PAC: Water Regulator must act to secure a better deal for customers

13 January 2016

The Committee of Public Accounts today calls on water regulator Ofwat to adopt new measures intended to secure a better deal for customers.

In its Fifteenth Report of this Session, the Committee concludes Ofwat has consistently over-estimated water companies’ financing and tax costs when setting price limits.

As a result, water companies made windfall gains of at least £1.2 billion between 2010 and 2015 from bills being higher than necessary.

The Committee finds Ofwat’s efforts to ensure these gains were shared with customers “secured limited results that varied significantly” from company to company.

Financial support for customers who struggle to pay water bills also varies substantially.

Other concerns raised by the Committee include customers in areas of water scarcity paying to develop expensive new capacity, when water trading with other companies might be more cost-effective.

Among its recommendations, the Committee urges Ofwat to review its approach to setting allowances for the cost of debt and corporation tax, and report publicly on what actions it intends to take to improve its performance.

It also calls on the regulator to use comparisons with other sectors and international suppliers to develop a clearer picture of what services should cost if provided efficiently.

Meg Hillier MP, Chair of the PAC, said today: “Ofwat was set up to protect the interests of customers, most of whom have no choice over who supplies their water yet must pay bills typically running to hundreds of pounds.

“Many householders will therefore be appalled to learn these bills could have been smaller had Ofwat adopted a different approach to setting price limits for water companies.

“This approach must be reviewed as a priority. We are also calling for greater transparency over windfall gains made by water suppliers, and more effective action to see these gains passed on to customers.

“There should be consistent financial support for people who struggle to pay their water bills, which can amount to a significant chunk of household spending, and accompanying measures to ensure those people know what help is available.

“These and other concerns set out in our Report represent significant and pressing challenges for Ofwat.

“It must move swiftly to develop and present clear plans to achieve a better deal for customers, both now and in the years ahead.”

The water industry in England and Wales, privatised in 1989, now includes 18 large independent privately-owned companies who are monopoly suppliers to 22 million households and to most of the 2 million non-household customers.

The Department for Environment, Food and Rural Affairs and the Welsh government set the policy and legislative framework for the water industry in England and Wales.

Ofwat is the independent economic regulator of the water industry. Its main statutory duties include: protecting the interests of consumers; securing the long-term resilience of water supply and wastewater systems; and ensuring that companies carry out their functions and are able to finance them.

Companies are funded from customer bills and financed through private investment. Ofwat sets limits to the prices companies may charge for 5-year periods, allowing for operational and financing costs of delivering services to customers, and making assumptions about the efficiency improvements that companies should make.

The average household bill in 2014-15 was £396.

PAC REPORT SUMMARY

The Water Services Regulation Authority’s (Ofwat’s) approach to setting price limits for water companies in England and Wales has not resulted in the best possible deal for customers.

By consistently overestimating financing costs, Ofwat has allowed companies to make windfall gains which have not been shared in a structured way to ensure customers get a fair deal.

Ofwat uses comparisons between water companies to help improve overall efficiency, but acknowledges that it should do more to benchmark companies’ costs with other sectors and internationally, to ensure that the amounts customers are charged are minimised.

Ofwat should also do more to promote water trading between companies instead of developing expensive new supplies.

CONCLUSIONS AND RECOMMENDATIONS

Ofwat has consistently over-estimated water companies’ financing and taxation costs when setting price limits. As a result, companies have made substantial windfall gains from customers’ bills being higher than they needed to be. In setting water companies’ price limits, Ofwat makes allowance for investors to earn a return on capital invested. Ofwat, like other economic regulators, has repeatedly overestimated the cost of finance in successive price reviews. For the 2010 price review Ofwat also set an allowance for corporation tax charges which was not adjusted to reflect the falls in the headline tax rate that subsequently occurred. As a result, water companies made windfall gains of at least £1.2 billion between 2010 and 2015 from bills being higher than necessary. Other regulators have adopted different approaches to setting revenue allowances for tax and debt costs. For example, the energy regulator Ofgem updates these allowances annually to reflect changes in corporation tax and the market cost of debt for companies with similar characteristics to those it regulates.

Recommendation: Ofwat should review its approach to setting allowances for the cost of debt and corporation tax, taking into account the methods used by other economic regulators, and report publicly on what actions it intends to take to improve its performance.

Ofwat’s efforts to ensure that the windfall gains made by companies were shared with customers secured limited results that varied significantly from company to company. In the absence of any statutory powers to compel water companies to share windfall gains with their customers, Ofwat in 2013 sought voluntary agreements from companies to raise their bills in 2014/15 by less than the regulator had originally permitted. Only six out of the ten largest water and sewerage companies heeded this call, though the sector eventually shared some £400 million with their customers once absorbed costs and additional support for customers struggling to pay are taken into account. Ofwat did not quantify the scale of the windfall gains by company, provide guidance on what an appropriate share for their customers might be, or pass this information on to customers.

Recommendation: Ofwat should monitor water companies’ windfall gains, report publicly on their scale and set out what actions it intends to take to ensure all companies provide a proper share of windfall gains that arise in future to their customers.

Ofwat does not do enough to benchmark the efficiency of water companies against comparators from outside the sector. Ofwat uses cost data from the companies it regulates in England and Wales to set the sector’s efficiency targets. This approach has generated benefits in the past but these have diminished over time – Ofwat assumed £39 of new efficiency savings in the average household bill between 2000 and 2005, but this fell to £11 between 2010 and 2015. Ofwat’s focus on comparing the companies it regulates means it lacks evidence on whether some activities are undertaken more efficiently by international water companies or by other UK-based industries which undertake similar activities. Comparisons from these sources could result in a more exacting efficiency challenge to the water sector and lower bills for customers.

Recommendation: Ofwat should use comparisons with other sectors and international suppliers to develop a clearer picture of what services should cost if provided efficiently.

Financial support for customers who struggle to pay water bills varies substantially from company to company. For the 10% of lowest income households, water bills on average represented 5.3% of spending in 2013, compared to 2.3% for the average household. Water companies have several schemes to help customers who struggle to pay, including social tariffs which provide discounts to vulnerable consumers, paid for by slightly higher bills for other customers. Companies consult with their customers on what financial support should be provided and to whom. Currently 14 of the 18 large companies in the sector have introduced social tariffs. The water companies and the Consumer Council for Water recognise that there are varying levels of customer awareness around eligibility for these schemes which is an obstacle to take-up - especially where customers are served by different water and sewerage suppliers.

Recommendation: Defra and Ofwat should ensure that all companies provide a minimum threshold of support for low-income customers who are struggling to pay, and oblige companies to advertise clearly the support they provide to all customers. Defra and Ofwat should monitor take-up rates to identify priority areas where improvements are needed.

Customers in areas of water scarcity are paying to develop expensive new capacity when water trading with other companies might be a more cost-effective option. Since privatisation, companies have made significant investments in integrating their own water supply networks, but the volume of water traded between companies has remained fairly constant at about 4 – 5% of total supplies. The potential benefits from greater water trading are substantial: Ofwat estimated in 2010 that it could yield benefits of £1 billion over 30 years, but did not set explicit targets for the sector. Changes brought in by the 2014 Water Act will from 2019 make it easier for new entrants to provide water resources, but the lack of visible prices for water resources continues to be an obstacle to a well-functioning market.

Recommendation: Ofwat should set out what it intends to do to promote more water trading between companies and greater transparency of costs, to encourage new more cost-effective suppliers to enter the market.

The full text of the Committee’s Conclusions and Recommendations is included in the Report attached to this email.

Members of the Committee are available for pre-records and live interviews. Contact Tim Bowden on 07917 488162 / bowdent@parliament.uk 

http://www.publications.parliament.uk/pa/cm201516/cmselect/cmpubacc/505/505.pdf

http://www.publications.parliament.uk/pa/cm201516/cmselect/cmpubacc/505/50502.htm

Additional material relating to this Report can be found here. http://www.parliament.uk/business/committees/committees-a-z/commons-select/public-accounts-committee/inquiries/parliament-2015/economic-regulation-of-water-sector-15-16/

Committee membership: Meg Hillier – Chair (Labour (Co-op), Hackney South and Shoreditch), Mr Richard Bacon (Conservative, South Norfolk), Harriett Baldwin (Conservative, West Worcestershire), Deidre Brock (Scottish National Party, Edinburgh North and Leith), Chris Evans (Labour (Co-op), Islwyn), Caroline Flint (Labour, Don Valley), Kevin Foster (Conservative, Torbay), Mr Stewart Jackson (Conservative, Peterborough), Nigel Mills (Conservative, Amber Valley), David Mowat (Conservative, Warrington South), Stephen Phillips QC (Conservative, Sleaford and North Hykeham), Bridget Phillipson (Labour, Houghton and Sunderland South), John Pugh (Liberal Democrat, Southport), Karin Smyth (Labour, Bristol South), Mrs Anne-Marie Trevelyan (Conservative, Berwick-upon-Tweed)

For an overview of the Committee’s work, including open inquiries, visit the PAC home page here. http://www.parliament.uk/business/committees/committees-a-z/commons-select/public-accounts-committee/ Follow us on Twitter @CommonsPAC https://twitter.com/CommonsPAC

Watch select committee hearings on Parliamentlive.tv http://www.parliamentlive.tv/Commons

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