Examination of Witnesses (Questions 140-159)
3 MARCH 2004
MS FIONA
PETHICK, MR
PHILIP FLETCHER
AND MR
BILL EMERY
Q140 Chairman: Sorry.
Mr Fletcher: This may be about
some of the inherent difficulties in cost-benefit analysis in
the environmental field. First of all we are talking on the benefit
side about the straight use benefits, much more difficult are
the less tangible but still real benefits, the benefits that come
from the mere existence of an environmental good, even if it is
not always apparent to those of us living in the middle of London
that those environmental benefits exist. Those aspects are largely
addressed through willingness to pay studies and obviously a lot
depends on the way you frame the question and just how you get
the balance right. I shall be appearing in a fortnight's time
in front of the Public Accounts Committee where the same issue
will come up in relation to sewer flooding. There has only been
one decent study so far by Yorkshire Water and the lessons from
that study were not readily transferable to all sorts of other
sites. I have to say that the Environment Agency's approach does
involve transferring in all sorts of ways from site to site, from
one set of customers to another set of customers. I am not doing
that in a spoiling manner, I recognise the difficulties confronting
the Environment Agency, I am giving it as an example of some of
the difficulties that confront all of us who are engaged in the
process.
Q141 Chairman: Your primary function
is economic, is it not?
Mr Fletcher: Yes, although partly
as a result of the previous recommendations of this Committee
but with my very full support Parliament has passed legislation
which will apply to Ofwat once the provisions are implemented,
a sustainable development duty. I am now more than happy to feel
accountable to this Committee and to Parliament at large in terms
of all four legs of that duty: the economic issues are obvious
enough but there are social issues as well, social inclusivity,
environmental improvement and prudent use of natural resources
I see all of those as important factors for Ofwat in carrying
out our own specific role and needs.
Q142 Chairman: Although you are not yet
required to take into account sustainable development, you are
already doing so and decisions that you are taking reflect that.
Mr Fletcher: Yes. It frankly hurt
when this Committee in its previous report talked about Ofwat
demonising the environment. That was under my eminent predecessor
but I do not demonise the environment and I do not think he would
have accepted that either. It stung. We are trying to go out of
our way to ensure that we have a balanced approach to the issues,
and the environment is a crucial issue within that balance.
Q143 Chairman: Do you take that commitment
to the environment as making a judgment on the necessity of individual
environmental measures, are you qualified to make that judgment?
Mr Fletcher: The key issue for
which we are all waiting is the ministerial guidance. It is a
bit like the Secretary of State saying "Godot must be round
the corner soon". Some of the friction you have detected
in the evidence given to you is all of us itching a bit as we
wait for the Secretary of State and the Welsh Assembly Government's
guidance on this key issue. I, of course, accept it is for the
democratically elected government in both cases to tell not just
the regulators but the industry and all of the stakeholders what
they think is needed to deliver the international and national
and statutory obligations which the United Kingdom has incurred.
I do not try and set myself up as a rival authority in that. What
I do look for is that the environmental improvements, which have
been huge, and which will go on being a very important driver
of the programme, should be delivered in the most cost-effective
way possible. That is an area where we can raise questions and
do raise questions and seek to ensure that an outcome desired
is delivered in the best possible way.
Q144 Chairman: I am not entirely clear
what I have to say on that answer.
Mr Fletcher: Can I give you an
example?
Q145 Chairman: Yes, that might be helpful.
Mr Fletcher: From the last review
we have the issue of the chalk streams in Wessex in the Downs,
very important for all of the SSSIs, and the concern about the
problems of low flow in these streams in dry periods, particularly
where that is caused by heavy water company extraction. There
were various ways of dealing with that in the initial guidance,
the proposition was to spend over £100 million on developing
new sources. The proposition, which at the moment I believe has
every prospect of proceeding, has been put in place to test out
other means of maintaining that flow, including permission for
Wessex to draw extra water if they need it from the Severn through
another water company, Bristol Water, and provide it with a reserve
if needed. That hardly costs the customer anything. It is a very
stark example but I believe there will be other examples where
if we had more time to develop appropriate approaches we would
get the environmental goods at very much less cost to the customer
than is possible within a heavy end of pipe solution.
Q146 Chairman: Which touches on an issue
we came across yesterday and in other submissions about the suggestion
that some water companies are inflating environmental costs when
preparing their draft plans, do you think that is a fair allegation?
Mr Fletcher: It fits in with the
costs issue that you were exploring with Water UK witnesses. We
believe, as Bob Baty was describing, we have improved the process
of cost testing this time round so that the draft business plan
submitted by the companies were a whole lot more robust than a
simple bidding exercise with inflated costs in them. As Mr Baty
explained those costs have been examined and audited by engineering
consultants to ensure they are not mere stabs in the dark, they
are reasonably robust costs. We will go on scrutinising them very
carefully. We are alive to the possibility that some companies
might still, I think it is fewer and fewer, see some sort of company
advantage in very large and inflated programmes and we will be
seeking to ensure that any such inflation is cut out. I do believe
we start in a much more robust position than last time round and
any appearance from the witnesses you had yesterday that it was
very different last time and the costs are all going to come tumbling
down at a later stage in the process I really think is a misunderstanding.
We have advanced the process, the costs are now more robust than
they were at this stage in the previous review.
Q147 Chairman: Thank you. Are you grappling
with the question of diffuse pollution that you would have heard
us discussing? Nobody seems to own that and somebody needs to.
Mr Fletcher: I absolutely accept
that. I have no doubt when you call Elliot Morley in front of
you, I believe next week, he will accept—I am not speaking
for him—that the Government is not only due to produce any
time now their principal guidance to me on this issue but they
are also due to produce for consultation their action plan on
diffuse pollution. This must be a key issue for Government to
give us all a lead on. All of us, and I include in this the Environment
Agency, English Nature and RSPB see the very difficult issue of
controlling diffuse pollution as the key challenge over the period
that will develop from 2010 onwards. We need to get on with it
now so that we are ready for the key implementation stages of
the Water Framework Directive when controlling diffuse pollution
and the production of really good outcomes for the water environment
must be a key driver.
Q148 Chairman: Lastly, there have been
reports, I am sure you will have seen them, that there has been
political pressure in the run-up to this process, sensitivity
about the forthcoming election, prices going up and suggestions
that the environmental side of all this process is going to be—no
pun intended—watered down. Are you aware of any direct pressure
being applied in relation to these issues?
Mr Fletcher: No, Chairman. I am
the independent Regulator and Parliament has given me the job
of setting these price limits through statute. I do not expect
it to be an easy ride when I announce it in the summer but they
will be my decisions. Of course Government has key inputs to make
and I have been, boot on the other foot, offering them advice,
as have the Environment Agency, English Nature and others. I think
the process has been absolutely proper, the fact there is a bit
of friction in it at the moment I would agree with Pamela Taylor
is a sign of transparency and health rather than something to
get too concerned about.
Q149 Chairman: Friction but no heavy
breathing.
Mr Fletcher: I think that is right.
We do have a good working relationship with the environmental
regulators, even though we do not agree about everything, which
ensures that the basic work gets done properly. That is rightly
a concern the Committee has and I offer my assurance about it.
Q150 Joan Walley: As a long-standing
member of this Committee I have to say in view of your previous
comments there has been some progress in terms of sustainable
duties in terms of Ofwat. In respect of the agreement about the
guidance given by the Environment Agency on the size and scope
of the environment programme of I think in the region of a 6%
rise per annum, which would work out at 30% over five years, given
the concerns that the Environment Agency are addressing about
the over-estimation or possible over-estimation of the cost of
carrying out the environmental improvements by the water companies
do you agree with that? What have you done to address the concerns?
Mr Fletcher: Can I say that we
can quickly bury ourselves with the figures because they are difficult
to grapple with. Not least on the costs side we have the issue
raised by the water companies that we are not talking about a
steady cost for everything, there are incremental rises. The moment
that a company starts bumping into problems with financability
and the ratios that the City insist on before it will lend money
then we see the cost of that marginal increment escalating very
sharply. The table I offered in our evidence shows the various
drivers in terms of an average bill, the overall net increase
that the companies in their preferred strategies offered in their
draft business plans—this is not an Ofwat view, it is a
company view—50% of that net increase after the efficiency
gains which have been taken away is down to the overall quality
improvements. Nobody thinks for a moment, certainly not me, that
you could remove those quality improvements, we are going to go
on making improvements, they will go on being a heavy part of
the bill but this overall percentage increase for any given adjustment
to the environmental programme will vary. The RSPB offered a figure,
I have no idea where they got it from at all, of £2, I do
not recognise that at all. The figure that I offer is if you are
talking about £20 billion on the one hand and £15 billion
on the other then you might be talking about somewhere between
5% and 10% on the bill.
Q151 Joan Walley: What would that 5%
or 10% mean?
Mr Fletcher: You are talking
about somewhere between £15 and £25, it will vary a
lot from company to company depending on where they are in terms
of financability. It is very difficult to pin. It is impossible.
I am not going to reach a view on this until I have the guidance
from the Secretary of State, I have the final plans from the companies
and I am in a position to set draft price limits and they are
available to the world for comment and criticism.
Q152 Joan Walley: I think you have said
that the scope for improving efficiencies this time round is small,
are you sure you have that right this time?
Mr Fletcher: What we know is that
the companies have under the pressure of economic incentive-based
regulation made huge strides in efficiency over the last 15 years,
it is almost self-evident. The easier gains have now been made
and it will get significantly harder from now on, what we will
never accept is that somehow there is a ceiling on this and you
will never get more efficiency gains, we will always be pushing
for more and efficient companies will always have something more
that they can do. It is getting harder. We cannot make wild assumptions
on efficiency gains going forward, we have to make realistic assumptions
and all of the evidence, including various consultant studies
that we and others have had done, show the scope this time is
very much less than it was in the first ten years of the period
since privatisation and even significantly less than the five
years 2000-05.
Q153 Joan Walley: In the scope of greater
transparency that we have heard a lot about this afternoon do
you have anything else up your sleeve in terms of reducing costs?
Are you having any talks with the Treasury about any possible
tax concessions that are on-going?
Mr Fletcher: I believe Barbara
Young suggested that I should talk to the Treasury despite the
fact that companies do face a change in their tax regime which
from my point of view—
Q154 Chairman: She did not suggest that
you should be, she pointed out that you might.
Mr Fletcher: Thank you, Chairman.
She can trust me that I will pull every obvious lever to try and
reduce the pressure on customers via the pressures on companies.
There are a lot of pressures this time and tax is one of them.
Q155 Joan Walley: What sort of concessions
are you thinking about?
Mr Fletcher: I am not thinking
of concessions, almost all of the pressures we are talking about
on companies come through the economic facts of life or through
one way and another statutory or government pressures, I include
tax within that. You talked about debt, the ban on disconnection,
has very good social justification, nonetheless it is helping
to drive up bad debt which unfortunately other customers have
to meet through the price limits I shall set. We face extra pressure
through the right to opt for a meter, which again has all sorts
of good justification but it leads to capital costs and loss of
revenue which are borne by customers as a body.
Q156 Joan Walley: How might the Chancellor
respond to some of those concerns?
Mr Fletcher: This is where it
gets difficult, I have a lot of sympathy, let us say with the
Inland Revenue to keep it nice and neutral, because the water
industry here has been on a rather different tax basis from most
of the rest of industry. They have enjoyed a tax advantage. The
Revenue signaled five years ago they would lose that tax advantage
from 1 April 2005. That is a transparent process, it would have
required a very clear perception on the part of the Treasury that
they did not want additional pressure on the companies to rescind
that view taken five years ago. That is even-handed. The main
pressures that can be reduced come from all those involved in
putting on the pressure, thinking very hard about whether that
pressure is absolutely essential in the five years we now face.
Five years which, in my judgment, are going to see significant
price increases for customers overall despite Ofwat's best endeavours
to ensure that customers pay no more than they have to. I am very
conscious that the customers are customers of monopolies and they
have no choice and they depend on Ofwat to ensure that they are
not paying more than they have to. I want to earn that trust.
Q157 Joan Walley: Finally, briefly, going
back to the issue about the robustness of the draft business plans,
are you anticipating any significant changes in the costing in
the final business plans?
Mr Fletcher: Yes, they will be
up and down. The companies are submitting their final plans to
me. Once I have the principal guidance from the Secretary of State
we will have to take account of factors that have appeared since
they did their draft, including rafts of critical comment behind
closed doors from Ofwat about aspects of their plans and public
comment too, which we have made clear in our published documents.
I cannot be absolutely sure that when those plans are submitted,
they will be submitted with figures lower than those we saw in
the drafts.
Q158 Joan Walley: Presumably you would
say to this Committee that pending duties in relation to discussing
stainable issues it would underpin any changes that you might
require in relation to those—
Mr Fletcher: I will look to those
balanced four elements of the sustainable development duty.
Q159 Joan Walley: Will the sustainable
development duty will be prioritised?
Mr Fletcher: I will be taking
all of that into account within my primary statutory duty to enable
efficient companies to carry out and finance their function. I
must take account of everything that is placed on them and be
realistic in my assumptions about what it is going to cost them
to carry on while at the same time protect customers to ensure
that when I get the guidance that guidance is properly reflected
in the draft price limits.
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