Summary of the Director General's
Annual Report 1999-2000
This leaflet is a summary of the 1999-2000 Annual Report of the Director General of Water Services, which is available from the Stationery Office, price £12.00, ISBN number 0-10-556761-2.
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DIRECTOR GENERAL'S STATEMENT
This report deals chiefly with events in the year 1999-2000 and reports to Parliament and all other stakeholders on our performance. I also take this opportunity to reflect on our first decade of regulation.
The achievements of the last ten years stemmed from:
Ten years ago many felt that a monopoly would inevitably create conflict between private profit and public good. In practice, our methods of price regulation have ensured that the search for high profits has led to lower costs and lower bills. Because we regulate outcomes, rather than expenditure, better quality and better service are being achieved economically, keeping down the costs to customers.
Customers' bills
The costs of the significant investment needed to finance
improvements in water and environmental quality – some £50
billion by 2005 – have put great pressure on customers' bills. Despite this, the greater efficiency of the water companies has now enabled us to bring bills down for customers – on average by 12% – this April. This shows customers that regulation works in their interests.
Over the last ten years, average household water and sewerage bills have risen substantially above the rate of inflation. This has enabled the companies to meet EU objectives for drinking water quality and to repair most of the environmental damage of the last 200 years.
Privatisation and regulation have driven the companies to make greater efficiency savings. Without that, the pressure of the environmental programme to drive up bills would have been much greater. Bills could have risen by as much as another third – that would be another £80 on today's bills in real terms. That is a successful outcome for customers. <![endif]>
Outcomes
Customer service has also improved. We have pressed all companies to adopt the practices of the best. We have monitored, and publicised, comparative performance. Companies that fall behind face scrutiny and penalty. We also continue to make companies drive down leakage to sensible and more justifiable levels – now at a third of its peak.
Environmental and social policies
Quality, environmental and social standards are rightly set by elected politicians in London and, increasingly, Brussels. The economic regulator must ensure that they can be financed, but customers, through their bills, have to pay for this work. They should know how the balances are struck between environmental concerns and potential increases in their bills.
For the 1999 review, as for the 1994 review, we worked closely with Ministers, the Drinking Water Inspectorate and the Environment Agency. I hope that we can build on this joint approach to enhance further the quality of decisions on new standards, particularly through better information on the benefits of expenditure on water quality and environmental improvements.
Incentives for companies
Price cap regulation gives strong incentives to reduce costs. Companies are now assured that savings can be retained for five years, irrespective of the timing of the price review.
These incentives also relate to capital expenditure. Privatisation has seen a doubling of capital expenditure, including a doubling of expenditure on maintaining the companies' assets.
Companies delivering particularly good service to customers and to the environment have been rewarded in price limits and poor performers have been penalised.
Price limits are tailored to the funding requirements of individual companies. Through specification of outcomes and through incentives, regulation acts as a surrogate for the pressures that each company would face in a competitive market.<![endif]>
Incentives for customers
We started a debate on how customers should pay for water soon after we were established, in the Paying for Water consultation. Since then, there has been a significant, and welcome, shift towards metering and customers now have a right to a meter at home free of installation charge.
In approving companies' charges schemes, I have sought to align charges more closely with costs and to secure reductions in average prices without damaging incentives to economise in the use of water.
Consultation and transparency
Because consumer choice is limited, the regulator often has to make decisions that affect a range of stakeholders.
Stakeholders have a right to know how these decisions are reached. My judgements have always been based on a published approach and on consultation. I have required companies to provide information about performance and plans. Good, timely information enables all participants to understand both the emerging picture and the outcome.
Transparency is the key to accountability – accountability to customers, to the public, to Parliament and, now, to the National Assembly for Wales. We have increasingly used the Internet to achieve this.
Representing customers
Customer Service Committees (CSCs) are at the heart of regulation. They have their own statutory duties and publish their own annual reports. In 1993, I formed their chairmen into the Ofwat National Customer Council (ONCC) and have treated it as though it were a statutory body.
I have valued the advice of the CSCs and ONCC on a range of issues. In particular I consulted all of the CSCs immediately before deciding on final price limits last November. Without such close contact the regulator would be less well informed on regional issues and on the concerns of individual customers.
I now want to draw up a Memorandum of Understanding with ONCC, in anticipation of the creation of an independent Consumer Council for Water.
The Office
Our particular strength is our policy staff – accounting for about 40% of the annual budget. Their range of skills and experience means that outside consultants only supplement our work. I used a panel of senior industrialists working closely with my senior staff to help me with the price review. I will continue to operate such an arrangement to provide me with outside advice.
Our success in regulation is also built on sound methodologies, good processes and an efficient office. We collect information systematically from companies, much of which is scrutinised by independent Reporters. The analysis of each company's performance – published in my annual reports on financial performance, relative efficiency and levels of service to customers – is an important part of making judgements about price limits.
Judgements about price limits are further informed by our own analytic work.
We are constantly working at our own efficiency, too, to ensure that we give value for money. This year we have been able to reduce our licence fee by £500,000.
Ofwat costs each connected household less than 50p a year.
Co-operation with other regulators
I regularly meet other regulators to pursue issues of common concern. We have agreed a policy about the regulation of multi-utilities. Our staff collaborate on operational and financial issues, such as the cost of capital. We produce regular reports on what we are planning to do and what we have achieved.
Looking ahead
The Competition Act has opened up the prospect of market competition and I look forward to a sea-change in this area. We were the first utility regulator to issue guidelines on the application of the Act.
I have wanted to see a lowering of the threshold for inset appointments. I am pleased that the Government has now announced this. As competition develops, we should see some shift in the emphasis of the work of the office away from regulation towards that of a competition authority. Competition is preferable to regulation, but some elements, in particular the natural monopoly distribution networks, will always require some regulation.
Competition may lead to changes in the structure of the industry. If so, the regulatory arrangements will need to adapt to ensure that any monopoly elements are properly regulated, to the benefit of customers.
As this is my last annual report, I want to record my thanks to all those who have helped me in an arduous task. My first thanks are to my staff, at all levels here in Birmingham, to the members of the CSCs and ONCC and their staff, to my senior industrialists, to officials in other Departments of State, many with sharp minds and long knowledge of the water industry. Last, but by no means least, I thank my critics, who have challenged my thinking and kept me focussed on the interests of customers.
TEN YEARS ON
Ofwat was set up in 1989 and our first annual report was published in 1990. Ten years on is an opportunity to review our achievements in a rapidly evolving regulatory environment.
Review of the Ofwat Forward Programme (1999-2000)
In March 1999 we published Ofwat's first Forward Programme following public consultation. This set out our priorities and our work for the year from 1 April 1999. It delivered a broad range of objectives aimed at protecting customers, safeguarding the environment and providing incentives to the companies to improve performance. The key outcomes for customers are summarised below and covered in more detail in the rest of this report.
Setting new price limits:
On 25 November 1999 the Director published Final determinations: Future water and sewerage charges 2000-05. The companies have been more efficient than ever and these savings have enabled us to deliver major benefits to customers – a 12% average reduction in bills and a £15 billion investment programme: to improve drinking water quality and protect the environment; to maintain the industry's infrastructure to deliver services to customers; and to ensure that the supply of water meets essential demands without over-abstraction. As a matter of good project management, Ofwat reviewed its overall approach and management of the determination process.
Extending competition:
The 1998 Competition Act came into force on 1 March 2000. This legislation is designed to prevent anti-competitive behaviour and the abuse of a dominant market position by all enterprises. The Director has strong new powers to enforce the Act with respect to the regulated water companies. This means better services and more competitive pricing for customers. This year, we have developed new policy and guidance to support the Act.
Regulating company performance:
Comparing company performance in public is one of the Director's most powerful methods for generating incentives to greater efficiency and improved services. We monitor and analyse the companies' performance and service to customers. Independent Reporters have examined and tested the company information; we have developed and improved our measures. Our five annual reports on company performance contain more information.
Paying for water and approving charges:
Most of our new work this year was driven by the Water Industry Act 1999. For the first time, the companies had to obtain the Director's approval of their charges schemes. These new powers further protect customers' interests.
Working with customer representatives and customer protection:
Ofwat continues to work closely with the Customer Service Committees (CSCs) and the Ofwat National Customer Council (ONCC). The CSCs have throughout the year made a major contribution as the independent voice of the customer; influencing the outcome of the price review and the approval of charges schemes. They have received over 12,000 complaints, obtained compensation and refunds amounting to £0.5 million, and audited the companies' customer services. Ofwat HQ dealt with 749 complaints and disputes in the year. We obtained compensation and rebates for customers amounting to £286,340.
Cost effective regulation:
We deliver value for money by scrutinising our expenditure, evaluating and learning from outputs, and developing our main resource: staff. We have now achieved Investors in People status. This year, we have reduced costs further despite the additional work associated with the Competition Act 1998 and the Water Industry Act 1999.
Open and effective regulation:
We achieved most of our Customer Charter standards this year – and more than last year. We are committed to joined-up government, working with other departments and regulators to deliver successful outcomes for customers. During the year, a good deal of joint working was carried out on the Utilities Bill, price reviews, the Competition Act and monitoring the Millennium Bug. The Director and fellow regulators meet regularly to consult on cross-industry issues. We pride ourselves on being open and transparent. We have consulted widely and kept in close contact with all stakeholders to explain our work, to understand their views and to explain how we have taken representations into account in making our decisions. We have published a wealth of information about our work and about the companies, and all of our new publications are available on our website: (http://www.open.gov.uk/ofwat/).
THE 1999 PERIODIC REVIEW AND THE
REVIEW OF THE REVIEW
1999 saw the culmination of three years' work on the periodic review, setting price limits for 2000-2005. The Director achieved his objectives to reduce prices for customers and enable companies to deliver a programme of environmental and water quality improvements.
DELIVERING THE PERIODIC REVIEW
Ofwat established a process which delivered 27 separate determinations in a confidential environment and on time. A phased process allowed timely debate on the issues and enabled stakeholders to make informed contributions to decision-making.
The decision-making phase started in 1998 and continued in 1999. Draft decisions were published on 27 July 1999. The final stage of external comment on the draft determinations led to the announcement of the final determinations on 25 November 1999. Companies had two months to decide whether to accept them or to request a re-determination by the Competition Commission. The companies then submitted their charges schemes for the Director's approval. The new price limits took effect from 1 April 2000.
Company Business Plans
Each company submitted a Business Plan in April 1999 setting out its board's proposals for the next five years.
The Director considered the arguments and evidence presented in the Plans, as well as the findings of studies commissioned by the companies and Ofwat. He asked the CSCs for their views.
We placed public versions of the Plans in the Ofwat library and one-page summaries on the Ofwat website. This allowed all interested parties to get involved.
The draft determination
Ofwat published Draft determinations: Future water and sewerage charges 2000-05, on 27 July 1999. This set out draft price limits, infrastructure charge limits and minimum required outputs for the five years 2000-05. It gave companies and other stakeholders a final opportunity to comment on Ofwat's proposals.
Consulting on the draft determinations
In response to the draft determinations, the Director received representations from companies, customers and customer groups, the CSCs, environmental groups, MPs, local government organisations and other interested parties.
The Director met with the companies to listen to their final representations and met with each CSC to listen to their views.
To encourage stakeholders to put forward their views, Ofwat held a series of seminars between July and September 1999 for:
business customers
consumer groups and
environmental groups.
Presentations were also made to City institutions, to inform and gain feedback on the critical issues.
Decisions on quality and the environment
The water quality and environmental improvement programme was widely debated over the three years and required decisions about the setting of new standards and the timing of implementation. This process has involved Ministers, as the standard setters, and, for the first time, the National Assembly for Wales. The quality regulators – the Drinking Water Inspectorate (DWI) and the Environment Agency (EA) – advised on the water quality programme and on the environmental programme respectively. Other statutory bodies such as English Nature and the Countryside Council for Wales also gave advice.
Customers, the companies and groups representing environmental interests were all involved in the quality debate.
The Secretary of State for the Environment, Transport and the Regions, and the Secretary of State for Wales gave guidance on the environmental and quality objectives to be achieved by the water industry in 2000-05 in Raising the quality (September 1998). The Environment Minister supplemented the guidance in March and November 1999. The Director took full account of this guidance (for England) and of advice from the First Secretary of the National Assembly for Wales in setting price limits.
The final determination
On 25 November 1999 the Director announced his final decisions on price limits in Final determinations: Future water and sewerage charges 2000-05. · At privatisation the expectation was that average price limits for the first five years would increase at just under 5.5% and 4% for the second five years.
· In practice, price limits for 1995-96 to 1999-2000 rose at 1.4% on average.
· The average price limit for 2000-01 to 2004-05 is –2.1%, with a one-off reduction in prices of 12.3% in 2000-01.
Price limits will allow the companies to invest over £15 billion in the next five years – equivalent to £8.5 million a day – to improve water quality and to protect the environment.
Final determinations - outcomes for customers : · Average water prices came down from April 2000. The average annual household bill could fall by £30 over the next five years. That is from around £248 to £218.
· Removal of the risk of sewer flooding for 4,500 properties in
· England and Wales.
· Removal of low-pressure problems for 2,000 properties.
· Further reductions to leakage levels.
· Improvements at 531 water treatment works, sufficient to serve15 million consumers, to meet new standards in the EU Drinking Water Directive.
· Modification to water treatment works, providing water sufficient for 30 million consumers, to reduce the risk from cryptosporidiosis.
· Installation of treatment at water sources, sufficient to supply 17 million consumers, to reduce lead dissolved in company pipes and household plumbing; plus replacement of 1.25 million of the companies' lead communication pipes.
· Improvements at water treatment works, sufficient to serve
8 million consumers, to overcome exceptional problems of deteriorating raw water quality. · Rehabilitation of 22,000km of water and distribution mains to reduce problems associated with discolouration.
Final determinations - outcomes for the environment :· Improvements at sites discharging estuarial and coastal waters, with a population equivalent of 8 million, to reduce the environmental impact of sewage effluents on the marine environment and to improve bathing water quality.
· Enhancements to nearly 1,800 sewage treatment works.
· Improvements to nearly 4,500 intermittent discharges from the sewerage system.
· Provision for nearly 3,700km of rivers to be protected or improved.
· Meeting higher standards for dealing with over 1 million tonnes of sewage sludge on agricultural land; to reduce the risk of pollution from discharges of sewage in wet weather and to protect some bathing waters and shellfish harvesting areas.
LATER STAGES IN THE REVIEW
Competition Commission references
The Director applied fair and consistent policies, developed in an open and transparent manner over several years; he also took into account the individual circumstances of each company.
All companies accepted the package, except Sutton & East Surrey Water and Mid Kent Water. These two companies asked the Director formally to refer the price limits to the Competition Commission, which he did on 7 February 2000. The Commission will examine the evidence and reach a decision within six months. Meanwhile, the Director's price limits will apply.
Licence Condition B amendments
The licence changes also apply to three matters which the Director has not taken into account in price limits. These Notified Items all relate to provisions in the Water Industry Act 1999. The first two relate to potential loss of revenue arising from uncertainty about: The third relates to additional operating costs to implement the new scheme which protects vulnerable customers, who pay on measured tariffs, from high water bills.
Monitoring Plans
Once price limits were set Ofwat asked all companies to submit a Monitoring Plan for the next five years by the end of March 2000. The Plans set out the companies' commitments to deliver water quality and environmental improvements, and standards of service consistent with the Director's price limits, together with company plans for maintaining the serviceability of their assets to customers.
Ofwat will examine each company's Monitoring Plan. Should any Plan not commit to achieving minimum outputs, the Director may judge this company to be at risk of not discharging its functions and take appropriate regulatory action.
Some unfinished business
Ministers asked the EA, other regulators and officials, together with the relevant companies, to look again at the value for money of some proposed initiatives. These initiatives mainly concern the cost of expensive schemes identified to meet river quality improvements, together with a major water transfer proposal by Wessex Water to deal with environmental problems in the Hampshire Avon catchments.
We have set out our expectations for this case-by-case reappraisal in Appendix E of Final determinations: Future water and sewerage charges 2000-05 (November 1999).
Final decisions on whether or not to proceed with the initiatives will rest with Ministers, after full consultation.
Folkestone & Dover Water Services/Mid Kent Water bulk supply
In deciding the terms of supply, the Director followed ministerial guidance such that:
Incentive regulation
In this review, half of the benefits of efficiency savings have been passed on to customers in the form of lower bills, with the balance invested in environmental improvements.
We have developed additional incentives:
MANAGEMENT OF THE REVIEW
Throughout the process we consulted widely. We involved all stakeholders – customers and customer representatives, companies, environmental and consumer groups, the Government, the City, the media and other interested parties.
An executive project group, supported by a group of team leaders, directed policy development, planning and monitoring.
The Director took account of the views of the CSCs and ONCC, his panel of senior industrialists and his financial advisers, Singer and Friedlander. He consulted the financial markets about the financial viability of his methods.
Senior industrialists
Ofwat's advisory panel of senior industrialists met on ten occasions during the year.
The panel gave the Director helpful and constructive advice. The focus has been on four main areas of the Periodic Review: efficiency; incentives; the cost of capital; and other financial issues.
Work of the Reporters
The independent Reporters audited and challenged the company information submissions and the company Business Plans. They checked that companies complied with Ofwat's reporting requirements and guidelines, and ensured that all assumptions were either exposed by the companies or highlighted in their own reports to us. This scrutiny enables Ofwat to make informed comparisons between companies.
Role of the CSCs
The CSCs, as part of Ofwat and as the statutory representatives of water customers, played a special role in the price review. CSC Chairmen were involved in planning the review and had regular access to the Director throughout the process.
THE REVIEW OF THE REVIEW
As a matter of good project management, Ofwat reviewed its overall approach and its management of the process. We will publish a summary of the review in June 2000.
EXTENDING COMPETITION AND HANDLING MERGERS
The past year has seen several important developments in market competition. When companies propose to merge, it is our job to make sure that customers' interests are protected.
DEVELOPMENTS IN PROMOTING EFFECTIVE COMPETITION
The past year has seen several important developments in market competition. · The Competition Act 1998 has significantly strengthened the
Director's competition powers.· We have published a guideline on how the Competition Act will be applied in the water and sewerage industry.
· Significant progress has been made in developing a coherent framework for common carriage.
· The Director has granted a greenfield inset appointment that
could see new household customers benefiting from competition for the first time.
Competition Act 1998
The Competition Act 1998 came into effect on 1 March 2000. It strengthens the Director's general competition powers. The Director has concurrent powers with the Director General of Fair Trading to enforce the Act in the water and sewerage sectors.
Ofwat's guideline
In January 2000, Ofwat published a guideline on how it will apply the Act to the water and sewerage sectors.
Common carriage
The Competition Act opens up the scope for market competition through common carriage, when one company supplies water or sewerage services to its customers by using another company's network. In November 1999, Ofwat provided guidance (MD 154) on a number of important issues that companies should consider when developing their terms and conditions for common carriage. The Director asked the companies to have in place by 1 March 2000 a statement of principles governing access to their networks. The companies have done so. MD 158 (January 2000) stressed that specific legislation is not necessary for common carriage.
To help Ofwat develop its policy on and approach towards common carriage, the Common Carriage Consultative Working Group has been formed. This comprises Ofwat staff, Professor Stephen Littlechild (Director General of Electricity Supply 1989-98), Professor David Newbery (Director, Department of Applied Economics, Cambridge University), Roger Corbett (Chairman of the ONCC Competition Group), and Kyran Hanks (Director, Government and Regulatory Affairs, Enron).
Ofwat will investigate cases where a company unreasonably refuses to share its infrastructure, or offers unreasonable terms. Such conduct might be an abuse of a dominant position and thus infringe the Competition Act.
Inset appointments
Building on the guidance published in February 1999, Inset appointments: Guidance for applicants, Ofwat held discussions with potential inset applicants and customers throughout the year. Some customers have, after considering competitive alternatives, made a positive choice to remain with their existing suppliers. Ofwat has also been able to tell customers about other competitive opportunities.
Abstraction licences
Ofwat supports greater flexibility in the abstraction licensing regime. Ofwat contributed to a study commissioned by the Department of the Environment, Transport and the Regions, which included a consideration of possible trading in abstraction licensing. The report is due to be published shortly. The Director also initiated discussions with the EA on how to administer the current regime more flexibly. A government consultation paper on possible reforms to the abstraction licensing regime will also be published at the same time.
Review of competition
In the March 1999 Budget statement, the Chancellor announced a review of competition in the water industry. · In October 1999, the Director changed Hartlepool Water's licence to include nine greenfield sites at Wynyard South near Wolviston in Northumbrian Water's area. The developers plan to build houses as well as a hotel and leisure complex.
For the first time, new household customers can see the benefits of competition. · In May 1999, Albion Water (the first new licensed water supplier since privatisation) took up its appointment as the supplier for Shotton Paper on Deeside.
· The Director has appointed Hartlepool Water to supply water to Kodak in Harrow in place of the existing supplier, Three Valleys Water (19 April 2000). This is the first inset appointment in the South East.
· Ofwat published proposals that would allow Northumbrian Water to replace Hartlepool Water as the water supplier for a greenfield site that is to be developed for industrial purposes at Tofts Farm near Wolviston in Teeside.
COMPANY MERGERS
Ofwat has been concerned to protect customers' interests following mergers. Ofwat policy on mergers has developed in response to the Competition Act 1998.
Parliament has indicated that it does not want to see mergers without tangible benefits. We have always argued that reducing the number of independent water and sewerage companies harms the public interest because it reduces our ability to compare company performance. In some cases, this harm may be remedied by price cuts.
The development of market competition could now be an alternative remedy. This, too, would lead to lower bills and better service for customers. There may be a case for the Competition Commission to approve mergers if the companies involved are willing to deliver competition and, more importantly, to lose the market share in their own area.
Merger activity this year
There has been one merger this year. In December 1999 UFACEX UK Holdings plc, a subsidiary of Union Electrica Fenosa SA, announced that it had acquired the entire share capital of Cambridge Water plc.
Developments from previous mergers
The Director believes that, when companies are under the same ownership and control, customers' interests are best protected by replacing their separate licence with a single one.
During the year we settled the licence arrangements to protect customers' interests in respect of two mergers (reported last year): REGULATING COMPANY PERFORMANCE
We use comparative competition as our main vehicle for improving company performance. It encourages companies to provide a better service at lower cost. Comparative competition stimulates the behaviour that market competition might produce.
REGULATORY INFORMATION COLLECTION
We collect a range of detailed information from the companies throughout the year to enable us to compare their performance and to set them challenging but fair efficiency goals: All of the companies make an annual return each year to the Director. These returns set out the companies' regulated activities, service to customers, expenditure and performance. They include the regulatory accounts. Reporting guidelines set out the information that companies are required to submit. The returns are available for purchase on CD-ROM and can be inspected in the Ofwat library. The submission date was brought forward from early July to early June in 1999.
REPORTERS
Each company must employ a named individual as Reporter. The Reporter reports to the Director on the accuracy and reliability of regulatory information, and on underlying company assumptions.
MONITORING PERFORMANCE
All water companies are obliged by law to meet a range of quality standards on time. When setting price limits, we assume that companies will improve their assets to meet these quality standards for drinking water and environmental water – for example, in rivers, estuaries and coastal waters.
The DWI and the EA are responsible for monitoring and enforcing the relevant standards.
Since 1995, a joint regulatory approach has developed. Both quality regulators provide information on company performance each year to the Director. The Director assesses whether the companies are delivering the improvements he expects. If there are shortfalls, the Director adjusts prices at the next review to ensure that companies do not gain financially from being late, or from failing to deliver.
Defining standards of service indicators
Measures of service need to co-evolve with the industry.
As companies' performance has improved across the industry, existing comparative assessments risk drawing distinctions on performance that customers do not perceive as significant and of encouraging companies to invest in areas that are not real priorities. We have therefore defined standards in all areas where performance is measured, except for flooding from sewers (as the weather causes significant variation) and water pressure (where performance is improving rapidly). This means that companies are clear about the minimum standards needed, and what is a good standard.
Ofwat is also working with the industry to develop means of measuring quality of service: for example, on handling telephone calls. The work of the CSCs in carrying out random audits continues to be important, and Ofwat has worked with them to secure greater consistency of assessments. <![endif]>
Monitoring serviceability
We have monitored company performance in delivering serviceability to customers, including mains bursts, interruptions to supply, low pressure, sewer collapses and flooding. Serviceability has been maintained and in some cases improved. In their annual returns, companies have also been reporting substantial efficiencies in their capital programmes. We have taken account of these in the 1999 price review, enabling future prices to reflect both past efficiency and the scope for future efficiency. <![endif]>
International comparators
We believe the water industry in England and Wales to be among the best in the world. Ofwat keeps abreast of international developments.
Since 1998 we have sought to extend the boundaries of our work and consider how water and sewerage services are provided overseas. Our latest report (August 1999) looks at Sydney Water and Western Australia. <![endif]>
MULTI-UTILITY REGULATION AND TRANSFER PRICING
During 1998-99, Ofwat visited eight water companies, including the multi-utilities, to ensure that they are trading at arm's length with other group companies. Where companies failed to demonstrate arm's length trading, Ofwat made a downward adjustment to the water companies' base operating costs at the Periodic Review. This adjustment was based on the principle that any services provided by group companies which were not arm's length, should not earn any profit, and so should essentially be viewed as services provided in-house. In addition to these adjustments Ofwat also published companies' compliance with RAG 5.02 – the guideline for arm's length trading – in the 1998-99 Report on financial performance and capital expenditure.
Strengthening ring fencing
Ofwat strengthened the ring fence of seven more water companies this year, which are subsidiaries of larger groups. These are Bournemouth & West Hampshire Water plc; Essex & Suffolk Water plc; Folkestone & Dover Water Services Ltd; North Surrey Water Ltd; South East Water plc; Tendring Hundred Water Services Ltd and Three Valleys Water plc. This ensures that customers are adequately protected from cross-subsidising other services received from or provided by other companies within the group.
PUBLISHING THE FIVE ANNUAL REPORTS
The results of our monitoring are published in five annual reports that provide and interpret this information for customers and other stakeholders. The reports are free of charge and are all available on the Ofwat website: · The 1999-2000 Report on tariff structure and charges (May 1999.)
· The 1998-99 Report on the financial performance and expenditure of the water companies in England and Wales (September 1999.)
· The 1998-99 Report on levels of service for the water industry in England and Wales (September 1999.)
· The 1998-99 Report on leakage and water efficiency (December 1999.)
INFORMING REMUNERATION COMMITTEES
The Director wrote to the Remuneration Committee of each company enclosing his annual reports on levels of service and unit costs and relative efficiency. In doing so, he encourages them to be transparent in any links between services delivered to customers and decisions on directors' pay. This is in accordance with Ministers' wishes as expressed in the White Paper, A fair deal for consumers.
Regulatory action and dealing with failures · All but two companies met leakage target levels set by the Director for 1998-99 – Bournemouth & West Hampshire Water is required to report quarterly to Ofwat about its progress after narrowly missing its target.
· In Autumn 1998 we wrote to13 companies about aspects of their performance. As a result, most companies reported improvements.
· An Ofwat inquiry was carried out following Mid Kent Water's failure to maintain a piped water supply to 3,000 of its customers. Management failures were found to be at the rootof the problem and a number of learning points emerged. The company accepted that better contingency planning is required and has implemented an action plan intended to address these issues.
Everybody living in the affected areas received compensation of £50
PAYING FOR WATER AND APPROVING CHARGES SCHEMES
Ofwat continues to protect customer's interests in respect of the charges they pay for water and sewerage services.
Under the Water Industry Act 1999, The Director approved companies' charges schemes for the year beginning 1 April 2000.
WATER INDUSTRY ACT 1999
The Water Industry Act 1999 received Royal Assent on 30 June 1999. For England and Wales, the Act provides new entitlements for water consumers, particularly household customers.
For the first time, each company had to obtain the Director's approval for its charges scheme.
Approval of charges schemes
Once price limits are set, each company has to decide individual charges. These are published in annual charges schemes.
For the first time, the Director approved companies' schemes this year. The Director consulted customers, companies and others, then set out the approach he would follow in approving these schemes. The Director has taken account of guidance from the Secretary of State. He has also ensured that the schemes implemented the new legal entitlements under the 1999 Act.
In the context of the first year reduction in charges underlying the new price limits, the Director applied six key principles in approving charges schemes for 2000-01. · Companies should set a fair balance between measured sewerage charges and trade effluent charges. Differences in bills should reflect only differences in volume and strength of discharge.
· Companies should offer rebates for customers whose properties do not drain surface water to the companies' sewers. Five more of the water and sewerage companies offered rebates for the first time this year (bringing the total to seven). Following pressure from Ofwat, the remaining three companies have now committed to introduce rebates by next year.
· Companies should set charges for large users, with reference to the long run marginal cost of supply (LRMC). Where there was scope for reductions in the final determinations, Ofwat required the companies to justify proposed changes in large user volumetric rates by reference to robust estimates of LRMC – the continuing costs of meeting increases in demand.
Companies must have a charging strategy in place for managing possible increases in demand – the LRMC. Tariff structures need to be developed so that those customers placing additional demands on companies should face tariffs that reflect additional costs.
Details of Ofwat's approach, together with information on companies' charges and tariffs, are contained in Ofwat's 2000–01 Report on tariff structure and charges (8 May 2000).
Other changes introduced by the 1999 Act
The 1999 Act makes a number of significant changes to water charging arrangements. These came into effect on 1 April 2000.
Optional meters
All household customers are now entitled to have a meter fitted free of installation charge. The Director has powers to determine any disputes about practicalities or expense. Ofwat has ensured that companies have followed this approach in their charges schemes.
Where it is impractical or too expensive to install a meter, the Director has required companies to offer customers the option of an assessed charge.
The 1999 Act requires companies to set out in their charges schemes their timescales for installing meters. The Director has agreed timescales ranging from three to six months for the first year, but expects all companies to have a timescale of three months or less next year. Where companies do not meet these timescales, they must compensate customers.
Tariffs for vulnerable groups
The 1999 Act enabled the Secretary of State and the National Assembly for Wales to make regulations protecting customers who might face hardship as a result of being charged by meter. For companies in England, these come into effect on 1 April 2000. Similar provisions are being offered to customers in Wales. Ofwat played an active role in advising the Department of the Environment, Transport and the Regions on the regulations and ensuring that they were made in time for companies to incorporate them into their charges schemes for 2000-01.
FURTHER CHANGES AFFECTING BUSINESS CUSTOMERS
Trade effluent charges
In August 1999, the Director wrote to the companies (MD 150). In the context of continuing investments in wastewater treatment, he outlined best practice guidance on how to introduce any increases in charges resulting from new levels of treatment. · Companies should give their customers appropriate price signals in advance of commissioning new treatment facilities.
· Companies should also undertake surveys to gauge the impact on demand of increasing charges for these services.
· If companies do not follow best practice, they should offer some form of transitional relief (for example, capped charges for up to two years).
The Director has asked the CSCs to report to him regularly on company performance.
Tariff basket changes
This year Ofwat amended the companies' licences to remove customers using more than 250 million litres of water a year from the tariff basket. This change came into effect on 1 April 2000. Large user customers are part of a competitive market that does not require the same degree of regulation as other groups of customers. Taking large users out of the tariff basket now means that companies cannot recoup from other customers lost revenue arising from reductions in tariffs to large users. <![endif]>
Special agreements
Some customers pay a non-standard charge for their water supply or sewerage or trade effluent service. These charges should reflect the costs the customer imposes. Ofwat has placed a special agreements register in the public domain again this year.<![endif]>
CUSTOMER PROTECTION AND WORKING WITH CUSTOMER REPRESENTATIVE
Close working relationships between the Regulator, the ten CSCs and the ONCC are essential to ensure that water industry regulation serves the needs of customers.<![endif]>
CUSTOMER REPRESENTATION
The Director works closely with the CSCs and ONCC to achieve benefits for customers.
Reviewing company performance is a crucial part of the work of the CSCs. They produce reports which allow the Director to make more accurate, informed decisions about the service provided by companies to their customers. This in turn affects the price limits which the Director sets.
The CSCs received over 12,000 complaints in 1999-2000. They obtained compensation and refunds for customers amounting to £0.5 million.
Review of CSC appointments
Membership of the ten CSCs is reviewed annually. Of the 35 members whose appointments expired in April 2000, 20 were re-appointed and 14 new appointments were made.
At 31 March 2000 the total membership of the CSCs was 118. There were 47 (40 per cent) women and nine (eight per cent) from ethnic minority groups.
Annual reports
The work and achievements of the CSCs and ONCC are described in their annual report, Representing water customers 1999-2000, which will be published in June 2000.
REFORM OF REGULATION
The Utilities Bill implemented the policies in the Government's White Paper, A fair deal for consumers: modernising the framework for utility regulation (July 1998). It also confirmed the Secretary of State for Trade and Industry's July 1999 announcement that the office of the Director General of Water Services would continue, but that the Director would work with a legally-constituted advisory panel, appointed by the Secretary of State, and would seek its advice on specified matters.
The White Paper proposed changes in the arrangements for consumer representation, greater regulatory transparency and more joint working between sector regulators. When the Bill was published, the Director expressed reservations about its prescriptive nature. He was concerned that it did not effectively translate the Government's policy into legislation. He was particularly concerned that the relationship between the regulator and the new Consumer Council for Water was clumsy and untidy.
The Director was concerned that many of the provisions in the Bill would either: The Director will argue that any clauses which are brought from the Utilities Bill should take account of concerns about the relationship between the regulator and the proposed Consumer Council for Water. These include: CUSTOMER PROTECTION
Complaints
Ofwat HQ dealt with 749 complaints and disputes in 1999-2000. This is an increase of 108 (16%) over last year. We obtained compensation and rebates amounting to £286,340.
The Director dealt with 26 cases alleging breaches of statutory duty or licence requirements. He concluded that no company was in breach of statutory or licence requirements.
The Director considered 29 complaints which the CSC had been unable to resolve with the companies. Fourteen cases are ongoing.
Water connection charge disputes
The Director settled 37 disputes. Of these, 33 determinations were in favour of the customer. Companies were required to make refunds ranging from 3% to 85% of the original charge and
averaged 32%.
Following consultation with developers, and the water industry, the Director introduced a time limit for the consideration of connection charge disputes. From 1 April 1999 the Director will only consider disputes which are referred within two years of the connection being made.
The Director reviewed all companies' connection charges schemes. He has raised concerns about the level of charges with some companies and ensured that all companies provide appropriate advice about his power to determine disputes.
Sewer appeals
The Director received nine appeals and 32 enquiries during the year. Five appeals were resolved informally. Two determinations were issued, upholding the appeal.
Trade effluent
Of the ten cases brought forward from last year, seven formal determinations were issued. Four new cases have been received and it is anticipated that six of the seven outstanding cases will be resolved without the need for formal determination.
Pipelaying in private land
Seventy-six informal complaints were resolved, usually by the company agreeing additional compensation payments, or by doing further reinstatement.
Guaranteed Standards Scheme (GSS)
The Director settled 13 disputes under the GSS and in five cases concluded that the customers were entitled to payments.
Review of the Guaranteed Standards Scheme
The GSS provides for statutory levels of compensation where a company fails to deliver a minimum standard of service to its customers. The new regulations will come into effect by the summer.
Customer satisfaction surveys
Ofwat has been discussing with the industry the best way to monitor routinely general customer satisfaction with the services provided by companies. Ofwat is currently consulting the companies on a proposal that they should report the results annually to Ofwat.
Customers with special needs
Ofwat, together with the CSCs, continues to monitor companies' policies and practices in providing services to customers with special needs. This work feeds into the overall performance assessment for each company. Company activity is generally satisfactory. In October 1999, key sections of the Disability Discrimination Act were implemented and Ofwat is convening a conference of interested parties to discuss the requirements of the Act and promote good practice.
Water resale
In 1999 the Director undertook a consultation on a proposed approach to limiting the maximum amount which may be charged by a person reselling water or sewerage services. The proposals were based on the principle that resellers should be able to recover only the costs of those services plus any costs associated with billing and maintaining meters. The Director's proposals received broad support and a draft Maximum Resale Price Order has now been published (April 2000).
The efficient use of water
Ofwat has continued to monitor how each company fulfils its duty to promote the efficient use of water by its customers. Industry activity has increased significantly since 1996-97, and companies are generally meeting the commitments laid out in their initial water efficiency plans. Ofwat has required the companies to review aspects of their plans and to submit the results in June 2000. There are concerns about: Ofwat is addressing these concerns. <![endif]>
OPEN AND EFFECTIVE REGULATION - OFWAT MANAGEMENT
Ofwat's resources are committed annually to support the Director in delivering his statutory duties and Forward Programme objectives.
STAFF DEVELOPMENT
During the year, Ofwat has recruited new staff in preparation for the Competition Act 1998 and the Water Industry Act 1999. In October, Ofwat achieved Investors in People accreditation. The achievement was marked by a presentation by Environment Minister Chris Mullin MP in December.
Over £200,000 was spent on training and development during the year, to help staff achieve their potential and to develop their talents. We sponsored a graduate trainee scheme and have so far sponsored eight staff places on a post-graduate course on utility regulation at Warwick University.
Ofwat has a total of 209 staff, of whom: · 60% are women;
· 16% are from ethnic minority groups;
· 7 are members of the Senior Civil Service
· 11% are employed on fixed-term and casual contracts;
· 12% work part-time;
· 24% work in the CSCs.
The salary of the Director is £112,463.
Organisational structure
In November 1999, the office restructured its management team to respond to the Competition Act 1998 and the Water Industry Act 1999.
FINANCE
During the year, the office spent £10.9 million.We maintain sound financial management to ensure that Ofwat can fulfil objectives within budget. The Periodic Review and the Competition Act generated particular cost pressures. At the end of the year we had met our financial targets.
Efficiency savings
As companies are required to manage efficiently, Ofwat also has an objective to control costs and provide value for money. In March 2000 companies were notified that licence fees for 2000-01 would be reduced by £500,000. This fall in the charges to companies was delivered through economies achieved in the financial year 1998-99. We will continue to keep within our licence fee ceiling and manage an efficient office.
The office remains on target to convert its accounts in line with the Government's Resource Accounts and Budgeting initiative. Ofwat's expenditure is entirely covered through licence fees paid by the water companies directly to the regulator.
SUPPORT SERVICES
We have continued to implement best practice in support services, notably this year by promoting effective security management and adopting more 'green' practices.
INFORMATION SYSTEMS
The past year has laid a solid foundation for the future following previous years' investment in a new IT infrastructure and applications. These systems passed the ultimate test of the Periodic Review.
Information technology strategy
The IT strategy concentrated on keeping the system available during the Periodic Review. We are now developing an Ofwat Intranet and connecting to the Government Secure Intranet. We are working to improve the security of our system.
Millennium Bug
In 1998, Ministers asked the Director to take the lead in monitoring Year 2000 preparations of the industry, to ensure that no disruption took place to customer services. Ofwat supervised two independent assessments by leading engineering consultants which verified that the industry had taken all necessary action. Ofwat issued regular updates and a leaflet to keep customers informed. These steps reassured customers that services would continue as normal and that contingency plans were in place. As the date changed to 2000, it was business as usual for Ofwat, and the water companies reported no incidents of service failure.
OPEN AND EFFECTIVE REGULATION - COMMUNICATION
We have successfully developed an open communication network including all key stakeholders.
CUSTOMER CHARTER
Ofwat's continued commitment to the charter standards was demonstrated by our meeting most of our standards this year – and more than last year – even though the price review generated more enquiries than in previous years.<![endif]>
OTHER STAKEHOLDERS
Joined up government
Ofwat is committed to working closely with other government departments and regulators to develop effective policies that benefit customers. The utility regulators meet regularly to pursue issues of common interest such as competition and Millennium compliance. In November 1999, the regulators published a statement setting out details of a number of areas of joint working. Working groups have also been established to collaborate on issues of common concern. Ofwat has taken the lead in the groups on multi-utilities, service delivery standards and the cost of capital and is represented on the other joint working groups.
Millennium Bug
Ensuring that customers were kept informed about the industry's progress in dealing with the Millennium Bug involved contact and liaison with a wide range of groups, notably: · Cabinet Office,
· Action 2000, and
· the water companies.
Parliamentary affairs and the Assembly
The Director and members of Ofwat's senior management team appeared before the Environment Sub-Committee of the Environment, Transport and Regional Affairs Select Committee on 27 July 1999. This was also the day the Director announced his draft determinations of price limits. The Director also briefed the Associate Parliamentary Water Group on his final determinations of future price limits at the House of Commons on 25 November 1999. Ofwat's Director of Costs & Performance and Chief Engineer briefed the Secretary to the Local Government and Environment Committee and the First Secretary of the National Assembly for Wales in Cardiff at the draft and final determinations.
Environmental and consumer groups
Ofwat is keen to involve stakeholder groups in its decision-making. Throughout the year officials met environmental and customer representatives to discuss a range of issues.
Business customers
Quarterly meetings are held to ensure that business customers' views are sought and that they are kept informed.
The City
Effective communication with finance providers and City commentators is an essential part of good economic regulation. Our policy of encouraging communication with City institutions is particularly important during price reviews. During the year, Ofwat adopted a strategy of City-wide communication. We talked with: · City analysts,
· institutional shareholders,
· credit rating agencies, and
· banks and bondholders.
This involved, in particular, briefing analysts and institutional shareholders on both the draft and final determinations.
Overseas visitors
Ofwat's reputation as a global leader in utility regulation continues to grow. The overseas demand to hear more about utility regulation continued in 1999 with 31 separate visits to Ofwat taking place. Visitors from as far afield as Africa, Australia, South America and South East Asia.
INFORMATION SERVICES
The media/press conferences
The Periodic Review has been the major focus of attention. We held press conferences for both the draft and final determinations. Each of these days saw some 20 press releases issued and the Director, supported by other senior staff, took part in TV and radio interviews spanning regional and national media. Interest in competition rose as the year progressed and we held a series of media briefings and seminars seeking views and explaining our decisions.
Sixty-five press releases were issued by Ofwat this year, with a further 92 for the CSCs. We saw a large increase in media calls handled this year: more than 5,000, compared with 3,000 last year. The number of media interviews also increased to just under 150. We contributed articles to a range of consumer, technical, financial and parliamentary publications.
Publications
Ofwat continues to make a wide range of publications freely available. Most publications are now free and are on our website.
Website
Ofwat's website is increasing in popularity, reflecting the general growth in Internet usage. The scale of the increase in people accessing the site – a 143% increase year on year, from 37,000 hits in 1998-99 to nearly 90,000 this year – highlights its increasing importance as a way of communicating.
Open Government
We answered all six requests for information under the Open Government Code of Practice on Access to Government Information within the target time. The library houses and maintains the Director's Register, which is available for public consultation. We levy a small charge for copies of extracts. Determinations made by the Director under the Water Industry Act 1991 are also available for inspection.
The Freedom of Information Bill
This Bill was introduced into the House of Commons on 18 November 1999. It gave effect to the Government's commitment to open government, following public consultation on a draft Bill.
Library and information services
The library is the Public Enquiry Unit and our publication sales and distribution point. This year we answered 14,000 enquiries and issued around 28,500 publications.
Ofwat's public enquiry unit can be contacted via
e-mail at enquiries@ofwat.gsi.gov.uk
Conferences and seminars
Senior staff, including the Director, accepted invitations from various conference organisers and organisations to speak at conferences and seminars. Staff also attended seminars, workshops and lectures covering a broad range of topics. | 
Annual reports
