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
