Examination of Witnesses (Questions 203
- 219)
WEDNESDAY 3 NOVEMBER 2004
BARONESS YOUNG
OF OLD
SCONE AND
DR ANDREW
SKINNER
Q203 Chairman: Can I welcome you
both. Baroness Young, you were before the Committee yesterday
and we are very grateful that you have been able to find time
to come back and see us again. In your very helpful summary of
evidence you say, "We are disappointed that the draft determinations
have excluded some of the schemes we proposed, which are required
to meet the environmental obligations and polices required by
the Government's principal guidance on the 2004 Periodic Review.
The Agency will issue permits requiring the improvements to water
companies' assets to be delivered by 2010 whether or not companies
consider them to be funded." It is a sort of disappointment
on the one hand but a "get on and do it" on the other
hand. Does that raise in your minds issues about the effectiveness
of the way in which this review has been conducted? It would be
very interesting, in the context of that interesting paragraph
which I read out from your evidence, to know what your impressions
have been about the way that this particular exercise has been
carried out. Is it better this time than it was last time, notwithstanding
your comment?
Baroness Young of Old Scone: I
think we should say from the outset that there are some things
that have gone much better this time than they went last time.
For example, the joint market research that WaterVoice also referred
to I think was a major step forward, as indeed was the work that
happened between Ofwat and the companies themselves on getting
water resources plans into the process and making sure that water
resources plans flowed through into the companies' business plans.
I think that was a major step forward, as was the work, though
it was rather late, with Ofwat to challenge the costs of schemes
that resulted in some of the reduction in the total cost of the
programme. I think those things went better. There is the fact
that we have arrived at the end of the process with a substantial
size of environment programme. Though it is smaller than the previous
two settlements, nevertheless a substantial number of schemes
that we believe should have been funded are not funded, but there
is still further work between now and the final determination
on many of these schemes to see whether we can reach a point where
they can be brought back into the programme. That does highlight
some issues that we believe need to be corrected in any future
process. Perhaps I could run through some of the things that we
think need to be better in the process. Clearly the issue of cost
reductions came quite late in the day and therefore it was quite
difficult for the Minister to adequately frame his principal guidance,
since he did not really know what the full and proper costs were
of the guidance he was going to give. That has resulted in us,
with the Minster's support, saying that we will alter the permit
requirements for companies to reflect the totality of what the
Minister had in the principal guidance, because we believe those
are the basic environmental requirements that need to be delivered
during the period of a review. We will have to go ahead with those
changes if we are going to comply with European legislation and
to meet the mandatory requirements for the environment. The cost
issue was a factor. I think there are a number of other things
that we would like to see differently. There was a huge nervousness
about affordability, and you have had a very long discussion about
it. I should say that affordability was about a range of issues,
not just the environment programme, though it was very much laid
at the door of the environment programme for a period at least
during the review. We would like to make the point that moves
towards universal metering, or near universal metering, would
allow a much more sophisticated approach to charging customers
through the tariffing system. Though metering is going up and
there is some money for metering in the price settlement, nevertheless,
it is only going to improve by 2% per annum, which is really a
very slow rate. We are not going to be close to satisfactory levels
of metering very fast at that rate. One of the last issues that
we would like to make refers very much to the point you made about
our clarity as a result of the ministerial guidance. For future
reviews, apart from issues like transparency and taking a much
longer term approach and a whole variety of things about timing,
we believe that one of the key things is that there is a real
clarity of roles. We must be careful about the roles that are
supposed to operate. As the environmental regulator, we put forward
the objectives for the environment; the Minister takes a view
about those and decides what needs to be included in the programme,
taking account of a whole range of issues, including the political
issue of affordability. The economic regulator is there to make
sure that those programmes are delivered at the most cost-effective
level and that the companies can finance their operations. I think
in the review this time we have, from time to time, reached a
point where the economic regulator has begun to take environmental
decisions de facto. We are particularly concerned about
that in terms of a further feature of the final determination,
which I do not think has been touched on so far, and that is the
protocol that the economic regulator will announce with the final
determination for what is going to happen to all those schemes
on which decisions need to be made during the next five years.
That changes the rules of the game completely and I think significantly
diminishes our role and diminishes the role of the Minister, and
certainly changes the rules about schemes that are driven by the
statutory drivers of environmental requirements coming from Europe
and enshrined in UK law in that they are not simply going to be
judged on how that can be delivered in the most cost-effective
way but they actually say: are we really going to deliver them?
Is there a cost benefit case for this environmental improvement
happening at all? That is a very different kettle of fish from
the way the rules of the current price determination are done.
We are concerned about that protocol for the interim determinations
of the future. There is a multitude of other changes we would
like in the system. We will be doing some work with the economic
regulator, but also on our own behalf, to look at the changes
we would want to feature in the whole way that the next review
is conducted.
Q204 Chairman: So a bit more objectivity
and a little less horse trading?
Baroness Young of Old Scone: It
is always going to be a horse-trading process because, as you
have heard, it is a big political issue of great concern to people;
it is a big chunk of money and it is a big chunk of environment,
the biggest single environmental programme at all of any of the
bits of policy that we have around on the environment at the moment.
It is always going to be hotly contested but I think we do need
to have clarity of roles and, at the end of the day, alas, the
poor Minister has to be the one who stands up and is counted in
terms of the environment programme.
Q205 Chairman: One thing that worries
me is this. You have laid out a series of unavoidable environmental
agendas. You did not name them but it was implicit in what you
were saying. The point that I put to the companies earlier on
is that they have a pretty shrewd idea of what, in the nicest
sense, the customer can bear. It is surprising that they do not
start from the point of view of how much does what the customer
can bear generate in revenue and then break it back within the
business to what can that revenue buy, to take into account those
obligations which they have to fulfil. Therefore, by definition
what is left can do some of the things that you can prioritise.
What is the process is bottom-up? The company starts off against
a background of some initial guidance and puts up a big shopping
list knowing it is going to be hacked back. That does not strike
me as entirely rational. I want to move on to transparency issues
briefly because, in paragraph 11 of your evidence, you make a
point here in the context of commenting about London and the efficiencies
of the Victorian sewerage scheme. You say: "However, the
exact detail of how Ofwat have dealt with schemes in the environmental
programme in draft determinations is confidential to Ofwat and
companies but have been shared with the Agency under a confidentiality
agreement." What information, more so than is at present,
do you think ought to go into the public domain? What information
would you have liked to have had that you have not had and what
are the gains to the greater transparency? I am still struggling
a little bit to understand what is so confidential, particularly
about the ways of meeting the environmental programme. I can understand
from the point of view of those companies where, on the industrial
supply side, there may be people who are competing with them to
supply water. I can understand that. Here we have: how do you
deal with environmental issues? This is dealt with under "commercially
confidential". Perhaps you could shine a bit of light into
this?
Dr Skinner: Certainly, and I will
do so in two contexts: the situation now and as it would pertain
to future price rounds. These are not rules that we make. We have
found it very difficult when talking to our interest groups around
the regions to explain to them what the consequences of the draft
determinations are because, although we know under privy information
from Ofwat what schemes are funded, parked or minded not to be
funded, that is not public information.
Q206 Chairman: Let us just stop there
because you are putting up a fog for me. You talk about schemes
that are parked. You know about the schemes. Help me to understand
it because I do not.
Dr Skinner: In the draft determination,
which was published in August, the Director General effectively
classed all the environment programmes into three categories:
those which he did not want to fund and was not minded to; those
which he had problems with; and those which he accepted on ministerial
advice and our advice could go forward.
Q207 Chairman: Are the ingredients
of those three areas confidential?
Dr Skinner: The contents of those
three categories are not in the public domain.
Q208 Chairman: Here we have a public
servant who has made a judgment within categories of environmental
programme as to what he is prepared to allow the water companies
to spend money on or not. Do some of them fall into the category
of statutory obligations?
Dr Skinner: They most certainly
do.
Q209 Chairman: Why does Mr Fletcher
decide he is going to be judge and jury when, either at European
or national level or ministerial level, there has been a determination
that something will or should happen? You are telling this Committee
that Mr Fletcher effectively is saying there are some things that
he says will not happen.
Dr Skinner: In his draft determinations
he has said they are something that might not happen. In his defence,
although we do see this as a problem, there is a search for further
information from the companies on some issues. Sometimes companies
have not provided a good defence for their scheme or their cost.
Q210 Chairman: Coming back to the
programme, if he has a list of things which are in the three categories,
why is he unwilling to make those public? What is so secret about
them?
Dr Skinner: That is a question
you ought to ask him.
Q211 Chairman: What do you think
it is? The next question I want to ask you is: what are they?
Dr Skinner: We do not think it
is a good idea, and indeed quite often the companies whose information
it is have made that available under their own aegis but it is
not part of the defined process.
Baroness Young of Old Scone: One
thing is going to have to change for the future because water
resources plans are going to be statutory in future and will have
to be consulted about, so that part of it is going to have to
be in the public domain. I think also one of the things we would
like to see in any future process is a much greater standardisation
of what the companies have to put into the public domain. Some
of the companies were very open and did put a lot of information
into the public domain and others did not.
Q212 Chairman: Let me probe this
a bit. I do not want to put you into the difficult decision of
having to break confidences that have been shared with you. I
think there are dangers in doing that. Give me your view as somebody
who knows what is on this list: what would be the consequences,
in your judgment, if all of that information was in the public
domain?
Baroness Young of Old Scone: We
have had this discussion with the economic regulator and my understanding
of his concern—and I may be misquoting him—is that
if all of the array of capital schemes in the environment programme
were in the public domain, people who wanted to make investment
decisions anticipating his settlement would be able to begin to
guess at what his settlement was and, since that is share price
sensitive, that would be unfair on the market. Only he can judge
that. I cannot judge that; I am not sufficiently financially expert
to be able to judge that. It is quite a bit chunk of these settlements
but not the totality. It is probably the bit that is most unpredictable,
unless you have insider information. This would be tantamount
to insider information. He gives us pretty hard grief if we even
look as if we are going to leak any of this.
Dr Skinner: Could I make a point,
Chairman, about taking that forward into the next price review
because the next price review will be intimately linked with the
Water Framework Directive. The Water Framework Directive is, as
you have heard from a number of your witnesses today, a cross-sectoral
issue where one has to make in river basin plans decisions about
whether it is a diffuse pollution scheme affecting farmers or
a water company scheme or something affecting drainage in urban
areas. Unless all those sectoral plans have an equivalent level
of transparency, the Agency as ring-master of the Framework Directive,
and the public, whom we are obliged to consult, cannot possibly
have any clear idea about the issues. We think it is a position
that has to change. It has been a struggle this time but it is
going to be fatal for future price rounds.
Q213 Chairman: I can understand what
I might call the "things that I would like to do because
I would like to make an improvement" approach as opposed
to "the things that result from water framework and other
similar statutory obligations". If you are going to explain
this process to people, you have got to understand the universe
of the interior in which it operates. The fact that a regulator
is making decisions in secret about things which various elected
and other statutory bodies have said ought to happen is concerning.
I think the Committee may well wish to probe the regulator further
on some of these matters. As I say, my task is not to put you
into the embarrassing position of disclosing to us that about
which you have been sworn to secrecy. I am going to conclude on
that programme.
Baroness Young of Old Scone: There
is one other point. If we are blowing the gaff on schemes, I think
the most difficult one that is omitted is the Thames Tideway,
the whole business of cleaning up sewer pollution into the Thames.
We did not spring that on an unsuspecting world and break the
confidence, it managed to do it itself the day before the draft
determination by having the worst sewerage incident for some considerable
time, but not totally out of line with the ones that happen on
average about 50 times a year in the Thames.
Chairman: You have talked about market
sensitivity. Market sensitivity is a two-way street. If in fact
people do not disclose what is happening, that can be as bad as
disclosing. Let us park this and deal with the regulator on that
and move on to Mr Tipping.
Q214 Paddy Tipping: Can we return
to the environmental programme? It has moved around certainly
in the newspapers, and I think you used the phrase "it was
laid at the door", that price rises are the cost of the environmental
programme. That is not the reality, is it?
Baroness Young of Old Scone: No.
In fact, we have always made the point that the environment programme
is a big of a bargain, to be honest. It has been pretty rigorously
tested. Quite a large number of schemes that did not stand muster
in terms of their value for money were dropped out of it. The
remaining schemes have had some pretty hard hammering in terms
of reduction in costs. So the programme really is pretty finely
honed and we believe is not at the minimum but below the minimum
that is required. That has meant that of all the drivers for price
increases, the total drivers for price increase are on average
about £54 per bill over a five-year period; only £20
of that £54 is actually for the environment programme. We
are not entirely clear as to why that is not the way the environment
programme is represented in the draft determination where it is
represented as a much higher proportion of the bill increases.
That is because of the way in which things like the efficiency
programme are dealt with in the way that the economic regulator
presents the figures. We feel that the environment programme has
been overrepresented as causing bill increases, both at the beginning
part of the programme when the horse trading about what would
actually be in and out and how much it would cost was taking place
and latterly in the draft determination and presentation of the
figures. I do not know whether Andrew Skinner wants to come in.
Q215 Paddy Tipping: Before Dr Skinner
comes in, let us just stick with the figures for a minute. In
your evidence to us you said the bill was going up to £33
not the £54 you have just mentioned.
Baroness Young of Old Scone: The
figure of £54 is net before you take efficiency savings into
account.
Q216 Paddy Tipping: You say £20
of that is portrayed by the regulator as for the environmental
programme. The environmental programme is only 20% of the total
capital costs.
Baroness Young of Old Scone: That
is right.
Q217 Paddy Tipping: There is a disparity
that leads to a false perception?
Baroness Young of Old Scone: This
is part of the problem in the way in which the price increase
can be portrayed. There are apples and pears in this. It is quite
difficult to pin down exactly what the environment programme represents
but it is 20% of the capital programme. Alongside all the other
drivers, things like pension costs, the taxation issue, some of
the financing issues for the companies, operating costs, capital
maintenance of assets, plus other improvements like the drinking
water quality and various improvements, the environment programme
is only one part of that.
Dr Skinner: Could I perhaps develop
the point? One of the issues which gives rise to that problem
and we think will be a problem in the future is that effectively
we are counting money two ways: we are counting money for the
environment programme and we are counting money for other costs
the companies incur. Although that may have been a useful distinction
in 1989 when there was a big backlog of investment in sewerage
works, as water companies have dealt with many of those issues,
we get a much closer interaction between the infrastructure
management for the water companies and the environment programme.
The best I can understand the way the financial regulator presents
the figures is that he is essentially saying that the environment
programme sits at one side and all the efficiencies bear down
on all the other costs, and therefore they reduce, but our environment
programme somehow is not delivered with efficiency and therefore
it sits there as a larger and larger proportion of a declining
total sum. I think that is a false representation to the
public and to stakeholders. I also think it is leading us to a
situation where we are looking at funding of companies in a way
which does not actually relate to the way in which companies'
actions impact on the environment because increasingly it is about
the way they manage their sewerage systems, it is the way in which
they manage the broader infrastructure, and it is an example of
where a 1989 way of doing things is not going to be a very good
way in 2009 for the next price review.
Q218 Paddy Tipping: Can I just pick
up one of the points. I think I understood what you were telling
me but I want to be clear on this. I think you were saying, Barbara,
that you are the environmental regulator and you have got to make
a judgment about the European Directives that have been translated
into UK legislation and regulations and you can prise that open;
you have a clear view on that. In reality, because economic regulation
has got to take affordability questions into account, things that
you believe should be done because of statutory environmental
requirements are either not happening or, to use the phrase that
is around, being parked. In a sense, you are being superseded
by the economic regulator?
Baroness Young of Old Scone: It
is quite a complex process and there is quite legitimately the
capacity for joint judgements, as it were, in that we look at
the environmental drivers and come to the conclusion as to what
needs to be delivered. We then talk to the companies and ask them
to put forward schemes to deliver those programmes. The companies
cost the schemes and those costs are reviewed by Ofwat, not by
us, but we do take a view because we have a track record of working
through those schemes with the companies. It has been a joint
programme of trying to reduce the costs of those schemes. I think
where we are anxious, and we are certainly anxious in terms of
the protocol that is going to be used for the interim determinations
for the future, is when the economic regulator, with the issues
of affordability in his mind no doubt, takes a view that, despite
the statutory nature of a driver, the price, the cost of a scheme,
is just higher than he thinks is legitimate and it is not value
for money. In the case of optional schemes where it is not statutory,
I think cost benefit is quite a legitimate process. Our understanding
of the way in which the system should operate in this price round
is that if there is a statutory driver that means that environmental
benefit needs to be delivered. The question is: how can we get
that delivered in the cheapest, most cost-effective way and not:
should we be delivering that at all? We have helped that process
of getting the programme down to levels which are affordable by
being pretty hard-nosed ourselves and saying: for schemes that
are coming in at big costs, perhaps that is not the answer and
perhaps we should take it away, look at it again and see if there
is another way of doing this. If companies are coming forward
and they have clearly not quite cracked how they are going to
deliver this, we might agree that they would look at investigation
rather than at full delivery of a scheme so that we could get
a better handle on what is required and what the scheme would
actually be. Having done that pretty rigorously, we are now in
a position where a number of schemes we felt are fully justified
and are pretty good value for money are still being challenged.
That is the process we are working through between now and the
final determination.
Q219 Paddy Tipping: Can you tell
us what those schemes are or is that confidential?
Baroness Young of Old Scone: We
can tell you what sorts of schemes there are.
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