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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