Select Committee on Environmental Audit Minutes of Evidence


Supplementary memorandum from the Office of Water Services (Ofwat)

  Response to specific questions from the Environmental Audit Committee following Ofwat's oral evidence session, 3 March 2004

CONSTRAINED ENVIRONMENTAL PROGRAMME

    —  The Committee would like details, if available, of the constrained environmental programme put forward by Ofwat. Is it correct that with regard to the nature conservation schemes it proposed only including projects of level of certainty 1?

    —  Do you feel qualified as regulator to make a judgement on whether certain projects are necessary or not, from an environmental perspective?

  1.  To help decision-makers understand the implications for price limits of the decisions they were taking we provided an illustration showing the price limits that would result if new investment continued at broadly the same rate as for the current five year period—£15 billion. We also checked that we could compile a credible programme made up of companies' costed proposals. In some areas we assumed that the timescales for improvements could be extended a little and in other areas, for example the nature conservation schemes we assumed that only the most serious problems needed to be addressed without further assessment of the most cost effective way of achieving the benefits required.

  2.  A programme of improvements costing £15 billion could have been arrived at in various ways. However, our illustration is now overtaken by Ministers' Principal Guidance.

  3.  It is not my role as the economic regulator to make environmental policy but my duties require me to set price limits at a level that I judge will allow an effective and efficient company to finance its functions. Part of this does require me to make judgements, as to these functions. I also have a duty to protect the interests of customers. As an independent regulator Ofwat employs expert staff including environmental economists, engineers and scientists experienced in the water industry, so we are in a position to review and where appropriate challenge proposals put forward by companies, environmental and water quality regulators. I will ensure that all schemes included in price limits meet the following five criteria:

    —  It is required by the quality regulators, and confirmed by Ministers, or is a new obligation under current legislation.

    —  It delivers a measurable defined output, which is enforceable.

    —  It has a clearly defined timetable and due date for delivery in line with regulations or other legislation.

    —  There are defined asset improvements or changes to operational procedures to deliver the output.

    —  he costs are identified and the proposed solution has been challenged and validated by the company's reporter (an independent professional who scrutinises and gives his opinion on the company's business plan to Owat).

  4.  We seek guidance from the environmental and water quality regulators and the Department for Environment, Food and Rural Affairs on the improvements they consider are necessary. We make decisions on the information that is available at the time of our determinations on the outputs that need to be delivered.

  5.  New requirements placed on companies during the price review period can be financed through an interim determination or through logging up the net additional costs to be financed at the 2009 periodic review.

  6.  We now have Ministers' Principal Guidance on the improvements they expect the companies to make in the period 2005-10. The Environment Agency and the Drinking Water Inspectorate are confirming what this means in detail for companies. Companies will provide us with costs in their final business plans in April.

CUSTOMER DEBT AND AFFORDABILITY

  Water UK has stated the level of bad debt "raises customers" bills by an average of up to £10 a year'. This could be, assuming levels do not increase, up to £50 per customer over the next review period.

    —  How much does this affect Ofwat consideration of water pricing?

    —  Is Ofwat happy that companies are doing enough to address this issue?

    —  If debt rises, as it is likely to do if prices go up as expected, this may become a very significant problem and have an increasing impact on paying customers' bills.

    —  Would Ofwat consider limiting future price rises if a water company was not making enough effort to prevent or recover long-term debt?

  7.  The costs of managing debt are considered as part of each company's operating costs when we set price limits. Since the ban on disconnection of domestic customers, in the Water Industry Act 1999, we have seen a rise in the numbers of customers in debt and the levels of customers' debt. In "Setting water and sewerage price limits for 2005-10: Framework and approach" (page 51) we said that companies' base operating costs will include a provision for the current costs of providing for bad debt and for the costs of debt recovery. We will assume continuing efficiency as we do for all operating costs. At the 1999 price review we introduced a specific bad debt notified item. This means that if a company's costs rise significantly it can include the net additional costs in any interim determination it pursues. We propose to retain the notified item at this price review.

  8.  Generally, we are assured that companies are taking reasonable, practical and cost-effective steps to address the issue of rising debt. Although there is scope for continuing improvement as with other costs. We have worked closely with companies to ensure that they take appropriate action to deal with customers in debt. Companies are refining their approaches to debt recovery and becoming more effective in managing the issue. At this stage it is therefore difficult to predict, with any confidence, what will happen to debt and recovery costs in the future. To avoid the risk of asking customers to fund costs that may not materialise and to keep the incentive on companies to manage the issue, we do not currently propose making any assumptions about increases to base costs to cover increasing costs for bad debts in the next period. We will review our position in the light of the companies' final business plans and the data on 2003-04 debt related costs once available.

  9.  We expect all companies to manage debt efficiently. We have issued guidance to companies on best practice in dealing with customers in debt. In making our considerations of companies' applications for price increases at a price review or any interim determinations to cover increasing debt we will consider and challenge, as we have in the past, companies' activities to manage and recover long-term debt. We also assume that companies will become more efficient over time.

WATER FRAMEWORK DIRECTIVE

  In their evidence to the Committee the Environment Agency has suggested that Ofwat and Defra are taking a short-term view on capital expenditure and that cutting costs now would simply store up problems for the future. This is particularly seen as being the case with the Water Framework Directive. The Government has taken the position in its draft guidelines that water companies do [not] need to take much action over any of the provisions as yet.

    —  Is this point of view supported by Ofwat and if so why?

    —  Is Ofwat looking forward to the impact the Directive will have on the next review period? What are your views on the issues so far?

    —  In an ideal world, where there were not so many other demands on water company expenditure, would you be happier if some of the work required were begun within this period rather than waiting until 2010-15?

    —  Would you be happy to accept a programme, following guidance from Ministers, which resulted in the UK failing to meet statutory obligations?

  10.  It is for Government to decide what must be done to ensure that the UK meets its national and international obligations. There are legitimate questions to ask on how these obligations are best met and by whom. We agree with Defra that it would not be sensible for the companies to take action on the provisions of the Water Framework Directive until it is clear what is needed. There is a great deal of investigation and preparatory work to be done. There is a long process ahead to develop the river basin management plans. In due course, the confirmation of the programme of measures by the Secretary of State will inform the companies' future investment priorities. The Secretary of State will need to make informed judgements on the approach to implementing the Directive, we are at too early a stage for that at present.

  11.  Decisions need to be made across all the sectors involved on the improvements required to meet the Directive's objectives. Diffuse and point pollution from sources other than the water and sewerage companies will need to be tackled if we are to meet our national obligations under the Directive. We understand the Government will be consulting, this spring, on the approach to controlling diffuse pollution control.

  12.  We recognise that this Directive could have an impact on the price limits we set in 2009 for the period 2010-15. Well-developed river basin management plans, thorough investigations and action on diffuse pollution should provide the information needed for the Government to make the necessary judgements on what to do in the first round of river basin plans.

  13.  We do not consider it prudent to build assets on the assumption that these might be required to meet the Water Framework Directive. The Government's decisions on the measures required will arise from the river basin management plans. We expect that many of the outputs that are delivered as a result of investment confirmed at this price review, many in response to other subject specific European Directives, will go a long way towards achieving compliance with the Water Framework Directive. At future reviews the river basin management plans, endorsed by Ministers, will give the details of all schemes necessary to ensure that companies meet their obligations under this Directive. And thus help to ensure that the polluter pays principle is observed in relation to the costs that should properly be borne by the water customer.

March 2004


 
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