Examination of Witnesses (Questions 20-39)
WEDNESDAY 11 JUNE
2003
MR PHILIP
FLETCHER AND
MR ROGER
DUNSHEA
Q20 Mr Mitchell: They do not need
to capture you if you are that sympathetic to their profits!
Mr Fletcher: Well, it is back
to your analysis of just where they do stand. First of all, I
accept your analysis in respect of the early and the late 1990s.
The rate of return which the companies were making was far higher
than would be justified by what ought to be a basic low-risk business.
I am not saying that it is easy to manage water companies, I am
not supporting your point there, but this is an area where the
technology does not move as fast as it does in telecoms for example,
where they are monopoly businesses, where they are operating in
a regulatory environment which gives them absolutely certain revenue,
subject of course to heavy industry disappearing and that sort
of thing. So, there is a lot of risk to which many companies are
exposed to which this sector is not fully exposed and that ought
to be fully taken into account and I seek to ensure that it is
in relation to the cost of raising capital for them. If you look
at some of the indicators now, they are not so rosy. The share
prices of those companies that are independently quoted have been
running at a discount to the regulatory capital value of the companies
more or less solidly since first indications of the outcome of
the last review in 1999. Other things being equal, one would expect
to see that share price running at a premium at this stage, the
mid point between the last review and the next one, as investors
see an opportunity to buy into this safe product, but it is not,
and most of the takeovers to which you have referred have been
at a discount to the regulatory capital value, which is an indication
that all is not well. Part of that is your other point, which
again is not for me to comment on but I can see exactly what you
are saying, that some of these companies' investments in non-regulated
business have not been very successful. If their problems as a
company arise from unsuccessful non-regulated business, I take
great care to ensure that that does not spill over into my judgments
which are solely related to the regulated water or water and sewerage
company. They must take their chance and, if they are in trouble
and we have seen examples of trouble—Hyder in Wales expanded
into a lot of other businesses, the normal market pressures operated,
Hyder had to seek takeover and duly did so and the eventual outcome
of that was Glas Cymru. Enron faded very rapidly indeed. Wessex
had to be taken over and was through normal market processes.
So, the system is there to keep going and the ring-fence around
the regulated company through the licence has held, in both cases,
to protect customers. It would have been very easy, for example,
if Enron's creditors had been able to exercise almost a blackmail
by getting hold of the assets of the water company. One can see
all sorts of trouble arising. They were not able to do so because
of that ring-fence around the regulated business. Wessex's customers
continued to receive a service without any diminution through
the period of that takeover.
Q21 Mr Mitchell: At the same time,
you say that you need money for investment but you cannot mandate
them to invest, can you? You have no way of compelling that.
Mr Fletcher: We can in effect
and the "we" here is not just a sort of royal "we".
Q22 Mr Mitchell: How?
Mr Fletcher: This is ministers
saying to the water and sewerage companies as an integral part
of the review which is coming up, "You will achieve these
outputs by these methods during this coming review period"
and ministers in saying that are advised by the Environment Agency,
by the Drinking Water Inspector and by English Nature, the environmental
regulators, and, incidentally, by Ofwat. We do not absolve ourselves
from that. The companies must then achieve those outputs and it
is my job to finance them to do so. One of the potentially beneficial
parts of the system is that they are not just told, "Go and
build an office block with this design in this location or its
equivalent" and "Go and build this sewerage treatment
works in precisely this form." They are told, "You need
to do X to achieve an outcome Y. You go off and you do it in the
most efficient way you possibly can and, if you can achieve that
outcome and you make a profit on it, well, fine. For the moment,
you will keep the benefit of that for your shareholders but only
for the moment because, after five years, I or my successor will
collect that benefit and ensure that the customers of that monopoly
company see their bills either reduced or held below the levels
they would otherwise be as a consequence."
Mr Mitchell: Just one more question on
prices before Candy takes up the issue. We stopped companies cutting
off people for non-payment of bills, which I thought was a very
sensible and socially just thing to do because, frankly, I was
appalled by the hard-hearted attitude of Anglian Water to people
who could not pay their bills. It was shocking and should never
have been allowed from a public utility. We have put an end to
that, which means that you have a problem—
Chairman: You are not expressing a Committee
view.
Q23 Mr Mitchell: Yes, I am. We are
all socially just in this Committee. Besides, it is a majority
view of the party which is most numerous on the Committee, but
let us not get into politics because I never do! The point I am
making is that debts arise. Why should the companies not have
to carry those debts rather than taking on the impossible job
of extracting them from very poor consumers?
Mr Fletcher: There is a general
issue around debt and I am not trying to pin at least part of
this answer solely on the statutory ban on disconnection of domestic
customers for debt. What is a fact is that debt up to 48 months
old has increased by 10% by £65 million since 1998-99.
Q24 Chairman: You cannot get it back;
it is unrecoverable.
Mr Fletcher: Although that is
not true of all companies, 18 out of the 22 have reported increases.
It is not confined to this sector, but I think there is little
doubt that the ban on disconnections has led some who could pay
to play the system because, unlike energy for example, they cannot
be cut off. It is not my job to defend—and I am not going
to—the companies, some of whom were ham-fisted in their
operation of disconnection. Most of them did see it very much
as a last resort. After all, these are their customers that we
are talking about, not mine, and a bad story in the local press
around a totally unjustified disconnection for debt of a family
in dire poverty was bad news for the companies. Most of them—and
I am not saying all—were actually quite careful before they
disconnected, but the threat was there and a part of this rise
in debt, I believe, is due to the ban and there is no sign at
the moment that that increase is tailing off. If anything, it
is starting to get worse. Why should the companies not be made
to bear that in their profits? That is where the whole system
of regulation has to take account of new statutory burdens or
effects on the company where it applies to the water sector as
opposed to the economy at large. Where it is the economy at large,
it is dealt with by our RPI-X incentive-based approach to regulation.
Where it is specific to the water sector, as for example there
would be with the prospect of a significant change in the tax
regime for water companies deferred from 2000 to 2005, that would
be one significant factor when the new regime kicks in in leading
me to believe at the moment that it is likely for most companies
on average, not necessarily all, customers, I am afraid, will
be looking at increases rather than reductions when we come to
the next review. I have to build that in; I cannot simply say,
"Take it on your chin for profits." What profits should
be about is the company's own performance. Efficient, more profits.
Less efficient, no profit. Not my problem and not the customers'
problem, something for the company and its shareholders to sort
out.
Q25 Mr Mitchell: So, what is to happen
to it?
Mr Fletcher: I will need to allow
probably more where I believe it is due to the ban on the disconnections
as opposed to poor management of debt. So, we are encouraging
companies to manage debt properly and to be sensitive to those
customers who do find real difficulty in paying. In the south
west, for example, the highest bills in the country by a long
way—
Q26 Ms Atherton: We are aware!
Mr Fletcher: And I am very aware
too . . . there is more of a problem. Not to say that their debt
is higher but I have had to allow an increase in bills in the
south west and in one or two other areas, partly due to the rising
debt linked with the ban on disconnection.
Chairman: May I just draw to your attention
that, when Mr Mitchell comments as to what a doddle it is running
water, he was of course a starring member of the House of Commons
University Challenge team!
Q27 Ms Atherton: Unkind but true,
Chairman! I will come back to the South West Water which you know,
Mr Fletcher, is a burning issue with me, although that is perhaps
not the right term to use when we are talking about water. Going
back to the bills issue and the debts, I hear rumours that there
are proposals that landlords could become responsible for tenants'
unpaid water bills. Have you heard of this and have you been involved
in these discussions?
Mr Fletcher: That could only happen,
I think, by amendment to the Water Bill currently in front of
the House of Lords. This is not something that could happen like
that. I have heard it mentioned as an idea—and it is for
you to judge the politics, not me—on the basis that a ban
on disconnection having been put in place, there is no way in
which it is going to be changed and, looking at it from my point
of view, I cannot see—
Q28 Ms Atherton: So you have not
had discussions on this issue?
Mr Fletcher: I have not been involved
in discussions. I may say that the one successful judicial review
of Ofwat was on the issue of pre-payment meters where, because
pre-payment meters were liked by many customers and are still
liked in the energy field, my predecessor was extremely reluctant
to take enforcement action against companies that wanted to persist
with those pre-payment meters despite the ban. He lost a case
against Birmingham City Council and others and pre-payment meters
have disappeared from the water scene.
Q29 Ms Atherton: And that would have
been widely mourned by those who liked them because I went to
see people assuming that everyone would hate them and in fact,
as a politician, if I had knocked on the doors and met the reception
of enjoyment and happiness about pre-payment meters that they
received, I would have been a very happy politician! Let us move
on to regional disparities. Can you see any end in sight for my
constituents and those of South West Water who still are paying
the highest water rates in the country, who receive no recognition
in their benefit payments, they receive the same percentage of
benefit as those, say, in Merseyside who actually end up with
a higher percentage because their water bills are that much less
and yet, in my view, many people did not receive cuts of the average
when the prices went down? We were the ones that still went up.
So, in every way, the people of the West Country, who are paying
for 30% of the beaches to be cleaned up—3% paying for 30%—are
going to continue to suffer. Is there ever going to be a time
when you are going to take this bull by the horns and give it
a good old rattle?
Mr Fletcher: This is one where
I am liable to be craven and to say that this was there in Parliament's
decision at the time, in 1989, of privatisation. It was debated
at the time of privatisation. The south west, at the time, was
already lined up for relatively low population, relatively poor
population and relatively high burdens emerging and they have
emerged still more since 1989 as you say, obvious enough, but
a very long coastline and the European directives in particular,
which have come in subsequently around bathing waters and around
urban wastewater treatment and a whole host of other things do
tend to bite severely on the south west. The system as I have
to operate it—and I think appropriately so because it would
not be appropriate for a publically appointed official to be trying
to do something different—is to ask, in relation to South
West Water, comparing them with all others and being as consistent
about it as I can be, are they doing a proper job and setting
a price limit which assumes that they will behave efficiently
which does not make any concessions to them but nonetheless is
at the level they need to continue to finance what may still,
for them and for other companies, be a considerable programme?
I do not have the option of saying that South West Water customers
shall be subsidised either by the taxpayer or by the customers
of other water companies. The problem has to be looked at in its
own terms. I know that there has, for example, been some debate
around the Objective One status for part at least of the region
and whether that means eligibility for some water or wastewater
works and the availability of funds from the European Union. However,
so far that does not seem to have got very far, and I suspect
that if it ever did happen, it would be very small beer. I am
as dedicated to the interests of the customers of the south-west
as to every other part of England and Wales, but I cannot do any
sort of special arrangement for them. I am obliged to work within
the same parameters, and any change must be in the hands of Parliament
rather than those of the appointed water regulators.
Q30 Ms Atherton: Well, it will not
go away in the West Country, and it is just getting worse. Whilst
water may not be at the top of the political agenda in other parts
of the country, it certainly is in the West Country.
Mr Fletcher: I am not trying to
say anything special about the south-west, but, clearly, if bills
do have to go up, that very much focuses attention on the issue;
and there are a number of other relevant issues too, including
the right to switch to a meter, which domestic householders have.
The higher the bills are, the more people will find it in their
financial interests to switch.
Q31 Paddy Tipping: You have talked
about the European directives, and the big one coming up is the
Water Framework Directive. How much is it going to cost?
Mr Fletcher: I have just been
reading the Government's response to the Committee's earlier report.
As you will know—and I am afraid I have no great wisdom
to add to this—the range of costs falling first of all across
the country, and secondly specifically on water customers through
their companies, is at the moment so huge as to be very hard to
give any meaning to. I have given evidence to the Committee in
part on this when you were doing your special examination, but
there is a tremendous importance of thinking things through in
good time. The coming periodic review will only, so to speak,
touch on the fringes of the Water Framework Directive. There will
be many specific directives that will be the main drivers. However,
as the Committee has said, thinking things through in good time,
which means from now on—and as the Government is effectively
saying in its response to you—is very important if we are
going to get value for money for the implementation of what is
at heart a directive that I would certainly cheer. It focuses
on outcomes and really brings into the picture the diffuse polluter—the
farmer, the motorist—as well as the water and the sewerage
company, which can only do so much by clearing up the point sources
of pollution.
Q32 Paddy Tipping: The Water Framework
Directive is coming, over a period of years; and at the same time
you are looking at your next periodic review. How do those fit
together? What is your preliminary thinking about the Water Framework
Directive and the next review period?
Mr Fletcher: I think the "polluter
pays" principle, which again I am glad to see being soundly
endorsed in the Government's response to you, is absolutely key
here. The difficulty is that the timescales just do not match.
Water companies are having to spend customers' money now on improving
water treatment, as a consequence of nitrates added to the land
twenty or thirty years ago; but unless something is done about
those nitrates and the phosphates now, it will be still worse
a problem, not just for the aquifer but for the whole aquatic
environment in twenty or thirty years' time. It is something that
needs to be tackled; and the reform of the CAP is obviously at
the heart of that. It is not my job, thank goodness, to reform
the CAP, but I do look to work closely with my colleagues in the
Drinking Water Inspectorate, English Nature and the Environment
Agency. We do not always see life entirely through the same spectacles,
but I am glad to say that we see enough of it in the same light
to be working together, listening to each other to try and ensure
that the thinking is starting now—not so much for the review
for 2005-10 but for the review 2010 onwards—which will include
the key period leading up to the absolutely key date of 2015 for
the implementation of the Directive.
Q33 Paddy Tipping: You have been
looking at our report and the Government's response to it; therefore,
you will know that we were suggesting that your price review period
and the six-year review of river catchment placements perhaps
should run together in some way. What is your view on that?
Mr Fletcher: I entirely accept
the underlying thinking of the Committee there. It is very important
because the Water Framework Directive will be a key part of the
next review but one. However, I am not sure that it is necessary
to achieve it by an exact correlation of timescales. In fact,
I think the very provisional way it might work out is not too
badly wrong. We shall have the river basin management plans in
around 2008 or 2009, which will feed in to the next price review,
decided in 2009 and taking effect in 2010. For other reasons,
I should like us to be able to extend the period, if we can, beyond
five years. Five years, or any relatively short period, has adverse
consequences. First of all, it disrupts the capital programme;
it tends to lead to a pattern that tails off just before the next
review, and then it takes some time to recover, so that there
is a constant dip and trough and peak. Another effect is that
it disrupts investment at the City end. If you look at share prices,
they also rock around the periods of uncertainty in just the same
way, which is not good for keeping that cost of capital down to
the benefit of customers. I would therefore like to get the period
longer, but it can only be longer if the Government, the environmental
regulators and the economic regulator, are all ready, in 2009,
to set a programme that will go, however much longer that it can
decently be done, than five years, taking us beyond 2015 to some
subsequent date. It is hard enough to ensure that Government is
going to have real meat for its decisions on this periodic review
by January next year, which is when we are looking for the Government's
principal guidance to the companies and me on the issue, to make
me just a little bit sceptical about just how much further ready
we shall be in 2009, but at least we have got a little bit of
time to get ready for that.
Q34 Paddy Tipping: Do you share our
scepticism about the rate of progress of this?
Mr Fletcher: I do not think that
you, as a committee, underestimate the fact that this is a very
difficult process; it is not something where a magic wand can
be waved and it will all work through. Therefore, it makes sense
that as much time as possible should be devoted to trying to get
these various ducks set up in a row.
Q35 Chairman: Mr Fletcher, given
that most investors look at the water companies as pretty stodgy
animals, and given the fact that spending in 2001 on investment
fell 19% below the anticipated levels, how confident are you that
they can finance the infrastructure and environmental investments
which are going to be required of them?
Mr Fletcher: Looking at the period
we are in now, a certain amount at least of the expenditure has
followed that rather undesirable peak/trough pattern, I expect
them to make it up over the next couple of years, towards the
end of the review period. Some of it will be genuine efficiency
gain, which will mean they will keep the benefit. They will have
achieved the outputs and outcomes, but they will not have to hand
the money back, so to speak. Some of it will simply be under-performance;
they may not fully complete the programme, in which case I claw
back at the next review the under-performance, the things they
have not done that they should have done. Some of it was down
to genuine further thinking on quality issues. For example, my
predecessor allowed, in the last review, for very substantial
lead pipe replacement. Most of that will not now happen in the
current period because the Drinking Water Inspector first wanted
the effects of chemical dosing orthophosphate dosing, to be fully
tried out. So far, against current standards, it is performing
rather well. Therefore, some of the lead pipe replacement assumed
has not been required of the companies in the end, and I will
get the benefits back for the customers at the next review. The
following review is a real issue on the financing, and that comes
back to earlier parts of the discussion on the need to ensure
that these companies, which have been steadily building up debt
and therefore are much closer to the covenants that they need
to make if they are to continue to raise money, may find that
the cost of raising that money for the future rises significantly.
I will have to take account of that in my approach.
Q36 Chairman: We all are, to some
extent, trying to make a forecast of what might be required in
terms of regulation, mainly coming from Brussels. There are genuine
questions, are there not, about what is the value of incremental
gains in, for example, quality standards, against the prices?
In the Water Framework Directive, which Paddy has been talking
about, we heard complaints that there would be requirements for
absolute zeros, which are unattainable because environmental effects
meant that that could not be achieved. In all the discussions
about nitrate vulnerable zones, we have had complaints that requirements
have been set way beyond any possible detectable benefits. At
the end of the day, the consumer pays. I have to say that I see
you have commissioned Mori to do some research; but, quite frankly,
why the consumer says he would not pay more than £2 as opposed
to £1.9875 or £2.18 plus a free watering can—I
do not give much credibility to that. If somebody asked me that
question as a consumer, I would just pluck any figure out the
air, quite frankly. There is a real issue, however, is there not,
about to what extent one wanted to go on squeezing the last drops
out of this, as it were, where there may well be no discernible
benefit, particularly as we are all beginning to learn now to
perhaps take a slightly mature attitude towards risk?
Mr Fletcher: If I can very briefly
just touch on that customer survey, without for a moment challenging
your scepticism, Chairman, it is to say that we have made one
advance in this review. We are doing this exercise together with
all the other main stakeholders; that is with the customers' representatives,
with the companies through Water UK, with the environmental regulators
and with Government, so that when you come to examine me around
the success or otherwise of periodic review, hopefully you will
not find, as your predecessors did last time, different players
waving each their own pet little survey, which had questions that
happened to suit that particular player: rather, you will see
some collective view, which I believe will be helpful to a degree
in showing us what customers want and what they are prepared to
pay for it.
Q37 Chairman: We will not pursue
this. I merely note that everyone will be talking the same baloney!
Mr Fletcher: There is a point
in the European Union where I have a great deal of sympathy with
WaterVoice. There is no proper representative of British water
customers' interests who is, so to speak, on the inside track
for Brussels in examining directives. That is not for want of
trying. It is an example of a Brussels catch 22, which I can entirely
understand, whereby the Commission only talks to international
representatives, and yet, because we are the only country with
an organised consumer body, we are the only people trying to play
in Brussels. Therefore, the Environment Directorate General is
always rather subject to those dedicated environmental groups
that say, "we can and should do more" and very seldom
subject to the counter pressure of those representing customers
who say, "we too are concerned about the environment, but
we are also concerned about our bills". On your point about
standards, I welcome the Water Framework Directive because it
does focus on the outcomes; it does not just try and ratchet down
the standard always another notch. The Bathing Waters Directive
revision, which is going on at the moment, has seen important
amendments as it has gone through; and this is Brussels responding
to just that sort of concern not to push the thing to an absurd
extent. Some prospective amendments have, as I understand it at
present, fallen by the wayside on just the sort of issue that
you have raised.
Q38 Mr Mitchell: What part do you
play in the process? There has got to be some kind of cost/benefit
analysis. We cannot go on just legislating and issue directives
about higher environmental standards without looking at the costs.
First of all, do you play any part in whatever cost/benefit analysis
goes on; and, secondly, what is your view of the adequacy of the
cost/benefit analysis presently applied to these kinds of directives
and changes?
Mr Fletcher: I do think that until
relatively recently quite a lot of the environmental directives
had not been fully thought through in terms of their likely costs.
I think the Commission is now looking at this with more careful
attention. I entirely accept your point that we ought to be seeing
cost/benefit analysis of major schemes that are not public expenditure
admittedly, but costing the water customer directly. My predecessor
and I have both been vociferous in encouraging the Environment
Agency and the companies to apply proper cost/benefit disciplines
to these major projects. There is a problem: where it is a statutory
requirement, as it is if it is required under a directive, it
has to be done, but always by the most cost-efficient means possible.
That is something which I urge on Government and on my environmental
regulator colleagues as a necessary part of our collective accountability
to the water customer; that if they are going to be made to pay
more—and, as I say, I fear the bills may go up—then
at least we shall be able to say, "and you will be getting
value for it because we have done the proper exercise designed
to achieve it."
Q39 Mr Mitchell: Your job is to—
Mr Fletcher: Advise, encourage
and warn—not to carry out the cost/benefit analysis. It
is occasionally to set up a sort of pilot project which can sometimes
demonstrate that things can be better done. The Wessex low flow
rivers I give as an example where, with Ofwat encouragement and
with WaterVoice encouragement, a better answer was found to supplementing
the flow of chalk streams in the Wiltshire area, which is very
important ecologically, but doing it with water from the lower
Severn rather than a very expensive development of new boreholes
within the Wessex catchment area.
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