Examination of Witnesses (Question Numbers
1-38)
Regina Finn and Keith Mason
13 October 2010
Q1 Chair:
Good afternoon. May I welcome Regina Finn from Ofwat. Thank
you very much for joining us today. Would you like to introduce
your colleague for the record?
Regina Finn: Thank
you. This is Keith Mason, Director of Finance and Networks at
Ofwat.
Q2 Chair:
I am going to ask about the previous Government's policy, but
following your submission--thank you for your help with this inquiry--may
I ask how Ofwat balances its social and economic roles?
Regina Finn: Balance
is at the core of what we do. Our job is to protect the interests
of water customers now and in the long term, and the way we do
that is by seeking to make decisions that deliver a sustainable
water sector. That means a sector that will meet customers' needs
today but also allow the needs of future customers to be met.
We see that as having three legs. There is environmental sustainability,
which means we have to live within our environment, but it is
also important that we have social sustainability. That means
customers need to be both aware of what they are paying for and
willing to pay their bills, so bills should be as affordable as
possible across the board. Then we need to balance that with
the third aspect of sustainability, which is financial sustainability.
That means making sure the water sector can continue to build
on the £90 billion investment it has already made over the
past 21 years to continue to deliver that sustainable contract
in the long term. We take all of those aspects into account when
we set price limits, which is essentially the price and service
contract that each company has to deliver over a five-year period.
We balance those issues. We listen to customers' views. We
did extensive customer research as we set the price limits this
time around. We heard what customers told us about the difficult
economic times they were in; we heard what the markets told us
about the need to ensure that investment was stable; and we heard
what the companies told us about what they needed to do to deliver
their services. We struck a balance that I think is a fair one
and has been accepted. It meant that bills, before inflation,
were set broadly flat over a five-year period for an investment
package of more than £22 billion over the same period.
That is a pretty good outcome for customers, and the feedback
was that customers were fairly satisfied with that. That is what
we do at a high level. In the long term we need to make sure
that our regulatory tools and framework are fit for purpose to
deliver that sustainability in the face of significant challenges
that the sector sees ahead. I think there is general acceptance
of those challenges: climate change; population growth; the stressed
economic times; the need for further investment; continued environmental
drivers; and indeed customers' demands for high levels of service
and, at the same time, concerns about affordability.
Q3 Chair:
How do you think that the views of the customer would best be
heard in the process?
Regina Finn: Over
the past number of years we have worked to develop how we take
into account customers' views, specifically in the price-setting
process. In our most recent price round we did extensive joint
research with all the other stakeholders: Defra, the Welsh Assembly
Government, Consumer Council for Water, the Drinking Water Inspectorate
and the Environment Agency, the whole range of stakeholders.
That was very helpful because we were able to consider the views
in those surveys when we came to set prices and understand customers'
views on willingness to pay. However, there is a challenge ahead
in terms of how we can strengthen customer engagement in the price
review process. Earlier this year we launched a project to review
how we use our price-setting tools in future, and one stream of
that is about customer engagement. We are looking at a range
of options on constructive engagement, negotiated settlement and
understanding customers' preferences and choices to see whether
there is a more effective way to ensure that customers can be
communicated with and we can understand their views during the
process.
We also want to work on using the views of customers
when we look at how we carry out compliance reporting. Therefore,
when we look to see how companies are meeting what their customers
want them to do, rather than have a data-heavy approach where
we examine every company every year, we look at how we can better
hear from customers what their concerns are in terms of the service
they receive so that we can take a more risk-based and targeted
approach and listen to customers that way and engage them. We
have done a number of bits of research. A number of academics
have done some papers for us, which we shall be publishing next
week, along with a draft report on how we might take forward this
process. We are conscious that quite a lot of reviews are going
on at the moment, both institutional reviews, reviews of the competition
and consumer framework, and indeed a review of the water regulatory
framework proposals for a Water White Paper. We shall have regard
to all those developments, too.
Q4 Chair:
Could you outline what you think the benefits are of having a
separate regulator for the water industry?
Regina Finn: I
have worked at regulating a whole range of industries. I have
regulated the telecoms industry, electricity, post, gas and indeed
broadcasting in various jurisdictions, so for me the concept of
economic regulation has some commonality across networked industries
where there are particular monopolies that you want to regulate
to deliver for customers. What I have found in all the sectors
in which I have worked is that there are also individual characteristics
that you need to learn about. When I joined Ofwat three or four
years ago I was new to the water sector. I certainly had a good
understanding of economic regulation because I had been doing
it for all my career, but there were water-specific issues that
it was important for me to learn about. There is some sectoral
expertise quite specific to the different sectors, and I think
it is important to have that.
I will be perfectly frank and will not give an opinion
on institutions because you can create any institution you want.
What is important is that you have that specific sectoral expertise,
wherever it sits, in order to ensure that your regulation is fit
for that sector, you understand the long-term challenges that
the sector faces and you can make sure your regulatory tools drive
the right behaviours for customers and the environment in the
long term.
Q5 Chair:
What would your message be to Defra on the outcome of its review?
How would you like to see the end of the review process leave
Ofwat? What do you think the timetable should be, without impacting
on the next price review?
Regina Finn: Timetables
are tight. We set price limits for a five-year period but, frankly,
it is a big, three-year process. We will have to publish how
we are to set price limits by the end of 2012 so that companies
can start to understand what they need to do and we can start
the engagement process. But I think we have a fantastic opportunity
between now and then because we have just set price limits for
five years so we have quite a stable environment. We will be
setting them again from 2012. We will have to talk about it before
then, but from 2012 we will start the process to set them from
2015.
We have a very good opportunity with the Water White
Paper, the Natural Environment White Paper, which has water aspects
to it, the Defra review of Ofwat, in which we are very pleased
to participate, and our own review of our tools that we have been
carrying out since we last set price limits. We think that together
all those need to look at how we can make this regulatory regime
a more flexible, modern one that can adapt to the really big challenges--climate
change, weather volatility, flooding and drought--where we do
not know what they will deliver for us. We do not know what the
outcome will be but we would like clarity from the outcome and
any legislative proposals within that window. We think that is
doable.
It would be good if the various reviews and the policy
look at the sector helped us look at our tools, such as our licensing
system, which is 20-odd years old. We have 20-plus different
licences, each of which has different terms and conditions. There
is a lot of legal redundancy in there; frankly, it is lawyer heaven
when you try to start using them. We could usefully have a much
more simplified, modern, streamlined, modular licensing system
that would be clearer for companies, for us to enforce and for
customers to understand to what they are entitled.
To come back to your first question, it would also
be useful if the review focused on how we can best engage customers
and the policy framework around customers. That includes the
Government's position on social policy and social assistance for
water customers, just as in other income-deprived areas in the
country. It would be very useful for us to understand Government
policy around that so that we can build the appropriate frameworks
on which to deliver over time, and, again coming back to what
you said, to make sure that we have systems and processes to ensure
customers can be heard and are at the heart of this. If there
are changes to that aspect of the regime we want to make sure
we can capture and have access to that customer voice by hearing
what customers are complaining about, understanding the issues
they are raising with their companies or making sure we can keep
that intelligence as part of the regime.
Q6 Chair:
Do you think that the previous Government got the assessment right
in their policy paper Future Water for 2030? Were there
bits that they should have implemented but have not? How do you
think this was reflected in the legislative framework?
Regina Finn: We
were very pleased that Future Water tried to grapple with
putting the whole story together around water and waste water
because it is a huge sector and it is fundamental to our economy
as well as our health and lives. We thought it was a really good
first step. It did start to highlight the challenges, and we
now have a pretty common consensus on those challenges, so that
is very positive. It paved the way for important further works.
Work was done by Anna Walker and Martin Cave in their reviews,
so it started some of that going.
In the period of time between then and now, through
our dialogue with our stakeholders, we have learnt how crucial
valuing water is at the centre of developing our policy and frameworks
around water. That was certainly touched on, but probably we
did not develop it then as well as we have now. Essentially,
if we do not really understand the environmental, economic and
social value of water, we do not necessarily make the right decisions
about how we use it. I am not talking here just about customer
pricing but about the companies that have to deliver the infrastructure.
They know the cost of collecting it, treating it and moving it
around, but not necessarily the relative value of it between a
water-scarce area and a water-rich area, so the concept of understanding
and valuing the resource is perhaps something that could be developed.
In the light of more experience and what we have
learnt in the period since Future Water, the point you
raised about understanding the role of the customer and how the
customer's voice can be engaged is something that could be developed
further. The final point is that obviously a lot of actions have
not moved forward because they were the subject of further work
and none of the recommendations--apart from a few from Anna Walker's
or Martin Cave's reviews--has yet been taken forward into proposals
for legislation. That has not been done.
Q7 Mrs Glindon:
You have talked a lot about improving the engagement process.
From all the work you are doing, have you been able to identify
customers' priorities?
Regina Finn: Yes,
in that we do an awful lot of research with stakeholders. We
did a lot of joint research throughout the periodic review process.
One of the difficult things in engaging with all customers in
the country is that you have a lot of voices and it is very hard
to hear them all, so we needed to try to use surveys to do that
and ensure we used a common set of surveys so all stakeholders
understood customers' priorities, because if you do your bit of
research and I do mine we may well get different views. That
was an important way to make sure we could understand customers'
priorities.
We also asked all companies to do customer research
locally so they could understand customers' priorities when they
put together their business plans. CC Water also does research
on customers' priorities and publishes that and we also have access
to their views, which is very helpful. That has been reasonably
successful. There are difficulties with it. One of them is that
it is inter-generational, so you have today's customers and we
must protect the interests of tomorrow's customers and tomorrow's
customers are not there to tell us their priorities, so that is
a balancing act we need to do. The other issue is that we have
tended to survey customers as a whole.
One of the things we are now learning when looking
at how we might improve engagement is that they are not all the
same; different types of customers have different priorities--for
example, large and small businesses, small and medium sized enterprises
(SMEs) and household customers--and different customers have different
priorities in different areas, and their priorities change over
time. Because we did a number of surveys over time, we captured
information that was as up-to-date as possible when setting price
limits. The challenge for us now is how we can make that a richer
and more-informed debate with customers going forward, so we think
there is more to be done.
Q8 Mrs Glindon:
This is a different aspect of the customer's point of view. You
have also mentioned changing the regulatory burden and making
it more flexible. How can that change be balanced with the need
to retain the customer's confidence in any regulatory outcomes?
Regina Finn: That
is absolutely right. The first priority of which we are always
aware is that our job is to protect customers' interests. Where
they do not have any choice, customers need somebody to protect
their interests. As you have just alluded to, they need to believe
that somebody is protecting their interests. We need to do that
and ensure that they are aware of it. When we talk about simplifying
the regulatory burden and potentially reducing data collection,
we would not make a change in our processes; that would not be
beneficial or enhance our outcomes. The outcome we want is to
deliver for customers now and in the long term. We want to ensure
that we do that in the most efficient, value-for-money, effective
way, and we think the continued heaviness of the way we look at
data might not be the best way. We are not looking at changing
it for the sake of changing it; we just think there may be better
ways to do it, better ways to serve the customer interest, and
better ways to hear those customers and focus our limited resources
on the things that customers want us to focus on rather than a
kind of blanket approach to everything.
Q9 Dan Rogerson:
Mary's first question to you was about what customers' priorities
were and you set out quite clearly the methodology of how you
consult and also said there was a range of responses. Are you
able to give us a flavour of what those priorities are?
Regina Finn: The
first priority for customers remains, frankly, safe, clean drinking
water. We all turn on the tap and take it for granted after so
many years, but if you ask customers to think about it they will
say that the most important thing is that that water keeps coming
out of the tap and that it is safe, clean and they know they can
rely on it and do not have to worry about it. They want that
at affordable prices; prices they feel are fair. They are certainly
willing to pay for it but they want to feel they are paying the
right amount. You will remember that when we did this research
in the price review period we went through the credit crunch and
all of that economic uncertainty and we saw customers' priorities
changing a bit. They became concerned about some of the investment
that we call discretionary. There were some things they wanted;
they wanted a certain amount of resilience; they wanted to be
sure they had back-up supply; and they wanted the environment
to be clean, but they were second-order priorities and the primary
priority was safe drinking water. Keith, do you have anything
that you want to add to that?
Keith Mason: Only
to say that the point about safe, reliable drinking water was
clearly well ahead of any other priority that they had. One that
was very specific for certain groups of customers was sewer flooding.
It affects only a very small minority of customers but when it
happens it is not pleasant, so clearly those who were affected
thought that was very important to them. We have tried to address
that by including within price limits just over £1 billion
to do that, but it does become very expensive. That is probably
the only other one I would draw out.
Q10 Chair:
I have one small question about Ofwat's view. Obviously, if customers
do not pay their electricity, telephone or other bills they will
be cut off. Obviously, bad debt is growing incrementally and
all the paying customers are paying quite a bit. If everybody
has the right to water, but those who can pay won't, what should
we be doing?
Regina Finn: You
are right. The difference with water is that if household customers,
not businesses, do not pay their water bills they cannot be disconnected.
That is a clear policy decision for which there is obviously
a good reason because you cannot do without water; it is essential
for life and health. It contributes to a difficulty in the sector,
and revenue outstanding is much higher in this sector than, for
example, in the energy sectors; currently, it is running at £1.59 billion
or £1.6 billion. For those who do pay, bad debt adds about
£12[1] to their bills.
The point we would make here is that in that group of people
who are in bad debt there are some who are seriously vulnerable
and have genuine difficulties in paying their bills; they have
an affordability problem, and we need to identify and target those
vulnerable customers. We believe that is very important. It
is only when we do that that we gain the legitimacy to try to
tackle those customers who frankly can afford to pay but just
do not pay. They think they are ripping off the water company
by not paying, but they are ripping off their next-door neighbour
who is paying.
We put forward some proposals in the last legislative
round, and through the Flood and Water Management Act, about how
we could better tackle that by giving water companies some tools
to do it. For example, that included a tool better to identify
whom to chase for the bill when they do not pay, so there is a
hierarchy: if you cannot find the tenant because they have done
a skit, you can eventually find the landlord and somebody who
has a liability to pay that bill, and there are a number of variations
on that. I know that is subject to discussion and needs regulations,
but we think that those tools would give water companies slightly
better means to collect bad debt.
Let me not be complacent here: water companies really
need to get better at this as well; they need to focus on collecting
this bad debt, but sometimes it can cost more to chase the bad
debt than what we get back, so we understand there is a cost-benefit
there. We think it is important that the proposals that were
accepted in the primary legislation but are being consulted on
and need regulations are brought forward. There will always be
more that water companies can do and that is partly about them
getting to know and understand their customers better. The third
point would be that, if we do focus on those genuinely vulnerable
customers and try to help and protect them, it will be easier
and people will understand when water companies try to collect
outstanding bad debt.
Q11 Chair:
Have you had any indication that this will be included in the
White Paper?
Regina Finn: My
understanding is that the White Paper will look broad-brush at
the priorities for the water sector as a whole, including Government
social policies, so I would assume that the social goods that
Government want out of the water sector would be included in that.
But even before that there is an opportunity to move this forward
because this is the opportunity to put the tools in place through
regulations, and I think that is in train at the moment.
Q12 Thomas Docherty:
Going back to the point you made earlier about how water is perceived,
I think the phrase often used is "valueless commodity".
You said that you felt it needed to be challenged. For example,
we recognise that there is both a monetary and environmental cost
to electricity. Could you expand on what steps you think should
be taken to get that across to the customer?
Regina Finn: There
are two aspects to this. There is the end customer, the household
customers who use water and their understanding of its value,
and, from the point of view of our regulatory framework, there
is a need to ensure that the sector that is delivering the water
understands the value. Just to unpick the two of them--both are
very important--this sector has invested £90 billion
and that is what the average bill of £339 goes to pay for.
It is a huge amount of money, and it is going to be more. In
deciding what to invest in, water companies make choices, and
when they make choices they add up the costs and benefits. For
example, in a water-scarce area or where a river such as the Thames
is over-abstracted and we do not want to abstract more from that
river, clearly, water has a value there, but there is not a monetary
value on it. Then we have areas of the country where there is
excess water. If a company in the Thames area that has to satisfy
its customers thinks it will have a water shortage, it may well
want to build a new reservoir or desalination plant because those
are the options. As you say, the water it takes out of the environment
is not valued. If there was a relative value on that compared
with an area where water is plentiful, instead of building a desalination
plant it might build a pipeline and move some water from the water-rich
to the water-poor area.
That is a made-up example, but we think it is important
to use some market forces to reveal that value within the value
chain so that companies can make sustainable investment choices.
That means they should not invest in things we do not need but
in things we do need, and we think that should be at a lower cost
to customers overall. That is the first place where we see valuing
water as being of fundamental importance. We think the tools
are perhaps a degree of water trading between companies and the
ability to trade abstraction licences. We have a project with
the Environment Agency to help develop that.
At the customer end, undoubtedly there is more we
need to do in terms of customers' understanding of how valuable
the product is. The purist approach is to say that you respond
to price signals and if the price goes up you will be more careful
about it, and that is true to a degree. We do see that metering
customers gives them fair signals about how much they are using
and then they can understand to conserve water, and that is true
to a degree. But one of the things we want to learn more about--it
is part of the work we are doing and in our review--is whether
there are other ways to engage with consumers and help them change
their behaviour. The buzzword is 'nudge economics' or 'behavioural
economics', which just means: how can we understand what drives
the choices that customers make so we can help inform their behaviour?
It is not always just price; it is many other things as well.
We think that is a piece of research and work we need to do.
We think water companies need to do it and engage with their
customers. We have set water efficiency targets that require
water companies to drive water efficiency through their customer
base and get them to use water more efficiently. We have done
a number of things there already, but there is more to be done
on how customers see and value water.
Chair: We shall be coming
to some of these items.
Q13 Tom Blenkinsop:
Has Ofwat quantified the potential benefits to be gained from
lowering the threshold for competition in water supply?
Regina Finn: We
provided input to the Cave review. Martin Cave's review did a
cost-benefit analysis on lowering the threshold to allow for competition,
so the answer is, "No, but yes," in that we provided
data and information for Martin to do that cost-benefit analysis
and worked with him and his team. That is why Martin Cave's report
to the Government based on that cost-benefit analysis showed a
positive net benefit and recommended that the threshold be reduced,
so we gave that information and helped do that analysis.
Q14 Tom Blenkinsop:
Could Ofwat have been more proactive in progressing competition
under the current legislative framework given the anticipated
benefits for the customer?
Regina Finn: We
have highlighted that the current legislative framework has difficulties.
When we talk about the areas where we would like to see change
they are to give us more flexible and proactive tools to develop
the competitive regime. Having been through market liberalisations
before, I recognise that it is very reactive. The current regime
says that somebody really has to want to come into the market;
they have to come along and try to negotiate getting into the
market and only when it all fails can they go to Ofwat and only
then can Ofwat try to help. Traditionally, when you are trying
to open a market that is a huge barrier and cost for a new company.
It has no guarantee that it will get in; it has no idea if it
will get over the hurdles.
We would like to see a more structured framework
whereby ex ante--that is, up front—a new entrant can see
how he can get into the market, what the terms and conditions
are, what it has to do, how to get a licence, how to connect and
what it has to pay. We have been working on that. Under the
legislation we are not allowed to set ex ante prices—it
is too restrictive—but we have been preparing the ground
as to how we would do a lot of that on the basis that, if the
Cave recommendations were to be taken forward, we would be able
to develop the tools to do that. We think it is a bit restrictive,
including the cost principle that sets the access-pricing regime
and restricts how we can do that. Could Ofwat do more? We can
always do more, but I think that the framework as it is will not
work; it does need change.
Q15 Tom Blenkinsop:
Earlier you brought up the point about customer-led intelligence
and priorities. How will you ensure that customer interests are
protected during the review of your organisation? What do you
believe is a reasonable timeframe for the review and the knock-on
changes that will obviously affect it?
Regina Finn: In
the first instance we are reviewing how we use our tools and throughout
that our central ethos and duty is to protect the interests of
consumers now and in the long term, so I can assure you that customers'
interests are at the heart of everything we do when we look at
how we use our tools. When we look at the wider review of Ofwat
that Defra is doing, how we sit within the broader water policy
framework, ultimately even in the White Paper, and how all of
that work is taken forward, we will be making sure that in our
representations and submissions the interests of the consumer
are strongly represented because that is what we are there to
do. There are other routes by which the consumer voice will be
heard: through CC Water, to whom you will be talking later, and
business forum customers as well. They can stand up and give
their own views in that review, which is good, but in so far as
we continue to have a duty to protect customers I can assure you
we will do everything in our power to make sure their interests
are represented.
The timetable is a bit tight before we come to set
price limits again. Ideally, if the review carries on over the
winter and Christmas we would like to see it coming out with ideas
in time to feed into the White Paper which will be published in
the summer. If that is published in the summer we think that
will be very helpful, because we will be able to think about that
as we set our framework for setting prices. I think that timetable
would work. The one wild card is that, if some of the issues
in the White Paper need legislative proposals, we would want to
know very quickly what the legislative timetable would be for
that to provide clarity and a road map. You can deal with change
but usually you need a road map to manage it.
Q16 Tom Blenkinsop:
Just one last question: if water companies are to be required
to separate retail from network operations what is Ofwat's calculation
of the impact on water companies' costs?
Regina Finn: First,
we have developed a system called accounting separation whereby
we get companies to account for their retail business and their
network business. That is one of the first things we need to
do to try to understand costs. Second, we have asked companies
for their views of the costs of separating out their business.
We know there is a wide range. Some companies that have structured
their business with a separate customer arm can do it quite easily
because they have their billing systems and account managers.
They have set it up that way anyway. Other companies have not
set it up and think it will be a more difficult job because they
have to separate out their retail units. That is a function of
how a company runs its business and sets itself up. It is not
necessarily a function of separating a business; it is a function
of where they are coming from. That will differ from company
to company. We look to companies in the first instance for their
estimates of that.
Keith Mason: I
think the proportion of total costs for a company represented
by retail is not that large; on average it is probably only 10%.
As Regina said, there is a wide spread around that and for some
companies it is much smaller than 10%; for some companies it is
a lot bigger. In those companies where it is quite large they
have to work out exactly why their costs are so high, but it is
just not a big proportion of the total costs. Some companies
have structures such that it will be easier for them to move;
others do not, and perhaps others have taken time. They probably
do these things only once every 10 years, but they have to upgrade
their customer billings systems in any event, and those with more
modern systems will probably find it easier to do than those that
still have relatively old systems.
Q17 Chair:
In your view is the Scottish model working?
Regina Finn: The
Scottish model has given us quite a lot of information and is
very helpful. We are conscious it is coming from a different
base because it is one company that is publicly owned and has
split off Scottish Business Stream, which is the business side
of serving business customers of that publicly owned company.
There are then a small number of competitors in there. We hear
from colleagues in Scotland--we look at what they are doing quite
frequently--that that has driven down overall costs and driven
up quality of service significantly. I hear personally from big
customers that it is the driven-up quality of service that has
been the most outstanding thing for them. They are so pleased
to get one electronic bill for their site instead of 560 paper
bills, and that is a benefit to any business; it is taking a cost
out of the business at a difficult time. We have heard that anecdotally.
We certainly have seen figures that show that the total cost
has been driven down; and we have heard from some of the English
water companies that have become competitors up there. They feel
that there are some learning points to come out of it for our
sector as well, so overall the answer is, yes, it is working and
delivering benefits. It is not an exact map across to what we
do in England because we have a different situation, but there
are good lessons to be learned.
Q18 Neil Parish:
You have talked a bit about the Anna Walker report. One of her
conclusions was that the current charging system is creaking at
the seams. Does Ofwat agree? Under what circumstances should
water companies be mandated to require all customers to have metered
supply? Should these be intelligent meters in all cases? The
final facet of the question is: how does Ofwat think the regulatory
framework can help to keep down the costs of metering and ensure
that affordability is not compromised for larger water users on
low incomes?
Regina Finn: The
first thing to say is that the charging system that we have, albeit
we can bring it into disrepute, has delivered an awful lot of
benefits and water bills are a hell of a lot lower than energy
bills. The average water and sewerage bill at £339 is a
lot lower than the average energy bill, so we start from a good
position. We think Anna is right in that the issue of affordability
and the level of a water bill for some customers is now on their
agenda whereas it may not have been in the past, so we think that
is true. It is also true that we see other pressures on the system.
Where a company has already metered a high proportion of its
customers and they have moved on to metered charges there is a
consequential impact on the unmetered customers because their
bills are going up. Those issues are creaking; I agree we need
to address those. We need to address the core issue of affordability
and find out who is vulnerable and having difficulties and have
a framework to help them.
We also need a framework to help manage the impact
of that metering roll-out. One example is Southern Water. We
have approved near-universal metering roll-out for them. When
they started to consider how they would do that we found that
it would have big impacts on some customers. Some would be big
winners; some would be big losers, and we have made the company
work very hard on a transition programme that helps manage the
transition; otherwise, it will not be acceptable to customers.
We think that customer legitimacy is very important when you
change charges.
As to metering generally, we think it is the fairest
way to pay. The rateable value system that we use is creaking
and the inherent cross-subsidy in it, depending on the size of
the house you live in, is not well targeted; it does not necessarily
help the people who need it most. We think that is true. Anna
recommended that companies should be able to meter compulsorily
where it is cost-beneficial. Clearly, that is a policy choice.
It is a choice for ministers and so it is not one that we would
make, but we will help with the analysis to see whether that would
be more cost-beneficial for customers. The argument is that,
for example, at the moment in a water-stressed area companies
can choose to meter compulsorily and that is why Southern is doing
it. If it were cost-beneficial to roll out meters by street instead
of by individual household, then under Anna's proposals it would
be possible to do that. I know that is a proposal on which ministers
will be consulting over the winter in parallel with preparations
for the White Paper. That is a policy choice.
As to what we can do, with Southern it is almost
like working with a test case. We can gather that data and information
about what happens when you do this to help inform the policy
choices of ministers. That is really important. We are learning
a lot from the process that Southern is going through. We can
help with development of these transitional mechanisms whereby
tariffs will be phased in over time, and I think that within any
framework the Government sets around social policy on affordability
we can implement anything like that that helps target vulnerable
people. If you are moving on to more meters you will be unwinding
cross-subsidies for people who do not need them and some people
who do need them. You need to find those and make sure that they
are helped through that transition. We are working closely with
Southern as a case study and we will work with other companies
that want to do more compulsory metering. Following any final
decision by ministers on how this is to be rolled out, our job
will be to make sure the evidence base and cost-benefit methodology
is clear and helps inform those decisions.
Q19 Neil Parish:
But you would largely support metering?
Regina Finn: We
would agree that metering is definitely the fairest way to pay
and I think customers also agree with that. The main issue is
that customers generally like choice, so compulsion feels uncomfortable
to them, but they recognise that it is the fairest way to pay.
Q20 Neil Parish:
What regulatory changes are required to reduce the level of bad
debt for water? We talked about £12 on the customers who
do pay, and we talked about the people who cannot pay, but how
can you distinguish between those who can't pay and those who
won't pay?
Regina Finn: If
we could do that, we would not have £1.6 billion of revenue
outstanding. That is exactly the difficulty with which water
companies are grappling. Frankly, they are in the front line;
it is their customers. We are a small organisation regulating
20-odd companies around the country. It is those 20-odd companies
that have a relationship with their millions of customers. They
are the ones that need to understand their customers better and
the characteristics of the "won't pays". Some of them
do: some of them are transient student populations, some of them
are tenants and things like that, but we think that in the first
instance it is a matter for companies to do that. What we do
is collect information on their bad debt collection policies and
how they do this. We publish best practice; we compare them and
try to show them the best of the best. We continually drive forward
new ways to do it, but we cannot do that; we are not in the front
line; companies must do it.
From a regulatory point of view we have supported
the introduction of proposals to make landlords more responsible
because they account for a big bunch of the 'won't pays', if I
may call them that. Rather like the energy bill, if there is
somebody with whom the water company has a relationship effectively,
they can seek payment from that individual. Consultation is taking
place at the moment on draft regulations on that point. Ultimately,
a water company does not have a contract with its household customer
in the way you would have a contract with your energy supplier.
The water company does not have a contract; it has a duty to
supply the premises. It may be there is a possibility of making
that relationship more contractual in future. It is not, strictly
speaking, a water regulation issue; it is a customer contract
issue that could be considered in the longer term.
Q21 George Eustice:
On the subject of the Walker review and specifically the South
West, Anna Walker recognised there was real unfairness there,
and, as a result, bills in the South West are significantly higher.
What options are you looking at now seriously? I know that the
Government has asked you for feedback in this area.
Regina Finn: Anna
was asked to look at this issue. In the South West water customers
pay the highest bills in the country. Anna identified, broadly
speaking, three groups of options and they are the ones we have
been looking at, but we have looked around the margins. The three
groups of options are: first, if there were to be a financial
injection into the South West, such that all bills could be reduced
by a flat £50, how could that be done? We have had a look
at that and how much it would cost. It would cost about £750 million.
That would have to come from somewhere. That is not a choice
we would make; obviously, that is a policy choice, but an injection
of about £750 million would reduce bills overall. We have
modelled that and we will be providing that data to Defra Ministers.
The second set of options--there is a whole subset
within it--is to do with what you might call a cross-subsidy.
Anna suggested there could be a cross-subsidy from water bill
payers in the rest of the country to the South West. We have
modelled what that might look like and we are working on the figures
to see how much that cross-subsidy would need to be to bring bills
down by about £50. We have to remember a couple of things.
First, even by bringing bills down by an average of £50
they will still be among the highest in the country. Second,
what is the rationale for any such cross-subsidy? What is the
basis and reason for that cross-subsidy? Clearly, there would
have to be equity and fairness. If the cross-subsidy was to pay
for an environmental good we would have to consider whether there
might need to be other cross-subsidies in future to pay for environmental
goods, so the comparison is: if the cross-subsidy was to pay for
the environmental good of clean beaches in the South West there
might be an argument to say that the building of the Thames Tideway
tunnel to clean up the Thames river is an environmental good and
there should be a national cross-subsidy for that. Therefore,
there is a question for policymakers as to what they want around
that, but we are modelling those options so as to provide the
evidence of who would be impacted, how much it would cost and
how much money that would bring into the area. There are a number
of options around that.
The final set of options as to what could be done
is focused less on the high bills and just reducing everybody's
bills. Remember, some people in the South West can afford their
bills, but there are some who genuinely have affordability issues
because of those high bills. That set of solutions is a different
one. There we are looking at whether there are any packages of
options, including water efficiency advice, or particularly targeted
subsidies, or assistance for vulnerable customers in particular,
that could help with their bills, which would address the affordability
concern, but not necessarily the overall concern about high bills.
There are lots of subsets or variations within that, but broadly
speaking those are the three areas on which we are punching the
numbers.
Q22 George Eustice:
To press you on the second one, from memory I think Anna Walker's
report estimated that to get a reduction of £50 to £100
in the South West it would add about 13p per month to the average
household bill in other parts of the country. Are your figures
in that ballpark?
Regina Finn: We
are working on the figures. We have talked to a number of MPs
in the South West before about this work, and we have said we
will share that work with them at the same time we share it with
ministers. I think we shall be doing that on the 21st of this
month. I do not have the final figures yet, but you are very
welcome to come along to that briefing. At the moment I think
our figures will show--they are still moving--that the amount
on everybody's bill around the country would be a couple of pounds
and it would reduce bills in the South West only by about £50.
I put a caveat on those numbers because we are still finalising
them, but we shall be talking through those numbers with both
the Minister and South West MPs to explain what it looks like.
George Eustice: You will
appreciate that the second option is the favoured and fairest
one as far as we in the South West are concerned. When it comes
to the criteria, clearly the point is that the real unfairness
came about because, when South West Water was privatised, inadequate
account was taken of the fact that EU legislation was around the
corner that would require it to do this work. It was not just
an environmental improvement; it was required by law. Obviously,
that is the difference between that and the Thames project to
which you referred. It is also the fact that, because of the
very low population in the South West, that unfairness has led
to a huge spike in bills, whereas London with a population of
millions can absorb it more easily.
Q23 Neil Parish:
Can I add to that? The big problem in the West Country is that
it has 3% of the population and 30% of the beaches.
Regina Finn: I
am not arguing here about history, gentlemen; my job is to implement
the regulatory regime within the framework of the policy that
Government sets, and that is what we are going to do. I am suggesting
that we need to be coherent and consistent. We will model the
numbers and show the options. It is not our decision; obviously,
it is a policy decision. Our job is to work within the Government's
policy framework and be accountable to Parliament, which we will
do. What we have agreed to do is share the information with this
Committee, other MPs and Ministers so everybody understands the
impacts. Anna did look at why bills are so high. Frankly, one
of the key reasons bills are high is that in the South West there
was no sewerage system and the population was dumping sewage straight
into the sea. That was what we did and to do that in a modern
society is not acceptable. I think that is the core reason.
Q24 Dan Rogerson:
Based on that, Ofwat having been the regulator over the period
since privatisation, do you think it has done a good enough job
for the people in the South West in terms of regulating and
allowing that disparity to occur? I appreciate the reasons for
not calling for legislative change and for something like this
to happen earlier. How has Ofwat responded to this over the past
20 years?
Regina Finn: Frankly,
not just Ofwat but the regulatory regime as a whole has served
customers extraordinarily well. Looking back 20 years not just
at the South West but elsewhere in the country, I think we had
a reputation as the dirty man of Europe; we had appalling river
and water quality; pretty poor customer service; we had crumbling
and, in some cases, no infrastructure, which was the case in the
South West; a need for investment; and no money. The independence,
transparency and certainty of the regulatory regime that was set
up enabled £90 billion to be invested in the sector. I said
earlier that customers' priority is that the water coming out
of the tap is clean. They have become so used to it because of
that regime. Average bills have been kept about £110 lower
than they would have been without the regulatory regime. That
rigour has applied to the South West just as it has applied to
the rest of the country. Working within the policy framework
and delivering on our duty to protect consumers now and in the
long term, I believe Ofwat has done a pretty good job within the
framework it has been given. There is more to be done in future
and that is why we are now talking about reviews. I think there
are opportunities and challenges we need to rise to, but we are
lucky because we have quite a good platform on which to do that.
Q25 George Eustice:
I want to move on to the second point about water efficiency on
which you touched earlier. Do you think that Ofwat's remit needs
to be changed to reflect that and give it greater focus? A second
linked point, which you also touched on, is about the market incentives
to prioritise water efficiency. You talked about abstraction
licences. Can you expand a little on how that might work?
Regina Finn: To
be honest, our overarching duty allows us as an organisation to
have a vision called Sustainable Water, which is about long-term
sustainability for the environment, customers and the sector's
security. I think that enables us to consider the role of water
efficiency and its importance because it is one part of a bigger
picture. I do not think we need any change in duties, and the
evidence for it is that, for example, we have imposed water efficiency
targets on companies, which never existed before; in other words,
we have required them to deliver more water efficiency over time.
In the five-year periodic review, along with water efficiency
targets, metering and fixing leakage, we shall gain more water
out of the savings side than the new resource development side.
Therefore, it is already well embedded in our vision and in our
communication with companies on how they do their business planning
that we must make this sustainable, and that includes managing
water wisely and efficiently.
That message is there. I do think, as I said earlier,
there is a lot more to do here. The concept is one of valuing
a scarce resource and making sure we use it wisely, not just in
terms of how it comes out of the tap but in terms of where we
take it from and move it to, how far we move it and whether we
build a new large reservoir or move some water around. Those
choices need to be informed more by the long-term sustainable
impact that they have on our environment and society. That is
what I mean by revealing the value of water in what we call "upstreams"
where choices are being made about what to invest in. The example
I gave was that a company might decide that if it needed extra
water it would be cheaper to buy it from a neighbouring company
as opposed to building a new reservoir or treatment plant. If
two companies on either side of their boundary needed more treated
water, you might find them both building treatment plants, on
each side, with the carbon impact that has and the investment
cost to the two sets of customers, whereas one plant and a sharing
of water might be sufficient, but because there is not a value
on the water those companies cannot make that calculation and
do not have an incentive to deliver the more sustainable solution.
That is where we want to see potential change in the framework
and do more and drive a flexible framework that will help companies
make better decisions in the long term.
Q26 Chair:
What is your view on water abstraction?
Regina Finn: Water
abstraction and the licensing of it is done by the Environment
Agency, so clearly the Environment Agency is in the lead here.
We have had a project going with the Environment Agency which
itself is looking at how we can deliver a more sustainable level
of abstraction. There are parts of the country where there is
over-abstraction, as in too much water has been taken out; there
are parts where there is over-licensing. Maybe not all of it
is being used but it is licensed to be used. We have been working
with the Environment Agency to try to help them develop tools
to restore a more sustainable abstraction level. We have been
exploring with them the possibility of abstraction licence trading
whereby, if the holders of the licences can trade them, the water
will be used in the more valuable areas and the unsustainable
abstractions, which will be high cost, will be traded out. That
is a nice idea but it is a complex one. That is a long-term project
on which we are working with the Environment Agency. Clearly,
we have a common goal, which is to get the water valued and used
efficiently for society and the environment, but we recognise
that it is a complex issue on which we need to work with them.
Q27 Chair:
The Environment Agency is looking for a voluntary approach on
the sharing of information on water supply and demand purposes,
particularly for energy, agriculture, navigation, industry and
commerce. Do you go along with that view, and do you think there
is a role for Ofwat as a regulator in that regard?
Regina Finn: Our
role is the economic regulation of the water industry. We do
not have a role in regulating the other sectors that abstract
and use water. Clearly, there is a wider stage that the Environment
Agency needs to consider as opposed to the area that we regulate
which is just water companies. There are significant interactions
between water companies as water users and abstractors. I think
they account for about half the water that is abstracted. As
you say, there are power companies and everybody else who have
abstraction licences. Our view is that better information and
clearer processes for trading licences should help, and that is
part of the project we are talking about.
Q28 Bill Esterson:
I want to ask about linking energy saving and water efficiency
and get your views on the regulatory issues and what prospects
there are for Ofwat and Ofgem (Office of the Gas and Electricity
Markets) to work more closely together.
Regina Finn: This
is a really interesting topic; there is a lot we do not know about
yet but there is a good deal of potential.
Keith Mason: Heating
water in the house accounts for about 25% of electricity bills.
We think that is a very important link and one that is perhaps
not made across both parties. We also think that smart meters,
to which we referred before--but we did not pick up the point--could
be useful, and we are exploring with Ofgem how we can piggyback
a little bit on their roll-out of smart meters and learn from
what they are doing there. There is a cost-benefit point to smart
meters in that they give you a lot more information. They certainly
give the companies a lot more in terms of good or different types
of tariffs that they cannot do now. They are more expensive to
buy and put in, but they certainly have operating cost savings.
Therefore, there is a cost-benefit trade-off, but it is important
that we explore with Ofgem how we can join together because there
are a lot of links between water and energy, not least the point
about heating water, which produces a lot of carbon and is expensive
for customers.
Regina Finn: To
add to that, we have worked with Ofgem as they have developed
what they call their Smart Meter Prospectus to make sure it is
possible, in the case of water, for that information at some stage
in the future to be sent over the same data protocol so as not
to close down options. The extra bit in this is that you have
energy and water but, interestingly, you have carbon. If you
could reduce your water wastage and maybe not heat as much water
and then let it cool down again and, therefore, save energy, you
would also save carbon, so there could be a virtuous cycle here.
How smart meters will deliver that information and help us get
there I do not know, but potentially it is quite exciting.
Q29 Bill Esterson:
What about some of the current barriers where companies cannot
claim credits for savings from the same device?
Regina Finn: We
have talked to Waterwise, the Energy Savings Trust and Ofgem about
that. We can see the concern there and we are working to try
to see if there is a way to resolve it. We agree that is something
that needs to be dealt with. We are conscious of it and are trying
to deal with it.
Q30 Tom Blenkinsop:
In terms of joined-up thinking, recommendation 39 of the
Pitt review says: "The Government should urgently put in
place a fully funded national capability for flood rescue, with
Fire and Rescue Authorities playing a leading role, underpinned
as necessary by a statutory duty." Do you think if that
was put in place it would reassure local authorities about further
expansion of sustainable drainage systems?
Regina Finn: Obviously,
the Pitt review talked about Sustainable Drainage Systems (SUDS)
and other drainage issues but was talking much more widely about
flooding of the landscape. The issue of a national flood authority
or the Environment Agency's role is outside our remit. It is
for Government to decide what structures it wants to put around
that. For us the important thing is the word "sustainable",
so it is how we can make our drainage system sustainable in the
long term. We have all seen what happens with floods. Keith
mentioned customers' priorities. If there is sewer flooding it
is an absolutely awful thing to happen to anybody. We need to
think about how we can manage that, and sustainable urban drainage
systems are a part of that because they are necessarily a way
of stopping water getting into the drainage system and causing
flooding.
We have encouraged and allowed water companies to
adopt those or build on them where they are the best solution
instead of building more sewers because, frankly, digging up all
the sewers and making them super-sized will not make this problem
go away, and it would be enormously costly. I think our role
is to ensure that the sewerage companies try to make sure they
deliver their services in the most sustainable ways. Michael
Pitt's review talked a lot about who is responsible for these
things and joining up these things a bit better. I know that
the Flood and Water Management Act went some way towards implementing
those recommendations. Our view would be that there is more to
be done to clarify rules and understand who is responsible for
what beyond water companies. I am not talking just about water
companies here; you mentioned local authorities. I think--
Q31 Chair:
I want to come in here because this is my pet subject. You will
recall that at the Committee stage there was a proposed amendment
that did not find favour. Does Ofwat have a view about who should
own SUDS in all their various forms, whether they are highway,
ponds or whatever? First, who should own them? Second, who should
maintain them? Should it be the local authorities or the water
companies? I think it would be a mess to do both, but do you
have a view?
Regina Finn: Our
view is that the problem with SUDS means an awful lot of things.
In some cases it is a big engineering project and a water company
should build it because it is exactly part of its infrastructure,
and it really helps in terms of being cost beneficial, diverting
flood water and making sure it does not go into its drains. We
would encourage them and allow them to have it, manage it, fund
it and for customers to pay for it. I think water companies largely
have the expertise to deal with that type of asset and they should
do that.
I am not sure that water customers should pay for,
and therefore water companies should manage, every type of SUDS
because some are local solutions, which I think are more appropriate
to local authorities. I think the key here is the one you have
hit upon: who has the skill-set to maintain and manage these things?
That is the bit that needs to be clarified, along with who pays
for them. You can do that a number of ways. We see a lot of
contracting and out-sourcing. You get people who are good at
something and you pay them to do it. From our point of view you
will not be surprised to hear that the important thing is to protect
water customers and make sure they are paying for the service
they get, not for protection for other people, and we would be
keen that that be clarified.
Q32 Chair:
There are two points. One is existing SUDS as you have mentioned.
The worry is that we do not know where they are, who necessarily
who owns them and whether they are being maintained at all. The
other is future SUDS. I do not want to put words into your mouth,
but it strikes me that the local authority should be responsible
for the planning and development of new SUDS, but responsibility
should pass to the water companies both to engineer them and maintain
them afterwards. But it strikes me that in the Bill the difference
between existing and future SUDS is a bit of a grey area. Do
you agree?
Regina Finn: My
concern--I think we said it at the time--is that the entity that
is planning and requiring somebody to spend money to do something
should be the entity that is responsible to the people who have
to pay for that. We would be very concerned if water companies
or local authorities were able to tell sewerage companies to build
things, whether or not those companies wanted to or thought it
was a good idea, and that had to be paid for by the sewerage companies'
customers. We do not think that would be a good result for customers.
Essentially, if you take away accountability--effectively, the
sewerage companies are accountable for draining their areas--and
let somebody else dream up what to do you break that link. That
is a very bad thing for customers. We think that is extremely
important.
In terms of new SUDS, water companies may plan and
opt to use SUDS because they are cost beneficial; they are the
best thing to do instead of building a new sewer or link. We
think that is absolutely sensible. We would be concerned if a
local authority decided that a SUDS was needed, but it was not
cost beneficial and it should not be there, and the water company
was somehow required to deliver that asset. That would be unfair
to customers. I think it is the governance that needs to be sorted
out. Who is accountable? Whoever makes the decision should be
accountable to the customers who have to pay for it.
Q33 Chair:
But in one sense do not the same people who pay either way? All
of us are either council taxpayers in the area of the SUDS or
water company customers. The question is how the funds are raised.
Regina Finn: What
I am saying is that, through our regulation, a water and sewerage
company has a responsibility to ensure they deliver fairly for
their customers. They have a responsibility to listen to their
customers and show that something is cost beneficial for those
customers. We already have a situation where sometimes, because
of legislation, a water company has to do something that is not
cost beneficial, so customers have to pay for it. It may be an
environmental improvement for which they have to pay. That is
a difficult issue. What I am trying to say is that, in terms
of the choice of what needs to be built, where, why and how much
it will cost, the entity that is doing that should be the one
responsible for collecting the money and paying for it; otherwise,
you lose accountability. We are part of the public sector. It
is hard to hold a public sector organisation accountable for a
spend that it does not have to justify because it is coming from
somebody else's bill. That is what is important.
Q34 Chair:
What would you like to see in the comprehensive Water Bill that
we are expecting after the White Paper? Do you have any indication
of when we might expect it?
Regina Finn: What
we are really positive about is the nature of the reviews that
are taking place now and their timing. It is a good opportunity
for us to think about how we can improve the regime and make it
more sustainable, to use that buzzword. We will be feeding our
views on the key issues into the Water White Paper response and
the Defra review, but, if I were to focus at quite a high level
on some of the things that we think are important, the first one
would be that we need the tools to ensure we reveal the value
of water throughout this value chain and start to understand how
companies can make the best possible investment decisions now
and for future generations. We think there are a number of tweaks
to the legislation that would be needed to help us do that, and
we will be explaining those. That includes using market forces
where we can through water trading and the possibility of an interface
with the Environment Agency around abstraction licences. I think
that will be a very important area for any future legislation
to look at.
The second area that we think is very important is
that we do not want to write legislation every two years; we want
to ensure that we put in place a framework that will stick the
pace and will be flexible enough as the challenges that we know
are there become real. We know there is climate change and weather
volatility. We do not quite know how it will pan out, but we
need to be ready to adapt to that. Therefore, I think we need
a modern, transparent and potentially simplified regulatory regime.
To come back to the example about licences: instead of having
quite a complex set of 21 old licences that has grown up over
21 years, with different clauses everywhere, if we streamline
them into a more modern, modular licensed approach we can perhaps
have a more flexible regulatory regime so it is clearer to everybody
what their obligations are and it will allow us to manage it more
effectively.
The third set of things that probably needs to be
there is essentially what was left over from Martin Cave's and
Anna Walker's reviews—the issues that were not tackled because
of the time through the Flood and Water Management Act. I think
they are important issues about innovation, giving business customers
the choice that they really want right now, particularly when
they are trying to survive in a tough economic climate, and affordability,
social policy and frameworks for social assistance for vulnerable
customers. All of those matters raised in the two reports would
be the third area I would like to see addressed in this legislation.
Q35 Chair:
To be clear, you think they require legislation and have not been
fully dealt with?
Regina Finn: Some
of them do, yes.
Q36 Chair:
I want to ask a very technical question. Where a plumber has
repaired a wastewater pipe in someone's home and unfortunately
it has been connected to the surface water system, which clearly
should not happen because it is causing damage to the main infrastructure,
in your view who should pay?
Regina Finn: This
is the issue of misconnection and whether there should be some
regime to deal with it. Keith, do you want to handle that?
Keith Mason: I
think we will have to come back on that one. Initially, you would
go back to the person who had misconnected it in the first instance.
That will probably be the developer. One suspects they are unlikely
to be around some time later, but perhaps we can write to you
on that particular point.
Q37 Chair:
That would certainly be helpful. One other point on which perhaps
you can write to us is the percentage of non-paying domestic customers.
I think it is well documented, but can we have that figure for
our inquiry?
Regina Finn: The
percentage of bad debt that comes from domestic households?
Q38 Chair:
Yes.
Regina Finn: We
will get that for you.
Chair: Thank you both
for being so generous with your time. I am sure we will have
many opportunities over the coming months and years to invite
you back.
1 Note by witness: Recent 2009-10 figures show that
this figure is now £14. Back
| 
