The Rt Hon Michael Meacher MP
Minister for the Environment
Department of the Environment, Transport and the Regions
6th floor
Eland House
Bressenden Place
LONDON SW1 6DE

14 May 1998

WATER CHARGING IN ENGLAND AND WALES – A NEW APPROACH

Your department asked for responses by 14 May 1998 to the Consultation Paper Water Charging in England and Wales – A New Approach. This letter covers the main issues. An appendix sets out a full response on the matters addressed in the Government's proposals.

I believe that the proposals strike a fair balance between meeting the needs of vulnerable customers and the need to ensure sensible and sustainable use of water resources. There are, however, many issues of implementation to be considered. Some of the proposals could lead to rising bills for many customers at a time when there are other pressures for higher prices. The proposed ban on disconnection and the right to a meter installed free of charge could raise bills significantly. The help to vulnerable groups could also affect the bills of the majority of customers.

Objectives

I welcome the Government's approach. It would encourage companies to design tariffs which:

• would lead to due economies in the use of a national resource by charging those customers whose demand is responsive to price, the full cost of the water they use; and
• would ensure access to an indispensable service and protect public health by tailoring charges to vulnerable customers who use water only for essential domestic purposes.

I am disappointed that Ministers continue to impose the costs of highway drainage on water customers. These charges should be paid by road users or highway authorities acting on their behalf. Otherwise water users are effectively being taxed to pay for road transport. This is neither fair nor efficient.

Managing the demand for water

Metering gives customers choice in paying for water and enables companies to manage future demands for water in ways that can help the environment. The Government's proposals support the selective extension of metering. Companies should, however, continue to be able to meter compulsorily households in areas where water resources are scarce. The right to an average bill should be sufficient to protect vulnerable households in such a situation.

I welcome the Government's agreement that metering is the appropriate basis for charging for properties built or substantially altered after 1 April 1990. Most companies do this; I think the others should follow suit.

I am already asking companies to develop new measured tariffs, such as seasonal tariffs to achieve a better balance between supply and demand. Some companies have already begun to do this for large and medium users. There is scope for sophisticated tariffs for business customers. This can be extended to the pricing of water for discretionary household use, for example, where there are peaks in household demand due to garden watering.

I have encouraged companies to offer a free meter option to customers except where costs of installation are excessive. Where costs of installation are excessive, eg for customers in tower blocks, some form of collective metering may be appropriate. I have reservations about giving households the right to revert to an unmeasured charge. If this is not to be unnecessarily costly and ineffective in conserving water it should be carefully restricted. It should not be available to later occupiers of the property and should, as the paper proposes, be time limited.

I have encouraged companies to reduce standing charges for customers taking a measured supply. Further reductions may be desirable but complete abolition may have some unintended effects by, for example, reducing bills for second homes.

Unmeasured charging

I welcome the Government's support for the continuing use of rateable values. This will provide a suitable basis of charging for customers using water only for essential domestic purposes. A principal complaint that the use of rateable values discriminates against single person households would be met by meter options with low standing charges.

I agree that an unmeasured charging system based on Council Tax data would not relate charges to consumption or to ability to pay any better than the present RV based system. Water companies may be able to devise better banding systems but evidence so far is not encouraging. I am happy to continue to monitor such developments and to sanction them if they are an improvement on rateable value charging.

Vulnerable groups

I welcome the emphasis in the Consultation Paper on the protection of vulnerable customers. I also welcome the support in the paper for the further voluntary development of charitable trusts by the companies to assist those in financial difficulty.

Decisions about protection for particular groups are essentially matters for Government rather than the Economic Regulator especially where any measure that reduces bills for one group of customers may need to be funded by higher bills for others. There are major issues of implementation to be considered. These include the specification of vulnerable customers, the incentives placed on customers and the costs to other customers. Ofwat may be able to advise Ministers on the effects of proposals; they will need to balance the social and environmental considerations.

Prohibition of disconnection

I do not support an outright ban on household disconnection. Bills must be paid. The proposals for helping vulnerable customers, together with the already improved practices of the companies in this area, should mean that customers in genuine difficulties would not be disconnected. Without the sanction of disconnection those who can pay may decide they do not need to pay. The effect may build up gradually but could be very real. Alternatives to disconnection may be less effective. Rising levels of uncollected accounts would lead to pressure for higher bills for water customers as a whole.

Implementation

The Green Paper on Utility Regulation, A Fair Deal for Customers (CM3898), indicates that the Government will issue statutory guidance on social and environmental issues and that where policy objectives require action which would have significant financial implications for consumers or for regulated companies, such action should be implemented by means of new, specific provision in legislation.

Many of the proposals in the Consultation Paper would involve placing new legal obligations on companies, specifically the right for customers using water only, for essential domestic purposes, to continue on an unmeasured charge; the right of all customers to have a meter free of charge; and the prohibition of household disconnections.

Such legislation must be clear about crucial matters such as the definition of vulnerable groups, special needs, and what constitutes use for essential domestic purposes. I am ready to advise Ministers on these issues.

In other areas I could ensure policy is implemented by having, and using, power to approve companies' charging schemes. In exercising this power I would act under the statutory guidance which the Government proposes to issue on social and environmental objectives.

Tariff rebalancing and the tariff basket

The Government's proposals will mean that companies will need to think carefully about their metering programmes and tariff structures. I believe that this process should be transparent and should play a part in the forthcoming Price Review. I believe, therefore, that your proposals strengthen the case for revising the tariff basket as I have proposed. Following consultation, I will shortly publish an amendment to companies' licences designed to achieve greater transparency in this area.

I C R BYATT

RESPONSE BY THE DIRECTOR GENERAL TO REVIEW OF CHARGING CONSULTATION PAPER - APPENDIX TO DIRECTOR GENERAL'S LETTER

1. Main charging issues

The Appendix follows in this section the order of issues as listed on page 44 of the consultation paper.

(a) Choice for Customers

The Director warmly welcomes the general support in the consultation paper for the development of metering as a means of giving customers choice in paying for water. Allowing customers to opt for metering also gives them greater control over the bills they pay for water and sewerage services. Customers generally have shown their support for metering in recent years. The percentage of all households on meters is currently 14% and is rising annually at present by about 3%. The large majority of this increase is in response to existing meter option schemes. The right to have a meter installed proposed by the Government will extend this area of choice to all customers.

The Director supports the proposal to give all households, including tenants as well as owner-occupiers, the right to have a meter if they wish. In the past some landlords in both the public and private sector have prevented their tenants from having a meter installed. The right to revert to unmeasured charging, however, should be carefully restricted.

It should apply only to the customer choosing to be metered at the time, and not to subsequent occupiers of the property.

The Director believes that customer choice would be further extended if, subject to supervision, companies were encouraged or at least allowed to develop alternative measured tariffs. Households could choose the tariff most suited to their circumstances. This is already the case, for instance, for household customers of Anglian Water Services who can choose between the standard measured tariff, the SoLow tariff which is designed to be attractive to low users, or the Plus 4 tariff designed to be attractive to large users

(b) Meter installation free of charge

The Director is concerned that the right to have a meter installed free of charge combined with the right of measured households to revert to an unmeasured charge could be costly and, therefore, affect customers generally. 13 water companies (out of 28) at present have free meter installation schemes but these are subject to conditions to avoid excess installation costs. There are also conditions relating to location and supply pipe leakage. These need to be taken into account in framing the entitlement.

The capital cost of installing a meter allowed to companies by Ofwat at the 1994 Periodic Review was £160 (where no meter box was present). Companies are, therefore, not likely to accept the statement in the appraisal section of the consultation paper that the net cost of this new right to a free meter will be small (p 50).

The additional costs of the right to free installation together with the right to revert could fall on customers generally as companies recover their expenditure attributable to a new legal obligation. The extent of these costs will depend on the number of households who switch to metered supplies. If, for example, an additional 5% of households were to switch as a result – which may well be possible - charges to all customers could need to rise by £1.20 per annum or about 1% of the annual household water bill.

(c) Changes to charging structures

Standing charges for measured customers

The consultation paper proposes that standing charges for household metered customers should be abolished. The annual cost of operating and billing a household meter was estimated by Ofwat at £12 in 1992-93 or £14 in current prices. The proposal is that the costs that these charges represent be absorbed into the volumetric rate which would therefore be higher than under the existing measured charging structures.

Ofwat considers that a number of effects need to be considered in assessing the impact of the possible abolition of standing charges:

The Government argues that such a change would benefit vulnerable groups particularly low income households. The proposal would certainly favour low users at the expense of high users because of the impact of the higher volumetric rate. However, many high users are on low incomes (eg families with children in receipt of benefits); similarly, many low users would include those with second homes, holiday cottages etc.

• The proposal could also increase costs to other users as many lower users (not necessarily poor) on unmeasured charges switched to metering. The Government is proposing that meter installation be free of charge (see above). Coupled with free meter installation and the right to revert, the abolition of standing charges would give households further incentives to switch. The effects of this further incentive could be that an additional 5% of households could switch to metered supplies. If as a result of these incentives 10% of households were to switch, the increase in charges to customers as a whole could be as much as £2.40 per annum or 2% on the annual household water bill.

  The consultation paper does not say whether the measured/ unmeasured differential would be maintained. However, if the costs (represented by standing charges) were not absorbed into the volumetric rate and were instead spread across all households (ie the differential were no longer maintained) the incentives to switch to metered use would be yet stronger. The effect on bills would be more marked as the costs of the extra switching were absorbed into charges. If as many as 20% of households were to switch the increase in water charges could be as much as £4.80 per customer or 4% on the annual bill.

• In contrast the higher volumetric rate that would result could mean that prices might be set closer to the continuing costs of supply (or long run marginal cost). This would send a strong signal to customers to manage their demands carefully.

Existing measured tariffs

The Director believes that companies with existing alternative measured tariffs for households such as Anglian Water Services SoLow and Plus 4 tariffs should, subject to his supervision, be enabled to continue with them. To do so would be consistent with the proposals in the paper for increasing customer choice as discussed above. (Plus 4 has a minimum block charge and a lower volumetric rate than the standard tariff). If companies offer alternative measured tariffs (including tariffs with standing charges) then it would be for the customer to choose which was the more suitable to his needs. It would be wrong, therefore, to be too prescriptive in tariff design.

Metering for Demand Management

The Director believes that a rapid change to universal household metering would be uneconomic. However, in areas where water resources are scarce there is a case for companies being allowed to extend metering compulsorily for demand management purposes (as is the current practice being pursued, for example by Folkestone & Dover Water). He believes allowance should be made for this to happen. Other proposals in the paper such as the right to an average charge should be sufficient to protect vulnerable households in such a situation.

(d) Use of rateable values

The Director welcomes the Government's decision to allow for the continuing use of rateable values (RVs) as the basis for unmeasured charging and the proposal to legislate to allow the use of RVs beyond 1 April 2000.

The Director has, for some time, argued that Council Tax bands would be an unsuitable alternative basis for charging by the companies. It would give rise to many gainers and losers without achieving a charging system related to use.

(e) Protection and additional choice for vulnerable households

Right to an average charge

The Director welcomes the proposal that vulnerable households who are on a metered tariff should have the right to a charge based on average use. The proposed right, however, requires further discussion. The charge should perhaps be based on use for essential purposes only. If average use, it is not clear whether this use would be that of all metered households, all unmeasured households, or all households or only for that property or household type.

Payment options

The Director agrees that vulnerable households should have a range of payment options including frequent payment options. This is one of the key guidelines in the Guidance on Debt and Disconnection issued by Ofwat to the companies in 1992. If this is to be made a right the relevant group needs to be carefully defined.

(f) Customer information

The Director agrees that all customers should be made fully aware by the companies of the charging options that are open to them. Many companies already do this and this will be essential as tariff schemes are developed by them.

(g) Charitable trusts

The Director supports the further development of water company charitable trusts to help customers in serious financial need. Ten companies already have these trusts and others are already considering establishing them. The Director supports the view of the ONCC and the CSCs that the smaller water only companies could be encouraged to set up joint trusts or to contribute to existing trusts in their region.

Some trusts have charitable status registered with the Charity Commission and operate fully independently from the appointed business. Others are more in the nature of hardship funds and are operated by the appointed business. In all cases, however, the costs are met by shareholders out of distributable profits, and not by customers generally.

The Consultation paper leaves open the question of whether companies should be required to establish such trust funds. The advantage of making it a requirement would be that customers could, if they face particular financial hardship, have an opportunity for assistance; and this would not be dependent on where they lived. On the other hand a statutory requirement on companies to establish trust funds would mean that companies could legitimately argue that the costs should be borne by customers generally.

Ofwat considers that the balance of advantage lies in continuation of the existing voluntary arrangements for charitable trusts.

(h) Debt and household disconnection

Disconnection

Ofwat agrees that disconnection is a drastic step to take to recover debt. Accordingly it has taken action in recent years to ensure that companies have appropriate debt procedures so that disconnection is the last resort. Companies' procedures are monitored regularly by CSCs through random audits of debt cases. The result has been a continuous reduction in disconnections since 1992 such that in 1997-98 the number was only 1,907, less than 15% of the annual number disconnected in the year before privatisation.

It may be possible to reduce that number even further and, as the Consultation paper states, a few companies are managing to avoid disconnections altogether. It would be wrong, however, to conclude that this means that the threat of potential disconnection is no longer necessary. Comparisons with Scotland and Northern Ireland are not meaningful since the collection of water charges in those countries is an integral part of local taxes, and not a separate bill as in England and Wales.

The consultation paper asserts that alternative methods of recovering debt will be no more costly for companies. Ofwat is not in a position to support or contradict that assertion but notes that companies have reported that recourse to other recovery methods has proved ineffectual. It is for them to demonstrate this, and Ofwat would expect companies to pursue efficient recovery procedures. Unlike other suppliers of services, however, they have a duty to continue to supply. There is, therefore, a likelihood of extra costs for companies, either because of additional recovery costs or lost revenue. The Government should consider very carefully whether the remote risk to public health outweighs the likelihood of customers who do pay their bills, including those on low incomes, having to bear those costs.

The primary concern of the Consultation paper is protection of public health. One option that could overcome this concern, but also provides companies with an effective sanction, is the use of low flow valves. These would allow sufficient supply of water for essential hygiene purposes, but no more.

One company, North Surrey Water, has used these on a limited scale with, it claims, some success. It may be necessary to explore the implications more thoroughly on the basis of a larger trial. Ofwat considers that, as an alternative to disconnection, the use of low flow valves should be given serious consideration.

Budget payment units (BPUs)

If the Government proceeds with its intention to prohibit disconnection, Ofwat agrees that BPUs which also can lead to the complete disconnection of supply should be prohibited – as is now the case following the recent High Court ruling. BPUs have, however, proved popular with a section of customers who found the discipline element of having a BPU helpful. This advantage could be retained by the use of BPUs which disconnect supply to some water using appliances only, such as washing machines or baths. This could overcome concerns about public health. Similarly BPUs fitted with low flow valves would meet these same concerns. Ofwat considers that both these options should be considered before final decisions are taken.

(i) Measures for community buildings

The Director supports the proposal for small community buildings to have access to household tariffs. They should be able to choose from a range of measured tariff options one that suits their circumstances.

2. Other charging issues

2.1 Non-household customers

The Director welcomes the Government's support for the eventual extension of metering to all non-household customers. In the charging year 1998-99 some 83% of non-household water customers will be metered. The same figure for sewerage customers will be 75%. He agrees that community buildings and care and nursing homes should be metered.

The Director is not convinced by the case for additional protections for care and nursing homes. Care and nursing homes are businesses providing commercial services albeit of a health care nature. He does not believe that they should be exempt from the sanction of disconnection for non-payment. (paras 7.8 –7.10).

2.2 Drainage charges

The Consultation paper discusses and rejects the case for transferring from sewerage customers the costs of highway drainage to those who benefit directly from the service. The Director is disappointed by this conclusion. These costs could be met either by the highway authorities or by road users themselves. An opportunity for reducing bills to households could be taken here.

The Consultation paper asks whether customers not connected for surface drainage should have the right to an abatement of this part of their charges. The Director has been pressing companies for some time to make such abatements. He strongly supports such a right, and the proposed power to the Director to approve company charging schemes could be used to ensure that this happens.

3 Competition (paras 9.1 –9.5)

The Director welcomes the recognition in the Consultation paper of the role of competition in increasing customer choice and developing more cost reflective tariffs. He believes that competition can lead to improved service and lower prices in the water and sewerage industry as in other utility sectors.

3.1 Inset appointments

The Director believes that the existing mechanism of inset appointments is stimulating the development of competition for large users and for greenfield sites. In the charging year 1998-99 some 22 (out of 28) companies will have large user water tariffs and 3 (out of 10) will have large user sewerage tariffs. Water users (in the range 50 - 300 Ml/a) are able to achieve reductions against the standard volumetric rate of between 15 - 30%.

The Director is seeking to encourage more inset appointment applications which involve new sources of water or new methods of effluent treatment. In the past year there have been a number of important developments in competition in the water industry. Two inset appointments (one water, one sewerage) were granted by Ofwat and the Director finalised his proposal for a third. In March 1998, he announced the prices he is minded to determine for eight sewer connection agreements and published proposals for determining bulk supply and sewer connection prices and improvements to the inset appointment application process.

The Director is committed to developing the inset appointment system to its full potential for strengthening competition.

3.2 Further development of competition

The Director welcomes the Government's support for the further development of competition. He supports the development of inset appointments referred to in the paper. As the paper proposes this could be achieved by making them time limited, by modifying the current restriction to large users by reducing the threshold, and by allowing premises to be combined to meet the consumption limit. In the light of experience he suggests that the threshold should be reduced to 100 Ml/a from the time when his proposed changes to the tariff basket come into force on 1 April 2000.

The Director also supports the more ambitious option outlined in the Consultation paper of developing proposals to allow common carriage in the water industry. He believes this could be achieved along the lines of the paper Water – Increasing Customer Choice published by the DoE and the Welsh Office in April 1996. In particular he supports the proposals in that paper on cross-border supplies and on connections to the water mains. He would welcome the necessary legislation to achieve this (para 9.4).

The Director would like to see developments in the abstraction licensing system to provide greater scope for new entrants in the water supply. He believes this issue should be tackled in the DETR's Review of Abstraction Licensing. In particular, the Director would like to see proposals for the greater use of economic instruments (eg the structure of abstraction charges) and the need for a simple mechanism for the revocation and compensation of abstraction licences.

He believes the Competition Bill currently before Parliament will strengthen the competitive forces in the water and sewerage industry. The Director believes proposed concurrent powers between the utility regulators and the DGFT will provide increased powers to deal with abuses of a dominant position and anti-competitive behaviour. The Bill is also likely to mean new powers to deal with predatory pricing and to help open up the market to common carriage.

4. Implementation (paras 10.1 & 10.13)

4.1 Role of the Director

The Consultation paper discusses the roles of Secretaries of State and the Director General. The Director understands the desire to avoid detailed direction in legislation for charging systems. He notes that the Government in the Green Paper (Cmnd 3898) intends issuing statutory guidance on the social and environmental objectives relevant to regulation in each utility sector. If he is given the power to approve company charging schemes, he could implement a number of the Government's proposals in this way, in accordance with the guidance given.

A number of the proposals, however, would have significant financial implications for consumers or for the regulated companies such as the protections to be offered to vulnerable households. They will require careful definition in legislation if they are to be successfully implemented. The Director would welcome the opportunity to work closely with the Government on such details. In particular the right to remain on an unmeasured charge (for households not using water for discretionary purposes) requires careful definition as to what is discretionary use. This is one reason that the Director considers this right should be restricted to vulnerable households.

4.2 Charitable trusts

The suggested role for the Director in overseeing the development of company charitable trusts is inappropriate if the trusts remain voluntary. Many of the existing charitable trusts are set up and run by the Plcs and not the appointed businesses. They are not, therefore, within the scope of the Director's regulatory powers.

4.3 Resource costs to the Director

Giving the Director power to sanction and approve charging schemes and to oversee the development of companies tariff structures will impose significant extra costs on his office. At present, the Director has only limited power to direct the companies as to their charging schemes and his office is staffed accordingly. The assessment and sanctioning of company charging schemes will require additional resourcing.

4.4 Unmeasured charging

The Director welcomes the endorsement in the consultation paper of a role for him in overseeing the development of other unmeasured charging schemes (p38).

4.5 Promotion of economy by the companies

The Consultation paper states the Government's desire to see the development of more imaginative tariffs by companies to provide stronger incentives for customers to economise on the use of water for discretionary purposes. At the same time tariffs should be designed so as not to discourage essential use. This could be achieved by amending Section 93A of the Environment Act 1995, which currently prevents water undertakers from "imposing any requirement on any of its customers" (Section 93A(3)). Such an amendment would be in place of putting a new duty on the companies.