliance
with this Directive.
IN CONCLUSION
37. We support the objectives of the Directive
and the role this will play in achieving sustainable use of water.
We particularly welcome the emphasis in the Directive on soundly-based
analysis of the environmental, economic and social costs and benefits.
The Directive allows some flexibility about timing. All our efforts
in the short-term should be on developing the methodology. This
will take time and resources, to ensure that all those involved
can all have confidence that the objectives of the Directive are
carried out cost-effectively and that the costs are shared fairly.
38. We will co-operate fully with Government,
the Welsh Assembly Government, the Environment Agency, other regulators
and agencies, customer representatives, voluntary bodies and the
water industry to contribute to implementing this Directive.
Office of Water Services
27 September 2002
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