Environment and Rural Development Committee, 29 Sep 2004

Meeting date: Wednesday, September 29, 2004

Official Report 300KB pdf

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Water Services etc (Scotland) Bill: Stage 1

Today is the fourth day of our consideration of the Water Services etc (Scotland) Bill at stage 1. We will be focusing on the model of competition and regulation that is proposed and on comparisons with United Kingdom bodies. We will also have a go at examining the charge determination regime and the provisions on coal mine water discharge in part 3 of the bill, so we need to take some quite specific evidence.

A series of witnesses has been selected to enable us to tackle those issues in depth. As members have no relevant interests to declare, we can move straight to our first panel. I welcome Alan Sutherland, who is the water industry commissioner for Scotland, and Dr John Simpson, who is the director of cost and performance in the office of the WIC.

We will not have opening statements. I am very grateful that, as with other witnesses, you have provided evidence in advance, which will form the basis for our questions. You may also find that we put the same questions to you that we have put to previous witnesses, to find out whether we get the same answers. I invite Rob Gibson to kick off with the first question.

I welcome the chance to talk to the water industry commissioner and his colleague on the regulatory regime that they have been seeking to apply. The tone of your paper seems to acknowledge that that is the means by which utilities will be regulated in future. Some of us, at least, find that the move to competition is not necessarily related to the best interests of customers, many of whom have been failed by the current system. Debate has developed in other committees, such as the Finance Committee, about exactly what kind of and how much investment Scottish Water should have.

Your evidence states that much of the evidence that we have heard on the setting of wholesale prices

"is likely to be conditioned by self-interest".

Why should I think that your submission is not conditioned by self-interest?

My submission is conditioned by and based on the interests of customers in general. On my comment about self-interest, the evidence from the gas and electricity industries is fairly clear that, when a split is suggested or imposed, the incumbent companies inevitably say, "You don't understand how difficult the split will be—it cannot be done and it will not benefit customers." However, the evidence from general utilities sectors is that splits have brought benefits.

You are talking about non-domestic users, but the fact is that the bulk of the people whom we represent—the domestic users—are not likely to be materially affected by the thrust of the proposals. The retail and wholesale issues relate more to the operation of the Competition Act 1998 and not to the reasonable provision of water supplies to domestic customers in Scotland.

When we prepared the strategic review for the minister in 2001, we suggested that the introduction of retail competition could benefit customers in general and that the benefit of simply injecting greater transparency into the industry's cost structure would be at least as great. I have talked at length with people in industries that have been through similar splits and I have often been told about the debates that happen between companies at the time of the splits. One company might say, "That's your cost," while the other replies, "No it's not; I don't want that cost." Many activities that do not really add value for customers, both domestic and non-domestic, are identified in that process and companies ask why they are doing them. Therefore, the overall costs for the industry come down.

Transparency is important. There can be no real doubt that the transparency on cost that has resulted from the work of the regulatory regime in the past three or four years has brought about the 20 per cent reduction in Scottish Water's operating costs in the past two years. That is money that would otherwise have had to come from customers. By the end of the present regulatory period, as a direct consequence of the reductions in operating costs, customers' bills will be 15 per cent lower than they would otherwise have been.

You describe a process, but it is difficult to bring competition to bear in a system in which there are around 200 different sources of water. The system is different from that anywhere else, apart perhaps from Yorkshire, which is the nearest possible comparator in England. The idea that the reduction in water prices that you talk about has somehow helped people to get more water supplies is not correct because we know that it has not tackled development constraints. That shows a direct mismatch between the reduction in prices and the ability of many communities to get the water supply that they require. You certainly make the case that there has been a reduction in costs, but you do not address the fact that many of our witnesses have said that the proposals are a total mismatch with what is required.

Several issues are tied up in that question, but let me tackle development constraints. Of the three options in the Executive's consultation on quality and standards II, ministers adopted the middle option. Post consultation, ministers recognised that not too much money had been provided for dealing with development constraints, so they added in £50 million to deal with first-time connection to the water supply and rural sewerage. However, 5 per cent of the post-efficiency £1.8 billion investment programme—that is, £90 million—was put in to handle growth issues in addition to that pre-efficiency £50 million allocation, which was reduced to £42 million to reflect the efficiency target. Those moneys were in addition to the industry's basic maintenance of capital—some £500 million to £600 million over the regulatory period—that will also marginally affect the ability to connect to water supplies and sewers.

The delivery of the investment programme is a different issue. In our revenue settlement, we charged Scottish Water with delivering that £1.8 billion in roughly equal instalments in each of the four years. To date, that has not happened. In our April investment and asset management report, which was based on Scottish Water's first almost two years, we highlighted the fact that, if it was to complete the £1.8 billion programme by the end of the regulatory period, Scottish Water would have to spend at a rate that was unprecedented in monetary terms. The percentage increase that is required has been achieved only once before.

I suggest that the mismatch is not between the reduction in operating costs and the development constraints—we are well aware of what people are saying about those constraints—but between the delivery of the allocated investment programme, which is being paid for by customers at this time, and the development constraints. Operating cost reductions are not the issue.

If there is a disagreement between the regulator and Scottish Water about how that can be achieved, will providing a clearer definition of the water industry commission's powers solve that problem?

Solve what problem?

Will it meet the need to tackle development constraints at the levels that require to be spent?

It is important to understand that the current function of my office is to advise Scottish ministers on the revenue requirements for delivering the investment programme that ministers specify after consultation. Under the new system, the office will have a slightly different function. Scottish Executive ministers will still have the responsibility to define the investment programme that they want, but the commission will then have to reach a decision, rather than simply offer advice, on what pricing level is required to fund that investment programme.

That is a helpful clarification.

Further to Rob Gibson's question, I want to ask whether Alan Sutherland's impression is that Scottish Water will fulfil its investment programme even if the programme is back-loaded. Will the work get done even if it is all concentrated in the final part of the investment period?

It is not for a regulator to predict how Scottish Water will do. We thrive on evidence and data; we do not like hypothesising. I can only repeat that, in pound terms, the extent of spend that is still required to be delivered has never been achieved in the history of the UK water industry. In percentage terms, as an increase over what was delivered in the first two years, the amount of expenditure that has still to be delivered has been achieved only once. It was achieved only by one company, on the basis of a much smaller capital programme than that which is to be delivered in Scotland. The delivery of the entire programme by 1 April 2006 would represent a significant achievement—it would be a first. Nora Radcliffe asked whether everything would ultimately be delivered, to which I reply yes, because regulation will ensure that that happens. We are working hard to ensure that we have proper definition of the capital programme and can vouch for its delivery and the benefits that customers have been promised.

I want to pursue that point a wee bit. What has caused the bottleneck? Is it true that, as some people suggest, the downsizing of the water industry and loss of personnel have led to a lack of capacity to deliver?

It is not for me to comment on how Scottish Water is managed. Scottish Water still has more operating cost available to spend in relation to its size and geography than has any company in England and Wales, which is why it is still rather inefficient, despite its creditable performance in its first two years—we look forward to more of that. There is still an efficiency gap. The resources are there and it is for management to consider how to use them. Customers are certainly providing an adequate amount of money.

I would like clarification on some of the points in your submission. You say:

"It is important that Scottish Water should be able to appeal a decision to the Competition Commission or could challenge process through a judicial review."

Can you clarify that statement and expand on what it means? Does it refer to two different types of appeal or are you suggesting that there should be an appeals process beyond an appeal to the Competition Commission? What are the pros and cons?

When the proposed new water industry commission determines how much it should cost to deliver the policy objectives that ministers will set out in January, it is right and proper that there should be a mechanism whereby Scottish Water can appeal if it does not like the commission's analysis. It is likely that such an appeal would be complex, because it would involve many issues—colleagues keep telling me that I assume the issues are too simple. The issues are complex and our method of going about the process will fill five thick volumes, which gives an indication of the volume and detail of activity that we have to deal with. It is reasonable that an appeals body should have the expertise and experience to be able to respond to those issues.

Judicial review, as I understand it, is different and involves the consideration of whether we have acted in accordance with the proper process. If we do not act in that way we, like other public bodies, can be subject to judicial review.

Are you suggesting that there should be two routes of appeal for two different types of dissatisfaction?

Yes. I think that that is in line with general regulatory practice.

That is fine. I just wanted clarification because I was not sure whether the statement about two types of appeal represented an either/or approach—

We were not proposing a three-tier system.

Are you happy with the drafting of the bill in that respect, or should it be amended?

I am not a lawyer, so I am probably not the best person to comment on the drafting of statute. The bill seems reasonably clear to me, but that might be because we think that we understand the regulatory process in England and Wales and in other utility industries. Perhaps that conditions our view, but I think that the question should be answered by someone who is rather more specialised in legal drafting.

But you are saying that you are pretty happy with what is in the bill and that it seems to do the job. Someone else can debate the question whether it does exactly what it is intended to do.

The policy memorandum has moved us forward considerably. Indeed, it and the letter that Mr Finnie sent me in May about starting work on the next review have very much clarified what the responsibilities of ministers are and what the responsibilities of the commissioner/commission will be in order to calculate the costs of the very important ministerial policy objectives that I am sure will be debated by members.

Following on from Nora Radcliffe's question about appeals and our discussion about whether Scottish Water should be able to appeal certain decisions, I wonder what your view is on the suggestion that there should also be an appeal process for individual consumers who are unhappy about their banding or the amount that they are being charged.

The third volume of our approach sets out a number of questions for consultation on the introduction of what are called tariff baskets, which are effectively the tariffs that apply to discrete groups of customers. Instead of trying to predict in advance each particular tariff, of which there are about 250 in Scottish Water, we would set only 10 price limits for the various baskets. We expect guidance from ministers in January on the exact weightings that they want between the various groupings in light of the consultation paper, "Paying for Water Services 2006-2010", which the Executive has already launched and the study that it has commissioned on cross-subsidy in the water industry. After those two processes are complete, we expect to receive fairly clear statements from ministers about what they expect each group to pay in relation to the other groups.

In the consultation, we have suggested that metered customers with household-type characteristics—which would cover the few hundred households in Scotland that have a meter, or smaller businesses—are grouped together instead of being lumped into a tariff basket with all other metered customers, which is what happens in England and Wales. As a result, you would be able to look at prices or receive clear guidance from ministers about how they expect the household or small business user to be treated in relation to the various other water service users.

But what about appeals? What happens if someone is not happy with the bill that they end up paying? This is particularly important, given that bills have been rising. I know that people can complain to Scottish Water, but if they are not happy with its response, should they have recourse to someone else? No one has suggested that the water industry commissioner should take on the job; however, it has been pointed out that with other utilities people can complain to bodies such as energywatch.

In that respect, the committee might want to discuss the water customer consultation panels. I was keen for them to be set up at the time and I feel that they play a valuable role. Perhaps members will feel it appropriate to give the panels the additional function that you outlined. I certainly think that their role should be expanded and strengthened. A customer group should be able to lobby with regard to particular situations; on the other hand, I am required by statute to fulfil a regulatory function that immediately has to reach the general customer interest by balancing one group against another.

I think that I understand that. The representations to the water customer panels are to do with different key interest groups but, a couple of weeks ago, we were debating the issue of individual customers who are unhappy with their bills. Whom do they go to? I do not think that the water customer panels want to hear those complaints.

If someone is paying on a rateable value, I suppose that one of their options is to appeal it. If they are unhappy with their council tax banding and the charge that relates to that, I assume that they can appeal the banding. I appreciate that that is probably not terribly helpful, but it is not the commission's role to consider individual customers.

I was not suggesting that it would be a role for the commission. I was saying that we were talking about regulation of utilities and that other utilities industries have organisations to which people can complain. Do you think that that is a good idea? It has been suggested by other witnesses that there is a gap in the water industry.

The parallels in the water industry in England and Wales and in other regulated utilities would be where a customer who was unhappy with the level of their bill and who appeared to have no recourse of complaint to the company complained to a body similar to the panels that we have in Scotland. For example, they could complain to WaterVoice or energywatch. Dealing with complaints would be the day-to-day activity of that type of body. There is a role for the panels in Scotland in dealing with that kind of issue. It would be very difficult for a regulatory body to do it.

We will come back to that. I would like to read the evidence because I do not think that that was the view of the water customer panels.

There are four things in the submission that I would like to clarify. Convener, is it all right for me to carry on and for other members to come in behind me?

Yes, if you keep your questions focused.

Page 3 of your submission mentions the consultation on the detailed principles of the licensing regime, the draft licence and the fact that you are proposing to hold

"two further rounds of consultation before a licence was issued to a new entrant".

Are you referring to a new entrant other than Scottish Water?

Absolutely. Assuming that the bill goes through, in April next year we plan to consult on the principles that we should include in the licence for the retail arm of Scottish Water. There would then be a separate consultation on a draft licence for Scottish Water retail. Between 2006 and 2008, when it is suggested that new entrants might be able to come into the market, we plan to have a further two rounds of consultation, basically structured in the same way, on the principles that ought to be put into a new entrant's licence and on a draft base licence for a new entrant. Hopefully, we can expand the consultation and ensure that people have a full opportunity to comment on the process as it progresses.

Presumably, if the second consultations came up with a slightly different licence, Scottish Water would have to be relicensed under the modified arrangements.

The normal process is that either the licence giver and licensee agree or such matters get referred to the Competition Commission.

Thank you, that is helpful. The final two questions are about your possible approaches to setting wholesale prices. I burned a lot of midnight oil trying to get my head round this. Are those approaches mutually exclusive or are you likely to arrive at a combination of one or more of them?

Three of the approaches are mutually exclusive. We do not consider the efficient component pricing rule to be appropriate when two businesses have been physically split, because it concerns the pricing of access and not a wholesale price per se. However, some of the principles that underlie that rule could be used. To ensure comparability in the next review, we will calculate the initial wholesale price on a retail-minus basis, but it will probably be a retail-minus accounting basis rather than an ECPR basis.

The long-run marginal cost approach is almost the mirror image of the ECPR. It would probably give extra benefit to new entrants at the incumbent's expense, so we are not terribly keen on it.

The other two approaches that we talk about, which are the accounting approach and the commonsense check of how much it costs the gas industry to read a meter and to serve and bill a customer, for example, are not mutually exclusive. We hope that it is reasonably good practice analytically to reach one answer based on a debate with Scottish Water about where activities go and what the costs are, but to compare that with other industries and processes, to ensure that the answers that we receive are realistic.

If you go for the comparator approach and consider other utility industries, I presume that the state of infrastructure will be a major factor in your comparisons, because the state of the infrastructure in the water industry is different.

We would examine retail processes, not pipes and assets. We are often told how bad the infrastructure assets in Scotland are. For anyone who is interested, we reported in our investment and asset management report in April on what Scottish Water's data say versus the situation in England and Wales. The infrastructure may well not be in as good nick as it could be on either side of the border—it is not just a Scottish problem. Perhaps we ought not to beat ourselves up too much on how much worse Scotland's infrastructure is, because the objective data do not support that.

I was talking about comparisons of utilities. Some utilities have a far better, more efficient and more modern infrastructure than the water industry does.

Our intention is not to compare the wholesale parts of water and gas businesses, because it is clear that the activities and engineering are different. We want to compare the retail parts—

The administrative operations.

That is because common sense suggests that those activities should be broadly the same in different utilities.

I will ask about the composition of the water industry commission. The commission's role concerns price regulation, but that is with a view to facilitating Scottish Executive policies on economic development, social equity and environmental protection. Should the commission be composed entirely of economists, or should other advisers have a role? I raise that because the submission to the committee from the Office of Water Services talks about the water services regulation authority in England and the establishment of sub-committees. I presume that sub-committees will work on aspects of stakeholder involvement or even policy objectives and their delivery. Will you share your thoughts on that? Should such arrangements be established here? Do you have a view on how the commission should be composed? Would sub-committees or sub-groups have a role in it?

The size and nature of the commission are decisions for ministers. Clearly, the results of the commission's price determination will have consequential impacts on customers, businesses, households and all sorts of issues. One of the strengths of what is being proposed is that, after a draft determination of prices is produced in June next year, there will be an opportunity for people to make representations and for ministers to decide that they do not like the price outcome and that they want something else included or something removed. One of the strengths of going for this structure is that there will be clarity between the ministerial responsibility to make policy decisions and the commission's ability to price the lowest sustainable cost of delivering the policy objectives. That clarity is important.

It is for others to decide who should be a member of the commission. Clearly, the role of the commission should be to cost what ministers state is the policy rather than to get involved in the interpretation or development of policy. To do otherwise would be for the commission to turn itself into a mini-representative body, which is not what it is meant to be.

But clearly you are enabling Executive policy to be implemented. I accept that price is crucial to investment in environmental protection and to the cross-subsidies between domestic and non-domestic consumers and between large and small businesses. In effect, you are recommending those major decisions to ministers.

No. Ministers are saying—

But you are coming up with proposed solutions.

No. As we speak, the quality and standards III process is under way. The process involves multiple stakeholders, including the Scottish Environment Protection Agency, the Convention of Scottish Local Authorities, the drinking water quality regulator, business, the Scottish Consumer Council and water panels. They are looking at all the investment requirements over the next eight years in Scotland. The Executive has raised a number of issues that are out to consultation at the moment.

In January, post the consultation, ministers will reach a decision on what needs doing. We will then look at the programme, cost it and include the costs in the price determination. The programme has been costed by Scottish Water, but the costs do not get reviewed until ministers say what bits of it they want. After the draft determination is concluded in June, there will be a second opportunity for people to say that they want a bit more or a bit less environmental benefit, given what they are willing to pay. The draft determination will become final only at the end of November next year and it will take effect for customers in April 2006.

Neither the commission nor the commissioner is taking any decisions about whether to protect a particular estuary or whether to give people in Dundee a better quality of water supply. Those decisions are part of the ministerial process, post consultation.

We will be discussing the issues with the minister next week. Given that we have been debating quality and standards III and "Investing in Water Services 2006-2014" for the past few weeks, we have an overview on that.

I will stick to the issue of the task of the water industry commission. Would it be helpful to have a requirement in the bill that, when you are reaching your conclusions, sustainable development should be one of the guiding issues that you must consider, as it is for the water services regulation authority?

That is one of these questions that is difficult for me to answer.

You can give the committee your thoughts, without necessarily giving us a yes or no.

My thoughts are that we should all live by principles of sustainable development. We all ought to be conscious of what we are doing now and the impact that that has on others now and in the future. However, when I think about the issue, which is something that we have done a lot, I keep coming back to the point that there is a clear distinction between the policy side, which has to be the responsibility of ministers, and what ought to be the responsibility of the bean counters—us—which is to cost that policy. I would expect ministers to tell us that they want us to take sustainable development into account and that they want the investment programmes to deliver sustainable development, and to say what they mean by "sustainable development". Although I am ready to be corrected on this, I do not think that it is right that the people who are charged with calculating how much ministerial policy costs should interpret what sustainable development means or decide to include additional costs that ministers have not said that they want, following their consultation and according to their definitions.

There is a role for sustainable development but, particularly given the need to avoid replicating what was probably a lack of clarity in the old regime, I am not sure that we should have a lack of clarity in this framework about what ministers are responsible for, what the commission is responsible for and what Scottish Water is responsible for. Clarity is important and we should not do anything to compromise that.

We may come back to that point with other witnesses.

I will move away from what we have been saying and go back to basics. You made it clear earlier that you believe that competition is beneficial to customers. Given some of the reservations that have been raised by other witnesses, do you think that the model of competition that is provided by the bill is adequate to deliver enough competition to deliver such benefit?

Rob Gibson raised an issue about the number of sources of water. If I remember rightly, the committee has heard evidence on the absence of a national water grid. That limits the areas of the water industry where there can be competition in the sense of different people doing the same activity, as opposed to competition for who can do something cheapest—for example, deciding whether to contract something out or to do it yourself is a form of competition. We went through a fairly extensive analysis of the matter back in 2001. We concluded that the only area where there can be in-the-market competition, as we economists would call it, where different people do the same thing, is in the area of retail.

Such competition can bring benefits in a couple of ways. First, retailers typically up their game when they are in competition with one another—they give a better service, their billing is more accurate and timely and they respond more quickly to queries. Secondly, a new entrant will often have significant advantages in terms of the scale and scope of their activities. If they already have a billing system for customers—if they already send out bills to customers for their electricity, gas and, perhaps, their telephone—issuing another bill through the system would only have a marginal cost. Therefore, that would allow a company to consider going into another market and unless an incumbent expanded the scale and scope of its billing system, it would be relatively disadvantaged. There is typically a margin compression.

We have heard concerns that retail competition would be possible in such a limited area that it would be unattractive for many companies to become involved. Is there a danger that the bill's scope will not extend far enough to create the kind of regime that would begin to deliver benefits? I think that you have answered that question already, but I am putting it in a more straightforward form.

We are not short of approaches from people who are interested in doing various things in the Scottish water industry. People are interested in coming into the market. They would probably come into it now if Parliament was not considering this bill. Rather than making their intentions known now, they are waiting for the clarity that will come from the bill.

I think that there will be entrants to the market and that you will get messages. Some of the submissions to you are interesting on the subject of the market being terribly small and uninteresting. That is what people said about the gas and electricity markets.

I will try a third time. Might some of the potential new entrants to the marketplace be more attracted if the terms of the bill were slightly broader in creating the opportunity for them to enter?

If the Parliament was interested in exposing the entire industry to competition and throwing all the domestic customers into the same pot, I am sure that the market would inevitably be bigger and that there would be more interest. I have my views on whether that is worth doing in public policy terms and I am sure that you all have your views on that.

I think that I have got the answer that I was after.

Okay. If there are no other questions, I thank the witnesses for coming along. It has been useful having your written evidence and being able to ask you questions.

We will have a quick, two-minute recess while we let the first set of witnesses escape—although they are obviously allowed to stay for the next evidence—and the second panel come to the front.

Meeting suspended.

On resuming—

I welcome the second panel of witnesses. We have with us Tony Smith, the director of competition and consumer affairs at the Office of Water Services—Ofwat—and John Banfield, the senior inquiry director at the Competition Commission. I noticed you in the gallery earlier and I thank you for being here. We will not take opening statements from you because we already have your written submissions, so I will go straight to members for questions. Alex Johnstone will kick off.

Thank you.

Do the witnesses think that the bill will open up competition in the Scottish water industry, or do they regard the bill as an attempt to restrict possible current competition?

I do not think that it is particularly for us to comment on the choices that are made in Scotland. You will have read in our evidence about what is planned as a result of the Water Act 2003 and you will have noticed a couple of key differences between England and Wales and Scotland. First, there will be no forced retail separation in England and Wales. However, the flip side is that there will be the potential for new entrants to access the water undertakers' networks.

Another feature that is different is the fact that, for the first three years of the new regime, there will be a threshold that will mean that only customers who use more than 50 megalitres a year will be open to competition. That is the amount that a large hospital, a school or a university would use, or, in the business sector, a company that uses water for its processes—for example, a company in the brewing industry or a paper manufacturer.

A combination of features will make the markets somewhat different. Our view is that there will be interest in the market in England. Initially, the market will be limited and is likely to have only around 2,300 customers. It would be helpful for potential new entrants if the market was bigger—people have already said that down in England. Nevertheless, we think that there will be interest, both in the retail market, which is more restricted than it is up here, and in common carriage, which is the aspect that you do not have up here. I do not know about the situation in Scotland.

Following on from what we heard from the water industry commissioner, I wonder whether you believe that the bill's proposed model of competition will be robust enough to stand up to challenge?

That is a tricky one because none of this has been tested in the courts yet. Down in England and Wales, there are debates about whether the model there is legally sustainable. Certainly, the Department for Environment, Food and Rural Affairs' view is that it is; hence DEFRA has put that sort of regime in place.

There have not been any challenges to the regime as a whole, although we are aware of companies that would challenge our interpretation of what we call the costs principle, which is a key element of the regime in England and Wales that concerns how prices are set. It is too early to say whether there will be a challenge. Only time will tell.

Finally, I have a question on how we should defend the concept of competition. One of your roles is to monitor the effectiveness of competition in the industry. Do you believe that competition delivers cheaper water?

We expect it to, but we will have to see. As a result of the way in which the regime will be structured in England and Wales, due to the costs principle that I mentioned, competition should occur where it is effective. The regime will not be based on companies and new entrants who try to pick cherries, to use the jargon, and to get the most attractive customers who cost the least to serve—companies will not be able to do that under the regime that will exist in England and Wales. There will be competition where there is a competitive advantage for a company that comes in to compete with the incumbent water company. In that respect, we expect that there will be benefits to customers.

As far as the Government's objectives are concerned, it is equally important that there will not be disbenefits to customers who cannot get into the competitive market because of the limit on the regime or who choose not to get into it; therefore, there is protection for such customers in how things are set up. However, I hope that there will be direct benefits for those customers who are competed for.

The experience of other utilities in England and Wales and elsewhere is that there are knock-on benefits. There is no doubt that even the prospect of competition causes companies to raise their game—we are seeing that even in the water industry in England and Wales. When companies start to understand their customers better, they will ensure that they provide a better service and they will understand their costs much better, which makes them far more effective in dealing with customers and with the costs of doing so.

The new regime in England and Wales might be small—certainly for the first three years—but we think that it will be attractive to new entrants. It will have benefits for customers and will not have any disbenefits for customers who are not directly touched by competition, which is important.

Is the Competition Commission in a position to compare the model that has been chosen in Scotland with the model that is operating south of the border? Can you say whether the levels of competition that they provide are equal or different?

No, unfortunately. As yet, we have not looked at competition in water supply even in England and Wales. We have been involved in competition issues in other utilities—especially gas—but the contexts of utilities differ somewhat. I would not want to express a view on the matter.

The Ofwat submission talks about setting and monitoring price limits in England and Wales, and states:

"In setting price limits, Ofwat takes into account guidance from the Secretary of State and the Welsh Assembly … on the improvements to drinking water quality and the environment that the companies are required to deliver".

Where does the Welsh Assembly's agenda for social development, or that of the United Kingdom Parliament, come in there? You might have heard in earlier evidence that we are quite concerned about, for example, expanding infrastructure for social housing and so on. Where do such matters sit with you? How are they dealt with?

We receive guidance in various respects, and not only to do with the periodic review, which is referred to. We receive guidance from ministers and the Welsh Assembly Government for us to take into account in the price-setting process. As the paper says, that guidance is primarily around the big items of the programme, such as the environment and water quality.

They also put in issues that they are concerned about. For example, we are currently reaching the end of our price review. Affordability is an issue for customers who already find it difficult to pay and who will find it even more difficult to pay after the review, when prices are likely to go up. Both the Secretary of State for Environment, Food and Rural Affairs and the National Assembly for Wales have expressed their concerns about that. They have given us their view on the issue and have told us what they are doing on the topic. A review is considering the options for customers who find it difficult to pay their bills.

That is one angle; however, it does not stop there. The prices are set for five years, but each year we have to approve the charging schemes of all the companies. When we do that, we consider tariff proposals to ensure that they will not discriminate against groups of customers and that they are cost-reflective. We also take into account guidance that is given to us by the Secretary of State for Environment, Food and Rural Affairs about things such as vulnerable groups of customers and ensuring that, if there is any rebalancing to be done between customer groups, that happens gradually and price changes are phased in so that a customer whose demand has not changed does not have a rapid change in price from year to year. Ministers' views are made known to us through various sets of guidance that we observe as we do our job.

So, is there cross-subsidy in the pricing structure?

Cross-subsidies between groups—say, between domestic and non-domestic groups—have probably been largely unwound since privatisation. However, to the extent that there are still prices across a company for a particular set of customers, there is a cross-subsidy. Within any particular company, there are some customers in regions which it is easier and cheaper to serve and other customers in areas of the company's territory that are more expensive to serve. When it considered the provisions in the Water Act 2003 relating to competition, the Government was keen not to unwind those cross-subsidies.

It does not want to unwind them.

It does not want to unwind them. It wants to maintain common, cross-company prices for customers.

When people pay for their water, does an element of the charges pay for the development of infrastructure—for example, for social housing in rural areas—or is that paid for by a separate Government department? Do you know how it works?

I am not sure how that specific aspect works. Each time that there is a pricing review, development and growth are considered as part of the companies' plans, which must respond to development demands. The situation in England is somewhat different from the situation in Scotland, in that developers pay for connection to the system. Indeed, they pay at two levels: they pay an infrastructure charge for the impact that they will have on the system as a whole; and they pay a site-specific amount for connection.

The companies' plans and the pricing deal for the next five years that we have to come out with will include the work that the companies have to do to respond to development. In some areas of England and Wales, that involves a pretty significant amount of money, especially in the south-east of England where there is pretty rapid growth in some areas. Development issues have to be addressed constantly, but they are addressed overall rather than, for example, rural housing being dealt with specifically.

Yes. We have made a distinction between commercial development, which the developer will make money out of, and development for social purposes to meet a need in a community.

I want to pursue the issue of guidance. To what extent are indicators and targets part of the guidance that you work with or things that you must be aware of? I am thinking of indicators on water poverty or investment in social housing, or targets on leakage, for example.

Ministerial guidance has clear implications for the environment and water quality, because it is translated into standards that companies must deliver or consent levels for discharges of effluent. Ofwat and the environmental and water quality regulators consider what the guidance will mean for companies and companies consider the investments that they will need to include in their plans if they are to deliver what is required. In that sense, there are specific outcomes.

That applies to issues on which there is statutory guidance, but how would the policies of the National Assembly for Wales or the Westminster Parliament be delivered?

I think that it is true to say that ministers have not set a target on water poverty that identifies percentages for the maximum amount of money that a customer should have to spend on water, for example. There are guideline levels, but the guidance does not specify limits. We are not allowed to set prices in a way that is driven by the amount that people who can least afford water can spend; we are statutorily required to set prices that allow the companies to do what they need to do—to "finance their functions" is the term that is used.

However, we take account of the implications for customers because not only is the Government concerned about those implications but the companies themselves are concerned about them. If a customer cannot pay, the company has to deal with debt issues and all the rest of it and, as members know, other water customers pay more. The approach is less specific than setting targets in the way that Mark Ruskell mentioned.

The WIC said that, in essence, you have a bean-counting function. I am concerned to know whether you count the right beans and whether you design pricing in a way that reflects an awareness of the various policies.

As you can imagine, we take part in stakeholder discussions and do a huge amount of research on what people are thinking. Various poverty groups tell us about their issues and we encourage that, both in the lead-up to the review and in the aftermath of it. There are two stages to the process: a draft determination, which contains our proposals; and a final determination. During the four or five months between the two stages, we take account of everybody's comments. In England and Wales, we encourage discussion even before the review process starts, by asking the water companies to put their business plans in the public domain. That encourages a debate around the consequences of proposed price increases or around the environmental and price implications of proposed programmes. There is plenty of opportunity for everybody to input to the process. As you can imagine, people are not slow to come forward and tell us about their concerns.

I am intrigued by your comment that the Ofwat board tries to make decisions that are politically sound as well as trying to deliver effective outcomes. Given that you interpret ministers' indications of what should happen, how are you dealing with the emerging targets and indicators on sustainable development? Your submission discusses the matter in terms of your general aims—thank you for that—but, during the next few years, there will be much more specific indicators and targets for sustainable development.

I ought to say that the sustainability duty will come into force only when the new water and sewerage regulatory authority is in place, in 2006, so we are not formally obliged to meet that duty at the moment. However, as we pointed out recently in our draft determination document, we already act as if that duty were in place. We take account of the four threads of sustainable development. The water services regulation authority will have to work on that area, because you are right—targets on sustainability will become more specific as we move forward.

We address each of the elements of sustainability as a result of the various aspects of guidance that we get, but as yet there are no specific measures on sustainability. The issues are there—environmental protection and social development are examples of issues that we must take into account. In our draft determination document, we have outlined how we have taken account of each of those elements this time. It will be for the new regulatory authority to consider how that develops over time, in the light of progress in understanding what sustainable development means. It is critical to consider how we trade off the four threads of sustainable development against each other. We still have thinking to do on that, in preparation for the establishment of the new authority.

I want to explore a little more of your thinking on water conservation, how you have tackled that this time and how you think that progress on that will be made.

As you will recall, leakage is quite a big issue. In the mid-1990s, the water industry, prompted by Ofwat, put in place a set of targets—which it is largely achieving—which have resulted in, for example, a reduction of well over 25 per cent in the peak levels of leakage.

There is also the subject of metering. I think that it is true that there are many more meters in England and Wales than there are in Scotland. Although we would not advocate universal metering, we would support certain customers opting for meters and the selective use of meters in particular circumstances.

We operate in a way that we think seeks to conserve water, but we take account of the economics of the situation—as we should do, given our role. For example, we do not want leakage to be reduced at all costs; we want it to be reduced to the point at which it would be uneconomic to go any further.

It is interesting that, under the Water Act 2003, the secretary of state will have a role to play in achieving water conservation; I think that he or she will have to produce a report every three years on what actions have been taken to do that.

That was useful; thank you.

That was helpful. Although we focus on water conservation, there are obviously other issues that we should think about when we consider sustainable development, such as the use of energy for processing water. It gets very difficult to work out the trade-offs between the different decisions. We are keen that such trade-offs are made and that they are part of the process. We do not want it to be assumed that such matters are being considered; we are eager to find out where that is put into the system. Everyone has to do that in different ways. We would not expect the WIC or the minister, who sets policy objectives, to do that to the same extent. It is a question of ensuring that sustainable development is taken into account throughout the process. That has been our concern when we have discussed whether there should be a statutory function at the regulatory end.

That is a political choice. One could give each of the regulators—the quality regulators as well as the economic regulator—a specific role. That could produce a healthy tension between the regulators, who have a narrow set of objectives and whose activity has limited scope, and the ministers, who set the objectives. Alternatively, one could get the regulators to share a common agenda by giving them a broader set of complementary duties. That choice exists.

That is a very concise way to put it, and I think that we shall put that to the minister next week when we have him before us.

I would like to ask John Banfield about two angles on the same question, which we have heard from a number of witnesses. If we are talking about the Scottish water industry, why should we go to the United Kingdom Competition Commission as a last port of call on competition issues? That question was raised both by a large company and by those representing consumers, and they came at it from two different angles. There is a general sense of concern about how, as an overarching UK organisation, the Competition Commission can be in tune with the policy issues and the reality on the ground in Scotland. There is also concern about the whole issue of competition, as there will be different regimes operating to slightly different policy objectives.

There is a concern that, because England and Wales is a bigger area, that would shape the Competition Commission's views in considering decisions in the Scottish water industry. Some people fear that that would push us down the route towards greater privatisation than is necessarily wanted in Scotland. I am putting to you what has been said to us, and I would like some reassurance from you. Do you think that those are fair concerns? How would you attempt to reassure people that they will not be a problem?

They are understandable questions. We are quite used to dealing with Scottish references. We have done quite a few over the years and I have done two in the past two years that solely concerned parts of Scotland, the latest being the bus-rail merger. We have Scottish members. On the specific legal context of any case, we do every regulatory inquiry in the context of the slightly varying sets of statutory objectives that apply in the particular case, so we are broadly adaptable. Nevertheless, there tends to be a common thread in how we approach regulatory inquiries.

We would undoubtedly take evidence and as many views as possible would be invited, and we would have hearings in Scotland. In other water inquiries, we have always had hearings with local consultative committees, and I am sure that we would do that in this case as well. In my view, we would be well aware of the local views on specific issues. On competition issues, we have not actually dealt with water competition cases as such in England and Wales, so we might find that things actually work the other way round if we come across such issues in the Scottish water context before we come across them in an English and Welsh water context. However, every inquiry that we do is done in the context of the specific statutory duties. We would take into account the local context and we would undoubtedly get evidence from the Scottish Executive and from consumer groups.

That is helpful. We are all aware that competition policy is set at UK level, but a clear policy on how the water industry is operated is coming through in the bill that we are debating. It is quite important that that issue is addressed up front and in an open way.

Going through the papers makes it clear that your focus is different from that in respect of other utilities that I have dealt with in other parts of the country, and we would be alert to that.

That is useful. I thank both witnesses for their written evidence and for being prepared to come along and answer our questions today.

Meeting suspended.

On resuming—

We now move to our third panel of witnesses. We shall try to create a bit of sparkiness in the committee, because we have been in session since 9.30 this morning. Our witnesses are Stuart Rolley, senior development manager, and Stephen Hill, development manager, from the environmental team of the Coal Authority. I thank them both for attending.

As with previous panels, we will not hear opening statements from you, but we have copies of your written evidence. We were particularly keen to have you along this morning, because part 3 of the bill has probably had least attention. We had a brief discussion of part 3 last week, when representatives from the Convention of Scottish Local Authorities were here, with regard to the Fife interests, but we want to ensure that we scrutinise that element of the bill more fully.

I think that I should give Mark Ruskell the opportunity to kick off, as he expressed an interest last week in the practical application of the bill, particularly in the area that he represents, Mid Scotland and Fife.

Do you believe that the bill is clear enough in setting out your responsibilities with regard to discharges from mine workings?

I believe that it is. For some time now, we have had an on-going programme of remediating mine water discharges. There are issues with liability on a site-specific basis, as you would imagine, but our focus is very much on cleaning up mine water pollution. We work closely with SEPA, which provides much of the information on the discharges that it considers are in need of remediating. We use SEPA's priority list as the basis for our work and cleaning up mine water pollution is very much the focus of that work.

Will the bill affect your relationship with SEPA? I know that, at the moment, you work through a memorandum of understanding.

That is correct.

Will that change in any way?

No, it will continue in much the same way. Until now, we have been working under the auspices of Lord Strathclyde's statement on the coal industry in 1993-94. The bill gives us a more formal statutory basis for the work that we are carrying out.

Thank you for your submission; I now understand your role much better than I did before.

The one issue that has been brought to my attention, and which I would like to raise briefly, is the compulsory purchase powers. I understand why compulsory purchase powers would be necessary—your submission is very detailed on that matter—but I would like to clarify the nature of what you would be seeking to compulsorily purchase. In the event of access being denied, would you seek to purchase land in order to gain access to a mine, or are we talking about the purchase of abandoned mines?

The mine workings underground are virtually all vested in the Coal Authority, so they are, in effect, our property. Problems occur when the water rises and comes out of those mines and causes pollution. Our preferred way of trying to treat that is by means of a type of reedbed site whereby we can clean up the water. We go through a feasibility process to work out all the possible ways in which we can treat water. As members might imagine, in some circumstances, such as those involving reedbeds and ponds, we need the land to be reasonably flat and close to the discharge. Indeed, when the requirements of a piece of land are very distinctive, we require reasonable amounts of it to construct reedbeds and other facilities to clean up the water.

In this case, we are talking about land to access and perform certain works. I presume that, in the vast majority of cases, agreements can be reached well in advance of compulsory purchase orders having to be made.

Absolutely. We see compulsory purchase orders very much as a last resort. During the feasibility process, we consider all the options, some of which centre on land. However, in some cases, because of geography and the underground situation, we are limited in that respect. It is pertinent to point out that we have been delayed in dealing with two of the most polluting discharges on SEPA's priority list because we have been unable to gain access to the land.

How likely is it that the power will be used? Are the two cases that you mentioned the only current examples in Scotland?

They are the most pressing cases, simply because they are the worst examples in the country. To be perfectly honest, I think that they are the worst examples in the UK and, under normal circumstances, we would have resolved them. However, because of access problems, we have had to resolve problems further down our list. That said, because we are working on a phased basis, we have not reached the bottom of that list, but I imagine that there will be problems further down it: there always are.

But I am sure that you will agree that the compulsory purchase option can often smooth negotiations.

It helps.

Alex Johnstone has asked many of the questions that I wanted to ask. Have you ever had to have recourse to the compulsory purchase option in England and Wales?

No.

The compulsory purchase process usually takes quite a long time. Are you prepared to comment on the nature of the powers that might be required?

We are aware that the process can be complicated and long-winded; that is another reason for it being our last resort. However, as has been mentioned, the important point is that we have the powers. People are no longer able simply to say no and to leave the matter at that. We have another option, even though we would not ordinarily choose it.

At the current rate, it will take almost 20 years to deal with the nearly 90 discharges that have still to be tackled. Should we not consider introducing enhanced compulsory purchase powers, even if only to persuade people that we are serious about dealing quickly with such matters?

We hope that under our current programme we will complete our work on the discharges by 2015. That is not quite 20 years.

As I have said, the very threat of our being able to use compulsory purchase powers will unlock the majority of situations. I genuinely do not think that we will ever exercise them.

In your submission, you say that the extra powers that you have to access land and monitor the situation will help to concentrate landowners' minds. Is that how you intend to use those powers?

We need to monitor what is happening underground. However, British Coal left us very little information about the underground water situation in some areas, which means that we have to drill boreholes at certain places. As you might imagine, the position of underground workings determines where we can drill boreholes for access. On occasion, we have found it difficult to get a certain piece of land, which has meant that we have had to compromise on where we have positioned the boreholes. Obviously, that also compromises the kind of information that we receive from below the ground, which is not as good as we would like it to be.

How does your work relate to SEPA's work as our environmental regulator? Your submission comments that it will take 20 years to deal with some of the pollution problems and says:

"This is not consistent with the … EC Water Framework Directive".

At what point does a system kick in and say that it must be done faster? You have raised a big issue.

We intend to comply with the water framework directive, and that is why 2015 is an end date for us. The polluting discharges on the list that SEPA and the Environment Agency in England and Wales have identified are programmed to have been processed by that time.

In addition, although the majority of the known discharges will have to be treated by 2015, the underground situations are developing and will develop at different rates. Some might not need anything doing with them until beyond 2015.

Equally, they might deteriorate and you would need to work on or monitor them.

That would add to the number.

How do you report discharges? To most of us, what you do is new. What is your process for communicating the level of the problem? In the Parliament, we debate environmental justice issues and SEPA bringing cases against companies that pollute the environment. Not a great deal of attention has been paid to that in Scotland in recent years, and what you have said has put it on our agenda.

We are aware that there is a public relations problem. We have six-monthly meetings with SEPA at which we go through what we have done in the previous six months. SEPA sometimes adds items to the programme and sometimes takes them off. At the local level, a planning process accompanies our construction of the schemes and there is advertising alongside that. Beyond that, it is difficult for us to get our work out into the public domain, although we use all the usual publications and take interested people round what we do. We are proud of the programme, because it has made a real difference in the 10 years that the authority has been around, but we would welcome any suggestions on how to publicise the work more.

Have any mine owners or owners of polluted land been prosecuted for not dealing with the problem or not helping you to address the issue?

That is probably a question for SEPA; I do not know.

I just wondered whether you were aware of it having happened.

Not to my knowledge.

Your work is a good way to concentrate the mind, and I know that SEPA has used it as a way of highlighting which companies have not helped them to tidy up environmental pollution.

You say that anything that you plan goes through the planning process, so I assume that you are not exempt from it.

We have permitted development powers for certain elements, but, in essence, we still go through the full planning process and end up with planning permissions and conditions like everybody else does.

There is a safeguard in that.

If you drill a monitoring borehole, what is the evidence of the hole above ground? I presume that it does not occupy a big footprint.

Most of the time, a borehole would simply be covered by a grate that we would lift up to get access to it.

So there would not even be a building above it; it would be only a hole in the ground with a cover on.

Yes, exactly that.

You talked about how important it is to get access to the roadways, but do you have reasonable plans of the mines with which you expect to have to deal?

Yes, we have. One of the authority's major functions is to provide information on coal mining, and we have a repository for all the old mining plans from British Coal and way back, so we have access to all available mine plans. As you can imagine, the more modern plans are very accurate and useful because of surveying techniques, but the older the plans get, the more unimpressive and difficult to use they are.

Are you the holding body for that information?

Yes.

When new railways, for example, are built, we keep getting nasty surprises, but as you are the repository for such information, anything that comes to light will be fed to you.

In the same way, when somebody buys a house in an old mining area, the mining report that they do comes through us. We use the information that we hold to give them that report.

Does the bill go far enough? Is there a need, or is there scope, for similar legislation to be introduced for other types of mine working?

The authority was set up, resourced and funded on the basis of coal mining pollution. We have plenty to do in dealing with that. If mines other than coal mines were to be considered, resources and budgetary concerns would have to be addressed.

In purely practical terms, the treatment of coal-mine water is similar to that of water from other mines. Our technical knowledge—again, it is something of which we are proud—is nationally and internationally renowned. Many people from various countries visit us to see how we work and what we do. We are quite capable, technically, of taking on other types of mining.

Should we be concerned about other types of mine working? Have such concerns reached your horizon?

We consult and work closely with SEPA and the EA and we know that they are concerned about other types of mining. We have no detailed knowledge on the subject as it is outside our remit.

Is it the case that all active mining operations, including opencast mines, fall under the auspices of SEPA and therefore would not be your responsibility?

That is right. In the case of closures post-1999, it is the operator's responsibility to satisfy SEPA that no pollution will result from the closure of their operation.

I thank you both for coming along and helping us to understand how the bill will be enacted and what its impact will be. Your point about the topic's low profile should be of concern to everybody. It is obvious that, although this is a big environmental issue, it is not as visible as some of the other issues that have come before us. Thank you for answering our questions and for your submission.

That concludes today's evidence-taking session. Next week, the minister will be before us. Following discussions with the clerks, we have asked the Scottish Parliament information centre to refresh the list of issues on which we might want to focus with the minister. We have covered a huge amount of ground over the past few weeks and we do not want to lose sight of any of the key issues in our questioning of the minister. In addition to looking at the bill, we will look at the consultations on the principles of charging, quality and standards III and the investment programme. The real challenge for us next week will be how to get through everything.