“Overview of the water industry in Scotland”
Agenda item 2 is a briefing from the Auditor General for Scotland on his report "Overview of the water industry in Scotland", which has been circulated to committee members. I welcome the Auditor General and his team and ask him to give the committee his briefing.
Mr Robert Black (Auditor General for Scotland):
Thank you, convener. Back in November 2002, I published an overview based on the audit findings for the three previous water authorities for the financial year 2001-02. My report identified some issues arising from the merger of the water authorities that Scottish Water needed to address, and I undertook to produce a further report on Scottish Water's progress.
In the latest overview, I examine the roles and responsibilities of the key agencies that are involved in the Scottish water industry. I also review the progress that has been made in integrating the three former water authorities and summarise Scottish Water's performance since it was established. In the report, I also describe how Scottish Water is regulated and review what the regulators have said about its performance.
Scottish Water is the fourth-largest water services provider in the United Kingdom and one of the 20 largest businesses in Scotland. Its annual turnover is almost £1 billion. It is also in the middle of a major capital investment programme that is expected to cost about £1.8 billion in the four years to April 2006, when a further investment programme will be started. So there is investment to come over a number of years.
Scottish Water is a public corporation with responsibilities to the Scottish ministers and, in turn, to the Scottish Parliament. It sits within a complex regulatory regime. Different regulators are responsible for regulating its economic and customer service performance, the quality of drinking water and the discharge of treated sewage to water courses. In reviewing what those regulators have said about Scottish Water's performance in its first few years, I take the opportunity to set out the roles and responsibilities that those various regulators have and how they relate to one another in the water industry.
The overall message from the report is that Scottish Water has made good progress in merging the three previous water authorities and improving the industry's efficiency and performance, but that there is scope for further improvement. In the report, I cover five main areas: Scottish Water's progress in merging the three previous authorities; improvements in its efficiency; customer service performance; water quality; and recent changes in the regulatory regime. I will comment briefly on each of those areas.
The first heading is Scottish Water's progress in merging the three previous authorities. Scottish Water has undertaken a number of projects to transform its business from the three previous water authorities into a single organisation. One example, which we give on page 9 of the report, is the rationalisation of three customer service centres into a single customer management centre.
Another significant consequential change in moving to the new business has been the reduction in staff numbers from 5,650 to 3,750. The auditor has reported that Scottish Water now has robust corporate governance arrangements in place, that its financial stewardship is sound, that it has met its financial targets in the first three years and that its financial surpluses have been reinvested in the business.
My second heading is improvements to efficiency. The key benefits expected from the creation of Scottish Water were increased efficiency and competitiveness, better value for money from economies of scale and harmonisation of customer charges. The water industry commissioner had the main responsibility for regulating Scottish Water and set targets for improving its efficiency and performance. Scottish Water is on track to reduce its annual operating expenditure by £175 million to £265 million by 2005-06 through efficiency savings in its operations and as a result of the merger. The commissioner also expected Scottish Water to deliver its four-year capital investment programme to 2005-06 for £1.8 billion. That is some £500 million less than the figure originally estimated by Scottish Water. However, although Scottish Water has clearly made efficiency gains, a significant number of capital projects, worth about £250 million, are unlikely to be completed until after March 2006.
It appears from the audit evidence that we took that a significant challenge facing Scottish Water in delivering its capital programme in line with its plans relates to the requirement to get local authority planning approvals and Scottish Environment Protection Agency discharge consents in respect of individual projects. I understand from the auditors that, although Scottish Water has progressed many of its applications, many are still outstanding.
I should also point out that, as I am sure members of the committee are well aware, Scottish Water has now harmonised its charges for similar groups of customers across the country. In some areas, that has led to charge increases. However, in the north of Scotland, charges have fallen in real terms; they have gone up in money terms, but they have fallen in real terms. In exhibit 14 on page 18, we show the trend in the average band D charges between 2000 and 2006 for each of the areas—east, north and west—previously covered by the former water authorities.
Scottish Water measures how its customer services are performing over four areas: customer services; response to billing inquiries; asset performance; and debt collection performance. Scottish Water reports that it has met most of the customer services targets that it set itself in the first three years. However, the water industry commissioner used a different set of customer service performance measures, which he developed from the approach used by the Office of Water Services in England and Wales. Using those performance measures, the commissioner reported that Scottish Water's customer service was generally worse than that of water companies in England and Wales in 2002-03. Scottish Water, however, considers that the commissioner's comparisons did not put its performance fully in context. Both sets of performance indicators are described on pages 20 and 21 of the main report, in exhibits 16 and 17, so you can see the full range of indicators that each party was referring to. One of the recommendations that I have put in my report is to urge the water regulator to ensure that any customer service targets and performance indicators provide a full picture of Scottish Water's performance.
The fourth heading that I mentioned was water quality. My report summarises the available data from the regulators and confirms the quality of drinking water and surface water, and the finding is that the quality is improving. There has been a steady improvement in the microbiological quality of drinking water since the early 1990s. Overall, less than 1 per cent of tap samples now fail to meet the relevant standards. Significant improvements have also been made to the quality of water in rivers, estuaries and coastal areas. Those improvements are all closely associated with Scottish Water's investment in new water and waste water treatment works. Having said that, sewage discharges remain the most important cause of poor water quality in Scotland. Accordingly, ministers have set further targets to improve water quality through Scottish Water's next capital investment programme, which starts in 2006 and will run until 2014. That will involve further investment to improve the capacity and quality of sewage treatment works.
My final main heading relates to recent changes in the regulatory regime. As I have said, the regulatory regime for the water industry is complex. Scottish Water's monopoly position means that customers have little or no choice about who provides them with water and sewerage services, so economic regulation is needed to protect the interests of water customers. It is important that there is transparency in what the regulators do to provide clarity to stakeholders.
On page 13, in exhibit 8, there is a diagram describing the changes to the economic regulation that came into effect on 1 July this year. As a result of the recent legislation, the water industry commissioner was replaced last July by the Water Industry Commission for Scotland. Where the former commissioner recommended to ministers how much income Scottish Water could collect from charges to customers, the new commission will be responsible for determining Scottish Water's maximum charge limits, based on principles set by ministers, which is a significant change.
The Water Industry Commission has a new line of accountability to the Competition Commission. If a dispute ever arose about charging determinations between the Water Industry Commission and Scottish Water, the Competition Commission would have a duty to arbitrate.
Scottish Water has established a sound basis for strategic planning, business planning and performance reporting, but there is still scope for improvement. Robust regulation is appropriate for a public sector monopoly, but those involved need to co-operate to ensure transparency and the minimisation of regulatory costs.
Scottish Water's core costs need to be understood more clearly by all parties to ensure that accurate information is provided to the Water Industry Commission. Scottish Water has made significant improvements in its efficiency and performance, but there is scope for more. Its capital programme is essential to deliver future quality and efficiency improvements, but it will be challenging to achieve that within the timescales set. I have asked Audit Scotland to undertake a study of the issue of capital programme management, on which we will report before the end of 2006.
This is, in a sense, a form of stock-taking—a baseline for the new water industry. I hope that members find the report informative. As always, I am happy to answer questions to the best of my ability.
Thank you. The floor is open to members to ask questions on the report.
Mr Black, you say in the report that staffing has been reduced by about a third, and you just said that customer service centres had been reduced from three to one—I suspect that that might give me the answer that I am looking for. Can you tell us confidently that in reducing staffing Scottish Water has lost staff in areas where there was duplication rather than staff at the sharp end, who should be delivering the kind of service that we are looking for? You said that there were issues about getting planning permission. Have problems been caused because the people who were working on specific projects have been lost, or has the reduction in staff been well managed?
I apologise, but I cannot give you a specific answer about the nature of the staffing reductions; you would have to put that to the management of Scottish Water. However, as my report describes fully, the performance of Scottish Water has continued to improve in all the key matters that are important to the people of Scotland, not least of which are water quality, progressing a major capital investment programme and responding to customer queries. Your concern about the reduction in staff numbers and the particular categories of staff involved have to be considered in the context of clear evidence of significant improvements in how the water industry is managed and the services that are delivered, in general terms.
Can you say a bit about Scottish Water's problems in getting planning permission from local authorities?
We do not have the detail on that, unfortunately. However, Scottish Water gave us a clear indication that one of the constraints facing it was getting planning permission and discharge consents in time. I have reason to believe that part of the problem is Scottish Water's capacity to progress the programme as quickly as it would like, and obviously planning applications need to be clearly specified. However, to an extent, that is conjecture; I do not have robust evidence on that point. That question would best be put to the management of Scottish Water.
The report has a chapter on the impact of new building developments. I would like to ask a follow-up question on the point to which Mary Mulligan alluded. Most of the enquiries that I receive about Scottish Water are about connection to clean water supplies and the sewerage system. Developers who have been involved with local authorities and who have subsequently been included in the local community plan are being held to ransom in certain areas—they cannot get planning permission because Scottish Water has been one of the objectors.
Given that you are satisfied with the internal processes of Scottish Water since its amalgamation, would it not be appropriate to look at the future to see how Scottish Water can be part of the community planning process? Scottish Water should no longer be able to hide behind the position that it did not know that local authorities A and Y were going to be building X amount of houses over a 10-year period. Such a move would reduce the burden on local authorities, developers and the purchasers of houses or commercial properties. Scottish Water gives no assessment of economic impact.
It might help if I summarise the background to the programme for connections and the evidence that we have gathered. When the quality and standards II programme, amounting to £2.3 billion, was set, it allowed for £50 million to be spent on new developments and first-time connections. Some might argue that that is a comparatively small sum relative to the size of the programme. That gave rise to concerns from housing developers and others, including SEPA, which believed that the network did not have the capacity to cope with new development. It was recognised as an issue.
Scottish Water's next capital investment programme, Q and S III, which will run from 2006 to 2014, includes greater provision for Scottish Water to provide connections to new housing. On that basis, Scottish Water's second draft business plan, for 2006 to 2010, proposes an investment of £221 million to meet demand for new network capacity and a further £70 million for first-time connections to existing properties.
The balance of the different elements in the programme is, of course, a policy matter for the water industry, together with ministers, to determine. As the committee will understand, I do not want to comment on whether that is entirely appropriate. However, it is clear that significantly more money is available to address the issue.
The picture is changing, and perhaps we should monitor developments in future. I will note the point, but the context is changing.
Would it not assist Scottish Water in its involvement in the community planning process to be at the table? Would it not be helpful for Scottish Water to say whether it has capacity problems in a given area? That would avoid the situation in which a developer or householder gets hit with a huge bill for a connection.
You raise issues that are worth serious consideration. Given the significant expansion in the provision for connections, there is a need for Scottish Water to interact well with others involved in the development process so that—[Interruption.]
Can I ask you to hold on for a second, Auditor General? We may have an audio problem. I suspend the meeting until the problem has been addressed, as it will affect our recording of the meeting for the Official Report.
Meeting suspended.
On resuming—
The system has been rebooted and we are able to use the microphones again.
I will conclude my previous response.
We have recorded in our report that, as part of the Q and S III investment programme, ministers set Scottish Water the objective of providing sufficient strategic capacity to meet the requirements of estimated new development. We also understand that Scottish Water will now publish annual information on its network capacity and plans to develop it. From March 2006, Scottish Water will also monitor sewage works that are at risk of overload. Scottish Water is addressing some of the issues.
That is good.
I must ask my colleagues to bear with me, as I want to ask about things that members who have been on the committee longer than I have probably know about. Having read the report, I am a bit more sure of who is who. I knew what SEPA is and where it came from; I now know what the Water Industry Commission is and where it comes from, and who the drinking water quality regulator is and where he, she or it comes from. However, I am not sure about the Competition Commission. Can somebody tell me in one sentence what it is and where it comes from?
The Competition Commission is a United Kingdom body that is statutorily charged with ensuring that fair competition is applied across the whole of the British economy—primarily in the private sector. The legislation that has been passed by the Scottish Parliament provides for the Competition Commission to have a power to arbitrate between the Water Industry Commission and Scottish Water if there is any dispute over charge determinations that cannot be resolved between them.
Are there any implications for the Scottish Parliament's scrutiny of something that is partly regulated by a body that is not a Scottish body?
This is speculative. It is certainly unusual for the ultimate arbiter in these matters to be outwith Scotland. Having said that, in that hypothetical situation, the Water Industry Commission would have issued a determination of the maximum charge limits within the principles set by ministers. Those maximum charge limits would be an issue of contention between the commission and Scottish Water. I suggest that it would not be a case of Scotland losing control of the issue; the question would be whether the determination by the Water Industry Commission was reasonable and fair, all things considered. In other words, the Competition Commission would not have a role in setting a different maximum charge limit; it would have an arbitration function.
The report mentions the water customer consultation panels. That is the first that I have heard of them. I wonder how effective they are and how local they can be thought to be if there are only five in Scotland. Is there any objective measure of customer satisfaction? I have had discussions with Scottish Water about people's complaints about the chloramination process, which has replaced chlorination. People say that it has affected the taste of the water, but Scottish Water's reply is that there is no standard for taste. Are there any objective measures, such as the figures for sales of bottled water as a surrogate for tap water for dissatisfied customers?
The customer consultation panels' powers were expanded to allow them to make recommendations to the Water Industry Commission, and they will probably have a higher profile in the future as a result of that. They can also make recommendations to ministers, the drinking water quality regulator and SEPA. All those bodies, including Scottish Water, must have regard to the panels' recommendations.
Moreover, the panels have now assumed the water industry commissioner's responsibility for investigating customer complaints that Scottish Water has not resolved and, henceforth, the annual report by the convener of the panels must refer to his complaints investigation work. As a result, that aspect of the complex regulatory regime will become more transparent to the public. With the new requirement on the various parties to have regard to the panels' recommendations, the power of the panels will be enhanced.
I apologise, but I find it difficult to answer your question about bottled water.
Perhaps I was not being fair.
I have three questions but, in light of the previous exchange, I want to comment briefly on the water customer consultation panels. Although I am in no doubt about the need to increase public transparency, I should note for the record that, in my experience, the panels have been pretty proactive in communicating with MSPs about their work.
My first question concerns creating greater clarity and understanding with regard to measuring Scottish Water's performance. I am somewhat concerned by the disparity that you have identified between the commissioner's views and Scottish Water's views about how that should be done. I realise that the situation has moved on, but in the report you urge the Water Industry Commission to produce a full range of performance indicators. Given the complexity of this area, it is all the more important that we have clarity and that all those who are involved agree on how best to measure and publish performance indicators. The fact that it has proved difficult to reach agreement at that level does not bode well for us as parliamentarians—or, for that matter, for Scottish Water's customers—in understanding how well the organisation is performing. In light of the report, how do you expect to monitor improvements in performance measurement and the publication of Scottish Water's performance either at its own hand or through the Water Industry Commission?
I have two more questions, but I will pause and let the Auditor General deal with that big area.
Exhibits 16 and 17 on pages 20 and 21 of the report describe Scottish Water's different customer service targets and the water industry commissioner's comparison between those targets and targets in England and Wales. Scottish Water and the Water Industry Commission should be encouraged to enter into a good dialogue on the importance of the various customer targets to ensure that we have a comprehensive set. It seems that, in the past, although Scottish Water reported high performance against its own targets, the commissioner challenged it on other targets that he considered to be appropriate to the water industry.
Because, in recent years, the water industry commissioner expressed a lack of confidence in some of Scottish Water's information, the Scottish Executive brokered an understanding between the commissioner and Scottish Water that resulted in the new appointment of a reporter with the specific responsibility of ensuring that reliable and relevant information was prepared and made available to what is now the commission. Clearly, there is quite a long way to go on that matter. However, from informal conversation with the chairman of the new commission, I know that the commission will give serious attention to the matter.
I for one am very pleased that the Auditor General has indicated to the committee a number of times that it is his intention to examine generic themes across various aspects of public sector management. Two of the areas that you have mentioned today strike me as being particularly fertile terrain in that respect. One of those areas is capital project management; there are also issues to do with expediting the decision-making process around matters such as planning and SEPA approvals. To what extent does Audit Scotland intend to weave in the analysis that has been done following the report that is before us with any wider work that you are undertaking on some of the common themes around the public sector? We recognise that certain aspects or dimensions are specific to Scottish Water, but others have a wider resonance.
Appendix 2 of your report covers Scottish Water's transformation programme, which is, by any measure, one of the most wide ranging that any public sector body in Scotland has undertaken in recent years. We would all agree that, as your report identifies, there is room for further improvement—there are always things that could be done better. However, it is fair to say that Scottish Water's performance—in terms of both managing the programme of change and marrying that with the maintenance of high standards of operational and financial performance—compares most favourably with that of other organisations. There must be aspects of good practice to be identified in the management of the transformation programme. Having examined Scottish Water's practices, has Audit Scotland applied its observations to other areas of its work?
As I think I have mentioned, we have a commitment in our programme to continue examining Scottish Water's capital project management. The main focus will be on how the new vehicle, Scottish Water Solutions, operates. I hope that we can do two things as a result of that work: first, to give an objective account of how efficiently and effectively that programme is being developed and, secondly, to draw out the lessons from that. One of the reasons for undertaking that study was that we considered, given the sheer scale of Scottish Water's capital programme, that there must be a good chance that we could draw some lessons from it that would be relevant across the public sector. We will present those lessons in a way that is helpful and relevant in that context.
Audit Scotland is considering whether it would be helpful—although it is not part of our formal, published programme—to do a piece of work on best practice in the development and management of major capital projects. As committee members are well aware, quite a number of major projects are going on, not just in the water industry; the other major sector that springs to mind is the transport industry. We might be able to make a contribution there by considering best practice and, in a sense, laying down a baseline for it. That work will be relevant to our forthcoming overview of the transport sector as a whole, which we are due to publish in the course of next year.
I turn to the second part of Susan Deacon's remarks and her question about the transformation project. I very much agree with her comment that the transformation project has been a significant undertaking on the part of Scottish Water. We have not considered the detail of it at all, but it may well be that there are lessons for the rest of the public sector. I would caution, however, that the Scottish water industry is a rather unique set of bodies, considering the three historic water authorities' transformation into one, so the transposition of best practice might not be quite so easily seen in the transformation project.
You may have covered this point in your earlier remarks. I note from the report that the key area of efficiency savings within the operation appears to be staff costs, as Mary Mulligan said. In relation to potential efficiency savings, a figure of just under £23 million is given for unidentified costs. The report tells us that £23 million of savings were unidentified at the time of the business plan because of the risks that would be involved in cutting costs too quickly. Can you tell us whether any of those potential savings have become more clearly identified in the course of time? They appear to amount to about 20 per cent of the operating costs.
I cannot give you a definitive answer to that question, which would probably best be answered by the management of Scottish Water. As you say, the £23 million was unidentified because of the risk that cutting costs too quickly could affect service delivery. I think that the figure was a result of the continuing negotiations between the regulator and Scottish Water. The regulator set some quite robust and challenging targets for efficiency savings and, as you might imagine, there was a process of dialogue. Given the scale of the business, which is very large indeed, an understanding was eventually reached that, in order to meet the regulator's performance targets, Scottish Water would have to find another £23 million of efficiency savings, but those savings were not explicitly identified up front. As the transformation programme continued, it became clear to Scottish Water that it could achieve those savings of £23 million, but I am not in a position to say exactly where those savings came from.
With regard to your first comment, the savings in staff costs were significant. Having said that, there has been an enormous efficiency gain between the initial figure for the cost of the planned capital investment programme—some £2.3 billion—and the figure that was ultimately agreed, of £1.8 billion, so the regulator's work with Scottish Water has generated significant efficiency improvements.
You mentioned that Scottish Water's completion of some of its capital investment procedures, such as getting consents from local authorities and from SEPA, might delay matters. Is that delay simply procedural, or could Scottish Water do more to achieve those consents sooner and therefore to complete its investments?
I indicated in my response to an earlier question that there may well be a factor involving the planning of individual projects. Specifying the nature of the capital works that are to be undertaken is essential before a planning application can be made, and there is evidence that there may be bottlenecks in the system in Scottish Water in terms of its capacity to plan all that work thoroughly and effectively according to a timescale that would allow completion on schedule of the entire, very large investment programme.
In your briefing, you mentioned exhibit 16 on page 20. If one looks at "Asset management" and at the line for "Number of properties affected by unplanned interruptions", one sees the target coming down from 4,000 to 3,500 and then to 3,350. The actual performance varies within that band, although it has been below the target on every occasion. Do you have a view on whether those targets are challenging enough?
I am sorry, but I do not have that information. That matter would be best addressed by the water industry commissioner.
Okay.
I refer you to exhibit 17. Under the heading "Asset performance", I note that where a performance comparison is made—I accept that comparisons are not always possible—Scottish Water comes off worst only once. Scottish Water fares less well in the comparison on customer service. Would it be a fair judgment to say that the problems that are identified in the commissioner's performance comparisons are mainly in customer service rather than asset management?
The water industry commissioner is concerned about both areas. Scottish Water has a view about the relevance of the water companies' targets in England and Wales and how directly applicable they are in Scotland, but its clear view is that the customer service targets are entirely appropriate.
Similarly, the water industry commissioner has done a great deal of modelling work on efficiency. As a result of that, he has settled on the figure of £1.8 billion rather than £2.3 billion for the delivery of the programme. The water industry commissioner's work is based to a significant extent on his analysis of the efficiency of the delivery of the capital programme in English water authorities. Not all that analysis would have been fully accepted in the past by Scottish Water.
That leads me to my final point. The first bullet point on page 24 of the report says:
"The asset performance comparison does not reflect the poor state of the water industry's assets in Scotland compared with England and Wales".
It goes on to say:
"The WIC contends, however, that there is no evidence that Scotland's water assets are in any worse condition than those in England and Wales".
How do we square those two points of view?
They reflect a difference of judgment on the available evidence. The water industry commissioner has done a lot of analysis in that area and he has been confident in his conclusion. However, again, that matter might be best addressed by the water industry commissioner.
As there are no further questions, I thank the Auditor General for his briefing and his full answers to our questions. The committee will discuss its response to the report and the briefing under agenda item 5, which we will take in private.