|
UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 416-ii House of COMMONS MINUTES OF EVIDENCE TAKEN BEFORE environmental audit COMMITTEE
Water: The Periodic Review 2004 and the Environmental Programme
Wednesday 3 March 2004 MR BOB BATY, MR CERI JONES and MS PAMELA TAYLOR MR PHILIP FLETCHER, MR BILL EMERY and MS FIONA PETHICK Evidence heard in Public Questions 74 - 176
USE OF THE TRANSCRIPT
Oral Evidence Taken before the Environmental Audit Committee on Wednesday 3 March 2004 Members present Mr Peter Ainsworth, in the Chair Gregory Barker Mr Colin Challen Mr David Chaytor Sue Doughty Paul Flynn Mr Malcolm Savidge Joan Walley ________________ Memoranda submitted by Water UK and Northumbrian Water Examination of Witnesses Witnesses: Mr Bob Baty, Chief Executive, South West Water Ltd., Ms Pamela Taylor, Chief Executive, Water UK, and Mr Ceri Jones, Regulation Director, Northumbrian Water, examined. 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 there will be no reference plan A; some are between 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 per cent 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. 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, exactly what will be require 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. Q80 Sue Doughty: You feel that they will fulfil a good environment programme. Mr Jones: The scope of the environmental programme depends ultimately on decisions from ministers, but we are happy that the programme we have agreed on a local basis with the Agency represents a reasonable way forward. Mr Baty: I should also point out that it will vary with different companies across the country. I can only speak on behalf of the South West, and again in this particular review, our environmental programme is tiny compared with the enormous investment we have made in the past, and the impact on customer bills is very low with the programme we are talking about - perhaps between £4-6 increase in bill every five years. In relative terms it is a much smaller environmental programme than we have ever delivered in the past. Our challenge is carrying the burden of the environmental burden and financial burden of environmental programmes we have already delivered because that carries cost going forward. AS an industry we all spend more money than we have in every day, so we are all cash negative; and the cost of borrowing that money carries on beyond the delivery programme itself. It is quite important that people are looking at the cost of the programme going forward and carrying also the cost of the previous investment over the past fifteen years. Q81 Sue Doughty: You have had some disagreement, have you not, about the Environment Agency's version of the costs and your version of the costs, certainly in the submissions they have given to us? Do you think they have been fair in their comments, or was it gold-plating? Ms Taylor: No, we do not think they have been fair in the comments they have made at all. We do not think the comments have been necessary, and we are satisfied that the system is completely robust enough for any differences to be worked out as we go forward. We do not accept the criticisms at all. Q82 Sue Doughty: You are quite happy with what you are doing. Mr Baty: We believe that the costings we have carried out and the submissions we have made are as accurate as we can possibly get in the circumstances. There is no gold-plating in any way, shape or form. We have confidence in our company, and that is the way we have tackled it. Ms Taylor: If you look at the programmes that we will be looking at as we go forward, say with the Water Framework Directive, if we are looking at the money that companies will have to raise because, as Bob has just said, the companies are cash negative, we have got to retain the confidence of the markets as we move forward because we will need to borrow that money to carry out the future environmental improvements that will be required of us; so it is in nobody's interests to get these figures wrong. Q83 Chairman: The Environment Agency said yesterday that they had underestimated the benefits in their analysis, for the reason that some of the benefits could not be costed. Do you accept that as a possibility? Mr Baty: You may say it is a possibility, but it is terribly subjective because at the end of the day, when we are looking at how much the customers can actually afford to pay in the South West, that is a big issue. I am anxious to keep the charges to customers as low as possible, recognising that over £1 billion of investment has already been made, and there is a carrying cost of that. As we look forward, it is diminishing returns. We get into a subjective area in terms of how robust the cost-benefit analysis is. We do accept - and I am not saying they are all totally wrong, but some of those included diminish very quickly relative to what the customers can afford to pay in our region. Mr Jones: The cost-benefit analysis is quite a difficult issue because it is as much art as science. It is very difficult to know whether any errors of omission are in one direction or another. I am not quite sure how the agency could be sure that they have underestimated the costs. Chairman: They have certainly given a wide range of potential benefits, which indicates the uncertainty of the exercise, but you are not prepared to say that you think that it is unlikely that they have underestimated the benefits. You are not prepared to say anything! Gregory Barker: May I ask you a question arising from evidence that the Environment Agency gave us yesterday? They said that the very detailed and vigorous work they carried out to determine what should be included in the environmental programme represents the absolute bare minimum that needs to be done. Do you agree? Q84 Chairman: Can we leave you to ponder that while we vote? The Committee suspended from 16.10 pm to 16.22 pm for a division in the House Ms Taylor: We need to bear in mind that we have been talking about three plans here. Plan A would be the minimum; plan B would be more than that, and decisions to be taken; and then there is the third plan, which is the company-preferred plan. At this stage, to say that what is being discussed is the bare minimum we do not believe to be correct because we are discussing three possibilities at this stage. Obviously, when we see the ministerial guidance, that should give us an indication as to what we are looking at as we go forward. At this stage, it would be premature to make a comment. Q85 Gregory Barker: You have stated to us that the industry's environmental duties are not an optional extra; that they are a statutory requirement. However, not all water companies have included all statutory requirements in their preferred plans. Do you support this? Ms Taylor: Companies have looked at, and made a judgment, company by company, so we think that is right. We also think it is right that that information should be in the public domain, and we also think it is right that it should be open to challenge and scrutiny. What you will then see going forward, is to whether or not a judgment that has been taken will stand. Q86 Gregory Barker: How will that be challenged? You say you will see how it stands. Mr Baty: One of the issues we have been wrestling with is where there is a statutory driver and that is clear, the grey area is how much investment by the water company will address that statutory driver. If it is 5 per cent; is it 10 per cent, or is it 100 per cent - there is no doubt about it at all; but if it is maybe 20 per cent or 10 per cent and there are no plans to address the other 80 per cent, is it appropriate at this stage to be delivering that proportion of that statutory obligation while the rest of it is still exposed, given the pressure that the customer charges are under? That is where there is a subjective area. One would hope that that sort of area will be clarified by ministerial guidance. Q87 Gregory Barker: A statutory obligation is a statutory obligation. Ms Taylor: It is, you are absolutely right. The question in our minds however is to how much of that obligation has to be met by the water company and the water company's customers picking up the price for it. If you take an issue such as diffuse pollution, there are many, many policy leaders that, if you like, could be pooled in terms of addressing the issue of diffuse pollution but we do not own them. In terms of point source pollution, we have cleaned up our act, but if you look at poor agricultural practice, for example, that will be a major driver of diffuse pollution. The question has to be, going forward: should the investment be carried out by the water company and the bill picked up by the water company's customers, or should we look at another way of tackling the issue, namely looking at farming practice and improving that? That is where the grey area is. It is not that we would dispute at all what is the statutory requirement because we absolutely agree. The point is though how much of that should be picked up by the water operator. That is where the discussion is. Q88 Gregory Barker: The bill does not have to be picked up by the water company's customers, does it? You could accept a lowering of your margins. Ms Taylor: It would not be a lowering of your margins because at the moment, as we explained earlier, companies are cash negative. They are spending more than they are collecting from their customers each day in any case; so companies have to go to the markets in order to borrow the money to carry out the work. It is a bit like taking out a mortgage on behalf of your customers, so companies have to go to the markets to borrow that money in any case. We need to make sure that we continue to be attractive to the markets, because we can see the considerable investments not only this year, in this period review, but in future years in future periodic reviews; and the City will have to be confident that it is funding something which, frankly, in their minds, stands up. Mr Baty: There are two very narrow tramlines. One is customer affordability and their ability to pay for it; and the second is the ability to raise money in the market, as Pamela said. Those tramlines are very narrow, and the industry has been investing over the last 15 years. Q89 Chairman: Are you saying that where companies have not included efforts to meet their statutory requirements, it is only in cases where the industry does not have direct responsibility for the problem and it is only in those areas? Ms Taylor: Not always. Mr Jones: It is not as clear-cut as that. The existence of statutory obligation is generally fairly clear, but exactly what you need to do when you discharge that obligation is not always absolutely clear, and there is some room for difference of opinion in that respect. I think Northumbrian Water is in a fairly fortunate position in that we believe we did include all of our statutory obligations and I do not think there is any dispute about that from the Environment Agency. In defence of my colleagues in other parts of the country, I can easily see that there are areas where it is not entirely clear what one has to do in order to fully discharge one's obligation. One can see that parties would come to slightly different views about what would be appropriate to do, particularly in a given timescale of the next five years. Q90 Chairman: But if you have been able to do it, why can others not do it? Is it to do with geography? Mr Jones: It is clear that the different drivers impact very differently in different parts of the country. Both of the companies here today are fortunate in that the environmental programme appears to be somewhat lower than it is in some other parts of the country. The drivers are the same, but the way in which they impact on the locality are very much determined by geography. Q91 Mr Challen: Are there regional variations in the margins that you can deliver? Mr Baty: Not in the costing of them; it is a standard costing arrangement where the companies will price the standard things recommended by Ofwat, and they are certified by the reporters as fair costings; so there is not a margin as such; it is a question of the cost of providing that particular facility. When adjustments are made for efficiency, if one company thinks it can do it for X and another one says Y, understandably the Regulator says "if they can do it for that price we want the rest of you to be as close to that price as possible". Q92 Mr Challen: I asked the question because some water companies wanted to get rid of their water side of the business. Yorkshire Water wanted to put that side of the business into some kind of mutual arrangement, and one or two other companies looked at other ownership structures so that they could free themselves of the regulatory burden. Ms Taylor: They could never do that. Mr Baty: Sorry, no, the regulatory burden will stay with the licence-holder, however it is separated out. The reason for assessing some of these optional structures is the financeability issue and whether or not it is more cost-effective to raise money for debt or equity and to get that balance right is quite a difficult challenge. Ceri is an economist and I am a poor engineer, but some companies make an assessment as to whether raising debt is cheaper than raising equity. The difficulty there is that going forward, if there is a bigger capital programme in future that we do not know about, how do you raise still more debt? Q93 Mr Chaytor: What I am trying to say is that these companies, like Kelda, had diversified. Yorkshire Water, the original part of the business, seemed to them to be a bit of a burden at the time, and they wanted to shunt it off to one side and give it to the customers, as it were, with a mutual arrangement, so that they were not then the whole business, the group business, and burdened with these regulatory requirements. Ms Taylor: There are no circumstances in which a water operator can avoid the regulatory burden, either from the economic regulator, the environmental regulator or the quality regulator, or indeed the Government guidance. There is no structure that would enable them to do that. They were looking at their finance-ability as they go forward and making a decision at board level as to what would be the best way of taking out that mortgage we were talking about earlier on behalf of their customers. They were shaping themselves to be able to shop around in the market for the easiest and least expensive way of raising the finances they needed in order to carry out the work they needed to do. In those circumstances you are always trying to see how much of the risk you get, in terms of what the City would perceive as risk. That was something that admittedly Yorkshire Water flirted with at the time, but now they are certainly on record as saying that their board does not believe that it is the right way for them to go in the future. That does not mean that boards do not keep this constantly under review because, obviously, they have a responsibility to do that because they will need to raise money for the future. Mr Jones: Thinking about the original point about margins varying, if one is thinking about the margin used when setting price limits, it is Ofwat that assumes the financing costs in that calculation; they assume the cost of capital, and that is done on an industry-wide basis. It is the same cost of capital, same financing costs that are assumed for all companies when prices are set. Q94 Gregory Barker: How aware do you think your customers and indeed the public at large are of the environmental improvement work that the water companies are doing? Do you have a policy of raising that awareness? Ms Taylor: Yes, we do. We think it is important that customers should appreciate what it is that they are paying for when they pay their water bill, and we also think it is important that customers should have a view on what it is they are paying for in their water bill. In the beginning it was easier for customers to understand; now I think it is a little more difficult when you are looking at issues that we touched on earlier such as diffuse pollution. Is it right for a water industry customer to pick up the bill for cleaning up water that has been polluted by chemicals from farming? I do not think that is right. In terms of raising customer awareness, as to what it is they are paying for, we work with other environmental groups. We work in partnership with the RSPB and the Wildlife Trust to reach customers more effectively. We join and fund programmes jointly with them in order to raise awareness and to bring projects and issues to communities. There is a whole raft of things that we do. Q95 Gregory Barker: What does it actually mean? Ms Taylor: For example, in the Wildlife Trust, we will fund programmes that they carry out, and that is then something that local communities will be part of, so they will understand through the work that the Wildlife Trust does, the role that the water company also plays. Then they will begin to have a practical understanding of where some of their money is going. Mr Baty: We also write and tell the customers. Q96 Gregory Barker: Could you do more? Ms Taylor: Always. Q97 Gregory Barker: If you did do more, they might be more willing to pay for the environmental improvements. Ms Taylor: We carried out research this time around, and are very pleased that for the first time it has been joint research with the regulators, WaterVoice and environmental groups and so on. The headlines of the research show that customers would be willing to pay a little more - not all of them - for environmental improvements. It is important that they should understand that as we go forward, particularly if we look at the Water Framework Directive. We have to not just persuade customers more and more and more that they should pick up more and more of the bill, but we should be looking at how appropriate it is for customers in the future to be picking up all the bill. Should farming be picking up some of the bill; should transport be picking up the bill? I think there is some cleverer thinking that needs to be done. Q98 Gregory Barker: I want to touch on investigations by water companies. We understand that some of the actions you are due to carry out during AMP3 were investigations you agreed to carry out so that the results could be fed in to the current review. However, English Nature told us yesterday that this has often not been the case. Why is this? Does it mean that once some of the investigations are completed, as you are committed to doing, there may be more work that will still need to be carried out and perhaps be postponed to the next review. Ms Taylor: I am pretty scared about the thought of your Chairman saying we have been silent twice, but I am not sure I understand. I cannot think what that may be. If it would help, we would take that away and look at that issue. Q99 Gregory Barker: I was not here at the evidence session when it arose, but perhaps colleagues can shed light on that. Ms Taylor: We would happily take it up and write to the Committee. Chairman: The allegation was that there was work that you had agreed to do which was going to help in future assessments in the periodic review process, which for certain cases was possibly deliberately being deferred so that it was not possible to analyse the outcome of that work in time for the next periodic review. Q100 Joan Walley: It was also about the transparency of what you are doing and who is doing it, and how that is adequately monitored. Mr Jones: The industry does publish a lot of information; indeed Ofwat publishes a lot of information each year on the output being delivered. Generally, the industry is very much on track. We deliver all the outputs that were allowed at the last periodic review. I cannot think what the specific issues are that were being alluded to, but generally the context is that we are very much delivering on all of the outputs that were assumed for this five-year programme. Mr Baty: There is a June return to the Regulator every year certifying where we are up to in delivering the programme, and that will appear in public documents in the course of the year and published on the forms of each company. Gregory Barker: Perhaps we can invite English Nature to specify. Q101 Chairman: They did not specify yesterday particular examples of this, but indicated that it was a practice of which they were aware and which they deprecated. Ms Taylor: In that case ----- Q102 Chairman: Given the close and warm relationship that you described earlier yourselves ----- Ms Taylor: That was the Environment Agency. I am sure we will have no problem at all. Q103 Chairman: It is something that you would like to sort out, and we may wish to make further inquiries into it. Mr Jones: Of course. Q104 Mr Chaytor: I would like to ask about the judgments made on the environment programmes, particularly in respect of Northumbrian Water. You appear to have deferred a substantial amount of your environmental programme, and the Regulator has expressed some concern about the deferral aspects in 2010. Can you give us a flavour of how you come to the judgment as to what to defer, and what you think the long-term consequences will be? Are you not simply storing up problems for the future? Mr Jones: The only area that I can think you are referring to is the discharge combined sewer programme, where we have proposed delivery over a 15-year period. The distinction is between the outputs the Environment Agency has identified which they see as a priority and would wish us to do quickly, and outputs that we as a company have identified that have not been investigated and the Agency would not have known anything about. The Agency at this time do not believe they are currently resulting in problems in terms of the quality in the water course. But we are aware that work does need to be done to improve those assets over a period of time. The programme we have put forward would deliver all of the priorities that the Agency has identified within the next five years, and it would make a start on the other assets that we, through our proactive investigation, have identified. We think it is appropriate to deliver that latter category over a longer period. That is something that we have agreed with the Agency locally, and it meets their priority requirements. Q105 Mr Chaytor: Are you saying categorically that there would be no impact on water quality and ----- Mr Jones: Yes, that was very much the basis of that decision. Q106 Mr Chaytor: In the preferred plan you published the bill increase for environmental issues, which is modest compared to the increase introduced for routine maintenance ----- Mr Jones: That is right. Q107 Mr Chaytor: If the Regulator were to propose reducing that, how would you respond? You are suggesting that there should be an increase of £8 over a five-year period to cover environmental works. Mr Jones: We believe pretty much the statutory minimum programme. It is possible that in some areas the Agency could take a different view. However, the programme we have put forward is what the Agency considers to be the statutory minimum, and we do not really dispute that. We do recognise that there are areas for judgment, so we are not saying that the Agency are wrong. We are saying that there are some areas where it might be possible to take a different view. We have come to the view that the programme is a sensible one. It is likely that unless ministers take radical decisions, they would not be able to reduce the programme by that much, but I am not saying that every single programme in there is absolutely a minimum requirement. There was always an element of judgment. I suspect that any reduction would be less in our case than in those companies which have much larger programmes, quite simply because if you just took a driver out, for us the impact of taking that driver out would be much more modest than it would be in certain other areas of the country. Q108 Mr Chaytor: Turning to South West Water, your projected increase again is absolutely insignificant. Why are you so unambitious in your approach to environmental ----- Mr Baty: Probably because the improvements we have delivered in the past have been enormous, and the maintenance costs of carrying that work forward and maintaining it going forward is a big cost driver for us. But in terms of dealing with the Environment Agency as to what is require, there again, as I mentioned earlier, there is little between us in terms of the size of that; but it is relatively small because of the enormous environmental investment we have made in the past. The price we are paying for that is that we are now having to spend a lot of our money on renovation of the water distribution network, which was curtailed during the previous 15 years to give headroom to enable us to deliver the coastal programme. It is getting that balance right which is the challenge we face, against the background of the highest charges driven mainly by that environmental programme, and the ability of customers in the South West to pay those bills. Q109 Mr Chaytor: Can you say, hand on heart, to customers and visitors to the South West that the beach clean-up programme, which you have invested in fairly heavily, has now been entirely successful and you are absolutely satisfied? Mr Baty: Of the 141 beaches that we have, 140 of them met mandatory standards and 85 per cent met the guideline standard, and that is exactly in line with ----- Q110 Mr Chaytor: So 15 per cent of them obviously did not. Mr Baty: Eight-five per cent complied with it. Q111 Mr Chaytor: That is 15 per cent which did not. Mr Baty: That is correct, but that is because those pollution sources are from other discharges, nothing to do with us. That is ahead of the Government target that was set when we embarked on that programme. We are very satisfied and very delighted, but it is the cost to our community that we represent and work with that we are very mindful of. Q112 Mr Chaytor: Given that we are talking about increasing customer bills by £4 per customer by 2010, is this not a lost opportunity, because the nature of environmental improvement programmes surely is that this is not a finite activity? There are infinite improvements that can be made going beyond the minimum. Are you not again losing the chance of building up your work now, and will you not find that beyond 2010 you are likely to have to put up customer bills even higher to compensate for that? From the customers' point of view, is it better not to have a gradual steady year-on-year increase rather than as a political fix for a few years to keep the name of South West Water in lights, in terms of their customers, and then you are going to lose out after 2010? Mr Baty: To some extent it is the reverse because if you go back to the early nineties, our charges were going up 16 per cent year on year and that is why we are away from the pack, driven by the cost of that enormous environmental programme. The standards that we have achieved - we have got the best bathing waters in the country and the highest percentage of top-quality river water in England. Our environmental standards are high; it is a highly sensitive environmental area and we need to sustain that, but we have to be careful about pushing it any further at this stage, given the impact it has on customers in the region and the money they are paying for it. Our bill is significantly higher than many other parts of the region. You say that it is only £4 but it is £4 on top of a bill which will be £407, given our draft business plan, compared with figures significantly less than that for the rest of the country. One cannot look at this in isolation. You reach a point where customers say, "we are not going to pay at all", and that is a bigger issue for the industry and the environment. Ms Taylor: We also have to bear in mind that expenditure on maintenance of the infrastructure, which is what Bob is looking at in terms of a profile of his spend as he goes forward, is spent that will have great impact in terms of the environment as well. Obviously, if you have a faulty infrastructure, then you would have pollution that seeps out and so on. It is therefore important not to think that there is environmental spend over there, and infrastructure spend over here; that one does not have an impact on the other, because it does. What Bob is looking to do is progress the work that has been done and underpin that work. He believes the profile is best done by at this stage looking at maintenance. Mr Baty: The capital investment programme in total will be at the same level as the last five years, but it will be focused on different areas of responsibility. Mr Jones: The very large quality programme that we have invested in over the past decade and more has created a lot of new assets, which themselves need to be maintained. Q113 Mr Chaytor: I appreciate that. Can I ask Water UK about your attitude to the environmental programme, because you have stated that you think the concept of the environmental programme within a five-year review is -the time has been and gone really and you are arguing that the environmental part should be taken out. Can you tell us why this is; and what is your view about the current arrangements for the five-year review? How should it be improved? Ms Taylor: It is certainly one of the things that we suggest needs to be addressed, along with a raft of possible ways forward. We are not pretending that we have got a perfect solution to this. What we are concerned about is that if we look at the position when the periodic review was first set up, when it was felt wrongly that people did not know at the time that if you put a large amount of expenditure in at the beginning, a bit like setting up the NHS, then everything will get jolly healthy and then you could afford to keep it topped up as you go along. Obviously, that is not true with the environment. If we look ahead to the directives that we will need to implement, then we can see that the investment profile on the environment is going to get higher, not lower. We believe that we need to make sure that we have a process that enables us all to be fit to face those issues in the future. One of the things that we do not have, that we think we should have, is a clearer overall framework. We think that that is the job of government. Defra made a good start with its publication directing Directing the Flow. However, it has gone quiet and they have not taken that further forward. As we have been exploring with you earlier today, there are some issues that the periodic review process cannot deal with, for example diffuse pollution. It cannot tackle those. There are some policy levers that the economic regulator does not own; the Government owns them, if it has created them, such as looking at diffuse pollution. We believe that we will need to look at how we can get hold of this idea of integrated catchment management, which requires a range of policy considerations and levers, many of which are outside the periodic review. That is just a fact. We need to make sure we know how to get hold of these levers and make sure that in the future we can look at the environment in a sensible and constructive way. If not, we are in danger of demonising spend on the environment, and that would not be right. Q114 Mr Chaytor: Do you have support for this from any other players in the field? Ms Taylor: We have been very pleased that just with the initial discussions - and I would not want to make it any more than that because it would be unfair to tie in our regulators - with Ofwat and the Environment Agency, English Nature and Defra, nobody is saying "we do not want to have those discussions" or "this is absolutely perfect so leave it as it is. We have signalled that we would like to look at this as we go forward. Mr Chaytor: Am I right, Chairman, that that is what they said at yesterday's meeting? Q115 Chairman: I do not want another show-stopper here, but the fact is they did express satisfaction at the present arrangements and saw no merit in ending the process of periodic reviews. Ms Taylor: If that was the Environment Agency, I have to say that surprises me. At the last meeting with the Environment Agency, where we specifically raised the issue of carrying out joint research to look at how this might be better done, they agreed that that would be a very good idea. Q116 Chairman: The quality of the liaison between the various organisations is coming under increasing doubt. Ms Taylor: I do not think it is. I think perhaps the quality of evidence given to you might be because I am absolutely satisfied with the liaison we have had with the Environment Agency, and I am satisfied that what I am saying is accurate. Q117 Joan Walley: In the light of the debate and dialogue we are having, is it your view that as far as Ofwat is concerned there could be some useful strengthening of Ofwat's environmental duties? Ms Taylor: That is something that can certainly be discussed. What you have to be careful about is the periodic review process that was set up in a different era from now, and hanging more and more bits on to it - you have to make sure it is viable as you go forward and we do not just pull the whole process down. They could take further account. Already there will be additional duties in terms of sustainability and so on, but how can the economic regulator take into account policies to do with farming or transport? It cannot be done, so there has to be a broad framework within which we set these discussions. Q118 Mr Chaytor: What is that broader framework? Who else is involved? Al the key players are talking to each other already. Ms Taylor: They talk to each other already, but it is very much a dance where the steps are agreed in advance. When you get up on to the dance floor, you know what steps you are going to be taking, even if you are a little late taking them as the Government is right now! At this stage all that the Government is able to do is comment on the environmental aspects of it; but would it not be good if the Government had re-read its own paper Directing the Flow and said "long-term this is what we are looking for; these are the objectives" so that periodic reviews would become milestones rather than an argument as to which direction you need to go in for the next five years. That is what we are looking for. Mr Baty: In the early days of privatisation it was very clear that a lot of the environmental impact was as a direct result of the activities of the water industry, which water customers were paying for. The background to that has changed now and as those have been removed then the issues are coming from other sources. Is it right that water customers should be paying for those improvements going forward, and that is a question for society generally not for the water industry or for customers to make a judgment on. That needs to be put in a much bigger forum to understand the position. Q119 Paul Flynn: You have mentioned diffuse pollution several times. Can you put a figure on the extent that diffuse pollution affects your finances? Is it a problem that those that cause the pollution find that someone else picks up the tab for it? Ms Taylor: At the moment, diffuse pollution already costs customers around £7 per year, and that is set to rise. Q120 Paul Flynn: Why is it set to rise? Ms Taylor: Because we will need to implement the Water Framework Directive. What concerns us is if the only way of implementing the Water Framework Directive - which we hope will not be the case - is to say that there is more and more end-of-pipe solutions that we are looking for, more kit to be put on the end of pipes, then this will cost even more. If you contrast that £7 at the moment, which is set to rise, say with South West Water £4 in the year for the environment programme, that cannot be right. Q121 Paul Flynn: It is a problem that the farmers and farming industry are not paying and there is rally no pressure on them to reduce them. What is diffuse pollution? Is it mainly silage, pesticides ----- Mr Baty: Cattle grazing - in the ground and it rains and it washes into the river. Q122 Paul Flynn: So in this case the polluter is not paying. Ms Taylor: Exactly. When Bob mentioned beaches and how there are some that are not under his control, that will be because it will be washed off from the land. Mr Baty: That is the river just going into the bathing area. Q123 Paul Flynn: This does not come out clearly in your written evidence as far as I can see. Ms Taylor: Sorry if it does not. Q124 Paul Flynn: Perhaps you could give us some more on this. Ms Taylor: Of course. Q125 Joan Walley: I am slightly struggling with the need for investments, which may not have been apparent at the start of the periodic review however many years ago and which has come up very quickly on the radar screen, perhaps in relation to the serviceability of pipes for example, which might prevent pollution in one way or another. I am not exactly sure in relation to the sequencing of the need for action and getting that into the long-term periodic review and whether more could be done to get greater flexibility so that we could all sign up to an environmental inspired programme that would be fit for purpose as far as the water companies were concerned and also as far as the needs are concerned, where there clearly are ongoing problems; but because we have missed the boat, we have had to wait a very long time to get the next boat, as it were. Ms Taylor: I think that what we are both saying is that the chance of five years may have been appropriate in the beginning when the industry itself had to do the work and could put its arms around the work in terms of if it was our responsibility; but now, as we look forward to more complex circumstances, and we look at the time frames that are coming in for other directives - the Water Framework Directive, the Revised Soil Directive and so on - we are looking at time frames that are quite, quite different from the periodic review type frames. We are going to need to find a more flexible way of going forward and a way that is transparent and has the confidence of stakeholders. Q126 Joan Walley: Do you feel that that is being taken care of, and in the sequencing of how things fit together there is a framework in which you can do that; or what needs to change for that to happen? Ms Taylor: I think what we fear is that when we get towards the end of the current process, when prices have to be set, we will then see there are still some issues unresolved and we will have to attempt to agree with the Economic Regulator and in discussion with the Environmental Regulators as to how these issues, which will be outstanding, should be resolved. We do foresee that that will be a challenge. Q127 Mr Challen: With customers nationally £434 million in debt in the last financial year could you tell me if there are regional variations in levels of debt between Northumbrian Water and South West Water? Ms Taylor: Yes, there are differences company by company. I am afraid we do not have the actual figures with us but we could let you have that information. Chairman: That would be helpful. Q128 Mr Challen: Could you give us a brief description of why that might be the case, these variations? Mr Jones: I am not sure about the original variation. I think it is clear that the rising level in customer debt is an issue in all regions to a greater or lesser extent. We are going to see that having an impact on bills going forward. Just last year we had an interim price increase in the North East and about half of that was due to increases in customer debt since the ban on disconnection, so it is a significant issue. Historically our levels of debt have not been particularly high but it is a growing issue and with regards to the starting position it is increasingly a significant position round the country. Ms Taylor: It is a relatively small number of people but the relatively small number of people is getting more into debt. As far as the companies are concerned for the people who cannot afford to pay they have a range of payment schemes to try to help people, a charitable trust that was set up, there are free phone help lines, and so on. If you are a customer who is not paying, if your bills are increased next year you are going to continue to be a customer who is not paying and that debt will increase. Whilst we are talking about an increasing problem in terms of the amount owed we do not know yet whether it will be an increasing problem in terms of the numbers of people who cannot afford to pay. It is something that I have written to the Secretary of State Margaret Beckett about and it is something that we very much want to engage with her on and with consumer groups as regards people's ability to pay. Q129 Mr Challen: This is a major issue in the periodical review as well, is it? Ms Taylor: We believe it is an issue that we should as a responsible industry want to address. It is something that we cannot address alone. There may well be some social issues that Government could help with. North of the border it is dealt with in a different way from south of the border. Q130 Mr Challen: It does sound like an affordability issue, what can the Government or Ofwat do to help, have you put forward any specific proposals? Ms Taylor: We have talked to Government about measures they might be able to introduce, ways in which we might be able to help customers through social security, and so on. We have looked at a raft of possible measures and we are continuing to have discussions with Government departments on that. I am pleased that Margaret Beckett has said that she specifically does want to engage in looking at this. Q131 Mr Chaytor: If I just can add to that, is there any evidence that the level of debt varies according to householders who are on metres or paying according to the ratable value of their house? Is the method of calculating the bill a factor in the level of debt? Mr Baty: I do not know about that relationship but one of the options we do when people are on an unmeasured arrangement and getting into debt it is going to be cheaper for them to have a metre, to get them on to a metre as soon as we can. I am not sure on the relationship, I will have to look that up. Q132 Mr Chaytor: The implication of that advice is that those on unmeasured bills save money with a metre, the implication of that is that the ratable value system is a regressive system, it is more expensive for poorer people. Mr Baty: It depends on the individual circumstances, it is not a clear-cut arrangement. Q133 Mr Chaytor: How do you feel about that as the basis of the system? Do you feel that the ratable value system provides a fair bill in relation to the typical consumption of different kinds of properties? Mr Baty: It is up to individuals to choose on that basis. Customers who think they are going to save money by using a metre switch over to a metre. Ms Taylor: If they are wrong they can have it taken out after a year if they are not satisfied. Mr Baty: It will depend on individual circumstances as to what is the most appropriate way of paying. Q134 Mr Chaytor: Would the general approach of water companies be to make up the shortfall as a result of debt through this interim charge or would you also consider making cuts, and if that were the case would the environmental aspects of your work be the first target? Mr Baty: Once we have the regulatory contract for the five years we are obligated to deliver the output, and that is what we monitor on an annual basis, and it is monitored very assiduously. The option for not delivering is not something that is open to us because, quite rightly, the Regulator will take issue if we have not delivered an output he believes within the five year contractual arrangement we are obligated and have been funded for. If the change to that funding stream is affected by circumstance outside our control then that is the opportunity to go back to the Regulator and explain to him the background and he will take due process and he will make an adjustment if necessary. Mr Jones: Part of that scrutiny will be to satisfy himself the companies have done everything they could to manage the debt position. Q135 Chairman: Picking up on the final part of Colin Challen's question, there is a feeling amongst some that when there is pressure on budgets, when the Government is looking to keep bills down it is always the environment that gets itself into the firing line first, is that an impression you share? Ms Taylor: I think it is an impression, how accurate this is we are not sure. We do not want to demonise spend on the environment but if you took a red pen to the whole of the environmental spend you are still going to see prices rising. It would be wrong to say that the only problem with all of this beautiful system is the environment, it is not. As far as we are concerned the environmental spend should be considered fairly and sensibly along with all other aspects of the spend. Q136 Chairman: It is as important. Thank you very much and thank you for your evidence and also your written evidence. Ms Taylor: Thank you very much.
Memorandum submitted by Ofwat Examination of Witnesses Witnesses: Ms Fiona Pethick, Periodic Review Project Manager, Mr Philip Fletcher, Director General and Mr Bill Emery, Ofwat examined. Q137 Chairman: Good afternoon, thank you for joining us and thank you for your written submission. You were able to hear the evidence session immediately before you and no doubt you may wish to comment on some of the things we have been discussing. Can I ask you first about one of the new elements in the process which is the cost of the benefit analysis which has been developed by the Environment Agency, I think you were involved in determining the methodology behind that? Mr Fletcher: We have certainly consulted as the methodology has developed and we accept that what the Environment Agency is now doing is a considerable improvement on their multi attribute techniques approach, which is the approach used as some of the longer standing members of the Committee may remember at the previous review. However, I do think it is worth pointing out that the cost-benefit analysis, echoing Water UK, in the environmental field is a very difficult science and it is still being developed. We believe there is more to be done and it is worth noting that cost-benefit analysis, even in this still fairly elementary form, has only been applied to some 10% of the programme which the environmental regulators are seeking because the rest of it is driven by the statutory requirements and is therefore declared to be necessary. I think for customers it is regrettable we are not looking more at everything in terms of whether cost matches the value to be achieved, but I recognise we can only make progress over time. Q138 Chairman: Given those caveats in practical terms has it been a worthwhile exercise for you? Mr Fletcher: Yes, it has. It all helps to advance things. We are not in this whole business for a year, two years, five or 10 years, it is a very long-term industry, it will be making progress over a very long time and the progress that we make incrementally will yield fruit steadily over time. Could I on the back of that just make the point that we are not going to go backwards. This sort of debate can get rather confused with issues like cuts. The huge improvements that have been secured by the water industry at the expense of its customers, many of them environmental improvements, over the last 15 years are secure and will remain secure, more or less whatever it takes, in terms of additional pressures on customers' bills. Q139 Chairman: That is of some comfort. We were told yesterday by the Environment Agency that more than just querying the reliability of the cost-benefit process, which is known to be difficult, you had some specific criticisms to make about some of the outcomes of that, are you able to shed any light on that? Mr Fletcher: I was not unfortunately able to be here and for some reason my colleague who was here was not able to get into the room for the first ten minutes so I am not fully aware of what was said. 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 those environmental benefits exist. Those aspects are largely addressed through willingness to pave 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 on 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 proven use of natural resources, I see all of those as important factors of 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 and 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 through 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 glints 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 principle 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 on 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 costs. 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 million on the one hand and 15 million 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 a draft price and it is 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 official companies will always have something more that it 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 have had done 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 to 2005. 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 panel disconnection, which 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 metre, which again has all sorts of good justification but it leads to capital costs and loss of revenue which are borne by customers as the 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 principle 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 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. Q160 Chairman: Thank you for that answer. I notice that you aim to include elements of sustainability within the framework. Is it in fact the case that given issues of financability the economic arguments are always going to come ahead of the environmental ones? Mr Fletcher: I do not think I do accept that, Chairman. We have got to ensure that the price limits are realistic, we cannot do a King Canute job on them. The environmental improvements which are going to be required of the companies will be very significant. Q161 Chairman: And indeed required in the country? Mr Fletcher: Particularly through the European Directives, of course I accept that. Q162 Paul Flynn: Bearing in mind what you have already said about the cuts in the letter to the Secretary of State in your memorandum to you us you the example of cutting capital expenditure for the period of 2005-2010 to 15 billion roughly at the level of at 2000-2005 investment. Is this before or after inflation? Mr Fletcher: That would be before inflation. I noted the points that have been made by Water UK on what it looks like when you add inflation in. Again when you get into figures you can cut them different ways, the figure in the 1999 crisis was about 15.6, that was before the companies implement those plans, they have made efficiency gains which the system is designed to encourage which we shall build into the floor for this review so that all of that benefit comes back to customers in terms of lower bills than they would otherwise have been. The 15 billion I was using was an illustration, it has appeared as the Ofwat proposal and I can see why. It is trying to ensure that all of the stakeholders, including Ofwat, are thinking very hard about whether all elements of the capital programme: Maintenance, sewer flooding, security of supply and the environmental element all need to be done in terms of the 20 billion or 25 billion programme that was being talked about in the different exemplifications over this particular five year period. Q163 Paul Flynn: You also said that improvements can be undertaken over a longer time frame therefore as we all understand the costs would then be mitigated. When you say the improvements are you referring only to the environmental improvements? Mr Fletcher: I have to take a view about all of the elements here, I am regarding all of them as improvements. If I can take maintenance as one example it has focused our attention in a previous look at the 1999 review on whether enough was being done on maintenance and we responded to that challenge. The industry and Ofwat under the auspices of the industry research body have a much better approach this time round, that means that I cannot ignore the evidence that there is likely to need to be significantly more invested in maintenance in this coming periodic review period. Q164 Paul Flynn: Could you put a figure on the five billion plus that you have used? Mr Fletcher: Can I can give you broad orders of magnitude. The overall figure you might use for illustration in relation to that 15 billion would saw 8 billion to retain base service, to ensure all of those assets, including the recently installed and rather short-lived vital high technology assets that companies have purchased are maintained, that would be 8 billion against the 9 billion the companies have firmly said they need in their draft preferred strategy. In enhanced service, at the last review the Regulator only allowed 100 million, 0.1 billion for enhanced service, most of it went into dealing with the very nasty problem of sewer flooding. We have had to say subsequently frankly that was not enough and the companies are doing significantly more in 2000 to 2005 to deal with that, all of that will be taken into account in the price limits I set this summer. There is very heavy pressure on me, very understandably, from water boards representing customers to do yet more on the basis that it is unacceptable to have sewage in your living room. Say one billion against the 1.2 the companies say they really need for mostly sewer flooding in the next five years. Supply and demand issues, we got through nine to 10 months of very dry weather last summer because the improvements already made by companies and without any hose pipe ban across the country. We were very pleased. We are relived it has rained for a large chunk of the winter. The companies say they need 2.8. If I were using an illustration of that 15 it might be of the order of two billion. Then the quality issues, the companies said in their preferred strategy they wanted just under seven billion for drinking water and environmental improvements, my question was would four billion be enough? One can understand the extreme vexation and unhappiness of the environmental interests and regulators at such a figure. Again the question I recognise needs to put in the context of our statutory obligations was just that, a question, would this be a tolerable level to hold down the capital programme to a level round the scale that it has been running at since 1989, which itself was roughly double the level that the water industry used to be able to invest when they were clamped by the Treasury? Q165 Paul Flynn: You mentioned the statutory obligations, do you agree this programme you have means water companies do not have to abide by their statutory obligations? Mr Fletcher: They always have to abide by their statutory obligations, the issue is really one for government on what they think the water and sewage companies need to carry out to fulfill their statutory obligations. That is the question for government. It is not one where I try to take Mrs Beckett's difficult decisions from her but it is a question from me to her head of principal governance on what almost is the least that would be necessary to fulfil those obligations rather than do other things, which we all recognise as desirable but which maybe could be done over a slightly longer period, and bring in the important new information we will have through river basement management plans, catchment area management strategies, bringing in the diffuse pollution elements from 2010 onwards. Q166 Paul Flynn: It might be said after reading your guidance to ministers and your memorandum to us that the environment is at the top of your "how to cut costs" list. Would that be an unfair conclusion? Mr Fletcher: We are back to the "whose cuts?". What has been happening since 1989 is that the environmental programme, I think rightly, has been given very great prominence, priority indeed. I think if my predecessor was sitting here, and Bill Emery can almost speak for him because he has sat through various reviews, he would say that the last time round we were still being very constrained, though not, we believe, running any risks with the maintenance of the assets, so that the overall programme was not set in being whilst the environmental programme went through its last peak, five years, 2000-2005, and it was not just Stephen Byers. Lord Ramsay, the then Chairman of the Environment Agency, was saying five years ago that most of the damage from the last 200 years (the Industrial Revolution) will have been repaired by 2005. The expectation was that 2005 will be when maintenance really does get its proper chance along with the other things, like sewer flooding. I am resigned to the fact that we shall see probably a significantly larger programme than £15 billion. I do hope very much that I shall be able to stand up in front of customers and assure them that that programme represents value even though it will increase their bills. I would feel more confidence in that if we had been able to develop the cost benefit work - I say "we" because it is a collective effort - further than we have actually managed in this review period. Q167 Paul Flynn: There have been some press reports that there has been pressure from other departments on Defra regarding water pricing. Water UK in their memorandum have said, "We believe that decisions on what is included in the guidance are made by Government collectively and not by Defra alone, so that the effectiveness of the debate between what are normally seen as key players is in reality constrained". Would you agree with that? Mr Fletcher: I think that is, if I may say so, properly a question for Elliot Morley when he comes in, but it would not be surprising if the government recognised that there are some really difficult issues here, and they confront all of us involved in the process. None of us wants to see bills going up, yet I am afraid overall they will and maybe quite significantly. None of us wants to play fast and loose with our international obligations, let alone with maintenance of these absolutely essential assets which have brought these huge improvements. It is a huge success story. There is a danger in focusing on what still needs to be done and losing sight of how big a success it has been. Paul Flynn: I think we recognise that. I am very grateful. Q168 Mr Challen: I was quite encouraged to read the outcome of the customer survey that you did. Looking at table 3 in your submission, "Willingness to pay for improvements", we have, under "Company preferred plan" a two to one majority in favour of probably willing to pay more than definitely willing to pay more, a two to one majority on those under reference plan A and still an overall majority under reference plan B. I was just wondering to what extent this research has influenced your decisions and whether after this research you will be taking a more liberal line on price increases. Mr Fletcher: The first thing to do is to pay tribute to the committee. It was again part of your last report that the various players in the last review had done themselves no favours by coming up each with their own little survey with their own carefully prepared questions. What we have done this time, and it has not been easy, is get all the stakeholders together, including Wildlife Link, representing the environmental NGOs, and the customer representatives. We have agreed on the list of questions, we have jointly financed a large survey, we have reasonable confidence that a very proper job has been done in these responses that all of us are committed to. Yes, I find it encouraging that we have sophisticated customers who appreciate the need overall to make various changes, including continuing environmental improvements, on the basis of (when they gave these answers) some basic understanding of what had been included in their own companies' draft business plans. I am less comforted by the fact that there are still significant numbers of customers who are really very unhappy about the prospect of significant increases in their bills and a minority, admittedly, but a significant one, who just do not see how they could mint that sort of increase. In relation to those areas like the south west where the bills are very high, even in relation to energy bills, I think that is a very real problem. Q169 Mr Challen: I have suggested that support for the poorer customers should be a matter for government but that is not currently the case, so does that influence your decisions in these matters more to that end, if you like, rather than being encouraged by the large majority that is in favour of paying more? Mr Fletcher: The water regulator cannot really bale out the poorer customer by acting as a sort of Robin Hood to charge richer customers more in order to subsidise the poorer customers. We already have, and perhaps that will give my view on the point earlier made by Mr Chaytor, the rateable value system which is a progressive system. It is very crude but those who have got the bigger houses will pay more for their water bills, with the rescue of the poorer individual pensioner who finishes up in a higher rateable value house having the safety hatch of going on to a meter and reflecting his or her usage. That is one safeguard, one reason why I am not too sorry that we have a mixed regime of metering and rateable value at the moment, but I do see metering as increasingly important to help safeguard supplies. It is the only sure way of making sure that people really pay attention to their water usage. Exhortation never does all that much except when you have got a drought, so again it is a nice balance of how you go forward. What the government can do is think about the tax system. I have to say I am not holding my breath for changes to the benefits system to give special help to water customers. The Vulnerable Group Regulations, which at the moment only help a tiny fraction of those on meters, themselves only 25 per cent on average, and those who are in particular need with very large families on benefit or with medical conditions that require very high use of water. Q170 Mr Challen: If the government did provide more support for poorer customers would that then let prices rise a bit quicker, do you think? Mr Fletcher: I think a 30 per cent average increase is already a pretty dramatic increase before you start adding inflation. If it turned out to be necessary to have a price increase of anything like that scale I would be concerned about customer reaction to it, and not just the poorest customers, although obviously I should be particularly concerned about the affordability implications for poorer customers in high bill companies. Q171 Mr Chaytor: Just pursuing the rateable value question, which exercises me greatly, as you will have appreciated, are you saying that the ratio between the lowest band of rateable values and the highest band of rateable values is proportionate to the ratio between the typical levels of consumption between the smallest and the poorest ones and the most affluent ones? Mr Fletcher: It is not perfect. It is a bit like democracy. It is the least bad system that one can possibly have. Q172 Mr Chaytor: Why is not a universal metering system? Mr Fletcher: Because to implement it instantly would be hugely costly. We would be looking at vastly bigger increases in bills. There would be, for you rather than for me, I am glad to say, questions of whether this was politically acceptable, and in terms of its major benefit to the environment of reducing demand it would be not very effective. It would be universal. It would apply in those areas which have plenty of water, Northumbria, for example, with Kielder Water, just as much as the dry south east, whereas Parliament has passed legislation which gives the government, if companies and government want to use it, a much more precise instrument in water scarce areas where mandatory metering could be introduced provided the government were convinced by the case for it. Q173 Mr Chaytor: But you would accept that the limitations of the rateable value system are partly due to the age of the property because of the lack of revaluations up to date? Mr Fletcher: Yes. The valuation is still there. It is pretty arbitrary, I know, but it still bears a rough --- I am not trying to argue for it more than that. I think myself it is better to stick to rateable values than move to council tax which would have all sorts of winners and losers in incidents around whether we stick with rateable value until we are ready to move on to meters almost universally, and while we have still got it it is not that bad as some means of enabling people to pay their bills and recognise that water and sewerage services represent a significant service. Q174 Chairman: Thank you, Mr Fletcher. We are nearly at the end. I just wondered whether you had any inkling as to when you might be going to get this long-awaited review. Mr Fletcher: I do hope very soon because it is now over a month since the promised time. The government were aware of my very strong hope that they would produce it at the end of January. Every few days that now go by put the timetable for the review at some risk. That is perhaps for the benefit of others, not putting the final delivery of price limits for Christmas in time for all the bills to be properly set from April 2005. That is not at risk but what is at risk to a degree is proper process, the process not least of companies discussing the proposals with their customers, including their business customers as well as their domestic customers, all parties having proper time to think about each of the remaining stages, the final business plans, in the light of the guidance, due in on 7 April. I am afraid that is probably very difficult to sustain given that we have lost a month. Delivery of draft price limits by the end of July. It was hoped for before the House rose. That may not be possible. Frankly, I do not want to announce them in August but I might be driven to it. Finally, a very long time. It reassures the City. We have had the end of November in place for the final price limits. I do not want to slip on that. At the moment I cannot absolutely guarantee that I will hit that date. Q175 Chairman: These are all points which we will no doubt want to put to Mr Morley when we see him a week tomorrow if the government has not already announced its review. Mr Fletcher: Exactly. Maybe your committee's inquiry will help to ensure it. Q176 Chairman: Let us hope that the argument has moved on by then. We are very grateful to you for your time. We may have a few further questions for you. I hope you will not mind if we send them to you in writing. Mr Fletcher: Please do and we will reply promptly. Chairman: Thanks very much. |