Environment, Food and Rural Affairs CommitteeFurther written evidence submitted by Ofwat

Introduction

1. We welcome the Government’s Natural Environment White Paper (NEWP) and the inclusion of some commitments to improving the quality of our rivers and water bodies. We are pleased to have the opportunity to contribute to the Select Committee’s inquiry.

2. Following publication of the Department for Environment, Food and Rural Affairs’ discussion document, “An Invitation to Shape the Nature of England”, we were invited to respond. A copy of this response, which provides a comprehensive overview of our thoughts in this area, can be found in appendix 1.

3. Following the publication of the NEWP, we submitted a response to the Environment, Food and Rural Affairs Committee’s initial call for evidence. As the NEWP contains only a limited number of specific commitments directly relevant to our work that submission should be considered our primary contribution.

4. In order to provide greater clarity on a number of the specific issues we have already raised, and reflect the progress of work within Ofwat, we have provided some further detail in this evidence. This focuses on the Water Framework Directive and diffuse pollution, catchment management and commitments for the Water White Paper.

5. As ever, we will be happy to provide the Committee with any further information on issues relating to the water and sewerage sectors that is required.

Water Framework Directive

6. The NEWP highlights the importance of tackling diffuse pollution and meeting our obligations under the EU Water Framework Directive (WFD).

7. As we have outlined in some considerable detail in our response to Defra’s discussion document (appendix 1), the costs of meeting WFD requirements have so far fallen mostly on water and sewerage customers. While we agree with the Government’s objective of meeting our international commitments, we consider that, in future, customers should not be required to fund improvements from which they do not benefit. Nor should they deal with the impact of pollution for which they are not responsible. With potentially very large costs involved in complying with WFD commitments, it is essential that water and sewerage customers are not seen as an easy source of funding.

8. With specific regard to diffuse pollution, last year’s National Audit Office report1 confirmed that such pollution—the bulk of which is of agricultural origin—has a major impact on water quality in England. We were therefore pleased to see the NEWP commitments to:

targeted, risk-based enforcement (the need for which was stressed by the NAO);

increasing the focus of CAP agri-environment payments on schemes to tackle diffuse pollution (and pressing for a higher proportion of CAP funds to go to agri-environment schemes);

continuing the Catchment Sensitive Farming Initiative; and

encouraging voluntary action by the farming community.

9. We look forward to seeing more detail about how these commitments will be met in due course, along with the new strategy for tackling non-agricultural diffuse pollution.

Catchment Management

10. The NEWP makes reference to United Utilities’ Sustainable Catchment Management Programme (SCaMP) as a case study demonstrating the potential for adopting a payment for ecosystems service approach. A number of other water companies are piloting similar schemes that focus on using incentives to encourage more sustainable behaviour by land managers in order to reduce treatment costs. There are also a number of other potential benefits involved, such as habitat restoration and carbon storage.

11. We have recently concluded a report into these schemes that is designed to further our understanding, outline the broad approach we will take and help companies when considering these types of schemes in the future. A copy of this report is attached as appendix 2.

12. In summary, the report acknowledges that upstream catchment management schemes could be a more environmentally sustainable way of ensuring good quality drinking water with a reduced impact on customers’ bills by tackling diffuse pollution at source. Early results suggest that some catchment management schemes are beginning to deliver benefits to customers, but there is not yet enough evidence overall to show that they always deliver better water quality at a lower treatment cost. As customers are currently paying for these schemes through their water bills it is important that clear benefits accrue to them in the form of reduced costs.

13. When we set price limits in 2014, we anticipate that the water companies will propose new or continued catchment management approaches. We will expect them to have clear evidence that such schemes are likely to deliver benefits to their customers.

Water White Paper

14. We particularly welcome the commitments in the NEWP to announce changes to the abstraction regime in the Water White Paper. As we set out in our response to Defra’s discussion document, there is much to be done to restore sustainable abstraction and ensure that the value of water is understood more fully.

15. If as regulators, companies and customers we are to make sustainable choices, we need to properly understand the value of water in different locations and at different times. Understanding this value will help drive more sustainable investment decisions and may encourage the use of more innovative methods. It will also help establish the right balance between increasing supply and managing demand to ensure that we have enough water in the future.

16. Section 2.77 of the NEWP states that “the new regime will provide clearer signals to abstractors to make the necessary investments to meet water needs and protect ecosystem function”. It is important that any proposals take into account the impact of increased investment on customers’ bills and considers where innovation and better management of resources can lead to a reduction in spending, particularly on large, carbon-intensive, assets.

17. Understanding the value of water, and the ecosystem services that rely on good-quality fresh water in the right place and at the right time, is crucial to improving much of our natural environment. It is essential, when considering all the policy proposals in the NEWP—particularly those relating to whole areas or landscapes—that water is factored in as a critical component.

18. Although there is a need for these long-term reforms, in the short term we are exploring steps we can take in the price review to ensure sustainable use of water resources. When we have considered the appropriate mechanisms in this area we will be happy to brief the Committee further.

3 October 2011

APPENDIX 1

OFWAT’S RESPONSE TO THE DEPARTMENT FOR ENVIRONMENT, FOOD AND RURAL AFFAIRS DISCUSSION DOCUMENT “AN INVITATION TO SHAPE THE NATURE OF ENGLAND”

Executive Summary

We welcome the opportunity to respond to the discussion paper “An Invitation to Shape the Nature of England” published by the Department for Environment, Food and Rural Affairs (Defra) in July 2010.

The forthcoming Natural Environment White Paper (NEWP) presents a great opportunity to set out a new, locally-based and deregulatory approach that delivers for the environment and for water customers. This can be carried forward through the Water White Paper and subsequent Bill.

We agree that our natural environment underpins our economic prosperity, our health and our wellbeing. This includes providing the sources of raw water crucial for our way of life.

We have already done much to ensure that the monopoly water and sewerage companies we regulate play their part in maintaining, and improving, the natural environment, at a price that customers can afford and are willing to pay.

But, a new set of challenges pose a significant threat to continued progress. These include:

adapting to a changing and unpredictable climate (with the anticipated increase in extreme weather events putting more stress on water resources, drainage systems and infrastructure);

reducing emissions to help mitigate climate change;

population growth, particularly in south-east England where water is already scarce;

changing consumer expectations (for example, for more tailored, bespoke arrangements, as in other sectors) and lifestyle changes;

economic uncertainty, and the consequent affordability issues this raises; and

further tightening of environmental standards, including those resulting from implementation of the EU Water Framework Directive.

These challenges are different in nature, scale and complexity from those of the past. They will make delivering sustainable water and sewerage services increasingly challenging. As a result, they may require a different set of responses and approaches from the wider water and sewerage sectors.

Our response focuses on key areas where we consider new thinking and more sustainable approaches are needed. The main points of our response are set out below.

An Opportunity for Change

Water is both an essential part of the natural environment and a resource that is vital to our economy and our way of life. As such, it is crucial that we value it properly.

But, at present, there are no mechanisms to reveal this, whether it be the value of:

keeping water in the environment;

the treated wastewater returned to the environment; or

water at stages in between.

Exposing this value more clearly will drive:

more sustainable investment choices by the water companies and others;

more sustainable decisions on the location of water-intensive industries;

more sustainable decisions by water users; and

the development of markets for ecosystem services, involving local buyers and sellers of environmental goods.

We agree that the challenges set out in the discussion paper are broadly in line with those we consider the most significant to ensuring a sustainable water cycle now, and in the long term. But, in particular, we would emphasise the need to:

take a proportionate and flexible approach to mitigating and adapting to climate change;

tackle diffuse pollution; and

meet the requirements of the Water Framework Directive (WFD) in a sustainable way.

Tackling the Erosion of our Natural Value

In terms of mitigating and adapting to climate change, we suggest:

developing low-carbon, sustainable solutions to water quality challenges;

developing more sustainable planning, drainage and land management solutions to reduce the demand we place on drainage infrastructure and help avoid future “overflow” pollution of the water environment;

leaving the door open for rolling out smart metering and more joined up approaches to promoting both energy and water efficiency;

ensuring that EU legislation takes climate change properly into account, for example by not requiring compliance with fixed discharge emission standards where the environmental impact of waste water discharges is low; and

helping address unsustainable abstraction by using the value of water to incentivise bulk water trading and making the abstraction licensing system more flexible.

In terms of tackling diffuse pollution, we suggest:

where the potential benefits to customers can be identified, encouraging joint working between the companies, farmers and landowners, and other stakeholders to improve upstream catchment management;

working jointly to identify which catchment management schemes are successful and promote good practice;

urgently developing well-targeted incentives to encourage land management practices which can address diffuse pollution at source—for example, by redirecting available agri-environment funding, and by focusing the Common Agricultural Policy (CAP) more generally on delivery of environmental goods;

providing effective information to farmers and land managers to boost awareness of the unintended environmental impact of their activities;

improving baseline regulation of existing environmental standards for farmers and land managers, for example through strengthening crosscompliance provisions under the CAP; and

encouraging joint working with producers of agrochemicals and pharmaceuticals to improve products or guidance on their use.

In terms of the Water Framework Directive, we suggest:

ensuring fairer cost apportionment across sectors, in line with the “polluter pays” principle, so that a disproportionate burden does not fall on water customers;

allowing for the development of proportionate and flexible catchment-scale approaches;

taking climate change fully into account, while accepting that some change is inevitable;

taking full advantage of the possibility of allowing exemptions on grounds of disproportionate cost;

extending the disproportionate cost provision to other EU environmental legislation; and

removing inconsistencies and barriers to optimum outcomes and efficient implementation, such as the “one-out all-out” rule in defining good ecological status.

Building and Enhancing our Natural Value

There is much scope for using well-targeted incentives to encourage sustainable behaviour by all players within the water cycle.

Catchment management, and other such schemes, have the opportunity to allow best practice to be shared and good behaviour to be rewarded. Some element of regulation and penalty will still be needed to control those who act unsustainably.

With most consumers currently not metered, which contributes to a lack of understanding of the true value of water, it is important that we look at other ways that consumers can be encouraged into sustainable behaviour.

Behavioural economics is one potential solution, as is a wider appreciation of the changing value of water as a commodity.

As markets in ecosystem services develop, there will be scope to connect those who provide and maintain good quality water, with those who benefit from it. These markets can be linked in with the market forces in abstraction and water trading that we discuss elsewhere.

The water and sewerage sectors have been encouraged into more sustainable behaviour. They are required to take a long-term approach and understand their role in our natural environment, taking a holistic view. There are lessons here for some other sectors.

1. Introduction

1. We welcome the Defra discussion paper, “An Invitation to Shape the Nature of England”, published in July 2010.

2. Safeguarding our natural environment is essential to our well-being. As well as being of great aesthetic value, it provides us with a wide range of vital goods and services on which our economy depends. This includes providing sources of raw water crucial for our way of life.

3. Water is a precious resource. We turn on the tap and we take it for granted that there will always be fresh, clean water for us to use, even though there is less water available per head in many parts of England, including the south-east, than in southern Spain or Morocco.2 We rarely think about the impact on the environment of delivering clean water to our homes and businesses and taking away our wastewater for treatment.

4. Yet every day we take more than 35 billion litres of fresh water out of the environment, 15 billion litres of which is used for public water supplies.3 The remainder is used for power generation, agriculture, fish farming and other industrial uses.

1.1 The achievements we need to build on

5. We have already done much to ensure that the monopoly water and sewerage companies we regulate play their part in maintaining and improving the natural environment at a price that customers can afford and are willing to pay.

6. When the companies were privatised in 1989, some commentators considered the UK to be the “dirty man of Europe” because of our polluted beaches and rivers, and neglected water infrastructure. Poor water quality resulting from years of pollution meant some waterways were effectively lifeless.

7. But since then, the sectors have invested about £90 billion (in today’s prices) to improve services to consumers and the environment. This has enabled the companies to maintain, renew and improve their assets so that consumers can access safe and effective services while balancing and safeguarding the needs of the natural environment. They have specifically targeted about £30 billion of this investment on delivering environmental and water quality improvements. This has transformed the sectors’ environmental performance.

8. The capital required has largely been raised from investors, on the basis of continued revenue from customers’ bills, at no additional cost to taxpayers. While this means that bills have gone up as a result, our efficiency challenges have kept them about £110 lower than they would otherwise have been.

9. But it is important to bear in mind the real customer legitimacy issue that exists, when considering the share of environmental costs that fall to the water and sewerage sectors, as opposed to others across the economy.

10. Over the past 21 years, the combination of the companies’ efforts and a balanced framework of economic and environmental regulation driven by extensive water legislation—much of it at a European level—have delivered tangible benefits for consumers and the environment.

11. This has included dramatic improvements in the quality of our water, from bathing waters, rivers and other surface waters to the water that comes out of the tap. In turn, this has benefited wildlife, landscape, leisure and amenity. It has also encouraged economic regeneration (particularly in the case of city centre waterfronts).

12. So, today, for example:

98.6% of bathing waters around England and Wales meet European Union (EU) standards for water quality (78% in 1990);

more than 70% of English and some 90% of Welsh rivers are rated “good” or “very good” for water quality, representing 20 years of continuous improvement—our rivers have not been cleaner since the start of the Industrial Revolution;

119 beaches across England and Wales meet the Blue Flag standard, compared with 12 when the scheme was launched in 1987;

125 species of fish have been recorded in the River Thames, with record numbers of sea trout (there were none 50 years ago);

record numbers of salmon and sea trout have been recorded in the Tyne this year (again, there were none 50 years ago);

99.95% of drinking water complies with tough EU standards;

otters have returned to rivers in every English county, except Kent; and

leakage levels have fallen by about 35% since their peak in the mid-1990s.

13. And there is more investment to come. As a result of our 2009 price review, the companies will invest a further £5.3 billion (including work on the Thames Tideway and associated projects) between now and 2015 to maintain and improve the environment and drinking water quality. This is far more expenditure to improve the environment than that made by any other sector.

14. Much of this investment is to comply with EU legislation such as the Water Framework Directive, as well as directives governing urban wastewater treatment, freshwater fish and bathing waters. Notably, it also includes nearly £400 million for schemes directly benefiting conservation and biodiversity, including some £340 million for schemes to implement the EU Habitats Directive.

1.2 New challenges requiring a new approach

15. While this situation is far from dire, a new set of challenges poses an incremental, but significant, threat to continued progress. These include:

a changing and unpredictable climate, with the anticipated increase in extreme weather events putting more stress on water resources, drainage systems and infrastructure;

a need to reduce emissions to help mitigate climate change;

population growth, particularly in south-east England where water is already scarce;

rising consumer expectations (such as for more tailored, bespoke arrangements, as in other sectors) and lifestyle changes;

economic uncertainty and the consequent affordability issues this raises; and

further tightening of environmental standards, including those resulting from implementation of the EU Water Framework Directive (WFD).

16. These challenges are different in nature, scale and complexity from those of the past. They will make delivering sustainable water and sewerage services increasingly challenging.

17. So, a new approach is needed if the sectors are going to be able to continue to respond efficiently and effectively to future pressures, and ensure the continuing availability of reliable supplies of safe drinking water and affordable water and sewerage services.

1.3 Value of water

18. We think there is an overarching need for mechanisms that properly reveal the value of water, reflecting both changes in external circumstances and expectations as to its future availability.

19. Revealing this value to decision-makers at all levels, and at all stages of water and sewerage service delivery, would help them to make more sustainable decisions. Centrally set (or “command and control”) approaches are artificial and unresponsive. They are also becoming increasingly difficult to sustain given future uncertainties such as climate change, population trends and the need for economic development.

20. So, revealing the value of water would influence decisions on:

whether to respond to abstraction and other water supply pressures by trading water, introducing new demand management measures, tackling leakage or developing new resource capacity;

options for grey water recycling, rainwater harvesting and other local collection and storage solutions (including finding sustainable ways to address the pollution caused by spills and overflows from sewerage networks, resulting from greater pressure on the drainage infrastructure because of the expected effects of climate change); and

where to site new development.

21. Allied with this, we need to make sure that frameworks are flexible, risk-based and drive efficient responses by delivering effective signals and incentives to all players involved. Such an approach would encourage optimum solutions for consumers and the environment, for example through local catchment-level solutions and joint stakeholder working. The effect of this would be to balance cost and responsibility appropriately. It would also help to develop markets for ecosystem services.

22. We also think that specific action is necessary to:

develop tools and mechanisms to tackle diffuse water pollution;

take a shared, proportionate and flexible approach to implementing the WFD; and

mitigate and adapt to climate change, including dealing with the anticipated pressures and uncertainty from abstraction to drainage.

23. We outline these in more detail, in response to the specific questions raised in the discussion paper.

24. Our responses focus on the water and sewerage sectors, their impact on the environment, and their role in improving that environment. We do not address questions we do not consider relevant to our role. And, in order to avoid unnecessary duplication, we have referred to previous answers in places.

2. An Opportunity for Change

Defra discussion paper Q1

What do we need to do to embed the true value of our natural resources in decision-making at all levels?

25. The Defra discussion paper emphasises rightly, the link between the natural environment and our economic prosperity. Water is both a precious and essential part of the natural environment, and a resource that is vital to our economy and way of life. As such, it is essential that we value it appropriately.

26. But there are no mechanisms to reveal this value at present, whether it be the value of:

keeping water in the environment;

returning the treated wastewater returned to the environment; or

the value of water at stages in between.

27. For example, there are no price signals to deter abstractors from over- abstracting.

28. So, as well as the impact on customers’ bills, any decisions the companies make on the water and sewerage services that they provide must reflect the value of water as a resource. This must take into account:

the effect of taking water from the environment;

the carbon impacts of providing clean supplies; and

treating and disposing of used water.

29. If the value of water were exposed, it would drive the companies to make more sustainable investment choices. It would also encourage more sustainable decisions on the location of water-intensive industries, and more sustainable behaviour by water users, and by local buyers and sellers of environmental goods.

30. What we need are mechanisms that reveal the differing value of water in different locations over time, instead of relying on setting a static and artificial value of water centrally and factoring it into the decision-making process. This value would reflect changing external circumstances at a local level, and expectations of future availability.

31. Revealing the value of water in this way would avoid the danger of setting inappropriate targets that risk distorting investment decisions, and becoming irrelevant in the face of the uncertainty brought by factors such as our changing climate, population trends and development pressures.

32. The signals that these mechanisms would create would have added benefit, if coupled with other market reforms that allow the sectors to respond more flexibly. For example, more flexibility could be built into the frameworks governing trading of water abstraction licences, water entitlements and bulk water supplies.

33. This would benefit all water users (including other abstractors, such as farmers) as it would provide more options to access water when it is needed. It would also maximise the potential for moving it from places where it is in plentiful supply, to those where it is scarce.

34. Similarly, separating the retail function from other parts of the existing monopoly water companies would give the retailers the incentives to develop as water service providers. They could offer packages to customers to help them reduce their demand for water and, for industrial customers, their trade effluent.

35. The recent drought in north-west England highlighted the problems that arise when water becomes scarce—either at a point in time, as in this case, or over time as in the south-east. While a national water grid would be unfeasible, carbon intensive and very expensive, responsive mechanisms to reveal the value of water would encourage the companies to share and manage resources in more effective ways. This might allow investment to increase supply to be deferred, to the benefit of both consumers and the environment.

36. More specifically, revealing the value of water would influence a variety of decisions that the companies and consumers make every day, including:

deciding whether to use water trading (for example, through interconnecting pipes) or to develop new resources as a means of reducing unsustainable abstraction and other water sourcing (and water quality) pressures;

deciding whether to respond to supply pressures by introducing additional demand management measures (such as installing meters), tackling leakage, or building more resource capacity (particularly if carbon is properly taken into account);

the best way to develop markets for ecosystem services by identifying and bringing together providers and beneficiaries of both good quality raw water and wastewater discharges;

options for grey water recycling, rainwater harvesting and other local collection and storage solutions—which save carbon emissions associated with treatment, as well as costs, and for sustainable urban drainage solutions—which often have wildlife and amenity value;

how to maximise the value of wastewater treatment and discharge—which could help with the development of options for catchment-scale permitting, and dynamic and flexible consenting of wastewater discharges, currently being investigated by a number of companies jointly with the Environment Agency;

how to invest in solutions to reduce, or avoid, spills or overflows from the sewerage networks polluting valuable water resources; and

where to site new development, bringing about a closer relationship between the scale of economic development at particular locations, available water and the capacity for managing run-off.

37. So, revealing the value of water would influence both upstream and downstream decisions. This would drive more efficient use of resources, and reduce environmental impacts throughout the sectors. At the same time, the way we regulate prices would protect household customers from unacceptable increases or fluctuations in the amount they pay for their water. We also need to consider how further to inform and help household consumers to use water more wisely.

Defra discussion paper Q2

Have we identified the right overarching challenges for the White Paper to consider? If not, what should we focus on? How should we approach these challenges?

38. The challenges set out in the discussion paper are broadly in line with those that we consider to be the most significant to ensure sustainable water and sewerage services now and over the long term. In particular, we would emphasise the need to:

tackle diffuse pollution, which does so much to hold back progress in our rivers and streams; and

address the pressures associated with meeting the WFD in a sustainable way—one that does not unnecessarily impact on water customers’ bills or increase carbon emissions.

2.1 Tackling diffuse water pollution

39. In a recent study4 published in July 2010, the National Audit Office (NAO) estimated the cumulative cost of water pollution in England and Wales to be about £1.3 billion a year.

40. The NAO study suggested that diffuse water pollution is now the biggest challenge to improving water quality in England and Wales. According to the Environment Agency,5 agriculture is the source of about two-thirds of the diffuse pollution in watercourses in England and Wales. It contributes about 60% of nitrates, 25% of phosphates and 75% of sediments.6

41. The RSPB7 estimates that the costs of water pollution from agriculture are between £445 million and £872 million a year. Over the next five years, it will cost the companies £125 million in improved treatment capacity and processes, just to remove pesticides and nitrates in water. This is in addition to the £1.6 billion invested for this purpose since privatisation, and before energy and other operating costs are taken into account.

42. The impact of diffuse pollution on receiving waters means that water customers have to pay more both to make the water taken out of the environment fit to drink, and also to have their wastewater treated to a higher standard than normal so it can be returned to the environment. In fact, in some cases, discharges from sewage treatment works actually improve the quality of water in rivers.

43. While it is clear that the water and sewerage sectors have a role to play, we think that tools need to be developed to enable other sectors to play their part. This is so that water customers no longer bear a disproportionate amount of the cost of tackling this key challenge.

44. We need urgently to develop well-targeted incentives to encourage practices that can address diffuse pollution at source. As the NAO study stressed, we also need to improve baseline regulation of existing standards. This would deter those willing to ride roughshod over the efforts others have made.

45. Although other sources of diffuse pollution will have an impact (for example, -run-off from urban areas contributes about 14%, contaminated sites and, residential housing about 4% each, roads 3% and industrial estates 2%8), it is clear that the problem will not be addressed unless it is possible to find ways to reduce its agricultural component.

2.2 Implementing the Water Framework Directive

46. It is essential that environmental and water quality legislation, much of it set at EU level, is implemented efficiently, effectively and fairly.

47. The WFD seeks to put the water environment in a wider context, and acknowledges costs and benefits for the first time. We welcome this. But in 2008, Defra estimated that the total cost of implementing it in the UK could be between £30 billion and £100 billion across all sectors by 2027.

48. This is a huge sum, particularly given current economic difficulties. So, it is essential that the WFD is implemented as fairly and as flexibly as possible, taking full advantage of the possibility of allowing exemptions on grounds of disproportionate cost.

49. The first round of River Basin Management Plans (RBMPs) under the WFD, covering the years 2010–15, focuses on putting in place monitoring programmes, investigations and intelligence gathering, to ensure that the right pollution pressures are addressed going forward.

50. We support the need to avoid unnecessary investment. But, we consider that the flawed way in which the WFD measures progress (the “one out, all out” rule—see paragraphs 77–80) means that we are likely to see only a modest increase in the percentage of water courses in England and Wales meeting good ecological status (from 26% to 32%). Defra expects a further 2% increase because of additional local initiatives within the period.

51. At the same time, the Environment Agency expects the cost of compliance measures to rise significantly over the next two planning periods if we are to get close to meeting the WFD’s objective of good ecological status for our surface water bodies—or chemical status for groundwater—by the 2027 deadline.

52. This makes splitting costs fairly and a proportionate approach even more important. In the first cycle of RBMPs, the companies (and so their customers), are due to meet more than 82% of costs.9 This is far in excess of their impact compared with other sectors. If the current approach is unchanged, water customers could face significant bill increases (with some estimates as high as 25%) for implementing the WFD in future cycles.

2.3 Adapting to and mitigating climate change

53. We also need to ensure that legislation—and its implementation—takes into account both the impact on carbon emissions, and the need to adapt to a changing climate.

54. Climate change is one of the biggest challenges we all face. It could have a significant and permanent impact on the water cycle. This would have major implications for the long-term sustainability of the water and sewerage sectors in England and Wales.

2.3.1 Climate change adaptation

55. Work we have carried out with the Met Office shows that the frequency of extreme daily rainfall events is likely to more than double by the 2040s. Given this uncertainty, we must adopt a proportionate and risk-based approach, sharing the burden fairly between current and future water customers.

56. In this context, we need to be sure whether, in adapting to climate change, we are trying to protect and preserve the environment as it is today (making a static assumption), or planning for an environment that is evolving because of climate change that cannot be prevented. The latter clearly has lower cost implications than the former.

57. Climate change is likely to exacerbate existing problems, particularly in south-east England, where too much water is sometimes taken out of the environment through abstraction, causing damage to sensitive ecosystems, plants and wildlife.

58. Climate change is also likely to increase the pressures on drainage infrastructure, resulting in the need for further action to reduce or avoid pollution through spills and overflows from wastewater networks.

2.3.2 Climate change mitigation

59. There are clear links between water, energy and carbon. The water and sewerage sectors are currently responsible about 1.1% of UK greenhouse gas emissions, but this rises to 6% if the emissions related to water use are included (which accounts for about a quarter of all household energy use). So, the sectors will be expected to play their part in reaching the UK Government target of an 80% reduction in greenhouse gas emissions by 2050.

60. This means that it is important for the sectors to develop low-carbon, sustainable solutions to water quality challenges, such as working with land owners and managers on catchment management approaches.

61. Reducing the volume of water that individual consumers use can also help to reduce carbon emissions and abstraction pressures, as well as keeping costs for consumers down by reducing the investment needed in new resources.

62. Smart metering and the Green Deal could have a role here, and we think there could be significant benefits in rolling these out together for both energy and water use, where there is a sufficiently strong case to do so.

63. It is also important that EU legislation takes climate change properly into account. If this does not happen, water customers could end up paying for measures to comply with inflexible water quality standards governing local operations, that could have unintended and undesirable carbon consequences for the broader, global environment.

64. This is arguably already the case with the Urban Waste Water Treatment Directive, which requires compliance with fixed emission standards, irrespective of the environmental impact of wastewater discharges.

3. Tackling the Erosion of our Natural Value

Defra discussion document Q3

What are the existing policies and practices aimed at protecting England’s natural assets that currently work most effectively? What works less well?

3.1 Tackling diffuse water pollution

65. Diffuse pollution is now the biggest challenge to water quality in England and Wales. At present, the water companies use costly treatment processes to remove diffuse pollution from water supplies. Ultimately, it is customers that pay the costs of this through their bills, and we think this is neither fair nor sustainable.

66. The standard approach to dealing with pollution is to internalise the costs through the “polluter pays” principle. Making those that cause the pollution pay for the costs of removing it incentivises them to minimise the pollution they cause. So, the principle is promoted widely in measures such as the WFD, and we support its pragmatic application.

67. In our view, all sectors need to play their part in tackling diffuse pollution in order to get the most economically efficient outcome for England and Wales as a whole.

68. Whilst there is no one all-encompassing solution, we think that much could be done through a combination of:

the companies and others working with landowners and managers to improve upstream catchment management;

better targeted incentives to landowners and managers to provide public environmental goods, for example through agri-environment schemes under the Common Agricultural Policy (CAP);

better information to farmers to boost their awareness of the unintended environmental impact of some of their activities;

tighter baseline conditions for receipt of public funds by farmers and landowners, properly enforced; and

working with agrochemical and pharmaceutical manufacturers to improve either products, or their guidance on use.

69. One approach would be to focus more environmental stewardship schemes on water. Part-funded under Pillar 2 of the CAP, these schemes have traditionally targeted biodiversity and landscape improvements, rather than water quality.

70. The NAO study noted that while 70% of “entry level stewardship” options taken up had the potential to improve water quality, less than 2% had water quality protection as their primary objective. The study concluded that the impact of voluntary incentives for tackling diffuse pollution had been modest and piecemeal.

71. That is not to say that there have not been some significant changes in agricultural practice over recent years, often driven by cost pressures. The NFU has recently quoted figures10 to suggest that there has been a 33% reduction in average nitrogen application, and a 66% reduction in average phosphorus application since 1987.

72. Yet serious problems persist. For example, 11% of designated “drinking water protected areas” under the WFD in England and Wales are at risk of non-compliance because of pesticides,11 with nitrates and colour also causing problems in some areas.

73. More recently, the environmental stewardship scheme has taken steps to place greater emphasis on resource protection, including water. This may have an effect, as may the Government-funded catchment sensitive farming initiative (despite NAO criticism of its effectiveness), and voluntary initiatives such as the campaign for the farmed environment, the voluntary initiative on pesticides and the NFU’s “tried and tested” guidance on optimising nutrient use.

74. But, we think we need to rethink how farmers are incentivised to deliver public goods. We discuss this in more detail in paragraphs 117–120.

3.2 Implementing the Water Framework Directive

75. The WFD has introduced a legal framework for the sustainable management of water resources across Europe. Under its provisions, each Member State is expected to draw up management plans for its designated river basins. The RBMPs drawn up for England and Wales show the extent of the water quality, and quantity, pressures from a variety of sources.

APPORTIONED COSTS—FIRST STAGE RBMPS

82.4%	Water companies and customers
12.9%	Environment Agency
3.5%	HMG
0.6%	Angling and conservation bodies
0.2%	Industry
0.2%	Navigation and ports
0.1%	Agriculture

76. Although it may be easier for the companies to pass these costs on to their customers (and the companies have a good record of delivery), this is not consistent with either the “polluter pays” principle approach, or current concerns about rising affordability problems for water bill payers. Neither does it address the environmental impact of the water pollution.

77. The way that good ecological status is defined under the WFD means that achieving compliance will be enormously expensive.

78. Many of the improvements to the more than 14,000 kilometres of water bodies provided for in the RBMPs will not count toward the good ecological status required under the WFD. This is because the criteria used to determine if a water body in a particular catchment achieves good ecological status reflect 37 water quality measures. These include the aquatic life found in the water, as well as the biological or chemical composition of the water at particular locations.

79. But using these criteria is not straightforward. For example, low levels of migratory fish in a particular catchment may be the result of physical barriers such as dams rather than water quality. Overfishing may also be a problem in certain areas.

80. As things stand, an individual catchment can meet almost all of the criteria for good ecological status, but still be classed as failing. Because a single failure against any indicator means the water body cannot be classified as “improved”. This has become known as the “one out, all out” rule. According to the Environment Agency, a third of water bodies missed out on “good” status by just one of the 37 indicators.12

81. To illustrate this, when the Environment Agency rated rivers in England on their chemical and biological water quality in 2009, more than 70% were classed as “fair” or “better”.13 And yet, only 26% of those same rivers meet the good ecological status required under the WFD. Such conflicting messages are very unhelpful.

82. The WFD also works against efficient and effective measures in other ways. For example, the “no deterioration” rule means that in theory it is not possible to improve 10 water bodies from “poor” to “good”, if it meant that one other water body in the catchment deteriorated from “excellent” status to merely “good”.

83. This makes it more difficult to achieve strategic, flexible and lower-cost catchment-scale approaches. Instead of searching for the best approaches (such as allowing higher discharges at some works and lower ones at others, depending on where improvements could be made most cheaply), attention focuses on the measures necessary at each individual sewage treatment works.

84. The result is that costs increase and work (for example, to identify the scope for lower discharge requirements when the amount of water in the water course is high, thus diluting the effect of the discharge) is discouraged.

85. Strategic and flexible measures such as catchment permitting could ultimately apply across sectors. For example, in Chesapeake Bay in the USA, nutrient trading between sectors is being trialled to try to ensure the most cost-effective way of meeting water quality standards for nitrates and phosphorus.

3.3 Adapting to and mitigating climate change

3.3.1 Climate change adaptation

86. The UK is already well placed in its understanding of the likely impacts of climate change, thanks to the world-leading efforts of the Met Office and the UK Climate Impacts Programme (UKCIP).

87. But, a prerequisite of shifting responsibility for decisions from the state to businesses and civil society—as recommended by the Adaptation Sub-Committee in its recent report14—is the need to work ever harder to ensure that information is accessible, and as easy to understand as possible. This applies equally to the need for data sharing on flood risk for resilience and catchment modelling for implementing the WFD.

88. WWF estimates that one-third of catchments are already at risk from unsustainable abstraction pressures,15 with 15% classified as over-abstracted (that is, existing abstraction causes unacceptable damage to the environment at low flows) and 18% as over-licensed (that is, if licences were fully utilised there could be unacceptable damage at low flows). The combination of over-abstracted and over-licensed catchments exceeds 50% in some river basins.

89. WWF also estimates that current abstraction amounts to between 50% and 60% of licence “entitlement”, suggesting that the real impact of over-licensing is yet to be seen. WWF says that somewhere between 1.1 billion and 3.3 billion litres more water a day is taken out of rivers, and other water courses than the environment can sustain.

90. It considers a reduction in abstraction of between 5% and 15% would be necessary to return to a sustainable level of demand—or alternative supplies developed. Climate change is likely to add to these pressures.

91. As part of its restoring sustainable abstraction (RSA) programme, the Environment Agency is investigating about 320 cases of potential over-abstraction that could impact on important, ecological sites (see below). The aim is to address such problems through revoking or modifying licences, or other related measures. The RSA programme was established primarily to ensure compliance with the Habitats Directive, but the WFD could be a significant driver in the future.

STATUTORY DESIGNATED AREAS IN THE UK

6,569	SSSIs (Sites of Special Scientific Interest)
1,240	LNRs (Local Nature Reserves)
608	SACs (Special Areas of Conservation under the Habitats Directive)
394	NNRs (National Nature Reserves)
246	SPAs (Special Protection Areas under the Birds Directive)
145	Ramsar sites (under the Ramsar Convention on wetlands)
50	AONBs (Areas of Outstanding Natural Beauty)
43	ESAs (Environmentally Sensitive Areas)
3	MNRs (Marine Nature Reserves)

92. The problem is that water licences are like property rights, in that under the Water Act 2003, compensation has to be offered for any modifications or revocations that are not voluntary. Existing abstractors are meant to fund the compensation payments. But the system is under strain—the UK Government and Environment Agency lack the resources to finance modifications up front (in 2009, the Environment Agency estimated that the necessary RSA licence changes would cost £448 million for currently identified sites).

93. The result is a very laborious and inflexible system that struggles either to deal with the environmental challenge of unsustainable abstraction, or to make water available for users (such as farmers or new businesses). Even where licence entitlements are not currently taken.

94. Economic growth may also be constrained because water is allocated largely against historical need, and because there are significant barriers to trading in licences or water. The result is, water may not be getting to the users that value it most, and can generate greatest economic value from it, at a particular time.

95. There is a danger that water customers will be called upon to meet the costs of restoring sustainable abstraction, even though the companies (and their customers) will be already paying nearly £400 million for capital schemes to implement the EU Habitats Directive, the UK Biodiversity Action Plan and the Countryside and Rights of Way Act, between now and 2015.

3.3.2 Climate change mitigation

96. The WFD and other EU water quality legislation do not yet take the need to mitigate climate change properly into account. As a result, the plans for implementing the first phase of the WFD across England and Wales:

do not place sufficient value on the costs of carbon emissions;

exclude the need to cut emissions from impact assessments; and

shift the responsibility for cutting emissions on to a few large sectors (including the water companies).

97. This results in tensions between ever-increasing quality standards, and efforts to reduce greenhouse gas emissions. Driving emissions upwards, through ever tighter treatment requirements, will mean that the companies will be further penalised under the Carbon Reduction Commitment.

98. We estimate that the carbon implications of the environmental and drinking water quality improvement programmes that the water companies are required to deliver between 2010 and 2015, largely driven by the demands of EU legislation, amount to:

1.6 million tonnes to build the infrastructure for enhanced treatment (“embedded emissions”); and

180,000 tonnes every year to run them (“operational emissions”).

99. This additional infrastructure is equivalent to an extra 450,000 cars on the road, and the operational emissions are equivalent to an additional 45,000 cars for every year the infrastructure is used.

100. Given the links between water, energy and carbon, we need to ensure we leave the door open for integrating smart metering across energy and water. Also, the Green Deal should fund financing for water savings (particularly hot water), as well as energy.

Defra discussion document Q4

What mechanisms should we focus on to ensure we manage our natural systems more effectively in future? How should we define success?

101. There are a number of mechanisms, some reasonably well established and some just being explored, which can be implemented to manage water more effectively. These can generally be measured using outcome-based measures, although the cost of the inputs and processes, particularly on water customers, should always be considered.

3.4 Polluter pays principle

102. Although it is relatively straightforward to apply to point source pollution, the “polluter pays” principle is harder to apply to diffuse pollution. One solution would be to tax agricultural inputs such as fertilisers and pesticides. But this approach does not discriminate between those that use these inputs responsibly, and those that do not.

103. There is also a tendency for such tools to lose sight of their original purpose in the wake of scientific and technical developments. For example, the development of fertilisers that impact less on the environment may actually be impeded by a blanket tax that has as its aim reduced fertiliser use, not reduced impact.

104. But under current arrangements, there is no incentive on those who are responsible for causing the pollution to consider alternative options. This means that pollution remains both upstream and downstream of the treatment works, where it continues to impact (often for some time) on the life that our rivers and streams can sustain.

105. Yet many of the actions that farmers and landowners in particular could take to minimise their contribution to diffuse pollution are quite simple and cheap to carry out. There are many examples of profitable farms that have taken action to reduce diffuse pollution by adopting good nutrient management practices and low-cost capital investments. The problem is that there are a small number of poor performers, whose actions reflect badly on the sector as a whole.

3.5 Catchment management

106. At the 2009 price review, we demonstrated our commitment to sustainability by supporting a range of catchment management initiatives that the companies proposed in their business plans for the next five years.

107. These involve the companies working with local farmers and landowners to investigate and address deteriorating raw water quality in the catchment, rather than pursuing traditional, capital-intensive treatment solutions.

108. Catchment management schemes can offer potential savings to customers by reducing the cost of treating water and wastewater. In addition to improving raw water quality, they can also offer long-term benefits. This includes:

improved raw water quality;

lower greenhouse gas emissions;

enhanced carbon storage;

improved biodiversity; and

contributing to more stable river flows (flood protection).

109. Also, they often involve a collaborative, landscape scale, approach to problem-solving that involves all those who have an impact on the quality of the raw water sourced by water companies—which is more effective than each participant acting in isolation.

110. Catchment initiatives may be particularly suitable in areas where there is a specific and well-targeted problem, such as use of a particular pesticide. For example, several companies have detected metaldehyde (a widely used molluscide to combat slugs) in their raw water. While the levels at which it is being found do not constitute a danger to health, they do exceed regulatory standards. But, there is no cost-effective treatment process to remove metaldehyde currently available.

111. So, catchment management measures represent the only viable option at present. A stewardship group, involving manufacturers, the farming and growing communities, and water companies, is co-ordinating actions to this end.

112. It should be noted that catchment management schemes are long-term investments. They can take many years to deliver benefits. Inevitably, there is also a degree of uncertainty about whether they will actually deliver the benefits they are intended to achieve. This is mainly because they rely on the complexities of changing the behaviour of individuals and organisations within catchments, rather than more visible and predictable hard engineering solutions, such as treatment works.

113. The risk with these schemes is that water customers may end up paying for both the scheme and the end-of-pipe solution if they do not prove to be effective.

114. We think it is essential that the sectors learn lessons as quickly as possible so that those catchment management approaches that are most successful in reducing diffuse pollution, meeting environmental standards, reducing emissions and delivering benefits to water customers can be confirmed and promoted.

115. We would expect the companies to propose more cost-beneficial catchment schemes at the next price review. In cases where real customer benefits warrant it, the companies may wish to explore the possibilities for directly incentivising better practices themselves. One company has already considered subsidising a farmer to not use a specific pesticide because it is difficult to treat at the downstream treatment works.

116. Given the uncertainties, our support for catchment management at the 2009 price review represented something of a leap of faith for Ofwat. But, the expectation that these schemes would act as a catalyst for other catchment stakeholders (such as land managers and highway authorities) to contribute to the sustainable solutions that are needed, reinforced our support. The companies and their customers cannot be expected to solve this problem alone.

3.6 Targeted incentives for land managers and others

117. In our view we need to rethink how farmers are incentivised to deliver public goods, to effect the real change needed. We think there should be a significant increase in the proportion of available agri-environment funding, under the CAP, that is spent on natural resource protection, such as improving and protecting water quality and water resource management through, for example, enhanced buffer strips and improved manure storage.

118. In particular, we consider that land managers could be offered better incentives to reward them for the delivery of public environmental goods, such as an improved water environment, over and above the legitimate demands of the statutory and regulatory baseline.

119. The reform of the CAP in 2013 could be an opportunity to improve the coherence between EU policy objectives for water (WFD), climate change and agriculture. It could develop both better incentives for farmers to improve the water environment, and strengthen the requirements for “cross compliance”, which are the basic minimum standards that farmers must meet to be eligible to receive their area-based payments under the CAP.

120. CAP reform could also be an opportunity to strengthen Pillar 2 (support to rural communities and environmental protection and conservation measures, currently responsible for about 20% of CAP spending), at the expense of Pillar 1 (direct payments to farmers, currently responsible for some 70% of CAP spending). This would reflect the fact that EU spending directly on the environment currently represents a fraction of spending on agriculture.

3.7 Better information, regulation and enforcement

121. Experience on the ground suggests that many farmers and land managers are keen to engage in good practice when the impact of their activities is clearly presented to them. Self-monitoring has proved a useful tool in this regard. Defra’s demonstration test catchments project16 may help provide compelling evidence as to what can be achieved when farmers adopt good practice.

122. While effective incentives and information must be part of the solution, so too are effective regulatory sanctions where poor land management practices persist. The NAO study was clear that such sanctions are lacking in England and Wales, drawing attention to poorly co-ordinated regulation and the lack of progress on the designation of water protection zones. Ultimately, as in other sectors, a regulatory stick is needed to deal with persistently poor practice.

123. Regulation does not have to be burdensome or complicated. Fixed penalty notices and other civil sanctions could be used. One option might be to consider formalising voluntary codes of practice under general binding rules to tackle diffuse pollution, as in Scotland. This would provide a clear basis for taking further enforcement action, if advice and awareness raising did not have the desired result.

124. We would like to see the framework for good agricultural and environmental condition (GAEC) extended, under Pillar 1 of the CAP, to cover the protection and management of water resources. This would require sufficient resources to be put into monitoring and enforcement. But this may largely be a matter of improving co-ordination.

125. We set our more details of our position in “Ofwat’s response to the European Commission’s public debate on the future of the Common Agricultural Policy”, which we published in June 2010.

126. We would also like to see more progress towards the establishment of water protection zones under the WFD, where drinking water supplies are under particular threat. Even designating candidate zones could drive the necessary behaviour change voluntarily.

127. There are many exciting technological and knowledge-based developments within agriculture (such as “precision farming” and advanced livestock nutrient products). These should help to both reduce diffuse pollution, and increase the profitability of the farms over the long term. But there are still some poor performers that have not yet taken the basic, low-cost measures necessary to protect the water environment.

128. Regulation is being introduced to tackle some non-agricultural forms of diffuse water pollution. One example is the ban on inorganic phosphates in domestic laundry cleaning products, which will come in to force in 2015. Measures to address misconnections could usefully be included in the Water Bill that is expected to follow the Water White Paper. We also need measures to deal with run off from highways and urban areas.

129. Given the constraints on public funding and the difficult economic climate, it may be worth having considering once more the potential role of producer responsibility in tackling diffuse pollution.

130. For example, the agrochemical sector could contribute to the funding of the catchment sensitive farming initiative and risk assessments for products. The pharmaceuticals industry could also take more responsibility for endocrine-disruptors. Under the current system, water customers are paying for the clean-up costs (and suffering from a poorer environment) irrespective of their personal choice of products used.

3.8 Balancing outcomes

131. We agree that it is important to measure progress towards a cleaner environment rigorously. We also think it is important to focus effort and resources on finding solutions in areas where the greatest problems remain. But, we consider that the current way of measuring performance against the WFD is misleading and can lead to unnecessary efforts and wasted resources, including water customers’ money.

132. If future WFD costs are to be controlled, a light touch will be needed for the cost-effectiveness work on priority substances arising from the chemicals investigations (including substances in wastewater discharges) currently under way.

133. In the past, such work has been very resource intensive and has resulted in over-designed and unnecessarily expensive implementation. Practical rules of thumb need to be established for deciding between options such as end-of-pipe treatment, restrictions on marketing or use/control of trader consents, in accordance with the “polluter pays” principle wherever possible.

134. While we welcome the clause in the WFD that allows measures to improve the quality of the water environment to be postponed if the cost is “disproportionate”, we would like to see it applied to all investment to implement EU environmental legislation.

135. Despite the disproportionate cost clause, the inflexibilities inherent in the WFD tend to make it more problematic and “absolute” than other Directives. The impact of the clause is too often trumped by other EU environmental drivers for schemes that do not have such a provision.

136. Our work at the 2009 price review revealed that much of the non-WFD investment required to meet EU environmental standards delivers benefits that are outweighed by their costs, particularly when carbon is taken into account (see below). This is despite our cost challenges.

137. In fact, some drivers (like the Freshwater Fish Directive) have costs that are almost three times bigger than the benefits the schemes will deliver. As the table below shows, on average every pound spent delivers only 30p of benefits. This is an average figure that obscures the fact that individual schemes had costs hundred of times greater than benefits. Yet because they are statutory schemes, we ultimately had no choice but to include them in our price limits.

COST-BENEFIT ANALYSIS OF COMPANIES’ SCHEMES TO DELIVER EU DIRECTIVES

	EU Directives
	Freshwater Fish Directive	Habitats Directive	Revised Bathing Water Directive	Urban Waste Water Treatment Directive
Number of schemes by companies	31	60	98	77
Present value of benefits (£m)	244.55	372.47	659.52	850.57
Present value of costs (£m)	704.19	442.47	377.91	850.61
Net present value (benefits minus costs) (£m)	-459.64	-70.00	281.61	-0.04
Ratio of benefits to costs	0.35	0.84	1.75	1.00

Note: Costs/benefits are present value and so do not correspond to capital expenditure supported at the 2009 price review.

138. There are apparently no calls in Europe to extend the deadline for achieving good ecological status. This is surprising given the expected cost of implementing the WFD, the number of Member States that are struggling to make the progress required, and the current economic climate. Such an extension could be dependent on satisfactory direction of travel and adoption of a risk-based approach, under which those rivers most in need of improvement and protection are tackled first.

3.9 Sustainable abstraction

139. We consider that we need to work towards mechanisms to reveal the true value of water, at a particular location, at a particular time, if we are to maximise sustainable use along the value chain.

140. At present, water users—the companies and their customers, or farmers and other industries—do not receive the right information about the value of the water they use. The amount they are charged for using the water taken out of the environment bears little relation to how little water there is in a particular area. In fact, it can cost more to abstract water from areas where it is plentiful than where it is scarce.

141. We are working with Defra, the Welsh Assembly Government and the Environment Agency to explore what other actions can be taken over the short, medium and long term to move towards a more sustainable water abstraction system. In particular, we have been working with the Environment Agency to develop a market for trading the rights to abstract raw water, as well as increasing trading of bulk water, where environmentally appropriate.

142. In “Harnessing upstream markets—what’s to play for?”, which we published in March 2010, we included our findings from a desk-top study that suggested that savings of almost £1 billion over 30 years could be achieved by moving water from areas of surplus to areas of scarcity, through interconnecting pipes, in addition to significant environmental benefits. If the value of water reflected its scarcity value, the savings from interconnections would become even more significant.

143. A more detailed study17 found that an approach involving more resource sharing in south-east England could lead to savings of £501 million by 2035, compared with the £762 million cost of the water resource schemes identified in the companies’ draft water resource management plans.

144. This shows the benefits that could ensue if the companies and other interested parties were to receive clearer signals to inform their decisions about how to meet water demand, whether through innovation, trade or investment.

145. Water trading and abstraction licence trading could contribute to tackling over-abstraction. It could also reduce the need to develop new water resources, which carries its own environmental cost (although the interconnecting pipes and pumping costs would have a carbon cost to take into account). Interconnections could also help provide increased resilience to extreme weather events and other emergencies.

146. A true value for water, reflecting its actual and predicted scarcity, would impact on the economic level of leakage and the viability (and popularity) of water efficiency schemes. It would also encourage alternative collection and storage schemes (such as rainwater harvesting) and grey water recycling. And help us to comply with the WFD’s requirement that water pricing policies provide adequate incentives for users to use water resources efficiently.

147. We consider that a future Water Bill would represent a good opportunity to provide the legal basis for reform of the current abstraction system. We think we need to go beyond the idea of time-limiting licences as they come up for renewal, about which the previous Government consulted.

148. At a minimum, a Bill could provide for reverse auctions to buy back abstraction licence entitlements. It could also:

encourage the introduction of “use it or lose it” provisions to prevent licence holders retaining licences even though they do not use their entitlements; and

establish clarity over the parameters for determining water availability now, and best estimates regarding future availability, taking into account the impact of climate change.

149. There is also a lack of clarity over how much water is required for the environment in the future. This is complicated further by the fact that the environment that we are protecting is also evolving because of climate change. These issues act as a block to exposing the long-term value of water.

150. Revealing the current and future scarcity values for water would, along with greater clarity over the property rights conferred by abstraction licences, provide a platform for market-based measures that would encourage efficient trading of licences, water entitlements or bulk supplies of water. These market-based allocative mechanisms would also allow more flexible responses to periods of below-average rainfall.

3.10 Market mechanisms

151. The development of markets could help address the problems of both over-abstraction and climate change. This would require identification of areas where subsidies or income streams could evolve into market-based mechanisms to deliver both climate change mitigation and adaptation, and environmental improvements. An example would be incentivising farmers to manage their catchments in such a way as to reduce flood risk, or to create carbon sinks through forestry.

152. Carbon trading already takes place through the European Union Emissions Trading Scheme (EU-ETS). But this only covers 40% of the EU’s emissions, and in the UK there are a number of other schemes to incentivise carbon reductions.

153. These schemes have a variety of carbon prices associated with them—for example, about £13 per tonne of carbon dixiode equivalent (CO₂e) in the carbon reduction commitment to more than £100 per tonne in the renewable heat incentive. The development of ecosystems services would be encouraged if there were a single, and strong, carbon price.

4. Building and Enhancing our Natural Value

Defra discussion document Q6

What best practice and innovative approaches to protecting and enhancing our natural environment do you think should be considered as we develop the White Paper?

154. Please see our response to questions three and four in chapter three.

Defra discussion document Q7

How best can we harness and build on public enthusiasm for the natural environment so people can help improve it through local action, as informed consumers or by shaping policy?

155. One of the biggest positive impacts that water users can have on the natural environment is to reduce the volume they waste.

156. If consumers used less water, then there would be less need to take it out of the environment (as well as reducing the associated infrastructure to treat, store and transport it). This would have substantial benefits for the natural environment, and for reducing carbon emissions, in those parts of the country where water is already scarce.

157. There are a number of issues that prevent this “consumer-led” change from occurring. One of these is the way the customer pays. For example:

63% of households in England and Wales do not have a water meter—they pay a flat annual fee regardless of the volume of water they use; and

even in areas where the level of metering is relatively high, the price that customers pay does not reflect its real value at different times.

158. This means that many water customers receive no—or very limited—signals about the value of the water they use, and there is little incentive to use it more efficiently.

159. So, this is why we are, among other things:

considering the case for increasing the rate of metering;

reviewing approaches to charging to see if different arrangements can send better signals about the real cost of water supply;

looking at what drives consumer choice and behaviour in addition to price; and

looking at the role that separating the retail function of existing monopoly water companies from other parts of their business could play in helping customers to reduce their water use.

160. The way in which people react to market signals, including price, and to other factors (such as regulatory incentives and obligations) may be a long way from what we would expect. Behavioural economics could expose more information about the way consumers and businesses make decisions.

161. A better understanding of this field would allow us to explore ways to “nudge” people into more responsible and sustainable behaviour. We also hope to use behavioural economics to bring insights into how participants in the market will respond to information and influences, to ensure that our regulation is effective and efficient.

162. We are also exploring opportunities for closer working with the energy sector, including the roll out of smart meters and through the Government’s Green Deal.

163. We explore some of these issues further in “Waste not, want not—making the best use of our water”, which we published in June 2010, and “Valuing water—how upstream markets could deliver for consumers and the environment”, which we published in July 2010.

164. We also recommend that, while there are powerful economic and social arguments for favouring approaches that support consumer choice, there is also a role for the UK Government to mandate changes that will help consumers become more water efficient should they wish to do so.

165. For example, regulations have limited toilets to a six-litre flush when 7.5 litres used to be normal. Measures of this kind have little, if any bearing, on consumers’ experience, so they have no material impact on personal freedoms. Yet they can make a valuable contribution to using water wisely.

166. Making sure that customers understand what they are paying for in their bills, particularly in terms of environmental improvements going forward, will be an essential part of future customer engagement. We are currently exploring ways that customers can become more central in the decision-making process.

Defra discussion document Q9

How best can Government incentivise innovative and effective action on the natural environment, across England, at the local level?

167. Please see “Catchment management” (page 24) and “Targeted incentives for land managers and others” (page 26).

Defra discussion document Q10

How best could the economy reflect the true value of nature’s services in the way business is done, to drive smarter, greener growth?

168. We think it is important to develop mechanisms to reveal the true value of water at specific locations at specific times.

169. More needs to be done to develop markets for ecosystem services, whereby those that provide environmental services (such as good quality raw water or wastewater) are put in contact with beneficiaries. Farmers and land managers could come into the former category, and water companies, anglers or surfers, for example, into the latter.

170. As the RSPB18 has identified, the Government could encourage the development of payment for ecosystem services approaches by:

increasing the evidence base for the private benefits of ecosystem services, which may encourage private markets to emerge;

creating metrics to measure services, for example carbon sequestration;

mediating the development by funding benefits that do not accrue to the business; and

regulating to establish upper use limits on natural resources such as bodies of water, setting a cap on their use.

171. As the potential actions to mitigate and adapt to climate change and improve the environment are many, varied and localised, there is significant scope for markets to help delivery by informing those decisions and therefore setting the right incentives to change behaviour. Clearly, such markets would be deregulatory in nature, rather than centralised command and control.

172. In the absence of competition within the sectors that enables water customers to indicate their preferences, we seek to ensure that the services customers are being asked to pay genuinely reflect what they need and want when we set price limits. This means that the companies must take customers’ views into account when they make their business decisions. We are currently reviewing how we do this.

Defra discussion document Q11

Responsible businesses are already looking for ways to reduce their impact on the environment. How can we encourage more action like this?

173. At the 2009 price review, we required every water company to produce a 25-year strategic direction statement. In this way, we encouraged the companies to take a long-term view of their business and the environment. The companies’ strategic direction statements explored the challenges they considered they would face in terms of resources, taking into account, regional population growth or the effects of climate change.

174. The Government also requires the companies to produce a 25-year water resources management plan that specifically sets out their plans for water resources in their supply area.

175. We consider that both of these developments have been a positive step in helping the companies understand their obligations to explore their long-term impact on the environment—although the interaction between the two needs to be kept under review.

177. As part of their efforts to improve the quality of the raw water they treat, and improve the natural environment, many companies are taking forward plans to help reduce pollution of water courses, including through the previously discussed catchment management programmes.

178. Businesses need to understand their impact on the whole landscape. Damage to the natural environment is not just felt at the point at which a pollution incident occurs, deforestation takes place or water is over abstracted. The wider impacts can also last years, sometime decades.

179. There is already a duty on the companies to promote water efficiency to both household and non-household customers. Many offer subsidised or free water efficient fittings. Others offer free water audits for businesses to advise them on how to reduce the volume of water they use. It is this type of corporate social responsibility that can help businesses join up their expertise to help in protecting the natural environment.

180. By becoming more water efficient, every business can reduce its impact on the natural environment. This includes reducing the amount of water that needs to be abstracted from rivers and lakes. In addition by using less water, less of it will need to be treated and pumped, which are carbon intensive processes.

Defra discussion document Q15

If you could choose just one priority action for the NEWP to drive forward locally, nationally or internationally—what would it be?

181. To develop mechanisms and processes for revealing the value of water.

182. Our vision is for sustainable water, and we would like to see an approach that maximises welfare to water customers and delivers for the environment. Key to this is ensuring that resources are allocated in the most efficient way so costs can be minimised, whilst creating the greatest benefits for society and the environment. In achieving this goal we will need to incentivise innovation and to adapt to the future in a flexible way.

APPENDIX 2

OFWAT’S REPORT ON CATCHMENT MANAGEMENT

http://www.ofwat.gov.uk/sustainability/prs_inf_catchment.pdf