Regulating the water industry: Swimming against the tide or going through the motions?

Ecologist

Volumn 27, Issue 1, 1997, Pages 6-13

  Schofield, Richard ^a   Shaoul, Jean ^b  

^a UNIVERSITY OF BOLTON   (United Kingdom)

^b UNIVERSITY OF MANCHESTER   (United Kingdom)

Author keywords

[No Author keywords available]

Indexed keywords

INDUSTRIAL REGULATION; INFRASTRUCTURAL INVESTMENT; INVESTMENT FAILURE; PRIVATISATION; REGULATION; WATER INDUSTRY; WATER RESOURCE MANAGEMENT;

UK;

EID: 0030741610     PISSN: 02613131     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (49)

1. These ten companies are Anglian Water, Northumbrian Water, North West Water, Severn Trent Water, Southern Water, South West Water, Thames Water, Welsh Water, Wessex Water and Yorkshire Water. Britain's water industry comprises these ten companies and the already privately-owned Statutory Water Only Companies (reduced in number via takeovers and mergers from 29 to 19 as of April 1996). This article considers the ten water and sewerage companies only and excludes the water only companies.
2. Department of the Environment, "Privatisation of the Water Authorities in England and Wales", Cmnd 9734, HMSO, London, p.13.
3. The head of OFWAT is lan Byatt. A Drinking Water Inspectorate was set up to monitor the quality of drinking water, while environmental regulation and implementation of EU directives went to the National Rivers Authority (part of the Environment Agency since April 1996). The NRA assumed overall management and resource planning of the water environment; to a large extent, this determines how much the privatized water companies have had to invest in, for example, the management of urban waste water and the clean-up of coastal waters.
4. OFWAT, "Future Charges for Water and Sewerage Services", Report, Birmingham, 1994.
5. OFWAT, "Issues involved in Regulation of Privatised Water Utilities", Speech by Alan Booker, Deputy Director General, OFWAT, to the Institute for International Research, Malaysia, "Financing Water Utilities Symposium", 1992.
6. The formula devised for British Telecom and used in the other privatized utilities, See Littlechild, S., "Regulation of British Telecom's Profitability", report to the Secretary of State, Department of Trade and Industry, HMSO, London, 1983; Littlechild, S., "Economic Regulation of Privatised Water Authorities", Department of the Environment, HMSO, London, 1986.
7. The formula devised for British Telecom and used in the other privatized utilities, See Littlechild, S., "Regulation of British Telecom's Profitability", report to the Secretary of State, Department of Trade and Industry, HMSO, London, 1983; Littlechild, S., "Economic Regulation of Privatised Water Authorities", Department of the Environment, HMSO, London, 1986.
8. The other privatized and regulated utilities had been required to reduce their prices in real terms, whereas the regulatory mechanism for the water industry provided for rising real prices so as to provide the finances to comply with EC legislation mandating higher water quality and waste water treatment standards. It was estimated in the 1980s that more than £28 billion needed to be invested to compensate for years of neglect and underinvestment and to meet rising public health standards. This estimate was revised upwards in 1990 and additional investment required. The European obligations would have made the privatization unattractive to potential buyers unless they could be recouped by price rises. See OFWAT. Annual Report 1990, Birmingham, 1990; OFWAT, "1992-93 Report on the Capital Investment and Financial Performance of the Water Companies in England and Wales", Birmingham, 1993; OFWAT, op. cit. 4.
9. The other privatized and regulated utilities had been required to reduce their prices in real terms, whereas the regulatory mechanism for the water industry provided for rising real prices so as to provide the finances to comply with EC legislation mandating higher water quality and waste water treatment standards. It was estimated in the 1980s that more than £28 billion needed to be invested to compensate for years of neglect and underinvestment and to meet rising public health standards. This estimate was revised upwards in 1990 and additional investment required. The European obligations would have made the privatization unattractive to potential buyers unless they could be recouped by price rises. See OFWAT. Annual Report 1990, Birmingham, 1990; OFWAT, "1992-93 Report on the Capital Investment and Financial Performance of the Water Companies in England and Wales", Birmingham, 1993; OFWAT, op. cit. 4.
10. The other privatized and regulated utilities had been required to reduce their prices in real terms, whereas the regulatory mechanism for the water industry provided for rising real prices so as to provide the finances to comply with EC legislation mandating higher water quality and waste water treatment standards. It was estimated in the 1980s that more than £28 billion needed to be invested to compensate for years of neglect and underinvestment and to meet rising public health standards. This estimate was revised upwards in 1990 and additional investment required. The European obligations would have made the privatization unattractive to potential buyers unless they could be recouped by price rises. See OFWAT. Annual Report 1990, Birmingham, 1990; OFWAT, "1992-93 Report on the Capital Investment and Financial Performance of the Water Companies in England and Wales", Birmingham, 1993; OFWAT, op. cit. 4.
11. In 1990, OFWAT costed this investment for all the water companies in England and Wales up to the year 2000 at £30.5 billion at 1990-91 prices. For the five years 1995-2000, the 1990 projections estimated that the programme of improved standards and maintenance projects would cost £14.3 billion. In 1994, these were scaled down by one billion pounds despite inflation rising at about three per cent per year. The 1994 estimates did include another £11 billion for the Urban Waste Water Treatment and Disposal programme and other EC requirements not included in the earlier projections. See OFWAT,. op. cit. 4. In addition to the drop in projected investment costs, actual expenditure has fallen as well. Investment between April 1989 and March 1995 totalled £11.360 billion, but cost the companies considerably less because such investment qualified for tax allowances. The projected gross expenditure for 1990-1993 (at 1990-91 prices) was £9.946 billion for all the companies, but the actual net cash spend was £9.2 billion, a considerable shortfall in real terms. See OFWAT 1990, op. cit. 7.
12. The local authority obtained a reversal of this definition via a Judicial Review.
13. OFWAT, "1991-92 Report on Capital Investment and Financial Performance of the Water Companies in England and 'Wales", Birmingham, 1992, p.4. Since 1992, OFWAT has provided data about the actual and expected expenditure levels for each of the companies on water, sewerage and both services together. See OFWAT, op. cit. 4; OFWAT, "1994-95 Report on the Financial Performance and Capital Investment of the Water Companies in England and Wales", Birmingham, 1995.
14. OFWAT, "1991-92 Report on Capital Investment and Financial Performance of the Water Companies in England and 'Wales", Birmingham, 1992, p.4. Since 1992, OFWAT has provided data about the actual and expected expenditure levels for each of the companies on water, sewerage and both services together. See OFWAT, op. cit. 4; OFWAT, "1994-95 Report on the Financial Performance and Capital Investment of the Water Companies in England and Wales", Birmingham, 1995.
15. OFWAT, "1991-92 Report on Capital Investment and Financial Performance of the Water Companies in England and 'Wales", Birmingham, 1992, p.4. Since 1992, OFWAT has provided data about the actual and expected expenditure levels for each of the companies on water, sewerage and both services together. See OFWAT, op. cit. 4; OFWAT, "1994-95 Report on the Financial Performance and Capital Investment of the Water Companies in England and Wales", Birmingham, 1995.
16. There are indications that, contrary to most major capital expenditure programmes, for instance, the Channel Tunnel between Britain and France, capital investment in the water and sewerage industry turned out to be less expensive than expected. But the companies were not investing in uncharted waters; the total projected spend was for numerous relatively small-scale projects whose technologies and costs were well-known. It should not have been difficult to specify or cost the investment programme accurately. The plans were never made public, nor the extent to which the original plans were adequate to meet statutory obligations and wider public health requirements. See OFWAT, op. cit. 10.
17. The regulator, in part at least as a result of the public outcry over the rising water prices, reviewed prices at the end of the first five years, instead of allowing the price formula to stand for the 10 years as intended. The first Periodic Review in July 1994 set an average price increase of inflation, as measured by the Retail Price Index, plus 2 per cent. OFWAT did not claw back to any significant degree any of the profits via the price formula either during or at the end of the initial five-year period. See OFWAT, op. cit. 4.
18. Any expenditure on overground assets or on increasing the capacity of the underground network is classified as investment on additional assets and depreciated annually. Any expenditure on maintaining the underground network is classified as "renewals"; the water companies average the anticipated cost of maintenance over a certain period and charge it as an annual operating expense. Thus "renewals" is not an accurate reflection of actual expenditure in any one year, although the-over and underspend should balance out at the end of the specified term. As part of its 1989 asset management plan, each company estimated how much it needed to spend on maintenance over the following five years (this period has been changed without explanation to 15 years) and then allocated a proportion of this each year.
19. OFWAT, op. cit. 4, p.37.
20. OFWAT, op. cit. 10, p.43.
21. The total cash generated by the water companies since privatization was more than the total expenditure on investment and provision for infrastructure maintenance. In other words, the companies could have covered their investment expenditure from revenues if they had not had to satisfy the demands imposed by private ownership for dividends and future dividend growth. Instead, investment has been increasingly financed by loans. Some parent companies are recycling cash generated by the water companies back to the companies in the form of interest-bearing loans, thereby earning interest from the core businesses but at the same time increasing their costs. See OFWAT, "1993-94 Report on the Financial Performance and Capital Investment of the Water Companies in England and Wales", Birmingham, 1994.
22. OFWAT, op. cit. 10.
23. Ibid., p.46.
24. Ibid., p.46.
25. OFWAT, op. cit. 4, p.43.
26. OFWAT, "Leakage of Water in England and Wales", Report, Birmingham, 1996.
27. The information which it collects as part of the annual July return was made available for the first time at the end of 1996. See OFWAT, "Format for the July Return, Regulatory Accounts and Information from Quality Regulators from 1996", Birmingham, 1996.
28. Uff, J., "Water Supply in Yorkshire", Report of the Independent Commission of Inquiry, Tourcrete Ltd, London, 1996.
29. Some of this information is provided by OFWAT in its reports on the levels of service and the financial performance and capital investment. Other information is provided by the Drinking Water Inspectorate and the Water Services Association, the companies' trade association.
30. The status of these levels of service indicators and targets is far from clear. While at least one company has argued that they are obligations flowing from the statutory duties imposed on the companies, the regulator has variously interpreted them to be free-standing indicators of performance; criteria of satisfactory performance to be used as the basis for rewards or penalties during the five-year Price Review; and indices which determine how much extra maintenance expenditure needs to be allowed for in the next Price Review. See OFWAT, op. cit. 4; Monopoly and Mergers Commission, "South West Water Services Ltd", A Report on the Determination of Adjustment Factors and Infrastructure Charges for South West Water Ltd, HMSO, London, 1995.
31. The status of these levels of service indicators and targets is far from clear. While at least one company has argued that they are obligations flowing from the statutory duties imposed on the companies, the regulator has variously interpreted them to be free-standing indicators of performance; criteria of satisfactory performance to be used as the basis for rewards or penalties during the five-year Price Review; and indices which determine how much extra maintenance expenditure needs to be allowed for in the next Price Review. See OFWAT, op. cit. 4; Monopoly and Mergers Commission, "South West Water Services Ltd", A Report on the Determination of Adjustment Factors and Infrastructure Charges for South West Water Ltd, HMSO, London, 1995.
32. OFWAT, "1994-95 Report on the Levels of Service of the Water Companies in England and Wales", Birmingham, 1995, p.40.
33. The number of drought orders obtained by the water and sewerage companies has declined since 1989 because rainfall during the summers in the early 1990s was relatively high. The information on water shortages was obtained from the Water Services Association. It was published by OFWAT in this form in 1992 only, a good year. OFWAT did, however, publish information on water use restrictions on a national basis, but in such a format that does not permit evaluation of company performance over time.
34. OFWAT, op. cit. 26, p.20.
35. OFWAT, "Levels of Service Report for the Water Industry of England and Wales 1993-94", Birmingham, 1994. In 1994-95, Yorkshire did achieve its target but was still the worst performer.
36. OFWAT, op. cit. 26, p.4. Some of the service standards are directly enforceable by customers via the Guaranteed Standards Scheme (GSS), introduced under statutory regulation Water Supply and Sewerage Services (Customer Service Standards), amended in 1993. The GSS allows customers to claim compensation in the event of a water company failing to: keep an appointment; respond within 20 days to an account query or complaint; install a meter after payment; give notice of a planned supply interruption or failing to restore the supply within specified period; restore supply within 24 hours after an unplanned interruption; or sewer flooding. As the 1996 independent enquiry into Yorkshire Water remarked, there is no right to compensation, either as a guaranteed standard or as a legal right, for interruptions to water supply, even if the interruption amounts to a breach of the company's licence condition. See Uff, J., op. cit. 23.
37. OFWAT, op. cit. 26, p.4. Some of the service standards are directly enforceable by customers via the Guaranteed Standards Scheme (GSS), introduced under statutory regulation Water Supply and Sewerage Services (Customer Service Standards), amended in 1993. The GSS allows customers to claim compensation in the event of a water company failing to: keep an appointment; respond within 20 days to an account query or complaint; install a meter after payment; give notice of a planned supply interruption or failing to restore the supply within specified period; restore supply within 24 hours after an unplanned interruption; or sewer flooding. As the 1996 independent enquiry into Yorkshire Water remarked, there is no right to compensation, either as a guaranteed standard or as a legal right, for interruptions to water supply, even if the interruption amounts to a breach of the company's licence condition. See Uff, J., op. cit. 23.
38. OFWAT, op. cit. 26.
39. The regulator has announced that in future he intends to measure investment by outputs. See OFWAT, op. cit. 10.
40. Ibid.
41. OFWAT, op. cit. 26, p.32.
42. Ibid., p.32.
43. This seems to be because the NRA is unwilling to prosecute rather than any inability to obtain convictions in the courts. Failure to prosecute means that there are no effective sanctions against the companies which therefore have no reason to improve.
44. OFWAT's main methods of monitoring the water companies' compliance with their duty to maintain an efficient and economical system of water supply sufficient for domestic purposes are system performance measures, levels of service indicators, and quality indicators. If performance against these measures is sufficiently poor to constitute breach of the water companies' duties, it could result in statutory enforcement proceedings. Domestic purposes is defined as "water supplied on any premises for drinking, washing, cooking, central heating and sanitation. In relation to houses, it also includes water used for garden watering and car washing, but only if the water is drawn from a tap inside the house without using a hosepipe or similar device". Similar duties exist in relation to the sewerage service.
45. OFWAT, op. cit. 21, p.2.
46. OFWAT, "Report on the Conclusions From OFWAT's Enquiry into the Performance of Yorkshire Water Services Ltd", Birmingham, 1996, p.1.
47. Ibid., p.3.
48. As OFWAT stated, "Those who bought the original shares and retained them up to March 1994 would have made an annual return of between 25 and 34 per cent in real terms after the payment of income tax at the standard rate." The average return on the ten water companies and the FTSE 100 index for the period since privatisation was 94 per cent and 35 per cent respectively. Water shares outperformed the market by nearly 300 per cent. The regulator drew no conclusions from the fact that shareholders had earned an above average return on their original investment. See OFWAT, op. cit. 4, p.38.
49. OFWAT, "Mandatory Leakage Targets Will Mean Higher Customer Bills Says OFWAT", News Release, Birmingham, 31 October 1995.