Official Report 456KB pdf
We will now hear evidence from the Water Industry Commission for Scotland on its annual report and accounts for 2010-11 and related matters. I welcome our witnesses: Professor Gordon Hughes, who is the chairman of the commission, and Alan Sutherland, who is its chief executive. Gentlemen, I invite you to make a brief opening statement.
Thank you. Like you, I am new to this in that I became chairman of the WICS in July so, in part, we will be talking about matters from before I took over. However, I repeat Ronnie Mercer’s offer that, if there are matters of interest in relation to the proposed new water bill, the committee should feel free to contact and consult us if that would be helpful. I am afraid that we have nothing as exciting as a waste water treatment plant to show you—although we do have some new offices—but we would like to be of as much assistance as possible.
Is Scottish Water on track to meet the ministerial objectives that were set out for the 2010 to 2015 control period?
Scottish Water is making more progress on the various targets that have been set for it than had been expected over the regulatory period, so we think that it is on track. We hope that it will continue to outperform the targets as the regulatory period continues.
That is encouraging, although the picture is perhaps not quite the same as the one that we got in the earlier witness session.
We will seek to do exactly the same as we have done in the past, which is to get the best deal possible for customers in Scotland. How we seek to do that has evolved. We are trying to get away from the process whereby Scottish Water submits a business plan that is, in essence, a bid for resources, and we end up cutting away at that bid to get to something that we consider reasonable. We are trying to do that by ensuring that, in advance of Scottish Water even beginning to write a business plan, we have agreed the key parameters, such as the sorts of returns that it can expect and reasonable operating cost levels. We will also have much more involvement from customers in responding to that business plan, to which end we have been working with Consumer Focus Scotland and Scottish Water to set up a customer forum, which will bring together the non-household and household interests to challenge Scottish Water directly to deliver what is most important to the customer. That will make Scottish Water much more directly accountable to customer representatives than it has been in the past.
I have two further points. In giving evidence to the committee earlier this year, Mr Neil said that he had not yet been in touch with the WICS to discuss the Scottish Government’s future objectives for the next regulatory period. That is still the case. We expect to have discussions with the Scottish Government during the next few months. Until those objectives are defined, the extent to which resources and other things are required is a little bit hard to predict, because it will depend on what those objectives are.
Do we make comparisons only with English water companies? Are they the gold standard, or are there international comparators that might offer a better standard to their customers?
I have specialised in doing international comparisons. We do not restrict our comparisons to the English water companies. Indeed, that becomes more difficult over time as the nature of the information that is collected and the nature of the business change gradually. On the other hand, the fact of the matter is that conditions are national. There are differences in the access to capital and in the way in which regulatory and other systems operate in different parts of the world, so comparisons with other comparators are different from those with the English water companies. However, we have made and can make comparisons with other parts of Europe, with Australia and with some other parts of the world.
Where, internationally, are the good water systems?
If you want something that is excellent but very expensive, the answer is Japan, perhaps followed by Germany. On the other hand, if you want a different balance between the use of resources and costs, parts of the United States are relevant and the UK does not do badly. Some countries put a tremendously high premium on having low levels of leakage, but that is expensive and the resulting water is expensive.
I suppose that it depends on how much of the resource countries have available in the first place.
Yes, and how they choose to maintain or replace their capital.
I think that I saw you gentlemen sitting in the public gallery when we took evidence from the previous panel of witnesses. Perhaps you heard a bit of our exchange with Scottish Water about the provision of water to business customers and about Business Stream in particular. I want to explore that matter with you.
When we introduced and worked on the system from the passage of the Water Services etc (Scotland) Act 2005, we were clear that the sign of success or otherwise should not be the number of customers who switched but the number of customers who were better off. We should not have to force someone to switch to get them to a better deal.
I am trying to get my head round what more a customer could need from a bill to meet their needs than a normal bill provides.
Let me give you a very simple example.
Please do—the simpler, the better.
If I send one bill to a business, it must spend a certain amount of time and effort processing that one bill. If I send it two bills, it has to process two bills. If the business is Asda or Tesco and it gets four water bills a year for each store, four sewerage bills a year for each store and maybe separate bills for surface drainage as well, and each store has two meter points, which means that everything is doubled again, it must process every one of those bills. One of the leading supermarkets is on record as saying that it saves £80,000 a year in administration costs because it gets only one bill for Scotland. That is quite a big deal. It would have to sell a lot of pints of milk to make £80,000 profit. Creating pressure in the system for people to do things differently leads to that sort of outcome. Surely we would all welcome that—otherwise, the price of milk goes up.
Scottish Water said that it has non-residential customers who were surprised by the size of their bills when they switched to using a meter. One of the things that Scottish Water can do, through Business Stream, is change the nature of the meter, give customers advice and help in order to save on their water consumption, track down water leaks and so forth. It is quite common around the world for utilities to have an interest in helping their customers make better use of their services, in order to keep the customers’ good will and retain their interest, which may be more important than just having the lowest price on offer. It is about bundling a variety of services that go beyond purely the delivery and billing of water.
I will give another example. Procurement Scotland launched a tender for the entire public sector in Scotland, which makes up more than 20 per cent of the non-household demand in the country. For the tender, 35 per cent of the weighting was on price and 65 per cent was on value-added services such as more efficient billing, help to detect leaks, the identification of consumption variations that can be dealt with and benchmarking across different parts in order to identify premises that are water efficient or inefficient. There is a lot of value in that process. To be honest, I think that it is something that we were not terribly good at. However, now that Business Stream is exposed to the opportunity for its customers to choose, suddenly the kind of thing that I have described is happening. At the same time, Business Stream’s costs are coming down.
How realistic a choice is it? What other players are out there? What are you doing to encourage more players?
There are two subsidiary companies of English and Welsh water and sewerage companies: Anglian Water, which is trading through a subsidiary by the name of Osprey Water; and Wessex Water. There are two other much smaller entrants into the market: Imera and Satec, which are both quite active. Some familiar household names, such as Belhaven, Ladbrokes, Debenhams and Gap, have switched suppliers. Others, such as Tesco, Asda and Marks and Spencer, have chosen not to do that but have completely different service levels. As I said earlier, no one should have to switch in order to get a better service. The fact is that they should get the best of service. Competition is not an end in itself but only a means to an end.
Is there any concern that Business Stream is misusing its position as the dominant supplier?
Not at the moment. The level of switching might be rather more of a concern if we came back in two or three years and still found that only 2 per cent of the market was in the hands of companies other than the dominant supplier as a result of competition.
That would be a concern because that contradicts what I just heard about—
No, no. This is a process by which, to begin with, there are rather large pressures on Business Stream to improve its performance. If the level of switching remained low over a significant period into the future, we would be worried that Business Stream might become too comfortable and would not feel under significant threat of losing business. We would then have to ask ourselves whether competition was delivering all that it possibly could. There has been a similar opening up of the markets in other places—in England and Wales and in other parts of the world—but it does not happen quickly.
How would Business Stream be placed to take advantage of its experience of a competitive environment in Scotland? Would it seek to move in south of the border?
Undoubtedly. I am sure that Business Stream would wish to do that. It feels that it has a large amount to gain from the market opening up in the rest of the UK. Given its experience and what it has learned, that would represent a large opportunity for it as a commercial retailer of water.
I will try to give you some colour on that. When Business Stream was first separated from Scottish Water, its cost level relative to its revenues was slightly better than the average for water and sewerage companies in England and Wales, but its service level was considered by its customers to be quite poor. The same customers would now say that Business Stream is among the best—if not the best—in Great Britain. At the same time, it has brought down its costs by more than £9 million a year, which is a percentage in the mid-20s. That would put Business Stream in second place in the costs league and in first or second place in the level-of-service league. By the time the market opens in England, it will also have at least five or six years of experience in working out the sort of packages that keep business and public sector customers happy, so it should be well placed and might be an example of a water business going forth from Scotland and doing rather well.
I have one other question on the subject. What do private suppliers to businesses have to pay to access the publicly owned water network? Do they have to pay anything?
Sorry—I do not understand the question, I am afraid.
If I set up a company to supply water to businesses, I would take advantage of publicly owned infrastructure. What would I have to pay to do that?
You would pay exactly the same as Business Stream pays—the wholesale charges for the water that you consume.
I was counting Business Stream as a private supplier.
Suppliers all pay the wholesale charges that are set at a macro level by us and that are set individually by Scottish Water and approved by us.
In its main business with respect to non-residential customers, Scottish Water is a wholesaler and provides water on identical terms to anyone who is a licensed supplier of water. They must have met the requirements for registering as a licensed supplier, but, once that is done, the process is anonymous and the pricing is the same for Business Stream as for any other licensed supplier.
Before it comes up, I emphasise that there is no question of risk in that. Those retailers pre-pay the wholesaler by 45 days down to 15 days and then they pay again in advance, so there is no credit risk to Scottish Water. The credit risk and the bad debt risk in the non-household sector are the responsibility of the retailer and a cost to the retailer.
Let us move on to funding issues. Sir Ian Byatt has expressed concerns about the financial environment and its effect on Scottish Water’s investment. In particular, he has flagged up the absence of borrowing this year. What impact could the decision on zero borrowing have on Scottish Water’s ability to meet its objectives? How do changes in borrowing influence the charging regimes that you recommend? I presume that they do.
As Scottish Water explained, our overall envelope was for £700 million of borrowing over the five-year regulatory period. As a result of the cash situation of the company in the past financial year, it felt that it would be able to do without borrowing for one year. However, the Scottish Government gave a commitment to make up the total amount over the full period of five years. At the moment, we have no reason to doubt the Government’s intention to do so. Were there to be any change, at that point some consideration would have to be given to which parts of the investment programme might be affected by the lack of resources. Ultimately, it is for the Scottish Government to decide whether it has the capital resources to continue to stick by the £700 million overall envelope.
At the moment, you do not share your predecessor’s concern about that.
I would share his concern if the money was not delivered. We are all aware that there is a great deal of pressure on public funding and that there has been particular pressure on capital budgets. Nevertheless, we cannot plan for something on which a decision has not been made.
Would you make up for any deficiency in borrowing simply by increasing charges?
I doubt it very much. No. The squeeze would have to come through reducing capital spending. There is an element in the capital spending programme that we refer to as unallocated spending, which is moneys that are required to meet a variety of environmental objectives that have not been precisely quantified. Two major examples are meeting the bathing waters directive—in respect of which studies are currently being carried out to see what would need to be spent where—and some relatively large plans for dealing with drainage and other problems in greater Glasgow. Those moneys have been nominally allocated to specific purposes, but they do not have the name of a particular project on them. Choices might have to be made between those possibilities for capital spending as well as in other areas.
Can you not foresee circumstances in which changes to the borrowing consents would influence the charging regime?
If the Scottish Government were to cut the level of borrowing and require exactly the same level of investment to be made, and if Scottish Water could not make extra efficiency savings to bridge the gap—in which case we would be talking about a serious number of millions of pounds—the only thing that could give would be a price factor.
Do you accept the need to meet objectives and targets as a given, and that you have to set your charges within that framework?
The 2005 act requires the commission to set the lowest reasonable overall cost for Scottish Water to meet the Government’s objectives for the industry. That must be done in line with the Government’s principles of charging—specifying what cross-subsidies there are in the system and who cross-subsidises whom, and that sort of thing.
It is not even remotely likely that, if the Scottish Government said that all the objectives remained the same, it would also say that there would be substantially less access to borrowing than was originally planned. The whole point of the regulatory process is to try to provide stability in the relationship between spending, charges and environmental objectives, which are all in a balance that I am sure the Scottish Government would not wish to disturb.
What percentage of the investment programme is mandatory under European Union regulations?
A large part of the programme is, in effect, mandatory—although there are a variety of timescales over which it has to be implemented. The overall programme is pretty much driven by EU environmental requirements of various kinds, and by the need for some service upgrades as well, which we regard as being of high priority.
What impact will increases in costs that are above the rate of inflation—especially in capital works—have on Scottish Water’s performance?
Inflation in capital works is tending to be very low at the moment. That is one of the ways in which more might be afforded than was once thought likely.
I think that Malcolm Chisholm’s question referred to charges being set for a control period. Can charges be reviewed?
Yes, they can.
What is the process for that?
There are two ways of reviewing charges. First, the Government has a right, at any point it chooses, to ask the commission to reassess the charges that should apply for a revised set of deliverables. Secondly, charges can be reviewed if either Scottish Water or the commission believes that there has been a material change. Scottish Water might come to us and say that it thinks that it does not have enough money because of X, Y and Z—in a different world, the rates bill might have been such an issue. On the other side, the commission may say that Scottish Water has access to too much resource and that customers need to get some back. The facility has never been used, but it could be.
Adam Ingram wants to ask some questions on targets.
No doubt the witnesses heard my exchange with Scottish Water on customer service. I asked a question about the OPA targets, specifically the ones that it had failed to achieve. I did not get a straight answer to that question, so could you help us out by telling us which OPA targets Scottish Water is failing to achieve?
I will try to help you. We give Scottish Water an overall target across a basket of indicators. We do not give it separate targets for individual indicators. We can tell you where it did a bit worse than last year, where it did better than last year and how it compares with some of the companies down south. We published that information in January and you referred to it. With any long-term business of the same type, it is almost inevitable that there will be fluctuations in performance. The good news is that the overall standards—we accept that they are overall standards and not individual customer experiences—are getting better.
It is not the regulator’s job to try to micromanage Scottish Water. That is why we give it an overall customer service target rather than a series of specific ones. We also give it a target over a period of time—the whole regulatory period—and it is up to Scottish Water to decide how it devotes its energy to achieving our overall target over the full five years.
Following on from that, I invite comments on Scottish Water’s performance on leakage reduction. Are the targets on that sufficiently robust? That area seems to be permanently dragging.
Customers and many of us rightly get exercised about leakage. It is fair to say that Scottish Water has made dramatic progress on that over the past four years or so. Leakage has come down by something in the order of 35 to 40 per cent over that period.
Yes, but it needed to.
Yes, it did. There is a concept of economic leakage, which one could never explain to any customer, so it is probably esoteric at best. The expectation is that we must get performance to levels that match those of the better companies in England, not only because of the wasted water but because of the carbon implications of that. There is still some way to go on that. Reductions of upwards of another 15 to 20 per cent could probably be justified as being worth paying for, but it depends on where customers want it to go. Customers would probably prefer no leakage that they can see.
Can I pick up on an important point? In answering a question from the convener, I referred to other parts of the world where there is better performance. I will tell a little story about a conversation that I had with the director of the water company for Yokohama, which is a very large city in Japan. I was told that the company had reduced leakage to 7 per cent but that the cost of doing that was so expensive that it could not afford to maintain it. It had reverted to regarding a leakage rate of 10 per cent as reasonable.
I have never been to Yokohama and I was not borrowing from that example. It is also important to say that I am not imposing the targets—they have not come from me. The targets are the ones that have been set, so they were obviously thought to be achievable. I appreciate that, as long as there is water aplenty, the argument about how far Scottish Water can afford to manage waste and leakage is perfectly legitimate. I am not arguing about the general principle as you have outlined it; I am referring to the targets that have been set, which were obviously thought to be ones that Scottish Water should be working to achieve.
Scottish Water is making substantial progress towards achieving those targets.
It has been meeting them each year.
So, you are pleased with the progress that is being made.
We are pleased with the progress, but we are not necessarily pleased with the current resting point that we are at on the journey to where we need to get to.
A 15 per cent reduction is half as much again, is it not, given the 30 per cent reduction that you said that you would like to see?
I was talking about a 30 per cent reduction from where Scottish Water currently is—there is a difference.
There is a fair way to go and it will take time; however, at the moment it seems that Scottish Water is on the path to meeting its targets. No doubt, in the next regulatory review period, we will look at whether those targets should be made tighter again.
Now that you have mentioned it, I will refer to it as the Yokohama standard. Where will Scottish Water ultimately be in relation to the Yokohama standard?
If you interpret it as being 7 per cent of the total water treated, that is the percentage of water that they treat in their plants that they cannot account for as having been delivered to customers. A figure of between 7 and 10 per cent is outstanding around the world; it is very unlikely that Scottish Water’s figure will fall much below 20 per cent.
So, we are only half as good as the Japanese.
It would be very expensive to go much below that.
Thank you. It helps to clarify all of that.
You will have heard our exchange with the previous panel about structures. What discussions have you had with Scottish Water, the Scottish Government and the Scottish Futures Trust—I do not know whether you have been involved with SFT—in relation to the forthcoming water bill and potential changes to the structure of Scottish Water?
There are two issues, which Scottish Water highlighted, the first of which is the internal organisation. We can think of Scottish Water becoming a holding company with a series of divisions that do different kinds of business, from Business Stream to the wholesale business and so forth. As I understand it, that is the main thrust of the change in the structure that is envisaged.
The briefing that the committee received before the meeting says:
You referred to our responsibility to promote competition in the non-residential sector. I prefaced my introduction by saying that I am new, but I have no cognisance of any significant discussion that has taken place in any way in the commission about promoting competition in the residential market. That seems to be something in relation to which we have no specific focus or concern at the moment.
I refer you to some of your organisation’s publications, then—
That is in the past. I can talk only for our position now.
Some of the publications are from the quite recent past. I am concerned that papers are circulating that are often difficult to find on the commission’s website or in annual reports. However, that is another matter.
With pleasure. Let us consider a water catchment area—a valley, basically. If there is intensive farming on the sides of the valley, pesticides can get into the watercourse, which must be taken out and treated if the water is ultimately to become drinking water. Indeed, the presence of pesticides could be the reason for a general environmental water-quality failure. There are two ways of dealing with the issue: we can put in the appropriate waste-water treatment or we can work with the farmers to change their land-management processes so that the pesticides never make the river in the first place. A growing body of evidence suggests that doing the latter is more effective and cheaper. Therefore, we are keen that it be pursued by Scottish Water. That is why we included some allowances for Scottish Water to explore the options in different catchment areas.
I am assuming that Scottish Water could look at different solutions that could be delivered in a more cost-effective manner, quicker and in a more environmentally friendly way.
Part of the general problem of regulatory pressure on water companies—not just Scottish Water—is that it is easy to focus on operating costs, which are reported in a straightforward way and allow comparisons to be made easily on the efficiency side. The example Alan Sutherland gave is a case where one may need to spend money on operating costs in order to save money on the capital side. We may not be rewarding the fact that people are adopting the least expensive option in the right kind of way. As regulators, we must consider whether we are giving companies the incentive to choose the right balance between spending money on treatment plants and spending money on operating things in a different way.
Is it your view at present that the balance lies the other way, rewarding capital investment?
Yes.
Is there anything likely to come out of the bill that will change that?
I do not know whether there is anything that will come out of the bill to change that. The regulatory framework for the next price review will explicitly remove from the current framework the bias towards capital expenditure. It will reward the achievement of the outcomes that ministers want, which are not necessarily achieved by pouring concrete. That is important because the Parliament has put the obligation on us, as public bodies, to do what we can to reduce carbon emissions in Scotland. This is potentially an important contributor to that.
I find it quite surprising that we have the Water Industry Commission for Scotland and Scottish Water and neither of them knows what will be included in the water bill.
Watch this space. I thank the witnesses for attending. It was an informative meeting and we look forward to working with you in this session of Parliament.