Examination of Witnesses (Questions 363-379)
MR PHILIP
FLETCHER, DR
WILLIAM EMERY
AND DR
ROWENA TYE
WEDNESDAY 27 NOVEMBER 2002
Chairman
363. Now Office of Water Services (Ofwat), Mr
Philip Fletcher, the Director General, Dr William Emery, the Director
of Costs and Performance and Chief Engineer, and Dr Rowena Tye,
who is the Head of Quality Enhancement. Is all that kosher?
(Mr Fletcher) Yes.
364. Very good; thank you very much indeed.
We have done an awful lot of talking about money, but we have
now got the chap who has got to make the decisions about the money.
So, Mr Fletcher, who is going to pay for all this? Until you appeared
before us, this inquiry was rather like playing Hamlet without
the prince.
(Mr Fletcher) I am conscious, Chairman, that Hamlet
came to a sticky end. The water customer is going to pay for all
this.
365. At least there is not an arras between
us, if I may say so.
(Mr Fletcher) The water customer is going to finish
up paying for that part of the work to implement the Directive
which is required of the water companies. But, as we have been
hearing this morning, this is a complex Directive and, I would
agree with Water UK, getting it right is a very big interaction
between the water companies, whose customers will pay, and the
other causers of pollution. We have talked quite a lot about farmers,
because I suspect they are at the heart of the matter, but it
is also us who choose to drive cars, or carry out all sorts of
other things, as citizens of the country.
366. The principle of "polluter pays"
is sort of embedded in this Directive and we could draw up lists
of the polluters, and it would be really quite difficult to come
to an end of the list, would it not, in many ways? You have said,
for those of us who drive cars, for that matter, for those of
us who drive public transport pollute as well, we have mentioned
farmers, we have mentioned the run-offs, for example, from large
commercial expanses, for example. How do we allocate those costs
then? Clearly, for the water companies, the more those costs can
be allocated up stream the less they have to pick up, as sort
of the cleaners of last resort, and the less they then have to
pass on to their customers, and the lower the charge its customers
will be able to benefit from. But how do we allocate the charges
higher up, and then how do we make sure the policy instruments
deliver that charge to them?
(Mr Fletcher) I think no-one pretends it is going
to be easy. Obviously, one of the first things to do is to try
to stop subsidising people to pollute, and the reform of the Common
Agricultural Policy is at the heart of quite a lot of the solution
to the issues. Allocating costs is all too easy when it is a point
source of pollution that you are dealing with, hence the concerns
we have heard expressed this morning from the industry that, at
the end, when everyone starts to panic at the last moment, it
might all fall on them, ie on the water customer. I do not think
that need happen, I do not think it should happen, it is certainly
not what this Directive is about. And one of the things that is
very welcome about the Directive is the focus on outcomes and
not simply on controlling inputs. But your point, Chairman, is
a very fair one, it is desperately difficult to see just how you
allocate the costs and make sure you control them.
367. How confident are you that thinking really
is joined up in this? You said a moment ago that agriculture probably
was the major problem we have to face. Now there has been a great
spate of reports about agriculture recently, including our own,
as a matter of fact, and so we might as well do a mea culpa
as well. I do not think any of us have said that some of the environmental
schemes, or support for farmers to farm in a more environmentally-friendly
way, should be related specifically to the requirements of the
Water Framework Directive, and we have just had the suggestion
that perhaps farmers should get some assistance so they do not
farm along the river banks, or farm in a particular way along
the river banks. The Curry Report makes no mention of it, the
ministers who have talked about that have made no mention of it
whatsoever. So what do we do, do you think; first of all, should
we start bending these public policy instruments to try to deliver
another public policy, and how do we get the sort of joined-up
thinking, first of all perhaps within departments, which would
be helpful if they were going to get it between departments?
(Mr Fletcher) Clearly, the creation of DEFRA, as everybody
recognises, creates a great opportunity to make sure that the
thinking is done together around this sort of issue. The Water
Framework Directive is almost built around the responsibilities
of that department. I am hopeful, because I do not think this
is the sort of thing that can happen overnight, that that thinking
is coming together, will come together further, but certainly
it is not going to be a straightforward task. And the point that
Pamela Taylor was making, about quite simple things: You do not
keep your stock and you do not put your pesticides or your phosphates
right next-door to the water course. This could make a huge difference.
The whole issue of stocking the uplands, which interacts, as this
Committee knows better than I, with the flooding we have been
seeing, is another example of the same sort of issue, the need
to get the joined-up thinking, and sometimes to stop the subsidy
that distorts the natural practice. And by distorting, actually,
that is most perverse, leads to the large costs down stream to
put it right by a very expensive route.
368. You have had to adjudicate on the price
which the companies can charge, and the companies said that they
are producing a document which tries to make some sort of estimate
of what they may be. When do you expect to be the first occasion
when you have actually to sit down and make a calculation as to
whether there should be an allowance for conformity with this
Directive; how soon is it to harmonise, in other words?
(Mr Fletcher) The periods for reviews of price limits
at the moment are every five years, and the next review, which
has just been launched, will take effect in price limits from
April 2005. As I see things at the moment, I think it is unlikely
that there will be a lot of capital expenditure which water companies
will need to carry out which can be decided as specifically linked
to the Water Framework Directive, as opposed to all the other
Directives, which will feed in towards the outcomes required under
this Directive by 2005. This means effectively Ministers' firm
views on what is to be included in what we call the "quality
programme" are needed by 2004. It is hard enough, as we feel,
in talking to our environmental regulatory colleagues, DEFRA,
the Welsh Assembly Government and others, to get firm ideas about
what will need to be done over the 2005-10 period by 2004. Now
some of the worries we have been hearing are about fears that
constrains what the water companies will need to do in a brutally
short timespan between 2010 and 2012. That is really not quite
how we see it. The specific answer to your question is, I would
expect issues needing expenditure by water companies to surface
very clearly, through the River Basin Management Plans, completed
2008, 2009, which is actually not bad timing for the 2010 period,
a period, incidentally, which might go beyond 2015, there is no
sacredness about a five-year period. But, clearly, doing everything
in those three years would be perverse, and there are provisions,
as you know, in the Directive, where clearly there is a good reason
for it, for the implementation to take rather longer. And a good
reason does not mean, "Oh, we didn't think about it early
enough," a good reason is "We have got the most cost-effective
solution, the solution is best for the environment, we think,
and we need to test it out, and it may not cost a great deal of
money, but we need to monitor it over time, before we decide whether
some great capital project is also needed."
Mr Mitchell
369. That is a worrying proposition, it means
that the consumer is going to have to prepare themselves for major
shocks, does it not, in 2005 and 2010?
(Mr Fletcher) The history at the moment, as you probably
recall, is that bills for water customers have gone up, on average,
by 20 per cent real terms since privatisation in 1989, that includes
a 12½ per cent reduction at the last review in 1999, on the
back of the efficiency gains the water companies had been making.
Now I believe it is too soon to say what is going to need to happen
in 2005, there are a lot of other issues besides those we have
been discussing. Just very briefly, they include things like the
quality of the infrastructure, the need for capital maintenance
of the existing huge infrastructure and whether we are spending
enough on that. There is the whole business of financing these
companies, they have had very large capital programmes for the
last 15 years, they need to get all their money from the City,
so there are issues around what it will cost them. And then, on
the other side, there are the efficiency gains they have been
making, and how fast they are going to go on making them, which
enables me to reduce costs to customers. So at the moment all
I have said is that I think it would be unwise for customers to
expect another reduction, on average, in 2005. If we have very
big capital programmes, and there is still a lot of work to do
under the existing Directives, then that is not generally good
news for customers' bills.
370. That is really toning down, you need to
be prepared to say "Fasten your seat-belts, you've got a
shock coming." And Severn Trent said, effectively, that these
increases are going to have to be factored in in the next three
rounds?
(Mr Fletcher) This is probably the point, Mr Mitchell,
where I sort of stop the sweetness and light with the water industry
and say I shall be pushing that industry to live within its means,
as far as I properly can. It is my duty to enable them to finance
their functions, but I am certainly not saying to them, "Don't
worry, there's going to be a big bill increase on the back of
customers from 2005 onwards." If there needed to be, and
it is not clear yet, that is what I would have to do, but at the
moment I shall be looking to them to go on demonstrating the efficiency,
to keep those bills at the level that is necessary, and no more.
371. These are not Boy Scouts, and exhortation
does not do much good. It is my impression that you have been
a fairly generous regulator and given the companies a pretty generous
rate of return, profitability, on the regulated services?
(Mr Fletcher) For your own company, as mentioned earlier,
Anglian, the only decision on price limits I have had to take
for Anglian was to turn down their application for an interim
determination. So I am not sure they would share your view. But
we do need to allow them enough, and yet no more than that.
372. But you gave an increase to Yorkshire?
(Mr Fletcher) It is still a draft one. But perhaps
that illustrates my point.
373. It is about £12 a consumer, and my
impression is that Yorkshire's profitability on the regulated
services is about 20 per cent, whereas on the other businesses
it has gone into, where its management skills can be displayed
and it is not regulated, it is only about 5 per cent. So this
is generous regulation?
(Mr Fletcher) The profits, in the very broad sense,
in very large part go to financing the new capital infrastructure.
And probably several of us have read little articles in Private
Eye, for example. They take no notice of the amount of the profit
that needs to be spent straight back into the works required of
these companies before they start thinking about dividends. The
companies, I think, if they were lined up there, would be shouting
blue murder at this point.
374. Of course.
(Mr Fletcher) Of course, and we all take allowance
for that, but we look at their share prices, they took a really
big hit over 1999-2000, they are now a little bit better. I will
be looking to ensure that they do not have excess profits, and
certainly it is the view of those who invest in them at the moment
that they are not making excess profits.
Mr Drew
375. I am dealing with a project at the moment
which is looking at the possibility of introducing a reed-bed
as a form of farm sewerage disposal. It would involve flooding
for part of the year because of the natural overflow of a river
connected to that. The problem is that you have got these time
periods which are quite a constraint on the particular water company,
and I wonder how much influence you could have if, for example,
we were to pay the farmer an environmental subsidy, rather than,
if you like, just to carry on the way we are going, which is more
hard technology. The criticism I would voice is, you are not able
to influence anything other than the water companies and their
pricing structure and tell them what they may be allowed to spend
in terms of their technological improvements. But what you really
want to be doing is working with DEFRA directly, to say let us
think laterally, let us find alternative ways in which we can
solve some of the problems we created for ourselves in the past,
and deal with the issue of water in a much more holistic way.
How do you see your approach to things changing over the next
few years, and have you got the powers to do that, and can you
influence Government directly to make this happen?
(Mr Fletcher) To take your last question first, I
think, yes, is the straightforward answer, we can influence Government.
There is obviously quite a nice balancing act, I am an independent
regulator, at the same time I am head of a non-ministerial government
department, so the price limits will be, in the end, what I judge
are necessary. But the inputs to setting those price limits will
come from a lot of careful discussion, particularly with DEFRA,
the Welsh Assembly Government, the Environment Agency, the Drinking
Water Inspector, English Nature and, in a slightly different frame,
with the water industry, representatives of the customers and
others. Now on the specific, which is helping, perhaps it comes
most with the farmers. The farmers should be paid to farm in an
environmentally-friendly way; now that general principle I can
agree with. I think it gets difficult if we were in the business
of saying to the water companies, "Please will you subsidise
the farmers so that they stop the pollution which at the moment
the current system of subsidy encourages them to undertake."
A subsidy, effectively, to offset another subsidy does not seem
to me a straightforward application of the "polluter pays"
principle, which I think is a crucial principle to hang on to.
376. Can I just come back on that, because what
I am interested in is what would be the mechanism if a water company
wanted to look at, let us call it, soft technological answers?
Do you see yourselves having, maybe on a localised basis, a meeting
with the great and the good, DEFRA, Ofwat, the Environment Agency,
representatives of the local communities, local authorities, for
example? Will you sit down and say, "Right, this is the proposal,
let's see if it's a sensible one, we'll cost it, but then let's
see if we can fund it"? And can that decision be taken by
yourself, unilaterally, or would it have to be part of a dialogue,
and, if so, how do you see this structure evolving? Because, otherwise,
it could be a bit of a muddle, at best, but also it could mean
that we miss a lot of opportunities, because what will result
is, my experience is, you end up having to put in the hard technology
because that is the only thing that can be done in the time allowed.
(Mr Fletcher) Obviously, that is the fear about this
Directive, because the principles are alright, it is just how
it gets implemented in the end. I see Ofwat as being a relatively
modest player here, we are a small organisation with particular
expertise. I would see the Government, DEFRA, as being very much
at the heart of bringing things together at the national level,
with the Environment Agency as the competent authority, and Ofwat
lending support at that national level with our particular expertise.
So I welcome the fact, for example, that Government is consulting
on a proposition that the Secretary of State should be in charge
of where the economic principles need to be applied, with advice
coming from Ofwat to the Secretary of State. I think the example
you are giving is particularly the sort of thing which really
does need to be worked out on the ground, and that too links in
with earlier parts of the discussion this morning, and requires
all the players, the farmers, probably the local authorities,
the representative bodies of various sorts, perhaps including
WaterVoice as the representative of customers, and the RDA, etc.
Mrs Shephard
377. What we have heard described and what you
are describing seems to me to be a nightmare in terms of accountability.
Both you and Ms Taylor described the "need for" there
to be a water forum, or there to be bodies brought together by
the Government, or whatever. Do you agree with that, and do you
see any moves on the Government's part to make accountability
machinery available? And do you see your job as impossible unless
they do so?
(Mr Fletcher) Certainly I see accountability as very
important, I see it as resting with the democratically elected
Government of the day, and that is entirely right, not with an
appointed official. I see a lot of us as having a contribution
to make. I do not see it as a nightmare, I just think this is
an extremely complex set of issues, and that it is terribly important
that we work them out properly now. So, again, I am not too worried,
and the last thing I want to sound is complacent, that it is going
to take till 2008-09 for these River Basin Management Plans, with
the Environment Agency in the lead, to be properly worked out,
because a great deal of thinking needs to be done to get to the
optimal environmental and economic solutions. I think it can be
done. I recognise the worry you have about accountability, I do
not think it need work through as a problem if it is carefully
put in place as we go.
378. I take what you say. How time-consuming
do you think it is all going to be to put that machinery into
place?
(Mr Fletcher) To get local solutions that are appropriate
on the ground is going to take time, and, in theory at least,
this Directive allows time, where there is a good reason for it,
where, for example, you have put a measure in place and then need
to test how well it is working. We have got one or two, I think,
good examples of the sort of thing that can be done, which does
not necessarily cost a lot—the Wessex low-flow rivers is
one of them, the work that Yorkshire Water has been doing up on
the Derwent is another—where you look for the optimal solution,
you test things, you measure them, which in environmental terms
means taking years before you really know what the effects are,
and you proceed that way, rather than leaping in with the big
capital engineering solution as your first choice. I do not think
actually anybody is saying that is the right answer, the fear
is it might be the only answer if we do not get a move on with
the planning now. And I think we can and should be getting on,
and are getting on, with the planning now.
Mrs Shephard: I do not want you to reply to
this, but when I say time I mean man-hours, I do not mean years;
that, I think, is the problem.
Mr Borrow
379. We have had quite a bit of discussion with
the water industry on the role of the competent authority, and
I think, Mr Fletcher, you mentioned that you would envisage the
Environment Agency emerging eventually as the competent authority,
and obviously your Ofwat role and linkage with the Environment
Agency is crucial. The Committee has received evidence from SERA
to the extent that after the Asset Management Planning process,
the last one, there were some communication problems identified
between Ofwat and the Environment Agency. I would be interested
to hear if progress has been made on resolving those difficulties,
in view of certainly the need for very close co-operation if the
Environment Agency becomes the competent authority?
(Mr Fletcher) I was not around for the last review.
I know that a parallel committee talked at the time about Ofwat
demonising the environment, and perhaps I can just take the opportunity
to say it is not how we see it at all and we would welcome as
the Government propose a sustainable development duty under the
proposed Water Bill to enable us to take account, as I believe
in fact we do, not just of economic but of social and environmental
factors as well. I accept entirely we need to work closely with
the Environment Agency. We have different purposes, it would not
be surprising if we did not absolutely see eye to eye on every
single issue, but I can assure you that we do work closely together,
and with, for example, Drinking Water Inspector, another crucial
environmental regulator, to ensure that we understand their role,
they understand ours, and that we have an opportunity to comment
to each other around them.
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