The Agency's proposals to review abstraction licence charges in England and Wales were issued in January (ENDS Report 348, pp 39-40 ). They followed reforms to the abstraction licensing regime in the Water Act 2003, and are a response to the need to fund compensation for abstractors who will have their licences revoked to protect wildlife sites.
The Agency estimates that an additional £745 million will have to be raised by abstraction charges before 2010.
The key issue which concerns Ofwat is how these costs will be allocated between water companies, which pay some 88% of abstraction charges, and other abstractors.
The Agency's consultation paper assumed that the industry will fund its own costs through its asset management process and higher water bills. It also proposed that non-water industry costs - estimated at £309 million - should be funded from a general abstraction licensing fund.
Ofwat's response was that the proposals would be "clearly inequitable". It questions why water companies should have to pick up all of their own costs as well as contribute the lion's share of compensation costs to abstractors outside the industry.
Ofwat argues that compensation costs should be shared among all abstractors through the charging scheme. This would land companies with just 88% of the costs, though it would not be straightforward because many schemes to replace damaging abstractions have already been included in water companies' business plans. The costs will be met through water bills in 2005-10.
However, if only non-water industry costs were to be recovered from a general compensation fund, then 88% of these would fall on water companies, which would already have had to pay all of their own costs. Back-of-the-envelope calculations suggest that this might end up with water firms footing almost 95% of the compensation bill - leaving them £48 million out of pocket.
If Ofwat's argument is accepted, the compensation burden will fall more heavily on other abstractors such as spray irrigators and the electricity industry.
Ofwat also argues that compensation costs should be allocated regionally, rather than nationally as the Agency proposes. The issue is highly significant because some 75% of the costs will fall in the Anglian region.
Water customers in Anglian region should pick up the tab without subsidy from other regions, Ofwat argues, just as South West Water customers have done for sewerage schemes to improve the region's bathing waters. The regulator also reasons that this would promote higher water efficiency in the region.
However, the increases in abstraction charges in Anglian region would be so large that they would require the Agency's regional water resources account to run in deficit for 13-24 years, assuming a cap of 5-11% on annual increases. The Agency is concerned that the scale of charges in the region would be inconsistent with its duties to promote sustainable development and consider the economic well-being of local communities.
Ofwat also demands that the Agency should alter its charging scheme to reflect the environmental damage caused by abstractions. The current system includes a complex series of weighting factors which estimate the environmental impact. Ofwat wants a more empirical method, and questions whether water companies are actually responsible for 88% of the environmental damage caused by abstraction.
Ofwat takes issue with the Agency on its proposals to introduce higher abstraction charges for licences which are not time-limited. The Agency is proposing a financial incentive to persuade all abstractors to shift their abstraction licences onto a time-limited footing, so that they can be subject to regular review.
"We do not support the use of a time-limiting factor," Ofwat says. "This would penalise those abstractors who have licences that are not time-limited and do not wish to expose themselves to the added regulatory risk associated with time limits."