Certain things should help
Director general Ofwat, Phillip Fletcher, talks exclusively to WWT
WWT: Ofwat now seems to have a warmer relationship with the water industry
than under your predecessor. Do you think this is a matter of substance or style?
I think it makes sense for each of us to acknowledge all of our respective
roles. And while it is not my job to manage the industry, it is my job to regulate
it in the interest of customers and I do not think there is any difference between
me and Ian Byatt on that.
But it is also important to recognise the achievements of the industry since
privatisation, on which all of us will build for the future of the regulatory
WWT: So you think we are now in a period when things are a bit easier?
PF: That is a part of it but again, it is in all of our interests that regulatory
certainty should be a firm part of the picture, so the [water] companies, the
customers, all the stakeholders, and the investors and lenders have a very clear
picture of how the regulator interacts. I have been making it my business of
course to talk to the companies, but also go out there and talk to those who
are already or might be investors or lenders – and their representatives – to
make quite sure they understand how the regulator approaches the task and there
is no confusion which could add to the cost of the capital, the borrowing.
That is not to say the regulator can ever be completely certain, to do the
job I have got to take appropriate action in response, but where I am taking
action in anticipation I look to consult on it, I look to give signals in advance
so that I am not deliberately or as far as possible inadvertently causing the
markets unnecessary concern.
WWT: Is there a greater level of dialogue than existed previously between
Ofwat and financial institutions?
PF: Yes, I think that probably is so. It is the right time to be doing it,
in the period before the next periodic review, both as a means of consultation
and as a means of making sure that people do not get the wrong end of the stick.
If I could just take the example of the cost of capital, which is vital for
water companies given the £3Bn per year they are investing, there was
an impression in some quarters that the cost of capital set by Ofwat was very
different to that set by other regulators in different contexts. In fact, given
we are regulating different sectors and there are some differences, the cost
of capital we are working with is very similar to that used by Ofgem or by the
Competition Commission when they have pronounced on cost-of-capital issues.
It is that sort of thing which you can help sort out by dialogue.
WWT: So do you think things are moving together with more of a sense of
PF: Yes. To give you another example, we are about to consult on publishing
prospective regulatory capital values. Companies are free to publish now but
only Welsh and Severn Trent have chosen to do so. We will be consulting on the
way in which we might publish this information across the water companies, to
help create greater certainty and understanding across the board.
WWT: Do you think the information you are putting out now goes far enough.
Is Water UK, for example, still seeking greater openess?
PF: This is one of the tensions. Yes they would like more and there are various
areas where we have promised to give more. For example we are developing the
financial model in readiness for the next periodic review in such a way that
will enable us to share it with the industry. Things will start on a much more
common understanding and I hope that will make the review a little bit easier
than it would otherwise have been.
There is also the issue of how much information we collect from the companies.
I do not want us to collect more than we strictly need for the purpose of regulation.
But there is always a feeling from the companies that it is too much, we do
not need all of it and we do not really study what we get. I think that we do,
but we also need to focus on whether we are collecting something because it
would be nice to have the information or because we really need it to regulate
WWT: The development of competition has been glacial. Do you think customers’
interests would be better served by greater levels of competition?
PF: The threat of competition has been quite significant in the way the companies
approach their largest customers, those most vulnerable to going elsewhere.
It is my impression, both from talking to customers and the companies, that
utilities have been paying a lot more attention to the needs of these customers.
Of course it is also my job to ensure they do not give big customers a good
deal at the expense of other users.
But I agree with you that the development of price competition has been very
slow, we have not even had a new inset appointment in my time at Ofwat. Common
carriage is quite slow to develop too. This is not confined to the water sector,
if you are looking for cases under the Competition Act, all the regulators have
found the initial process has been slow in developing case work and understanding
issues, so that should not worry us.
I do think it is going to be fairly difficult to get price competition really
working in the water sector in advance of new legislation. That is where Michael
Meacher’s announcement at the end of March comes in, with the indication the
government would look for secondary licences for the production and retail functions,
leaving the distribution network as monopoly, and I think that sort of an approach
will meet some of the difficulties we have got at the moment.
We are launching another consultation on common carriage and access. We have
been building on current access codes to look for best practice, which we will
use as our guidelines for considering action under the Competition Act. It could
be the foundation for a national code at some stage. To give water regulators
the assurances they need, secondary licences which clarify the accountability
and leave no doubt that a licensed entrant will be fully accountable for what
they do would be very helpful.
WWT: A recent Utility Buyers’ Forum (UBF) survey found 90% of respondents
wished to change water supplier but did not feel able to because it was too
difficult. Does that surprise you?
PF: It does not greatly surprise me. Of course it will vary, if you are looking
at a sample you are not looking at many of the large exceptions who are in a
position to choose. A Water Bill with a significant and properly-integrated
competition element I believe will be the way of helping to take this forward.
WWT: Another point which came out in our talking with the UBF was that although
the threat of competition had improved standards, delays in passing the Water
Bill could see these improvements lost.
PF: I do not have quite such a pessimistic view. I think there are some benefits
in the government taking its time to come up with what hopefully will be a carefully
thought through, really integrated bill. Presumably the earliest this could
be is autumn 2002, but that gives them time to put it all together.
One of the issues I hope further thinking will help on is integrating the competition
regime with the abstraction control regime, where the government has already
got the proposals they have consulted on, but where competition introduces a
set of new elements which need to be brought into line with the legislation
on abstraction. If the price of a year’s delay is a much better integrated statutory
framework, I think it is worth paying.
WWT: The Better Regulation Task Force made it clear that its criticisms
of regulatory culture could be applied to all economic regulators, not just
Oftel, Ofgem and the CAA. Are you aware of a ‘game-playing, cat-and-mouse’ mindset
PF: I think the task force was addressing sectors which already had a substantial
amount of competition so not all their findings were applicable to water. I
think that water was not to be covered initially, but they picked up some things
as they went along which looked relevant more generally.
All of us would like to reduce the gaming that occurs around the periodic reviews.
When we come to the next one I would like to ensure that as far as is possible
we are focussing on real issues and not playing games. That said, there will
be points where the water companies and I disagree, perhaps strongly. My hope
would be that we could do that and still come up with an appropriate answer
in terms of the price limits, which everybody should be focussing on.
Large parts of the report will be fairly common ground. I want to move, within
the legislation as it stands, towards the report’s notion that rather than having
individual regulators, things should be focussed on a board approach. There
is a lot to be said for that, although I think there is a lot to be said for
the single regulator in terms of flexibility and speed of manouvre, but I can
understand those who argue a board would be better. Although I can not change
the single regulator set-up because it is primary legislation, I can recruit
non-executive advisory directors and I intend to set about that.
WWT: The back-end loading of AMP3 work has led to some quite grim predictions
of work not getting done, or costing more than the water companies have budgeted
for. How far do you share these concerns?
PF: The first point is that within the context of the last review, we were
conscious of the rollercoaster profile that had come in the mid-1990s, and we
wanted to seek to minimise it as far as possible. We are not being starry-eyed
about it, there is a period of uncertainty around the periodic review and it
would be hard for the [water] companies to ensure there was no blip over that
period, but we wanted to keep the blip to a minimum.
We did various things designed to that end. We gave water companies a protocol
on the timing of investment, we have very definitely not back-end loaded the
investment for AMP3. We are looking for an even profile with some small peaks
in years two and three.
Now what has happened? In the first year of AMP3 the spend has been significantly
lower, 20% lower – still not as big a fall as we saw in the mid-1990s – but
bigger than I am entirely comfortable with, in the interests of efficiency.
There is still full time for the companies to deliver the objectives of AMP3
to which they effectively signed-up when the majority of them chose not to refer
the issues to the Competition Commission at the last periodic review.
There have been a number of particular factors, we had a very difficult winter
last time round, so I am not going to get too upset about the position in the
first year. Also, there were issues around quality, and still are, which are
being thoroughly thought through. There is no point in saying you must do precisely
what we thought right two, three, four, five years ago, because it may no longer
be the most efficient way of doing it. And if it turns out, at least to a degree,
that spending on plumbosolvency treatment delivers the outputs required better
or as well as a huge pipe replacement programme, then it does not make sense
to press on with pipe replacement just because that is what you thought of in
the first place.
WWT: But from the supply chain we hear genuine concerns that the capacity
will not exist to complete the work by the end of the period to the costs agreed.
PF: Water is only one sector in a much bigger picture. Water has been consistently
a significant element, especially since privatisation, in the construction and
civil engineering business. Accepting there were more significant dips than
we wanted to see around the last review and the one before that, none-the-less
we have seen a level of investment – twice the pre-privatisation level, 3Bn
per year going in – which will continue, so there is a measure of certainty
up until 2005. As a result I am not sure I buy the argument that the programme
is so uncertain as to mean contractors have no basis on which to take their
proper business decisions.
WWT: The impression we get is not that the work is not there, but there
is too much work and too little time.
PF: On the whole that is what the market is used to dealing with. Of course
major construction, major engineering needs proper planning, the lead-in time
is often a very significant part of the whole project, and that is why it is
very important the [water] companies get on with the AMP3 business and start
to get the signals in place for AMP4 when they sensibly can. But I believe the
contractors have shown that they are up to the challenge and I hope and believe
they will continue to be up to the challenge as we go forward.
I accept that it is up to the water companies themselves, whose programmes
we are talking about, and to the regulators behind them to help as far as they
can to ensure the certainty is there to give the market the confidence to make
the necessary decisions.
WWT: So you do not feel the timescale and costings agreed are under threat?
PF: Obviously I listen to them, but I think there is still plenty of time for
the companies to succeed in completing their AMP3 programmes in the timetable
we have set.
I am not saying it is not challenging, but with the will and the element of
clarity and certainty we have so far provided the potential is there to achieve
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