MPs recommend water review shake-up

The House of Commons Environmental Audit Committee published the findings of its inquiry into water prices and the environment in November. 1 While the report finds that the industry's periodic review process generally works well, it suggests that a more long-term vision is needed. It particularly criticises short-term thinking on asset maintenance and Ofwat's narrow economic outlook.

The water industry's last periodic review in 1999, known as AMP3, agreed an environmental investment programme of £8.5 billion and cut water bills by an average of 14%. However, it was highly adversarial and left the water industry bruised and critical of its regulators (ENDS Report 294, pp 41-42 ).

The outcome was in stark contrast to the previous round in 1994, when environmental spending proposed by the then National Rivers Authority was cut back from £919 to £522 million. Water companies were left rich enough to fund special dividends and share buy-backs worth £1.5 billion shortly afterwards.

  • Long term planning: The Committee's major conclusion is that five-yearly reviews do "not sit comfortably" with the long-term planning necessary in an industry with long-lasting assets which needs to look 20 years ahead to plan new resources. Long-term environmental targets "must not be compromised by short-term political decisions" or the economic convenience of the five-yearly reviews, it says.

    The report suggests the periodic reviews need to sit in a "comprehensive, clear framework of longer term policies and goals." Particular areas where long-term planning is needed are water resources, environmental quality and serviceability of water pipes and sewers. The Committee urges the Department of the Environment, Transport and the Regions to take the lead in setting the long-term policy framework.

    The Committee also sympathises with the industry's view that the DETR should take a stronger lead in running the review process, conducting its own "comprehensive and independent" survey of customer opinion and putting an end to the "confusing plethora" of surveys used as ammunition by the different players during the last review.

  • Ofwat's broader role: The report criticises Ofwat's role in past reviews in several areas. In particular, the Committee wants it not to "demonise" environmental spending. The regulator's statements during AMP3 portrayed environmental investment as the key upward pressure on prices without emphasising the benefits that it delivered.

    The report also suggests that Ofwat's Director General should be directly accountable for ensuring that the organisation makes a "positive contribution to the Government's sustainability agenda," backed by a specific duty to have regard to sustainable development.

    In particular, it criticises Sir Ian Byatt, head of Ofwat until earlier this year, over his belief that environmentally-driven projects should be funded only if the costs could be demonstrated to be less than the benefits. This "goes further than a sensible cost-effectiveness approach and is contrary to the precautionary principle", the report says.

    The Committee also concurred with earlier criticism levelled at Sir Ian by the House of Commons Environment Committee in 1998 (ENDS Report 277, p 31 ). He had seen his role "in terms only of protecting the consumer from rising bills", that Committee concluded, while neglecting duties to protect water supplies and the environment.

    But the report sides with the regulator in criticising Ministers for raising customer expectations on water prices during the last review in advance of any announcement from Ofwat. In future, it says, they should respect Ofwat's independence and role in determining price limits by keeping quiet about their own expectations.

  • Asset maintenance: The Committee finds fault with Ofwat's methods for determining the adequacy of levels of investment in asset maintenance and renewal. Ofwat currently monitors the serviceability of assets by collecting data such as the number of sewer collapses or burst water mains. Sir Ian told the Committee that evidence since 1991 suggested that assets were being adequately maintained.

    However, the report says this "no deterioration" policy is flawed because it risks being over-optimistic and because underlying deterioration could be masked by other changes, such as in the weather or in operational tactics. It also criticises Ofwat's "failure-based approach" and suggests that the regulator adopts a more forward-looking system designed to prevent failures.

    Accusing all sides of "intellectual neglect" of the problem of managing asset renewal, the Committee supports a promised initiative from the DETR to develop a new approach. It suggests this should allow companies to prepare to renew or repair infrastructure which may all come up for refurbishment at the same time due to past peaks in building activity.

    Perhaps mindful of the apparent failures in maintenance of the railway infrastructure, the Committee warns that it is "imperative" for the new approach to be in place in time for the next review.

  • New obligations: The report draws attention to £320 million worth of environmental schemes which were not funded in the 1999 review due to lack of agreement on costs. Ofwat also told the inquiry that schemes worth a further £700 million might be required by new obligations before the next review in 2004.

    The cost of any new works is dealt with by a "logging up" procedure in which companies fund the works and claim back the costs at the next review, or by interim determinations from Ofwat allowing companies to increase prices.

    The Committee was impressed by concerns from environmental groups of the scope for delay in implementing obligations as companies or Ofwat sought to keep water prices low or defer schemes to the next review. But it also sympathised with claims by the industry that companies had little financial headroom for such additional investment, and would be likely to appeal against it.

    The report concludes that there is a lack of clarity in dealing with new obligations and recommends that Ofwat reconsiders the situation before the 2004 review.

  • Assessing costs and benefits: The report urges the Environment Agency to strengthen its capacity to assess and demonstrate the benefits of the environmental improvement schemes it proposes. Otherwise, it says, the Agency could be left in a weak position to defend proposed improvements against Ofwat's cost-orientated scrutiny.

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