Select Committee on Environment, Food and Rural Affairs Nineteenth Report


2  THE CONDUCT OF THIS REVIEW

6. The price review process is clearly a crucial one for water companies and their customers, but it is also a very important time for the environmental and quality regulators. The Environment Agency explained that it represented the "biggest single environmental programme".[4] The significance of the process therefore means that the way in which the review is seen to be conducted is very important if all the stakeholders involved are to trust the regulator and accept his decisions.

7. In both of our inquiries we therefore paid particular attention to the conduct of the review and especially to the questions of its transparency and the extent of 'horse-trading', the process whereby companies tend to overbid and the regulator tends to undercut, both of which had been criticised in previous reviews.

Transparency

8. At the beginning of this price review, Ofwat stated that it aimed to conduct the review in a transparent way.[5] In both this and our previous inquiry into this review we asked to what extent Ofwat had succeeded in this aim. In our previous report, we commented on two significant improvements to the transparency of the process, both of which were welcomed by all stakeholders: the introduction of draft business plans in which companies set out what improvements and maintenance they intend to carry out in the next five years and their estimates of the costs of those projects; and the joint customer research that was conducted by the major stakeholders in the early stages of the review. We concluded that, overall, the initial stages of the review had been carried out in a more transparent way than in previous reviews.[6] However, some areas of contention have emerged in the later stages. These centre on the nature and extent of information placed in the public domain and the way that costs have been presented. There have also been some comments about the blurring of roles in environmental decision-making.

9. Water UK, representing the UK's statutory water and wastewater operators, told us that the reasoning behind the regulator's draft determination was not clear.[7] Environmental and consumers' groups said that, at the draft determination stage, too little detail was given on individual projects in the quality programme for customers and other stakeholders to make informed judgements about company plans or Ofwat's determination of price limits.[8] There were also complaints about the disparity between the information made public by different companies, which again makes any comparison of companies' performance or the reasons behind their price rises more difficult to make.[9]

10. In response, Ofwat stated that it and the water companies published "considerably more detail than was published in the past", and cited independent comments that the review process was "significantly more transparent" than before. However, Ofwat also noted that there is "a delicate balance to be struck between complete exposure of all information provided and respecting necessary commercial confidentiality." For companies to expose all the information contained in business plans on, for instance, revenues, costs, quality enhancements and service improvements "could compromise their position in competitive markets". Ofwat also consider it would be prejudicial to customers' bills, and to the delivery of the improvement programme, to expose the costs of individual schemes in companies' business plans.[10]

11. We are disappointed that Ofwat felt it could not be clearer about which maintenance and improvement programmes were allowed for in its draft determination of price limits. We hope that this is resolved in its final determination of price limits, in order that customers and other stakeholders may have the clearest possible understanding of what they can expect water companies to deliver. If Ofwat chooses not to present this information, it should write to us explaining its decision.

12. WaterVoice, which represents water and sewerage customers, has criticised what it sees as a lack of transparency in the way that Ofwat has presented the likely increases in bills, arguing that it is difficult for most customers to understand the information given to them.[11] WaterVoice says that Ofwat generally presents headline figures in terms of the change in the average bill, which takes into account both metered and unmetered customers and Ofwat's estimate of the number of customers likely to switch to a metered supply during the relevant period. In company-specific information, Ofwat also presents figures for "typical" bills, which refer to the amount that an unmetered customer living in a house of average rateable value would pay, or that paid by a metered customer using an average amount of water.[12]

13. WaterVoice would prefer Ofwat "to present bill figures based on a range of rateable values in terms of unmeasured bills and based on consumption for different households for measured bills".[13] WaterVoice set out examples of what it views as a more readily understood format in its evidence to this inquiry.[14] We recommend that Ofwat considers WaterVoice's suggestions for clearer ways to explain to customers the impact of changes in price limits during its evaluation of this price review.

14. There has also been criticism of the way in which the reasons behind the likely price increases have been presented. Both the Environment Agency and environmental groups argued that too much emphasis has been placed on the cost of environmental improvement - in effect, the "blame" for the price rises has been laid at the environment's door.[15] Part of this perception may arise from the way in which Ofwat presents the 'drivers' for price increases, in which it separates out the increases due to improvement programmes and the decreases due to improvements in efficiency.[16] Environmental improvements appear as a cost; efficiencies as a reduction in cost. Another contributing factor is that some schemes classified as "environmental" may have wider benefits. It is no longer the case, as it was in the early days of privatisation, that most programmes can readily be classified as environmental or non-environmental. Many of the programmes put in place to meet the requirements of environmental legislation also provide other benefits. Spending on a new storm water holding tank in Manchester, which United Utilities told us was driven by the Freshwater Fish Directive[17], would be of general benefit to the people of Manchester, but the cost would be attributed to the 'environment' column. Ofwat insists that it is not its intention to downplay the importance of the environment programme, but there does appear to be some confusion in the way the cost of the environment programme is presented.

15. The controversy over the cost of the environment programme risks giving the impression to customers that water bills are a source of investment for environmental work, albeit vital work, that it would otherwise be difficult to fund. There is no perfect way of presenting information about these costs, but Ofwat should consider how information can be presented to give customers the most accurate possible picture of the costs of and reasons for the environment programme and how they contribute to the overall bill. The Government should also consider making a statement at the start of the process stating in clear terms details of the environmental legislation which the water companies will have to comply with over the five-year period of the pricing review.

16. Whatever the arguments about the way information is presented, there is a more fundamental point to be considered about the funding of solutions to environmental problems. In our previous report, we supported the application of the 'polluter pays' principle to water and sewerage services, but with the important proviso that not all problems are caused by the water company alone.[18] Therefore funding will in some cases need to be found other than from water bills. We are particularly disappointed that the Government has been slow to address the problems of diffuse water pollution and flooding caused by urban run off and that as a result the costs of these problems fall on water customers. The Government should consider whether charging via water bills is the most equitable way of funding the effects of these environmental challenges as well as the impact of climate change. The Government should make clear, at the earliest opportunity, its plans for solving these problems.

The respective roles of Ofwat, the quality regulators and Defra

17. The roles of the government, quality regulators, Ofwat and the companies themselves in the price review process appear at first to be quite distinct. The Secretary of State for the Environment, Food and Rural Affairs, with advice from the quality regulators, sets out what water and sewerage companies are expected to deliver in terms of quality of service and protection of the environment. The companies estimate what it will cost them to meet these standards. Ofwat makes a judgement about whether those cost estimates are reasonable and, in the light of that judgement and its view of the other ways in which companies can raise finance, determines how much the companies may charge their customers. The price review allows for this process to go through more than one iteration, in order that each party can refine their views and cost estimates in the light of fresh information.

18. The regulator has a duty to ensure that prices are no higher than they need to be and is free to query the costs put forward by companies. In some cases, where the regulator has judged that the companies' costs are too high, he has asked them to find other ways of achieving the same ends. The Environment Agency argued that, in choosing which costs of environmental projects to allow for in the draft determination and which to exclude or to delay until further information is available, Ofwat has in effect assumed the role more properly taken by the Secretary of State of taking environmental decisions.[19] The Agency has said that, regardless of which plans Ofwat allows for in its final determination, it will

    issue permits requiring the improvements to water companies' assets to be delivered by 2010 whether or not companies consider them to be funded. [20]

19. As the price review system stands, it is not for Ofwat to determine the content of the environmental and quality improvement programmes. We are concerned that, if the final determination does not fund statutory requirements, those companies will apply for further increases in their price limits before the next review. This would undermine the value of the price review process. We recommend that the Government examine closely how the regulator has responded to its guidance and to what extent statutory schemes have been allowed for in the price limits.

'Horse trading'

20. A key factor of this round was the halving by the Regulator of the opening price increase proposals put forward by the companies. Such a response, in what we accept is an iterative process, leaves the process open to accusations of 'horse trading'. As such it appears that companies overstate their likely costs, knowing that Ofwat will later attempt to reduce prices. In contrast, Ofwat sets prices lower than the level companies say is necessary, knowing that companies will have overstated their costs. In this price round, the price limits identified as necessary in companies' business plans were on average halved by Ofwat . Water UK argues that this is in part due to clarification of which programmes were necessary and of the cost of those programmes during the course of the review, but some companies remain dissatisfied with Ofwat's decisions.[21] The Environment Agency told us that in such an important process a degree of disagreement and an element of bargaining were only to be expected.[22]

21. We accept that an economic regulator for an inherently monopolistic industry like the water industry can never be a perfect surrogate for market competition. However we are concerned that the bidding process seems to result in such stark differences of opinion over costs, value for money and the scope for efficiency savings that the regulator, in his draft determinations at least, halved the bid set out by the companies. We recommend that the Government re-examine the methodology of the bidding process to identify the reasons for the striking differences between the companies' and the regulator's positions.



4   Q204 Back

5   Ofwat. Setting price limits for 2005-10: framework and approach, October 2002 Back

6   Environment, Food and Rural Affairs Committee, First Report of Session 2003-04, HC 121, paras 10-14 Back

7   Ev 44 [Water UK], para 2.1 Back

8   Ev 107 [RSPB], para 13 Back

9   Ev 92 [Environment Agency], para 28; Q 211 Back

10   Ev 23 [Ofwat] Back

11   Q169 ff Back

12   Q173 Back

13   Ev 80 [WaterVoice], para 3 Back

14   Ev 82 [WaterVoice], annexes B and C Back

15   Ev 91 [Environment Agency], para 26, Ev 107 [Royal Society for the Protection of Birds], para 13 Back

16   See evidence from United Utilities, Ev 57, Table 1, for an example of the 'drivers'. Back

17   Q 137 [United Utilities] Back

18   HC (2003-04) 121, paras 31-32 Back

19   Q203 Back

20   Ev 88 [Environment Agency], summary and para 12 Back

21   Qq126-130 Back

22   Q204 Back


 
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