Government response
Introduction
The Government welcomes the report of the Environment,
Food and Rural Affairs Committee into water pricing, as a constructive
and timely contribution to the debate on the Periodic Review of
water limits for 2005-2010. The Review is currently in progress,
with the Principal Guidance from the Secretary of State to the
Director-General of Water Services now expected to be issued in
February 2004.
The Government's policies seek to address the needs
of everyone—whether as customers of water services or as
users of the water environment. The Government also recognises
that the sustainability of the water industry is important if
it is to continue to provide a high quality service to customers,
whilst having regard to the environment. This requires a stable
policy and regulatory context.
Recommendation 1
We welcome the introduction of draft
business plans produced by the water and sewerage companies themselves
and the greater scope for scrutiny and debate that this allows
at an early stage in the price review process.
We are pleased the Committee recognises the value of draft business
plans. The production of these has allowed early debate of the
issues arising from the business plans and the prospects for future
price limits. This is particularly important in a climate where
it is likely that a majority of customers in England and Wales
will face increases in their water and sewerage bills.
The publication of summaries has put the companies
in the lead in presenting and explaining their plans. Production
of the draft business plans has also enabled Ofwat to understand,
at an early stage, the companies' strategies. It is working closely
with the companies to ensure that the business plans they are
due to submit in April 2004, which will be used to set price limits,
meet regulatory requirements.
The information in the draft business plans, including
the reference plans, has provided all stakeholders with an indication
of the effect on bills of various factors, including different
environmental and quality programmes. We have used the information
included in the draft business plans extensively in developing
the Secretary of State's Principal Guidance to the industry on
what we expect the companies to deliver in 2005-10, including
improvements to drinking water and the environment.
Recommendation 2
We welcome the introduction of joint customer
research, as it has limited the degree to which stakeholders have
made competing and conflicting claims about what customers really
want.
We agree with the Committee. The joint stakeholders—Defra,
Ofwat, the Welsh Assembly Government, WaterVoice, Water UK, the
Environment Agency, the Drinking Water Inspectorate, English Nature
and the Wildlife and Countryside Link—commissioned two surveys,
one between May and August 2002 and another in September and October
2003. The first survey involved 10 focus groups as well as 2,076
face-to-face interviews with people representative of the population
of England and Wales. The second survey involved a sample of more
than 6,000 customers. The results of this research were published
jointly in August 2002 and December 2003.
The second survey collected information on attitudes
towards current services and proposed future water and sewerage
services, as defined in each company's draft business plan. This
included details of proposed changes to current service levels,
and their effects on bills. Respondents were presented with information
that was specific to their supplier/s.
The results of the first survey[1]
revealed that satisfaction with water and sewerage services is
high throughout England and Wales. Nearly nine in ten are satisfied
and one in fifteen dissatisfied. The key results of the second
survey[2] again showed
that satisfaction with current water and sewerage services is
generally high. More than half of customers consider that current
services offer good value for money. The Government is taking
on board customers' views when making decisions for the Principal
Guidance.
Recommendation 3
We recommend that Government, Ofwat, the regulators,
water companies and consumers examine together ways of taking
into account long-term issues for the water industry.
The Government, the companies and all the regulators
recognise that water and sewerage is a long-term industry, and
are working, both separately and together, to embed this in approaches
to industry issues. In Directing the Flow—Priorities for
future water policy, published by Defra in November 2002 [3],
the Government set out water policy issues in the context of long-term
sustainability. The Committee mentions good examples of where
a long-term and sustainable approach is called for. In their approach
to Natura 2000 sites, cited by the Committee, Defra, the Environment
Agency and English Nature are working together to ensure that,
where these sites are impacted by water company operations, solutions
will be implemented within the period covered by the price review.
On the Water Framework Directive, Defra, and the Environment Agency
as the competent authority, are working on the long-term integrated
planning implicit in River Basin Management Plans. Periodic Reviews
of water prices take account of the long-term nature of the industry,
particularly the need to maintain assets now and in the future.
In 2005, Ofwat proposes to review the appropriate period for price
determinations from 2010.
Recommendation 4
We are confident that Ofwat itself has taken note
of concerns about the financial profile of water companies and
will act to address such concerns. It is obviously important that
the cost of financing investment is kept as low as possible, but
the weighted average cost of capital assumed by the regulator
must not be so low that it threatens the credit ratings or even
the solvency of water companies. There is a place for equity funding
and the price limits set must reflect this.
Ofwat and the Government agree that an appropriate
balance needs to be struck between keeping the cost of financing
investment as low as possible and maintaining companies' access
to the capital markets at reasonable rates.
At this Periodic Review, Ofwat has recommended that
there is no strong case for setting the cost of capital for the
industry as a whole any lower than it did in 1999, as set out
in Setting water and sewerage price limits for 2005-10: Overview
of companies' draft business plans. Although debt finance is currently
available at historically low interest rates, Ofwat believes a
cautious view towards current market data on the cost of debt
is necessary. It has also indicated that there is evidence to
suggest that the return required from equity investors has risen
since 1999.
At this Periodic Review, as at the last review, Ofwat
will set the cost of capital as a weighted average between debt
and equity, designed to allow efficiently run companies to maintain
access to the debt and equity capital markets. It will make an
industry-wide assumption about the weighted average cost of capital
and ensure that only the efficient costs of raising finance are
passed on to customers.
The companies will need to demonstrate robust financial
indicators to reassure providers of finance that water companies
remain a reliable long-term investment. If these indicators are
not maintained lenders could potentially demand higher rates of
interest. The indicators include the gearing ratios used by investors
and shareholders to judge the companies' financial health and
as a key factor to be taken into account when credit ratings are
assigned by the independent credit rating agencies. Ofwat takes
the view, which accords with the Committee's conclusion, that
credit ratings will need to remain comfortably in the investment
grade, i.e. above junk bond status, in this long-term industry
facing significant ongoing programmes of investment.
Recommendation 5
We encourage Defra to come to an early conclusion
about the best ways of reducing diffuse pollution to water bodies
and how the costs of doing so will be met.
The Government accepts this recommendation. Defra
is currently undertaking two policy reviews to develop proposals
for addressing both agricultural and non-agricultural diffuse
pollution. By Spring 2004 Defra intends to publish, for consultation,
a draft Action Plan for tackling agricultural diffuse pollution.
By then Defra will also have held a series of workshops with stakeholders
from other industries to help to develop a strategy for tackling
non-agricultural diffuse pollution, which it intends to consult
on later in the year. Also, as part of Defra's work to implement
the Water Framework Directive, it will consult in 2004 on detailed
proposals for new powers to prevent and control diffuse pollution.
Its policy reviews are considering the full range of policy instruments
that could help to tackle diffuse pollution most cost effectively,
including economic instruments and voluntary initiatives as well
as regulation.
Recommendation 6
Ofwat should pay particular attention to the methods
and assumptions that companies have used when calculating the
costs of environmental and other improvements to ensure that only
fair and reasonable charges are included.
The Government agrees that this is a vital part of
the process. Ofwat accepts the Committee's conclusion. It has
set out the approach it intends to take to companies' costs in
Setting water and sewerage price limits for 2005-10: Framework
and approach. The criteria it will apply in considering schemes
put forward in the companies' business plans are set out below:
- the scheme is required by the
quality regulators and confirmed by Ministers, or it is a new
obligation under current legislation;
- it delivers a measurable defined output, which
is enforceable;
- it has a clearly defined timetable and due date
for delivery in line with regulations or other legislation;
- there are defined asset improvements or changes
to operational procedures to deliver the output and
- the costs are identified and the proposed solution
has been challenged and validated by the company's reporter (an
independent professional who scrutinises and gives his opinion
on the company's business plan to Ofwat).
Ofwat will also look at expensive individual schemes
to ascertain whether they are necessary, that companies have explored
different ways of achieving the outputs required, and have taken
into account technological innovations.
Ofwat will test the costs of companies' schemes based
on both the relative efficiency of each company and the continuing
efficiencies expected of the industry as a whole during the period
2005-10. It will also test the companies' relative capital procurement
efficiency using information on the costs for typical projects
collected in its cost base exercise.
Recommendations 7 and 8
We agree that sustainable management
of water resources is in the interests of water consumers and
we endorse the application of the 'polluter pays' principle in
the provision of water and sewerage services: to the extent that
water and sewerage companies cause environmental problems they—and
by extension their customers - should pay for the solutions to
those problems.
We add two caveats to this conclusion.
First, where a particular problem has several causes and action
by the water company alone would not be enough to significantly
improve the situation, there is a case for delaying the requirement
on the water company to act until the other causes are also addressed.
Second, while the requirements for environmental improvements
are likely to keep increasing, customers' willingness and ability
to pay ever larger bills are not. Ofwat, the water companies,
the regulators and Government must begin to seek other ways of
addressing some environmental problems.
The Government is pleased that the Committee agrees
with its objective to manage water resources in a sustainable
way. The main principles of Government policy in this area were
set out in Directing the Flow. The Environment Agency aims
to manage water resources in a sustainable way and works with
abstractors, as part of the abstraction licensing regime, to prevent
or minimise damage to the water environment. The Agency uses a
holistic approach to identify and remedy any environmental damage
caused by abstraction.
The Government also welcomes the Committee's endorsement
of the application of the 'polluter pays' principle to water companies.
The Environment Agency and English Nature, when drawing up their
advice on the water quality environment programme, carry out technical
appraisals and other assessments to ensure that the pollution
issues to be addressed are correctly attributed to water company
discharges and that the solutions proposed are timely and effective.
The Government and the Agency accept that 'end of
pipe' solutions are not always the most appropriate or cost-effective
mechanisms for tackling water pollution. Defra's approach to dealing
with diffuse pollution is explained above. In other cases, for
example, the most effective solution might be for water companies
to take action to reduce pollution by controlling trade discharges
to sewer rather than by later treatment to remove or reduce the
polluting effects of the effluent. A parallel approach, tackling
water company discharges as well as diffuse and other point sources
of pollution is central to achieving the desired outcomes for
water quality.
Recommendations 9 and 10
Fixing bills at the level that the poorest in
society can afford to pay would jeopardise the improvements in
services and quality that have undoubtedly been made and would
fail to emphasise that water is a valuable resource. But the difficulties
some customers face in paying their water bills are a matter of
great concern to the Committee. Measures to help vulnerable customers
do not appear to have been effective.
People suffering from serious difficulty in paying
their bills should be helped through the benefits and tax credits
system. The Government should review the way in which poorer households
are helped with their water and sewerage charges. It should ensure
that mechanisms to help people pay their water bills take account
of the regional variation in those bills.
The Government shares the Committee's concerns about
the affordability of water. We are giving careful consideration
to a review of the way in which poorer households are helped with
their water and sewerage charges and will invite views from interested
parties in due course.
Current benefit levels are intended to help meet
general household bills, including water. The Third Party Deduction
Scheme enables companies to collect payments or recoup debts out
of customers' benefit payments, where the criteria are satisfied.
There is no regional variation of benefits.
The benefits system does provide help to those people
who satisfy the qualifying criteria. No separate amounts for specific
items are included in the income-related benefit rates - beneficiaries
are free to choose for themselves how they spend their benefit.
The Government does consider relevant research, like that produced
by the Family Budget Unit, when setting benefit levels, but we
also need to take into account other objectives like work incentives
and controlling public expenditure.
Ofwat is under a duty to set price limits at a level
that will allow efficient companies to continue to finance their
functions, while also seeking to protect the customers of monopoly
utility companies. It will endeavour to set price limits that
ensure that customers do not have to pay more than is necessary
to provide an efficient service.
The Government recognise that debt levels
in the water industry are rising and that some customers may face
difficulties in paying their bills. We expect companies to have
measures in place to allow them to deal effectively and sensitively
with customers in debt.
Recommendation 11
The Government should also issue its
response to the Vulnerable Groups Consultation as soon as it is
practicable. It should advise the Committee of its response to
the National Consumer Council's charge that the scheme reached
only 1.4% of eligible customers and cost more to administer than
was paid out. If the charge is correct, the Government should
inform the Committee how the proposed amendments to the Regulations
will resolve the problem and by what date we can expect a more
effective scheme to be in place.
The Government is currently examining
the responses received to the Vulnerable Groups Consultation and
will publish its response shortly. Any changes to the Regulations
will come into effect in April 2005, to coincide with the new
pricing period.
Recommendation 12
We encourage the Government and water
companies further to examine ways of managing and reducing the
usage of water and the leakage of water from the system.
In 2003, Ofwat and the Environment Agency
began a joint review on the current and potential future role
of customer demand management measures in balancing the supply
and demand for water. This will take a broad, strategic look at
leakage and water efficiency issues, although a good deal of activity
is already underway in these areas.
The Government undertakes a range of activities to
facilitate more sustainable water use. The Envirowise programme
provides advice to businesses to help reduce their water consumption
and the Enhanced Capital Allowance scheme was recently extended
to include designated water efficient technologies. The Sustainable
Buildings Task Group, launched at the Better Buildings Summit,
has been tasked to identify how to improve the environmental performance
of new and existing buildings. One of its aims will be to identify
specific measures to improve the water efficiency of new development.
Defra is also considering the feasibility of introducing a product
labelling scheme to help consumers identify water efficient fittings
and appliances. This will complement the existing statutory duty
on water undertakers to promote the efficient use of water by
their customers, under which they provide a range of information
and assistance, including water saving devices.
The Water Act 2003 also contains provisions to advance
water conservation by placing new duties on water undertakers,
public authorities and the Government. Water companies will be
required to further water conservation in carrying out their functions.
Public authorities will have to take water conservation into account
in their own use of water and where their functions might have
an impact on the water use of third parties. The Secretary of
State will be required to take steps to encourage water conservation
and report to Parliament on progress.
Ofwat has set annual leakage targets for water companies
in England and Wales, which have served to reduce total leakage
by about 880 megalitres per day (20%) since 1997. Most companies
are now at their economic level of leakage, which is the level
at which it would cost more to make further reductions than to
produce the water from another source.
Ofwat reports companies' leakage performance annually
in a press notice each July, followed by the annual report entitled
Security of supply, leakage and the efficient use of water.
It keeps companies' economic leakage appraisals under review to
account for changing economic, environmental and social factors.
However, the Government does not expect water companies to allow
leakage to rise, as it is very difficult for companies to regain
control of leakage once it has been allowed to increase. All companies
should continue to examine the scope for additional leakage reductions
over the longer-term.
The Government considers that further improvements
in leakage management can be achieved by fully implementing the
recommendations of the Tripartite Leakage Study[4]
(Defra, Ofwat and the Environment Agency). Companies should, for
example, establish and maintain economic levels of leakage in
each resource zone. They should constantly be seeking to improve
their performance, within the framework of economic leakage rates,
through improved leak management techniques and new technology.
The Government expects the growth of household water
metering to contribute to improved demand management. The tariff
framework should also encourage people to use water wisely, while
providing social and health safeguards. Legislation already allows
water companies to require metering in a wide range of circumstances
including on change of occupier and where households use water
for non-essential purposes. Companies may also apply for areas
with limited water availability to be designated areas of water
scarcity, where metering may then be imposed.
Conclusion
The Government is planning for the long-term interests
of the water industry and water customers, as set out in Directing
the Flow, and expects companies and regulators to do the same.
We recognise that a balance needs to be struck between
the interests of water customers and the needs of the water industry.
This means both protecting customers from high water bills unless
they can be justified, and ensuring the future viability of companies
by allowing prices to finance company functions. Equally, the
industry has to continue to be an attractive long-term investment
if it is to be able to attract sufficient finance, at sustainable
rates, to enable it to continue to invest in asset improvements
and maintenance.
Ofwat will consider companies' final business plans,
due to be submitted in April. It will review them in the light
of its statutory duties, guidance from Ministers and from the
Welsh Assembly Government and other relevant issues including
the Committee's report. It will publish draft determinations for
consultation before issuing final determinations in November 2004.
Companies have the right to refer those determinations to the
Competition Commission, which would examine the issues and make
its own determinations.
The Government welcomes the Committee's interest
in water pricing and will take account of its conclusions.
Department for Environment, Food and Rural Affairs
February 2004
1 available at: http://defraweb/environment/water/industry/research/index.htm Back
2
available at: ttp://www.ofwat.gov.uk/aptrix/ofwat/publish.nsf/Content/pn5103 Back
3
http://www.defra.gov.uk/environment/water/strategy/index.htm Back
4
Future approaches to leakage target setting for water companies
in England and Wales, March 2003 Back
| 
