Annual Report 2003–04 - Regulation Body of...

A n n u a l R e p o r t 2 0 0 3 – 0 4O F T H E D I R E C T O R G E N E R A L O F W A T E R S E R V I C E S

1Ofwat Annual Report 2003–04

Presented to Parliament in pursuance of section 193 of the Water Industry Act 1991 and to the Welsh Assembly Government.

Ordered by the House of Commons to be printed 29 April 2004.

HC 522 London: The Stationery Office £11.70

A n n u a l R e p o r t 2 0 0 3 – 0 4O F T H E D I R E C T O R G E N E R A L O F W A T E R S E R V I C E S

For the period 1 April 2003 to 31 March 2004

2 Ofwat Annual Report 2003–04

To

RT. HON. MARGARET BECKETT, MPThe Secretary of State for Environment, Food and Rural Affairs

and

RT. HON. RHODRI MORGAN, AMFirst Minister, Welsh Assembly Government

Dear Secretary of State and First Minister

I am pleased to present my report on Ofwat’s work for the year ending 31 March 2004.

We are committed to taking a transparent approach in exercising our functions. Thisreport is one expression of our accountability.

The focus of our work this year has been the price review for the period 2005-10. Afterintensive preparatory work, which included your principal guidance to me, the watercompanies are now submitting their final business plans. Our challenge in the yearahead is to set limits that enable well-managed companies to finance their functions andencourage them to perform well, but to impose no greater burden on the customers ofthese monopoly companies than is necessary.

During the year, the Water Act 2003 passed through Parliament and received RoyalAssent. We offered advice during its preparation and on its progress through bothHouses. We shall now work with your officials on its implementation. In particular, we aretaking a leading role in the development of the regime for price competition in the watersector. We shall also co-operate in the establishment of a new Consumer Council forWater, wholly independent of Ofwat, which will succeed WaterVoice from October 2005,and of the new structure for Ofwat under a Water Services Regulation Authority fromApril 2006.

Our work of monitoring the companies’ performance and responding to proposals forcompanies’ corporate and financial restructuring continues. Protecting the interests ofcustomers remains central to our role, working closely with WaterVoice.

Philip FletcherDirector General of Water Services

Office of the Director General of Water ServicesCentre City Tower, 7 Hill Street, Birmingham B5 4UA

Tel: 0121 625 1300 E-mail: [email protected] Fax: 0121 625 1348


Contents

Director’s review 5

1. Price setting 8

2. Protecting customers 14

3. Safeguarding quality and service 20

4. Companies’ finance and mergers 25

5. Price competition 29

6. The Water Act 2003 32

7. Communications 33

8. Resources 37

Appendices1. Ofwat’s milestones 2003-04 43

2. WaterVoice committees 45

3. Independent reporters and auditors 46

4. The water and sewerage companies 47

5. The water only companies 48

6. Ofwat administrative costs 49

7. Ofwat staff numbers 49

8. Ofwat structure 50


Our visionA water industry that delivers a world-class service, representing best value to customersnow and in the future.

Our missionTo regulate in a way that provides incentives and encourages the companies to achievea world-class service in terms of quality and value for customers in England and Wales.

How we do itBy:

● Setting price limits at levels which:

– enable well-managed companies to finance the delivery of services in line withrelevant standards and requirements;

– provide incentives for companies to improve efficiency and service delivery;

– share the benefits between customers and investors.

● Ensuring that we are aware of stakeholders’ views and priorities by consulting withcustomer groups, the industry and others, and undertaking customer surveys.

● Facilitating the development of competition to promote further efficiency gainsand, where practicable, further choice for customers.

● Working with the quality regulators to make sure that Ministers have theinformation they need to set the quality improvement programme within a long-term framework.

● Ensuring that customers’ tariffs are fair and do not unduly discriminate or showpreference to any class of customer.

● Handling disputes and complaints involving the companies economically,effectively and fairly.

● Monitoring the companies’ performance and taking action, where necessary, toprotect the interests of customers and other stakeholders.

● Openly and transparently publishing information, which allows customers andother stakeholders to have their say in regulatory decisions.

● Making sure that Ofwat delivers best value in its regulatory role and by valuingand encouraging the development of its entire staff.

● Assessing company performance by making appropriate comparisons betweenthe regulated companies, drawing on relevant information from other sectors andfrom international comparisons where available.

This year has been a period of intensivepreparation for setting price limits for thewater and sewerage companies for 2005-10. We have carried out researchand refined the options. Draft companyplans have been subjected to analysis,and to constructive dialogue with thecompanies and other stakeholders.During the year, the new Water Act hasalso passed through Parliament andreceived Royal Assent. Amongst otherimportant reforms, it will make changes toOfwat’s constitution and functions, andestablish a new framework forcompetition.

Our approachWe remain committed to the BetterRegulation Task Force principles ofaccountability, transparency,proportionality, consistency and targeting.

Our primary accountability is toParliament. We have, for example, givenoral evidence five times in the year to fourdifferent Parliamentary Committees onsubjects ranging from regulatoryaccountability to the price review, and tothe very unpleasant consequences ofsewer flooding in customers’ homes.

We are also accountable in a wider senseto all of our various stakeholders.Although by law our decisions are madeindependently of others, all of our keyissues are subject to appropriate priorconsultation, including the key regulatorydecision on company price limits.

If those decisions are to command generalassent, they must be approached in a waythat is transparent and consistent. Thus, forthe price review we have released our newfinancial model to companies and others,to clarify the processes underlying pricesetting. We have set out our approach tothe review and kept stakeholdersinformed of developments.


Director’sreview

To help ensure that our approach istargeted on those issues of most concernto customers, we have conducted marketresearch with Government, the qualityand environmental regulators, theindustry and representatives of customersand environmental groups into customerattitudes to prices. The findings showedgenerally high levels of satisfaction withcurrent services and gave indications ofthe willingness of customers to pay forthe proposals in their local companies’business plans. We also ensure that ourlimited resources focus on necessaryregulation – and avoid getting drawn intodetails more appropriate to management.

We have also sought to be proportionate,concentrating our action where it will havemost effect. For example, we have set ourown leakage targets only where these arenecessary as part of a programme toreturn to economic levels of leakage.

Setting price limitsOur primary statutory duty obliges us toset price limits that would allow efficientcompanies to finance the functions theyare required to carry out. At the sametime, for the customers of monopolycompanies, prices should be no higherthan they have to be. Key inputs to theprice review in the past year have beenthe submission of the companies’ draftbusiness plans, the confirmation of ourapproach to incentives, and theministerial guidance on the programme ofcapital investment which the companiesare expected to carry out (for the mostpart to meet the UK’s statutory obligationsin international law). The guidance waslater than had been expected, and hasrequired some adjustment to thetimetable for the final stages of the review.

Final business plans are now beingsubmitted by the end of April. They will bethoroughly scrutinised and I shall publishdraft price limits on 5 August and finallimits on 2 December 2004. The finaldecisions will take account of

representations made and of any finalguidance which the Secretary of Stateand Welsh Assembly Government maygive to me.

In the light of the information alreadyavailable before the final business plans,it is clear that price limits for mostcompanies will need to rise, in somecases significantly. Increases will beneeded to take account of additionalpressures to maintain day-to-day servicesin the face of significant extra costs,including tax changes; to ensure that thecompanies’ infrastructure remains fit forpurpose; and to finance the newinvestment programmes that Ministershave indicated are needed to improve theenvironment and water quality. Offsettingsavings from efficiency gains will not beas significant as at the last review. Manyof the easier gains have already beenmade. To sustain potentially very largeinvestment programmes, the companiesmust continue to be able to raise theappropriate finance. In setting appropriateprice limits, I shall need to take accountof the assessments of risk by investorsand lenders.

Currently, average prices for watercustomers are still lower in real termsthan they were in 1999. The prospect ofsignificant real term increases from 2005raises issues about the affordability ofbills, especially for less well-off customersin those regions where company bills arehighest. While we cannot set price limitsby reference to what customers canafford, we welcome the Government’scommitment to review aspects ofaffordability and will take a full part in thatwork.

Water Act 2003We offered technical advice on relevantissues during the preparation of thelegislation and the passage of the WaterAct through Parliament, both toGovernment and to Members who soughtour views.


During the year, we have begunpreparations to implement the newcompetition provisions in the Act and wehave participated with the Department forEnvironment, Food and Rural Affairs(Defra) and the Welsh AssemblyGovernment in the initial studies for thenew independent Consumer Council forWater, which will succeed WaterVoicefrom October 2005. We also stand readyfor the implementation of the WaterServices Regulation Authority, which willbecome statutorily responsible for ourwork from April 2006.

Regulatory monitoring andcomparative competitionThe essence of Ofwat’s approach to itstask is to provide incentives – carrots andsticks – to companies to enhance theirperformance, become more efficient, andprovide good services and good value formoney for customers. The 22 watercompanies, ten of which are alsoresponsible for sewerage services,provide worthwhile comparators whichstrengthen the basis of regulation. Wehave developed further our comparisonswith other countries, and report onrelative performance in England andWales against water services in Scotland,Australia, the Netherlands and the USA.In general, companies here areperforming as well as, and in some casesbetter than, their internationalcounterparts.

Company structuresIt is not for Ofwat to manage companiesor to establish their structures andfinancing provision. However, we respondto company proposals in the interests ofcustomers. We have, with Defra,commissioned research into trends inownership and financing, especiallyfollowing the trend to highly gearedstructures.

On mergers, we have seen continuingdevelopments in ownership within thesector. We have commissioned researchon the impact of mergers between watercompanies; research which indicated thatbigger does not always mean better.

ConclusionThis has been a demanding year for staffin Ofwat and WaterVoice, and the mostchallenging time is still to come as theprice review is completed andorganisational changes are made. I amvery grateful for the work of the staff ofboth Ofwat and WaterVoice, and toWaterVoice Chairmen and members, whogive their time voluntarily to representingcustomers.

Philip FletcherDirector General of Water Services


Price setting was the central focus of ourwork this year.

In December 2004 we shall set price limitsfor the water and sewerage companies forthe five years from 2005-10. The price limitis the percentage price change above therate of inflation that a company is allowedto charge its customers each year.

Our aims in this review

We aim to set price limits that providebest value for customers now and inthe future. We intend to:

● enable well-managed companies tofinance the delivery of services inline with relevant standards andrequirements; and

● provide incentives for companies toimprove efficiency and servicedelivery.

We recognise that there are many upwardpressures on customers’ bills at thisreview. We are committed to setting pricelimits that are high enough to enablecompanies to finance and run theirbusinesses, but no higher than they needto be for customers.

Managing the reviewprocessWe are making steady progress in linewith the framework we set out last year1.We organised the review in four phases:

● Phase 1 – framework and issues,

● Phase 2 – assessing the draft businessplans and market research,

● Phase 3 – decisions anddeterminations,

● Phase 4 – implementation.

This year we have completed phases 1and 2.

Figure 1 sets out the timetable for thereview.

In August, we issued a joint statementwith other regulators and Government2.This statement outlined the next stages ofthe review and explained to stakeholdersand the public how to get involved indeciding the scale and scope of thequality enhancement programme. It setout some key questions. We received 158responses; 33 from organisations and125 from individuals. The responses areavailable on our website. Most of thosewho responded supported furtherenvironmental improvements. Manyaccepted that this would increase bills.


1 ‘Setting water andsewerage price limits for2005-10: Framework andapproach’, March 2003.

2 ‘Setting water andsewerage price limits – Ajoint statement’, 12 August2003. Issued with Defra,Welsh AssemblyGovernment, theEnvironment Agency,English Nature, the DrinkingWater Inspectorate, theCountryside Council forWales.

CHAPTER 1

Price setting

The draft business plansThe companies submitted their draftbusiness plans in August 2003. The plansaimed to show the potentialconsequences of the key issues thatremain to be resolved in the price review.

Each plan set out the company’s ownpreferred strategy and one (or for thelarger companies, two) reference plans.

Each company also published asummary. This set out the company’sobjectives for the period 2005-10, thequality and service improvements itplanned to make and the implications forcustomers’ bills and for price limits. Thesesummaries helped all stakeholders tounderstand the issues the companiesface and informed the public debate thatfollowed.

To help companies draft their plans, weissued an update of our financial model,and guidance on the assumptionscompanies should use in their referenceplans about the scale of the quality

programme and other variables such asefficiency, and the cost of financinginvestment.

We published a summary of all of thecompanies’ draft business plans inOctober 2003, setting out the key issuesarising from our preliminary analysis ofthe plans. It was clear that there werehard choices to be made – and potentiallysignificant bill increases if the proposedambitious investment programmes wereconfirmed3.

The draft business plans provided thebasis for four strands of work through theautumn and remainder of the financialyear:

● understanding customers’ priorities,

● feedback to companies,

● advice to Ministers and Ministers’guidance,

● preparing for final business plans.


3 ‘Setting water andsewerage price limits for2005-10: Overview ofcompanies’ draft businessplans’, October 2003.

APR

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FeedbackCompaniessubmit draft

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limits and publishmonitoring

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Principalministerialguidancearrived

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Figure 1: Timetable for the 2004 price review

Understanding customers’priorities We use market research to help us tounderstand customers’ views. With eightother major stakeholders4, we conductedthe second joint market research survey5

for the price review. In December 2003,we published the results of the survey of6,000 customers6. We asked customers’views about the services they receivenow, and about proposals in their localwater company’s business plan for thenext five years, including the impact ontheir bills.

Satisfaction with current services wasgenerally high. Nationally, customersconfirmed the importance of maintainingcurrent levels of service. They alsowanted to see some improvements. Giventhe costs of plans, they gave mostsupport to drinking water quality andsupply aspects, followed by maintaining

water and sewerage systems. They gaveless support to environmentalimprovements and customer service.Most customers stated that they weredefinitely, or probably, willing to pay theprice increases associated with the plans,but a significant proportion were not. Onein ten customers said that they could notafford the price increases. Willingness topay went down as costs rose.

Feedback to companies Preparing the draft business plans was aconsiderable task for the companies.During the autumn we provided eachcompany with detailed written feedbackon its draft plan, and we met companyrepresentatives to discuss issues arising.

Advice to Ministers andMinisters’ guidance Government Ministers and the WelshAssembly Government each provideguidance on the scope and timescale fornew water quality and environmentalimprovements. Following their initialguidance7, the environmental and waterquality regulators established the detailedprogrammes that companies would, ormight have to, deliver8. These listsinformed the companies’ work on theirdraft business plans.

Like WaterVoice and the environmentalregulators, we offered advice to Ministerson the implications for customers ofquality improvements.

In December 2003, we wrote an openletter to Ministers9, setting out ourconcerns about the potential priceincreases. The letter was informed byscrutiny of the companies’ draft businessplans, the results of the latest marketresearch, the environmental regulators’publication ‘A good deal for water’ andthe Drinking Water Inspectorate’s (DWI’s)plans for improvement to drinking water.We set out as an illustration the effect on


4 Defra, Welsh AssemblyGovernment, theEnvironment Agency,English Nature, the DrinkingWater Inspectorate,WaterVoice, Water UK,Wildlife & Countryside Link.

5 The first research survey:‘The 2004 periodic review:research into customers’views’, November 2002.

6 ‘Customer research 2003:periodic review – nationalreport’ (MVA, WRC),December 2003.

7 ‘Initial guidance from theSecretary of State to theDirector General of WaterServices: 2004 periodicreview of water price limits’,Defra, January 2003 & ‘Initialguidance from the WelshAssembly Government tothe Director General ofWater Services on the 2004periodic review of waterprice limits’, WelshAssembly Government,March 2003.

8 The Environment Agencywith English Nature &Countryside Council forWales, produced‘Environmental Drivers forthe 2004 periodic review’ v3(RD 15/03, 15 April 2003).The companies madeproposals to the DWI on thework they thought theyneeded to do to improvedrinking water quality. TheDWI considered these andconfirmed the programme tobe included.

9 ‘Advice to inform theprincipal guidance on scaleand timing of further qualityenhancement’, December2003.

Figure 2: Percentage of bill-payingcustomers willing to pay for thecompany’s own preferred plan

Definitely not willing to pay 14%

Probably not willing to pay 19%

Probably willing to pay 46%

Definitely willing to pay 14%

Don’t know/can’t say 7%

price limits of constraining capitalinvestment to around £15 billion (roughlycomparable to capital spending between2000 and 2005).

In March, nearly six weeks later than hadbeen expected, Ministers issued theirprincipal guidance on the qualityprogrammes that the companies wouldneed to deliver10. The scale of theprogrammes envisaged lies between thesmaller and the larger referenceassumptions in the draft business plansand above the level sought by thecompanies in their preferred strategies.The Environment Agency and the DWIhave since clarified the implications of theguidance on which schemes are required.

The delay to principal guidance fromMinisters has affected the rest of thereview timetable. Following discussionwith the companies, we have agreedrevised submission dates for the finalbusiness plans. Publication dates for thedraft and final determinations have beendeferred to 5 August and 2 December2004 respectively.

Early start

Previous reviews had beencharacterised by severe troughs incapital investment profiles. For thecurrent review, we introduced an earlystart initiative to reduce (though it willnot eliminate) those troughs. Thisinitiative defined some of the outputsthat the companies would deliver inthe early part of the new price reviewperiod. We told companies the capitalexpenditure we would include forthese outputs in December 2003. Thisinitiative was supported by all parties.

Preparing for final business plansThe final business plan is the keydocument from each company for theprice review. It sets out the company’spreferred strategy for 2005-10, and in thelonger term. We met with each companyto discuss the key issues in its businessplan while the plan was being prepared.

In preparing for the final business plans,which would be submitted by the end ofApril 2004, we carried out further work on:

● future efficiencies;

● incentives;

● cost of capital;

● linking prices to service; and

● possible licence modifications needed.

Future efficiencies

Understanding the scope for futureefficiency is an important part of pricesetting. In the last year, we havecommissioned and published (on ourwebsite) further work from EuropeEconomics11, London Economics12, andStone & Webster13.

In addition, companies’ draft businessplans contained important information onhow the industry sees the potential forfuture efficiency.

Incentives

Regulatory incentives have to simulatethe pressures and rewards found in anormal competitive market. Suchincentives need to evolve to meet thechanging environment. We consulted onour approach to rewarding futureoutperformance and handlingunderperformance against regulatoryexpectations14. We published ourconclusions in March 200415.


10 ‘Principal guidance fromthe Secretary of State to theDirector General of WaterServices – 2004 periodicreview of water price limits’,March 2004 & ‘Guidancefrom the Welsh AssemblyGovernment to the DirectorGeneral of Water Serviceson the 2004 periodic reviewof water price limits’, WelshAssembly Government,March 2004.

11 ‘PR04: Scope forefficiency improvement –uncertainties andmeasurement issues’,(Europe Economics),November 2003.

12 ‘PR04: Scope forefficiency improvement –final report to Ofwat’(London Economics, Black& Veatch Consulting, Prof.Maurice F Shulter),December 2003.

13 ‘Investigation intoevidence for economies ofscale in the water andsewerage industry inEngland and Wales’ (Stone& Webster), January 2004.

14 MD 187, 24 June 2003.

15 MD 191, 26 March 2004.

Cost of capital

We commissioned Cambridge EconomicPolicy Associates and Europe Economicsto advise us on the cost of capital andrelated issues. We set out guidance forthe companies in March 200416. We havesaid that we believe there is no strongcase for setting the basic cost of capitalat a lower level than at the last review.

Linking prices to service

Our annual assessment of performanceleads to price adjustments at a pricereview. This gives companies theincentive to maintain service to customersby linking prices to service delivery. Weassess how each company’s servicelevels compare with the rest. During theyear, we consulted on proposals toupdate our overall performanceassessment (OPA)17. Some of theproposals take account of changinglegislation, such as satisfactory disposalof sewage sludge. Others updatemeasures to reflect improvements toservice monitoring, such as thedevelopment of a qualitative customersurvey about telephone call handling.Stakeholders broadly accepted theseproposals. In March, we published ourconclusions and set out our methodologyfor the OPA for 2004-05 to 2008-0918.

Possible licence modifications needed

In March, we consulted on modificationsto companies’ licences associated withthe price review19. We shall publish ourresponse to the consultation with the draftdeterminations.

Monitoring planinformation requirements Each company will publish a monitoringplan in March 2005, or later if it seeks aredetermination of its price limits at theCompetition Commission. This plan willset out for customers the service that will

be delivered within the new price limits.This will enable WaterVoice and others toassess the companies’ performance. Weare currently considering responses toour consultation20 on the informationrequirements for these plans. We willissue our conclusions in the autumn of2004.

Price changes betweenreviews

Ofwat can reassess price limitsbetween reviews if a company’s costsor revenues change materially inspecific areas. This is an interimdetermination. Either Ofwat or acompany can initiate an interimchange subject to strict criteria.

We wrote to the companies in May 200321,setting out our approach to interimdetermination applications for the year.Subsequently Anglian Water Services,Northumbrian Water and United UtilitiesWater submitted applications. We alsoreceived applications from NorthumbrianWater and Bournemouth & WestHampshire Water under the substantialeffect or ‘shipwreck’ condition of theirlicence of appointment.

We scrutinised the applications andpublished draft conclusions in November(and in January for Bournemouth & WestHampshire). In the light of these, AnglianWater decided to withdraw its applicationand its price limits for 2004-05 remainunchanged. We discussed theapplications with the respectiveWaterVoice committees and, after carefulconsideration, announced new pricelimits for Northumbrian Water and UnitedUtilities Water in December, and forBournemouth & West Hampshire Water inFebruary.

Both Northumbrian Water andBournemouth & West Hampshire Waterdemonstrated that their businesses


16 MD 190, 19 March 2004.

17 ‘Updating the overallperformance assessment(OPA) – A consultation’,December 2003.

18 ‘Updating the overallperformance assessment(OPA) – Conclusions andmethodology for 2004-05onwards’, March 2004.

19 MD 189, 3 March 2004.

20 RD 40/03, 17 December2003.

21 MD 186, 1 May 2003.

suffered substantial adverse effects,which were beyond management control.They had received less income than wasforecast from metered customers and asa result of large businesses closing.These new price limits were the first givenunder the substantial effect clause.

We are consulting on changes to thecalculation of the materiality thresholdboth for conventional and substantialeffect determinations, to ensure that thebalance and risk between companies andcustomers remains appropriate22.

Mid Kent Water and Sutton & EastSurrey Water agreed to adjust pricesfor 2005-10 to return benefits tocustomers that have accrued in 2000-05. This removed the need for aninterim determination in 2003-04 torecover these amounts.


22 MD 189, 3 March 2004.

Working closely withWaterVoice WaterVoice, through its ten statutoryregional committees and the WaterVoiceCouncil, represents the interests ofcustomers. Although currently maintainedby Ofwat, WaterVoice speaks as anindependent body dealing with consumerissues regionally, nationally and inEurope.

We work closely with WaterVoice under amemorandum of understanding. We valuetheir input on behalf of customers on awide range of regulatory and consumerissues.

WaterVoice’s views were particularlyinfluential in:

● assessing the quality of service tocustomers, based on sample audits andother assessments;

● providing a customer perspective on theprice review;

● providing options to enhance existinglevels of service;

● bringing to our attention customerservice issues that may require us toexercise our power; and

● monitoring implementation ofregulations to protect vulnerablegroups.

This year we have carried out customerresearch with WaterVoice and others on:

● customers’ priorities and willingness topay for companies’ planned workprogrammes over the next five years23;

● customer debt24 and;

● sewer flooding25.

As a result of the Water Act 2003,WaterVoice will become fully independentof Ofwat. Defra is leading a teaminvolving WaterVoice, Ofwat and theWelsh Assembly Government to managea smooth transition to the neworganisation.

Complaints and disputes WaterVoice deals with most complaints.Ofwat settles and reviews somecomplaints and disputes.

Ofwat dealt with 391 formal and 115 informal complaints and disputes in 2003-04. We obtained compensation andrebates amounting to £151,000.

We held complaint workshops in May andOctober for WaterVoice members andstaff.

We received four complaints thatWaterVoice had been unable to resolvewith the companies. Nine complaints hadbeen carried forward from the last year.


23 PR04: Customerresearch, December 2003.

24 ‘Paying for water’,(Accent Marketing &Research), September 2003.

25 ‘An investigation intocosts of sewer floodingalleviation schemes’,November 2003.

CHAPTER 2

Protectingcustomers

We dealt with 11 complaints andsupported WaterVoice’srecommendations in ten. The companiesaccepted our recommendations and weobtained compensation totalling £42,612.In one case, we were unable to supportWaterVoice. Two cases are ongoing.

We dealt with 66 complaints fromcustomers who were not satisfied withWaterVoice’s investigations. We upheldthree of these complaints and partlyupheld eight. We obtained compensationor rebate for the complainant from thecompany in 15 cases. Five cases areongoing. We did not uphold theremaining cases. We are satisfied thatthere is no evidence of significantshortcomings by WaterVoice in itscomplaint handling.

Connection charge disputes

Companies are entitled to recover thereasonable costs of making connectionsto water mains. Disputes may be referredto the Director for determination.

Of the five disputes closed, all were settledin favour of the customer. We requiredcompanies to make refunds to customersranging from 3% to 31% of the originalcharge (an average refund of 13%).

Of the 30 cases we referred to thecompanies to review their chargesinformally, 11 resulted in refunds to thecustomer.

Sewer appeals

If a company refuses to adopt acustomer’s sewer as public, the customermay appeal to the Director.

We dealt with 21 appeals and 36enquiries during the year.

Trade effluent appeals

Traders can appeal to the Director if acompany refuses permission to dischargeeffluent into a public sewer.

Six cases were brought forward from lastyear and we have received 10 new cases.One was resolved formally and seveninformally or withdrawn. The remainingeight are also likely to be resolved withoutthe need for a hearing.

Complaints about pipe laying instreets

We received 15 complaints, none ofwhich required formal arbitration.

Complaints about pipe laying inprivate land

One case was resolved formally with anaward of £2,000. We resolved 67 casesinformally, usually by the companyagreeing additional compensation, ordoing further reinstatement work.

Guaranteed Standards Scheme (GSS)disputes

Customers are entitled to guaranteedstandards of service, as laid down byGovernment. If a company fails tomeet any of the guaranteedstandards, customers can claim acompensation payment. We monitorthe scheme and recommend changes.

We settled two disputes under the GSS,one in favour of the customer. Weresolved a further eight cases informally.

New powers to determine disputes

The Water Act 2003 gives the Directorpowers to determine a new range ofdisputes. These include the terms andfinancial conditions of water, sewer andlateral drain requisitions26, the terms andfinancial conditions of self-lay agreementsand refusals by water companies to adoptself laid pipes supplying water fordomestic purposes27. Following theconsultation, we will be issuing guidance.


26 ‘Consultation paper onthe financial arrangementsfor self-lay and requisitioningagreements’, December2003.

27 ‘Process for handlingdisputes and appeals:Requisitioning of watermains and public sewers’,December 2003.

Sewer flooding During the year, we agreed with companiessubstantial work to address sewer floodingproblems in the next three years. We havealso worked with companies to understandtheir longer term plans.

We commissioned studies into the costsand economic benefits of alleviatingsewer flooding28.

The House of Lords gave their judgementon the sewer flooding case, Marcic vThames Water29. This case concerned aclaim by a customer for damages from asewerage company caused to hisproperty by repeated external sewerflooding. The Lords unanimouslydismissed the appeal and concluded thatcustomers suffering from sewer floodingdo not have a cause of action under thecommon law of nuisance or under theHuman Rights Act 1998. The Lordsacknowledged that the regulatory systemestablished by Parliament is theappropriate route for dealing with suchissues as it allows the Director to balancethe interests of flooded customers againstthose of customers generally as allcustomers would have to pay to solve theflooding problem. We and WaterVoicehave reviewed our arrangements forhandling sewer flooding complaints in thelight of the Marcic judgement.

We welcome the National Audit Office(NAO) study into sewer flooding30. We willcarefully consider the conclusions of thePublic Accounts Committee whose reporthas yet to be published.

We held a seminar on compensation,insurance and ways to reduce the impactof sewer flooding. We invitedrepresentatives from WaterVoice, thecompanies, Defra and the insuranceindustry. We discussed issues including:the customer perspective of a floodingincident, and the balance betweeninsurance, the Guaranteed StandardsScheme and other compensationpayments to those flooded. We alsoshared good practice in reducing the

damage caused when flooding occurs andways to avoid flooding within properties.We will continue to work on these issueswith the industry and expect to hold afurther seminar later this year and toaddress the issues in setting price limits.

Social issues Services to disabled or elderlycustomers

Companies have procedures to ensurethat support is available to customers withadditional needs.

In June 2003 we published the findingsand recommendations of WaterVoice’sreview of our guidelines on services fordisabled or elderly customers. These setout the essential elements thatcompanies are expected to adhere to inorder to meet these customers’ needs.

The review found that most companieswere following the guidelines, but thattake-up varied significantly. Itrecommended work to increaseawareness of the availability of specialservices, and to encourage stronger linkswith care and advice agencies toencourage take-up. We published revisedguidelines following consultation31.

Affordability

Various stakeholders have raisedconcerns about the affordability of waterfor households, particularly in light ofpotential price increases.

The Environment, Food and Rural AffairsCommittee, in its report on water pricing32,recommended that the Governmentshould review how poorer households arehelped with their bills. An inter-governmental steering group wasestablished, lead by Defra. We arecontributing to the review.


28 ‘An investigation intocosts of sewer floodingalleviation schemes’,November 2003.

29 Marcic v Thames WaterUtilities Ltd, 4 December2003 [2003], UKHL66.

30 ‘Out of sight, not out ofmind – Ofwat and the publicsewer network in Englandand Wales’ (NAO), January2004.

31 RD 23/03, June 2003.

32 ‘House of CommonsEnvironment, Food andRural Affairs CommitteeWater Pricing – First Reportof Session 2003-2004’,HC121 (2003-04), December2003.

Payment options

Access to suitable payment arrangementsis important, particularly for low-incomecustomers. Our monitoring shows that allcompanies continue to offer a wide rangeof payment methods, frequencies andpayment locations.

A number of companies proposed tointroduce, or increase, charges for‘payment related’ activities. These includecharges for dishonoured cheques orcancellation of direct debit agreements.We compared the level of chargesbetween companies, and encouragedthose with higher charges to reduce them.

We continued to work with the companiesand the Department for Work andPensions (DWP) to ensure adequatepromotion of ‘Water Direct’, wherebycustomers in debt and on benefit mayhave their water bills paid direct by DWPto the company. Improvements in theoperation of this scheme have resulted,for example, in the introduction of astandard application form, and a revisedJoint Statement of Intent, which sets outhow the scheme operates between thewater companies and the DWP.

Customers in debt

Following the abolition of disconnectionsfor domestic customers, the companieshad to review their debt recoveryprocedures, to make sure that they couldcollect debt from customers efficiently.

WaterVoice audits companies’procedures to see whether they areconsistent with our debt recoveryguidelines33. We hosted a debt auditworkshop for WaterVoice to helpcommittees to audit cases consistently.

We collect and publish companyinformation about the number ofcommercial water disconnections and thetotal level of debt recovery actionsrelating to domestic customers.

Levels of outstanding revenue and thecost of debt recovery continue to rise.

Debt levels and associated recovery costsin 2002-03 were higher than for 1998-99,the last full year before the ban ondisconnection. We are working with theindustry to improve information qualityand understanding about water debt.

We attended Water UK debt focus groups,to discuss debt issues with industryrepresentatives. We have also joined theproject steering group for Water UKresearch into the socio-economiccharacteristics of customers in debt.

Research on debt

In September 2003, we published nationalqualitative research with WaterVoice andWater UK, exploring customers’ views onpaying for water and debt. The researchcombined face-to-face interviews andfocus groups34. The bill for water was asimportant to customers as those for gasand electricity, after the top priorities of rentor mortgage and Council Tax. Customerswith water debt often had multiple debtsand continually juggled bills. Frequent,effective communication was found to bekey in encouraging prompt, regularpayments. WaterVoice is working with thecompanies to follow up the findings.

Water ingress to gasmainsWe worked with stakeholders to developa memorandum of understanding, settingout roles and responsibilities when wateraccidentally enters gas pipes. Thememorandum sets out how watercompanies and Transco will worktogether to help customers by removingthe water and restoring gas servicesquickly and safely.

Approving chargesschemes Within the overall price limits, eachcompany decides its own individual


33 ‘Dealing with customersin debt – guidelines’,October 2002.

34 Research carried out byAccent Marketing andResearch: ‘Paying for water’,September 2003.

charges and publishes these in an annualcharges scheme. To ensure thatcustomers are protected, we check andapprove each scheme before it ispublished. Companies submit drafts oftheir charges schemes, together with theirprincipal statements, which set out theircharges in detail. We scrutinise these toensure that charges:

● comply with price limits;

● reflect costs; and

● are consistent with guidance from theSecretary of State.

We consulted the WaterVoice committeeson companies’ charging proposals. Wesubsequently approved companies’ 2004-05 charges schemes in February 2004.

Full details of our approach to chargesschemes, together with information oncharges and tariffs, are set out in ourtariffs report35.

Reviewing companychargesOur main role in tariff policy is to ensurethat companies comply with licenceconditions. Companies must show neitherundue preference nor discrimination intheir charges.

The measured/unmeasured householddifferential

We reviewed the measured/unmeasuredhousehold tariff differential. Thisdifferential compares the averageunmeasured bill with the amount anaverage unmeasured customer wouldpay if they were metered. We use thiscomparison to check whether the balancebetween measured and unmeasuredcharges is fair. This year we havereviewed how to calculate the differential.We consulted on proposals, andpublished our decisions in January36. Thechanges take effect in 2005-06. They willresult in a fairer balance, taking accountof company-specific circumstances.

Non-household policy issues

Companies are developing new standby,interruptible and subscribed demandtariffs for business customers. In February2003, we consulted on our policy. Wetook account of comments and publishedour conclusions in August 200337.

We introduced changes, including a newcheck of standby charges, and weagreed to consider proposals for short-term interruptible tariffs.

We hold regular meetings withbusiness customers. We valueopportunities to listen to their views,and to update them on relevant policydevelopments.

Charging for surface water drainage

Companies adopt a variety of approachesto charging for surface water drainage.We reviewed those approaches andconcluded38 that, for non-householdcustomers, charges based on the sitearea of premises are preferable becausethey are cost-reflective and give thestrongest incentive to customers toreduce costs. We urged the companies toconsider this approach.

Licence condition B

We consulted on two proposedmodifications to licence condition B whichconcern charges. Licence condition Boperates in such a way that companiesare able to increase charges to othercustomers when they introduce new,below-average charges that add to thenumber of chargeable supplies. One ofthe modifications was to remove aloophole, which would allow companiesto secure, in effect, a bigger price limit asa result of this. The other modificationwas to ensure that large user charges aretreated consistently in companies’ annualprincipal statements and in the Junereturn39.


35 ‘Tariff structure andcharges report’, May 2003.

36 RD 02/04, 21 January2004.

37 RD 31/03, 27 August2003.

38 RD 35/03, 1 October2003.

39 MD 189, 2 March 2004.

Vulnerable groupsUnder government regulations, meteredcustomers receiving specified benefits,and who use a lot of water due to havinglarge families or certain medicalconditions, can opt for a capped tariff.Although we have continued to ensurethat companies advertise the availabilityof this tariff, uptake remains low.

The regulations changed in April 2003.We checked companies’ chargesschemes to ensure that their literaturereflected the introduction of the newqualifying benefits.

We responded40 to Defra’s consultationpaper ‘Reductions for vulnerable groups’,which proposed to extend the assistanceavailable to vulnerable customers. Wesupported a number of the proposals. Weawait Defra’s conclusions.

Water Resale Order The Water Resale Order 2001 protectscustomers who pay someone else – suchas their landlord – for their water andsewerage services rather than thecompany direct. This year, we formallydealt with over 100 queries from resellersand purchasers about how chargesshould be set.

At our request, the Water Act 2003included new provisions allowing us tospecify the information that resellersshould provide to customers explainingtheir bills. We will also be able to requirepayment of interest on excess charges.


40 ‘Ofwat response to Defraconsultation on thereductions for vulnerablegroups’, May 2003.

Comparative competitionWe use comparative competition toimpose on the monopoly companies aproxy for pressures that would exist in afree market for water and sewerageservices. There is a sufficient number ofcompanies to enable us to promoteeffective comparative competitionbetween them. We also compare ourcompanies with a number of companiesfrom overseas.

We monitor company progress indelivering the outputs and efficiencies weexpect from them. We compare theirperformance and set challenging goals.We encourage them to outperform ourexpectations.

Together with the environmental andwater quality regulators, the EnvironmentAgency and the DWI, we have developedmany comparative tools covering nearlyall aspects of the monopoly businesses.These tools range from simplecomparative measures (of reportingcompliance with quality requirements; ofservice; and of average bills), throughconsolidated indicators (such as ouroverall performance assessment), tocomplex statistical models.

All of the tools we use rely on goodquality and comparable information fromeach company. We achieve a high

standard of information through oursubstantial information requirements, andthrough scrutiny by reporters andauditors.

We have well established reportingprocedures. We collect the information weneed annually from the companiesthrough:

● the principal statement, which detailstheir charges for the forthcoming year;

● the annual charges scheme;

● the June return; and

● regulatory accounts.

In 2004-05, we plan to review our annualinformation requirements to ensure thatour data collection is optimal and doesnot place an unnecessary burden oncompanies.

In its June return, each company setsout the achievements in its regulatedactivity: on service to customers,spending and performance.

The Agency and the DWI also give us anannual report on the companies’ progressin delivering required enhancements. Wepublish our analysis of the data in ourannual performance reports. We alsorelease the data used for the analysis,


CHAPTER 3

Safeguarding qualityand service

thus enabling others to review, repeat andchallenge both our analysis and findings.We make the majority of information inthe June return available to the public. Upto 2003, we have produced a CD ROM aswell as placing the return in the Library.This year we also ran a successful pilotproject to put key June return public dataon the web. From 2004, the whole publicdomain June return will be accessiblethrough our website.

We published our five main annualreports, so that customers, WaterVoiceand other interested parties can seehow the companies are performing.They include details of regulatoryaction.

‘Tariff structure and charges 2003-04’,May 2003.

‘Financial performance andexpenditure of the water companies inEngland and Wales 2002-03’, August2003.

‘Levels of service for the waterindustry in England and Wales 2002-03’ September 2003.

‘Security of supply, leakage and theefficient use of water 2002-03’,October 2003.

‘Water and sewerage service unitcosts and relative efficiency 2002-03’,January 2004.

Monitoring operating andcapital maintenanceexpenditure and efficiency We believe that the efficiency regimecontinues to give companies the incentiveto drive down costs and improveefficiency. We monitor the companies’operating and capital maintenanceexpenditure and publish the results41. Thiswork shows that the industry continues toslightly outperform our expectations forreducing operational costs.

We have reviewed the capitalmaintenance econometric models, inassociation with a small group from theindustry and our external academiceconometric advisor. We shared therevised models with the companies andwe shall use them in association with thestandard unit costs (cost base) to setefficiency targets for the price review.

Companies submitted their standard unitcosts for review and comparison in March2003. We analysed these costs to derivepotential improvements in efficiency forthe poorer performing companies – inboth capital maintenance and capitalenhancements42. We aimed to help thecompanies understand how the cost baseworks and compare their unit costs withthose of other companies. Companiesalso had the opportunity to resubmit theirstandard unit costs with their draftbusiness plans for review and feedback.

We have continued our work onunderstanding how the performance andefficiency of companies in England andWales compare with those of water andwastewater service providers around theworld. Our annual report on this confirmsthat customers here receive a level ofservice that compares well with the bestelsewhere in the world43.

Reporters and auditors Independent professionals calledreporters scrutinise and comment oncompany regulatory information. Theygive us confidence in the consistency andreliability of the information.

The auditors examine companies’regulatory accounts, and comment in thesame way as with statutory accounts.They work with the reporters inscrutinising the financial aspects ofcompanies’ business plans.

The reporters worked on information inthree main areas this year:


41 ‘Water and sewerageservice unit costs andrelative efficiency 2002-03’,January 2004.

42 RD 22/03, 4 June 2003.

43 ‘International comparisonof water and sewerageservice 2001-02 report’,March 2004.

Performance monitoring information:

● 2003 June returns,

● sewerage service econometricinformation,

● 2004-05 principal statement of chargesschemes.

Regulatory information company-specific actions:

● Thames Water’s progress against itsleakage action plan,

● Severn Trent’s water balance andleakage levels,

● Southern Water’s work to meet theUrban Waste Water Treatment Directive.

Information in preparation for theperiodic review:

● company-specific special factors claims,

● draft business plans – we put one pagesummaries of the reporters’ reports onour website and in our library.

Reporters also commented oninformation supporting interimdetermination applications.

We continued to monitor and developreporters’ performance. Babtie Group, afirm of consulting civil engineers withwide experience in the water industry,reviewed the reporters’ processes for thedraft business plans, and published theirconclusions44.

We consulted companies, and currentand prospective reporters, about theprocess for the round of reporterappointments starting in late 2004. Weheld reporters’ and auditors’ jointworkshops in April and December 200345.

We assessed the reporters’ andauditors’ performance in 2003, sharedour findings with the companies andmade awards to the top performers:

June return 2003: Roger Sawdon ofW S Atkins (South West Water) andKeith Hall of Strategic ManagementConsultants (South East Water)

Draft business plan: Chris Turner ofHalcrow Management Sciences(United Utilities Water); Nigel Kent ofMontgomery Watson Harza (DeeValley Water); andPricewaterhouseCoopers (AnglianWater and Bournemouth & WestHampshire Water).

Monitoring environmentaland drinking water quality Companies are continuing theprogrammes of drinking water qualityimprovements to treatment works and thedistribution system. The DWI tells us eachyear how the companies are performingin meeting the required standards. Wemake that information available, alongsidethe information in companies’ Junereturns. Companies are generally oncourse with expected improvements. Insome cases, those expectations havebeen revised. For example, the DWI willreview the extent of the lead pipereplacement needed after the success oftreatment methods to reduce lead levelshas been assessed.

The Environment Agency gave us itsannual report on company progress inJune. We have reviewed companyprogress in delivering the substantialenvironmental improvement programmeset down by Ministers in April 2000. Withthe Agency, we held joint environmentalperformance meetings with all ten waterand sewerage companies in September2003. We reviewed and reported on theircurrent performance46 in meeting theirresponsibilities towards the environment,and on their progress in delivering newrequirements47.


44 ‘External review of thereporters’ audit of watercompany draft businessplans – summer 2003’(Babtie), January 2004.

45 RD 21/03, 16 May 2003and RD 04/04, 26 January2004.

46 ‘Levels of service for thewater industry in England &Wales 2002-03 report’,September 2003.

47 RD 03/04, 22 January2004.

Companies now have less than a yearbefore they should have completed theNational Environment Programme for2000-05. We asked companies to tell us ifthey envisaged completing this work ontime. We published a joint report with theAgency48, setting down the companyresponses that they were generally oncourse. We will follow this up in our jointenvironmental performance meetingslater this year.

Water Framework Directive

The regulations transposing this Directiveinto legislation in England came into forcein January 2004. This will have significantimpacts on all water providers and users.

We are working with Defra and theAgency to provide the information andanalysis required by the Directive. We arepart of the group looking at theimplementation of the Directive. We arealso members of the Economics SteeringGroup and the Economic AdvisoryStakeholders Group. With our experience,we are contributing to projects on howwater services are paid for, and the cost-effectiveness of measures to address theenvironmental objectives of the Directive.In February 2003 and March 2004, weparticipated in EU Commissionconferences on the economic analysisrequired to implement it.

Control of odour

We responded to Defra and the WelshAssembly Government consultations onodour control from sewage treatmentworks in March49 and June50 2003respectively. Following the recentclarification of the law on statutorynuisance and odour from sewagetreatment works (LB Hounslow v ThamesWater), we are participating in a Defra-ledindustry group overseeing the drafting ofa code of practice that will provide adviceand guidance on resolving odour fromsewage treatment works.

The Government is considering furtherwhat action may need to be taken inrespect of other nuisances such asmosquitoes.

We also responded to the followingDefra consultation papers.

● New designations under the FreshWater Fish Directive (in September2003).

● Existing private sewers (in October2003). We consider that the toppriority is to ensure that problemsassociated with private drains andsewers are not exacerbated. We arenot, however, convinced of the casefor a widescale transfer ofresponsibilities for private sewerseither to sewerage undertakers orlocal authorities and we want to seefurther research on the implicationsand costs of such a transfer.

Maintaining security ofsupply The ability to maintain water supplies isessential. The extended dry weather in2003 was a significant test for companies.Companies made some use of droughtorders and permits, but avoidedrestrictions for customers, largely due toleakage reductions since 1995.

But there is no room for complacency.This year, we worked with the Agency toaudit companies’ draft plans for long-termsecurity of supply. We participated in ajoint project with the Agency andcompanies to model shared waterresources for the South East of England.We also reported on companies’ progressin improving security of supply tocustomers, in particular Thames Water’swork in London.


48 ‘Delivering the NationalEnvironment Programme’(Ofwat/EnvironmentAgency), January 2004.

49 ‘Ofwat’s response toDefra consultation onproposals for the statutorycontrol of odour and othernuisance from sewagetreatment works’, March2003.

50 ‘Ofwat’s response toWelsh AssemblyGovernment consultation onproposals for the statutorycontrol of odour and othernuisance from sewagetreatment works’, June2003.

Ensuring serviceability tocustomers Each year we monitor and report on watercompanies’ service to customers and weassess their ability to continue to providethose services in the future51. Where weassess a company’s serviceability asmarginal or deteriorating, we expect thecompany to demonstrate its plans to restorestable serviceability for its customers.Overall, industry-wide assessments werestable this year, except for sewerage non-infrastructure, which was marginal.

Monitoring leakage andefficient use

Leakage

Most companies have leakage at aneconomic level now and we will set priceson the basis that this continues for theperiod from 2005. When assessing theneed for further leakage reductions,companies will take account of the socialand environmental costs of leakage aswell as customers’ needs for water.

We have continued our annual monitoringof all companies’ leakage levels. Weremain concerned about leakage atThames Water and the company isfollowing a detailed action plan to reversethe trend of rising leakage. Severn TrentWater was also subject to an investigationin 2003. This concluded that, whileleakage had risen slightly in recent years,the underlying level of leakage wassignificantly higher than previouslythought. We have set leakage targets torecover from the recent increase.

We have continued to approvecompanies’ codes of practice on leakagefrom customers’ pipes.

Efficient use of water

Companies have a duty to promote theefficient use of water by customers. Wecontinue to monitor their work in thisarea. We began joint work with theEnvironment Agency to review the currentregulatory arrangements for waterdemand management. We fed back tocompanies the results of our work withWaterVoice to gain a more customer-focused view of companies’ efforts in thisarea.

We also assessed companies’ plans topromote efficient use of water, includingextending water metering, as part of ourwork on their draft business plans.


51 ‘Financial performanceand expenditure of the watercompanies in England andWales, 2002-03 report’,August 2003.

Each company’s management is free tochoose its own capital structure. But wemust ensure that customers continue tobe protected and that the companiesremain capable of financing their presentand prospective capital programmesreadily and at reasonable costs.

The Water Industry Act 1991 requires theDirector to act in a way that he judges willenable efficient companies to carry outtheir functions properly and finance them,in particular by securing that they are ableto earn reasonable returns on the capitalthey employ given the risks they face.

The City plays a critical role in enablingthe companies to finance their functions.We held three City briefings during theyear (two in London and one inEdinburgh). These briefings provide theopportunity to explain our approach toregulation, to inform City contacts aboutdevelopments in the industry and to heartheir views and concerns. We alsoregularly meet with investors in theindustry.

Financial restructuring

Changes in levels of gearing

A highly geared company is onewhich raises a high proportion ofcapital through debt (borrowing)rather than through equity (shares).

The level of gearing in the water sector hasincreased substantially since the 1999review. We believe that it is for thecompanies to manage their own capitalstructures. We welcome innovationdirected at improving efficiency andeffectiveness. However, whilst higher ratiosof debt to equity may reduce the cost offinance in the short term – an importantaim in an incentive-based regime – it mightreduce the financial flexibility of companiesin the future. We must ensure thatcustomers are protected from undue riskand that companies remain capable offinancing their present and future capitalprogrammes. Any increase in financial riskshould be a matter for shareholders andlenders, not customers.

Where companies propose to outsourcethe majority of their operations, we expectthem to ensure that they do notcompromise safety and quality.


CHAPTER 4

Companies’ financeand mergers

Study into trends in ownership andfinancing

We published a joint study with Defra thisyear, which examined recent trends in thepattern of ownership and financing ofwater and sewerage companies and theirability to meet the Government'sobjectives for this sector52.

The report found no evidence so far thathighly geared structures affected waterand sewerage companies’ ability todeliver their objectives. Such structuresdid not seem to make them more averseto taking major investment decisions,although they were yet to be tested underadverse market conditions. The reportwelcomed the current diversity ofstructure in the industry. We see benefit inshareholder equity and aim to maintain aframework where both the traditionalequity model and more highly leveragedstructures can co-exist.

Refinancing activity

There have been a number of specifictransactions this year.

In 2002, Dee Valley Water plc completeda capital restructuring that raised itsgearing to around 80% of its regulatorycapital value. We consulted onmodifications to the company’s licence inMarch 2003. These were incorporatedinto Dee Valley Water’s licence inNovember 2003.

On 23 May 2003 Northumbrian WaterGroup plc (formerly Aquavit plc)announced that it had completed thepurchase of 75% of the share capital ofthe parent company of NorthumbrianWater. The former owner of NorthumbrianWater, Suez, retained the remaining 25%.We consulted on the change ofownership in June 2003. We published aposition paper in August 2003 and inNovember 2003 consulted on proposedamendments to Northumbrian Water’slicence that will further strengthen ringfencing of the appointed business. Theacquisition resulted in a sharp downgrade

in the corporate credit rating ofNorthumbrian Water and the bondsissued by the company. We arecontinuing to monitor the company’sprogress against a number of options thatmight improve its credit rating andfinancial position. We will concludewhether any further regulatory action isrequired in June 2004.

In July 2003 United Utilities Waterannounced its intention to launch a rightsissue. We commented that we see virtuein shareholder equity as a cushionagainst external events and as a spur togreater efficiency.

In February 2004 Bristol Water plcfinalised new financing arrangements thatwill increase the level of debt of theappointed business. We proposedmodifications to Bristol Water’s licencethat would bring its licence into line withother water companies with restructuredfinances. These licence modificationshave now been made.

Mergers Our objective is to ensure that acompany’s ownership structure maintainsincentives for improved efficiency andperformance.

We have long argued that the loss ofindependent companies through mergerspermanently harms the wholecomparative regime. Mergers also reducethe number of independent managementteams aiming to improve returns toinvestors and push back the efficiencyfrontiers.

However, we do not and cannot blockmergers. We recognise that mergers andchanges in ownership can be a powerfulstimulus for improved performance,particularly in poorly performingcompanies.


52 ‘Structure of the waterindustry in England: does itremain fit for purpose?’(Defra/Ofwat), November2003.

Any merger benefits need to beassessed against the detriment to theindustry as a whole, not simply inrelation to the customers who aredirectly involved. A merger could bringbenefits that outweigh losing acomparator. Innovative and highlyefficient management could benefit allconsumers in the long run if theoverall efficiency of the industry isthereby improved.

We remain unconvinced by arguments formergers in terms of economies of scale.The recent Stone & Webster report, whichwe commissioned in the light of therecommendations of the CompetitionCommission report on Vivendi’s bid forSouthern Water, in relation to comparativecompetition, did not provide evidence ofsuch economies53. We look for remediessufficient to outweigh the permanentharm of a merger to the comparativeregime. If no sufficient remedies can befound then the proposed merger shouldnot go ahead.

Any decision on a merger between UKwater companies remains for theCompetition Commission, not Ofwat. Inthe event of a proposed merger betweenwater companies, we will:

● look with an open mind at individualpropositions; and

● submit evidence to the Commission,including an assessment of the impactof the merger on the comparativeregime and any benefits it may bring.

If other mergers lead to a change ofownership for a water company, we willpublicly consult on any regulatory issuesarising and provide advice to the DirectorGeneral of Fair Trading (DGFT) ifrequired.

Changes of ownership for SouthernWater plc

The proposed acquisition of First AquaHoldings Limited, owners of SouthernWater plc, by Vivendi Water UK wasreferred to the Competition Commissionin May 2002 and we reported last year onits outcome.

Subsequently, in June 2003, we consultedon licence modifications for SouthernWater which were incorporated into theSouthern Water licence in November 2003.

The majority stake in Southern Water wasacquired by Southern Water InvestmentsLimited. Initially all the shares in SouthernWater Investments Limited were held bythe Royal Bank of Scotland (RBS). InFebruary 2004, RBS syndicated some ofthis stake to Perry Capital Ltd and D E Shaw.

Change of ownership for South EastWater plc

On 1 October 2003, Macquarie BankLimited announced that it had acquired allof the equity of South East Water plc andits affiliated businesses from Frenchgroup Bouygues. We consulted on theacquisition and its impacts in November2003. We invited views on a number ofchanges to South East Water’s licencedesigned to strengthen the ring fencearound the regulated business. We will beformally consulting on these changesshortly.

Enterprise Act

Later in 2004, the merger regime forthe industry will be subject to theprovisions of the Enterprise Act 2002.The Act maintains the mandatoryreference to the CompetitionCommission of qualifying mergersbetween two or more companies butchanges the threshold for qualificationto one based on turnover rather thanassets. Any merger between water


53 ‘Investigation intoevidence for economies ofscale in the water andsewerage industry inEngland and Wales’, (Stone& Webster) January 2004.

companies will continue to qualify foran automatic reference to theCompetition Commission. TheCommission must consider the effectof the merger on our ability to makecomparisons between watercompanies. In line with the changes tothe general merger regime, Ministerswill be removed from decisions onmergers, except in special cases.

Keeping costs transparent Maintaining transparency of watercompanies’ costs ensures that thefinancial ring fence around the Appointeeis effective and protects water customersfrom inflated bills. All costs declared bythe companies must be incurred in theproper performance of delivering waterand sewerage services.

Transfer pricing

Water companies are required to preventcross-subsidy by keeping their regulatedand unregulated businesses separate;and by trading at arm’s length withassociates. We monitor the companies toensure that cross-subsidy does not takeplace and that companies are complyingwith our guidance on transfer pricing(Regulatory Accounting Guideline 5.03).

This year we reviewed in detail tradingarrangements at Anglian Water Services,Northumbrian Water, Severn Trent Water,Thames Water Utilities, United UtilitiesWater, Mid Kent Water and Three ValleysWater. The companies are working toaddress the issues we identified.

We also work to ensure that greater levelsof integration between the water companyand associates in some groups do notcompromise the ability of the watercompany to discharge its functions ineach case.

We work with other regulators (principallyOfgem) to ensure that costs to watercustomers can be separately identifiedfrom other group costs.

Regulatory accounts We require companies to publish annualregulatory accounts in accordance withour Regulatory Accounting Guidelines(RAGs) 1 to 4. Following consultation weissued revised RAGs in January 2003. Aspart of our conclusions we said we wouldwork with the industry and others toconsider whether to develop proposalsfor companies to provide additional costinformation at a disaggregated level.

We have delayed this piece of work untilafter the 2004 price review. This willenable us to take into account thechanges arising from the Water Act.

We published our annual update toregulatory capital values for the period to2005 in March 200454.


54 RD 05/04, 11 March2004.

Water supply licensing andthe Water Act 2003The new Water Act (see Chapter 6) bringsin specific legislation for competition.

● From autumn 2005, customers who arelikely to consume at least 50 megalitresof water a year will be able to purchasewater from either their existing waterundertaker or from a water supplylicensee. We estimate that thiscompetition will be open to around2,300 customers, spending £200 millionon water each year.

● Companies will be able to apply foreither a ‘retail’ licence, which entitles theholder to purchase water from a waterundertaker (called a wholesale supply)and to retail it to eligible customers; or a‘combined’ licence, which authorisesthe holder to introduce water into awater undertaker’s supply system andretail it to eligible customers (commoncarriage). This will become availableduring summer 2005.

Undertakers will have a duty to provideaccess to their supply systems, and toprovide wholesale supplies, onreasonable terms. As part of this, we willissue guidance on price and non-priceterms for access, and will expectundertakers to have price and non-priceterms for access ready by summer 2005.

To enable the basic legislative frameworkto operate, the Water Act 2003 providesfor the making of secondary legislationand statutory guidance. Ofwat, Defra andthe Welsh Assembly Government willdevelop this secondary legislation, andwe are working together to produce boththe required statutory and non-statutoryguidance.

Setting up new advisory groups

This is an ambitious project requiring all stakeholders in the industry to worktogether to ensure that an effective regimeis delivered on schedule. To achieve this,we have established:

● a sponsor group with representativesfrom all industry stakeholders, tooversee the project and ensure itssuccessful delivery by autumn 2005;

● two advisory groups, withrepresentatives from all industrystakeholders, to assist Ofwat, Defra andthe Welsh Assembly Government, asappropriate, as they prepare the relevantsecondary legislation and guidance; and

● a regulators’ group involving Defra,Ofwat, the DWI, the EnvironmentAgency and Welsh AssemblyGovernment, to co-ordinate the variousactivities of each organisation.


CHAPTER 5

Price competition

Initial work on new licences

Under the new regime, water undertakerswill continue to operate according to theirinstruments of appointment, althoughthere will be some modifications toexisting conditions of appointment toreflect the competition provisions in theAct. Licensees will have a water supplylicence, which will be of a differentconstruction to water undertakers’instruments of appointment. Theselicences will have standard terms andconditions governing how licenseesoperate, together with specific individualconditions where appropriate.

In February 2004, we consulted onmodifications to water undertakers’existing conditions of appointment andconditions of water supply licences. Weexpect to consult on the formal text of thelicences in early 2005.

Self-lay

Self-lay is the mechanism by whichdevelopers or their contractors can installnew water mains and service pipesinstead of asking the water undertaker todo the work.

The Water Act introduces a statutoryframework for self-lay. In December 2003,we published a consultation on thefinancial arrangements for self-lay andrequisitioning agreements55. This set outthe financial arrangements that shouldunderlie water undertakers’ self-laypolicies and procedures for implementingthe Act.

We held a workshop in January 2004 forstakeholders to discuss the proposals.We will take account of comments in thefinal guidance, which we will publish inMay 2004.

Working with self-lay groups

We have continued to work with ourindustry self-lay advisory group (SLG).The SLG has supported us in preparingto implement the Water Act framework, by

commenting on the draft consultationpaper and considering the issues raised.The SLG has also produced nationallevels of service for water undertakers tofollow when handling self-lay applications.We carried out this work in conjunctionwith UK Water Industry Research, whichis producing a guide on the adoption ofself-laid water mains.

Insets An inset appointment allows onecompany to replace another as thestatutory undertaker for a specific area.

We continue to work with applicants on avariety of inset proposals. The insetregime will exist in parallel with the watersupply licensing regime. The existinglarge user inset threshold in England willbe lowered to 50 megalitres a year, in linewith the water supply licensing eligibilitythreshold.

Enterprise Act 2002The Enterprise Act reformed competitionlaw and consumer law enforcement in theUK. It came into force in 2003. The Actgives us new concurrent powers with theOffice of Fair Trading (OFT) to refermarket investigations to the CompetitionCommission. We also have the power toapply to the courts for ordersdisqualifying directors of companies whohave breached competition law.

Competition Act 1998The Competition Act prohibits anti-competitive behaviour and abuses bycompanies with dominant positions inmarkets. When we receive a complaint,we decide whether we have powers toconsider it under the Competition Act1998 or the Water Industry Act 1991 and,if necessary, which powers are mostappropriate. The Water Act 2003introduces a framework into the Water


55 ‘Consultation on thefinancial arrangements forself-lay and requisitioningagreements’, December2003.

Industry Act 1991 for licensing newentrants.

In April, we published our annual reporton the complaints that we have handledthis year and policy developments56. Wecontinue to improve the process fordealing with complaints by learning fromour experiences and those of othercompetition authorities, including theCompetition Appeal Tribunal.

Modernising ECcompetition law Regulation 1/2003 of the Council of theEuropean Union comes into force on 1 May 2004. This modernises ECcompetition law. It enables nationalcompetition authorities (the OFT andconcurrent regulators, including Ofwat) toapply EC competition law57.

The Regulation requires us to apply ECcompetition law when applying nationalcompetition law where there is a potentialeffect on trade between Member States.We are working with the OFT and otherconcurrent regulators to ensure theeffective and appropriate implementationof the Regulation.


56 Complaints consideredunder the Competition Act1998, April 2004.

57 Articles 81 and 82, ECTreaty.

In November, the Water Act 2003 receivedRoyal Assent. We offered technical adviceto Defra in its preparation and passagethrough Parliament.

The Water Act 2003 introducesimportant changes including:

● a regulatory authority, with a Boardstructure, in place of the DirectorGeneral of Water Services;

● water-specific legislation forcompetition;

● tougher penalties for companies thatbreach their licence conditions;

● an independent Consumer Councilfor Water; and

● changes to abstraction licensing.

A steering group is working on theestablishment of the new independentConsumer Council for Water. The group,chaired by Defra, and involving WaterVoiceand Ofwat, is now taking forward the workrequired to get the organisation up andrunning in October 2005.

The Water Services Regulation Authoritywill replace the Director General in April2006 and will not overlap with the pricereview. This will allow the current pricereview process to be fully completed.

The Act will give the Authority a duty tofurther the consumer objective whereverappropriate by promoting effectivecompetition. The Act includes provisionsto increase opportunities for competitionin the supply of water services (seeChapter 5). We have worked with Defra toconsider when each section of the Act willbe implemented.

The Act allows us to impose fines of up to10% of annual turnover on companies.However, we do not expect to imposefines of this level, except in a case ofextreme failure. In February 2004, weconsulted on the criteria we intend to usein deciding whether to impose a fineupon a company58. The consultation alsosought views on the factors that shouldinfluence decisions on the levels of suchfines. The consultation closes at the endof May 2004.

The Act also requires the Authority topublish a code of practice setting out howit will discharge its functions. Followingconsultation, we issued a code of practicegoverning the way we discharge ourfunctions59. Once the new Authority is setup, we expect to update this.


58 ‘A consultation paper onapplication of powers undersection 22A of the WaterIndustry Act 1991 to imposefinancial penalties’, February2004.

59 RD 33/03, 11 September2003.

CHAPTER 6

The Water Act2003

Good communication with stakeholders isessential to effective regulation.Stakeholders rightly expect to be keptinformed. We work to become more open,to provide information about what we doand to take account of the views of otherswhen we make decisions. Informedstakeholders make better contributions tothe debate, ensuring that our decisionsare based on sound evidence. And, byadopting a ‘no surprises’ approach, weaim to minimise regulatory risk.

Our redesigned website helps us todeliver our commitment to goodcommunications.

Our staff have contributed to over 70 conferences, workshops and otherevents this year. We have also held morethan 20 events ourselves, including ourannual stakeholder conference.

Ofwat continues to attract interest fromabroad and, during the year, we havereceived visitors at our offices inBirmingham from countries includingChina, Uganda, Malaysia and Jamaica.

PublicationsWe produce our reports in hard copy aswell as in electronic form in response toour readers’ demands. To help keepcosts down and speed up production, weproduce most reports in black and white.We aim to place all of our reports on ourwebsite early on the day of publication.

We have conducted 15 consultationexercises this year. We are currentlyrevising our code of practice to takeaccount of the latest governmentguidelines. Eight of our consultations hada 12-week response period.

This year we produced the followingdocuments:

86 Publications

7 Leaflets and information notes

67 Press notices and information bulletins

2 Price review newsletters

43 MD/RD letters

We aim to meet our commitments underthe Welsh Language Scheme. This yearwe produced two documents in Welsh.We did not receive any requests fordocuments to be translated.


CHAPTER 7

Communications

Table 1: Performance against our standards (1, 2)

Performance standards Achievement against standard

Replying to written Reply within 10 working days (unless Achievedenquiries the item is particularly complicated).

Our target is 95%.

Replying to phone Reply within 2 working days (by phone). Achievedenquiries Our target is 97%.

Reply within 10 working days (in writing). AchievedOur target is 95%.

Returning your If you ask us to, we will return calls left Achievedmessages on our answering machines within one

hour of re-opening.

Requests under the Code We will reply within 20 working days. No requests of Practice on Access of Government Information

Requests under the We will reply within 40 working days. AchievedEnvironment Information Regulations

Complaints handled by We will respond to enquiries within Achievedthe Director and disputes 10 working days.and appeals Our target is 80%.

We will decide formal disputes or Not achieved 3

appeals within 90 working days. Our target is 80%.

Internal review procedure We will tell you about the outcome Not achieved 4

within 20 working days.

Complaining to Ofwat We will tell you within 10 working days Achievedabout the WaterVoice whether we will investigate the matter.committees We aim to deal with 80% of complaints

within 40 working days.

1. WaterVoice reports on its performance against charter standards in its own Annual Report.

2. Complaints involving competition matters are excluded from our customer charter. These complaints tend to be verycomplicated so they are not covered by our standard complaint procedure.

3. 74% of complaints within the Director’s jurisdiction were settled within 90 days.

4. Cases we consider under the internal review procedure are sometimes long and complicated and involve a number ofdifferent parties. The 12 cases reviewed this year took from two to six months to complete. Three are ongoing. None ofthese cases was taken up by the Parliamentary Commissioner. We are currently reviewing this standard as it is notachievable.


60 ‘Customer Charter: Ourstandards of service’, July2003.

Customer charterWe aim to provide a high quality andeffective service. Table 1 sets out ourperformance against our key targets in

our customer charter60. We always workto achieve our goals and this year wehave met most of our charter standards.Where we have not done so, we aim toimprove.

Our website We continue to develop our website asour main communication tool. This isparticularly important in the price reviewwhen there is increased demand for webinformation.

Our website has seen a huge increase inthe number of hits again this year.

Our subscription service now holdsaround 500 email addresses. Users arenotified by email when new information isplaced on the web.

The website is also very useful forAquarius 3 users, as they can downloadupgrades, fixes and documentationrelating to the software.

The redesigned website was voted‘Website of the month’ in Public ServiceMagazine in July 2003.

Working with ParliamentWe have appeared five times beforeparliamentary committees this year, aswell as contributing a memorandum ofwritten evidence to the Environment,Food and Rural Affairs (EFRA)Committee’s inquiry into Sites of SpecialScientific Interest. Our first appearance

was before the House of LordsConstitution Committee’s inquiry into ‘Theaccountability of regulators’, on 11 June2003. Later the same day we alsoappeared before the EFRA Committee toanswer questions about issues covered inour Annual Report for 2002-03.

The price review prompted inquiries bytwo committees. We welcomed the timelyinquiry by the EFRA Committee into‘Water pricing’ following submission bythe companies of their draft businessplans. We gave evidence to the EFRACommittee in October 2003. It issued itsfindings in December 2003 and theGovernment’s response was published inMarch 2004. The Environmental AuditCommittee announced its inquiry into‘Water: The periodic review 2004 and theenvironmental programme’ in February2004. We appeared before the Committeein March 2004.

During the year, the NAO investigated thesewerage network in England and Wales,culminating in its report ‘Out of sight, notout of mind – Ofwat and the public sewernetwork in England and Wales’. Weanswered questions from the PublicAccounts Committee, arising from thisreport, in March 2004.

We also gave evidence to and appearedbefore the London Assembly’s PublicServices Committee as part of its inquiryinto London’s water supply.

Library and informationservices The library acts as the public enquiry unitand as our publication sales anddistribution point. This year we answered9,636 telephone enquiries and issued5,795 publications.

We received no requests for informationunder the Open Government Code ofPractice on Access to GovernmentInformation and one under theEnvironmental Information Regulations.


0

100,000

200,000

300,000

400,000

500,000

2000-01 2001-02 2002-03 2003-04

83,800 109,685

276,000

491,350

Figure 3: Number of website hits

The library houses and maintains theDirector’s Register. This is a collection ofdocuments, specified by section 195 ofthe Water Industry Act 1991, whichincludes water company licences,undertakings and determinations. It isfreely available for consultation by thepublic, with a small charge made forcopies of extracts. Determinations madeby the Director under the Water IndustryAct 1991 are also available for inspection.

The 2003 June returns were published onCD ROM and will be published on ourwebsite for the first time in April 2004. Weupdated the Special Agreements Registerand the price review section on thewebsite. We continue to update theInformation Asset Register. This is a list ofthe Government’s information sourcesand contains records of mainlyunpublished information. It is co-ordinated by the Cabinet Office andcan be accessed through departmentalwebsites and Inforoute on the CabinetOffice website.

We answered 1,091 written enquiries ofwhich 1,078 were by email. Emailenquiries increased by 10% over 2002-03.Thirty-seven outside visitors used thelibrary, fewer than in 2002-03, probably asa result of more information beingavailable electronically and also beingnear the end of the price review cycle.

Ofwat’s public enquiry unit can becontacted via email [email protected]

Freedom of InformationAct 2000We aim to make public as muchinformation as we can, subject toconfidentiality requirements. However, werecognise that the Act, which takes effectin January 2005, places us under an evengreater obligation to disclose information.

We reviewed our publication schemeduring the year. We are raising theawareness of Ofwat staff about their

responsibilities under the Act. We weregrateful to Maurice Frankel, Director,Campaign for Freedom of Information, forspeaking at a lunchtime seminar as partof our training programme.


Staff recruitment &developmentWe recruit on merit through fair and opencompetition. This ensures opportunities foremployment regardless of race, sex, physicaldisability, religion, or marital status. Recruitmentactivities are subject to external audit bythe Civil Service Commissioners to ensurethat we comply with our recruitment code.

During the year we undertook 40recruitments.

Level Number Proportion Proportion appointed of women from ethnic

(%) minorities (%)

Head of 3 0 0team/function

Middle 25 44 8management

Clerical and 20 85 15secretarial

TOTAL 48 58 10

Everyone was recruited through opencompetition, except three, who wereshort-term contract appointments.

Ofwat has a total staff of 251 (full-timeequivalent, as at 31 March 2004) of whom:

● 60% are women,

● 14% are from ethnic minority groups(this reflects the profile of the WestMidlands),

● 7 are members of the Senior CivilService (6 men and 1 woman),

● 7% are employed on fixed term andcasual contracts,

● 12% work part-time,

● 18% work in WaterVoice offices.

Staff turnover at the year end was 12%.

Training and development continues tobe a key activity. We encourage staff toundertake training necessary for theirwork, and to develop skills to their fullpotential. The main focus of training thisyear has been on the price review.

Senior staff changes, remunerationand non-pay benefits

Tony Smith joined us in May 2003 asDirector of Competition and ConsumerAffairs Division and Huw Brooker becameHead of Legal Services from April 2003.

The salary of the Director is £140,037.

Salaries for members of the Senior CivilService (as at 31 March 2004, £)

90,000 – 94,999 1

85,000 – 89,999 1

80,000 – 84,999 1

75,000 – 79,999 1

70,000 – 74,999 1

60,000 – 64,999 2


CHAPTER 8

Resources

Non-pay benefits

Annual leave and paternity leave wereincreased as part of our 2003 pay review.All staff were issued with a total rewardstatement, informing them of the totalvalue of their employment package.

Legislation

New legislation on sexual orientation andreligious observance was introduced inDecember 2003. We updated our policieson equal opportunities and harassment.

IIP reaccreditation

Following a full assessment, wemaintained our recognition as an Investorin People. This demonstrates our ongoingcommitment to developing staff toimprove business performance andfacilitate career progression.

Race equality scheme

Under our race equality scheme, wemonitor staff by ethnic group to ensurethat they do not receive less favourabletreatment because of their race or ethnicbackground. During the year, no ethnicstaff were involved in disciplinaryprocedures and no grievance cases weredue to race or ethnic background. Nodiversity issues were mentioned by staffduring exit interviews. Details of thescheme are available on our website.

Staff training attendance, April 2003–March 2004 by ethnic breakdown

Ethnic group No of days training %

White 751 87.9

Other ethnic groups 104 12.1

Total number of days 855 100

This broadly reflects the profile of ethnicminority staff in Ofwat.

WaterAid

During the last ten years the moneystaff have raised for WaterAid, throughactivities such as recycling, sponsoredrock climbs and quizzes, has helpedseveral thousand families access safedrinking water and sanitation.

We have sponsored WaterAid projectsin Ghana, India, Nepal and Ethiopia;the latter will help manage safe watersupplies for over 10,000 people. Thisyear our sponsored project will helpcommunities in the sand islands of therivers of Bangladesh.

WaterAid’s Fiona Blake visited us inFebruary to explain their work inAfrica.

WaterVoice recruitment,training and development The Director has statutory responsibilityfor appointing WaterVoice chairmen andmembers. These appointments areoutside the remit of the Commissioner forPublic Appointments, but the Director iscommitted to complying with theCommissioner’s code of practice. Anindependent assessor is involved in allnew appointments.

WaterVoice Chairmen and members

In August 2003, the appointments of threechairmen were extended to achieve auniform expiry date of 31 March 2005 forthe appointments of all ten chairmen inpreparation for the expected start of theConsumer Council for Water.

Membership of the ten WaterVoicecommittees is normally reviewed annually.However, this year appointments due toexpire were extended to 31 March 2005.Of the 33 members concerned, 28 agreedto stay on until then. Two membersdeclined re-appointment and threemembers retired.


We are discussing with chairmen andmembers possibilities for the extension oftheir current appointments to the newstart date for the Consumer Council forWater of October 2005.

At 31 March 2004, the total membershipwas 148 (including the 10 chairmen).There were 55 (37%) women and 12 (8%)from ethnic minority groups. Thiscompares with the national averages forpublic bodies appointments for 2002-0361

(the most recent data available) of 35.7%women and 4.7% ethnic minorities.

The age profile for chairmen andmembers is shown in Figure 4.

Names and biographical details ofchairmen and members are published inthe WaterVoice Annual Report‘Representing water customers’ and areon the WaterVoice websitewww.watervoice.org.uk.

Training

New WaterVoice committee memberswere invited to attend the followingtraining courses:

● Background to the water industry;

● Understanding water companyaccounts and the K factor; and

● Stronger voice (on being an effectiveconsumer representative).

Honours

WaterVoice members give their timevoluntarily. Piers Feilden, a member ofWaterVoice Wessex, received the MBE in theQueen’s Birthday Honours List. BrendaFinnigan, a member of WaterVoice Central,received the MBE in the Queen’s New YearHonours List. Since the committees wereestablished, 13 members have beenawarded MBEs for services to watercustomers.


61 ‘Public Bodies 2003’(Cabinet Office), July 2003.

Table 2: WaterVoice Chairmen as at 31 March 2004

Committee Chairman First Current Appointment Monthly Remunerationappointed appointment ends time (days) £

started commitment

Central James Perowne 01.8.02 01.8.02 31.3.05 8 20,531

Eastern Catherine Harvey 1.4.01 1.4.01 31.3.05 8 20,531

North West Maurice Terry 26.2.97 26.2.01 31.3.05 12* 30,796

Northumbria Andrea Cook 1.4.01 1.4.01 31.3.05 8 20,531

Southern Richard Sturt 1.10.01 1.10.01 31.3.05 8 20,531

South West Noel Olsen 1.4.01 1.4.01 31.3.05 8 20,531

Thames Herman Scopes 19.4.97 1.4.01 31.3.05 8 20,531

Wales John Ford 26.2.01 26.2.01 31.3.05 8 20,531

Wessex Sheila Reiter 1.8.95 1.4.01 31.3.05 8 20,531

Yorkshire Mohammed Ajeeb 26.2.01 26.2.01 31.3.05 8 20,531

* Includes four days as WaterVoice Council Chairman.

0

10

20

30

40

50

60

70

80

25-34 35-44 45-59 60-64 65-74 75+Age

4

15

74

24

1

30Num

ber

Figure 4: Age profile of WaterVoicechairmen and members

Setting up the ConsumerCouncil for Water The Water Act 2003 includes legislation toset up an independent Consumer Councilfor Water. We supported Defra as it beganplanning the new organisation. TheDirector of Operations and his staff haveworked closely with staff representativesto provide advice to those staff fromWaterVoice who will transfer to theConsumer Council.

IT development The focus of IT development has been toprovide systems to support the pricereview. We have developed the financialmodel, Aquarius 3, along with informationcapture systems for the draft and finalbusiness plans, for use by Ofwat and thewater companies.

IT services Secure email transmission

We have introduced a cost-effective,secure email transmission facility betweenstakeholders and ourselves through theGovernment Secure Intranet (GSI) usingthe PKZip protocol.

Dealing with viruses

All of the computer systems weresuccessfully defended against all virusattacks this year.

Wide area network (WAN)

We have signed the order for a WANbetween the WaterVoice offices and Ofwatto be implemented from April. WaterVoiceoffices will be connected by telephoneline to the same network as Ofwat. Thiswill improve our internal communications.

Operating system

Along with nine other public sectororganisations we evaluated the use of theLinux business software to support thediverse range of applications we operate.This pilot is coordinated by the Office ofGovernment Commerce and the Office ofthe E-Envoy to measure the effectivenessof this software against proprietarysoftware solutions.

Office services Safeguarding the office environment

Our priority remains the provision of ahealthy, safe and secure workplace for allstaff. This year, we have introduced newrisk assessment policies, held awarenesssessions on fire safety and security, andinstalled air conditioning/humidificationsystems. Contingency and businesscontinuity plans have been reviewed.

Finance Financial information provided in thisAnnual Report is an estimate and issubject to external audit by the NAO. Weprepare the accounts in accordance withHM Treasury Resource Accountingrequirements.

We expect to achieve a small underspendof 1.5% against a budget of £14.0 million.The price review was the main costpressure on expenditure. We continued tooperate well within the licence fee ceiling.Our expenditure plans are scrutinised byParliament and HM Treasury. Our incomefrom companies was £12.6 million (2001-02: £11.9 million, 2002-03: £11.9 million).The estimated total expenditure was£13.8 million (2001-02: £10.9 million,2002-03: £11.8 million). The income andexpenditure is summarised in Table 3.


Table 3: Estimated income and expenditure 2003-04

£000s £000s

Income

Licence fees applied from previous years’ underspends 1,037

Licence fees recovered 12,600

Other income 164

Total income 13,801

Expenditure

Permanent staff 8,336

Agency and secondees 200

Personnel overheads 767

Consultancy projects 1,160

Accommodation 1,519

Non-cash costs (eg depreciation) 456

Other 1,363

Total expenditure 13,801

We will carry forward an estimated £1.3 million of the previous years’ licence fees tooffset against future fees charged to the companies.

Table 4: Administration costs – by activity group

2002-03 2003-04 outturn estimated

outturn

£000s £000s

Regulatory action 6,417 7,901

External relations and legal services 1,138 1,084

Finance, human resources, office services and operations 1,353 1,537

Direct costs of WaterVoice and consumer representation 2,376 2,611

IT services and information management 541 668

Total 11,825 13,801

working with our external auditors, NAO,to achieve a faster close and audit of ouraccounts.

Resource allocation

Our expenditure is apportioned to theoutputs planned in our annual forwardprogramme. During the year, wereallocated finance to unplanned workincluding Competition Act cases and

Resource accounts

We published our resource accounts for2002-03 in October 2003 (HC1120). Theaccounts received an unqualified auditcertificate from the Comptroller andAuditor General. We plan to publish theaccounts for 2003-04 by October 2004.The resource accounts are prepared inaccordance with the GovernmentResources and Accounts Act 2000 anddirections issued by HM Treasury. We are


interim determinations. A summary ofresource allocation against our mainoutputs is shown in Figure 5.

Audit

Our financial and risk managementsystems and reports are scrutinised bythe Audit Committee. Members of thecommittee are John Baker (Chairman andnon-executive advisory director, NEAD),and Roger Munson (NEAD). NAO, Internal

Audit (KPMG), the Director General andsenior finance staff attend the committee.The Audit Committee met three timesduring the year.

Publishing forward workprogrammes We published our draft forwardprogramme on 31 October 2003 and finalprogramme on 31 March 2004. Theconsultation exercise included aworkshop in November 2003 at the NECin Birmingham. We made changes to thedraft as we received more detailedinformation about the Water Act, WaterFramework Directive and Enterprise Act2002. There were also policy andtimetable changes.

Risk management and RIAs We contributed to the Government-widedevelopments of risk management, andhave further developed our ownprocedures to strengthen internal controlprocesses. Regulatory impactassessments (RIAs) are policy tools toassess the impact in terms of costs,benefits and risks of any proposedregulatory actions affecting ourstakeholders. During the year we appliedRIAs to the new regulations arising fromthe Water Act 2003.


WaterVoice 23%

Price setting 38%

Safeguarding quality andprotecting customers 19%

Comparative competitionand regulatory finance 9%

Market competition 11%

Figure 5: Resource allocation

Table 5: Consultancy and professional services expenditure summary 2003-04(company contracts costing more than £50,000, excluding VAT)

Project Supplier

The cost base Babtie Engineering

Review of water company capital maintenance submissions Mott MacDonald

Scope for future efficiency studies London Economics

Price review customer research MVA Ltd

Cost of capital Europe Economics

Company tax projections Deloitte & Touche

Aquarius 3 audit Robson Rhodes

Corporate finance Deloitte & Touche

Appendix 1 – Ofwat’s milestones 2003-04 This table sets out our progress against the key milestones detailed in our forwardprogramme. Generally we achieved our milestones when we said that we would.

Price setting Date achieved

Release update of financial model (Aquarius 3) May 2003

Issue draft business plan information capture system May 2003

Publish initial feedback on cost base submissions May 2003

Publish updated guidance on the interim determinations process May 2003

Companies submit June returns 2002-03 June 2003

Companies submit draft business plans August 2003

Companies publish summaries of draft business plans September 2003

Publish document that identifies issues emerging from draft business plans October 2003

Publish results of independent external review of reporters’ work January 20041

on companies’ business plans

Provide feedback to companies and their reporters on draft October to business plan submissions December 2003

Respond to requests for interim determinations and issue September to counter notices where necessary October 2003

Provide companies with details of 2005-06 capital investment December 2003programme

Publish results of joint customer research December 2003

Ministers provide final guidance on the required quality programme March 2004

Safeguarding customers

Publish ‘Tariff structure and charges’ May 2003

Hold complaints workshops May 2003 and October 2003

Publish ‘Financial performance and expenditure of the water August 2003companies in England and Wales’


Appendices

1 Originally due to be completed by December 2003. We changed the process and decided to issue a preliminary report,which we did in October 2003, followed by the final report in early January 2004.

Consultation on measured/unmeasured household differential August 2003

Publish ‘Levels of service for the water industry in England and Wales’ September 2003

Publish companies’ leakage performance July 2003

Publish the June return 2003 October 2003

Publish ‘Security of supply, leakage and the efficient use of water’ October 2003

Report progress on Thames’ security of supply in October 2003‘Security of supply, leakage and the efficient use of water’

Approve companies’ draft charges schemes February 2004

Publish the results of the Water Resale Order review March 2004

Comparative competition and companies’ finance

Consult on proposed modifications to licence Condition B February 20042

Publish international comparison report March 20043

Publish ‘Water and sewerage service unit costs and relative efficiency’ January 20044

Hold reporters and auditors joint workshop December 2003

Publish results of assessment of reporters’ performance on December 2003June returns

Publish updated regulatory capital values (RCVs) for 2000-05 March 2004

Hold City briefings Ongoing

Respond to financial restructuring proposals As required

Respond to merger proposals As required

Competition

Second report on Competition Act 1998 casework April 2003

Consult on the possible industry working groups to help prepare December 20035

for the implementation of the Water Bill proposals on competition

Respond to Competition Act 1998 queries As required

Respond to applications for inset appointments within stated timescales As required

Proposed legislation

Publish the code of practice on discharge of functions September 2003

Develop new procedures to implement powers conferred by To be developed Enterprise Act 2002 in 2004

Resources and accountability

Publish our Annual Report May 2003

Publish our annual accounts October 2003

2 Originally due to be completed by April 2003. The consultation for these licence modifications was combined with othermodifications in respect of the price review. Publication was held back until the substantial effect determinations forNorthumbrian Water and Bournemouth & West Hampshire Water were complete in February 2004.

3 Originally due to be completed by October 2003. The work was delayed due to staff changes.

4 Originally due to be completed by December 2003. The slight delay was due to additional validation of data submittedfor the econometric modelling and the cost base.

5 Originally due to issue a consultation by September 2003. However, as we were unable to issue any publications untilthe Water Act 2003 had received Royal Assent, we issued an Information Bulletin in December 2003 and held an industryworkshop in January 2004, after Royal Assent.


WaterVoice Central For customers of Severn Trent Water andSouth Staffordshire WaterFirst Floor, Chanelle House, 86 New Street, Birmingham B2 4BATel: 0121 644 5252Fax: 0121 644 5256Lo-call: 0845 702 3953e-mail: [email protected]

WaterVoice Eastern For customers of Anglian Water, CambridgeWater, Essex & Suffolk Water, and TendringHundred WaterGround Floor, Carlyle House, Carlyle Road,Cambridge CB4 3DNTel: 01223 323889Fax: 01223 323930Lo-call: 0845 795 9369e-mail: [email protected]

WaterVoice Northumbria For customers of Northumbrian Water andHartlepool WaterEighth Floor, Northgate House, St Augustine’s Way, Darlington DL1 1XATel: 01325 464222Fax: 01325 369269Lo-call: 0845 708 9367e-mail: [email protected]

WaterVoice North West For customers of United Utilities WaterSuite 902, Ninth Floor, Bridgewater House,Whitworth Street, Manchester M1 6LTTel: 0161 236 6112Fax: 0161 228 6117Lo-call: 0845 705 6316e-mail: [email protected]

WaterVoice South West For customers of South West WaterFirst Floor, Broadwalk House, SouthernhayWest, Exeter EX1 1TSTel: 01392 428028Fax: 01392 428010Lo-call: 0845 795 9059e-mail: [email protected]

WaterVoice Southern For customers of Southern Water, Folkestone& Dover Water, Mid Kent Water, PortsmouthWater and South East WaterFourth Floor (South), High Holborn House,52/54 High Holborn, London WC1V 6RLTel: 020 7831 4790Fax: 020 7831 7253Lo-call: 0845 758 1658e-mail: [email protected]

WaterVoice Thames For customers of Thames Water, Three ValleysWater, and Sutton & East Surrey WaterFourth Floor (South), High Holborn House,52/54 High Holborn, London WC1V 6RLTel: 020 7831 4790Fax: 020 7831 4850Lo-call: 0845 758 1658e-mail: [email protected]

WaterVoice Wales (DyfrLais Cymru)For customers of Dwr Cymru Welsh Water andDee Valley WaterRoom 140, Caradog House, 1-6 St Andrews Place, Cardiff CF10 3BETel: 029 2023 9852Fax: 029 2023 9847Lo-call: 0845 707 8267e-mail: [email protected]

WaterVoice Wessex For customers of Wessex Water, Bournemouth& West Hampshire Water, Bristol Water,Cholderton & District Water2 The Hide Market, West Street, St Philips, Bristol BS2 0BHTel: 0117 955 7001Fax: 0117 955 7037Lo-call: 0845 707 8268e-mail: [email protected]

WaterVoice Yorkshire For customers of Yorkshire WaterEighth Floor, Northgate House, St Augustine’s Way, Darlington DL1 1XATel: 01325 469777Fax: 01325 369269Lo-call: 0845 708 9368e-mail: [email protected]


Appendix 2 – WaterVoice committees

Appendix 3 – Independent reporters and auditors

Water and sewerage companies Auditors Reporters

Anglian Water Services Ltd PricewaterhouseCoopers WS Atkins

Dwr Cymru Cyfyngedig PricewaterhouseCoopers Halcrow Management Sciences

Northumbrian Water Ltd Ernst & Young Black & Veatch

Severn Trent Water Ltd PricewaterhouseCoopers Halcrow Management Sciences

South West Water Ltd PricewaterhouseCoopers WS Atkins

Southern Water Services Ltd PricewaterhouseCoopers WS Atkins

Thames Water Utilities Ltd PricewaterhouseCoopers WS Atkins

United Utilities Water plc Deloitte & Touche Halcrow Management Sciences

Wessex Water Services Ltd KPMG Halcrow Management Sciences

Yorkshire Water Services Ltd Ernst & Young Strategic ManagementConsultants

Water only companies Auditors Reporters

Bournemouth & West Hampshire PricewaterhouseCoopers Halcrow ManagementWater plc Sciences

Bristol Water plc PricewaterhouseCoopers WS Atkins

Cambridge Water plc Deloitte & Touche Black & Veatch

Dee Valley Water plc Saffrey Champness MWH UK Ltd

Cholderton & District Water B Johnson Esq *Company Ltd

Folkestone & Dover Water Ernst & Young MWH UK LtdServices Ltd

Mid Kent Water plc Deloitte & Touche Monson Engineering Ltd

Portsmouth Water plc Grant Thornton Kellogg, Brown & Root Ltd

South East Water plc PricewaterhouseCoopers Strategic ManagementConsultants

South Staffordshire Water plc Deloitte & Touche Black & Veatch

Sutton & East Surrey Water plc KPMG Kellogg, Brown & Root Ltd

Tendring Hundred Water Services Ltd Ernst & Young MWH UK Ltd

Three Valleys Water plc Ernst & Young WS Atkins

* Cholderton & District Water Company is an exceptionally small company and does not provideannual return information.


South West Water Ltd

Peninsula HouseRydon LaneExeterEX2 7HR

Telephone: 01392 446688www.southwestwater.co.uk

Thames Water Utilities Ltd

Clearwater CourtVastern RoadReadingBerkshireRG1 8DB

Telephone: 0845 920 0888www.thameswater.co.uk

United Utilities Water plc

Dawson House Great SankeyWarringtonWA5 3LW

Telephone: 01925 234000www.unitedutilities.com

Wessex Water Services Ltd

Claverton Down RoadClaverton DownBath BA2 7WW

Telephone: 01225 526000www.wessexwater.co.uk

Yorkshire Water Services Ltd

Western HouseWestern WayHalifax RoadBradfordBD6 2LZ

Telephone: 01274 691111www.yorkshirewater.com

Anglian Water Services Ltd

Henderson HouseLancaster WayHuntingdonCambridgeshirePE29 6XQ

Telephone: 0800 145145www.anglianwater.co.uk

Dwr Cymru Cyfyngedig (Welsh Water)

Pentwyn RoadNelsonTreharrisMid GlamorganCF46 6LY

Telephone: 01443 452300www.dwrcymru.co.uk

Northumbrian Water Ltd

Abbey RoadPity MeDurhamDH1 5FJ

Telephone: 0870 608 4820www.nwl.co.uk

Severn Trent Water Ltd

2297 Coventry RoadSheldonBirminghamB26 3PU

Telephone: 0121 722 4000www.stwater.co.uk

Southern Water Services Ltd

Southern HouseYeoman RoadWorthingSussexBN13 3NX

Telephone: 01903 264444www.southernwater.co.uk


Appendix 4 – The water and sewerage companies

Albion Water Ltd

71 Clarence RoadTeddingtonMiddlesexTW11 0BN

Telephone: 0208 977 3055

Bournemouth & WestHampshire Water plc

George Jessell HouseFrancis AvenueBournemouth BH11 8NB

Telephone: 01202 591111www.bwhwater.co.uk

Bristol Water plc

PO Box 218Bridgwater RoadBristol BS99 7AU

Telephone: 0117 966 5881www.bristolwater.co.uk

Cambridge Water plc

41 Rustat RoadCambridge CB1 3QS

Telephone: 01223 403000www.cambridge-water.co.uk

Cholderton & District WaterCompany Ltd

Estate OfficeCholdertonSalisburyWiltshire SP4 0DR

Telephone: 01980 629203

Dee Valley Water plc

PacksaddleWrexham RoadRhostyllenWrexhamNorth Wales LL14 4EH

Telephone: 01978 846946www.deevalleygroup.com

Folkestone & Dover WaterServices Ltd

Cherry Garden LaneFolkestoneKent CT19 4QB

Telephone: 01303 298800www.fdws.co.uk

Mid Kent Water plc

High StreetSnodlandKent ME6 5AH

Telephone: 0845 850 6060www.midkentwater.co.uk

Portsmouth Water plc

PO Box 8West StreetHavantHants PO9 1LG

Telephone: 02392 499 888www.portsmouthwater.co.uk

South East Water plc

3 Church RoadHaywards HeathWest Sussex RH16 3NY

Telephone: 01444 448200www.southeastwater.co.uk

South Staffordshire Water plc

Green LaneWalsallWest Midlands WS2 7PD

Telephone: 01922 638282www.south-staffs-water.co.uk

Sutton & East Surrey Waterplc

London RoadRedhillSurrey RH1 1LJ

Telephone: 01737 772000www.waterplc.com

Tendring Hundred WaterServices Ltd

Mill HillManningtreeEssex CO11 2AZ

Telephone: 01206 399200www.thws.co.uk

Three Valleys Water plc

PO Box 48Bishop’s RiseHatfieldHerts AL10 9HL

Telephone: 01707 268111www.3valleys.co.uk


Appendix 5 – The water only companies

Appendix 6 – Ofwat administrative costs

£000s

2000-01 2001-02 2002-03 2003-04 2004-05 2005-06Outturn Outturn Outturn Estimated Plans Plans

outturn

Gross administrative costs:

Staff 5,897 6,407 7,312 8,536 9,307 -

Other 5,021 4,425 4,513 5,265 5,094 -

Total gross administration costs 10,918 10,832 11,825 13,801 14,401 -

Related administrative receipts from licence fees and other minor receipts (11,554) (11,563) (11,825) (13,801) (14,401) -

Total net administration costs (636) (731) - - - -

Departmental expenditure limit (DEL) (636) (731) - - - -

NOTES:

1) This table is included as a requirement stipulated by HM Treasury. Outturn figures are taken from ourpublished Resource Accounts. We operate on the basis that licence fees recovered from the industry shouldcover our costs. Surpluses of income stated in ‘Total net administration costs’ refer to the income generatedfrom our publications and monies recovered on behalf of the Competition Commission.

2) 2003-04 gross administration costs are based on estimated outturn and are subject to review by audit.

Appendix 7 – Ofwat staff numbers

1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 Actual Actual Actual Actual Actual Actual Actual Actual Plans

Civil Service full-time equivalents 183 175 176 195 202 210 231.5 243 245

Overtime 1 1 1 1 1 1 0 1 1

Casuals 4 5 7 15 6 7 1.5 7 4

Total 188 181 184 211 209 218 233 251 250



Appendix 8 – Ofwat structure

Keith MasonDirector ofRegulatoryFinance 0121 625 3600

Peter BucksSenior FinancialAdviser0121 625 1351

EmmaCochraneHead ofCorporateFinance0121 625 3623

TraceyAnderson Head ofRegulatoryAccounts andBusiness AffairsTeam 0121 625 1311

Dawn HarrisonHead ofFinancialModelling Team 0121 625 1317

Kieran DuffyHead ofTransfer PricingTeam 0121 625 1446

Tony SmithDirector ofCompetitionand ConsumerAffairs 0121 625 1334

Sue Cox Head of Service& PerformanceTeam 0121 625 1303

Clive RalphHead ofDisputes &ComplaintsTeam0121 625 1339

Beryl BrownHead ofCompetitionPolicy0121 625 1426

Paul Hope Head of Tariffs0121 625 3612

Bill EmeryDirector of Costs& Performanceand ChiefEngineer 0121 625 1394

Mark HannHead ofComparativeEfficiency Team0121 625 1437

Rowena TyeHead of QualityEnhancementTeam 0121 625 1364

George ButlerHead of CapitalMaintenanceTeam 0121 625 1452

Irene MillwardReporters’ Co-ordinator 0121 625 1487

George DayHead ofSupply/DemandBalance Team0121 625 1454

Roger DunsheaDirector ofOperations 0121 625 1305

RalphRandallHead of Finance& Services 0121 625 1330

Liz DavidsonHead of HumanResources 0121 625 1323

Nigel Milne IT ServicesManager 0121 625 1309

Carl PoultonInformationSystemsDevelopmentManager 0121 625 1349

Fiona PethickHead of CrossDivisional PolicyCo-ordination0121 625 3619

Julia HavardHead ofExternalRelations 0121 625 1450

Peter MandichSenior PressOfficer0121 625 1442

Ingrid OlsenParliamentaryAffairs &PublicationsManager0121 625 1325

Jane FisherLibrarian &InformationServicesManager 0121 625 1361

WaterVoice Council

Ten WaterVoicecommitteechairmen

Ten regionalmanagers

Philip Fletcher Director General of Water Services0121 625 1316

Private OfficeAnneke Vermeer0121 625 1316

Huw BrookerHead of LegalServices0121 625 1435

Roy WardleHead ofConsumerRepresentation 0121 625 1367

Ofwat BoardPhilip Fletcher

Non-executive Executiveadvisory directors directorsJohn Baker Roger DunsheaMartin Cave Bill EmeryJane May Keith MasonRoger Munson Tony Smith

Email: [email protected]


Ofwat’s senior management team and non-executiveadvisory directors*

Back row (from left): Keith Mason (Director of Regulatory Finance), Huw Brooker (Head of Legal Services),Roger Dunshea (Director of Operations), Roy Wardle (Head of Consumer Representation),Bill Emery (Director of Costs & Performance and Chief Engineer), Julia Havard (Head ofExternal Relations)

Front row (from left): Roger Munson (non-executive advisory director), Philip Fletcher (Director General of WaterServices), Martin Cave (non-executive advisory director), John Baker (non-executiveadvisory director)

* Jane May (non-executive advisory director) and Tony Smith (Director of Competition and Consumer Affairs)were unable to be present when this photograph was taken.

How to contact us:Office of Water Services

Centre City Tower7 Hill StreetBirmingham

B5 4UA

Telephone: 0121 625 1300

Fax: 0121 625 1400

Email: [email protected]

Website: www.ofwat.gov.uk


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