RD 16/02

TO ALL REGULATORY DIRECTORS OF ALL
WATER AND SEWERAGE COMPANIES
AND WATER ONLY COMPANIES                                                                

9 May 2002

 INTERMEDIATE USER TARIFFS: CONCLUSIONS

In September 2001 we published RD 15/01, a letter on intermediate user tariffs for customers consuming less than 50 Ml/a. It set out and sought views on our proposed policy position on these tariffs. We are grateful for the responses we have received. This letter reports our conclusions. We expect companies to take these into account in preparing their charges schemes for 2003-04.

We have organised our conclusions to correspond with the questions on which we consulted.

Is there any compelling evidence that intermediate user tariffs justified on differential peaking characteristics should not be structured on a seasonal basis?

We consider that intermediate user tariffs can be justified on the basis that these customers' demands are typically less variable than household demands over the year. It is less costly to supply such customers. We have argued that tariffs justified in this way should be structured on a seasonal basis. Few respondents disagreed, and we received no compelling evidence against a seasonal structure. When so justified we will therefore require companies to structure intermediate user tariffs on a seasonal basis. These tariffs can be justified only on the basis that they will be compulsory for all intermediate users.

Companies will need to consider how their intermediate user tariffs will interact with their large user tariffs. In particular, if intermediate user tariffs are seasonal and large user tariffs are not, customers close to the large user threshold may have an incentive to increase their consumption artificially.

Where intermediate user tariffs are based only on other cost drivers (see below) then we accept that companies should not have to structure them on a seasonal basis. However, we would not object if companies wanted to seasonalise these tariffs nevertheless.

 We note that companies that wish to signal to customers the costs of dealing with seasonal peaks in demand should do more than introduce seasonal intermediate user tariffs. Household customers who use significant quantities of water for non-domestic purposes are the most significant drivers of peak demands. Such companies should therefore be requiring customers who make high discretionary use of water for non-domestic purposes, such as sprinkler users, to be metered. These companies should also be keeping under review the economics of seasonal tariffs for household customers.

Do you agree with the general cost allocation rules outlined in RD 15/01?

In RD 15/01 we suggested a set of cost allocation rules that companies could use to estimate an appropriate differential between intermediate user tariffs and household tariffs.

Some companies have said that they should not have to follow these rules rigidly. We agree. The rules might better be described as guidelines. We will use them as a reference point when assessing companies' proposals. Our responses to some of the detailed comments we received are as follows.

• Some companies commented that intermediate users do not use the smallest parts of the local distribution system and that intermediate user tariffs may be justified on this basis. As we said in RD15/01, we will not object to such tariffs where companies can provide good supporting cost evidence. Our analysis has, however, shown that this cost driver can only justify small tariff differentials.
• Two companies argued that, unlike households, non-households do not always benefit from either supply pipe leakage allowances or a free supply pipe leakage service. They argued that it is appropriate to offer a reduced tariff on this basis. We agree, but we expect that companies would only be able to justify a small reduction.
• Two companies argued that it was appropriate to offer a lower price to intermediate users on the grounds that customer-related costs are lower for them than for households. We think that companies should recover customer-related costs through the household and non-household standing charge respectively. We think that it is inappropriate for companies to set different volumetric rates on this basis.

We will judge intermediate user discounts by reference to the difference between the average price paid by an intermediate user with steady monthly consumption and the volumetric rate for households. On this basis we think that the tariff reductions companies may be able to justify for intermediate users will typically be around 5% and will only exceptionally be above 10%.

Most companies agreed with our view. One company argued that discounts should typically be lower than we suggested. However, some respondents said that we should look at individual proposals on their merits. We agree. Where necessary we will ask reporters to challenge companies' cost justifications.

Some companies currently have an intermediate user differential of more than 10%. We will ask them to provide us with updated cost justifications for these.

Is there any compelling evidence to support the introduction of intermediate user tariffs for customers consuming less than 10 Ml/a?

Some respondents thought that it would be difficult to justify intermediate user tariffs for customers using less than 10Ml/a. Others disagreed, arguing that the unit costs of supplying these customers are similar to the unit costs of supplying customers taking 10Ml/a or more.

Where intermediate user tariffs are justified on the basis of peaking characteristics, we will not object if companies wish to offer them to customers consuming less then 10Ml/a. Since such tariffs will have to be seasonalised, these customers will only benefit if their demand characteristics are such that the unit costs of supplying them are similar to the unit costs of supplying customers taking 10Ml/a or more.

Where intermediate user tariffs are justified on other grounds, we will not object provided that companies can provide a robust cost justification.

Paul Hope
Head of Tariffs