Memorandum submitted by Water UK (Ofwat
19)
EVIDENCE FROM
WATER UK—SUMMARY
Water UK represents all UK water and waste water
suppliers at national and European level.
The Committee has asked for views on four aspects
of the current Periodic Review 2009 of water price limits. The
Committee will note that we are only part way through the review
process and that key decisions remain to be made.
In summary, the points we would like to draw to the
Committee's attention are as follows:
1. Conduct of the Review (paragraphs 2-16)
Although there is now greater transparency and
engagement with the industry, this has not been consistent.
The respective roles of regulators and government
could be clarified, to ensure better joined-up policy and regulatory
approaches.
Decisions about the cost of capital must be
based on sound advice involving investors.
2. Climate Change and Environmental Improvements
(paragraphs 17-30)
Climate change needs to be taken into account
at PR09, both adaptation and mitigation.
If the regulator's decisions were aligned with Government
policy objectives the water sector could better contribute to
Government targets for greenhouse gas reductions.
In order to meet carbon targets, and reduce
customer bills, pollution needs to be addressed at source, rather
than through end-of-pipe treatment methods.
3. Affordability of Water Services (paragraphs
31-42)
Water is good value but these are tough economic
times. Decisions made at PR09 need to avoid any unnecessary burdens
on customers (such as an increase in business rates).
Customer debt is a growing problem for the water
industry and a consequence of Government policy. Government should
introduce legislation to enable companies to recover outstanding
revenue outside of the court service, thereby reducing the debt
burden on all customers.
Government, and not private water companies,
has a responsibility to provide assistance to vulnerable customers
who struggle with their water bill.
4. How the Pricing Review Relates to the Cave
and Walker Reviews and to the draft Floods and Water Bill (paragraphs
43-53)
The Cave, Walker and Floods and Water Bill are
running on different timescales to the Price Review. They may,
therefore, have unexpected consequences for customers' bills,
beyond any increases agreed at PR09.
EVIDENCE FROM
WATER UK
1. Water UK is pleased to give evidence
to the Committee's inquiry into the Price Review 2009.
THE CONDUCT
OF THE
PRICE REVIEW
2009
Transparency of policy changes and engagement
with the industry
2. In a number of areas, there has been
a lack of transparency in Ofwat's methodology for PR09, and greater
engagement with the industry would have been helpful. Ofwat's
guidance to companies has, disappointingly, emerged only piecemeal,
and fallen short of the degree of transparency and consistency
of process that had been established during the PR04 process.
One underlying reason for this may be that Ofwat's resources have
been stretched, in particular by attempting to focus on both PRO9
and the introduction of competition at the same time.
3. This is most notable in the Capital expenditure
Incentive Scheme (CIS), the new approach to assessing capital
investment programmes that Ofwat has introduced for PR09. The
details of how Ofwat will apply the CIS have been evolving over
time, and Ofwat's new approach, and the supporting information
companies need to provide to Ofwat to justify their proposals,
is significantly different from that originally proposed. Whilst
the industry appreciates that these developments have significantly
enhanced companies' understanding of Ofwat's requirements, the
late timing has been unfortunate. For incentive-based regulation
to work effectively, clarity and consistency are required so that
informed decisions can be made.
4. Clarity on how issues such as climate change,
metering, pensions and the adoption of private sewers will be
handled at PR09 has also evolved piecemeal. While a certain degree
of evolution of approach might have been expected, more proactive
engagement with the industry, and where appropriate leadership
from Ofwat, could have enabled issues to be resolved earlier in
the process.
Clarity about the roles of regulators and government
5. Getting clarity on the desired objectives
for the sector is important for companies to be able to plan effectively.
This is difficult when a number of different regulators and stakeholders
have a direct role in the price review process. Defra's long term
vision Future Water, has aided this process significantly, by
setting out a clear vision for the sector.
6. A positive development has been the quadripartite
meetings held between the Environment Agency (EA), Drinking Water
Inspectorate, Consumer Council for Water and individual companies,
which provided a valuable early sounding board and gave all parties
a greater understanding of each other's views, which then informed
companies' business plans.
7. However, there are some specific areas
where there is the potential for mismatches between the expectations
of the regulators in the sector, for example on taking account
of the impact of climate change and metering.
8. In particular, we are concerned about
the lack of synchronisation between the PR09 process and water
resource management plans (WRMPs). Delays to the timetable for
statutory WRMPs mean that final business plans will be submitted
before WRMPs are finalised. This creates the real possibility
that final WRMPs will include unfunded obligations and expectations.
The CIS baseline and discussions with Ofwat do not give the industry
confidence that this issue is being addressed satisfactorily.
9. More broadly, it is currently far from
clear whether the outcomes of the current price review will make
a real contribution to the government's policy objectives, such
as addressing the impacts of climate change.
Ensuring that issues such as the cost of capital
are fully considered and based on sound advice and expertise
10. The 2009 Price Review is taking place
against a background of unprecedented events in financial markets
and what has been described as the most serious global recession
for 100 years. This means that it is crucial that key decisions
on the financing of the industry are based on sound advice and
expertise. The industry has contributed to the evidence base by
sponsoring independent consultants to report on the cost of capital
and, working with Ofwat, to survey the views of investors in the
sector.
11. Successive surveys of investors have shown
that they view the regulatory regime positively. However, the
most recent survey has shown that investors are understandably
nervous given recent events in the financial markets. They feel
there is a lack of clarity from Ofwat on how it will respond to
the changed external environment and on key policy positions,
both on PR09 and more broadly.
12. Over the remainder of 2009, it will
be crucial for investors to be fully involved by Ofwat in key
PR09 decisions, given the importance of maintaining investor confidence
in these turbulent times.
Making choices at PR09 that are appropriate for
the current circumstances
13. It is also appropriate to ask whether,
in these challenging times, there are changes that could be made
to reduce the burden on customers—given that much of the
investment planned by the sector is essential to maintain the
high quality of services.
14. In particular, we would like to draw attention
to a number of areas where relatively straightforward policy changes
could have a significant benefit for customers.
— Business rates are due to be revalued
in April 2010, and current indications are that this will result
in significant increases for the water sector—perhaps increasing
customer bills by £5 or £10 for no benefit to customers.
A freeze in business rates would reduce this unnecessary burden
on customers.
— Similarly, a freeze in the fees charged
by regulatory bodies such as Ofwat and the EA, rather than steadily
increasing charges, would benefit customers directly.
— Building on some initial steps by
the EA in this direction, a more flexible approach to applying
environmental standards, such as greater use of seasonal and variable
consents, would allow companies to reduce energy usage, costs
and carbon emissions, while continuing to protect the environment
at lower cost to customers.
15. Many of the areas where the conduct
of PR09 could be improved are consistent with the recommendations
from the Report into the Conduct of the 2004 Ofwat Periodic Review.
This was produced by an Independent Steering Group chaired by
John Baker, and the extensive stakeholder consultation carried
out before this by Water UK on the future direction of regulation
("Future Regulation").
16. It is disappointing that many of these
issues highlighted five years ago, remain outstanding at PR09.
How long term planning for climate change and
environmental improvements should be paid for
17. Water is one of the areas where the
impacts of climate change will be felt first and most acutely.
Both adaptation to climate change and mitigation of its affects
are both important.
18. Future Water set out a clear vision for the
sector. Government will wish to make sure that delivery mechanisms
are in place and that all stakeholders (companies, regulators
and others) are playing their part in delivering the Government's
strategy.
19. This means that we need industry, government
and regulators to work together to develop a common approach to
climate change scenarios, planning assumptions and areas of the
business where climate change impacts should be factored in, for
both clean and waste water. We are concerned this is not happening.
Adaptation to climate change
20. Adaptation is essential to maintain
levels of service as set out in the Government's statutory guidance
to the industry and Ofwat.
21. We are concerned about Ofwat's approach to
climate-related policy in PR09. Its supply-demand policy statement
(PR09/20) came out late and raised questions about climate strategy
in general and water efficiency in particular. A recent clarification
(PR09/27) has helped to address the industry's concerns, but reservations
remain.
22. Ofwat's decision effectively to exclude
significant supply-demand investment related to climate change
until the release of the UK Climate Impact Programme 2009 (UKCP09)
scenarios is disappointing. We should not delay necessary investment
to wait for better information, though we should review decisions
when it becomes available. It would be surprising if the UKCP09
scenarios showed less need for action than previously. The danger
of excluding investment now is that it could move significant
risk on to customers and the environment. Also, it is not appropriate
to rely on the change protocol mechanism for adjusting company
revenue between price reviews in such a matter.
23. Ofwat should allow well-justified investment
based on the best available evidence and should also support company
plans that target adaptation to protect critical infrastructure
or ensure the safety of dams and reservoirs.
Mitigation of the affects of climate change
24. On mitigating climate change, we recognise
the progress Ofwat has made (for example in encouraging companies
to estimate greenhouse gas emissions associated with business
plan submissions). But we are concerned that the regulator seems
to have excluded some cost-beneficial energy efficiency and renewable
energy schemes from draft plans. Companies are significant users
of energy and we believe there is substantial scope for them to
produce renewable energy from existing and planned regulated assets,
with benefits to customers, the environment and the economy. We
have urged Ofwat to reconsider its position.
25. Tightening environmental and quality standards
over recent years have added significantly to energy requirements
and associated greenhouse gas emissions by the water industry.
PR09 represents an opportunity to begin to tackle environmental
and quality issues in a more carbon efficient way, and we urge
all relevant regulators to work together to achieve progress in
this area.
Other environmental improvements
26. The main element of policy that should
guide what water companies do, and what water customers should
pay for, is the polluter pays principle. But while to date there
has been major investment in cutting pollution from regulated
"point" sources by water companies and heavy industry,
little has been done about diffuse pollution from agriculture,
transport and other industry.
27. Environmental improvements should be robustly
assessed in terms of cost benefit analysis (CBA) to ensure that
customers do not pay more than they should. Ofwat has done well
to emphasise CBA, but we are concerned about the timeliness and
transparency of its guidance on implementation and a potentially
mechanistic application and focus on bill reductions rather than
a holistic view of what is important to sustain the service and
give most value to customers and the environment. It is important
that we are not deflected from long term sustainability by the
recession and short-term concerns about water bills.
28. However we congratulate Ofwat for indicating
in its CIS baseline that all well-justified catchment management
schemes will be funded. This shows a commitment to sustainable
solutions and an acknowledgement that working to control environmental
impacts at source can be more cost-effective than "end-of-pipe"'
treatment. This approach should not however absolve government,
environmental regulators and other sectors from taking urgent
and active steps to target diffuse water pollution issues, so
that the impact on and costs for the water customer are minimised.
29. A further area that could be explored
by all regulators is the introduction of more seasonal and variable
discharge consents and abstraction licences, which would help
to reduce energy use, greenhouse gas emissions and cost.
30. One other concern is the new water efficiency
targets recently introduced by Ofwat. The significant increase
in expenditure that this represents for many companies is not
economic or cost-effective, and therefore represents poor value
for money for customers, and is of questionable benefit to the
environment. In this matter, Ofwat appears to ignore its own commitment
to the CBA principle.
Affordability of water services
31. There are two aspects of affordability
that affect customers. The first is the overall impact of the
Periodic Review at a company level and how "affordable"
the settlement is to the generality of customers (the level of
average bills). The second and more specific aspect of affordability
is how actual bills impact on individual customers and their particular
financial circumstances (distributional impacts).
Affordability of bills and value for money
32. Despite the large investment requirements
of the sector and the high quality of services provided, the overall
cost to customers is less than £1 per day (the average bill
for water and sewerage services in 2009-10 is £342).
33. The current deterioration in the economic
and financial climate has emphasised the importance of ensuring
value for money and affordability for customers. Companies already
had in their Draft Business Plans (DBPs) constrained price increases
to very modest levels compared with the past and also with some
other sectors of the economy.
34. Companies have put forward DBPs that
are strongly centred on customer research and customers' willingness
to pay for improvements. There is considerable variation across
the country in these plans as should be expected from the diverse
backgrounds and regional circumstances of the 21 companies. The
proposed price limits over the next five years range from 0.6%
to 6.7%, reflecting those circumstances. The average increase
based on DBPs is 2.4% over the five years 2010 to 2015.
Making bills more affordable
35. There are several significant cost drivers
that are within government or regulators' control that could be
reviewed to see whether they are entirely necessary in the current
financial climate. Essentially there are policy decisions and
levers available that can reduce costs to companies and make water
bills more affordable.
36. Government could also help the industry through
legislative change to make the recovery of unpaid water charges
easier and reduce the current debt burden that adds on average
£11 to all customers' bills.
37. When reviewing investment plans, maintenance
and resilience of essential infrastructure remains key, perhaps
more so through tough times. Investment by the sector does and
can also play a big part in contributing positively to economic
activity doing its bit to help sustain the economy generally.
Cutting back capital investment has risks to service and quality
standards, whilst the impact on bills may actually be less than
the measures outlined above that feed directly into operating
costs, and hence customers' bills.
Affordability for individual customers
38. The levels of future water bills should
not be based on the ability of lower income customers to pay.
However, the regulatory process needs to recognise such lower
income customers exist and some will struggle to pay current and
future water bills and inevitably get into further debt.
39. The majority of the £1 billion of household
water debt is owed by the poor—with around one third of
debtors having incomes below £10k. There are also signs that
changing personal circumstances due to the current economic situation
are leading to new "first-time" water debtors.
Providing assistance to vulnerable customers
40. Water is an essential and public service,
privately delivered. Therefore those that cannot afford the service
should be provided with support to meet the charges they incur
in receiving that service. Like other essential services, we believe
this support is the responsibility of Government to provide. In
the interim, the industry could do with clear guidance on the
role of water companies and the role of Ofwat in enabling social
tools to be developed. We are therefore very supportive of the
Walker Review and hopeful its recommendations will address these
long standing and complex issues. Its timing, and that of the
Cave Review and the Floods & Water Bill, do not however match
the Periodic Review timescale and any implications will affect
companies after Final Determinations and could lead to further
bill increases before the next Periodic Review in 2014.
41. A major problem for water companies is identifying
those with affordability problems who would benefit from assistance.
Water companies only have limited data on vulnerable customers—essentially
those who self select. There needs to be some form of data sharing
with government departments to identify those who could benefit,
though providing that assistance is the role of Government not
the water companies.
42. However, assistance with budgeting,
signposting to additional help and benefit checks and promotion
of financial inclusion, without the complications of data sharing,
could be provided through a development of the Post Office Card
Account (POCA), known as "Saving from Poverty" (SfP).
How the pricing review relates to the Cave and
Walker reviews and the draft Floods and Water Bill
43. Changes to the policy and legislative
framework resulting from Cave and Walker reviews, and the draft
Floods and Water Bill, could change the context and investment
drivers for companies in the period covered by PR09 and beyond.
These are crucial pieces of new policy and legislation for the
industry.
44. Proposals around competition could potentially
affect the market structure of the industry, its risk profile,
and indeed the costs borne by companies (and ultimately customers)
to implement any new framework. The Walker Review may lead to
changed policy towards metering requiring a change in level of
activity from that allowed for in the price review. Companies'
revenues could also be affected by recommendations concerning
water conservation, and those concerning measures and tariff changes
to deal with affordability and the mounting burden of bad debt.
Finally, the draft Floods and Water Bill (whose contents remain
unclear) may contain a raft of proposals related to responsibilities
for surface water management, for example the adoption of SUDS—again
with potential cost and bill implications.
45. However, the timelines for completion
of the Cave and Walker Reviews, the publication of, consultation
on the Bill, and implementation of the resulting Act, do not dovetail
with that for the Price Review.
46. There is also considerable uncertainty
as to what may ultimately be in the Bill, and even whether the
Bill will be progressed, given a general election is in prospect.
47. We recognise, of course, that timing
mismatches in policy development cannot always be avoided, and
indeed, that it is unrealistic—and even unhelpful for longer
term policy development—to expect all water policy to revolve
around the Price Review process. However, it is important to understand
the potential impacts of timing mismatches.
48. In particular, it means that companies
have not been able to incorporate the outcomes of the Reviews
and Bill into their business plans. This means that there could
be changes needed to investment plans and price limits after the
final determinations, undermining the predictability and stability
of bills for customers, and investor confidence in the stability
of the price settlement.
49. The uncertainty that is created is particularly
unhelpful at a time of turbulence in the financial markets, when
maintaining investor confidence in the sector is even more crucial
than normal.
50. While there are regulatory mechanisms
to handle such uncertainties, it is crucial that there is transparency
and extensive engagement with the industry and other stakeholders
to demonstrate a joined up approach across Government for the
development of the Reviews and ultimately the Bill proposals.
51. In addition to these impacts from timing
mismatches, there is a wider point about the need to ensure that
the policy developed through the Cave and Walker Reviews, and
legislation proposed in the Floods and Water Bill add up to a
coherent policy framework for the sector, with which regulators
are aligned and company plans—and where relevant price limits—can
be adjusted.
52. In this context, the publication of
Future Water at the start of the PR09 process provided a very
useful and welcome steer on the Government's high level strategic
aims for the sector, as noted earlier. However, as it has come
to rest with various regulatory processes to carry this forward,
we are concerned that this "common thread" has been
less evident, both in policy and organisational terms. We would
urge all parties to consider how this might be reinforced for
the rest of the Price Review process and indeed, beyond, given
the carry-over of the various reviews and the Bill beyond the
final PR09 determinations in November.
53. It is crucial that there is transparency
and extensive engagement with the industry and other stakeholders
to demonstrate a joined up approach across Government for the
development of the Reviews and ultimately the Bill proposals.
Water UK
March 2009
| 
