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MD 157
TO THE MANAGING DIRECTORS OF
WATER AND SEWERAGE COMPANIES
AND WATER ONLY COMPANIES
20 January 2000
LICENCE MODIFICATION - CONDITION B
I published with my Final Determination of price limits the proposed modification to Licence Condition B as relates to the calculation of Materiality for Interim Determinations. This followed previous consultation on the proposals set out in MD149and RD22/99.
The majority of company responses indicated agreement to the substance of the proposed modification.
The purpose of this letter is threefold:
- to provide a final proposed modification, in the light of company responses;
- to seek your consent to the proposed modification;
- to address other issues raised in company responses regarding details associated with the Notified Items for household optional metering, Bad Debt and Vulnerable Groups.
The Licence Modification
I attach with this letter a final draft of the Licence Modification. This addresses the substantive point made by most companies. That is, to ensure that the treatment of revenue loss in the assessment of Materiality is clear. I believe this is addressed with the new wording of the revised 13/14.2(6).
This makes clear that: - base cash flows that relate to capital expenditure (as defined) will continue to be assessed using the present calculation; and
- base cash flows that relate to revenue loss and operating expenditure (as defined) will be assessed using a 15 year calculation for Net Present Values.
It is not necessary to incorporate the suggestion that the revised 13/14.2(6) should include explicit mention of the date of any Reference Notice. This is already provided for with the definition of "Net Present Value" in 12/13.1 of Condition B.
For companies consenting to the revised wording of 13/14.2(6) and which have accepted the Final Determination, I will proceed with the Licence Modification.
The Notified Items
Companies also requested clarification on a number of issues relating to the Notified Items for household optional metering and Bad Debt/Vulnerable Groups.
(i) Worked Examples
Companies sought in their responses clarification on the workings of the revised Materiality calculations. It will enhance the transparency of the process for future Interim Determinations for further details to be provided. For that reason I intend publishing before 1 March 2000 a protocol which will set out such detail, including: - the workings of the Materiality calculations;
- the calculations of revenue losses associated with the Notified Item for household optional metering.
(ii) Revenue Losses for Meter Optants Some companies suggested the revised Interim Determination mechanism should apply to revenue losses attributable to all household meter optants in the review period rather than any excess over my Final Determination assumptions; in effect correcting for variances from my assumptions on optant characteristics where those variances are material.
The purpose of the Licence Modification is to ensure that Notified Item status for household optional metering is effective in providing a measure of protection against uncertainties about the number of households choosing to opt for measured charging. It is not, and should not be, a mechanism that provides, in effect, for automatic correction of all variances from the Final Determination charging base assumptions. This applies equally to variances that benefit companies.
As already indicated in RD22/99., however, the calculation of any revenue losses associated with additional household meter optants could reflect different assumptions from the Final Determination where this is supported by reliable and verifiable billing information on metered volumes.
(iii) Logging-up
Companies suggested that it was important to ensure that, where the appropriate net additional costs associated with Notified Items were not sufficient to trigger an Interim Determination, such costs should be recognised at subsequent Periodic Reviews, ie be logged-up. The point also applies where such costs are greater than the Materiality threshold but the company has chosen not to seek an Interim Determination.
My objective is to ensure that the base position at the next price review for the regulatory capital value, operating expenditure and income adequately reflects any appropriate net additional costs or revenue losses incurred.
I agree any such costs should be properly reflected in the base position for the purposes of setting future price limits. It is also important that such costs are taken into account in the assessment of company out-performance relative to the 1999 Final Determination assumptions. Had the 1999 Notified Items been part of the 1994 determinations, then the base positions for regulatory capital values, operating expenditure, revenue and the incentive allowance would have taken account of any such costs and revenues for the Notified Items under the methodology for the 1999 Periodic Review.
I consider that these procedures avoid placing perverse incentives on companies to trigger the Materiality threshold for Interim Determinations.
(iv) Bad Debts/Administrative Costs of Vulnerable Groups
Companies welcomed my decision in the Final Determinations to provide Notified Item status for the issues of Bad Debt and the administrative costs of the Vulnerable Group Regulations.
I agree with the need for further consultation on the data required to identify the revenue effects and additional costs in these areas. I therefore intend consulting with companies on these shortly.
I C R Byatt
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APPENDIX 1
FINAL PROPOSAL
WATER INDUSTRY ACT 1991 s.13(1)
MODIFICATION OF CONDITION B OF
THE CONDITIONS OF APPOINTMENT OF THE
WATER AND WATER AND SEWERAGE
COMPANIES IN ENGLAND AND WALES
Made on
Coming into effect on 1 April 2000
1. In Condition B, in place or paragraph 13/14.2(6)* there shall be inserted -
"13/14.2(6)(a) where any Base Cash Flows under (5) consist of items to which (b) below does not apply, what is the Net Present Value of those Base Cash Flows calculated up to the start of the first of the Charging Years for which the next Periodic Review falls to be carried out;
(b) where any Base Cash Flows under (5) consist of loss of revenue and/or Operating Expenditure, what is the Net Present Value of those Base Cash Flows calculated over 15 years -
and what is the aggregate of those Net Present Values calculated under (a) and (b) (the Materiality Amount);".
2. Paragraph 12/13.3 (Definitions of Costs and Receipts in paragraph 13/14 and in the definition of a 'Relevant Change of Circumstance') shall be amended as follows -
(i) after the semicolon at the end of (1) delete "and";
(ii) at the end of (2), delete the full stop and insert ";and
(iii) without prejudice to subparagraph (1) above, "Operating Expenditure" in subparagraph 13/14.2(6) includes those items currently so identified in Regulatory Account Guidelines 3 and 4 and in the July Return 1999 Reporting Requirement, line 22 in table 21 and line 23 in table 22. For the avoidance of doubt depreciation, the write-down/off of assets, the profit/loss on disposal of assets and infrastructure renewals expenditure or charges are excluded."
I C R Byatt
* NOTE: where a number appears such as 13/14, the first one is the paragraph number in the Water Companies' licences and the second is the number in the Water and Sewerage Companies' licences.
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Letters to Managing Directors
