THURSDAY 6 JULY 2000

SIR IAN BYATT AND MR KEVIN RIDOUT

  192. Good morning, Sir Ian, welcome to the Committee. May I also congratulate you on your knighthood—
  (Sir Ian Byatt) Thank you.

  193. —after eleven years, is it, in the job?
  (Sir Ian Byatt) Ten years, eleven months.

  194. It must have seemed like a long time, I am sure. A well-deserved honour after all that time.
  (Sir Ian Byatt) It has been a very interesting job and I think Ofwat has been a success, and I hope that Ofwat and the water industry can share in this.

  195. Thank you. Before we begin questioning you on your written evidence, is there anything you would like to add, however brief, and please be brief, to what you have already given us?
  (Sir Ian Byatt) Yes, I think it might be helpful to you if I were to say just a few words about my role in this price review which you are looking at. A major task, to ensure that the companies properly carry out their functions and can finance them; that is my primary statutory duty. Subject to that, to protect customers, to promote economy and efficiency and to facilitate competition. The proper carrying out of functions includes meeting water quality and environmental obligations which are placed on companies by Government ministers and meeting those obligations efficiently. Those are my duties. The price limits set last November enable companies to invest over £15 billion in the next five years, and by 2005 companies will in the 15 years from 1990 to 2005 have invested over £50 billion; a very large amount of money compared with what happened in the past. These price limits also gave customers an average reduction of over 12 per cent on their bills, that is broadly £30 for every household customer. This was in marked contrast to the situation in the five years from 1990 to 1995 when prices went up by 5 per cent a year above the rate of inflation, and from 1995 to the end of the century when they went up at 1½ per cent a year above the rate of inflation, much slowed but still going up. The companies, as a result of investment and higher operating expenditure compared with what otherwise would have happened, have delivered better drinking water, better waste water and so less pollution in our rivers and coastal water, better customer service and now, as I said, lower prices. These benefits have resulted to a considerable extent from the greater efficiency of private water companies under the regulatory regime which we operate, which gives them incentives to be efficient. The review itself was conducted over a period of three years; a very intensive and deep review. First, we set out after consultation the methodology and the information we needed for the review. I stress "after consultation", so a consultation paper and then conclusions from the consultation. The next stage of the review was to look at costed options and we published in the autumn of 1998 Prospects for Prices which set out in quantitative terms what the options were. Then, next, draft price limits in July of 1999, and then final decisions last November with a mechanism for appeal to the Competition Commission. I note that of the water companies only two small companies have chosen to appeal to the Competition Commission and their appeals are currently being heard. Also there is a mechanism in the future for incorporating new environmental obligations into price limits, in other words being able to finance them. The process has been open and transparent with opportunities for all stakeholders to contribute at all stages. We cannot please everyone but the environment has gained. John de Ramsey, the former chairman of the Environment Agency, said that the significant environmental damage of the last 200 years will have been reversed by 2005. My gloss on this is that this is the damage caused by the sewerage companies but there is also an issue about diffuse pollution, which of course was not dealt with in this review; diffuse pollution often from agricultural sources. Customers have gained in that bills have come down and at a national level will stay down. There has been some discussion of research and customer views. The research carried out by Water UK showed that customers wanted a better environment, better drinking water and lower prices, and this is what they have got. Ministers wanted price reductions and a big environmental programme to deal with environmental damage; that is what they got. We identified efficiency savings which amounted to some £60 per year per household customer, £30 of that went into better quality and £30 went into lower bills. Finally, Chairman, explaining to Parliament what I am doing I regard as an important part of my duties. After the draft determinations in July 1999 I appeared in front of the Environment Sub-Committee of the Select Committee on the Environment, Transport and Regional Affairs. After the final determinations in November I made a presentation, and all MPs were invited, under the aegis of the All-Party Parliamentary Water Group. So I much welcome being in front of you today to continue this explanation.

  Chairman: This is our third bite of the cherry, by the sound of it; perhaps our deepest bite of the cherry. Thank you very much, Sir Ian. We would like to start off with the outcome of the periodic review, and Mr Chaytor would like to ask you some questions.

  196. Good morning, Sir Ian. In your submission to the Committee you say that the period at the start of the review, from early 1997 to late 1998, saw Ofwat issuing a steady stream of consultation papers on a broad range of financial, procedural and technical issues. Did not the fact that the whole outcome of the review was pre-empted by your statements before that stream of consultation papers, saying there would be a big fall in prices, pre-empt the whole outcome and tenor of the review?
  (Sir Ian Byatt) No, it in no way did that. What we have always operated is an incentive based regime, so that when we observe efficiency by the companies then we allow for that to be given either to the environment, so to speak, to quality, or to lower bills. We made some estimates in 1994 of the extent to which the companies could increase their performance. We assumed they could increase their efficiency rather better than had been assumed by the Secretary of State in 1989, but in fact they quite quickly showed evidence of out-performance on operating cost and therefore there was some efficiency which potentially could be transferred to customers. So I drew attention to that and I think there was a hearing of a parliamentary Committee when I discussed that with the Committee. If you look at our final documentation, you will see that the divergence between actual operating costs and projected operating costs appeared quite early, so I knew there was some advantage from efficiency there. How big it was, I did not know, so the whole size of it was determined in going through the review.

  197. Could you tell us in more detail the kind of efficiencies that the companies made in the previous five year period and how you took that into account in the periodic review which has just been completed?
  (Sir Ian Byatt) I think the efficiencies were both on operating expenditure and on capital expenditure. On operating expenditure they clearly felt they could run their works with less staff, and so employment was reducing. I think they also found that, by changing the method of operation often by giving the more junior staff much more flexibility in carrying out their work, many operations could be carried out more cheaply. On the capital side, there were a number of innovative solutions. For example, in the Isle of Wight the original plan had been to have a number of sewage treatment works all the way round the coastline and they were consolidated in one simple one—I think there was a television programme which went into that. Then I think that procurement has been getting much more effective and planning has been more effective, so that the companies have been able to carry out their obligations with more streamlined methods. So a whole variety of things. But I think it is our job to observe the overall effect rather than to try and tease out all the possible things that might have gone into it.

  198. Given these efficiencies which occurred right across the operations of the companies, could this not have been anticipated by Ofwat five years previously?
  (Sir Ian Byatt) Hindsight is a wonderful thing. We thought they could increase their efficiency at a faster rate than they had in the past, and a faster rate than they had in the nationalised days. It turned out they could do better than that. The great advantage of our system is that we can observe that, and we have set out very good information collection systems so we can observe that, so that at the next review those benefits can be transferred either into environmental benefits or consumer benefits.

  199. Would you accept there was a lack of rigour in the scrutiny by Ofwat in its early years of operation?
  (Sir Ian Byatt) No. The information, of course, has got better and better, but I think in the circumstances of the time we made perfectly good estimates and at the time people did not disagree with those. It was only when the numbers began to show that the water companies could do better that I observed then there were some benefits to be had at the next review, and I believe those benefits arose because the full power of the incentive regime started to operate in that period. We saw it in the other utilities too. We now generate all our electricity with less than half the people who were needed by the old Central Electricity Generating Board. I think the efficiencies came earlier in the other utilities than they did in the water industry, but I am delighted that in the water industry they have come out. That does not mean there will not be more, and we have assumed in the price determinations they can continue to increase their efficiencies.