Forthcoming changes to new connection charges
The Water Act of 2014 allows Ofwat to set charging rules for new connections services in England and Wales. In December 2017, the Welsh Government issued charging guidance to Ofwat which included guidance on setting these rules. Using this guidance, we are now in the process of consulting on options for setting rules for new connection services for water companies whose areas are wholly or mainly in Wales.
Further information about the development of these new charges, which will include public consultation will be published on our website in due course.
Current new connection charges for Welsh undertakers
The Water Industry Act 1991 (WIA91) gives Ofwat a duty to make determinations on certain new connections disputes. These determinations largely relate to the level of charges and the terms and conditions of agreements made between a monopoly company and their customer.
Sections 42-43A and 99-100A of the WIA91 set out the method for calculating the requisition charge a monopoly company can recover from a customer when it provides a new water main, public sewer or lateral drain.
Section 51C sets out the method for calculating the asset payment a monopoly company will pay to a developer or self-lay provider (SLP) when a water main is self-laid and later adopted by the monopoly company. Asset payments are only paid for self-laid water mains – no asset payment is paid to the constructor of self-laid sewers, service connections or lateral drains.
Both of these calculation methods are based on what are considered to be the ‘costs reasonably incurred’ in providing the infrastructure.
Also, under sections 45, 47 and 51C of the WIA91 the charges monopoly companies can recover the costs or expenses reasonably incurred by the monopoly company when they provide:
- service connections
- works to enable the adoption of self-laid water mains.
Disputes arise about both the level of costs and the range of the cost items considered to be ‘costs reasonably incurred’. The most common areas of dispute referred to us include where:
- administration and overhead costs are included alongside the physical construction costs of materials and labour
- off-site works, to provide new infrastructure or reinforce existing infrastructure beyond those directly requisitioned or self-laid by a developer, are required to enable the requisitioned or self-laid infrastructure
- the infrastructure provided includes additional capacity beyond that required by the person requesting the new connection
- the income offset provided for in the calculation of a requisition charge or asset payment has not been offset against the costs incurred in providing off-site works or capacity, or is offset twice or separately for on-site and off-site works
- a water or sewerage company has recovered contributions towards off-site works through its requisition or self-lay charges as well as recovering infrastructure charges for each property newly connected to its network. Infrastructure charges are permitted by section 146(2) of the WIA91 and condition C of monopoly companies’ licences.
We investigate disputes on a case-by-case basis. We consider:
- the legal framework of the WIA91
- the evidence provided to us by the parties to the dispute
Given that we do investigate disputes on a case-by-case basis, there may be justifiable grounds for moving away from our general expectations in light of the facts of an individual case.
However, we have general expectations on each of the issues set out above that represent our starting point when considering disputes. We set these out below.
Administration and overhead costs
We recognise that when monopoly companies or SLOs provide new infrastructure, their costs are not limited to materials and labour. They also incur ‘non-construction costs’ for the administration of the services they provide. We consider:
- that costs reasonably incurred are likely to include some administration and overhead costs
- that these non-construction costs should be permitted where they are reasonably incurred and can be directly attributed to the provision of the infrastructure (‘direct on-costs’)
In 2014 we published an independent review of the overhead costs and administration fees for new water supply connections, which we use to inform our consideration of such costs when determining section 45 disputes arising from monopoly companies providing service connections.
Off-site works
Off-site works is a term used for works a monopoly company provides beyond those directly requisitioned by or self-laid by a developer. These are often works on the existing water or sewerage network, outside the boundary of the development site that is subject to a requisition or self-lay agreement.
For water mains and public sewers requisitions sections 43 and 100 of the WIA91 detail what can legally be included as part of the ‘costs reasonably incurred’ for the purposes of calculating the requisition charge a monopoly company can recover:
- Sections 43(2) and 100(2) state that these costs should not include costs incurred in the provision of additional capacity beyond the requirement of the requisition.
- Sections 43(4)(a) and 100(4)(a) state that the costs can include the costs of providing other infrastructure that it is necessary to provide in consequence of the new main/sewer. For water mains this other infrastructure can include other water mains, tanks, service reservoirs and pumping stations. For public sewers this other infrastructure can include other public sewers and pumping stations.
- Sections 43(4)(b) and 100(4)(b) state that the costs can include a proportion of the costs incurred in providing additional capacity in a requisitioned earlier main/sewer (provided in the 12 years preceding the new main/sewer) which falls to be used in consequence of the new main/sewer. So, we consider that where they are considered necessary to provide in consequence and reasonably incurred, the WIA91 provides for a monopoly company to include the costs of off-site works in their calculation of requisition and self-lay charges. Unlike the provisions for water infrastructure, the WIA91 provisions for off-site works when a public sewer is requisitioned are not mirrored when sewers are self-laid. This means that when a customer decides to self-lay their on-site sewers and exercise their right under section 106 to communicate with an existing public sewer, there is no legal mechanism within the WIA91 for monopoly companies to require a customer to contribute towards the costs of any off-site works that the monopoly company considers necessary to provide in consequence of the new connection. This again reinforces who monopoly companies should be engaging in timely conversations with their new connections customers and planning authorities to ensure the monopoly companies have planned and invested for these types of connections.
- Section 51C(8) requires that these same costs be included in the calculation of the asset payment for self-laid mains.
Section 51C(3) of the WIA91 sets out the costs a monopoly company can recover when it provides off-site works that are considered necessary to provide in consequence of self-laid water mains. This section cross-refers back to sections 43(4)(a) and (b), enabling the monopoly company to recover the costs of these specific off-site works as though under a requisition, as set out above.
Apportionment of additional capacity
Where infrastructure is provided solely to meet the requisition or self-lay requirement, we would not expect there to be a need to split (‘apportion’) the costs of providing it for the purposes of calculating charges. Our consideration of the reasonableness of the charge would focus on the level of the entirety of the costs.
But, where the infrastructure provided will also serve existing customers and/or potential future development(s), we would expect the costs reasonably incurred to be apportioned between the relevant customers. The WIA91 does not set out how costs should be apportioned except as previously mentioned under sections 43(2) and 100 (2); and 43(4)(a) and (b) and 100(4)(a) and (b).
In the majority of cases where this is an issue we consider it is most appropriate to apportion costs on the basis of the percentage of the total capacity provided that is used by the customer.
We consider that this approach:
- provides greater transparency for customers
- apportions both the costs and risks of providing additional capacity reasonably between monopoly companies and customers
This approach also helps to avoid situations in which a customer is charged on the basis of the notional costs a monopoly company might have incurred had it solely provided infrastructure to meet their need. For example:
- where a customer is the first to trigger the need for network reinforcement works, or
- where a monopoly company decides to provide more capacity than requested by the customer in order to serve other customers
It is our view that charging on the basis of the notional costs a monopoly might have incurred:
- is not sufficiently transparent for customers
- risks over recovery of the costs actually incurred
A notional costs approach also risks deterring development and distorting competition between new connections customers. This is because a new connections customer may have to:
- bear the risk of triggering a monopoly company’s decision to provide network reinforcement works or additional capacity
- face higher charges than other customers who will ultimately share the same infrastructure.
Our preferred approach again highlights the importance of monopoly companies working constructively with new connections customers and local planning authorities to understand and enable new developments.
Income offset
Sections 42-43A, 99-100A and 51C of the WIA91 set out the methods for calculating requisition charges and asset payments. They allow for the income that will be generated from the new properties being connected to the water or sewerage network as a result of the new water mains or public sewer to be offset against the costs reasonably incurred in providing that infrastructure.
In line with sections 43(4)(a) and (b) and 100(4)(a) and (b) of the WIA91, this income offset can only be applied:
- once, and
- against off-site costs where these are included alongside on-site costs as part of the total costs reasonably incurred. This is because these off-site costs are only permitted to be part of what are ‘costs reasonably incurred’ where they are necessary as a result of the on-site works.
It is important to note that the WIA91 does not provide for the income offset to be applied twice or separately for the on-site and off-site works.
Infrastructure charges
Infrastructure charges were originally established to enable companies to invest in general improvements in their existing network needed to meet increasing demand from new customers. Charged separately for water and sewerage services, they are payable when connecting a property to a public water supply or a public sewer for the first time for domestic purposes.
Monopoly companies are entitled to charge infrastructure charges under section 146(2) of the WIA91. Condition C of their licence sets out how the charges are calculated. This is based on a standard charge that rises annually with inflation.
Disputes often arise when a monopoly company both:
- seeks to recover an infrastructure charge, and
- includes the costs of off-site works in their calculation of requisition or self-lay charges and payments. Section 146(2) is separate and independent from the WIA91’s provisions for charging for requisitions and self-lay. Legally there is no interaction between these sections. As a result companies are legally entitled to raise charges under both provisions when connecting a property to their network(s) for the first time. In contrast, only the costs of those off-site works that are considered necessary to provide in consequence of a requisitioned mains or sewer or a self-laid main can be included in the calculation of requisition or self-lay charges and payments. So, these costs are directly attributable to the newly connected property against which they have been raised.
Monopoly companies can legitimately use the money recovered from both charging provisions to fund network reinforcement works. But these funding routes are distinct.
As a standard charge, infrastructure charges do not relate directly to the actual costs of a specific scheme of works. Instead they become a source of general funding monopoly companies can use to improve and develop their networks so they can meet general increases in demand. Therefore works funded by infrastructure charges may not occur at the same point either geographically or in time as the newly connected property against which they have been raised.
Some customers consider that this means they are paying twice for network reinforcement works arising from their connection. However there is a clear distinction and the two charges should not overlap.
Requisition or self-lay charges may only be used to recover the costs of particular off-site works that are considered necessary to provide in consequence of on-site works. They must not be used to fund other network works that are not considered to be directly attributable to the development site they are being raised against.
Infrastructure charges may be used for other network reinforcement works within the monopoly company’s area of appointment as and when they arise as a result of general increases in demand.
Monopoly companies should be working closely with their new connections customers to:
- make sure they understand the make-up of and rationale for the charges they are being asked to pay; and
- minimise confusion or frustration in relation to their charges.