Examination of Witnesses (Questions 74-79)
3 MARCH 2004
MR BOB
BATY, MS
PAMELA TAYLOR
AND MR
CERI JONES
Chairman: Thank you very much for joining
us. As you may know, we had an interesting evidence session yesterday
with the Environment Agency, English Nature and the RSPB, who
raised a number of issues which we would like to explore with
you today. We want to kick off by seeking your views on the draft
business plans.
Q74 Sue Doughty: Could you summarise
briefly for us the process by which you developed the draft business
plans that went to Ofwat last year?
Ms Taylor: Ofwat set the parameters,
which the companies would then have to cost; so the companies
would then go through those parameters and produce their costings.
Those costings were then checked independently by Ofwat reporters,
who are independent. This is an iterative process, so as time
goes on, Ofwat will get further and further understanding into
the detail. They also have a bank of knowledge and information
from previous periodic reviews; so this is not the first time
and obviously they have got previous data with which they can
compare.
Q75 Sue Doughty: Do you find the process
satisfactory?
Ms Taylor: The process this time
around has been different from before, and we think that this
time the process has been an improvement compared with before.
We have liked the idea that Ofwat has asked companies to produce
the draft business plans because we welcomed the opportunity of
being able to put those into the public domain. It has meant that
customers, and also customers' representatives such as their members
of parliament, consumer groups and environmental groups, have
been able to look at the plans at an early stage. We welcomed
that.
Mr Baty: The framework of the
plans of course offers the opportunity for three scenarios. One
is a price and environmental programme, which was deemed reference
plan A, which was identified as being the minimum requirement
to deliver statutory obligations; and reference plan B, which
was that programme plus those investments which were considered
to have a cost benefit by the Environment Agency; and we were
also invited as individual companies to submit a company-preferred
plan, and that varies from company to company. For some companies
these will be below reference plan A; some are between (A and
B) and some are at reference plan A; so this time it was a broader
spectrum to work on.
Mr Jones: It is also worth stressing
that in developing company business plans there has been quite
extensive consultation between companies and a range of stakeholders,
including in particular the Environment Agency, the Drinking Water
Inspectorate and WaterVoice. Much of that consultation has been
at a regional level between specific companies and the agencies
in respect of that region.
Q76 Sue Doughty: The whole idea of preferred
plans is very interesting. Is a preferred plan really a preferred
plan? Is it an ideal for you about what you would like to be able
to spend over the next five years, or is it something that you
have moderated as to what you think you are going to be able to
put in?
Mr Baty: Individual companies
are at liberty to assess the issues that that particular company
may be wrestling with; and certainly in the South West customer
affordability is very high on the agenda, and we are very conscious
about the impact of customer charges. In the South West we have
invested over £1 billion on environmental improvements since
privatisation, so there is a significant environmental benefit
already being enjoyed in the South West. We were looking to see
whether during this coming period, it is appropriate to balance
that out a little bit more given the pressure it is putting on
customer charges. We have done that in dialogue with the Environment
Agency, and that dialogue is continuing even today. We are waiting
for ministerial guidance as to just how that will balance up when
ministers' guidance is public.
Sue Doughty: Are there any other factors
that will affect your final plans that you would want to factor
in as well at that stage?
Ms Taylor: At this stage there
are still some things that we just will not be aware of and we
will not know how much they will cost or when they are going to
come in, because a lot of our spend—around 80% of it—is
driven by directives from Brussels. Obviously, one of the problems
we have is that the timescale for the periodic review, which is
in five-yearly chunks, does not fit with the timescales of Brussels
directives. There will be some issues therefore that we will not
yet know whether or not we will have to deal with them. A little
while ago, for example, it looked pretty certain as if we would
get a revised Bathing Waters Directive, but now we do not seem
to be getting one—at least we do not think so. There are
issues such as that, which, with the best will in the world, the
current system that we work in cannot cope with.
Q77 Sue Doughty: We had the Environment
Agency in yesterday, and they gave us a written submission.[1]
It was fairly critical with some of the submissions, in terms
of over costing projects and proposing work that the Agency does
not consider necessary, and some work that was not costed in there
that the Agency felt was necessary to establish the obligations.
What is your view of the environment programme that they are proposing
along with English Nature? We have had their views, but what are
your views on the programme?
Ms Taylor: We have to bear in
mind that this is deliberately quite a long process. We are attempting
to put more and more information into the public domain and to
engage more people. We are satisfied that, company by company,
the discussions that are happening between the Environment Agency
and companies are going extremely well. Initially, there was perhaps
some positioning publicly, as there is bound to be in a national
arena, regarding what is being said; but when you get into the
detail, company by company, we have been satisfied with the discussions
that individual companies have been able to have with the Environment
Agency. This is a long process and an iterative process, and we
would expect to see a coming-together rather than a pulling-apart
on things that had to be discussed. That does not mean that every
company is the same. We see wide variations between one company
and another as to what it is that they are specifying that they
believe they require for their environmental spend, and that is
to be expected because companies vary, company by company. In
terms of the process, so far, apart from that ministerial guidance,
we are happy with how it is developing.
Q78 Chairman: You have just said exactly
the reverse of what we were told yesterday. We were told that
all was fine and dandy to start with, and it was a much better
process and everyone was happy; but as we get to the crunch period,
the decision time, inevitably conflicts and disagreements are
bound to arise. I am not quite sure how we are getting such a
different picture from you.
Ms Taylor: Maybe because we have
been there before. We have been through so many crunches and so
many previous periodic reviews that this time around the crunch
does not feel particularly worse than other times. I suppose because
we are, understandably, pulled in different directions by an economic
regulator, and environmental regulator, a quality regulator and
the Government, we are just used to being in this position. We
think that the way in which Ofwat has conducted the process this
time around has been an improvement on the last time around; but
of course there will be differences of opinion as we go forward—and
you could say that is healthy.
Mr Jones: From the regional perspective,
the environmental programme we have put forward as a company is
exactly in line with what we understand the Environment Agency
and English Nature would wish to see. We believe that they support
it entirely. That has been very much guided by detailed consultation
and discussion with both of those agencies in respect of our area.
On the issue of costing, one of the problems we have sometimes
faced in the past is a lack of clarity about the outputs that
we need to deliver. It is quite difficult to come up with robust
costing if you are not sure what you are trying to cost. I think
we are in a much better position this time. We are in receipt
of some very detailed information from the Agency about what each
of the drivers would mean on a work-specific basis, and the only
way you can come up with very robust costs is to do it bottom-up,
assess exactly what will be required at each site and then add
those up. I think we are in a much better position than we have
been at previous reviews because we do understand what the impact
of the drivers will be on a work-specific basis; and we are therefore
able to put together some fairly robust cost estimates.
Mr Baty: We are not free, as companies,
just to say how much they will cost; there is a process we go
through in conjunction with Ofwat on a cost-based report to price
out individual typical schemes. They are compared by Ofwat to
set efficiency targets to feed back to companies, so there is
a competitive edge in terms of how much those different companies
think those particular schemes are going to cost. Then we use
that work back in to pricing against particular requirements in
an individual company. All that is monitored and checked by the
independent reporters, who are operating for Ofwat as the independent
regulator. It is not for the companies to freely decide how much
these are going to cost. The whole thing is audited and scrutinised
as it goes through. We are challenged, understandably, with improved
efficiency at each review, and year on year.
Q79 Sue Doughty: You are reasonably comfortable
with the cost-benefit analysis that the Environment Agency and
English Nature have done. Do you think it is giving good value
for money from where you are coming from?
Mr Baty: The cost benefit is a
slightly different element of it. This is getting the base costs
for the three programmes which we would be submitting, that is
the reference plan A, reference plan B and company-preferred solution.
In terms of the cost benefits on reference plan B, the methodology
for determining that—again, we have some reservations as
to whether or not that is appropriate in the way that cost-benefit
analysis is being carried out. Certainly, in the South West, affordability
is a key issue, and recognising the work that we have delivered
over the last 15 years we are reluctant to be moving significantly
into that particular part because of customer affordability. There
are one or two schemes where, clearly, we accept there is a good
cost-benefit, and it is very rational, but it gets into a grey
area. Clearly, there would be differences between ourselves and
our local Environment Agency, and that is where ministerial guidance
would clarify that part of it. As a company, we would be reluctant
to move too far on that cost benefit purely because of the affordability
in relation to customers in the South West, given the burden placed
on them over the last 15 years.
Ms Taylor: We think that more
work is needed on the economics of environmental measures. We
have been working with the Environment Agency and with NGOs on
some projects to look at environmental cost benefits because we
think there needs to be improvements in this area.
Mr Jones: Can I add, as an economist,
that it is a difficult area; cost-benefit analysis on environmental
improvements is not straightforward. It is pleasing that the Agency
is putting more effort into this area. They have made a very good
start, but there is a lot more work to be done. As far as the
preferred programme that we have put forward is concerned, we
have discussed any schemes where we had doubts about the cost
benefit with the Agency at a local level, and we are quite happy
that the schemes we are putting forward are good value for money.
1 Please see written memorandum, Ev. 1-10. Back
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