ofwat annual report 1997

OFWAT ANNUAL REPORT 1997The main message to come out of thepublication of OFWAT's Annual Report 1997is that the Director General of Water Services(DGWS) has stated that it was important thatany environmental improvements, whichwould be funded by water customers inprice limits post-2000, should bring clearand evident benefits. The DGWS is concernedabout pressure for improvements whichwould cost considerable sums of money forlittle benefit. In particular the DGWS drewattention to the recommendations made bythe Environment Sub-Committee on SewageTreatment and Disposal, on which a responseis due shortly from the Government.

The DGWS is expecting guidance by Julyfrom the Secretaries of State on the scale andtiming of the environmental programme to bemet by water companies after 2000. Even afteran initial challenge by OFWAT of the compa-nies' estimates of meeting the programme, thecapital costs could be around £11 billion overfive years if the Government adopts all theproposals costed. At the same time there areother pressures for expenditure to whichcustomers are giving higher priority. Forexample, security of supply, greater expendi-ture on maintaining assets and reducingflooding from sewers could add £4 billion tocosts over the period. The Government'scharging review would also have implicationsfor customers' bills.

The report looks at a number of issues. Thefirst chapter considers the 1999 price review.The report recaps that 1997 was primarilyconcerned with how OFWAT would carry outthe price review in 1999. OFWAT has pub-lished a series of consultation papers, culmi-nating, in February 1998, in the DGWS'conclusions on the approach to the pricereview. The strategy underpinning thereview is that the customer should benefit,and be seen to benefit, as soon as possiblefrom the efforts of the companies to reducetheir costs, to preserve incentives for thecompanies to maintain long-term serviceabil-ity of their assets, and to act efficiently and toconduct the review in a way that is wellinformed and transparent, so that the DGWS'decisions are publicly credible and defensible.

The report then goes on to considerconsultation papers and other forms of

consultation devices used by the DGWS todate, including meetings and seminars. Thenext stage of the review is to expose broadranges for the price limits for 2000±2005 andto consult on the main issues. During thesummer of 1998 the companies' boards willsubmit a number of key information returnsto the DGWS. These include:

. a supply balance submission, setting outthe companies' proposals for matchingsupply and demand in the light of a fulleconomic appraisal, including levels ofleakage and tariffs;

. a cost base report, detailing capital expend-iture unit costs for present and futureoperations;

. the annual July return and regulatoryaccounts, including additional data forcomparative efficiency studies, logging upadditional quality improvements and keyfinancial information;

. a report on asset inventory and systemperformance, describing the audit of thecurrent asset stock, value, condition and ageprofile; and

. a customer consultation and strategicoptions return, to report on consultationswith customers and set out the companies'proposals on their proffered businessstrategy.

In October the DGWS will publish the firstindications of ranges at a company level in aprospects for prices, strategic options andissues paper. This will draw together theissues, the results of consultations whichcompanies have carried out with their custo-mers, the advice of the Environment Agencyand the views of other customer and environ-mental groups. This paper will be subject tofurther consultation and will also containpossible price plans. In 1999 the companieswill submit their draft business plans, fromwhich the DGWS will determine price limits.

OFWAT will also be working closely withministers and officials to ensure that theGovernment's recent proposals on utilityregulation and charging can be translatedinto an effective framework which will allowboth government and regulators to dischargetheir respective responsibilities.

Chapter 2 of the report focuses on the``paying for water'' debate. The current price

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limits, set by the DGWS in July 1994, continueto lead to smaller increases in bills for mostcustomers. Customers of some water onlycompanies saw their water bills fall in realterms again in 1998. The average householdbill in 1998 was £242 before rebates (given bysome companies) were deducted. This was anincrease of £3 (1.4 per cent) in real termscompared with the average bill for 1997±98.In the four years since the last review waterbills have risen 4.5 per cent in real terms,while sewage bills have risen by 10.5 per cent.The report highlights the variation in bills indifferent regions. South West Water has thehighest average bill (£158), while PortsmouthWater has the lowest (£73). The level ofaverage sewage bills is £229 for South WestWater and £102 for Thames Water.

The report considers various consultationdocuments which have been published inrelation to water charging. The Government'sreview of charging will obviously have animpact on the regulatory structure, and thereport sets out the main recommendations. Inbrief, these are: to give increased choice tocustomers, through means of a free meteroption; to enable customers to continue to payfor water on an unmeasured basis if they arenot using water for discretionary purposes;the right to revert to an unmeasured charge,within one year, for customers who opt for ameter; a ban on disconnections (the numberof disconnections fell by 39 per cent to 1,907,with seven companies making no disconnec-tions); the use of meters and measured tariffsto promote the sustainable use of water;protection of vulnerable customers; and thecontinued use of rateable values after the year2000. Some changes will be made by OFWATto the tariff basket, including changing thestandard charges to recover only customer-related costs, and the Government hasproposed that standing charges should beabolished for measured household customers.The DGWS wants companies to developtariffs which take into account the distinctionmade for water used for essential purposesand water used for discretionary purposes.The Government also wants to help vulner-able customers and, again, the DGWS isencouraging companies to consider the issue.

Under the current licence conditions, whenhouseholders switch to meters, companies areable to recoup some of the lost revenue fromother customers. OFWAT has published pro-posals to amend company licences to preventthis. The DGWS has also looked at the

balance between water and sewage bills, andconsiders that customers should pay only forthe services they receive; for example, if acustomer is not connected to surface drainagehe should not pay for it. The companiesshould make it clear on customer's bills whatthey have been charged for, and shouldexplain trade effluent bills to customers inmore detail.

OFWAT has also revised the tariff basket,following consultations, and intends tochange the way in which the unmeasuredbasket calculates increases in charges to bringit into line with the way in which themeasured basket operates, and to removelarge users from the tariff basket. In relationto the large user tariff, 22 of the 28 companiesnow have a more cost-reflective tariff for largeindustrial users of water, and three of the 10water and sewerage companies have them forsewerage. In the past, when a companyintroduced these tariffs, they could increasebills for other customers to recoup lostrevenue. OFWAT has published proposals tolimit the ability of companies to do this.OFWAT has also considered charges made forthe receipt and disposal of waste from cess-pools and septic tanks. The DGWS is seekinglegislation to make such activities subject toOFWAT's jurisdiction, and is discussing thisissue with the Office of Fair Trading (OFT) sothat non-compliant companies may bereferred to the Monopolies and MergersCommission (MMC). The DGWS would liketo see companies develop optional meterschemes; but some companies have increasedthe cost of installing water meters and haveput restrictions on their location.

During 1998 the issue of budget paymentunits (BPUs) was held to be unlawful. Thereport states that the Government does notobject to BPUs if they do not result incustomers being disconnected. The DGWS isconsulting with the companies to see whetherthey are complying with the judgment.

Chapter 3 of the report is concerned withthe sustainable and efficient use of water. Themain area of concern is in relation to waterresources, in particular the issue of leakageand water efficiency. Mandatory targets forleakage have been set for 1998±99. The reportstates that, in general, leakage fell between1995±96 and 1996±97 by 475 million litres aday. OFWAT expects to see further reductionsreported for 1997±98. The biggest fall shouldoccur during 1998±99 when the mandatory

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leakage targets set by OFWAT will meansavings of 700 million litres a day ± enough tosupply all of the households served byYorkshire Water. Regulatory action will betaken where companies fail to meet targets.

At the Water Summit, the Government setout what it expected of the water companies.The water industry has demonstrated itswillingness to meet the Government'swishes at no additional cost to the consumer.Companies have accepted the followingpolicies: free leakage detection and repair(apart from Mid Kent Water); the provision ofwater-saving devices, as well as waterefficiency advice through water audits; effi-cient domestic appliances; and advice ongarden watering. All water companiesagreed to changes in their licences, suggestedby the regulator, to ensure that customerswould receive compensation if domesticsupplies were interrupted during a drought.

Chapter 4 of the report deals with facilitat-ing competition. The potential for competitionin the water industry is limited; however, anumber of initiatives have taken place. Thefirst two successful inset appointments weregranted this year at Buxted Chicken and RAFFinningley, both of which involved varyingAnglian Water's licence. A third application,at Shotton Paper on Deeside, has beenapproved, which involves a new entrant,Albion Water Ltd, as undertaker. Twenty-five applications were made, 22 of which wereby a new applicant, Enviro-Logic Ltd. AlbionWater is a subsidiary of Enviro-Logic andSouth West Water. Improvements have beenmade to the inset appointment process, interms of speed, and transparency of theprocess. The report states that the majorityof inset appointments are for bulk supplies orsewer connections. The DGWS would like tosee applications for new sources of water,treating and disposing of effluent. A numberof consultation papers have also beenpublished in relation to the bulk supplies ofwater. The DGWS is also working on guide-lines on matters which may arise as a result ofthe Competition Bill currently beforeParliament.

Chapter 5 of the report looks at assessingcompany performance. The report recaps onthe various methods for information collec-tion, including the July returns and meetingsof quality regulators to identify any areaswhich may need further action.

The report states that in 1997 the DGWSwas concerned about the level of the indus-try's capital investment. He secured theagreement of a number of companies not totake up their full price limit for 1997±98,saving customers some £34 million. Capitalinvestment recovered during 1996±97 andwas 22 per cent up on the previous year.Infrastructure renewals expenditure increasedby 29 per cent. Quality regulators confirmedthat they were content with the performanceof the companies. Early indications for 1997±98 are that capital investment is continuing athigh levels. OFWAT will also look at otheraspects of company performance. In 1997 noformal investigations were undertaken inrelation to company performance. Overall,the report states, companies' performanceimproved in matters relating to low pressure,sewer flooding, response times to billingcontacts, written complaints and the numberof metered bills based upon meter readings.For the first time OFWAT reported oncompanies' performance in relation toanswering telephone calls, on a comparativebasis. One in 10 telephone calls were aband-oned, and only 81 per cent of calls wereanswered within 30 seconds. Overall, this wasunsatisfactory. Some companies reportedperformance below the industry average andperformance levels in other sectors. If thisunder-performance was temporary, OFWATsought assurances from management thatsteps were being taken to redress the problem.In some cases companies were asked toprovide interim reports to show the improve-ments in performance. For a small group ofcompanies targets were set for 1998±99 andthese will be reported in the levels of servicereport. OFWAT is looking at ways to includequalitative aspects of companies' perform-ance, as well as the quantitative measurescontained in the performance indicators.

The National Audit Office (NAO) looked atthe quality of service to water customers andnoted that there were a higher number ofbilling contacts being referred to the regulatorthan in other utilities, and that furtherinvestigations may be needed. OFWAT under-took a comparative study of three utilities ofall the known billing contacts received, notjust those reported to their respective regula-tors, and found that the water companiesreceived half the number of contacts than theelectricity companies. The NAO also recom-mended that customer satisfaction surveysshould be developed, which OFWAT isconsidering.



The report reported information on landdisposal. The level of materiality for thenotification of land disposals to OFWAT roseto 500,000 to associated companies and onemillion to third parties in April 1996. Sincethen, OFWAT had received less notificationsfrom 92 in 1995 to 19 in 1996±97. In 1997±98,seven cases were considered. More details ofland sales will be provided in the financialperformance and capital investment reportprovided later this year.

Chapter 6 of the report concerns the issue ofmergers and the regulation of multi-utilitiesand companies within groups. The reportstates that there were no mergers during 1997.However, it follows up with reports on themergers which took place in 1996. Twocompanies, Mid Southern Water and SouthEast Water, are moving towards a singleappointment; both companies are owned bySaur Water. Consultation will take placeduring 1998 for a possible licence beinggranted during 1999.

The report then considers the issue of multi-utilities. The DGWS has developed rules,supported by licence amendments, to ensurethat a multi-utility has an independent board,with non-executive directors working solelyin the interest of the company. Prices to anyassociate company should be subject tomarket testing or be made at cost, and theDGWS's permission must be obtained for anyassets transferred, or loans or guaranteesmade by the business. Dividends should bemade in accordance with principles sanc-tioned by the DGWS, and customerrepresentatives of the boards should workclosely together. Investigations into multi-utilities and the water and sewerage branchesof those companies have been undertaken atNorth West Water Ltd and Dwr Cymru, andthere will be an investigation into SouthernWater in 1998. OFWAT found that the use ofmarket testing needs to be developed by thecompanies, and that there was overuse of thebenchmarking of process. To remedy the lossof stock market information when ScottishPower took over Southern Water a variablecoupon bond was listed on the StockExchange. Transfer pricing was also investi-gated again in 1998. This helped companies toconduct their transactions at arm's length.Market testing and audit trails were suggestedby OFWAT as a way of tightening up theprocedures in this area.

Chapter 7 of the report considers com-plaints, disputes and appeals. In some areasthe improvement in the number of complaintsand disputes dealt with satisfactorily are verymarked. For example, the number of proper-ties affected by sewer flooding has halvedsince 1992±93, and for the seventh successiveyear the industry registered an improvedperformance in the speed with which itresponds to billing contacts. For a smallgroup of companies, OFWAT required targetsto be set for 1998±99. Details of theircompliance will be published.

Chapter 8 of the report considers customerrepresentation. The OFWAT National Custo-mer Council (ONCC) and the 10 regionalOFWAT customer service committees (CSCs)keep under review issues of concern tocustomers and provide the DGWS withadvice on matters affecting customers. Theiractivities are set out in a separate annualreport, Representing Water Customers 1997±98.OFWAT has recommended that the ONCCshould be a statutory body and will treat it assuch, until legislation can be passed. TheDGWS has ceased to be a member of theONCC. The report considers the Green Paperon utility regulation, A Fair Deal for ConsumersModernising the Framework for Utility Regula-tion (March 1998). The DGWS and the ONCCwill submit a response to the paper. In linewith openness, especially in relation toappointments, the report deals in somedepth with the membership of the ONCCand the CSCs, and the appointment andrecruitment of members.

Chapter 9 of the report looks at operatingopenly and transparently, in terms of mediapublicity, publications, the library andinformation service, and the Internet: evid-ence was submitted to a number of parlia-mentary committees; conferences andseminars were attended; a roadshow washeld; and there was increased contact withMPs and peers. OFWAT received fourrequests under the Code of Practice on OpenGovernment, three of which related to its work.Details of the water companies' special agree-ments were made public for the first time in1998.

Chapter 10 of the report considersOFWAT's resources. OFWAT's estimated out-turn on running costs for 1997±98 is£9.9 million. The costs of running andsupporting the CSCs and the ONCC in



1997±98 are estimated at £2.2 million. OFWAThas a total of 206 staff.

The report should be read in conjunctionwith Representing Water Customers 1997±98,the annual report of the ONCC and the 10CSCs. The ONCC report begins with adiscussion of the constitution and role of theONCC, which meets formally five times ayear and has two working groups, one onEurope and the other on the periodic review.Meetings of the ONCC are held in private, butminutes are published subject to any confi-dential or internal OFWAT managementbusiness. The report states that the CSCs,which investigate complaints from customersabout water and sewerage companies,received 11,123 complaints in 1997±98, a10 per cent increase on the previous year. Ofthese, 2,913 (or 26 per cent) concernedcharges, one-third of which specifically con-cerned increases in bills.

The ONCC report considers the role ofONCC and the CSCs in the periodic review.

The ONCC has continued to press for pastefficiency savings to be passed back tocustomers ± the so-called ``P0 adjustment'' ±in the year 2000 (the first year of new pricelimits). It would like to see a cut of at least10 per cent in water and sewerage bills. TheONCC has also undertaken a small-scaleresearch project into the views of lowincome households. This has shown thatcustomers on low incomes want to see theirwater and sewerage bills reduced and believethe funding of many environmental improve-ments should be the responsibility of govern-ment and local authorities rather than watercompanies. The report states that the ONCChas had meetings with the quality regulatorsbut seeks lower bills with improvements inthe quality of water.

The ONCC report then considers Europeanwater quality. The report states that theONCC is concerned about the costs of newdirectives now being discussed within theEuropean Community. Last month, Euro MPsrejected an amendment calling for the costsand benefits of a new directive to be looked atbefore it is rubber-stamped. The ONCC statesthat proposals for higher standards must bebased on up-to-date and sound science andmust be base-costed, that the costs must bejustified by the benefits, and that the cost ofthe proposals, taken together with otherproposals, must be affordable over the

suggested timescale. The ONCC report statesthat it was satisfied with the timescale of15 years rather than 10 years for the newDrinking Water Directive standard on lead.The ONCC is also satisfied with the exclusionof lead piping in customers' domestic plumb-ing, and wants to see proper advice given tohouseholders about the removal of lead pipes,and whether financial assistance would beavailable to those customers in need. TheONCC is concerned that there is no monitor-ing and sampling method laid down in theDirective for lead; after raising this thecomitology procedure was changed so thatthe European Parliament would have a say inthe sampling method definition. The secondconcern the ONCC raised was in relation tothe reporting procedure. The ONCC wantsprovision for a report to be produced everyyear, as in the United Kingdom. At present areport is only required every three years.

The ONCC report also looks at progress ofthe Directive establishing a framework forwater policy. The ONCC is concerned aboutthe lack of information relating to costs ofoverall environmental quality objectives, theaim of reaching good status in all surface andground waters by 2010 and the inadequatedefinition of good status. This latter point wasresponded to, and two pages in the originalAnnex 5 of the Directive were replaced with a56-page proposal. The ONCC welcomes theidea of river basin management plans.

The ONCC report considers the regulatoryframework, and states that the ONCCresponded to the Government's Green Paperon utility regulation (referred to above). TheCouncil supports the Government's proposalsaimed at ensuring that a fair deal forcustomers is at the heart of utility regulation.The ONCC made a number of submissions,including proposals to make the protection ofthe interests of customers a primary duty ofthe DGWS rather than a secondary duty as atpresent. CSCs should be recognised as thirdparties with sufficient interest to appealagainst the DGWS' determinations of pricelimits. CSCs should also have a right to giveevidence to the MMC rather than by invita-tion, as is the case now. The ONCC wouldalso like to see a clear statement of the benefitsto customers before any mergers take place. Italso considers that multi-utility mergersshould be referred automatically to the MMC.

In relation to competition, through thereview of abstraction licences and a possible



bidding process when companies' licencescan be terminated in the year 2004, thewater industry could also be restructuredand broken up.

The next section of the ONCC report looksat water charging and the review of a watercharging system. The ONCC made sub-missions to the Government's review, statingin particular that low bills for certain custo-mers should not be funded generally byhigher bills for other customers. The reportstates that the ONCC is unhappy with thesystem of charging based on rateable values,but feels that it would be impracticable tochange the system before the year 2000. TheONCC therefore supports the continuation ofrateable values, but not indefinitely. TheONCC does not advocate compulsory meter-ing, except where water resources are underpressure or to encourage discretionary use ofwater, but supports optional metering. TheONCC would also like to see legislationintroduced to permit water companies tointroduce special needs tariffs after consul-tation, which could be used for meteredhouseholders on low incomes and wouldsupplement the provisions banning unduediscrimination and undue preference incharges. In relation to the payment of bills,the ONCC welcomes the introduction of paypoint and the direct payments scheme. TheONCC also considers issues surrounding thetariff structure, including long-run marginalcosts. The ONCC believes that water custo-mers should not have to pay for highwaydrainage, as at present. Revenue for suchdrainage could be raised through road tax, orbe met by highway authorities.

Other issues highlighted in the ONCCreport include the issue of compensation andrebates for customers. During 1997, CSCs,through investigating and resolving indi-vidual complaints, secured over £478,000 in

compensation and rebates for customers. Thisbrings to £5.1 million the total obtained byCSCs since they were set up in April 1990.The report also looks at the impact of thewindfall tax, which the ONCC is concernedwill mean that any reduction in bills may notbe so substantial.

The report considers issues in relation tolarge business customers, national security,emergencies in the water industry, leakageand drinking water prosecutions. The ONCCis concerned about the record of the DrinkingWater Inspectorate (DWI) in bringing prose-cutions against water companies for supply-ing water unfit for human consumption, andthe collapse of a case against South WestWater due to the inadequacy of DWI evid-ence. The ONCC welcomes the proposals toreview whether the DWI has sufficientpowers to bring prosecutions.

The ONCC has organised conferences andworkshops and has been represented at anumber of other meetings.

The report concludes by examining theconstitution and role of CSCs, which providesan interesting and wide-ranging view of thefunctions carried out by those committees.

The ONCC report is the second to bepublished in this format and is a welcomeaddition to OFWAT's various reports. To-gether with the OFWAT report, it highlightsthe difficulties and challenges facing the waterindustry as we move into the last year of thismillennium. It is hoped that these issues willbe resolved so that the water industry canprovide a high quality, sustainable waterservice for the next millennium.

DEBBIE LEGGE

Assistant Editor



ofwat annual report 1997

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