House of Commons - Environment, Food and Rural Affairs

Select Committee on Environment, Food and Rural Affairs Written Evidence

Memorandum submitted by WaterVoice

BACKGROUND

1. In November 2004, Ofwat will set water companies' price limits for the five year period from 1 April 2005. This will be the third price review conducted by Ofwat since the water industry was privatised in 1989 (price limits for the first five year period were set by the Secretary of State).

2. Ofwat is conducting the 2004 review in an open and transparent manner. This is exemplified by the consultation process it has adopted and by the approach taken to market research where the key stakeholders in the water industry including WaterVoice and Ofwat, have worked together to commission research into customers' views. The first stage of that research was published in August 2002[1] with the second stage due in December 2003.

3. WaterVoice benefits from a close working relationship with Ofwat. However, we have also been encouraged by the willingness of Defra, the Drinking Water Inspectorate, the Environment Agency in England and Water UK to meet with us to explain their objectives and to share information. For our part we are publishing a series of briefing notes at key stages of the price review to keep customers informed of the key issues.

KEY ISSUES FOR CUSTOMERS

4. WaterVoice has identified five key customer issues for the 2004 price review: addressing the backlog of asset maintenance, the scale and pace of environmental improvements, tackling sewer flooding, incentives and efficiency, and financial issues. Underpinning all of these issues is that of acceptability of the new price limits. Our views on whether water companies are meeting the aspirations of customers are set out below.

THE WATER COMPANIES' DRAFT BUSINESS PLANS

5. On 15 August 2003 water companies submitted their draft business plans to Ofwat. In addition to setting out their preferred strategies, each company was required to produce Reference Plan A which included a package of statutory drinking water quality and environmental improvements. Water and sewerage companies, and the two largest water-only companies, were also required to produce Reference Plan B which included a more extensive range of drinking water quality and environmental improvements.

6. In contrast to Ofwat, WaterVoice has, in general, had access only to the public domain summaries produced by each company. These summaries are of variable quality with some companies willing to lay their proposals open to public scrutiny whilst others have sought to guard the detail of their programme. Over the past month we have, via regional WaterVoice Committee meetings held in public, been able to obtain further details about company proposals for the next five years.

PRICE INCREASES

7. In their draft business plans companies are proposing:

— An average 31% real terms increase in the average household bill, taking it from £234 in 2004-05 to £306 in 2009-10;

— Real terms price increases over five years ranging up to 70% in the case of United Utilities whose bills are projected to rise from £243 in 2004-05 to £416 in 2009-10;

— An average first year real terms increase of around 13% (£14) for water and 11% (£14) for sewerage;

— First year real terms price increses ranging up to £48 for water (United Utilities) and up to £125 for sewerage (United Utilities).

  8.  Of the £20.5 billion capital programme outlined in the companies' preferred strategies the main drivers for price increases are:

Environmental improvements £4.6 billion

Drinking water quality £2.3 billion

Asset maintenance

—  sewerage £4.4 billion

—  water £4.5 billion

Security of supply £3.0 billion

Service improvements (including sewer flooding) £1.6 billion

ASSET MAINTENANCE

9. It is vital to the continuity of service to customers that water companies avoid a backlog of maintenance activity. We believe that previous price reviews have provided insufficient funds for companies effectively to maintain their networks. For example, our analysis of Ofwat's data on supply interruptions and mains renewal suggests a broad correlation between an increse in prolonged unplanned supply interruptions and reductions in mains replacement and relining activity. We have therefore called for an uplift in targeted asset maintenance over the next five years at least.

10. We are however, concerned about the wide variation in company proposals. For example, Bournemouth and West Hampshire propose to replace or reline just 1% of its mains over the five year period (taking total mains renewal since 1989 to just 5.5%). In contrast, Northumbrian's proposal is for almost 10 times as much activity on their mains (resulting in renewal of one-third of their network in the 20 years since privatisation).

11. We have similar concerns about the level of activity on the sewer network where some companies, such as Severn Trent and Wessex propose a doubling of expenditure on critical sewer renewal while South West propose to reduce their already limited expenditure by three-quarters. These differences in approach are not entirely explained by the history of companies' serviceability (the ability of assets to maintain services to customers.)

ENVIRONMENTAL IMPROVEMENTS

12. In the 15 years since privatisation the water industry will have invested £50 billion in programmes to improve drinking water quality, the water environment and customer service. This investment has been funded entirely through customers' bills. There has been no contribution from government grants or European subsidies. As a direct result of this investment:

;

13. Over the past 15 years, the water industry has taken action to reduce its impact on the environment. Sewage treatment works have been upgraded to meet tighter standards for the discharge of effluents. Most, but by no means all, storm water overflows have been decommissioned. The reduction in pollution of the environment by water companies was recognised by the Environment, Food and Rural Affairs Select Committee in its inquiry into the Water Framework Directive, when it concluded that agriculture was now the biggest polluter of the water environment.

14. WaterVoice supports further environmental improvements that give value for money but we question whether in view of what has been achieved to date, the same rate of expenditure is appropriate for 2005-10.

15. We suspect that several companies may have overstated both the need for additional environmental schemes and its associated expenditure. But we are nevertheless alarmed at the potential costs (£4.6 billion) outlined in the companies' preferred strategies. As a corollary, we are aware that most companies have not included the costs of compliance with new designations under the Freshwater Fish Directive within their preferred strategies. Defra has estimated the water industry's share of the cost of compliance at £700 million over the five years to 2010 (although Yorkshire Water has suggested that its costs would be £347 million alone). Furthermore, the prospect of designation of the North Sea, North East Irish Sea and the Solent, among other water bodies, as sensitive waters under the Urban Waste Water Treatment Directive has the potential of at least doubling the proposed environmental programme.

16. In September the Environment Agency stated that its "programme will contribute a modest portion of the household bill for water and sewerage—no more, on average, than the cost of a can of fizzy drink in the weekly shopping for each household"[4]. We question this claim as 22 million households in England and Wales each paying an extra 50p per week for five years equates to £2.86 billion, well below the current proposed expenditure on environmental schemes. Instead the costs seem to equate more to a bottle of premium lager each week.

17. In January 2003 Dieter Helm, Director of Oxera, suggested at an Environment Agency seminar on costing environmental benefits, that general taxation could be used to fund the wider public goods associated with bathing water, special environmental areas or other national assets. This is an idea that is worthy of serious consideration to ease the burden on customers' bills. It is arguable, for example, that as the Lake District and the Cornish coast are areas of national importance further environmental improvement should be funded centrally by tax payers rather than locally by customers.

DRINKING WATER QUALITY

18. In the 15 years to 2005 water companies will have spent £8.2 billion on new works and processes designed to improve drinking water quality. This level of expenditure has bought its rewards. Of around three million water quality tests carried out in 2002, 99.87% met required standards. The number of water quality tests failing a standard was less than one-twelfth of that in 1992[5].

19. Companies are proposing to spend an additional £2.3 billion over the next five years on a range of schemes designed to maintain or improve drinking water quality. We broadly support those schemes that will tackle issues of discoloration (a sizeable portion of the complaints we receive from customers), taste and odour and microbiological contamination. Together these schemes account for around £1.5 billion of expenditure. We have yet to be convinced that proposed schemes on nitrate and pesticide removal from raw water sources (£400 million) shoud be met from customers' bills in preference to effective application of the `polluter pays' principle.

20. We also have concerns about the extent of the lead pipe replacement programme (£160 million) and believe that a continuation of orthophosphate dosing programmes in those zones where lead pipe replacement is proposed could yield the same results for a fraction of the cost.

TACKLING SEWER FLOODING

21. Flooding from sewers is one of the most distresssing service failures that customers can face. Its prevention is one of customers' top priorities—even amongst those who do not know anyone who has experienced sewer flooding. WaterVoice has called upon Ofwat to allow the funding so that companies can:

— Resolve exisiting sewer flooding problems by 2010;

— Address new sewer flooding problems through normal operational cycles of maintenance and improvement.

22. WaterVoice accepts it is likely that (because of severe practical difficulties or excessive cost) a residual number of properties may remain at risk of sewer flooding beyond 2010. Nevertheless, we believe that the programme of work we advocate will benefit both customers (by removing the risk of internal and external flooding from sewers) and the environment (by reducing pollution of the land and watercourses caused by sewer escapes).

23. Companies are proposing to reduce the number of properties at risk of sewer flooding by around three-quarters in the period 2005-10. This will still leave over 2,600 properties (13 per 100,000) at risk of flooding once in ten years or greater. We are pleased to note the progress being made by most companies but believe that more could be achieved by some companies, most notably Severn Trent and South West. And while the main problem of internal flooding is at last being given greater emphasis it seems likely that several decades will elapse before external flooding is properly addressd.

SECURITY OF SUPPLY

24. Despite an increase in the number of metered households and more active promotion of water efficiency measures, demand for water is slowly rising. For those companies in the drier east and south east of England this position is exacerbated by the Government's proposals to sanction the building of 200,000 new houses in areas where water resources are already under stress.

25. In their preferred strategies, many companies have expressed deep concern that their overriding duty to supply water to customers is being compromised by the environmental regulators' desire to reduce or terminate companies' abstraction licences. Several companies have suggested that they will need to extend existing or build new reservoirs to meet projected shortfalls. Folkestone and Dover is seriously considering desalination as a means by which to meet peak demand.

26. We accept that there must be a balance between customers' needs for water and ensuring that wildlife is not adversely affected by over-abstraction. We are, however, not convinced that the Environment Agency has explored all available options with the water companies concerned. The last price review amply demonstrated that a willingness to think laterally could deliver broadly the same results for limited cost. [6]

INCENTIVES AND EFFICIENCY

27. The extent to which companies can and should achieve continuous improvement in ther capital and operational activities lies at the heart of regulation of the utilities sector. The past 15 years have seen water companies repeatedly outstrip the efficiency targets set by Ofwat. Whilst we do not doubt that savings are becoming more difficult to achieve there remains scope to improve efficiency, particularly through technological advancement, improved procurement activities and partnership agreements. The phrase "the low hanging fruit has already been picked" is fast becoming a water industry cliché. History has shown us that companies have been able to meet, and beat, challenging targets set by Ofwat.

28. In their preferred strategies, companies have tended to adopt a very conservative approach to setting themselves efficiency targets. The extent to which additional efficiencies can be stripped out of company operations over the next five years should be illuminated by the London Economics report on capital and operational efficiencies, commissioned by Ofwat and due to be published later this year.

FINANCE AND TAXATION

29. The water industry is a low-risk industry. The companies have licences that have recently been extended from 10 to 25 years' notice and their prices are regulated by Ofwat which has a primary duty to enable efficient companies to carry out and finance their functions. Conventional private sector companies do not have that level of security. It is our view that well-managed water companies should attract a cost of capital consistent with the bond/annuity end of the market. If this is achieved then it should help to keep prices down without necessarily limiting the ability of companies to deliver their commitments.

30. We have therefore been taken aback by the extent of companies' proposals for financing their business. These include:

— cost of capital—most companies have assumed a post-tax weighted average cost of capital at or close to 5.75% plus 0.95% small company premium (from the Water UK commissioned report by NERA) rather than adopt Ofwat's reference assumption that the cost of capital is 5.0% for existing assets and 4.75% for new assets (plus 0.75% small company premium);

— financeability—some companies are seeking additional revenues to bolster their financial ratios, including maintenance or improvement in credit ratings;

— taxation—an additional 3% on bills because of changes in the treatment of capital allowances from 1 April 2005.

ACCEPTABILITY OF PRICE INCREASES

31. WaterVoice has consistently argued that customers' willingness to pay more for water and sewerage services should not be assumed. As the joint stakeholder research undertaken by MORI in August 2002 identified, there is high satisfaction with both drinking water quality and sewerage services, and general satisfaction with the water environment. Where there is support for additional expenditure this is restricted to:

— Maintaining the quality of coastal and bathing waters;

— Maintaining the quality of rivers;

— Protecting important areas of wildlife and plants;

— Tackling sewer flooding;

— Improving the taste and smell of tap water.

However, customers were divided on the amount they were prepared to pay (if anything). Only 1 in 8 customers were willing to pay an extra £5 per year.

32. Against these results it is impossible to reconcile customers' willingness to fund a modest programme of water quality, environmental and customer service improvements with the proposals outlined in companies' preferred strategies. Even if the impact of taxation (circa £9 on the average household bill over the five years) was accepted as a fait accompli, companies are still proposing real terms price increases that, on average, amount to £12 per year, well above the amount most cusomers are prepared to pay.

33. The concept of affordability in relation to water and sewerage charges is a real one. In September 2003 Ofwat released figures showing that unpaid bills in 2002-03 totalled £781 million, an increase on £115 million on 1998-99. Revenue outstanding, as a proportion of total household revenue, increased from 13% to 17% in 2002-03. Of this, some £432 million had been outstanding for 12 months or more[7]. Even in a relatively benign economic environment this is a hugh debt burden for companies to carry, with the costs being borne by the wider customer base.

34. Affordability is most likely to affect those at the bottom of the socio-economic ladder, particularly those reliant upon the social security system. A good example of this is in the South West which has an above average population of pensionable age and, in Cornwall, the lowest level of average earnings across England. But it is in the South West that the average water and sewerage charge has more than doubled from £147 in 1989-90 to £342 in 2003-04. Water and sewerage charges in the South West are now currently on a par with the average standard gas bill from British Gas and around 50% higher than the average standard domestic electricity bill. [8]

35. Those in the South West are not alone in finding it increasingly difficult to make ends meet when presented with large water and sewerage bills. This was recognised by DETR in 2000 when it stated:

"Water and sewerage bills have risen steeply since privatisation . . . There has been an increasing burden on customers. This is a particular problem for those on low incomes, for whom water charges represent a larger than average proportion of disposable income and who may face difficulties where payment is required in sizeable instalments'

CONCLUSION

36. Customers know that they have to pay for reliable and good quality water and sewerage services, and are prepared to contribute to the cost of improving and protecting the water environment. But price increases of the magnitude seen in water companies' preferred strategies risk being counter-productive by turning customers against the industry, against the environment and against the Government, and resulting in a further increase in debts and financial hardship.

17 October 2003