Water Bill [Lords]

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Norman Baker: It was.

Mr. Lansley: We cannot get through a Standing Committee without one or two of those moments.

I do not know of a precedent in competition legislation on the gas or electricity markets, when competition was first introduced, for a cost principle to be set out in such terms or to such a degree of detail. It is deeply unwise to go down that path.

Amendment No. 251 is designed to show that there are two ways of proceeding; 251(a) is about the cost-plus method, and (b) is about the retail-minus method. However, I do not believe that it is necessary to specify them in the Bill; it would be acceptable to specify the cost principle by referring to a literal set of principles. We should try to set out not how the calculation works, but the desirability of allowing new and efficient entrants to enter the market while protecting

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the upstream variable costs of the existing undertaking. The extent to which incremental costs are associated with providing the service to the new licensed water supplier should also be protected. The fixed costs of the existing water undertaker could be jointly met in proportions to be determined by the regulator on the merits of the individual case.

Amendment No. 252 should be considered in its own terms. However, the regulator goes about its task, it should promote competition. The ''appropriate amount'' to be determined does not seem to take into account whether the regulator will permit competition. The authority's objectives in promoting the interests of consumers, where appropriate through competition, may conflict with its understanding of what the access pricing regime should be. The access pricing regime, as drafted in the Bill, seems to allow the authority little flexibility to make judgments on the merits of the case, or on the basis of what could promote competition and benefit consumers. I hope that the Minister will think more positively about amendment No. 252.

I hope that I have explained enough to encourage the Minister to consider removing the proposals in new section 66E and give us something that is designed to allow the merits of cases brought by new entrants to the market to be considered in all reasonable circumstances.

3.15 pm

Mr. Morley: That was an interesting contribution about how the cost principle is applied and I accept that there is a debate about how it should be done. The Bill's approach is that the cost principle is just that; it will be for Ofwat to sort out the detail, although as the hon. Gentleman rightly stated, a clear structure is laid out. It is to everyone's benefit that they understand what is involved.

There is justification for the retail-minus approach, because water has been in regulatory control since 1989. It is not the same for the postal service; the hon. Gentleman accepted that there were differences between water and post, and that is a key difference. It is important to recognise, too, that assets still have to be paid for in the water industry and the undertakers have to recover costs. Our approach is a means to achieve a balance in the unique situation that applies to water, which has universal service obligations. I shall expand on the issue of assets and the impact on other customers in a moment.

Mr. Lansley: Does the Minister accept that I made it clear that I thought it was perfectly reasonable, in so far as there are upstream fixed costs, for the new entrants to have to contribute to them? That was precisely what he said in relation to the requirement to meet the costs of the industry's assets. However, the Minister is proposing that all those costs should be attributed, including the profit element and the overhead costs, which also have to be met by the new entrant. That is not a rational approach. The Minister is talking about the merits of the argument; in a sense he is making my case. There will be difficult judgments to be made about the proportion of the

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fixed costs in particular that should be laid upon new entrants. The Bill states that all of them must be.

Mr. Morley: That approach is not unreasonable. We do not want to encourage people to compete who do not take a fair share of the infrastructure costs, because that would mean there were more costs on existing customers, who do not benefit from the competition. That is reflected in new section 66C, whereby licensees can enter if they can do things more cheaply than the current undertaker, which puts the onus on them to demonstrate their efficiency. A cost-plus system would allow inefficient entry into the market; there would be less emphasis on the need for efficiency because there would be an element of protection.

What I have said applies to the amendments. Amendment No. 250 would force the undertaker to try to recover the lost return from other customers not benefiting from the competition, which is one of the negative aspects of competition. We do not want prices to increase for consumers as a result of competition. That is why it is done in that way.

Mr. Wiggin: I am grateful to the Minister and to my hon. Friend the Member for South Cambridgeshire, who gave a clear and helpful description of the pricing mechanism. Will the Minister tell the Committee how much lobbying he had from existing suppliers? There is not a great tremor of terror at the thought of extra competition in the market; people are not worried about new competition because of how the Bill is structured. However, perhaps the Minister will say that there has been a lot of lobbying and that people are terrified.

Mr. Morley: I have discussions with all the stakeholders involved. It is true that some said that the threshold should be lower because they believed that the competition should be extended. The water companies have expressed some concern about the principle of competition. They are not all absolutely terrified, although that is mainly because we have approached this in a careful and balanced way. That means that we can evaluate this for the benefits of all concerned. That makes the difference.

Paddy Tipping: The threshold is extremely high and the number of businesses that can take advantage of competition is relatively small. Does the Minister believe that there is a competitive marketplace that new entrants can enter? I suspect that not many will.

Mr. Morley: At this stage that is difficult to predict. Potential new entrants are interested in this provision, but we cannot judge how many until the opportunity is there for them and they can take advantage of the measures in the Bill. We will have to wait to see. That is part of the evaluation.

Amendment No. 251 would have the further effect of allowing an option of an agreement or determination on an access or wholesale price to reflect only the expenses and reasonable return the undertaker incurs in providing access or a wholesale supply to a licensee. That could effectively leave an undertaker's other customers exposed to the full impact of covering all the undertaker's reasonable costs that are no longer recoverable from customers

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now served by the licensee. Again, that would adversely affect other customers. We have put in place a costs principle that is crafted as far as possible to protect other customers from those impacts and to recognise the needs of those who are coming in for competition.

Amendment No. 252 would also require the authority, in making a determination in price, to take into account the competition benefit for other customers. The amendment is not necessary because, under the Bill, we have already put in place an objective for the authority in furthering the interests of consumers to promote effective competition where appropriate. We have tempered the obligation by requiring the authority to have regard to the interests of other customers who will not have access to a supply by licensees. We have recognised the point about encouraging competition, but in a proportionate way. We cannot go as far as the hon. Gentleman wants because we are worried about the detrimental consequences that could have to other consumers.

Mr. Lansley: The Minister's principal concern is that there is effectively cross-subsidisation between the large consumers of water, who are likely to form part of the initial market that he anticipates and other consumers. If one moved away from the retail-minus approach that he recommends—or from any retail-minus approach—towards a cost-based approach, there would be a reduction in the cross-subsidy between different consumers of water. That may be his intention. It is perfectly possible to embrace some of the thoughts that I have put forward without necessarily doing away with that cross-subsidy.

I must caution him. Almost undoubtedly there will be an EC water directive on competition in the water industry. Eventually the resistance of the German Länder Governments will be overcome. The directive will say that there must not be discrimination and that the pricing regime must be based on costs. All of this will begin to be dismantled. It is possible to put into the Bill a structure that can continue to protect that by reflecting a retail-minus approach that is a bit more reasonable than that which is in the costs principle at the moment. He is allowing back to the water undertaker—the monopoly supplier in this case—all of the retail price that that water undertaker expects, minus only the cost that can be reduced or avoided related to the additional new entrants provision. The profit element will be part of that, too.

It will not be just other customers who get the benefit of the costs principle that the Minister is talking about; existing water undertakers will receive the benefit, too. Given the nature of the regulatory regime, it will be possible for the authority to maintain the pricing regime that the water undertaker has for other customers while enabling new entrants to come into the market. If there is a squeeze, it will be on the profit margins of the existing monopoly water undertakers. It does not automatically follow that the presence of new entrants will lead to an increase in prices for other consumers.

I am disappointed that the Minister has not seen sufficient merit in my argument to say that he will at least consider it further, as he should do. If the

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regulators get together, as they tend to do, to talk about regulation in different industries, Mr. Fletcher and Ofwat will recognise that the level of prescription in this legislation is undesirable. With any luck, they will begin the process of agitating for legislation that is less prescriptive and better able to offer opportunities for competition. I will not press the amendment; my purpose was to make the argument rather than divide the Committee.

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