House of Commons - Environment, Food and Rural Affairs

Select Committee on Environment, Food and Rural Affairs Minutes of Evidence

Memorandum submitted by the Department for Environment, Food and Rural Affairs

INDEX

1. INTRODUCTION

1.1 The Government's aims for the water industry are to protect public health, safeguard the environment, and to ensure that the water industry continues to provide sewerage and drinking water services and supplies at a price affordable to consumers. A sustainable water industry, well-managed and regulated and with a secure investment base is essential to deliver these objectives.

1.2 Defra has given evidence to previous inquiries on this subject and would refer the Committee to its written evidence to the Environment, Food and Rural Affairs Committee inquiry into water pricing, October 2003[1] and the Government's response[2].

1.3 Previous Select Committee reports, including those by the Environment Audit Committee in 2000 and 2004, and those referred to above, have helped to inform the ways in which Ofwat, the Environment Agency, the Drinking Water Inspectorate, English Nature and Defra have approached the current review.

2. HOW THE REVIEW HAS BEEN CONDUCTED

2.1 Responsibilities—who does what?

2.1.1 Ofwat, as the independent economic regulator, is solely responsible for setting price limits as part of water companies' terms of appointment. Ofwat designs and leads the Periodic Review process in order to meet its primary statutory function of enabling efficient companies to finance and carry out their statutory duties.

2.1.2 The Government's role is limited to setting the policies within which services must be delivered, and they do not have any role in deciding how companies are funded to carry out their functions. It is however Government's responsibility to inform Ofwat, the independent economic regulator and the companies of policy decisions which need to be taken into account in companies' business plans, and hence in the price determinations that Ofwat set.

2.1.3 The role of the quality regulators (the Environment Agency, English Nature, and the Drinking Water Inspectorate) is to give advice to Ministers, including technical advice, on what their policies on the environment should be. This guidance embraces how environmental policies, supply-demand balance, nature conservation objectives and European standards on drinking water quality shall be met by water companies. The individual quality regulators then work with companies to devise programmes of schemes to meet these objectives. The Agency also advises Ministers on water resources planning issues.

2.1.4 Drinking water quality regulation is the responsibility of the Drinking Water Inspectorate.

2.2 Timetable

2.2.1 Defra has issued three sets of guidance to Ofwat during the course of the current Periodic Review; the Initial Guidance, which was published in January 2003, and the Principal Guidance, which was published in March 2004. Final Guidance was published on 4 October.

2.2.2 Water companies produced their draft business plans, taking account of Initial Guidance, in August 2003. Final business plans were submitted to Ofwat in April 2004, taking account of the Principal Guidance.

2.2.3 Ofwat has recently (on 5 August) published its draft determinations of price limits for consultation. The consultation will close on 13 October 2004. The Director General of Water Services has said that he will publish his final price determinations on 2 December 2004.

2.3 Process

2.3.1 Ofwat devises the process and timetable and sets price limits. In order to discharge this function properly, it needs timely information from all stakeholders and, in particular, from Defra's Secretary of State, in the form of the published Guidance.

2.3.2 In this Review, after discussion with Ofwat, Defra Ministers decided that this should be done in three discrete stages—Initial Guidance in January 2003, Principal Guidance in January 2004 (issued 11 March) and Final Guidance in September 2004 (issued 4 October). This was designed to provide information at three key dates in the overall timetable for the review. The guidance on the Periodic Review may be considered as a subsidiary document to "Directing the Flow—Priorities for future water policy", which Defra published in November 2002. The policies set out in the Initial Guidance are specific applications of the principles in "Directing the Flow" to the water industry.

2.3.3 Water companies translated these requirements into practical, deliverable measures to meet these objectives on the ground. Companies then submitted business plans including projected costs and revenue. Ofwat will set its price limits on the basis of the relevant information.

2.3.4 Ofwat's role is to scrutinise and evaluate these proposals, having regard to cost-effectiveness and value for money. Ofwat takes customers' interests into account.

2.3.5 The process for ensuring the review takes account of Government policies has functioned as it was designed to do. The publication of three sets of guidance at appropriate stages in the price setting process has enabled Ofwat and water companies to plan and present proposals which are fully informed by Government policies for the environment and drinking water quality. This has also given the quality regulators a good basis for working alongside companies to help develop detailed proposals and provide the appropriate degree of challenge.

2.3.6 Once final price determinations are published by Ofwat in early December, the price setting process will be complete. It is however open to each company to ask Ofwat to refer its decisions to the Competition Commission for re-determination if it does not accept the price limits Ofwat sets.

2.3.7 Ofwat has indicated that it will conduct a review of the price review process. Defra will contribute to that review. Defra will also consider from its perspective, the lessons to be learned and the implications for the future of developments such as the Water Framework Directive. It is still too early to make definitive judgements.

2.4 How policies are decided

Meeting legal requirement

2.4.1 Ofwat has a duty to enable water companies' to finance their statutory functions as part of the price-setting process. The Environment Agency and the Drinking Water Inspectorate reviewed final business plans to check that water companies had accurately reflected the environment programme in their final business plans, as required by Principal Guidance. The Environment Agency also reviewed water companies' final water resources plans, and provided a report to Ministers[3].

Taking account of costs and benefits

2.4.2 When considering the costs of meeting environmental obligations, full account needs to be taken of the costs and benefits to the water industry and the wider public, having regard to the polluter pays principle. This applies especially to the water and sewerage industry because effluent discharged from sewage treatment works is an important contributor to the cleanliness of rivers and hence to river ecology. Equally, water companies often find they are treating water that has been affected by diffuse pollution inputs. Diffuse pollution from agriculture is a particular problem for drinking water, which requires treatment to remove pesticides and nitrates to meet mandatory EC standards. When considering costs and benefits, it is important that:

— definitions of costs and benefits are wide enough, and cover all relevant groups and policy areas;

— the impacts of new policies—both costs and benefits—on all relevant parts of the population and on business are taken fully into account, including costs to the water industry and to agriculture; and

— sustainable development needs are assessed and fully taken into account.

2.5 Stakeholder involvement

Joint Statement

2.5.1 In the joint statement published on 12 August 2003, regulators for the water industry and the Government explained how the price review would work and what decisions would have to be taken, by whom, and by when. It also set out some key questions for contributors to consider. The joint statement was particularly important because it was the first time regulators and Government had publicly explained their involvement in the price review process, at the outset, and sought input from others.

Joint customer research

2.5.2 Joint Customer Research took place in 2002 and 2003. Although there was a broad degree of satisfaction with services provided and a limited willingness to pay for environmental improvements, opinions varied on the amount they were willing to pay and the degree and urgency of any improvements needed. Chapter 8.1 of Ofwat's draft determinations document[4] summarised the results.

Involvement of other, non-regulatory stakeholders

2.5.3 Ministers and senior officials meet with other stakeholders; environmental, consumer affairs, trade and representative professional bodies. The Government takes the views they express into account in setting policies and in formulating guidance to Ofwat.

3. AFFORDABILITY

3.1 Affordability is a key concern, and this is particularly the case in areas with relatively high price increases proposed and large numbers of low-income households. However, it should be borne in mind that affordability is not an issue which is confined to the Periodic Review. It needs to be considered with a longer-term perspective.

3.2 A cross-Government steering group was set up earlier this year to review the way in which low-income households are helped with their water and sewerage charges. Views from interested parties outside Government were invited. A seminar was held on 18 June 2004 which brought together a range of stakeholders and this was followed by a series of bilateral meetings to examine the issues in more detail. A wide range of viewpoints and ideas have been put forward and the Government is carefully considering all of these. A report is due to be published by the end of the year.

4. POLICIES FOR 2005-10 AND THE LONGER TERM

4.1 Planning and continuity for the long term

4.1.1 The Government is determined that water policy is clearly grounded in the commitment to sustainable development, covering economic, environmental and social aspects. These important principles have been key to the development of the Secretary of State's guidance to the Director General of Water Services in order to inform the Periodic Review process.

4.1.2 Considerably more emphasis is now given to integrating water policies with other Government policies, for example flood management. Defra's Water Directorate now embraces flood management policy alongside other policies for the water environment. The ongoing Making space for water consultation on proposals for a new Government strategy for flood and coastal erosion risk management in England considers all types of flood risks, including sewer flooding, and all areas of Government policy together for the first time. The consultation framework emphasises the need for integrated flood management solutions that address the complete economic, social and environmental impacts of flooding, and that work with natural processes and can achieve multiple benefits, for example for water quality, biodiversity or community regeneration. It also emphasises the continued need for resilience and flexibility in the face of potential climate change adaptations and the importance of links with spatial planning policies.

4.1.3 The PR04 guidance given to Ofwat by the Secretary of State aims to integrate different aspects of water policy, including water quality, and water resources insofar as they impact on water company costs between 2005-10. Improvements to the water environment need to be seen more in terms of the broader enhancement of water ecology. This also needs to take account of current work to develop catchment-scale solutions, against the background of the future requirements of the Water Framework Directive and other European legislation.

4.1.4 As a result of this Periodic Review, taken cumulatively with the previous price reviews, there is a proven track record demonstrating continuous progress; year-on-year, there has been a steady momentum in quality improvements since privatisation. The fact that this is the case, despite the different financial climate prevailing in 1999 (PR99) than now (PR04), makes this achievement more striking. It can be seen, therefore, that the technical details of the price-setting process have not been allowed to detract from the delivery of long-term projects. For example:

Urban Waste Water Treatment Directive

Section 19 undertakings on drinking water

4.1.5 In 1999, against a background of falling prices, the quality investment programme was costed at £7.4 billion. Resources for investment in PR04 are expected to be very tight because of the concurrent pressures on other areas of the capital programme eg capital maintenance. Ofwat has said that price increases will be kept to a minimum consistent with enabling efficient companies to carry out and finance their functions. However, the quality programme for the five year period 2005-10 currently stands at £5.1 billion. In its draft determinations, Ofwat has assumed less expenditure on drinking water quality and the environment than in 1999, although the overall assumption for capital investment is more than £15 billion.

Water Framework Directive

4.1.6 Water Framework Directive objectives will be a significant driver for action beyond 2009, including water company investment through future Periodic Reviews, as well as action by other key players—especially farmers and others who contribute to diffuse pollution. However, measures to achieve the objectives do not have to be operational until 2012 and, as detailed requirements are still under development, it was not generally appropriate to include specific WFD schemes at this price review. However, Government guidance made clear to water companies the need to ensure that investment decisions taken for PR04 were consistent with the need to implement the Directive in the future (so as to avoid costly add-ons at a later date).

4.2 Climate change

4.2.1 Climate change is potentially a significant issue for the water industry, and will undoubtedly lead to investment in the future, not least to enable the ageing sewerage systems in metropolitan areas to cope with larger volumes of stormwater, and peak rainfall events on a more frequent basis. This requires decision-making and planning now. The water industry, along with other key sectors, needs to take on board current knowledge and seek to develop strategies to identify areas where additional investment may be needed.

4.2.2 In July, the Environment Agency reported to Ministers on the water companies' final water resources plans, which inform the business plans under PR04. The Agency's report indicated that most of the water companies have made an estimate of the impact of climate change. Some believe that the impact is small and that it can be managed within existing plans. Others have shown that it could have a serious effect on the supply-demand balance. The Government expects all companies to continue to refine their plans in line with the Environment Agency's recommendations, and in particular to carry out more detailed analyses to help them understand the scale and scope of the impact of climate change, and thereby to inform their choice of appropriate adaptation measures.

4.3 Water resources policies

4.3.1 Government policy in this area was previously explained in the Defra memorandum to the Environment, Food and Rural Affairs Committee's inquiry "Climate Change, Water Security and Flooding" in April. The Committee's report was published on 16 September[5]. The Government is currently considering the recommendations, including those which relate to the Periodic Review processes and water pricing, from this report. The Government will respond to these recommendations in due course.

4.3.2 Essentially, the Government expects all water companies to achieve and maintain a sustainable balance between supply and demand for water; final water resource plans show that all water companies expect to be able to meet their customers' needs in the short term, although some companies need to do more to address security of supply issues. Most companies are forecasting an increase in household demand over the next 25 years.

4.3.3 The Government would like to see demand management measures making a greater contribution to meeting the supply-demand balance, alongside the development of new resources. In the Final Guidance, Ministers have encouraged water companies to include more demand management in their water resources plans.

4.3.4 Where additional water resources are planned, companies need to be able to justify the need for this against other options such as further leakage controls and water efficiency measures.

4.3.5 Most companies are now at their economic level of leakage. The Government expects companies to continue to manage leakage within Ofwat's economic framework and, as appropriate, to exploit opportunities to reduce leakage further. In its draft determination Ofwat provided for a significant increase in investment in the maintenance of underground assets, including water mains, which will assist companies in their longer-term management and improve security of supply.

4.3.6 Water resource planning is also a key feature of Government planning for sustainable communities. Significant house building in the south-east will undoubtedly impact on the supply and demand for water. This has generally been factored into water companies' water resource plans, but will need to be updated as further, more detailed information on housing numbers and precise locations becomes available. The Sustainable Buildings Task Group identified a number of steps to improve the water efficiency of new development, including tighter standards in building regulations, which the Government is working to implement. Local authorities will need to ensure that the water companies are kept abreast of evolving development plans.

4.4 Policies for the environment

4.4.1 Water quality

4.4.1.1 The Secretary of State's Principal Guidance to the Director General of Water Services, published in March 2004, conveyed her main decisions and policies affecting the Periodic Review. This included a detailed analysis of the environment programme that Ministers wished to see included in Final Business Plans (chapters 4.2 and 6).

4.4.1.2 EU and domestic obligations play a large part in determining the size, scope and pace of the environment programme, setting for example, the standards for urban waste water treatment, bathing waters and for internationally important nature conservation sites. The Principal Guidance recognised that compliance with EU and domestic statutory obligations would not offer all the additional discretionary elements and these were left open for Ministers' decisions on the basis of a Regulatory Impact Assessment.

4.4.1.3 The Principal Guidance also took into account other factors such as the need to consider how water company activity in the period under review should be related to other initiatives, such as on diffuse pollution and on implementation of the Water Framework Directive, which will fall mostly in the next review period.

4.4.1.4 The environment programme is robust. The Environment Agency, English Nature and Ofwat have collaborated to assess the effectiveness of the companies' proposals in delivering the required environmental improvements and whether the solutions put forward were reasonable.

4.4.1.5 In addition to the appraisal work carried out before Principal Guidance, the Environment Agency and English Nature have undertaken further technical appraisal of some parts of the programme and some high cost schemes have been subject to further scrutiny. The outcome of this process substantially reduced between Initial and Principal Guidance the number of schemes needed to deliver the proposed programme.

4.4.1.6 Ofwat has undertaken extensive analysis of companies' Final Business Plans. This has informed its Draft Determinations which, along with the Regulatory Impact Assessment of the small amount of discretionary schemes will inform the Secretary of State's Final Guidance.

4.4.1.7 In the Final Guidance, published on 4 October 2004, the Secretary of State confirmed the policies that she wishes to go ahead in the light of water companies' Final Business Plans, further advice from the regulators and Ofwat's Draft Determinations.

4.4.2 What will the environment programme deliver?

4.4.2.1 The environment programme will improve and protect the quality of over 2,900 km of rivers in England and 260km2 of lakes and coastal waters. This programme builds on previous achievements. Over the last decade the environmental status of our inland and coastal waters has been significantly improved. For example, 65% of monitored river length in England was of "good chemical quality" in 2002, compared with 43% in 1990[6]. Over the same period, compliance with minimum EU bathing water standards has increased from 79% to almost 99%.

4.4.2.2 However, there is no room for complacency. More work is needed to improve the water environment, for example, to improve the condition of water and wetland Sites of Special Scientific Interest (SSSIs) and to meet the requirements of the Water Framework Directive.

4.4.2.3 The present environment programme is designed to help ensure that:

— treatment works, pipelines and sewers perform well and so underpin the improvements to the environment made in the last 10 years;

— companies have sound plans to provide enough drinking water, meeting the required standards, consistent with the needs of all water users and the environment;

— the environmental impact of abstractions and discharges is reduced;

— legal requirements are met; and

— the actions proposed within the constraints imposed by statutory regulations represent good value for money and promote sustainable development.

4.4.3 Nature conservation and habitats objectives

4.4.3.1 The environment programme will contribute to meeting nature conservation drivers such as those associated with the protection of internationally important sites, including Natura 2000 and Ramsar sites, and similarly important national sites, SSSIs. The Environment Agency and English Nature have recommended investigations and schemes to tackle abstractions and discharges which may be adversely affecting those sites. Schemes have also been recommended to tackle abstractions and discharges which may be adversely affecting Biodiversity Action Plan species and habitats.

5. CONCLUSIONS

— Early indications suggest that the process for incorporating Government policies in the current water price review has worked as intended (paragraph 2.3.5).

— Guidance given by the Secretary of State enabled key Government policies to be reflected in water companies' final business plans (paragraph 2.3.5).

— After the process has been completed, Ofwat will consider with Government what lessons need to be learned for the future. It is too early to make definitive judgements (paragraph 2.3.7).

— Affordability is a key Government concern and a cross-Government steering group will report by the end of 2004 (paragraph 3.2).

— Long-term planning has not been hindered by technical details of price setting process (paragraph 4.1.2).

— Climate change has been reflected in water resources plans and hence in the price-setting process. There is room to review analyses and update plans as further/better information becomes available (paragraph 4.2.2).

— Water companies do however need to include more demand management and water efficiency projects in their water resources plans (paragraph 4.3.3).

— There will be a significant increase, as indicated by draft determinations, in the amount of investment available for maintenance of underground assets, including water mains (paragraph 4.3.5).

— The quality programme for drinking water and the environment confirmed in Government guidance will continue the substantial improvements made in earlier prices reviews (paragraph 4.4.2.1).

25 October 2004

1 House of Commons-Environment, Food and Rural Affairs-First Report. Back

2 House of Commons-Environment, Food and Rural Affairs-Fourth Special Report. Back

3 Environment Agency-Maintaining Water Supply (July 2004). Back

4 "Future water and sewerage charges 2005-10: Draft determinations". Back

5 http://www.parliament.uk/parliamentary_committees/environment_food_and_rural_affairs/efra_climate_change_and_water.cfm Back

6 The chemical classification system assigns river stretches and canals to one of six chemical quality classes-A (the highest) to F. "Good" equals classes A and B. Back



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