UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 674-i

House of COMMONS

Oral EVIDENCE

TAKEN BEFORE the

Environment, Food and Rural Affairs Committee

Draft Water Bill

TUESDAY 23 October 2012

ROB WESLEY, COLIN SKELLETT, TONY balLance AND JEAN SPENCER

Evidence heard in Public Questions 1-51

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Oral Evidence

Taken before the Environment, Food and Rural Affairs Committee

on Tuesday 23 October 2012

Members present:

Miss Anne McIntosh (Chair)

Richard Drax

George Eustice

Barry Gardiner

Mrs Mary Glindon

Neil Parish

Ms Margaret Ritchie

________________

Witnesses: Rob Wesley, Head of Policy, Water UK, Colin Skellett, Executive Chairman, Wessex Water, Tony Ballance, Director of Strategy and Regulation, Severn Trent Water and Jean Spencer, Director of Regulation, Anglian Water, gave evidence.

Q1 Chair: Good afternoon and welcome. Thank you for joining us for our first evidence session on the Draft Water Bill inquiry. I will just say at the outset that we are not expecting a vote; if there is a vote, we will adjourn for the shortest possible period. That would normally be between 10 and 15 minutes, if you could bear with us. We are very grateful for your being here with us today. For the record, could I ask you to say who you are and which company you are with, starting with Mr Skellett?

Colin Skellett: Thank you, Chair. I am Colin Skellett, Executive Chairman of Wessex Water. I started in the water industry in 1961, so I have been around for a while.

Rob Wesley: I am Rob Wesley, Head of Policy at Water UK, representing water and sewerage companies throughout the United Kingdom.

Jean Spencer: I am Jean Spencer, Regulation Director at Anglian Water.

Tony Ballance: I am Tony Ballance, Director of Strategy and Regulation at Severn Trent Water.

Q2 Chair: I will just ask an opening question or two, if I may. Were you surprised by the direction of the Draft Water Bill? Do you believe that the Draft Water Bill entirely mirrors the direction of travel of the Water White Paper?

Colin Skellett: If I could start, if you look at the key challenges facing the water industry, there are three: there is climate change and its consequences, which takes you into the area of supply and resilience; for some customers there are issues of affordability; and there is retail competition for business customers.

The White Paper was wider than the Bill. The White Paper focused a lot on sustainability, resilience and these other issues. The Bill seems to be largely focused on the retail competition issue. The other big issue for the industry is maintaining the cost of financing. This industry has been successful because we have managed to maintain access to lowcost finance. Running across all these challenges and the way that we deal with them has to be the ability to maintain the lowcost financing of the industry. I think the Bill is in danger of being a lost opportunity to tackle the bigger issues. Unlike customers, we do not get water bills very often; they only come along very occasionally. It would be really good to use this Water Bill to deal with the bigger issues. Perhaps we can enlarge on that a little.

Jean Spencer: For us, the White Paper was very welcome because it put the focus very much on water resilience and the security of water supplies for our customers. For us, that clarity is missing in the Water Bill. Now, it may be that the issues around that do not require legislation, but nevertheless it seems to have been somewhat lost. Clearly, companies are ultimately responsible for security of supply and for resilience of their assets, but I think that having clear Government policy and Government direction around that, which regulators as well as companies would have to take notice of, would be very helpful.

We think that, clearly, the Government, along with all our regulators-Ofwat and the environmental regulators-and the water companies, played a key role in the recent drought. The work of the National Drought Group was extremely helpful. We think it would be really useful to build on that going forward through something like a new national water resource resilience group that can keep the focus that was there in the White Paper.

Rob Wesley: Another area that could be covered in more detail would be the linked areas of bad debt and affordability, which were referred to in the White Paper extensively but are essentially absent from the Draft Water Bill. On debt, the Bill does not address the growing burden of bad debt: £15 on every customer’s bill, and that is growing year on year. From an industry point of view, there is a frustration that there is a measure on the statute book already that is waiting to be implemented, which would require a flow of information from landlords to companies, so that companies can effectively bill customers living in rented properties where it is difficult to know who is the right customer to bill.

From the industry’s perspective, we are already taking measures to provide an easy route for landlords to provide information by implementing a national website. That will be a very easy route for landlords to provide information. It really is a very small administrative burden for something which would avoid customers, who are facing difficulty paying their bills, paying more because of bad debt.

Q3 Chair: I am sorry to interrupt, but can I just ask whether they need primary legislation to do that?

Rob Wesley: There is no need for primary legislation because the primary legislation was covered in the Flood and Water Management Act. It is purely a matter of implementing the already passed measures from the last Government. It really would be a quick win that could be implemented straight away.

On affordability, one measure that would make a real difference would be allowing companies to have access to benefits information; they would be able to better target affordability measures such as social tariffs. There is now guidance on implementing social tariffs, which is welcome, but access to benefits information would really be a key step towards being able to take things forward effectively and efficiently. I know this is a matter that the Committee has raised previously. We have had some preliminary discussions with the DWP, but that is at an early stage and we would welcome greater support from DWP to make allowing access to benefits information a reality.

Tony Ballance: It is clear-as my colleagues have articulated-that competition forms a large part of the Bill. It is probably worth reflecting that to some extent the Bill recognises that the water supply licensing regime probably has not delivered much in the way of meaningful competition in the sector. It is right, therefore, that a large focus is around getting appropriate competition for business retail customers, which is a space that a number of us are trying to enter into.

One of the areas where I specifically think the Bill could be strengthened is in relation to giving companies a genuine choice as to whether they wish to participate in the retail market by allowing companies to have a separate licence. Given that you have 20 or so companies, having 20 or so retailers will not allow for the economies of scale that are inevitably there in the retail sector. Thames Water, the largest company, would have the most customers, but even they are not really at the scale of the energy companies in terms of the economies of scale they would have.

We would be in favour of enabling companies to grow properly into that retail space and allowing companies to exit. Without that, it is extremely complicated for companies to have retail arrangements that allow one to compete out of their area but, obviously, maintain their business service offering in their area. It is very complicated, in terms of the arrangements that are required to do that.

Q4 Chair: We will come to that. I would just like to follow up on something Jean Spencer said about resilience. This is a personal wish list. In terms of resilience, reducing water stress and, perhaps, putting responsibility on developers when there are major new housing developments taking place, would it be appropriate to ask developers to contribute to some sort of fund so that, going forward, maintenance, looking at the adequacy of supply levels and any potential flood defence measures could be funded out of such a fund? Is that something that you think would sit comfortably with such a national water source resilience group?

Jean Spencer: That is not something I have thought about previously, so it is something we would need to think about. My first reaction, though, is that developers already have to make significant contributions to local infrastructure-both onsite infrastructure and also infrastructure to support individual sites. That already gives rise to some issues around affordable housing. I would question how that fits with affordable housing. Also, growth is more widely based; it is not just attributable to individual developers. The best answer is probably that this is something we can perhaps think about and come back to, rather than making more offthecuff remarks.

Colin Skellett: I think we need to be careful that we do not hit developers again. Developers have enough to deal with in the way of contributions. I think that part of the solution to the problem of unlocking development is to release some of those burdens. We do already have infrastructure charges; if the level of these was set correctly, then you could reflect this problem in those infrastructure charges that are levied. I think there is a case for revisiting the infrastructure charges.

The other thing I would say regarding resilience generally is that it needs to be a combination of encouraging people to reduce demand and encouraging interconnection between companies-the creation of grids and interconnection within companies. Those sorts of things will make a real difference to resilience, and development is part of that.

The other thing that we need, which could be included in the Bill, is to look more holistically at how we deal with flooding issues. Despite the Flood and Water Management Act, there is still a bit of a mismatch as to who holds those responsibilities for flooding. The Bill has the opportunity to bring some of these items together. We really need to encourage proper sustainable urban drainage, and the proper management of urban drainage.

Q5 Chair: Would you say this was a missed opportunity?

Colin Skellett: Generally, I think the Bill runs the risk of being a missed opportunity.

Q6 Chair: That is very helpful. Environmental groups have said that the Water Bill should have set out a legislative framework for abstraction reforms. Do you think there is any reason why the Bill should not have included such a framework?

Tony Ballance: If I may, Chair, I think we all recognise that abstraction licence reform could provide real benefits-not only to this sector, but to other water sectors. Notwithstanding that, we also recognise that it is a complex issue that does not just involve this sector; it also involves the energy sector and farming communities. We welcome the Government undertaking to do work in this area and to consult on it, but I think it is important to try and get this right, because what would not be satisfactory is to rush legislation in this space and get it wrong, because it does provide a great opportunity going forward.

It is also encouraging that our regulators have grasped the nettle on this; Ofwat are talking about including incentives around abstraction in the next price review period, to reduce abstraction in the most damaging areas. The Environment Agency have introduced new guidance on the trading of licences, whereby they will not automatically reduce abstraction licences when people wish to trade them. These are welcome steps that we should be getting on with. We obviously look forward to seeing the Government’s consultation in due course. I do not know whether Jean wants to add to that.

Jean Spencer: I also just wanted to add-the Chair may be aware of this-that Anglian Water is sponsoring a project through the Cambridge Programme for Sustainability Leadership on testing and building a trading platform to inform policy around trading. We are doing that by working with agriculture-the NFU and the Royal Agricultural Society of England-as well as regulators to test out and better understand some of the implications of introducing trading. Hopefully, when legislation does come forward it can be informed by that process.

Q7 Chair: Would this not have been a good opportunity, though, to pass the primary legislation and then have the secondary legislation at a later date?

Colin Skellett: That is a difficult area, I have to say. The last people who talked about water trading in that way were Enron-we happened to be owned by Enron for four and a half years-and they were keen to pursue water trading in the US. They were going to make a fortune out of it; unfortunately, rather like some of their other things, they did not. I think this is a really difficult area. It is fine to talk about it in principle, but you need to do a lot of work in order to ascertain how it will work in practice. I would caution against rushing too fast into this.

Q8 Chair: To sum up what you have said so far, the Draft Water Bill is potentially a missed opportunity, and there is definitely unfinished business in terms of SUDS, ancillary flooding issues, bad debts and social tariffs.

Colin Skellett: Yes. We also need to set the direction on things like metering, for example. There is no mention of metering in there. We must keep moving towards metering-at the very least, metering on change of occupancy; that is when people make decisions. All the evidence is that if you install a meter on change of occupancy people’s consumption reduces by about 20%. It is an opportunity; at the very least the Bill should set that direction, recognising that there are different needs in different parts of the country. It should set the direction of policy.

Q9 Neil Parish: You have started to answer my question for me, really. Where water companies have put in meters, they have found that there has been a 1520% saving when consumers actually work out whether they have leaking taps and are conscious of the amount of water they are using. Would you support the inclusion of a provision in the Bill that would allow water companies to roll out universal metering, not just those in areas of serious water stress?

Colin Skellett: I would not be in favour of compulsory metering. This is an industry that needs to take its customers with it. Compulsory metering will alienate customers. What we need to do is encourage the rollout of metering as appropriate, which is why a lot of progress has been made with voluntary metering and why metering on change of occupancy and similar measures to that would move us significantly forward. However, I would not be in favour of saying, "Everyone must have a meter".

Q10 Neil Parish: Are you saying that it should be compulsory when there is a change in occupancy?

Colin Skellett: Yes. If the occupancy of the houses changes, it should be compulsory.

Q11 Neil Parish: If a single lady is living in that house at one stage and then a large family comes in, it will not be to their benefit, necessarily, to have a meter, will it? This is just playing devil’s advocate.

Colin Skellett: If you know that is going to happen, you make a choice when you move. If you came down from space and looked at this industry, you would see we are charging a lot of customers on the basis of the rateable value set in 1976, or whenever it was; it is madness.

Jean Spencer: Different companies have taken different approaches. Rather than compulsorily charging on the basis of a meter, what we have done over the last five years or so in the east of England-because it is a waterstressed area-is have a rolling programme of fitting meters. We then give customer alternative bills, so we let them know what their bill would be on the basis of the meter, and the customers then have the choice of switching to meters; it is their choice. We do also make them active on change of occupier, but we also accompany that with a waterefficiency programme, which includes doing retrofitting in the home to ensure water efficiency there. It also gives us information about those customers who have not opted to be charged on the basis of a meter. Some of those customers would end up paying more, but it allows us to understand the effects of compulsory metering better and to think about affordability tariffs when we come to those in the future.

Tony Ballance: Certainly, as a company with one of the lower meter penetration rates-ours is something like 34%, compared to the average of 40% in the sector-we have been less advanced in terms of what we do with metering. What we have certainly found is that metering is not always the most economical way of balancing supply and demand. Certainly, as Jean alludes to, we have been very successful in getting water consumption down by water efficiency; we have one of the lowest per-capita consumption rates in the country as a result of that.

We are increasingly finding that meters are expensive to put in, and we are getting more bang for our buck by doing water efficiency and other measures to ensure that supply and demand are balanced going forward. We are not against metering, but we are less in that space of wanting to make metering compulsory on change of occupancy. We are trialling it at the moment in certain areas, but by no means would we want to do it across the piece.

Rob Wesley: Across the industry, each company is currently in the process of engaging with its customers and stakeholders on what would be the most appropriate arrangement in its own area. There are different circumstances in different areas, so moves towards metering on change of occupier would be more appropriate in some areas than other areas. There is a widespread agreement that metering is the direction of travel. The question is really as much about what the appropriate pace is for different areas.

Q12 Neil Parish: In the South West Water area-where you have very high sewerage charges in particular, linked to the amount of water that you use-I think something like 80% of people are on meters. Therefore, where they are paying high charges, people are very keen to go on meters. I am not suggesting that everybody should pay high charges, but it does have a reflection. Surely, given the resource and environment-and using that resource effectively-it is right to go on to a more vigorous metering regime.

Colin Skellett: At Wessex Water, we have just completed the largest meter trial since the Isle of Wight trials. That has shown clearly that if you put a meter in, people save 15% on average. The advantage of a meter, as well, is that it then enables you to move on to tariffs and different sorts of tariffs to control demand, and, also, the social tariffs that you need to deal with some of the affordability issues.

Q13 Mrs Glindon: Just following on from that discussion and answering the question about metering, in their written evidence Wessex Water made it clear what they feel about metering, but could I ask the other three of you-following on from what you have said-whether you agree with Wessex Water that the Bill should introduce a default position? Wessex Water have said that meters should be installed on change of occupier. Do you think there should be that sort of default?

Tony Ballance: We would see that as a matter of choice for individual companies. We understand Wessex’s position; in some senses, that is a part of the country which might require that. As I say, in Severn Trent’s case, we do meter on change of occupancy, on a trial basis. That will be something that we will look at in the future, but it would probably not be a step we would want to take now.

Jean Spencer: We aim to have 80% of our customers on meters by 2015. I do not think that we will continue to roll meters out to the remainder. We would rather do it with a phased approach rather than going all over the rest of the region and fitting meters on an ad hoc basis. For us, it is about getting that efficient roll-out of meters. As I said previously, we already have good coverage, so when customers with a meter fitted move house, then we will charge the new customer on the basis of a meter in any case, because the meter, by and large, will already have been fitted. We would not do it on an ad hoc basis.

Rob Wesley: Picking up on responses from Jean and Tony, there are different management views as to the most appropriate pace and style to progress towards greater metering across the industry. There are already some companies that do meter on change of occupier quite successfully. That may not be the appropriate solution for all companies, but it is definitely one of the tools available and potentially could be used more in the future. There is broad agreement that metering is the preferred direction of charging in the medium term. Really, the question is just about what the most appropriate way is of reaching that goal in each particular region of the country. This is probably an area where it is natural for it not to be a onesizefitsall approach.

Q14 Chair: Would you like to add anything, Mr Skellett?

Colin Skellett: No, not at all. As you can see, this is not a monolithic industry with one opinion. I would make the point that, although in theory it is open to companies to do this, in practice Ofwat must agree to fund it. We tried to introduce it at the last price review and Ofwat refused to fund it. It is about setting a tone that says, "This is where we ought to be going", while recognising that there will be different needs in different places.

Q15 George Eustice: May I ask you a question about the proposed changes to the special merger regime, which I think has been welcomed by both Ofwat and the industry generally? What are the main benefits of the changes that have been proposed, to have this twotier referral system?

Jean Spencer: Ofwat’s response to the twotier proposal seems to make a lot of sense, actually. Colleagues agree with that. Rather than have it as a set limit, having criteria around the impact on Ofwat’s ability to make comparisons and also the impact on markets seems to be a sensible way forward. Companies can then investigate opportunities and have sensible discussions with the OFT and Ofwat. It seems a sensible approach to us.

Tony Ballance: To build on that, certainly the current regime is extremely burdensome. As Colin alluded to, if you came down from space and asked how we go about merging in this sector, when we articulated how we do that, you might think that it is very odd that it is easy to take over a company if you are a foreign owner. For companies in the sector to have the opportunity to at least demonstrate that it would represent good value to conduct a merger is something that, obviously, the Bill seeks to address. We are very supportive of the twotier system that is being proposed. It is a step in right direction to allow sensible merger activity in the sector going forward.

Q16 George Eustice: Are there any disadvantages, though? Obviously, these provisions were put there for a very good reason in the first place, which is to avoid geographic monopolies of sorts. There was a view that you did not want to consolidate. The purpose of the Bill is to increase competition.

Colin Skellett: They were put there originally by Nicholas Ridley at the time of privatisation, because he was concerned about the French coming in and buying up the UK water industry. He put the provisions in for the mandatory reference. At the time Wessex Water was trying to buy South West Water, Sir Ian Byatt invented comparators and the values of comparators. What this does is it rationalises; it rationalises in a sensible way that says, "We need to look at this properly." We need to encourage some merger activity and some coming together. Again, if you started with a clean sheet of paper, you would not draw a water industry with 22 individual companies, 10 of which are water and sewerage companies and 12 of which are wateronly companies. You would have a different view of it. Some sensible coming together with appropriate safeguards should be encouraged.

Q17 George Eustice: There is an argument about the comparative data and the inability to do benchmarking properly. Are you saying that was a presentational ruse at the time?

Colin Skellett: I would not say it was a presentational ruse.

Q18 George Eustice: But was that not the reason for doing it?

Colin Skellett: There is clearly a benefit to being able to make comparators. Actually, the quality of comparators between the range of companies-because of the differences in sizes of companies-is less than you might think, but allowing some merger activity would be a good thing. What is being proposed is a sensible, balanced way of evolving the merger requirements.

Tony Ballance: If you go back through history, there was certainly a need to have rigorous, comparative competition in the early days using econometrics, the cost base and all the things that Ofwat used to do. The regulatory regime has evolved substantially, particularly over the last two or three years, and one might argue that comparative competition still remains important, but the need for 20 or so comparators is probably less important now than it was in 1994 or whenever. Therefore, this is a sensible step that does not automatically allow companies to merge but, where it is sensible, allows you to demonstrate that a case can be made.

Q19 George Eustice: Mr Ballance, you touched on this earlier, but the other question I had was about allowing companies to exit the retail sector. When we last looked at this-we looked at the White Paper initially-this was very much the view that was put to us by Ofwat. We bought in to that argument and concluded the same. The Government’s counter-argument was that you had to bear in mind that there are still household retail customers that have to be served and they wanted to be very sure that greater customer focus from water companies would also benefit households. They were not confident that allowing people to exit the retail market was the right thing to do at this time. What do you say to that?

Tony Ballance: The reasons for having more competition in the nonhousehold sector are pretty clear, because what we have are companies in sectors whose demands on water companies are quite different to the demands from households. You have multiplesite companies who want aggregate billing and more specialist services in terms of water efficiency on site. They are looking for a different bundle of services. That lends itself to a competitive space where new-entrant companies can get the right scales in that sector to service those companies properly. That is something that Severn Trent have stepped into with our joint venture with Costain. Yesterday, we announced the first switch of a major customer across the company to do that. Other companies in the sector are also trying to do that.

I think the issues facing households should not be conflated with the businesscustomer issues. Of course, customer service is paramount for our domestic customers, but things like the Service Incentive Mechanism that Ofwat are using to regulate the sector are having a very powerful impact on the way in which we look at our customers in that space. I still stick by the argument that allowing companies to have a separate licence to allow them to compete properly in that space is a good thing. We should not conflate the issue of domestic customers into that space, because that leads to a situation where you are not really allowing proper competition to take place in that businesscustomer space, which is of paramount importance, as the Bill recognises.

Q20 Chair: Would you like to comment?

Colin Skellett: I agree entirely. If we finish with 22 companies pursuing business customers, there will not be 22 companies in 10 years; there should not be 22. We have had a separate billing company, a joint company with Bristol Water, for 10 or 12 years. It works well; it is a separate company, and there is no reason why those companies should not be brought together, or why companies should not be allowed to exit. This is a natural progression of creating a competitive marketplace for business customers.

Q21 George Eustice: Do you see a situation, then, where there are very much two markets? You might have a statutory obligation on one water company to provide the domestic supply, but then you might have totally separate companies that specialise in business water.

Colin Skellett: Indeed you might.

Rob Wesley: To build on that, I think the key in this area will be for this to be a genuine choice for the management of water companies as to what the best arrangements are for serving the customers in their area, rather than this being in any sense a mandated or a guided choice, either by Government or by regulators. This should really be a genuine matter for the management of companies.

Q22 George Eustice: Finally, how likely is it that a company-say, Wessex Water-would want to exit the business market in its own patch? That is, effectively, what you are saying they should be allowed to do.

Colin Skellett: That depends on how successful they were. We have the lowest constant billing in the country at the moment, so we hope to be very successful and take on others. We are keener for others to exit so that we can buy their companies. However, it could be a business decision that a company says, "It is not working and we will allow consolidation to take place." I think if you do not do that, you create a terribly artificial business market.

Tony Ballance: If it is going to work well, some companies will be good at it and some will not be. The natural progression is to allow those who are better at it to take over those who are less good at it. We need to get the right economies of scale in that sector.

Q23 Barry Gardiner: You said it made sense to have competition in the business sector because businesses have multiple and complex needs, and that it would be good to have competition in there. Of course, the householder is very simple: they want to have gas and they want to have water in their taps. Why is this so dramatically different from gas? How is it that competition in the gas market is deemed to work? Why is water so special that competition could not work for households?

Chair: I dare say that water companies would like to increase their prices by as much as the gas companies.

Tony Ballance: The simple answer is that the case for competition in the gas sector was largely predicated on having successful upstream competition in combination with retail competition. You have much larger gas bills than you have water bills and you have much more ability to have largescale upstream competition with multiplesupply entry into that market, which allows customers genuine choice as to their gas provider. While Severn Trent is a supporter of market reform and more competition in the sector, we do not see-certainly immediately, but even in the medium term-that the water market going to be anything like gas market is. It is just a different commodity in the way that it is supplied.

Q24 Barry Gardiner: Are you in favour of upstream competition?

Tony Ballance: We are in favour of some upstream competition, yes.

Q25 Ms Ritchie: If I could move on to the issue of degrees of separation-I think Mr Skellett already referred to some of that. I suppose my question is about the encouragement of new entrants into the market. If we could elaborate on that, would you agree that those companies that voluntarily choose to legally separate their retail and wholesale arms should face a lightertouch regulatory regime?

Tony Ballance: If I may, I think this is quite a tricky question to answer. There are a number of components to it. Certainly, we are supportive of the direction of travel in terms of lightertouch or riskbased regulations. I have already alluded to the fact that Ofwat are moving that direction; that is a good thing. I have also alluded to the fact that, if companies are not allowed to separate their retail activities, it is a quite complicated activity to have a monopoly supplier and a competitive element.

Therein lies part of the answer to this question: if you stay in that state, it will require quite a lot of regulatory activity on those boundaries between the competitive and noncompetitive elements. So in principle, yes, but I think the behaviour of the participants in the regulatory framework is equally as critical in all of these questions about regulation. Before jumping up and saying, "Yes, that is certainly the answer," I think it is critical that the companies and the regulator act appropriately and in the right way in that framework. We are supportive of lightertouch regulation, but it has to be right for the participants.

Q26 Ms Ritchie: Could I move on? Particularly, I would like to move on to Wessex Water and Mr Skellett. Why did you set up Bristol Wessex Billing Services Ltd? What effect did that have on your business?

Colin Skellett: We set it up because one of the anomalies of history is that we have common territory. Bristol Water has about 500,000 accounts in common with us, where we provide sewerage services and they provide the hot water supply. It seemed crazy to us that we were sending two bills to customers. It confused them and added to cost. We initially set it up as a costreduction vehicle to drive costs down between the two companies. The only way we could agree to do that was to set up a separate legal entity that was owned by the parents of the two companies.

It has worked extremely well, because it has created a business that is totally focused on billing and customer service. It has enabled us to achieve the lowest unitcost for billing in the industry and very high levels of customer service. One of the things that came out of this is that focus is really important. The experience from Scotland of separation is that the focus that comes with it provides a better service. It has worked well; it has driven down costs. It is legally separated and has not caused us any problems at all. We very much welcome lightertouch regulation on it.

Q27 Ms Ritchie: As we move on into the whole area of separation and new entrants, how can the new entrants have confidence that there will be a level playing field, given that the Draft Bill does not specifically require any degree of functional separation between incumbents’ wholesale and retail arms?

Tony Ballance: Undoubtedly a large part of companies’ service provision is-and may well continue into the future to be-a natural monopoly. It is absolutely important that new entrants have some confidence in the rules that apply to the sector to allow them fair entry into it. I think the Bill lays down sufficient powers to Ofwat in terms of the way that it sets access codes and prices to afford quite a lot of protection, hopefully, to new entrants into the sector.

There are also the Competition Act powers; obviously, if those powers are not seen to be effective, there is a fallback for new entrants into the sector. To some extent, the proof of the pudding will be in the eating once the new Bill is hopefully enacted, in terms of how well it will allow new entrants into sector, in terms of whether there will be entry on fair terms.

Q28 Richard Drax: Do you believe that the Draft Bill strikes the right balance between legislation and guidance, in particular in relation to the introduction of charging rules and market codes? Mr Skellett, would you like to kick off? You are nodding your head.

Colin Skellett: No, I was shaking my head. It is surprising how much latitude has given to Ofwat within the Bill. I am surprised that Ministers do not want to take more control over this. Due to the way we develop these access codes-this is the replacement for the current cost principle-if we are not careful there is a danger that this will put additional burdens on other customers. This is an industry that is full of crosssubsidies. Once you start to unwind crosssubsidies, somebody else has to pay. It needs to be done very carefully and with a good degree of thought and control. Within Scotland, there is a duty on the Scottish regulator not to allow changes in one place to affect other customers adversely. That is something that the Committee might want to think about in relation to the proposed changes here. In general, however, I think too much discretion is given to Ofwat under the current proposals.

Rob Wesley: Building on that, one thing that is striking to us is the sheer number of codes, guidance, and regulations in the Bill. It does make it genuinely quite hard to assess what the full impact of the Bill will be. This copy of the Bill is marked up with all of the examples of where there are codes, guidance or regulations referred to in the Bill; it tells its own story. The question of whether regional averaging of charging could be undermined is something that is causing concern, as that has been a principle of the industry for many, many years. If the Government wish to depart from that, then we think that should be a point explicitly made in the Bill. We see no reason to depart from that, and see the benefit from regional averaging being maintained. That should be a matter for the Government rather than one deferred to the regulator.

Perhaps one broader point is that the Bill does confer a lot of discretion to the regulator but does not, to our mind, provide an appropriate appeals process or the correct degree of scrutiny of decisions made by the regulator to balance that discretion granted to the regulator. That might also be an area that the Committee might like to explore further.

Jean Spencer: I really just want to reiterate the comments that Colin and Rob have already made around the potential for deaveraging. One of the consequences of upstream competition is the likelihood of a move towards deaveraged charging. If that is not the intention, then that should be explicit. We have done some work previously to look at the effect of deaveraging in unwinding some of the crosssubsidies; we looked particularly on sewerage side. From the analysis that we did, the impact on rural customers in particular would be bills of about two to three times that of those being paid currently.

Chair: We will be coming on to deaveraging; if we could just stick to market codes for the moment.

Jean Spencer: Otherwise, I think the appeal rights point is important. There should be a route for challenging Ofwat’s decisions.

Tony Ballance: I will not repeat what my colleagues have said. What is important is to get the balance right. As I say, a large part of what we do is a natural monopoly. We have to earn the right to that position, and to some extent it is only right and fair that competition, where it can be made to work, is a good thing. If somebody can provide cheaper water in our area than we can, that should be allowed to happen. I will not repeat the deaveraging point, but it would be good to avoid a situation where we are compelled to deaverage our tariffs in order to have a fair and level playing field. Notwithstanding that, some competition in our activities is a good thing.

Q29 Richard Drax: Does the Draft Bill give Ofwat too much discretion? I think one of you touched on this already. In your view, what are the possible consequences of that?

Tony Ballance: I think we have already touched on that point. It is a difficult one, because the Government’s intention is to have less on the face of statute and give more guidance. As I said earlier, the proof of the pudding is in the eating, in terms of what those codes and the guidance for pricing will look like. If Ofwat get that right then we will have sensible competition. I think the key point that others have made is about having sensible appeals mechanisms when that is seen not to work. One particular example is that Ofwat will be given new powers under the Bill to go back five years in terms of fining, but we know the appeals mechanism in relation to fines is not a particularly good or robust one to challenge. That is a good example where the Bill could be strengthened.

Jean Spencer: I do not think I have anything to add.

Rob Wesley: One area where the Bill would give Ofwat greater powers and discretion is in relation to changes to companies’ licence conditions. As market reforms are implemented, some changes to companies’ licences will be required to implement those reforms. We would just flag that as an area where caution is required, because companies’ licences are an important part of the confidence that investors have in the sector. They have enabled the sector to raise a very large amount of finance to invest £100 billion over the last 20 years and raise that finance at very low rates, due to the stability and predictability that those licences and the regulatory regime give at present.

Colin Skellett: I would only repeat that if you look at the Bill at the moment it looks more like enabling legislation than a Bill that is actually going to be legislated on. The Bill ought to be explicit. Do you want to protect the subsidies? Are you going to allow one set of customers to pay for benefits that go to another set of customers? There are some fundamental public policy issues that are effectively being left to the regulator to deal with at a later date.

Q30 Chair: If we could leave that, you touched, Mr Wesley, on the amount of secondary legislation that is flagged up. Would you not normally expect the Secretary of State to be the person setting out the guidance? Parliament would then also have the opportunity to give a view. Is this the first time the regulator has been given the level of discretion that is set out here?

Rob Wesley: It is noticeable that a different approach has been taken in this legislation from the previous legislation, the Water Act 2003, where there was significantly more detail on the face of Bill and through the Secretary of State, rather than delegating to the regulator. We do wonder whether greater Parliamentary oversight may be appropriate on such crucial areas public policy such as the charging regime.

Q31 Chair: Am I right in thinking that the level of fines will also increase substantially-within the discretion of the regulator-and would go over an average of five years?

Tony Ballance: Yes.

Jean Spencer: Yes.

Colin Skellett: Yes.

Rob Wesley: It would allow fines to be over a longer period. The concern there is the one Tony alluded to: whether there is an appropriate appeals mechanism to ensure there is an appeals route that provides a safeguard to ensure that those greater powers will be used proportionately and appropriately by the regulator.

Tony Ballance: The current appeals mechanism, as I understand it, in that space is akin to a judicial review. It is not quite the same, but it is quite an onerous task. It is not that the appeal will go the Competition Appeals Tribunal as under the Competition Act. It is quite an onerous appeals mechanism.

Q32 Chair: Just to conclude that point, would you prefer the Draft Bill to define more tightly the circumstances in which Ofwat can modify company licences? Do you all agree?

Tony Ballance: Yes.

Jean Spencer: Yes.

Colin Skellett: Yes.

Rob Wesley: There is no dispute that as the reforms are implemented there will need to be changes to the licences, but rather than making any changes that the regulator might feel are expedient, there is an argument for making perhaps only those changes that are proportionate and necessary, with an appropriate appeals route, for example to the Competition Commission.

Q33 Chair: Just so the Committee is absolutely clear, is the appeals route that you normally would have now, to the Competition Commission, being taken out of picture?

Rob Wesley: Indeed, yes.

Q34 Chair: One is nodding his head and the others are shaking theirs. If we could just get on the record what the situation is.

Jean Spencer: I think it depends on which powers Ofwat is using. For example, currently if Ofwat wishes to amend companies’ licences, then companies either have to agree or, if not, the matter is referred to the Competition Commission. Discussions are actually ongoing with Ofwat at the moment around that. If Ofwat uses its Competition Act powers-so carries out a competition investigation-the appeal route for that is the Competition Appeals Tribunal. If Ofwat levies fines for things like misreporting, then there is no straightforward appeal mechanism for that, other than to say-this is my understanding-that Ofwat has been so outrageous case that there is a case for judicial review.

Tony Ballance: Yes, it is akin to that.

Jean Spencer: That is not quite the technical term.

Colin Skellett: The reason why this is so important is this fundamental point about the cost of financing this industry. The reason why people lend us money at knockdown rates is that we are seen as safe and secure, and we have a regulatory system that is safe and secure. The more that is undermined and the more it is open to a lot of discretion, the more difficult it will be. A 1% increase in the cost of capital puts 5% on bills.

Q35 Richard Drax: Will the continued operation of the inset regime for existing appointees lead to inconsistencies between their treatment and that of new entrants under the reformed water supply licensing regime?

Jean Spencer: I do not have a deep knowledge of this part of what is in the inset regime. I think it depends on how it is implemented. It is another example of where we do not know the full impact of the Bill, the substance of which will be in the codes and the guidance. I think we do not yet know the extent to which they will be treated differently. It depends on what comes through in the guidance and the codes in due course. I understand that Scottish Water and SSE made representations around this; I have not studied those in great detail. The answer is that it probably depends on how it is implemented.

Tony Ballance: It is just one of those complicated areas. You are splicing together different parts of the regime; it will depend how it works in practice. It should not be a problem, but it could be if it is not brought together properly and appropriately, with the use of guidance and so forth.

Colin Skellett: I bow to my colleagues’ greater knowledge; this is one that we do not really understand yet. In general, though, regarding inset appointments, I am not sure it is in customers’ interests to have these micro-monopolies for housing estates spreading across the country. I think it would be far better to focus on the bigger issues of retail competition, rather than the microinset appointments. That is a slightly different issue from the one you raised.

Rob Wesley: I have little to add to my colleagues’ responses, other than perhaps the observation that the Draft Bill sets out an ambitious reform programme, and there is a lot of detail to be worked through to ensure that all elements of that are practical and deliverable.

Q36 Neil Parish: Regarding the AngloScottish market, the Committee has looked at this. We are a little bit worried that, if we have Ofwat and WICS issuing licences between the Scottish and the English market, this will create a bureaucracy. Are you satisfied with the progress of the highlevel group, particularly in relation to the establishment of a joint Anglo-Scottish market? It may not be particularly interesting to Wessex Water; I do not know. It is a long way from Scotland.

Colin Skellett: We participate in the Scottish market at the moment.

Jean Spencer: I think it is a good start. The establishment of the highlevel group is very helpful in providing direction. Anglian Water’s Chief Executive, Peter Simpson, sits on the highlevel group, so we have been involved in driving that. In terms of looking at bringing together the Scottish and English markets, Anglian Water Group, through one of its subsidiaries, Osprey Water, is the biggest entrant in Scotland, so we have a number of customers up there.

I do not think we see any particular issue, at this stage, with bringing together the Scottish and English markets. As ever, though, the devil will be in the detail. One of the particular issues that will need to be addressed is the central market mechanism and the models around that. Again, I do not think it is necessarily an issue; it will just take time to implement. Also, I think we can learn a lot from the experience in Scotland, particularly regarding things like data quality. Peter Simpson is heading that workstream, because we have some direct experience of that in Scotland and can bring that into England.

Rob Wesley: Chair, if I may add to that, I agree there has been a good start so far from the highlevel group, and we are pleased that Defra has established an inclusive group, bringing all of the key parties together. That is a very positive development. Within the industry, we are very keen to make progress in delivering the choice to business customers that they have been asking for.

Looking forward, the highlevel group plays a key role in providing strategic direction, but we would see benefits in that being complemented by a broader implementation group to get further stuck into the detail and the nittygritty, to ensure we keep momentum going, that we manage to hit deadlines and that progress does not slow. We would support a broader implementation group to drive progress forward; the industry would be very happy to play a positive, constructive role in that.

Tony Ballance: I do not think I have much to add to colleagues’ points. It absolutely is an important area to get right; it needs focus and energy and that is being brought to bear at the moment. Obviously, there is still a lot of work to do.

Q37 Neil Parish: Could it be argued that there might well be greater competition available for business customers in the AngloScottish market on the borders of Scotland than there is in the rest of England?

Colin Skellett: I do not think so. We are talking about retail competition. It is the provision of billing, customer services and advice to customers. The evidence from the Scottish market is that people are not switching because of price; they are switching because of the quality of the service they are getting. Putting the two together makes an enormous amount of sense; learning from and building on the Scottish experience makes sense. We do not need to reinvent the wheel for ourselves. They have done a lot of work and they have something that operates. We should build on that and create a single market. I think the competition will be as vigorous in Cornwall as it will in Northumbria.

Neil Parish: I hope you are right.

Q38 Chair: Does it not surprise you that the highlevel group has only met once and has no plans, immediately, to meet again?

Jean Spencer: It has met once.

Chair: And only once.

Jean Spencer: It does have plans to meet again; I do not have the date.

Q39 Chair: Do you not expect a little bit more? I think, Mr Wesley, you said you would like to see some momentum. Does this smack of momentum to you?

Rob Wesley: Perhaps if I could expand on that. As well as the meeting of the full highlevel group, there has also been a workinglevel group meeting. In setting off this process, it is very important that there is a coherent vision for establishing the new market and that this vision has broad support from all of the stakeholders and participants. There is a lot of work to be done establishing the appropriate order and the appropriate tasks to be carried out; that is a crucial first step. Building that consensus is a key part of the process. The highlevel group, by its nature, is small focus group providing strategic direction. I think we would see a strong case for there being a broader and perhaps more detailed, workinglevel implementation group to be able to take the practical step of delving down into detail to meet that high-level vision.

Q40 Barry Gardiner: Reading the submissions that you have given to us, it would seem that sizable chunks of the industry have real problems with the upstream reforms. If I try and characterise them for the sake of expediency, they would be: the possibility of increased household bills, which would be if there were competition in one part of your business, the business unit supplying to other businesses, then you would look to recover that from household bills; declining investor confidence because of cherrypicking; loss of economies scale and a risk of stranded assets; and reduced resilience through a lack of clarity over the need to build capacity by new entrants into the market.

Those are really sizable objections that the industry is putting forward. Mr Ballance, you were good enough to say earlier that you are in favour of the upstream reforms. Can you explain to me why you disagree with some of your colleagues over the nature of the upstream reforms and the risks associated with them?

Tony Ballance: It is probably worth starting by breaking down the areas of upstream competition that are being promoted. We have discussed the issue of businessretail separation. I think the industry has largely reached a consensus around that being a sensible step to take and the extent to which that should happen. I think there are two components to upstream competition. The Bill effectively seeks to allow entry into the supply chain with new entrants coming in who can supply goods and services cheaper or more efficiently than the incumbent water undertakers. Secondly, there is scope to increase water trading through bulk suppliers and the Bill strengthens Ofwat’s powers in that regard.

Dealing with the bulk supply issue first and water trading, Severn Trent makes no secret of being advocates of that; we have, indeed, published work in the recent past on the economic benefits that would accrue to customers through encouraging more water trading between companies, where it makes economic sense. That is where one water company can develop water resources cheaper than their neighbour, and supply it across the border inclusive of the costs of transportation. Indeed, Jean and I were talking earlier in the summer when it was hot and dry-before it started chucking it down with rain-about a potential trade between Severn Trent and Anglian Water.

Q41 Barry Gardiner: Was it 50 billion litres? It was extraordinary. You never drew down on it, though, did you?

Tony Ballance: No, we did not need to, because effectively that water would have come from Birmingham, from pumping water out of the ground, into the Trent and down into Anglian’s region. It started raining. The Trent was full of water for the remainder of the summer period, so Anglian did not need the water. We make no secret of that.

Our view would be that it is possible to implement a water-trading regime without destabilising investor confidence in the sector because, to some extent, it leaves the companies’ funding mechanisms entirely intact.

If I then turn to the provisions relating to allowing new entrants to supply into the value chain, others have expressed the view that there is a risk there in terms of the impact that can have on deaveraging of charges, because we have large crosssubsidies in the way that we charge, and, if that competition was going to be extreme, then that might force us down that route.

Q42 Barry Gardiner: Sorry; could you be explicit about what that route is? That route is loading household bills to make up for it. Is that right?

Tony Ballance: That could be one consequence. It could be loading certain household bills, for example, or charging more in rural areas, because it is more expensive to supply, and cheaper tariffs for urban areas, in order to protect your customers from, effectively, new entrants being able to supply them at cheaper prices.

Jean Spencer: It might not necessarily be households.

Q43 Barry Gardiner: Is it protecting your customers or is it protecting you, as a company?

Tony Ballance: Getting the balance right in this space is important because it is entirely right, as I said earlier, that there should be some form of competition if it is on a level playing field. For years and years we have had the situation where breweries, or whoever, can drill boreholes into the ground and take water from underneath their factories if it is cheaper to do so than get water through the network, or companies can pretreat their effluent waste before sending it down the sewerage network to Severn Trent or whoever else.

We have always faced some form of contestability in the supply chain; it is a question of getting that balance right. It is sensible to have some competition, but if, to some extent, it is not on a level playing field, in terms of the way in which the price mechanisms work, that is where the concern comes, because you may end up with stranded assets or you may end up loading the bills of some domestic customers higher. Obviously, that is the concern that has been expressed in some quarters in relation to the provisions in the Bill.

Jean Spencer: I would say that it is not just about rebalancing on to domestic customers necessarily; it is rebalancing on to other business customers, particularly thinking about SMEs and especially those in rural areas. It is not necessarily the case that the unwinding of the subsidies would be from businesses to households. It would potentially be within businesses as well. Sorry to interrupt, Tony.

Colin Skellett: I think Mr Gardiner did an excellent job of describing why this is a good way of shooting yourself in foot. I think we are starting at the wrong end. We should not start from the notion of, "Competition is the answer; what is the question?" We should start from the question of, "How do we create resilience in system? How do we create additional capacity within the system?" It is perfectly possible to do this by requiring companies to continue to work on their grids, to work on their regional grids, to interconnect their regional grids and to work together. All the evidence says that once you create a regional grid-we have done it at Wessex Water-you actually create additional capacity, because you are able to move water around and meet demands in different ways. We need to focus on how we achieve that resilience.

I do not see how upstream competition will do anything to help with that. I think it will add to uncertainty; I think it will add to the cost of the industry; and it will lead to a horrendous unwinding of cross-subsidies. To me, this should start from another place, which is this: how do we achieve the resilience we need within the system? We can do that by setting the right incentives in place. Ofwat can do that by putting the incentives in place for companies to work together and trade. An additional point is that I would have thought that if we got into the national emergency situation of a serious, prolonged drought-and we are going to get more and more droughts-we would want to be able to have a more commandandcontrol approach to this, rather than saying that the market will sort it out.

We had a fascinating meeting of the chief executives of the water companies when we were looking at the drought and how we worked together to do the things that we described, moving water from one place to another. We were told very clearly by our lawyers at the time that, of course, if we were in a competitive market we would not have been able to do that.

Q44 Barry Gardiner: I go back to the Martian that you referred to at the beginning. You do not think that the size and shape of the water industry is the correct one any more than the Committee does, but what strikes the Committee-or certainly strikes me-as odd is that, for a privatesector business, you are remarkably resistant to a privatesector, marketled approach to sorting it out. Somebody might come along and says, "You know what, guys, we should use the market. We should use competition to drive efficiency into this industry. We should use competition as a way of rationalising it," so that the Martian can come down and have a look at it and say, "Actually, that makes sense," instead of, "Hey, this is a mess". You guys from the private sector would push back on that and say, "Hey, no. We do not want the market to do this."

If it is not going to be the market that will drive that competitive improvement and rationalisation of the industry, what will?

Colin Skellett: Can I be clear? We are absolutely in favour of competition in the right place. Competition on business customers makes an enormous amount of sense; it is what business customers want. There is a competitive market for providing the capital solutions in the way the industry operates now, but what you do not want to do is to create an artificial competitive market that simply increases the cost to the industry. That is not sensible way of doing this. Opening up the market and allowing more mergers and takeovers would continue to drive efficiencies in this business.

Q45 Barry Gardiner: Mr Skellett, with respect, you are telling me motherhood and apple pie. You are saying, "We do not want to introduce bad competition. We do not want to introduce competition that is going to drive up costs. Of course we do not." Come on, then. How will we change the shape of this industry, so that, instead of 22 companies, you might end up with five; you might go back to the Regional Water Authorities; and you might have a catchmentbased system that makes sense, and all of those other things? How will you do that? How do you need to change this Draft Bill in order to get back to a sensible system for your Martian?

Tony Ballance: One of the things we talked about earlier was abstraction licence reform, and we made the point that we largely would be in favour of that. That, I think, would be a catalyst to helping stimulate the movement of water in a different way because it would realise the economic value of that. Once there is a value associated with it, that would allow that. I wanted to go back the watertrading piece, because I think the Bill does push forward in that direction, strengthening Ofwat’s powers in relation to water trading. I see that as sensible upstream competition, which does not destabilise investor confidence in the sector, which is intrinsic to having a regulatory cap on the value of some forms of vertical integration.

Using the Martian example, if somebody in 1989 came back to the industry now and said, "Could you tell me how much water trading has happened since 1989?" and we said, "Very little, other than what was put in by the Victorians", I think they would be pretty surprised with that. What is lacking is incentives in that space. I think Ofwat recognise that; I think the Bill recognises that by strengthening the powers in relation to that. If we can get water trading working, which may require companies to work sensibly together, that will give us a form of competition. What it will mean is that some companies will be building resources in their own traditional area. Colin’s absolutely right that individual companies need to strengthen their grids for resilience purposes. We need resilience across boundaries and I think that will come from more water trading between companies, which is a real form of competition that does not spook the markets.

Colin Skellett: Can I answer the question in another way? This industry is not broke. It actually works and it works remarkably well. It has driven up standards for customers; it has driven up efficiency; it has kept bills much lower than they would have been without the changes that took place. What we are not trying to do is to recreate the industry. We are trying to sensibly evolve the industry. I agree entirely with what has just been said: we should put the incentives in place to encourage water trading and water movement. What we do not need is a complicated trading mechanism to do it. We need the right incentives put in place.

Q46 Neil Parish: Carrying on with Mr Gardiner’s question, is this not a case of, "Lord, make me good, but not just yet"? Is it not the case that you want to actually have competition and not be fearful of it? It could be argued that we handed a public monopoly over to a private monopoly; I am playing devil’s advocate here. Surely, what we need is a great deal more competition. That would actually drive prices down, ultimately, and not drive them up.

Rob Wesley: It is absolutely right that competition is right for business customers. We fully support that, and are working actively to make that happen on the ground. We are very conscious of the great benefit to customers of the ability of the industry to raise finance at extremely low rates. We touched earlier on affordability. There could be some significant consequences if that confidence for investors was lost. That is not to say that evolution cannot happen over time, but the confidence of investors has been hardwon and could be easily lost.

Obviously, we are conscious, being industry representatives, that you may take anything we say with a degree of scepticism. However, these are points that are being made by range of commentators on the industry, such as Dieter Helm, for example. There are some serious questions out there to be answered, and we would take the view that it is right that there should be a cautious approach. For retail competition, there is a model. There is an example which is working well north of the border, in Scotland. For the upstream reforms that have been proposed, there really is no model. These are untried and untested, so a cautious approach, of carefully working through how they could add value while maintaining investor confidence, has to be the right approach.

Q47 Chair: Is there anywhere in the world which has upstream competition in the private market?

Rob Wesley: There are no substantial examples of this. There are some areas on the margins with some degree of water trading.

Jean Spencer: There is some in Australia. We actually published a report last year, as a precursor to the work we are doing on the trading platform, called A Right To Water. That does set out some of the international experience. There has been some in Australia, but in Australia it is very much on a catchment basis, so it is not across even the whole of a region. It is very catchment focused. That is very much around trading, which, as Tony says and which we very much agree with, is important and should be the focus going forward, rather than some of the other reforms that are being suggested.

I would add to Rob’s point that whatever we say would be treated with some scepticism. It is important to look at other commentators; Rob mentioned Dieter Helm. I think it is also worth looking back at the National Infrastructure Plan that was published in December. I cannot remember which year that was. That sets out the respective cost of financing with different models. The cost of financing regulated infrastructure is significantly lower than financing competitive, marketbased infrastructural investment. I think you have to look at those other external commentators and not just at what water companies are saying.

Q48 George Eustice: You are right; we do treat it with a bit of scepticism. The arguments you are using do sound like arguments used down the ages by vested interests trying to protect their position. It is the type of thing people now use against opening new schools or decentralising the NHS.

I wanted to push you on a different point. I take your point that you do not want completely rival systems that would then increase the cost, but are there any elements that you would accept? For instance, if you want to encourage water companies to be able to leave areas where they are not efficient, could a water company, for instance, say, "Well, we were good at maintaining the pipework, but our reservoirs are not done very well. We are going to sell that bit of the business off to a new provider who can come up with the capital to invest in it more cheaply than we can. It is in our interests to do that." Or they might say, "We are not very good at sewage treatment works; we are losing money. We are not as efficient as we should be, so we should sell that element of it."

Are you being unrealistic in saying there will be 10 different systems of water pipes? Is the case that, in reality, you will be able to pick and choose which bits of the infrastructure you would maintain?

Colin Skellett: That is an interesting argument. There is already competition in the construction of the assets. That is absolutely clear. There is also competition in the operation of the assets, to the extent that all of us put those assets out for competition, in terms of maintaining them. In some places they are maintained by other companies; in some places they are maintained by us. What we have not thought about is the idea of selling off those assets to others.

I suspect that you have come back to the problem that you have created a regulatory asset base, against which people have lent money, and the overwhelming need to keep down the cost of that borrowing means that you want to keep that asset base intact. Now, you can look at it with a different approach for new assets, and that is happening in different places. However, I think selling off the existing assets on a piecemeal basis would present you with a lot of financing problems and would probably result in most companies breaching their various debt covenants.

Tony Ballance: There has been some interesting work done on what economists call the "economies of scope" in the water sector. We run complex networks comprising water treatment, distribution and resources; it is an integrated system that we run, rather than a separate system. I do not think there are many companies that have a separate watersupply division from a waterdistribution division, because you tend to run those things as integrated systems.

There are good economic reasons why you want to maintain integration in significant parts of the value chain. The point is that to some extent you are then trying to defend the fact that we want to keep significant elements of a natural monopoly, which is where the competition debate comes in, and people ask about how competition can work around something that is effectively a private monopoly. To some extent, we have to accept that, for a significant period of time, large parts of what we do will be a private monopoly. We need to have competition in the right space within that framework.

Q49 Barry Gardiner: The unbundling should provide the opportunity to anybody who wishes to challenge, rather than you saying that it is the one side of it that is unfair or will cause problems. Briefly, to wrap up, I wanted to ask a question. Given that upstream reform is likely to go through-it is in the Draft Bill-and given that what the Committee is partially about is to make sure we get the best Bill we can, rather than just start off in a new place, what changes could be made to the Bill so that the upstream reforms that we have been talking about do not have those perverse effects on investment confidence, on reduced resilience, on stranded assets and so on? What are the key changes that you would wish to see made to the Bill to avoid those deleterious consequences?

Jean Spencer: I think it is important that the Bill is clear on the intentions for upstream reforms. We have already heard that Ofwat say that it sees the Bill giving it the green light to look at separating companies’ functions or activities-for example, potentially taking water resources and treatment, and subjecting it to a different form of regulation, which means it might not be a RCV-based or returnbased form of regulation. I think the Bill needs to be clear on what its intention is. It is absolutely fine if the Bill’s intention is that Ofwat takes those next steps-that is a matter for Government policy-but it needs to be clear on what the policy is. That will be an important part of Bill.

Another key part is the point around averaging and the potential risk of de-averaging as a consequence of the Bill. That will be a consequence, unless it made clear that it needs to be addressed through the approach to setting prices. That can be dealt with; it can be dealt with through all participants in the market taking account of rural communities, for example, and paying their share of those additional costs. It is not an insurmountable challenge, but it needs to be clear what the Government’s policy is around that. Then it is also about continuing to maintain investor confidence.

Colin Skellett: I agree entirely with that point, but I have one additional practical thing: there needs to be clarity on where criminal liability will sit for supplying unwholesome water, because you are introducing different filters.

Q50 Chair: Could I just ask about cost-effectiveness? Bearing in mind that water is a lot heavier to transport than gas or electricity, is trading generally deemed to be a costeffective way to meet the increased demand that Defra hopes will come out of upstream reforms and water trading?

Tony Ballance: If I may respond to that, because I and Severn Trent have made the case for water trading. Water trading is not the only solution to balancing supply and demand going forward. It is one of a number of things, which would include things such as water efficiency, metering, leakage control, new resources and so forth. Certainly, the work that we have done suggests that trading more water across boundaries makes economic sense, but, as I say, it will not be the only solution to the country’s supplydemand balance going forward.

Q51 Mrs Glindon: My question is to Mr Wesley and Mr Ballance. Do you believe it is feasible for an incumbent water company to adhere to different market regimes on either side of the Anglo-Welsh border?

Rob Wesley: Everything is possible, but would that be desirable? Clearly, it would be an odd situation to be in, and we would really see this as a question that does need to be resolved between the Welsh Government and the UK Government. The simplest approach would be for only one approach to apply to one company, so that there is clarity and simplicity.

It is perhaps worth mentioning that Welsh Water is in a somewhat different position to other water companies, in that it is owned by Glas Cymru, which is a notforprofit company limited by guarantee and which exists solely to deliver better value to the customers of Welsh Water. Welsh Water has been doing equally so to its customers in Herefordshire and Deeside and to its customers in Wales. My understanding is that Welsh Water has not been asked at this stage-and neither has Dee Valley Water-to consider whether it could operate effectively within a different regime applying in England to that which applies in Wales. Clearly, that would be much more administratively complex. The obvious solution would be for one regime to apply to one company, as is the case at the moment.

Tony Ballance: Obviously, Severn Trent Water serves customers in midWales and is indeed proud to serve those customers. We do not envisage any issues, from our perspective, because we fall under the auspices of Defra and therefore, to some extent, the regime is clear for how those customers are treated, so we do not foresee any issues from our customers’ particular perspective.

Chair: On behalf of the Committee, can I thank you very warmly for being so generous with your time and contributing to our evidence session? We stand adjourned. Thank you.

Prepared 30th October 2012