Examination of Witnesses (Questions 200
- 219)
WEDNESDAY 10 JUNE 2009
MS REGINA
FINN AND
MR KEITH
MASON
Q200 Mr Drew: I am not clear where
you have actually done research in this area. Do you actually
talk to the constructors and the manufacturers as well as the
water companies themselves?
Ms Finn: Research has been carried
out under the auspices of the industry group and in terms of this
particular rollercoaster cycle, which has involved engagement
with the supply chain, and, yes, we do meet with and talk to the
supply chain also. However, their primary relationship is obviously
with the companies; our job is to put the framework in place that
enables the companies to manage that procurement cycle efficiently.
Q201 Lynne Jones: Can we have a discussion
on water efficiency and reducing water consumption? Future Water
has set a target for 2030 which is not very much lower than what
is already achieved in Germany, or has been for 20 years or more.
So we obviously have to up our game, and yet the pressure is still
to actually increase water consumption. First of all, how realistic,
ambitious, un-ambitious are the targets and what are mechanisms
for actually improving water efficiency? There is the Price Review
Mechanism which penalises companies who sell more water than you
have allowed for, but what mechanisms are there to actually encourage
positive investment in water efficiency and particularly in innovation?
Ms Finn: I think that this topic
is key to that issue of future challenges—you are right—and
we need to take a joined-up approach to managing our water use,
both companies managing it and customers managing it, and water
efficiency is one part of that. There are a number of mechanisms
within this PR09 Period Review that we have put in place to address
some of those challenges. They include—you have commented—what
is called the Revenue Correction Price cap, which is if they sell
more water they do not get to keep that money, that money is given
back to the customers.
Q202 Lynne Jones: How do you assess
the level at which they are meant to achieve this? How effective
is that target beyond which they are then penalised?
Ms Finn: I think there are two
aspects to it. First of all, we calculate the companies' revenue
requirement over the five-year period and that is what is allowed
for in price limits. If they collect more money and that is by
virtue of selling more water it is taken back, no matter how much
it is—so the amount of revenue they need to set at the beginning
of the five-year period. There is not an incentive for them to
sell more water because they will not keep the money and they
will not keep the benefit of the money—it will be given
back to customers. That is part of the picture. Another major
part of the picture is that companies have a duty to promote water
efficiency and we do monitor what they do and report on that regularly.
We have also introduced water efficiency targets on companies
for the first time ever; we have done that with the cooperation
of the companies because that is how we need to do it within the
Periodic Review process. Together we are looking at a package
of issues to promote water efficiency. In the actual Periodic
Review itself we consider water efficiency, large scale demand
management programmes and where they are shown to be cost beneficial
we will approve those and they will be implemented over the five-year
period. So there are quite a number of tools there. I think the
challenging thing for us all is in the longer term how do we ensure
that both the industry and customers properly value this really
essential life resource that we have and how do we incentivise
the right behaviours—investment choices and behaviours—both
by companies and by customers and one of the keys to that is understanding
the value of the water. Clearly metering plays a role in that
and companies proposing metering where there is water stress in
their areas is another tool to ensure that customers can understand
and manage their use better, and we are looking at proposals for
that from a number of companies as well. So together the package
of tools that we have are addressing it within the five-year period
but this is a key area where we need to look to the longer term,
where we need to look to ensuring that we have sustainable water,
we value it correctly and companies make the correct use of it
and consumers see and can make correct choices about the use of
it in the long-term; and I think that is where we are looking
towards the Flood and Water Management Bill to deliver more flexible
tools for us to do that.
Q203 Lynne Jones: How are you actually
setting what you are agreeing with them in terms of water efficiency?
Obviously that is going to bring about some improvements but is
it maximising improvements and how do your targets fit in? Are
they aligning with what do seem to be rather un-ambitious government
targets? And how do we ensure that companies are incentivised
to go beyond that bottom line that has been agreed, to actually
innovate and to encourage the installation of water harvesting,
SUDS systems and so on?
Ms Finn: Once again, I think what
you are talking about the future water target is for per capita
consumption; our target is for incremental water efficiency in
every company's area—because companies differ from area
to area in terms of their per capita consumption. I think you
have touched on an important topic, which is innovation by companies
and new ways of doing things. We have been encouraging companies
to come up with innovative ideas, particularly where they show
benefit, so that they are the best choice over other options.
So, for example, where metering provides a better incentive to
customers to save water then perhaps the cost of installing a
new supply from somewhere. We have asked companies to assess those
from a cost benefit point of view and to come up with the most
beneficial solution. So where companies can innovate to deliver
benefits they will achieve those schemes and that is quite an
important aspect of water efficiency.
Q204 Lynne Jones: Do we need a CERT
scheme for water which requires them to invest or help consumers
invest in reducing their water consumption and the way in which
their sewerage is collected and so on?
Ms Finn: The water companies are
required to promote water efficiency and we, Ofwat, as well as
a number of other stakeholders, participated in the water saving
group under the auspices of Defra where all the other players
have a role to play as well, including things like labelling their
goods and customer communication and I think all the players have
to play their part in that. A driver of customers using water
efficiently and saving water—not wasting water—has
to be visibility of what customers use and an understanding of
the value of that. I think that the incentive—which is the
question you asked—on companies is if they deliver this
in the most efficient way—going back to our medium-term
incentive regime—they get to keep those efficiency gains
for a period and then those gains are delivered back to customers
in the next period; so there is a win-win, both for companies
and for customers there. These are tools within the PR09 framework
and I do think that there is a bigger debate to be had about the
much longer term challenge about water stress and water scarcity
in this country and more flexible tools that will help us reveal
the true value of that water in the first place, which might actually
drive different behaviours, not just from customers but from water
companies in the longer term. I think that is the really big challenge—to
ensure that we have a sustainable water sector, not just for these
five years but very much in the longer term and not just for this
generation but for future generations as well. That is where we
are asking for this Committee's help in raising the profile of
that debate because we think it is crucial and certainly at the
heart of what we are trying to do.
Q205 Paddy Tipping: We talked earlier
about the very difficult financial situation but what assumptions
are you making in the next review period about the cost of financing?
Ms Finn: That is a process that
we are in the middle of going through at the moment and our draft
position on that will be published on 23 July. At this stage that
is very price sensitive so it is not something that I can discuss,
I am sure you will understand.
Q206 Paddy Tipping: But will that
be uniform across all the companies because some companies will
have stronger balance sheets than others and clearly that will
have implications for customers.
Ms Finn: In setting the cost of
capital we do set a single cost of capital across the industry
in principle; that is our approach. But perhaps Keith could expand
on this as it is his area.
Mr Mason: We do use a uniform
approach. We set one cost of capital and underlying that assumption
would be one capital structure. What we have said is that it is
for companies' management to decide how they want to be structured,
what their mix of debt finance is in the shareholders' funds.
But the risks of doing that lie with the management, the shareholders
and the investors, and what we have been clear to say is that
if you are too highly geared and get into trouble please do not
come to the regulator and turn to customers to bail you out of
that. So you are right to say that there may well be a range of
robustness with balance sheets but that is for the companies to
manage.
Q207 Paddy Tipping: But customers
are worried about their future bills and I get that this is price
sensitive, but clearly the cost of borrowing is higher now than
in the last period. What are the implications for customers and
how much are bills going to notionally increase, do you think?
Ms Finn: Yes, you are right, customers
are facing a tough time. These are tough economic times in terms
of cost of debt but they are tough for customers who are facing
a recession and have to pay bills and we are very conscious of
that. I think probably the best bit of information I can give
you is if we look at what the companies have put in in their final
business plans and that is published information. When you look
at that they propose that if all their proposals were accepted,
including their suggested cost of capital, that bills would go
up over the five years an average of £29 before inflation.
We are looking at that closely and we are challenging it. When
we consider the cost of capital when we set it we do not set it
based on today's cost of raising debt in the market; we take a
longer term view because it is a longer term business and companies
have raised some advantageous finance already and have that on
their balance sheet. They are facing a need to raise more finance
and it is important that we strike the balance there. So we do
take that longer term view and we do ensure that customers are
considered when we do that.
Q208 Paddy Tipping: Surely one way
of reducing the balance sheet is to reduce the capital programme.
Is that something you are looking at?
Ms Finn: The capital programme
is a function of, as far as we are concerned, what companies have
to deliver for customers; so they need to invest in the appropriate
capital programme to deliver the outcomes, and certainly Keith
and I have met every single company as part of this process—and,
as Keith said, more than once—and in the most recent set
of meetings between their draft proposals and their final proposals
we did ask each of them to think very carefully about the challenges
that their customers were facing in this period and how could
they manage their investment programme and their business and
the way to best balance the interests of their customers. Certainly
some of them have made a big effort to manage that and we are
now looking at those final business plans to see how that impacts
on customers' bills and we will be considering that balancing
act very carefully.
Mr Mason: What we have also done
is to ask companies this time round, compared with the last Price
Review, to set out how their investments are cost beneficial.
We have asked them to do that both for the mandatory schemes—but
obviously they are mandatory—but for the more discretionary
schemes, and if they can point to the fact that they are cost
beneficial that is better than if they are trying to do something
and it is not very cost beneficial.
Q209 Chairman: In terms of our water
utilities are you able to do any kind of comparison with reference
to their financial performance with other utility deliverers,
for example in the European Union or the United States, to get
some kind of benchmark as to relatively speaking how efficient
companies are in terms of their overall financial performance?
Ms Finn: We look at trying to
benchmark the water companies on a range of indicators, operational
and a whole range of other indicators. It is a little bit difficult
because our water companies are reasonably unique—there
are not an awful lot of direct parallels, they do not look the
same as other water utility providers in Europe—so we are
a bit limited there. We do look at their performance in comparison
to other similar industries like the electricity industry, networked
industries, regulated industries to continue to keep a view on
that. I think that the regulatory mechanism in the States is different
so again it is hard to compare performance. Keith, do you want
to amplify that?
Mr Mason: It is quite difficult
to unpack because obviously their structure and their legal position
is quite different, but I would say that the water companies have
been able to extend where they have borrowed money from into other
markets, so they have been able to borrow from European markets.
Some have borrowed in the US and so to be able to do that—
Q210 Chairman: But within the European
Union, where you have a common regulatory regime, surely it is
possible to do the most simple unbundling, which is: how much
does it cost to deliver a litre of water in a European Union country?
I accept the difficulties perhaps of comparing financial performance
but what about the performance of delivering the product?
Ms Finn: I would say that having
worked in both the energy and the telecommunications sector where
there is a common economic regulatory framework across Europe
you can do that. There is not a common economic regulatory framework
across Europe for water and that is where we are constrained.
We do try and carry out the type of comparisons you talk about
and we have published an international comparisons report regularly,
but there is a limited number of countries and water utilities
deliverers that can provide that data.
Q211 Chairman: I am trying to get
the measure and feel as to their relative efficiency/profitability
price-wise; is it more, less or about the same in terms of their
cost in delivering the product to customers here, versus, say,
France, Germany, Italy, the Netherlands—major similar sophisticated
European countries?
Ms Finn: I perfectly understand
your desire to want to see that. I would love to see that transparency
as well. Keith, do you want to talk about the international report?
Mr Mason: International comparisons
do fare reasonably well—they are near the top. They are
not at the actual top but they are not at the bottom. There is
not a huge selection to pull from but they do not look inefficient
relative to other European comparators. Perhaps one that is nearer
to home, we tried to benchmark Scottish Water and when it got
its own regulator they similarly tried to benchmark them and Scottish
Water were well behind in efficiency terms its England and Wales
counterparts and the water industry commissioner has used English
companies as a benchmark to improve the performance of Scottish
Water. That is obviously just one country but just on that comparison
all of the England and Wales companies were more efficient than
Scotland.
Q212 Dr Strang: In terms of the review
you said that the customers had been much more involved this time.
Could you describe how that has happened and what has been the
effect of this customer involvement? Do they really have enough
information about the industry and about what they are paying
for?
Ms Finn: We have changed the customer
research and involvement; not least we have put some recommendations
from this Committee at the end of PR04 and I will ask Keith to
comment on that.
Mr Mason: We have involved all
the major stakeholders, so Defra, ourselves, the Quality Regulators,
the Consumer Council for Water were all involved in a joint process
to get customers' views over a two-year period, and that has involved
focus groups and has also involved the more conventional, "What
do you think?" on a range of questions. So around 3,000 people
participated in that particular survey, all the companies were
covered, and by and large that survey showed that there was reasonable
satisfaction with the services that the water companies provided.
The English companies were around the 78 to 80% mark—much
higher levels of satisfaction in Wales. When they looked and turned
to the draft business plans that companies were preparing last
summer the customers were asked what they thought in terms of
value for money for those and around about 60% in England and
Wales felt that they were value for money and near 80% in Wales.
The thing that was driving that was really the scale of proposed
increases. So, as you saw, the companies that were proposing much
higher increases in their draft plans got much lower scores in
terms of value for money. The only exception to that is Southwest
Water where their bills are relatively high and that had a lower
satisfaction score. Seven companies, less than 50% of customers
felt that they were good value for money.
Ms Finn: To add to that: the important
thing this time was that Ofwat chaired a multi-stakeholder group,
so there is agreement on how we talk to customers and gaining
customers' views. The second thing is that it was three-stage
and quite comprehensive, including the companies doing research,
some deliberative research and then some quantitative research.
It involved un-informed views and then some education and information
and then informed views, so it was really quite comprehensive
for that cohort of people who were questioned. That does not mean
that the generality of the public necessarily have water on their
radar in the level of complexity at which this Committee is looking;
they see their bill and they see the water and they are the things
that they think about. One of the questions you asked is how has
that worked and one of the interesting things is, as I said when
Keith and I met the companies we did challenge them to say how
were they developing their proposals, both in the context of customers
facing a difficult time in the current economic climate and in
the light of this customer research, and a number of companies
have responded very well to that and said that, yes, they recognise
customers' views and they are working to try and manage their
plans and they change their plans from draft final to try and
respond to those customers' views. Now that we have the final
plans we are obviously looking at all those plans in the context
of those customers' views to see whether companies have responded
or not and to challenge their programme still further, so it is
a very active tool.
Q213 Dr Strang: It sounds as if you
think it has been a useful process, not just from the point of
view of the customer but from the point of view of the benefit
of the industry in future efficiency.
Ms Finn: I think it has been a
useful process and it is very important for the customers' views
to be heard. We do recognise that water bills are significantly
lower than energy bills so they are not as high up on customers'
concerns, but in the current economic climate they are becoming
higher and in a way the fact that customers are becoming aware
of their water bill and water usage is a good thing because we
think that the challenge ahead for this sector in the long-term
is a challenge for society and this economy as a whole and it
will be good to have customer engagement and awareness of those
issues.
Mr Mason: Coming back to the 25-year
plans that we talked about at the beginning, companies did involve
customers with that as well, so a lot went out with draft 25-year
plans and invited customers in to give their views on the longer
term perspective and I think that customers and the companies
themselves found that very useful in developing their final 25-year
plans.
Q214 Paddy Tipping: Surface water
drainage charges have become very controversial—scouts,
churches, sports groups are all in touch with us. What advice
have you given to companies? How do you think we should resolve
the problem?
Ms Finn: This comes back to the
core principle of sustainable water and drainage services now
and in the long-term. In order to have those sustainable services
it is important that customers understand the cost they are imposing
when they use something and then can amend their behaviour. Similarly,
it is important for companies to understand the value of the costs
as well and that is something we are very keen on. As a result
it is our view that charging for surface water drainage is best
done on a fair, non-discriminatory basis, which is related to
the amount of water that drains into the sewers so that the people
with very large tarmacced car parks, which drain into the sewers
that therefore impose a cost for maintaining and the upkeep of
those sewers will pay an appropriate rate, whereas the small shop
in the city centre on the bottom of a large tower block with no
drainage into the sewers will not pay a cost that it does not
impose. That is fair in principle and I think that is accepted
by everybody. And the move to charging non-households in this
way has happened in a number of companies already; it has happened
in a non-contentious way and a way that customers accept it. We
have recently had an implementation of this policy by a company
that went badly wrong.
Q215 Paddy Tipping: United Utilities?
Ms Finn: Yes.
Q216 Paddy Tipping: So where did
they go wrong?
Ms Finn: It is our view that the
reason this went wrong was because United Utilities were not fully
aware of the impact on a number of customer groups of this change
and therefore had not properly prepared for it and we are concerned
that customers were not communicated with and helped through that
process. So that lack of view of the impact on particular customers
led to some specific groups finding that they had significant
increases in a short period in their bills. Our guidance to companies
is that they should manage implementation of these types of changes
sensitively and over a sensible period of time that brings customers
in the community with them. So as a result United Utilities have
had to impose a moratorium for certain groups and they are working
to come up with the revised implementation. We know that this
can be done successfully because other companies have done it
successfully.
Q217 Paddy Tipping: Can you give
us some examples?
Ms Finn: Yorkshire Water and Northumbria,
for example, have done this successfully; and they have done it
through working with customers and helping them mitigate their
bill and managing the transition. We are watching United Utilities
very carefully; we expect to see their proposals as to how they
will implement this policy differently—we expect to see
that during the summer and over the autumn—so that they
can do this in a way that has the same level of customer acceptability
as other companies have achieved. There is one example of an area
where we want to see customers being able to understand how their
behaviour imposes costs and therefore they can change their behaviour
and that is a good thing—maybe digging up that tarmacced
car park and putting in place a gravel one so that it does not
cause flooding or it does not drain to the sewers, and that is
about sustainable drainage in the long-term and I think that is
very core, just like sustainable water usage, to make sure that
this sector delivers for customers not just now but for future
generations of customers.
Q218 David Taylor: Ms Finn, you have
been around in the regulatory profession—with telecoms and
with energy, I think—and you will be familiar with the Better
Regulation Task Force statement in 2003 that regulators should
conduct regulatory impact assessments ahead of any big regulatory
changes. Why did you not do that in relation to this particular
case here?
Ms Finn: In this case the policy
was to have fair and non-discriminatory charging, which in itself
was not a change in policy. The change in charges that is done
by companies is something that we have told them they need to
carry out an appropriate impact assessment on because they are
the only ones with the information on their customers to do that.
So the companies that did that effectively and understood the
impact were those that then implemented it in a way that was sensitive
and received customer acceptability. The key in this case that
went wrong was that that impact was not adequately understood
and I think the concern there is that the company did not understand
enough about the impact on their customers and that is where they
had gone back to do it again.
Q219 David Taylor: But you wrote
to us here after all the pressure that we had as MPs, amongst
other people, no doubt, saying that it was not the intention of
the policy to add significant or disproportionate impact on community
organisations. Why on earth did you not ask those questions before
the policy was recommended to the utilities?
Ms Finn: Again, the issue here
is that it is for the companies to structure their charges and
there are different ways that the companies structure their charges.
The policy as a context for them structuring their charges is
fair, sensible and non-discriminatory. When they come in with
their charge schemes to look for approval they have to demonstrate
the impact and how they are going to implement it. In this case
that was not done well. It was clearly done well in other companies'
cases so therefore this needs to be done again.
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