• Summary of key points and recommendations
  
• Section 1: Purpose and Background to the Submission
  
• Section 2: Customers' place in regulation
  
• Section 3: Institutional arrangements and accountability

• Section 4: Regulatory process
• Section 5: Price controls and a fair deal for customers
• Section 6: Other matters

SUMMARY OF KEY POINTS AND RECOMMENDATIONS

• The Director General of Water Services (the Director) should have a single primary duty to protect the interests of customers. Other existing duties should remain but be secondary to that duty.
• The integration of the Customer Service Committees (CSCs) and the Ofwat National Customer Council (ONCC) with Ofwat works well and is necessary to ensure the Director can meet his duties in respect of customers. However, the arrangements for representing customers' interests should be strengthened by:
  - making the ONCC a statutory body;

  - imposing a new duty on the Director to have regard to representations made to him by the CSCs or the ONCC.

• The Director should be under a duty to "take into account the interests of disadvantaged customers" but, the way in which he proposes to meet that duty should be agreed with the Secretaries of State for the Environment, Transport and the Regions, and for Wales.
• Ofwat's existing arrangements for involving advisors in key policy decisions could be formalised by the establishment of an advisory board which could include the Chairman of the ONCC and the Chairman of the Environment Agency. The Secretaries of State could be involved in the appointments to the board. 
• Accountability to Parliament could be improved by establishing a Select Committee from both Houses of Parliament with specific reference to the regulation of the water industry.  
• Regulators as a group could be asked to report on their work to identify good practice in utility regulation. 
• Regulators could be required to publish a Code of Conduct describing their processes and how they meet the principles of transparency and openness. 
• The long term interests of customers are better served by the current price capping regime of incentive regulation (RPI - X) than by formal profit sharing mechanisms. 
• Ofwat's ability to recover its expenditure from companies should be brought into line with the provisions governing other regulators.

SECTION 1: PURPOSE AND BACKGROUND TO THE SUBMISSION  

Purpose 

The Director welcomes the government's review of utility regulation. His submission covers the issues identified in the statement by the President of the Board of Trade when announcing the review on 30 June 1997. It draws on the Director's experience since 1989, when the regulatory framework for water was established and the views of other bodies in varied published reports on regulation over the period since 1989. We hope the submission will assist the review.

Utility regulation in the UK is comparatively young. Inevitably, policies and processes are constantly evolving in response to lessons learnt as well as in response to new issues and to pressures from the various parties involved. This submission sets out for consideration ideas for further change which build on recent developments.

Regulation in the water industry

The Director recognises the need to look across the regulated utility sectors since a number of issues are common to most or all of them. However, there are significant differences which need to be taken into account and, in the case of water, Ofwat would draw particular attention to the following.

First, unlike telecoms, gas and electricity there are no immediate prospects of widespread competition. Proposals for developing and extending competition are being considered by the Department of the Environment, Transport and the Regions (DETR). The incorporation of Article 86 of the Treaty of Rome into UK legislation should strengthen the ability of the regulator to prevent anti-competitive practices by water companies. The limited penetration of metering among household customers, the cost of transporting water and the absence of a national distribution network, mean, however, that in the medium term competition is likely to be limited to large customers. Ofwat's primary task, therefore, remains the regulation of monopoly suppliers of an essential service.

Second, the provision of water and sewerage services is a regional or local activity. This regional element and the differences between regions are important factors in the way in which the industry is regulated. In particular they emphasise the need for strong customer representation at the regional level.

Third, the Drinking Water Inspectorate (DWI) and the Environment Agency (EA) play important roles in regulating respectively the quality of drinking water and the quality of the water environment. The EA also has important responsibilities in the management of water resources. Overall responsibility for decisions in these areas rests with the Secretaries of State for the Environment, Transport and the Regions, and for Wales. The impact of higher quality standards, driven by EC Directives, is considerable both in terms of the level of capital investment required - currently equivalent to 50% of the annual turnover of the industry - and, of course, on customers' bills. Thus, while prices for other utility services have reduced in real terms, customers of the water and sewerage companies have seen continuous real increases since 1989.

The issues

The regulation of the industry has seen significant achievements, but these are not yet apparent to customers. In particular:

• incentives on companies to reduce costs are working well, but so far the benefits to customers are obscured by the upward pressure on prices to meet higher standards, especially environmental ones; 
• higher standards of drinking water and sewage treatment are being achieved but, by their very nature, these are not obvious to customers.

Ofwat has striven to develop an open and transparent method of working and to involve relevant parties in decision making based on the provision of extensive information. Nevertheless there remains some uncertainty about confidence in the system. In particular there are questions about whether: 

• the customer is sufficiently at the heart of regulation;  
• the institutional arrangements governing the role of, and decision making by, the regulator are appropriate; 
• the processes followed by the regulator are sufficiently transparent and open;  
• the customer is getting a fair deal from the RPI - X system of price controls.

SECTION 2: CUSTOMERS' PLACE IN REGULATION

The Director's duties

The main duties imposed on the Director by the Water Industry Act 1991 (which are shared with the Secretaries of State) are to carry out his functions in a matter that he thinks is best calculated to: 

• secure that the functions of the companies are properly carried out; and 
• secure that companies are able to finance, in particular by securing reasonable returns on their capital, the proper carrying out of their functions. 

• protect the interests of customers as regards charges and quality of service; 
• promote economy and efficiency on the part of companies; and 
• facilitate effective competition.

Such a change would also enable the Director better to take into account the interests of disadvantaged customers, and customers in rural areas, as and when competition develops.

Ofwat has always considered that the duty to ensure that companies can finance their functions does not mean that inefficient companies should be protected. There would be benefits in amending the legislation to put this issue beyond doubt. Ofwat also sees no need for a specific reference to "reasonable returns on capital" and omission of this reference would bring the Director's duties into line with the duties on other sectoral regulators.

Customer representation

It is vital that there are strong and effective arrangements for the representation of customers' views. The arrangements for this vary between utility sectors. In water, as in electricity, the regional Customer Service Committees (the CSCs) and the Ofwat National Customer Council (ONCC) are integrated with, rather than fully separate from, the Director. Ofwat considers that there are advantages to each party with consequent benefits to customers, from this arrangement.

The CSCs' duties are to represent customers' interests to the Director and to companies, and to investigate customer complaints. In practice their role is much wider.  

• First, the Director relies heavily on the CSCs to help implement customer protection policies (which they have helped to shape) through discussion and negotiation with their individual companies. This ensures that local circumstances are fully taken into account. 
• Second, the CSCs play an important role in monitoring the quality of services received by customers, and in reporting their findings to the Director. On many aspects of service the CSCs are best placed to do this, using their detailed knowledge of companies' practices and procedures gained through audits of companies' case files and their experience in handling complaints against them.

Separating the CSCs from the Director would weaken rather than strengthen their role and would in turn weaken the Director's ability to fulfill his statutory duties to protect customers' interests.

The advantages of integration to the CSCs, and to the ONCC, include access to information and expert advice that would not otherwise be available. Major policy issues are always discussed with the ONCC prior to formal consultation and continued direct access to the Director ensures that customers' concerns are high on his agenda.

Some commentators are concerned that integration could compromise the independence of CSCs and the ONCC in representing customers' interests. Ofwat believes that this concern is more apparent than real. Nevertheless, the Director considers that steps should be taken to strengthen that representational role, particularly at the national level in respect of the ONCC, and earlier this year the Director wrote to the Deputy Prime Minister about these. The key recommendations are:  

• the ONCC should, like the CSCs, become a statutory body comprising the Chairmen of the ten CSCs. (The Director is no longer a member of the ONCC.); and 
• the Director should have a statutory duty to have regard to any representations made to him by the ONCC or CSCs.

Information powers for the CSCs 

The Director has extensive powers to require information from companies to assist him in the exercise of his functions. The CSCs have no such powers. In practice this has not been a significant constraint on the CSCs' ability to perform their functions since they have access to Ofwat information. However, there seems no reason why CSCs should not similarly be able to require information from companies relevant to the exercise of their functions.

Rights of appeal for CSCs 

The Director recognises the apparent unfairness that water companies can appeal to the MMC against the Director's decisions on price limits while the customer cannot. However, companies have to weigh the risk that such an appeal may result in a less favourable decision than that taken by the Director - as happened in the case of South West Water in 1994. Were customers' representatives to be given such rights of appeal, the responsibility would indeed be a heavy one. There are also practical issues of who should have the right of appeal, who should bear the costs and whether the existence of such rights would lead to a proliferation of appeals which raise doubts about the ability of the MMC to cope.

Ofwat believes that consideration of this matter should take into account other steps outlined in this paper for securing the customers' place at the heart of regulation. Were it concluded that there should be a right of appeal, Ofwat's view is that it should be limited to each CSC in respect of decisions on price limits for the companies assigned to it and that a CSC should have to satisfy the MMC that the Director had failed to have proper regard to the representations it had made in respect of the proposed price limit.

CSC links with other bodies

The CSCs have close links with customers' groups in their regions and are developing closer working relationships with the Environment Agency's Regional Environmental Protection Advisory Committees. If regional assemblies are introduced the review should consider how the CSCs relate to them.

SECTION 3: INSTITUTIONAL ARRANGEMENTS AND ACCOUNTABILITY

Independence of regulation

The independence of economic regulation is not in question, but it is nevertheless important to recognise the benefits. While economic regulators are not immune from the political pressures that governments face, they are better able to cope with them while retaining the focus on the longer term. Stability is crucial to sensible planning and investment decisions by companies and enables achievement of lasting efficiency savings which ultimately benefits customers.

Ofwat has been able to develop processes and procedures to achieve more transparent and open decision making, involving consultation and public debate on the key decisions, in a way that it is not always possible for governments. Much more information is now publicly available about the water industry and the issues it faces. Indeed, comparative competition depends in good measure on reliable and publicly available information.

Regulation must, of course, operate within the statutory framework determined by Parliament. Even since 1989 there have been changes to the Director's powers and duties, principally as a result of the Competition and Service (Utilities) Act 1992 and the Environment Act 1995. In addition there is discussion and consultation with officials and Ministers at the DETR (and formerly the DoE). There is scope for this to be developed. Also, section 27 of the Water Industry Act 1991 empowers the Secretaries of State to give general directions to the Director about matters he should take into account in determining priorities and performing his duties and the exercise of his powers. So far, Secretaries of State have not invoked these powers. Broadly speaking, Ofwat believes that the present arrangements are satisfactory.

Social policy

There are, however, areas where decisions by regulators inevitably have implications for social or environmental policy objectives. These are matters more appropriately decided by Ministers, who are democratically accountable, than by unelected regulators. In the case of environmental objectives, Ofwat considers that satisfactory arrangements are now well established for securing the proper involvement of Ministers. In the case of social issues, however, the position is less clear.

The issue is one of striking a balance between meeting the duty on the Director (and on the companies) to avoid undue preference or discrimination in charges and ensuring that all customers can afford access to essential water and sewerage services. In other words, to what extent, if at all, should the generality of customers pay higher charges so that customers disadvantaged by income or disability can be helped?

Hitherto these issues have not been difficult to manage. First, there already exists in water a large element of cross-subsidy inherent in the rateable value system of charges, albeit that the impact is uneven. Second, companies themselves have generally been ready, sometimes after prompting, to adopt good debt recovery procedures and to provide payment methods and options, at no extra cost, to help low income customers manage the payment of water bills. For example, unlike gas and electricity, water companies make no extra charges for customers who chose to pay by budget payment units. Disconnections have fallen well below those prior to privatisation. Services to meet the special needs of disabled and elderly customers have been available for some time.

However, the cross-subsidy element in the rateable value system is unwinding as more customers opt to pay by meter. The accelerating spread of meters will in itself cause problems for those low income customers whose essential needs for water are above average. These issues have become more important as water bills have risen in real terms.

Many of these issues are under consideration in the current review of water charging initiated by the Deputy Prime Minister in May 1997. Nevertheless the Director considers that it would be appropriate to extend his duties more generally "to take into account, in particular, the interests of disadvantaged customers". This would be analogous to the existing duty imposed on him to take into account the interests of disabled or pensionable customers as regards the quality of services provided by companies. In both cases he should be required to seek approval from the Secretaries of State on how he proposes to meet these duties. This would ensure that the general policy in this area reflects government policy.

Environmental policy

As has already been mentioned, environmental standards are a central issue in the regulation of the water industry. These are relevant both to the discharge of waste water to rivers and coastal waters and, particularly since 1995, the extraction of water from rivers and aquifers. Although much of the pressure for higher standards is driven by EC Directives, national decisions on the implementation of those Directives and other initiatives are significant. Higher standards mean higher bills. Over the period 1995-2005 higher quality standards are adding £44 to an average 1994 household bill of £200.

A judgement is required between the conflicting interests of customers as bill payers, particularly those on low incomes, and the wider interests of the environment in which everyone has a stake. These decisions must be taken by Ministers. For the 1994 Periodic Review a quadripartite process was established involving the companies, Ofwat, the quality regulators and the DoE, to ensure that Ministers had relevant information on the costs and benefits of possible standards. The culmination of this process was clear published guidance to the Director to enable him to set price limits. A similar process is planned for the 1999 Periodic Review with added emphasis on a more transparent process, in which the views of all interested parties, including customers and environmental pressure groups, can be taken into account.

Decision making

Ofwat recognises the need to avoid regulatory decisions that are unduly influenced by the preferences or prejudices of a single individual. Ofwat does not favour the replacement of individual regulators by a Commission. The constraint imposed by the need to account for decisions is diluted when no single individual can be called to account. Experience since 1989 has shown the need, from time to time, to act quickly - and individual regulators clearly are able to do so in a way which may not be possible for a Commission.

Steps can be taken, however, building on current developments, to broaden the base of advice available to regulators and which would also help the Director to discharge the heavy responsibility which is imposed upon him.

As mentioned earlier the Chairman of the ONCC is an ex-officio member of the Ofwat Executive, and, as such, participates in Ofwat's strategic planning and policy decisions. Ofwat is currently seeking to appoint a panel of business advisors, with experience at a senior level in competitive markets, to advise the Director in connection with the forthcoming Periodic Review.

The Director sees advantages in formalising these arrangements by the establishment of an advisory board, that would meet regularly to consider and advise on Ofwat's business plan and key policy decisions. It would seem logical that the Chairman of ONCC should be a member of such a board, but others should be appointed on the basis of personal expertise and experience. Because of the importance of environmental factors in setting water prices, it could be sensible to include the Chairman of the Environment Agency on such a Board. The Director sees no reason why the Secretaries of State should not be involved in those appointments or that such a board should not be given statutory recognition.

Accountability

Contrary to popular belief the Director has to account for the exercise of his powers in a number of arenas:

• to the Secretaries of State in his annual report; 
• to Select Committees of both Houses of Parliament; 
• to the National Audit Office, and ultimately to the Public Accounts Committee, on matters relating to expenditure and value for money; 
• to the High Court, through Judicial Review of his decisions; 
• to the MMC in respect of decisions on price limits referred to it by companies and disputed licence modifications; 
• to the Parliamentary Commissioner for Administration, in respect of complaints by individual customers.

The Director believes that the existing arrangements for accountability work well, but that there is scope for more scrutiny by Parliament in the form of a Select Committee comprising Members of both Houses of Parliament with specific responsibility for matters relating to the regulation of the water industry. This should include the regulation of water and environmental quality as well as economic regulation.

Consistency between sectoral regulators

Many of the issues faced by Ofwat are also faced by other sectoral regulators and it is reasonable to expect a degree of consistency in the decisions taken about them, accepting always that there are differences between the utilities which must be taken into account. The same argument applies to regulatory processes and procedures which are discussed in Section 5

Arrangements for discussion and consultation have developed considerably in the last three years and have been formalised with quarterly meetings to consider papers prepared by their deputies. This has helped to identify `best practice' and the NAO, in its comparative study of the work of the regulators, has identified areas where greater consistency might be needed.

The natural wish for uniformity needs to be balanced with the progress that can be, and is, made through allowing innovation by individual regulators, which can be adopted and adapted by others. However, regulators as a group could be required to report annually on the work they do to develop good practice and secure consistency where appropriate. They could also be required to report to government on specific issues.

The MMC and the proposed Competition Commission

As in many other walks of life the appellate body can be expected to establish a degree of case law or precedent which in itself assists consistency. This has been slow to develop in utility regulation because referrals to the MMC are infrequent. Also there are limitations because of the constraint on the MMC to confine its considerations to the case before it. Nevertheless on some issues, such as cost of capital, a degree of consistency is now established.

The Director considers that establishing the new competition body offers an opportunity to review its role as an appellate body, including the processes used for reaching decisions.

SECTION 4: REGULATORY PROCESS

Accountability is closely linked to process. Without good process, accountability is weakened. Good process involves open consultation and transparent decisions. Ofwat believes that it has a good record and it plans to develop further its practices in this area.

Commitment to good process would be enhanced by a requirement on each sectoral regulator to publish a Code of Conduct. This would also facilitate comparisons between regulators and assist consistency between regulators in this area.

Key elements of Ofwat's processes, which have been in place since 1989, include the following:

• All formal communications with the companies are publicly available in a series of letters to Managing Directors (the MD letters) and to Regulatory Directors on more technical and operational issues (the RD letters).
• All formal decisions and the reasons for those decisions are published or lodged in the Ofwat library for public inspection. These range from decisions on price limits to the determinations of individual disputes. 
• Ofwat publishes a comprehensive range of information on the industry's performance. In particular, it now publishes annually five reports covering capital investment; tariffs and charges; levels of service; water delivered and leakage; and efficiency. 
• More generally, Ofwat provides a comprehensive information service to customers and interested parties on a range of matters relating to the water industry and the role and function of Ofwat. Ofwat publishes a series of Information Notes which are regularly updated.

• publication of Ofwat's Charter; 
• plans to publish Ofwat's Business Plan; 
• a statement of Ofwat's consultative practices; 
• placing companies' returns in the Ofwat library and making these available on CD-ROM; 
• extending information on Ofwat's website on the Internet.

Consultation and customers' involvement was a key objective of the 1994 Periodic Review. This involved requirements on companies to consult customers about future plans, including market research into customers' priorities and preferences. A series of consultation papers was published, and, so far as possible, Ofwat sought to encourage a public debate on the balance between higher standards and customers' bills.

After the price limits were determined, Ofwat conducted a thorough review of the processes followed involving all interested parties including customer groups, the companies, Ofwat staff and the CSCs. A number of lessons were learnt which are being implemented in respect of the 1999 Periodic Review. These include:

• publication of a consultation document on the process of the Review as a whole, including a detailed programme identifying the key consultation stages and the information requirement on companies; 
• publication and consultation on draft price limits; 
• a broader based approach to customer consultation;
• seminars with key groups;
•  companies' submissions to be placed in the public domain.

Consumer groups have expressed concern about secrecy and whether all relevant information is published. Ofwat's provisional view is that some, but very little, information is commercially sensitive. However, the burden of proof should be on those imposing the restriction to justify their decision and their reasons will be made public.

SECTION 5: PRICE CONTROLS AND A FAIR DEAL FOR CUSTOMERS

RPI - X

The current regulatory regime creates strong incentives for companies to minimise their costs within price limits. At Periodic Reviews, the Director resets price limits and takes account of the achievements of companies in reducing costs so that customers may benefit through lower prices in the future. Thus the current regime transfers companies' past efficiencies to customers over time, while maintaining incentives on companies to continue to reduce costs. The size of the customers' share largely depends on how quickly this transfer is carried out.

At the last Review, past outperformance was scheduled to be transferred to customers through the progressive reduction in the return on capital towards the cost of capital over the ten years to 2005 (the 1994 glidepath). Since then the concept of an initial, and immediate, adjustment to price limits at Periodic Reviews has emerged, and has been applied by the electricity and gas regulators. The Director proposes to adopt this approach for the 1999 Periodic Review.

Assuming Periodic Reviews every five years, and that savings are achieved by companies evenly throughout the five year periods, the customer's share of the benefits of outperformance, in net present value terms, is 68% following the 1994 glidepath. The effect of an immediate adjustment would be to increase that share to 82%.

Formal profit sharing mechanisms

The RPI - X system is a form of profit sharing in which the customer's share is large, but delayed. A formal profit sharing mechanism involves rebates to customers each year, based on the actual profits earned in the year over and above a normal rate of return to shareholders which was assumed when the price limits were set. Proponents of profit sharing argue that it forces companies to pass benefits to customers at the same time as to shareholders. Such an approach would mean that the customer's share of outperformance would be more than the 82% referred to above under the Director's proposed approach for the next Periodic Review. Exactly how much would depend on how excess profits are defined and the split as between shareholders and customers.

There are practical difficulties in operating such a system but the principal argument against it is that it would blunt incentives on companies to reduce costs. Companies would be encouraged to invest in lower risk, low return projects, rather in higher risk, high return ones, even though this strategy might run counter to the interests of the company and its customers in the long term. It could easily descend into a form of rate of return regulation with all its attendant disadvantages.

Balancing the incentives on companies to be efficient with the interest of customers is a matter of difficult judgement, but the Director considers that the likely outcome of the introduction of formal profit sharing mechanisms would simply be that customers have a slightly larger slice of a smaller cake. The Director nevertheless recognises the need to demonstrate to customers that the system of RPI - X is working to their advantage. He considers, therefore, that the outcome of the 1999 Periodic Review must be such that it gives customers that confidence. An Ofwat paper on profit sharing is enclosed with this submission.

In the meantime he has encouraged companies to share benefits in advance of the Periodic Review. A number of companies have responded by providing annual rebates to customers, the value of which the Director will take into account when he resets their price limits in 1999.

Improving service quality

The quality of services delivered to customers has improved significantly since 1989, although there remains scope in a number of areas for further improvements. In setting price limits in 1994, Ofwat did not make specific provision for improved service, other than for reducing the incidence of sewer flooding. It concluded that there was sufficient scope for improvements through improved efficiency, better targeting of capital expenditure and through changes in operational procedures involving no extra costs.

Ofwat's approach to service quality has been to use a combination of incentives on companies to improve services and more prescriptive action in the form of setting standards and other measures. Underpinning this approach are powers of enforcement and, subject to the Secretaries of State's approval, powers to prescribe minimum levels of compensation in respect of service failures.

The framework of incentives includes:

• making full use of the power of comparative competition. Since 1990 Ofwat publishes annual reports on company performance, increasingly in the form of league tables;  
• more recently Ofwat has compared the performance of water companies with the performance of the companies in other utility sectors and in other comparable service industries; 
• taking account of performance in setting price limits. Proposals for this are included in a recent consultation paper The Proposed Framework and Approach to the 1999 Periodic Review; 
• developing the statutory entitlements to compensation through the Guaranteed Standards Scheme. Proposals for compensation entitlements in the event of supply interruptions occasioned by emergency drought orders are currently with the Secretaries of State. Ofwat agrees with the ONCC that the position would be strengthened by amending the Sale and Supply of Goods Act 1994 to include water.

• the issue of guidelines (or best practice) in respect of a number of aspects of service including provisions for disadvantaged customers; 
• setting targets for individual companies whose service levels are unacceptable;
• approval of company complaint procedures and Codes of Practice; 
• careful monitoring of companies' performance, ranging from individual audits by CSCs to annual returns by companies in which information on performance is independently certified.

SECTION 6: OTHER MATTERS

Takeovers, mergers and multi-utilities

Unlike the other utilities, changes in the structure of the water industry are subject to an automatic reference to the MMC if the merger involves companies with assets each in excess of £30 million. The key consideration for the MMC in such cases is whether the loss of a company, would prejudice the carrying out of the Director's functions by weakening his ability to make comparisons between companies.

Since 1989 the number of licensed companies has reduced from 39 to 29 as a result of mergers (some arising from takeovers which happened before compulsory references were possible). Some of these involved small companies, but five proposed mergers were referred to the MMC. Two were allowed subject to price reductions and, in one case, the introduction of ring-fencing provisions in the licence. The last three, involving proposed takeovers of South West Water and Mid Kent, were not allowed on the ground that price reductions and ring-fencing could not compensate for the loss of comparators.

The multi-utility is a recent development. North West Water (now United Utilities) and Welsh Water (now Hyder) have bought Norweb and Swalec respectively. Southern Water is now part of the Scottish Power group. The effect is that the water companies are now subsidiaries within much larger groups and this has potentially adverse consequences. To remedy these, Ofwat secured changes to each water company's licence to strengthen the ring- fencing of the appointed business. There is a strong case for referring future mergers which would create multi-utilities to the MMC, so that the issues can be fully investigated by an independent body.

Important issues arise when, as in the case of multi-utilities, a service company is established to handle jointly a broad range of activities common to the water and electricity businesses. Most important is the question of the allocation of costs between the two businesses. This is a matter of concern to Ofwat when the electricity business will be operating in a competitive market, but the water business will not. This issue requires close working between Offer and Ofwat. It also requires additional resources for investigation of the water company's dealings with its associated company(ies).

The multi-utilities also raise issues about customer representation. These are best resolved by retaining utility-specific customer committees, but developing formal arrangements for liaison and co-operation over matters of common interest.

The longer term may see moves to establish the genuine one stop shop for utility services. This raises issues of data protection as well as issues for regulation which are now difficult to anticipate.

Competition

The development of competition in the water industry has been slow since the Competition and Service (Utilities) Act 1992 extended the provisions for it. Only one inset appointment has been granted by the Director - for a cross-border supply from Anglian Water Services Ltd to Buxted Chicken Ltd (formerly in the area of Essex and Suffolk). The opportunities for direct competition in the supply of water (or the removal of effluent) are expected to continue to be limited. The provision of water and sewerage services is a natural monopoly, combining considerable sunk cost in the infrastructure with high transportation costs. It is a rising cost industry, where cheap resources have generally been exploited first, and where the incremental costs of supply are generally above average costs. Furthermore, there can be geographical constraints on providing the supply and abstractions must be licensed.

The Department of the Environment and the Welsh Office published a paper in April 1996 (Water: Increasing Customer Choice) which considered ways of extending opportunities for competition in the water and sewerage industry. The paper proposed legislative changes for inset appointments, cross-boundary supplies, common carriage and liberalising the making of connections. The Director was involved in the preparation of this paper and supported the proposals, particularly those in relation to the introduction of common carriage.

The Government has published a Competition Bill. Ofwat welcomes the introduction of a prohibition based approach to competition law and the granting of concurrent powers to the sector specific regulators. While the prohibition of abuse of dominant position could enable common carriage to be developed for the supply of water (or the removal of sewage) in England and Wales, the Director believes that legislative changes may still be needed in relation to common carriage.

Resources

The review of regulation needs to take account of resources available to regulators. The changing expectation of regulation, the development of good processes and the increasing need for more detailed scrutiny of aspects of company performance (for example, leakage) all have resource implications. Ofwat is discussing these with the Treasury.

A particular issue for water is that Condition N of the licence imposes a ceiling on the amount that can be recovered from companies - some of the other sectoral regulators are bound by a similar ceiling arrangement, while others are not. The Director considers that Ofwat's ability to recover its expenditure from the companies should not be constrained by a ceiling set in 1989 - especially since current expenditure is close to the ceiling.