House of Commons - Ofwat Price Review 2009 - Environment, Food and Rural Affairs Committee

Ofwat Price Review 2009 - Environment, Food and Rural Affairs Committee Contents

2 A sustainable water policy

23. Future Water provides a vision of the sustainable water management practices needed to meet the challenges of the next two decades, including responses to seasonal water scarcity and increased volume and intensity of rainfall in parts of the country.[38] For the first time, this price review has introduced 25 year Strategic Direction Statements (SDS) in which the companies set out for consumers, regulators and other stakeholders their "direction of travel over the long term".[39] Ofwat considered that SDSs represented a "significant new step" which addressed the need for longer term planning and put "environmental improvements and costs in the context of long-term benefits".[40]

24. Water companies support this longer term approach. United Utilities believed that Future Water and SDSs together set out a "clear, strategic and coherent approach" leading to a much more rigorous approach to tackling issues such as "climate change, water resource management and sustainability".[41] However, Natural England questioned the impact of the SDSs since their 25 year horizon was inconsistent with the current five year business plans, thereby restricting the companies' ability to "secure any longer term obligations".[42] The Blueprint for Water coalition, representing environmental NGOs, viewed PR 09 as a break-through at the "company and regulatory level in the attitude towards tackling [water] quality problems at source" and believed this approach would help to find long term, cost-effective solutions.[43] However it considered that the amounts of investment being planned were the minimum required to achieve environmental objectives, particularly since much of this was to make up for historic deficits.[44]

25. The test of PR 09's success is how far it provides incentives to water companies to achieve Future Water's vision for sustainable water management. We recommend that Defra sets out how it envisages delivery of Future Water's objectives will impact on the industry and the regulator. Water customers will be part of the delivery mechanism of Future Water, particularly in relation to reducing water demand. Defra should include in its analysis the role played by water customers and the likely impact upon them.

Environmental improvements

26. There have long been requirements on water companies to safeguard the provision of clean and safe drinking water. In recent decades a wider range of requirements related to environmental standards have been imposed, particularly to require improved water quality for ecological and health reasons. For example, the Urban Waste Water Treatment Directive imposes stringent conditions on the treatment of waste water to reduce pollution levels and the Bathing Water Directive sets quality standards which must be met for each individual bathing area.[45] Under the Water Framework Directive,[46] Member States must draw up river basin management plans setting out objectives for each water body and summarise the measures which will be taken to achieve that objective.[47] The Water Framework Directive also requires bodies of water to achieve "good" ecological and chemical status by 2015,[48] but it permits derogations for some measures where there are economic grounds for taking alternative approaches. This would give the UK the option to phase or delay implementation beyond the timescales set out in the Directive. Severn Trent Water supported a 'freeze' on its implementation.[49]

27. A large part of water company investment is therefore needed to meet EU requirements. Severn Trent Water, for example, state that nearly half of its investment in sewerage treatment (ie £117 million) is to meet Urban Waste Water Treatment Directive requirements, with a further £24 million in response to the Habitats, Fisheries and Groundwater Directive. The Company will also spend £41 million as the first tranche of expenditure to meet the Water Framework Directive's requirements.[50] Other companies report similar levels of expenditure.

28. Ofwat believed that it was Government's responsibility to determine the environmental standards, and the regulator's role was to put in place a framework to allow companies to "finance and deliver" these outcomes.[51] Severn Trent Water said that it was essential for the environment and customers that Ofwat viewed their proposed package of investment holistically but it was concerned that in practice Ofwat might view parts of the plan in isolation. This could lead to a "price determination which will not provide the best outcome for customers, the environment and investors".[52] Similarly, Water UK was concerned that the price review mechanism encouraged "end of pipe" solutions rather than addressing water quality issues at source. The organisation did, however, "congratulate" Ofwat for its "commitment to sustainable solutions" shown by its assurance that "all well-justified catchment management schemes will be funded".[53]

29. The Consumer Council for Water (CC Water) recognised that there was a need to meet EU environmental requirements and that customers also wanted to see "a sustainable water industry".[54] However, it believed the 'polluter pays' principle should apply so that current water customers were not alone in paying for improvements.[55] Environmental improvements by water companies could be paid for by water customers or through general taxation. Ofwat told us that 96.5% of the cost of mitigating water pollution in England and Wales was met by water customers, which seemed to them to be "more than a fair share".[56] Water UK warned that the costs versus benefits of environmental improvements must be robustly assessed and customers should not "pay more than they should".[57]

30. Dame Yve Buckland, Chair of CC Water, believed that "… if the money did come out of taxation there would be a longer and much harder look at the cost benefit analysis behind some of the proposals".[58] However, the Blueprint for Water Coalition, representing environmental, water efficiency and fishing/angling organisations, warned that CC Water should not "neglect its sustainability duty" and that opposition to the "scope and scale of essential environmental investment" reflected CC Water's narrow focus on price.[59]

31. Anna Walker, chair of the independent review of household water and sewerage charges, believed that high water bills,⁶³ resulting from replacement of infrastructure to deliver high environmental standards, would have to be faced in the water sector as a whole and would impact on water customers.[60] She emphasised the importance of transparency in the costs of environmental improvements, telling us that it was important to explain to water customers "…what is at stake, what the costs are, and gathering their views in…".[61] She added that for environmental improvements to have legitimacy people had to understand "what it is that they are paying for and why".[62] This sentiment was echoed by CC Water which considered that there needed to be a greater analysis of cost benefits and how to "sell those benefits to consumers".[63]

32. Some water companies considered the proposed balance between funding environmental improvements and keeping bills affordable to be about right. United Utilities said the draft business plans "strike the right balance between the need for long-term environmental improvements—particularly to deal with the issue of climate change and the affordability of paying for those improvements in the current economic climate".[64]

33. We recommend that Defra explore the potential for derogations to implementation of the EU Water Framework Directive's requirements to enable the phasing of environmental improvements and their related costs, where the near-term burden of these on customers would be severe.

34. We further recommend that Defra provide clear guidance to Ofwat as to the application of cost benefit analysis and Ofwat's guidance to the companies needs to be clear and unambiguous.

35. Investment in water infrastructure varies significantly between regions of the UK, due in part to wide differences in the standard of historic infrastructure and in part to geographical characteristics of regions. Water prices also vary from region to region, reflecting infrastructure costs and uneven population distributions whereby large geographical areas with small populations have high costs spread among few people. For example, South West Water customers' bills are predicted to increase on average by £20 in real terms by 2014-15, compared to a £12 average rise for a Severn Trent Water household, and this comes on top of bills which are already nearly 60% higher than those of Severn Trent Water.[65] In the course of her review, Anna Walker conducted several workshops around the UK. She told us that at the workshop in Plymouth she was struck by the strong sense of unfairness about high water charges in the South West.[66]

36. CC Water argued that national environmental benefits were paid for regionally and that the benefits were taken up more by those on higher incomes while the costs were borne equally by all, regardless of income.[67]

37. The question of whether disproportionately high water charges should be borne solely by those living or operating businesses in a particular region, or spread more widely across the country, is complex. In the first instance the extent of differences in charges and service levels needs to be established, before posing the questions of whether those differences are appropriate, and what the consequences would be on different consumers of either reducing these, or indeed introducing further differences in the form of cross-subsidies. The Minister referred to the "idea of spreading of either the taxation burden or the water rates burden wider across the country", but noted that there were potential downsides such as reducing the incentive for water efficiency.[68]

38. Anna Walker's interim report, published in June, considered that "costs should reflect regional differences and that water prices should continue to be regionally based and geographically averaged". However, the report also said that "arguments as to whether environmental improvements should be paid for by the local water customer, the national water customer or the taxpayer are complex" and further views would be sought before a final conclusion could be reached.[69] Regardless of who pays for these improvements, Walker urged increased transparency, including full quantification of the additional cost on the national average bill and "those of each water company area".[70]

39. We note that the introduction of retail competition into the water industry could increase the charging variations within each company's region. Regional cross-subsidies already exist within the utilities sector, such as the power distribution cross-subsidy provided to the Scottish Highlands and Islands.[71] Rural populations have also benefited from cross-subsidies, such as the Countryside Stewardship Scheme, which reflect the greater environmental costs that they are responsible for.[72]

40. The question for Defra is whether environmental improvements in certain regions, such as measures to protect beaches in the south west, should be seen as a national benefit to be paid for by tax payers or as a regional infrastructure deficit to paid for by local water customers. Ofwat and Defra have so far failed to make the argument that regional variations in the costs customers must bear for environmental investment are fair and appropriate. We have found it hard to see how alternative charging mechanisms for infrastructure investment could be made to work effectively without significant changes to the current underlying regional charging regime. Defra must therefore examine how changes might be made to the way water industry investment is paid for when it is directly and expressly for the purpose of improving environmental standards for national benefit.

Climate change mitigation

41. Government policy recognises the need for all sectors of the economy to take action to reduce greenhouse gas emissions to meet the Climate Change Act's targets of an 80% reduction in carbon emissions by 2050,[73] with at least 34% by 2020, relative to 1990 levels.[74]While greenhouse gas emissions from the water industry contribute less than 1% of the UK's emissions, when energy used to heat domestic water is taken into account, water use generates around 5% of emissions.[75] Water companies referred to their efforts to reduce their own carbon footprints, with for example, Severn Trent Water planning to increase the percentage of renewable energy it generates from 17% to 30% by 2013.[76] The company pointed out that delivering the Water Framework Directive's objectives will increase carbon emissions.[77] Yorkshire Water expected their annual operational carbon emissions to rise by 10% by the end of 2015—86% of this increase would be due to "tighter environmental standards".[78] It wanted greater Government recognition of "the carbon impact of tighter river and coastal water quality legislation" so that "environmental improvements should only be proposed where the benefits exceed the carbon impacts".[79]

42. Defra should assess the impact of new requirements for water companies to improve water quality and conservation to ensure that only policies with net positive environmental outcomes are adopted. Ofwat should require the water companies to set out the carbon impact of their business plans and the measures they will put in place to mitigate any increases.

Climate change adaptation

43. The water industry acknowledges the imperative of long-term planning for climate change, including adapting infrastructure and services. Ofwat said that it wanted "each company to put forward proposals both to mitigate its own impact on the climate, and to adapt to the effects now and in the future".[80] The UK's climate projections anticipate that all areas of the UK will get warmer, with increases of up to 4 degrees celsius in south east England by 2080. Summer precipitation is expected to decrease, for example by up to 23% in south west England, while winter rainfall will tend to increase across the UK and by up to 16% in north west England by 2080.[81]

44. We received evidence setting out concerns about whether the current regulatory framework was encouraging sufficient adaptive measures to be taken. Water UK believed that the industry, Government and regulators were not working together to develop a common response to factor in climate change impacts into planning decisions for both clean and waste water.[82] Yorkshire Water was concerned that Ofwat had "required companies to remove climate change adaptation and wind power from their plans".[83] The company was not proposing immediate investment to adapt assets as the impacts were still "too uncertain" but was planning strategic research into the impacts of the latest projections on infrastructure before revising design standards.[84]

45. We suggested to the Minister that provisions of the Climate Change Act 2008 should be applied specifically to the water sector via the Flood and Water Management Bill.[85] The Bill could include an express requirement for those carrying out their responsibilities to achieve the Climate Change Act's objectives for effective adaptation in relation to water supply.[86] While Defra officials noted that local actions would take place within "that sort of framework" they would, subject to the Minister's views, look at "whether some sort of explicit linkage might be made".[87] Defra is currently consulting on how the power given to the Secretary of State under the 2008 Act, to require organisations to report on their adaptation programmes, will be discharged.[88] This includes proposals that Ofwat and water companies would be "priority" reporting organisations expected to report on their adaptation plans to the Secretary of State during 2010-2011.[89]

46. Climate change is predicted to have a significant impact on water availability throughout the country. The management of water resources will have to take climate change into consideration. We welcome Defra's proposal that Ofwat and water companies be considered as priorities for early reporting on how they will adapt to climate change. However, Defra should consider if changes are needed to the regulatory regime to ensure that water companies have incentives to take early action to adapt to climate change. We further recommend that the Flood and Water Management Bill should place an explicit requirement on water companies and Ofwat to exercise their functions with regard to the adaptation objectives of the Climate Change Act 2008.

WATER EFFICIENCY

47. Household demand makes up most (62%) of potable water demand in the UK. Anna Walker found that while per capita consumption (currently averaging 148 litres per person per day) has remained relatively steady over the last decade and is low in comparison to Mediterranean countries, it is "higher than in other European countries with a similar climate".[90] Demand per capita is expected to fall, but this will be more than offset by the expected 10 million increase in England's population by 2031; and the trend towards smaller households, which have higher per capita usage.[91] The Environment Agency predicts that by 2020 demand could increase by 5%.[92]

48. Water companies currently have a duty to promote the efficient use of water. However, they spend less than 1% of total expenditure on water efficiency and the Walker interim review concluded that the effect has been "equally small".[93]Ms Walker told us that the regulatory system as a whole needed to incentivise companies and customers to "think about using water carefully and economically".[94]

49. Ofwat has now introduced water efficiency targets on a trial basis for this financial year, but they will be mandatory from 2010-15.[95] However, the targets are not stretching in comparison to achievements elsewhere in Europe. In Germany, for example, per capita consumption was already at 129 litres per day in 1998—the target at which the UK is aiming today.[96]

50. Waterwise, an NGO promoting water efficiency, hoped for a "significant step change in the scale and number" of the water efficiency schemes proposed in the water companies' PR 09 business plans and funded by the final price settlement. It considered that PR 04 lacked firm evidence on the costs and benefits of larger scale water efficiency programmes.[97] The Environmental Industries Commission, a trade association for the environmental technology and services industry, believed that better regulatory incentives were needed for companies to invest in water efficiency, and other environmental improvements.[98] Northumbria Water agreed with this and called for more positive incentives since the current approach was too focussed on targets and penalties rather than rewards. It considered that incentives currently in place mainly related to "reducing costs" and did not "adequately address important issues such as climate change and sustainability".[99] South East Water wanted to see "changes of behaviour and investment in water efficiency of buildings" as well as water efficient devices and customer information, but did not consider that retail competition would in itself promote water efficiency.[100]

51. Regina Finn, Chief Executive of Ofwat, emphasised that water efficiency was a key area since the challenge in the longer term is how "ensure that both the industry and customers properly value this really essential life resource" and establish incentives for the "right behaviours".[101] Ofwat consider that the industry has no incentive to increase the volume of water sold because, under the 'Revenue Correction Mechanism' a water company would forfeit any additional revenue resulting from those sales.[102]

52. Waterwise noted the specific problem of water efficiency retro-fit programmes being classified as operating expenditure, rather than capital expenditure, which meant that water companies had an incentive to deliver "large scale supply-side schemes" as these could increase regulatory asset value and hence potential gains.[103] The NGO referred to the Cave interim report's conclusion that water companies were "unadventurous with regard to tackling environmental problems" and focused on "pouring concrete".[104]

53. Witnesses provided us with ideas for a range of water efficiency approaches, including a scrappage scheme to enable householders to replace inefficient water appliances, such as washing machines, dishwashers and showers, with more efficient equipment.[105] Unison believed this could cut water consumption by 50%, with a consequent reduction in need for infrastructure investment, helping to keep customers' bills down.[106] A number of witnesses considered that metering could help to cut consumption since it helped to put a value on water more explicitly and we examine this in more detail below.

54. Anna Walker linked affordability and water efficiency in her interim report published in June 2009. She recommended that companies be required to develop their own water efficiency programmes, which would contribute to their enforceable water efficiency target, with priority given to low income customers in debt or in receipt of Council Tax Benefit.[107]

55. There are clear parallels with approaches for improving energy efficiency levels, although there are differences between the sectors; for example the size of water bills is lower and arguably this lessens the incentive to reduce usage. Anna Walker told us that the water industry is "behind the energy industry" in terms of providing information and education to customers on efficiency and "more thought needs to be given to water efficiency".[108] We recommended in our report on Energy efficiency and fuel poverty published earlier this year that energy efficiency targets be set for existing homes, delivered through an area-based approach, focusing first on the areas of most need.[109] Funding for this would come from Government schemes such as Warm Front as well as the Carbon Emissions Reduction Target (CERT) activity funded by energy supply companies.[110] This is a model whose merits could usefully be considered for the water industry. Analysis of the full range of water efficiency technologies available is outside the scope of this report, but there is evidence that businesses and households have further opportunities to reduce water usage.[111]

56. We are not convinced that the mechanisms in the price review are sufficient to promote the increases in water efficiency necessary to ensure that water demand can continue to be met in periods of water scarcity. We consider that there are models from the energy sector that could usefully be adapted for water supply and Ofwat should assess how best practice in achieving improvements in energy efficiency can be applied to the water sector. We recommend that Ofwat and Defra explore more extensive water efficiency obligations, either by placing limits on volumes sold or a (CERT style) measures based approach. Ofwat should benchmark the performance of the UK industry in delivering sustainable water management on an international basis.

38 Defra, Future water: the Government's water strategy for England, CM 7319, February 2008. Back

39 Ev 69 Back

40 Ibid Back

41 Ev 128 Back

42 Ev 115 Back

43 Ev 151 Back

44 Ev 150 Back

45 Council Directives 91/271/EEC and 76/160/EEC. Back

46 Council Directive 2000/60/EC. Back

47 Defra, Statement of Obligations: information for Water and Sewerage Undertakers and Regulators on Statutory Environmental and Drinking Water Provisions Applicable to the Water Sector in England, December 2007. Back

48 A body of water is defined as a stretch of a river or coastline, a lake or a groundwater body. Back

49 Ev 43 Back