Supplementary memorandum from Water UK
1. Ofwat rules covering water leakages require
companies to bring down leakages to a level where the cost of
saving another unit of water through fixing a leak is the same
as the cost of providing a unit of water through a new supply.
What is your view of Ofwat rules covering leakages? Should the
rules by revised, and, if so, how?
Water UK participated in a recent Ofwat-led
series of studies to review and improve approaches to leakage
management within the regulatory framework. This included best
practice guidance on including external costs and benefits in
the sustainable economic level of leakage (SELL) calculation.
All companies follow this guidance, which does provide an acceptable
framework for companies to take account of a broad range of costs
and benefits (including environmental and carbon impacts, traffic
disruption from detection, repair and mains replacement work,
etc). Companies do therefore identify the most cost-beneficial
and sustainable leakage management strategy within a broader water
resource management and strategic business plan.
However, there are some aspects of the current regime
that we feel could be improved.
First, the SELL depends crucially on the value
of water, which in turn depends on the balance of costs and benefits
between leaving water in the environment and abstracting water.
Ensuring that the abstraction regime is sustainable is primarily
a matter for the Environment Agency (EA). The EA has a responsibility
to demonstrate any cases where existing levels of abstraction
are unsustainable (unduly impacting the environment) and to agree
a process for remedying these cases. Where the EA demonstrates
that a catchment is over abstracted, the SELL should fall.
Second, water companies have undertaken a great
deal of customer research to inform their PR09 business plan submissions
and recent 25-year Strategic Direction Statements. This research
clearly demonstrates that leakage management is important. Many
companies have long-term targets to reduce leakage, very significantly
in some cases. However, in Ofwat's final determination of prices
for PR09, economically justified leakage programmes for many companies
were cut back. As a result, leakage levels are expected to remain
stable or fall only slightly over the next few years, a situation
which falls short of company ambition and customer expectations.
Third, the current approach to setting targets
for leakage leads many companies to a sub-optimal approach. The
regulator can (and does) impose penalties for failing to meet
targets, but does not provide equivalent incentives for out-performance.
This leads companies towards a risk-averse approach, avoiding
penalties by allocating additional (uneconomic) expenditure to
leakage management. This occurred in 2008-09, the coldest winter
for many years in most of the country. We would normally expect
leakage to rise in such circumstances, but additional effort and
investment (taking many companies beyond the SELL) enabled all
companies to meet or better their targets. Incentives and rewards
for such out-performance should be part of the regulatory contract.
Finally, we believe there is a need for more
consistent communication around leakage. Companies are required
to follow the SELL approach, but many of the industry's key partners
and stakeholders argue publicly that leakage levels should be
lower than this. This sends a confused message to the public and
undermines the broader case for water efficiency. We think that
a common and consistent communication strategy, led by government,
would deliver significant benefits.
2. What role should the Adapting to Climate
Change Programme take in getting organisations to work together
in the first place? Is the Adapting to Climate Change Programme
well-placed to fulfil its role?
We have argued that water companies cannot deliver
many of the actions needed to adequately adapt water systems to
the impacts of climate change alone. Examples include diffuse
pollution, surface water management and water efficiency.
We agree that the ACC programme, which will
be co-ordinating adaptation work across government departments,
is ideally placed, through the national Climate Change Risk Assessment
and other projects, to lead and co-ordinate this work. The Climate
Change Committee adaptation sub-committee should also have a (more
limited) role, eg reviewing overall government adaptation plans.
Given the very different size, structure and
regulatory framework of different sectors, it is equally important
that government departments and regulators also work together
and co-ordinate responses to climate change. An example is catchment
management work to tackle diffuse pollution, primarily from agriculture.
Ofwat will not allow direct funding from water company customers
to the agricultural sector, even where this may be the most cost-beneficial
solution overall. This therefore requires other arms of government
and its agencies to work with the agricultural sector to address
diffuse pollution and ensure the impacts and costs of one sector's
activities on another sector are fully taken into account.
Other examples where action is needed to avoid
"mal-adaptation" to climate change are nitrate-intensive
agricultural practices encouraged by Common Agricultural Policy
incentives and the need for large quantities of water to support
bioenergy crops.
3. Has the water industry had any success
in addressing differences between those who pay for action towards
efficient adaptation and those who benefit from from such actions,
which could arise for example if current water customers are asked
to pay for adaptive action which might benefit future customers
or other sectors of the economy?
The water industry has had success in these
areas. Again, the example of catchment management is useful. Ofwat
has allowed funding for more than one hundred schemes to tackle
upstream pollution in PR09 (although not including direct payments
to farmers). Such schemes have a range of water quality, environmental
and other benefits, and reduce the need for expensive, energy-intensive,
end-of-pipe solutions.
However, such schemes, in common with much of
the water industry's extensive environmental and quality programmes,
involve water customers paying to clean up pollution from other
sectors. This issue was identified and discussed extensively in
the recent Walker Review of Metering and Charging.
In addition, water companies have long-term
(twenty-five-plus) plans, which mean that many investments made
today will necessarily benefit future generations. At the same
time, the high and continued industry investment needs mean that
companies effectively borrow from future customers to pay for
investment today.
So there is a range of cross-sector and cross-generational
transfer payments in the water industry. There are good reasons
for this, but there is no doubt that such payments reduce or remove
the incentive for other sectors/generations to take action that
might be in society's best overall interest.
Many of the benefits of adaptation occur in
the long term or to parties other than water industry customers
(eg private beneficiaries of flood defence works). It is therefore
difficult to justify short-term costs to the economic regulator,
particularly when the benefits are uncertain or discounted over
time. The government could provide clearer guidance in this area,
eg through extending the Green Book on public policy appraisal
to specifically cover adaptation for statutory bodies, with a
clear expectation that regulators take this into account.
We would encourage government and regulators
to look for and introduce positive incentives where possible,
for example by removing the automatic right of connection to the
public sewer, introducing site-based charging for drainage or
tackling diffuse pollution at source. Alongside this is a need
for better information so that people and organizations can make
more informed choices, for example better water efficiency labeling.
4. What do you think Government should do
to improve awareness of adaptation and get businesses to take
action where necessary? What is the best way of providing adaptation
advice to business (eg through a specialist body; through general
business support organisations, such as Business Links; using
climate change aware businesses to mentor SMEs)?
There are a number of ways to improve communication
and awareness:
— Using industry groups and trade bodies
such as the CBI and Water UK. We set up and co-ordinate groups
on a range of issues, including climate change, which gives our
members an opportunity to share information and good practice.
— Ensuring all government departments proactively
engage with their agencies, sponsored sectors and key stakeholders
on the impacts of climate change and opportunities for adaptation.
— Consistent messages from all areas of
government on why climate change matters to them, the potential/likely
impacts, simple measures that people and organisations can take,
and the opportunities for business development that adaptation
offers.
— Extending the adaptation reporting power
to other organisations and sectors that will need to take steps
to address the impacts of climate change. At present, the power
only covers around ninety, mainly large, organisations.
— Utilising partnership-based organisations,
especially those at regional or local level (since this is where
climate change impacts will be felt). These include regional climate
change partnerships, where many water companies take a leading
role.
5. In Q36 we said "if you have this five-year
system of operational expenditure and investment that is clawed
back after five years it disincentives long-term investment and
actions with long-term benefits".
At the start of each five-year period, Ofwat
makes assumptions about how efficiently companies will be able
to deliver their investment programmes. Companies have a financial
incentive to out-perform these assumptions. However, at the end
of the five-year period, the operational expenditure element is
reset and new assumptions are made. Companies only retain the
benefits of out-performance for five years. In addition, choosing
an operational expenditure solution tends to make companies appear
less efficient according to Ofwat's traditional means of measuring
efficiency.
Operational expenditure solutions, rather than
capital-intensive solutions, are generally the "softer"
measures that are particularly well-suited to climate change adaptation,
including catchment management and water efficiency. We think
Ofwat could give greater consideration to positive incentives
for operational-type schemes.
18 December 2009
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