SUPPLEMENTARY
MEMORANDUM FROM
YORKSHIRE WATER
(DFWMB 05A)
In response to your letter of 9 June, I
am pleased to supply the following answers and additional notes
as requested. Should you or members of the Committee require any
further details please do not hesitate to contact me.
1. IMPACT OF
COMPETITION
The impact of competition on Yorkshire Water
and our customers will depend on the scale of competition and
the way it is introduced.
Cave has recommended a step-by-step approach
starting with business retail customers. This would enable competition
for the supply of all non-household customers through mandatory
legal separation of water companies' retail activities in 2012.
New entrants would then be able to enter the market and compete
with the new retail entities. The residual "wholesaler"
will charge the new and other retail entities for its water and
waste services on an arms length basis, and retailers will compete
to supply non-household customers.
We would expect this to impact our business
in the following way:
— It will be necessary to establish and
maintain a legally separate retail business. There will be establishment
costs and also likely duplication of activities (for example,
income forecasting, customer service, regulation). Depending on
the exact form of separation it might be necessary to put in place
arrangements to restrict the flow of information between the retail
business and the rest of Yorkshire Water, which could lead to
further costs (compliance training, monitoring and enforcement)
and further duplication of overhead functions.
— Overall there will be an increase in
the regulatory burden on the business. In part this is because
the separate retail business will be both a competitive supplier
to non-household customers and a monopoly supplier to domestic
customers so that additional regulation will be needed to ensure
there is no unjustified cross subsidy between the two. Also we
anticipate that the retailer will operate under its own price
control arrangements.
— Retail competition could increase our
cost of capital if investors conclude it is the first step towards
extensive industry restructuring, vertical dis-aggregation and
a threat to regulatory asset values. In our case, every 25 basis
point (ie 0.25 percentage point) increase in the cost of
capital feeds through into a 0.6% increase in average household
bills.
Business customers may benefit from the opportunity
to choose their retailer, allowing them to aggregate national
sites and perhaps negotiate different levels of service. The gains
may be limited, however, since our ongoing business customer satisfaction
surveys show around 90% satisfaction with the level of service
we provide. Price benefits too are likely to be modest—in
our case retail accounts for less than 4% of total costs—and
Cave has estimated the overall net benefit from business retail
competition to be only of the order of 1% of "business as
usual" costs.
Domestic customers may also be negatively impacted
by retail competition. In particular, the creation of a separate
retail business will break some of the existing links between
Yorkshire Water's operational activities and our customers, potentially
reducing the quality of service for all.
Cave has recommended that government decide
whether or not to extend retail competition to domestic customers
from 2014, but the case for doing so is not convincing.
Following the introduction of retail competition,
Cave proposes competition to provide additional capacity in the
upstream (water treatment, distribution, collection, waste water
treatment and sludge treatment and disposal) parts of the value
chain. This is similar to the draft Bill's proposals for financing
large projects and would involve us in tendering the financing,
ownership, construction and operation of new capacity (for example
a new water treatment works) and demonstrating to an external
procurement panel that we have made the most economic choice.
The benefits of this are hard to see. We already
tender for the construction of capital works and have a powerful
incentive to accept the most economic submission and it is unclear
how an independent asset provider could finance and operate these
assets more effectively. There will however be costs—increased
capital planning costs and a further regulatory burden—plus
practical issues incorporating a third party asset into the integrated
operation of the remainder of our business. Furthermore, any suggestion
that proposals of this type might result in existing assets being
stranded or might limit the growth potential of the incumbent
water and sewerage companies could increase the cost of capital
and reduce its availability.
Looking further ahead still Cave (and Defra)
has explored time limiting abstraction licences and abstractions
trading to deal with growing concerns about resource availability.
These are likely to have profound implications for customers—not
least higher prices for water in aggregate to address water scarcity,
with associated water affordability and social issues—and
companies—water resource optimisation and the potential
for cross border trading and consequent investment decisions.
There might also be a role in the future for a regional or national
water infrastructure planning body.
2. SPECIAL ADMINISTRATION
REGIME
The Water Industry Act 1991 includes special
administration arrangements that allow the secretary of state
or Ofwat to override the ordinary insolvency process and transfer
a failing water company to one or more other companies to ensure
continuity of service. We agree that such arrangements are necessary,
and understand that the objectives of the draft Bill are to bring
them into line with modern insolvency practice and changes made
in other utility sectors.
In particular, the existing special administration
arrangements provide only for the transfer of a failing company.
The draft Bill proposes the possibility of a rescue package being
pursued by a special administrator if the company is essentially
viable but is unable to refinance its debts or costs have escalated
outside of its control. We believe this is appropriate, particularly
given recent difficulties in financial markets.
3. FINANCING
LARGE PROJECTS
The draft Bill proposes that water companies
be required to tender the financing, ownership, construction and
operation of certain infrastructure projects to regulated project
based "infrastructure providers". The suggestion is
that this would apply to large multi-company and/or multi-AMP
projects that would otherwise be too costly, risky and economically
inefficient for a single water company to take on. We have some
reservations with these proposals:
— The provisions seem purpose built to
deal with Thames Tideway, and no realistic examples have been
put forward of where else such arrangements might be necessary.
We question the merit of introducing such wide powers to deal
with such a specific case.
— These provisions may not actually be
necessary to ensure the efficient delivery of major projects.
Current legislation does not stop companies co-operating to deliver
large infrastructure projects, and it is difficult to see how
"infrastructure providers" will be able to finance and
deliver projects at a lower cost and risk than the existing water
companies. Indeed, the experience of PFI-type projects has not
been wholly positive.
— The criteria to be used in deciding whether
or not these provisions apply are left to ministers (or, if they
choose to delegate it, Ofwat) to decide. This means that in the
future water companies could be required to tender the financing,
ownership, construction and operation of much smaller infrastructure
projects (such as a new treatment works), thereby introducing
competition through the back door. If government wants to introduce
competition to provide new capacity then it should do so explicitly
in the Bill, otherwise the resulting uncertainty could increase
industry financing costs and customers' bills.
4. MANDATORY
BUILD STANDARDS
FOR SEWERS
Yorkshire Water supports the introduction of
mandatory build standards for sewers and is actively involved
with Water UK in drafting common standards for new sewers. We
believe this will provide clarity for developers, building control
and sewerage undertakers. The main risk is that the standard may
be seen as too prescriptive and may stifle innovation and the
development of new products and systems.
5. ADOPTION
OF SUDS BY
WATER COMPANIES
The draft Bill's proposals to remove the automatic
right of connection to sewers for surface water drainage and to
require developers to install SUDS in new developments are essential
proposals for the future of urban drainage. However, rather than
local authorities adopting, maintaining and operating these assets
we believe there is a strong case for this role to be carried
out by the water and sewerage companies. This is because:
— SUDS have the potential to be a key part
of an integrated drainage system, potentially reducing
the need for downstream sewer investment. It makes sense for this
system of assets to be operated together in order to maximise
the potential for synergy, cost saving and operational effectiveness
and to avoid the confusion over responsibility for different drainage
assets experienced in the 2007 floods.
— SUDS must be maintained and operated
effectively if they are to make a positive difference. It is unclear
whether local authorities will have the necessary technical and
financial resources to do this, or whether, at the margin, local
authorities will have other priorities for scare funds. Indeed,
our experience of SUDS in Rotherham and Leeds is that local authorities
have been reluctant to adopt them.
— Owning, maintaining and operating drainage
assets is a core activity for water and sewerage companies, who
are also able (subject to Ofwat agreement) to recover the associated
costs through sewerage bills. Indeed it is counter intuitive to
transfer responsibility for private sewers to water companies
whilst at the same time creating new drainage responsibilities
for local authorities.
— Ofwat is determined to hold water companies
accountable for flooding from its sewers and recognises that water
companies need greater control over what enters its sewers. Direct
ownership, maintenance and operation of SUDS by water and sewerage
companies will give this.
6. PROTECTING
CRITICAL INFRASTRUCTURE
Our AMP5 plans include £6.4 million
of capital schemes to provide flood protection at water and waste
water treatment works and pumping stations at high risk of flooding.
In addition we are proposing to invest a further £10 million
in multi-agency integrated surface water studies for Hull, Leeds
and Sheffield, working with the EA and local authorities, and
£16 million on 37 drainage area plans. Our plans
have been prepared using Ofwat's flood resilience guidance 'Asset
resilience to flood hazards: Development of an analytical framework'
issued in June 2008 and EA data on flood risk. If accepted
by Ofwat, this investment will be paid for by customers.
The relatively low level of investment in AMP5 reflects
the fact that much work has already been done. For example:
— In Yorkshire the risk of customer interruption
from a water treatment works being flooded is very low because
of investment already carried out. During the 1990s we invested
approaching £200 million to build the Yorkshire Grid,
allowing raw and treated water to be transferred across the region
and giving enhanced security of supply to 95% of our customers.
We are currently investing a further £11 million to
extend the Grid along the east coast towards Scarborough, and
have included a further £8 million in our AMP5 investment
proposals to complete this work. As a result, 99% of Yorkshire
Water customers will be connected to the Grid. With the exception
of the £8 million in our AMP5 plans, all of this
investment has been paid for by shareholders.
— We have invested £25 million
of shareholders' money in Hull since 2007 increasing pumping
capacity, undertaking flood risk assessments, installing sewer
monitors and improving flood protection at an electrical sub-station
in Hull and at Saltend waste water treatment works.
The relatively low level of investment also
reflects our decision to undertake further investigations (eg
the multi-agency studies) to identify the best long term solution
rather than jumping to hard engineering. We believe this will
provide the best level of protection at least cost to customers.
7. IMPACTS OF
CLIMATE CHANGE
Understanding the likely impact of climate change
on our business is a significant challenge. Yorkshire is not currently
water stressed, but this could change, our waste water treatment
processes could be impacted by rising temperatures and more intense
summer storms will impact the operation of our drainage assets.
We are not proposing immediate investment to
adapt our assets to climate change because the impacts are still
too uncertain. However, we do plan strategic research into the
implications of the latest climate change projections for our
infrastructure before revising design standards. We anticipate
that this investigative phase will run until 2015, at which point
we will review our position.
More urgent in the short term are activities
to mitigate our impact on climate change, and in particular to
reduce our carbon emissions. This is a particular issue for water
and sewerage companies because increasing environmental standards
are driving up emissions: we expect our annual operational carbon
emissions to rise from 450 KtCO2e to 495 KTCO2e by the
end of AMP5, and 86% of this increase is to meet tighter environmental
standards.
We have carbon reduction initiatives, including
building the shadow price of carbon into our investment decisions,
introducing modern fleet vehicles, energy efficiency, renewable
generation and leakage reduction, but alone these are not enough.
To achieve significant reductions in carbon emissions we will
need support from others, in particular:
— There needs to be greater recognition
at governmental level of the carbon impact of tighter river and
coastal water quality legislation. Environmental improvements
should only be proposed where the benefits exceed the carbon impacts.
— The existing static discharge consenting
regime results in effluent being treated to the same high standards
irrespective of the condition of the receiving water. This is
inefficient. The EA should lead a move away from static point
discharge consenting towards dynamic integrated abstraction and
discharge consenting that allows treatment to be optimised to
the needs of the catchment, reducing both costs and carbon emissions.
— There needs to be stronger political
and regulatory support if water companies are to make their full
contribution to emissions reduction. For example, regulatory support
for biogas CHP (through the renewables obligation) has been halved
and the potential for co-digestion is inhibited by the application
of waste management regulations.
In terms of climate change both PR09 and
the draft Bill are, in our view, missed opportunities. Ofwat has
required companies to remove climate change adaptation and wind
power from their plans and the Bill is largely silent on these
key issues.
We appreciate the opportunity to give evidence
to the Committee's review. Please contact me if you would like
any further details.
Yours sincerely
Jonathan Hodgkin
Director of Regulation and Investment
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