Examination of Witnesses (Questions 380-401)
MR PHILIP
FLETCHER, DR
WILLIAM EMERY
AND DR
ROWENA TYE
WEDNESDAY 27 NOVEMBER 2002
380. Can we look then, just briefly, at the
potential for a changed role for Ofwat under the Water Framework
Directive, and particularly in terms of your capacity to give
advice to the Environment Agency on the economic front. Given
that the Water Framework Directive, to a large extent, is dealing
with environmental matters, do you think there is a need for your
organisation to beef up the environmental side of its economic
advice, in order, rather than to take a narrow accountancy approach
to these matters, actually to have the capacity and skills within
the organisation to take into account the wider Water Framework
Directive?
(Mr Fletcher) We do have environmental expertise within
Ofwat, Rowena Tye heads that team within Ofwat. At the same time,
we are a small organisation. We have kept our budget below £12
million for four years running, I am afraid it will go up next
year as the review kicks in, but we have taken on board new duties
under the Competition Act, and so on. I take some pride, because
it is the customer that gets our bill in the end, that we should
not spend more than we need to, and we should not start trying
to do other people's jobs for them. So I accept the general principle.
We may need, depending on what emerges as our jobs under the Directive,
somewhat to beef up our environmental resource, but it would not
be in substitution or in direct conflict with what the Environment
Agency do, for example.
381. In evidence that has been given to the
Committee by RSPB, one of the concerns they have expressed is
the capacity of Ofwat, running a tight ship at the moment, shall
we say, to expand its role to give that enlarged advice to the
Environment Agency, but I hear what you say, in terms of that
is an issue that you are taking on board.
(Mr Fletcher) I think it is attitude, as much as anything.
Partly it is about resource, and we will think about whether we
do need to increase that resource somewhat, but it is also attitude.
We are definitely not approaching this solely in terms of, as
you might put it, a narrow accountancy view. We have got our own
expertise, and we need that in order to do our primary duties
around setting the price limits and regulating the industry. We
will make sure we are competent to engage in the wider debate,
to ensure that customers do not pay more than they need to, especially
if that were a less than satisfactory economic and/or environmental
solution.
Mr Jack
382. Can I just start and explore with you for
a moment what you understand to be quality water, because I think
it is ironic sometimes, we come into a group like this and we
are all busy quaffing away out of bottles, when I am told that
we have good quality water. And we are talking here about a Directive
which is designed to improve the quality of water and, as we have
been advised, this is not just a question of the purity of what
comes out of the tap, it goes into the whole sort of eco-relationship
between water courses, the ecology, the natural world, and all
the rest of it, which are very familiar to you. But just give
me a little, 30-second Ofwat scenario on this question of the
quality of the water. Because one of the things I struggle to
understand with this is, if I am told that we have good quality
water now, how much better is it going to be as a result of all
this on a scale of sort of nought to ten?
(Mr Fletcher) If I can take it as a question about
value as well as quality, if this (showed bottle of water) were
filled with Thames tap water it would cost us 0.07 pence. I hate
to think what Hildon water costs. The Thames tap water is at least
as good for us—at least as good—as the Hildon water.
It is a matter of, I guess, preference and convenience. In 1990,
just after privatisation, 99 per cent of tests were meeting the
Drinking Water Inspectorate's quality standards at the tap; it
is now 99.86 per cent. So you may say, only a fraction change,
but it is a crucial fraction. Fewer than one in 700 tests fails,
and sometimes that will be simply because something has got on
the tap, nothing to do with the water from the company. So in
terms of safe drinking water, we can have great confidence in
the product, and it has got a lot better over the last ten years.
I think the issues around value are that for the drinking water,
but then the very difficult issues around the long-term environmental
quality of the water. That too has got hugely better, and it should
have done because we have spent, as customers, enough on it over
the last ten years. So that rivers now, whereas before, ten years
ago, their chemical quality was around 84 per cent, good or fair,
that is up to 95 per cent; for biological quality 84 up to 94
per cent. So a big step change. But there are still issues. The
very recent English Nature report, which you may have seen, around
the quality of the maritime environment, picks out particularly
nitrates and phosphates, and those are very difficult to deal
with, I have experts either side of me who will tell you a lot
more, through the end-of-pipe solutions run by the sewerage companies.
Basically, we are back again to the issue of diffuse pollution
and trying to ensure that nitrates and phosphates do not get into
the water courses, they are either not used or stay on the land.
383. In terms of the timetable that is going
to be followed to try to implement this Directive, do you think
that it is going to be adhered to? I know we have not got the
definition yet of the competent authority, but do you envisage
that at some point in the not too distant future there will be
a place where we could go and say to a person, "Show me the
timetable, show me the milestones," and will they be achieved?
(Mr Fletcher) It would be too simple an answer just
to mention the relevant appendix in Directing the Flow,
the latest DEFRA document. That just gives the milestones under
the Directive. I have no reason to think those milestones will
not be hit. I think the issue will be trying to ensure, between
us, that we come up with the optimum solutions and that we are
far enough on with our planning, especially up to this crucial
stage.
384. May I just stop you, you used a very interesting
word "optimum". What is your definition of optimum?
Give me one instance of an optimum solution to a particular problem?
(Mr Fletcher) I can give you a practical example,
the Wessex low-flow scheme. Originally, before the last review,
the proposition was that because the chalk streams in Wessex,
which are crucial in biological terms, good for the fishermen,
good for the environment generally, are affected by abstractions
and were running seriously low, especially in the summer months,
then within the boundaries of Wessex Water solutions would be
found, which would be hugely expensive, of developing new resources
in order to reduce the existing abstractions. Whether it is an
optimum solution we do not know yet, but what we do know is that,
with a lot of thought by all involved, including Ofwat, the Environment
Agency, English Nature and the water companies, instead of that,
for the moment we are drawing water from the lower Severn, through
the Sharpness Canal into Bristol Water and on into Wessex, and
that is being used to save the need for very expensive capital
developments. And we will test over time whether it is going to
produce the benefits in terms of flow on these chalk streams that
we hope it will have, at almost no cost, and comparably costs
were being talked about of over £100 million, to the customer.
385. You brought in very elegantly the question
of costs, because what I was leading to was this question of getting
these definitions back, its optimum solutions, in sufficient time
that people can go through the process that you have described.
And I have a concern, there is almost a sort of, "Oh, well,
it'll all be alright on the night," kind of feel, from what
others have said in evidence to us this morning, whereas, in actual
fact, building on what you have said, if we were moving quickly
we would build more time to give thinking time to sorting out
the solutions to the multiplicity of challenges which the Framework
Directive throws up, to optimise what the costs and solutions
are going to be. Because if we have got at the moment between
£2 billion and £9 billion, I would be very interested
to know whether, at a £2 billion level, within the current
and subsequent periodic review, that could be taken in by the
water companies as part of the normal ongoing costs, but if it
is at the top end of the spectrum we may be into lots of add-ons
to bills. Just give me a view of that scenario?
(Mr Fletcher) The initial estimates produced by WRC,
which is where this up to £9 billion comes from, and, as
you know, up to half of that could be the water companies. It
as I understand it, very much a first shot, and we are looking
for more, and it will come next year from DEFRA talking to the
rest of us, who are very much part of this whole episode. To put
it in perspective, the water industry's capital investment since
privatisation, up to 2005, will be something around £50 billion,
of which getting on for half is around the quality improvements
to the environmental issues. So at the lower end you might say,
well, the Water Framework Directive, coming on top of the expenditure
needed for all the specific Directives, would not be a whole lot,
whereas when we are talking about £5 billion, yes, that is
a whole lot. I think when it is at the top of that range the fear
is we are talking about end-of-pipe solutions which are being
put in, because they are inappropriate. My hope is, as Pamela
Taylor's was, in her evidence, that we shall be seeing much more
modest estimates because we shall be going for the optimal solutions.
386. In the process then of managing this activity,
what would your recommendations be to turn your hope into reality?
If it is the Environment Agency that has to do this, what, in
your judgment, have they got to do to turn your hope into reality?
(Mr Fletcher) I think absolutely crucial to this will
be the River Basin Management Plans, coming up in six, seven years'
time, with of course a lot of groundwork going on towards them
now. My hope will be certainly that there should not be any shilly-shallying
now, because we have a lot of work to do. I hasten to say, I do
not share the views that have been expressed that we are in the
position of shilly-shallying, DEFRA are in charge of the process,
they are getting on with it. But there is a great deal to do,
and we will need to ensure that we have a good case for the Commission
so we do not get into infraction proceedings, and that we are
operating the Directive properly, which may include not trying
to do everything by 2015, very properly, under the Directive,
using the provisions for derogations when it makes sense to do
so, and where you can point to excessive costs and/or a sub-optimal
solution as being the consequence if you try to do everything
too quickly.
387. What is the financial health of the water
industry at the moment?
(Mr Fletcher) Could I just bring in Bill Emery first,
who was dying to say something, and then I will pick up that point.
(Dr Emery) Looking at it from the technical point
of view, I think to get credible River Basin Management Plans
in 2009 a large amount of analysis needs to be done reasonably
soon, in the next three to four years, and that needs to make
sure that all the options and all the solutions are carried forward
in that analysis and not jumping to a sewerage service solution,
either on the sewers or on the sewage treatment works, and to
involve a large number of people. And that is going to take quite
a long time. Also it has to take account of the progress that
is going to be made to the environment as the rest of the investment
programmes, that are ongoing now and will be ongoing as part and
parcel of other Directives in the next five years, are taken into
account. The numbers in terms of compliance with the River Quality
Objectives represent the performance of the rivers over a five-year
period to 2000, we are working on that and lots of work is in
place. So the difficulty here is to make sure we are not judging
a gap from where we are now but we are judging a gap from where
we will be and then addressing those particular issues.
388. Can I just ask, in terms of your role in
understanding the technicalities of what is involved to meet each
of the requirements of this Directive, if the industry started
to come to you, in the context of your next review, and said,
"Well, this is our best cockshy of what it's going to cost
to do all of these things," are you going to be in a position
to challenge them and say, "Well, hang on, no, no, we think
that that's a bit on the high side because it's not an optimal
solution"?
(Mr Fletcher) We have been in the business of challenging
the industry's estimates since 1989 and we shall certainly continue
with that role.
389. But, given the enormity of this thing,
are you, in your judgment, equipped now with sufficient resources
to wag the finger or ask the difficult question when it is appropriate?
(Mr Fletcher) This is where we need to work with the
Environment Agency, with the Drinking Water Inspector. Again,
we are not trying to duplicate their expertise, but it is terribly
important that they approach the issues, as we do, with cost/benefit
very much as part of our objective.
390. Coming back to my question, the health
of the water industry, in financial terms, what is your assessment?
(Mr Fletcher) The industry is in reasonable but not
excessive health, is how I would see it at the moment. There is
some controversy about the long-term position. If we just took
share prices, which is only one indicator amongst many, of the
limited number of companies still listed, we can see that they
have done reasonably well compared with the FTSE 100 over the
last couple of years, having done very badly compared with the
FTSE over the period of the last review. They do have long-term
issues, they are raising the money. After all, basically, this
is a fairly straightforward industry, a monopoly, regulated for
that reason, very certain revenues through the price limits; very
clear programmes to carry out, challenged through a system of
incentive-based regulation, RPI-X, to out-perform, and thus reward
their shareholders, a reward which is creamed back for the customers
at the time of the next review.
391. In terms of the time cycle of the reviews,
are you able to change them if necessary?
(Mr Fletcher) Yes. The licences at the moment provide
for a five-year period, and there will certainly be a five-year
period from 2005-10, but it is open to us to agree, and it need
not be agreed, it could always be resolved in front of the Competition
Commission, if necessary, to go for a longer period than five
years. The Conservative Government of the day originally thought
it would be ten, but it has been five since 1989. And I think
it is quite likely and proper and probably desirable that we should
extend the five years from 2010 onwards, to give more certainty
to the industry. It is one of my prime tasks, if you like, to
enable the industry to perform within a stable, certain platform
and transparent platform of regulation.
392. And just to ask the reverse question, having
once undertaken a periodic review on perhaps a longer timescale,
taking into account the assessment of the cost burden to the industry
of the Water Framework Directive, if you saw then, with knowledge
and experience, that solutions were coming in at lower perhaps
than the allowed for cost, can you reopen a settlement to adjust?
(Mr Fletcher) Broadly, the answer is, no. There are
specific things that can be done between reviews. But it goes
back to my stable platform, there needs to be, I believe, an incentive,
ultimately in the interest of customers, to companies to out-perform,
and if they knew that any second they out-perform the regulator
would be jumping on their back to claw off whatever might be regarded
as a surplus then they would not out-perform in the first place.
So broadly the system is, they keep their gains for five years,
and after that the regulator collars their gains on behalf of
customers.
393. And my final question, I think you were
listening when I asked, in the accounting terms, in looking forward,
how the industry should either tell its shareholders or account
for what inevitably are going to be future liabilities, because
the Directive makes certain requirements with an already published
timetable date, and therefore some degree of financial provision
will have to be made by companies, in terms of advising shareholders
of their future liabilities. Would you care to comment on that?
(Mr Fletcher) The strict accounting requirements are
just the same, of course, for the water companies as they are
for any other plc. I believe, in this case, they are in a much
more comfortable position perhaps than many companies, in that
they can draw the attention of the City to the fact that it is
my primary duty to enable them to carry out and to finance their
functions. I make the assumption, in doing so, that they will
be efficient, I certainly do not look to rescue an inefficient
company that is in trouble. But as long as they do their job properly
and efficiently, including any new requirements imposed on them
under this or other Directives, then the customer in the end will
have to find the money to enable them to do it.
Chairman
394. Mrs Thatcher, when she was Prime Minister,
said that, of course, Governments do not have any money, only
people have money. And what we are talking about really is just
where we take the money off the consumer, is it not?
(Mr Fletcher) Yes.
395. Because your job is to decide how much
we take off the consumer at the point of purchase of water. But
insofar as I am polluting because I drive my car, and the Government
decides to put in a fuel escalator, it is taking some money off
me at that point. If it puts restrictions on planning permissions,
and therefore the costs rise because of those restrictions when
it has taken the money off me in that respect, and if we pay the
farmers to farm in an environmentally-friendly way, then it is
my tax money which is going to pay the farmers. So we ought to
be careful, ought we not, that we do not give the impression that
consumers occur only at one point in this chain. The consumer
and the taxpayer are the only persons in the firing-line who would
like a longer chain, are they not, because they are the same people
who are going to benefit, ultimately?
(Mr Fletcher) Certainly, at the end of the day, the
consumer is at the end of the chain, but the consumer can be helped
greatly by paying less and getting a better outcome earlier up
in the chain. And that is where I suggest it is important that
also, in thinking about the Directive and similar issues, we think
about the possibility of economic instruments to help make the
system work as efficiently as possible, to make it in the interests
of all those different players, up the chain, down the chain,
to come up with the solution that will cost the least for the
best result.
396. And the problem the water industry has
got is that if all those things higher up the chain do not work,
because people are not prepared to take the decisions, or because
they do not have the instruments available to them, which is going
to be one of the problems, then at the end of the day they are
the ones who have to do the cleaning up?
(Mr Fletcher) At the worst, they have to do it at
two stages. They find their groundwater contaminated by nitrates,
they need to remove those nitrates or find other sources before
they can give us the drinking water, and then they have to clean
it up again when it comes through as waste water, in order to
meet the environmental Directives to ensure that the rivers and
the coastal environment are properly protected. So, yes.
397. The key will be the River Basin Management
Plans, presumably, because they should be able to identify which
is the highest practical place up the stream, as it were, to exercise
those controls in order to get the optimal solution, or the biggest
bank, whichever way you look at it?
(Mr Fletcher) And the answers will vary, of course,
from case to case, because of the different hydrological, geological
and farming and other patterns that apply.
398. And you are confident that our Government
is joined-up enough not merely within each part of Government,
within local government, which we have been told earlier on does
not have the faintest idea what day of the week it is, as far
as this Directive is concerned, regional bodies, you are confident
that at some stage all this will be brought together seamlessly?
(Mr Fletcher) I do not have Pamela Taylor's huge faith
in water forums, there is always a danger of talking shop, and
a danger of missing the most crucial people because they are not
represented properly.
399. Sort of synchronised swimming?
(Mr Fletcher) If we think about farmers, yes, the
NFU is there, but it is the hill farmer and the arable farmer
and all the other different sorts of farmer who have the crucial
input. Am I confident? I am confident that the will is there,
I am not going to speak for ministers, I know they will be appearing
in front of you before too long. I think there is an appreciation
of the issues. I think there is a way to go yet before we can
be at all confident that we have bottomed out what is going to
be a pretty complex process. But can I be permitted one last thing,
which is that we do love to groan, do we not; as a Member was
making clear earlier, the problems we face in this country really
are not on the same scale as those confronting the numerous nation
states bordering the Danube. We have organised around a River
Basin Management platform since the early 1970s; if we cannot
crack it then it is really pretty desperate for anybody else.
Chairman: That is a comforting thought, that
other people are getting it worse than we are.
Mr Drew
400. Clearly, you are dealing with individual
companies and setting their prices, and so on, and yet, partly
because you mentioned the movement of water through my constituency,
what we need is a national water grid. This was always the aim,
this was always the jewel in the crown of what the water industry
would move towards one day. And yet, in a sense, those areas that
have now got a surplus could be canny and say, "Right, okay,
we can afford to use the price mechanism to keep our customers
having their water at a lower price, and those with a shortage
can buy it off us, but they'll have to pay the going rate."
Are these issues in conflict, or can you manage to provide supply,
where there is shortage, at an affordable price?
(Mr Fletcher) I think, in terms of security of supply,
a great deal of work has been done over particularly the last
ten years but also before that. Whether it is appropriate to take
that to the sort of scale we have got in terms of gas and electricity,
I am very doubtful. As you know, we are talking about a very different
product, very expensive to move around and which has different
qualities in different areas, which when mixed can actually produce
something that is not palatable. So a full-scale national grid
I am not sure would be sensible.
401. Not even linked with a canal system as
well?
(Mr Fletcher) As you will know, Water Grid, under
the auspices of British Waterways, has just been launched, but
canals, broadly, were not built to transport water but boats,
and I think if the British Waterways Board were here, they would
be saying, "Well, a primary thing is to use our surpluses
competitively in particular areas where we happen to have a surplus,
rather than try and turn a canal into a full-scale national grid."
Where I do absolutely agree with you, and where a lot of work
has been done, is ensuring that we have got good regional grids,
so that where, for example, we had droughts in a particular area
then it is possible to ensure that compensating sources can be
brought into play, and that is where quite a lot of customers'
money has gone.
Chairman: Thank you very much indeed. That has
been an extremely helpful session. If there is anything you wish
you had said which you have not, do let us know, and anything
you have said you wish you had not, it is a bit late to do anything
about it. Thank you very much indeed.
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