NOTE - this paper comprises a submission to the "Independent Walker Review of Charging

and Metering for Water and Sewerage Services" which, as can be seen from the covering letter,

was dated 13 December 2008. The final report has now been published and is available on

the Defra website through the link given below. It may also be of interest to note that the

evidence given here, regarding excessive prices, excessive dividends and excessive debt,

all taken primarily from Ofwat sources, has been completely disregarded in the

final Walker report which turns out to be just another cover-up.

 
Walker Whitewash
(01803) 85 65 24 23 Penpethy Close
Brixham
Devon   TQ5   8NP
Review of Water Charging 13   December   2008
Second Floor
Ergon House
Horseferry Road
London SW1P 2AL
Dear Sirs,
Submission to the Review of Water Charging

In fairness to customers, any review of water charges in England and Wales should commence with a consideration of the statutory protection to which customers are entitled and any failures there may be in the provision of that protection.

The duties of the regulator (Ofwat) as regards the protection of the financial interests of customers are laid down in Sub-sections 2.2 and 2.3 of the 2003 Water Bill, a copy of which is attached for ease of reference (see appendix 1 below). As will be seen, the main requirements for the protection of these interests are that the regulator should encourage economy and efficiency whilst ensuring that customers are also protected as respects any activities which are not attributable to the licensed business. To this end it is required that the regulator ensure that companies "maintain and present accounts in a suitable form and manner".

The obvious intention is that companies should submit accounts in a form that will facilitate regulatory audit to ensure that operations are economical and efficient with expenditure restricted entirely to the operations for which the companies are licensed.

It is unfortunate that Ofwat clearly have no respect for these statutory requirements for the protection of customers. They prefer a more relaxed policy which they are pleased to refer to as "arm’s length regulation" (sic) with the working slogan "concerned with outputs not inputs - outcomes not expenditure". This lack of concern for water company expenditure - indeed, the blatant disregard of the statutory protection that customers are due - becomes immediately apparent from a perusal of the annual financial reports submitted to Ofwat by, as an example, South West Water (appendixf 2). As will be seen, the dividends of £75.0 million and £68.7 million (19.6% and 15.3% respectively) are surely excessive returns to Pennon (the sole South West Water shareholder) for what, after all, is a bog standard water and sewerage utility with no competition and an assured income. And this is without taking into account the £200 million special dividend voted for by Pennon shareholders in February 2006 (appendix 5). There are also the huge and increasing interest payments on a colossal debt of £1.4 billion which represents an average debt (and overspend) of about £2,000 for every South West Water customer.

This huge expenditure disposes of more than a third of total revenue (and customer bills) and is permitted by Ofwat on the assumption that the revenue of these non-commercial private monopolies can be considered exactly like commercial turnover from normal private businesses which are answerable only to themselves. With their "arm’s length regulation", Ofwat disclaim any responsibility for controlling dividends or debt (where, of course, the former is at least partly funded by the latter) and never mind economy, efficiency or whether such huge dividends are really essential and attributable to the water and sewerage operation. The Ofwat budgetary financial projections, on which the 2005-10 prices are based, are also of interest in this connection and are discussed in the enclosed overview of South West Water financing (appendix 3) with further comment on the excessive dividends in the paper "Commercial" Pennon (appendix 4).

In referring to their price determinations, Ofwat frequently claim transparency. In fact very little detailed information is revealed in the Ofwat reports and, as discussed in the South West Water overview (appendix 3), what is given tends to be unreliable or, as in their attempt to attribute the 2005-10 increases to the capital investment programme, an absurd fabrication. It is hoped that your review will take the opportunity to establish in greater detail the various allowances on which the 2005-10 price determinations were based and to establish what exactly was the additional expenditure that necessitated the huge and unexpected price increases. South West Water customers would also be interested in any justification there might be for them to finance the capital investment programme, pay a "return on capital" for that investment and also to contribute to servicing the debt incurred in financing the capital investment programme (appendix 3). (There does seem to be some duplication here.)

In their reports, Ofwat also make frequent reference the statutory requirement that companies "are able (in particular, by securing reasonable returns on their capital) to finance the proper carrying out of their functions" (see item (2A) (c) of the Act, appendix 1). Comment on these returns is deferred to Appendix 6 see below.

There is also insufficient transparency, as can be seen from the South West Water "operating cost" accounts (appendix 2). In the example it is apparent that more than half the total expenditure is aggregated under the two items "other external charges" and "other operating charges". This is certainly insufficiently detailed for the statutory requirement that accounts are presented in a suitable form and manner" for audit to ensure economy, efficiency and no inappropriate spending. Of course we cannot know what dubious expenditure might be concealed in the aggregate charges. However, 1994 operating cost accounts, included in a 1995 Monopolies and Mergers Commission report, show payments such as "Agents" (£2 million), "NRA charges" (£5 million) and "services from group" (£7 million) which should be of interest to Ofwat and would certainly be of interest to South West Water customers.

It is very evident that Ofwat is remiss in failing to impose restrictions on the excessive dividends taken by parent companies. It is worth noting, in passing, that Mr Gordon Brown, as Chancellor of the Exchequer in 1997, recognised that the water companies were "awash with cash" and levied a windfall tax of £1.69 billion on their than excessive profits but nothing was done to seriously restrict future excessive profits. There is also the Ofwat failure to limit the overspend now represented by a total industry debt of more than £30 billion with interest payments of more than £1.4 billion in 2007-08.

These examples of the lax Ofwat "arm’s length regulation", even without the other regulatory anomalies and shortcomings, must surely justify a full and detailed review of the Ofwat wayward interpretation of the statutory protection due to water customers. This would be most effectively accomplished by a full audit of the financial regulation of an example company for which South West Water, whose customers, since flotation, have suffered the highest charges, is an obvious candidate.

It is also essential, for the long term protection of customer interests, that the annual financial reports of the licensed companies are given wider circulation. It is suggested that parent companies are required to include a copy of their regulatory accounts as an appendix to the group annual reports.

Many people think of Ofwat as the water watchdog and therefore the protector of customer interests. This assumption is probably valid for non-financial matters such as water quality, drainage and so on. However, the fact that Ofwat actually determinate water and sewerage charges puts them in an executive role and rules out any prospect of an independent and impartial view on financial matters or prices. This makes it doubly important that others who should represent the customer interest are effective and truly independent. The two main groups who might be expected to speak for customers are the Consumer Council for Water (CCWater) and the All Party Parliamentary Water Group (APPWG).

CCWater has recently been formed to replace the ineffective WaterVoice. CCWater is said to have greater independence and more authority but key appointments have apparently been filled from Ofwat. Whatever the reason, in financial matters at least, CCWater is firmly in the Ofwat camp. As an example, in March 2008 a number of complaints about South West Water (appendix 5) were lodged with CCWater. These complaints were unequivocally rejected for no better reason than that no objection had been raised by Ofwat.

The APPWG is a group of MP’s with Eliot Morley MP (an ex-Minister for the Environment) as Chairman and Linda Gilroy MP as Secretary. Representations have been made to both Chairman and Secretary, as such, but with no more than a perfunctory acknowledgement. It is not known what are the specific objectives of the APPWG might be but they seem not to include any serious intent to represent the interests of their constituents as water and sewerage customers. Your review, will no doubt, seek comments from both of these groups, and perhaps others, and will be able to make your own assessment as to the extent of their commitment to the financial interests if customers. It is hoped that your review will include recommendations to ensure that water customers in future have an adequate representation regarding prices and the financial regulation of the companies in particular.

A final point. No doubt you are aware that the companies have submitted to Ofwat details of the revenues they say they need for 2010-15. Not surprisingly, South West Water are looking for yet further increases but customers are slightly relieved that the increases sought, according to South West Water, amount only to 7.4% over the 5 years. Artfully, in their table "Price limits and the effect on average bills", South West Water only present the average household bills for water and sewerage separately so that the total increases in the two tariffs are not revealed. The facts are that the revenue increases that are sought amount to 19.9% over the period with price increases of 12.9% in the measured tariff and 40.4% in the unmeasured tariff (see appendix 6).

The trick in the table of average bills that shows an increase of only 7.4% is to assume huge numbers of customers transferring from the unmeasured to the (supposedly) cheaper measured tariff. The greater increases in the unmeasured tariff charges (more than 6% a year above inflation) is of course to drive customers to the measured tariff which could prove costly to large families especially if they are not very good at sums. This deception by South West Water also demonstrates the indulgence of Defra, Ofwat and CCWater, none of whom have made any attempt to ensure that customers are not so misled but are told the truth about the proposed increases.

I shall of course be pleased to assist and attempt to clarify as necessary. I also recommend a perusal of my correspondence with Defra, Ofwat and CCWater and of my submissions to Defra and Ofwat Consultations. These will serve as a check list and also give a very useful insight into the responses of these groups to matters of concern to customers

I wish you every success with your review,

yours faithfully,
S. G. Beale

Water Bill 2003
Subsections 2.2 and 2.3

(2A) The Secretary of State or, as the case may be, the Authority shall exercise and perform the powers and duties mentioned in subsection (1) above in the manner which he or it considers is best calculated -

(a) to further the consumer objective;

(b) to secure that the functions of a water undertaker and of a sewerage undertaker are properly carried out as respects every area of England and Wales;

(c) to secure that companies holding appointments under Chapter 1 of Part 2 of this Act as relevant undertakers are able (in particular, by securing reasonable returns on their capital) to finance the proper carrying out of those functions; and

(d) to secure that the activities authorised by the licence of a licensed water supplier and any statutory functions imposed on it in consequence of the licence are properly carried out.

(2B) The consumer objective mentioned in subsection (2A)(a) above is to protect the interests of consumers, wherever appropriate by promoting effective competition between persons engaged in, or in commercial activities connected with, the provision of water and sewerage services.

(2C) For the purposes of subsection (2A)(a) above the Secretary of State or, as the case may be, the Authority shall have regard to the interests of -

(a) individuals who are disabled or chronically sick;

(b) individuals of pensionable age;

(c) individuals with low incomes;

(d) individuals residing in rural areas; and

(e) customers, of companies holding an appointment under Chapter 1 of Part 2 of this Act, whose premises are not eligible to be supplied by a licensed water supplier, but that is not to be taken as implying that regard may not be had to the interests of other descriptions of consumer.

(2D) For the purposes of subsection (2C) above, premises are not eligible to be supplied by a licensed water supplier if -

(a) they are household premises (as defined in section 17C below); or

(b) the total quantity of water estimated to be supplied to the premises annually for the purposes of subsection (2) of section 17D below is less than the quantity specified in that subsection.

(2E) The Secretary of State and the Authority may, in exercising any of the powers and performing any of the duties mentioned in subsection (1) above, have regard to -

(a) any interests of consumers in relation to electricity conveyed by distribution systems (within the meaning of the Electricity Act 1989);

(b) any interests of consumers in relation to gas conveyed through pipes (within the meaning of the Gas Act 1986);

(c) any interests of consumers in relation to communications services and electronic communications apparatus (within the meaning of the Communications Act 2003), which are affected by the exercise of that power or the performance of that duty.

(3) Subject to subsection (2A) above, the Secretary of State or, as the case may be, the Authority shall exercise and perform the powers and duties mentioned in subsection (1) above in the manner which he or it considers is best calculated -

(a) to promote economy and efficiency on the part of companies holding an appointment under Chapter 1 of Part 2 of this Act in the carrying out of the functions of a relevant undertaker;

(b) to secure that no undue preference is shown, and that there is no undue discrimination in the fixing by such companies of water and drainage charges;

(c) to secure that consumers are protected as respects benefits that could be secured for them by the application in a particular manner of any of the proceeds of any disposal (whenever made) of any of such a company’s protected land or of an interest or right in or over any of that land;

(d) to ensure that consumers are also protected as respects any activities of such a company which are not attributable to the exercise of functions of a relevant undertaker, or as respects any activities of any person appearing to the Secretary of State or (as the case may be) the Authority to be connected with the company, and in particular by ensuring -

(i) that any transactions are carried out at arm’s length;

(ii) that the company, in relation to the exercise of its functions as a relevant undertaker, maintains and presents accounts in a suitable form and manner;

(iii) that, if the person is a licensed water supplier, its licence does not authorise it to carry on any activities in the area of the company;

(e) to contribute to the achievement of sustainable development.

Return to -
List of appendices Murkywater home page Top of this section

South West Water
financial projections and reported expenditure

Ofwat financial projections for 2005-10 (£M at 2004 prices)(£M)
5 year
totals
annual
averages
Total revenue 1,759 351
operating costs 561 112
infrastructure renewals 96 19
Depreciation 382 76
Return on capital* 632 126
Taxation 88 18
*includes financeabilty

Profit and loss
regulatory financial report for year ending 31 March 2008
2007/08 2006/07
£M £M
Turnover 421.0 381.3
Operating costs (175.9) (167.2)
Depreciation (67.9) (62.4)
Operating income (0.1) 2.5
Operating profit 177.1 154.2
Other income 0.8 0.8
Net interest payable (64.9) (58.2)
Profit on ordinary activities
      before taxation
113.0 96.8
Tax on profit on ordinary activities (14.0) (23.0)
Profit on ordinary activities
      after taxation
99.0 73.8
Dividends* (68.7) (75.0)
Retained profit/(loss) for year 30.3 (1.2)
* does not include £200 million special dividends
taken by Pennon in 2006

Operating costs
regulatory financial report for year ending 31 March 2008
2007/08 2006/07
£M £M
Manpowercosts 37.2 33.6
Rawmaterials and consumables 13.6 13.7
Rentals under operating leases
     Hire of plant and machinery 0.6 0.7
     Other operating leases 1.5 1.4
Research and develoment expenditure 0.2 0.1
Auditors’ remuneration 0.1 0.2
Other external charges 80.7 79.0
Infra sstructure renewals charge 27.5 23.5
Other operating charges 14.5 15.0
Totals 175.9 167.2
Return to -
List of appendices Murkywater home page Top of this section

South West Water financing - an overview

    From the outset, the financial regulation of the private water and sewerage companies of England and Wales (by The Water Services Regulation Authority - “Ofwat”) has been seriously flawed. This view is widely held in the South West essentially based on the excessive charges for water and sewerage services. Explanations for the admittedly high charges have generally focussed on the cost of the coastal clean up and the need to properly reward investors and lenders. There have also been frequent warnings that lower prices will mean a return to dirty water and foul beaches.The lack of detail make these assertions difficult to refute but there are enough anomalies to show that a formal review of the financial regulation of the companies is urgently necesary.

    The fundamental misjudgement by Ofwat, at flotation in 1989, was to imagine that the licensed water and sewerage undertakers could ever be considered as normal private companies. They are, of course, privately owned but with no commercial revenue to speak of might more appropriately be thought of as publicly funded monopolies. They may collect the revenues from their captive customers but the amounts collected are determined by Ofwat to provide a total income also set by Ofwat. The fact is that, apart from collecting their own revenues, South West Water, as an organisation, is no more commercial than the Devon and Cornwall Constabulary.

    Being publicly funded, it might then be expected that companies would be required to account for their expenditure under the same headings used in the Ofwat financial projections. This is obviously essential for effective audit and to provide the regulator with essential feedback regarding the validity of the budgetary financial projections. The following table is derived from Appendix 6 to the Ofwat 2004 report, Future water and sewerage charges 2005-10, and are the most detailed figures that Ofwat are prepared to divulge.

South West Water
Ofwat financial projections for 2005-10 (£M at 2004 prices)(£M)
5 year
totals
annual
averages
operating costs 561 112
infrastructure renewals 96 19
Depreciation 382 76
Return on capital* 632 126
Taxation 88 18
Total revenue requirement 1,759 351
*includes financeabilty

    Unfortunately. Ofwat give only the 5 year aggregate figures which are not entirely reliable since they are contradicted elsewhere in the same report where the average annual operating expenditure is given as £112 million (which agrees with Appendix 6) but the average annual capital expenditure is given as £152 million (for which there is no obvious match).

    The huge 2005-10 price increases were attributed by Ofwat to the cost of the £16.8 billion capital investment programme. This programme obviously replaced that for 2000-05, the cost of which was £15.6 billion (or about £17 billion at 2004 prices) so this explanation by Ofwat is clearly absurd and a cannot possibly be true. Similarly, the South West Water annual charge per property for 2005-10 is given as £216 which replaces the 2000-05 charge of £213 (or £236 at 2004 prices). Again, these figures conclusively contradict the Ofwat explanation.

    There surely can be no disputing that Ofwat should be called to account for these deceptions and to explain the exact purpose for the increased revenue. Whatever the Ofwat intention, on 15 February 2006 the Pennon shareholders clearly saw an opportunity and passed a resolution for “the return of £200 million of cash to shareholders”. Only eight days later, on 23 February 2006, “in order to optimise the capital structure” of South West Water, a special dividend payment of £200 million was duly approved. The average cost per household of this payment to Pennon shareholders was about £280.

    Despite the Ofwat references to capital expenditure as a justification for price increase, it should be noted that there is no reference at all to this expenditure in Appendix 6. However, as will be seen from the table given above the projections on which the prices are supposedly based, although woefully lacking in detail, fit easily into a standard commercial “profit and loss” account. The “infrastructure renewals charge” would be included as the “operating costs” together with “depreciation to give the total “allowance against tax” as follows -

South West Water
Example “profit and loss” account (£M)
Total revenue 361
Operating costs 112
Infrastructure renewals 19
Depreciation 76
Total allowances against tax 207
Operating profit 144

    Depreciation is strictly a tax allowance related to the declining value of capital assets and essentially might be considered as untaxed profit. We can only assume that this allowance is intended as a contribution towards capital expenditure. There is also an allowance for “return on capital” which is substantial and is presumably a return on the capital assets that South West Water customers have paid for. It is ironic that South West Water customers, having paid the highest charges to finance the capital investment programme, were given no share in the equity but are now paying the highest return on capital to shareholders who actually contributed nothing to the investment programme.

    The supply of water and sewerage services are well established operations and, being free from commercial uncertainty, the operating cost and operating profits are predictable with some precision. This assures Pennon, the sole shareholder of the licensed monopoly, of substantial dividends and its managers of their profit related bonuses. Over the years, the dividends taken by Pennon have totalled about £1,400 million - about 30% of South West Water revenue at an average cost per household, since 1989, of about £2,000. Ofwat make much of the need to reward shareholders. However, of the £1,400 million taken from South West Water, only about £1,000 million has been passed on to Pennon shareholders so that about £400 million - an average of over £20 million a year - has been retained to subsidise the commercial operations of the Pennon group. Pennon shareholders may well have a view on the additional £400 million they might have shared in dividend had the loss making, commercial ventures never been attempted.

    With an averagee of more than £100 million a year expenditure on the dividend taken by Pennon, there appears to be a substantial shortfall, as can be seen from the example “profit and loss” account, on the £152 million quoted by Ofwat as the amount necessary to finance the capital investment programme. The clue here is the allowance for “financeability” included in the allowance projected as “return on capital” in Appendix 6. It seems that this allowance for “financeability” is included as a contribution to servicing the debt incurred to finance the capital investment programme. It therefore seems, from these Ofwat projections, that South West Water customers are paying addiitional charges to finance the capital investment programme, to service the debt incurred to finance the capital investment programme and to provide a “return on capital” for shareholders who made no contribution whatsoever to the capital investment programme. No wonder South West Water prices are so high.

    And this South West Water debt is by no means insignificant. In March 2008, it stood at £1.4 billion (an average of about £2,000 per household) and in 2007-08 the interest payable was £65 million (an average charge of more than £90 per household).

    It is very evident, even from this brief overview, that the financial regulation of South West Water is grossly unfair to customers. This essentially arises from the misguided Ofwat notion that revenue surpluses can be considered as commercial profit and need not be closely audited. One outcome of this lax financial control is that the South West Water expenditure on dividends and interest charges is currently well over one third of the total revenue. This is in blatant disregard of the Act which specifically requires Ofwat to promote economy and efficiency in the carrying out of the functions of a water and sewerage undertaker, to ensure that customers are protected as respects any activities which are not attributable to the exercise of those functions and, in particular, by ensuring that the company presents accounts in a suitable form and manner”.

Return to -
List of appendices Murkywater home page Top of this section

Commercial Pennon

The figures given below are derived from several sources and should be considered approximate and valid for illustration purposes only. The South West Water dividend is that taken by Pennon, the group parent company and sole South West Water shareholder. The Pennon dividend is the the total paid out by the group to public shareholders.

Pennon & South West Water
annual revenue and dividends from 1989 to 2008     (£M)
S.W.W.
revenue
S.W.W.
dividend
Pennon
revenue
 Pennon
 dividend
2007-08 421.0 68.7 875.0 69.1
2006-07 381.8 75.0 748.3 66.0
2005-06 351.0 197.9 645.7 61.0
2004-05 310.0 79.5 551.4 55.1
2003-04 292.0 75.6 455.1 51.1
2002-03 270.3 72.7 417.2 144.3
2001-02 260.4 66.7 374.8 51.4
2000-01 251.4 60.4 353.2 49.4
1999-00 281.4 64.0 467.0 65.1
1998-99 270.1 60.0 437.1 61.9
1997-98 251.2 165.1 382.4 54.1
1996-97 244.6 56.1 343.6 47.4
1995-96 239.3 46.5 314.4 38.9
1994-95 236.6 145.0 293.7 35.4
1993-94 210.2 41.5 251.6 32.0
1992-93 185.7 38.8 194.4 29.5
1991-92 160.4 34.9 166.5 26.8
1990-91 140.2 32.4 143.8 24.4
1989-90 121.1 34.6 121.0 21.3
Totals 4,878.7 1,415.4 7552.4 984.2

Regarding dividends, Pennon Group Plc (the parent and sole shareholder of South West Water) pride themselves on a generous and progressive dividend policy and, as shown, the total reportedly paid out by Pennon as dividend, since flotation, amounts to nearly £1 billion (about 13% of total revenue). However, the total taken from South West Water in dividend over the period is about £1.4 billion (about 29% of total South West Water revenue). The point to be noted at the outset is that if, as Pennon assert, the 13% average dividend is “generous and progressive”, the average of about 29% of revenue paid by South West Water as dividend must surely be considered ridiculously excessive.

It is generally expected that the various commercial operations within a group should make a proper contribution to the annual dividend payments to shareholders. If an operation is unable to contribute to this return on capital, it is obviously a commercial failure and in fairness to shareholders should be closed down. It need hardly be said that the assets can then be used to better, more profitable, effect.

In 2007-08, the South West Water and commercial Pennon revenues were very nearly equal, at about £421 million and £454 million respectively. On this basis, we might expect the contributions to the £69 million Pennon dividend payout also to be approximately equal. In fact the 2006-07 dividend taken by Pennon from the South West Water licensed operation, was £68.7 million. Commercial Pennon therefore, far from making a comparable contribution to the Group dividend payout, actually contributed only a meagre £0.4 million.

Actually, the fact that the commercial segment made any contribution at all in 2007-08 was unusual. As can be seen, the dividend taken from South West Water has normally been rather more than the Pennon dividend payout so that, as a rule, commercial Pennon has enjoyed a substantial subsidy by virtue of the excess, retained dividend. The commercial segment of Pennon therefore, over the years, has been in regular receipt of cross-subsidies from South West Water in the form of this excess dividend not passed on to the group shareholders. The total dividend retention, in fact, amounts to well over £400 million (the total “S. W. W. Dividend” received less the total “Pennon Dividend” paid out) and reveals an abysmal trading performance and profitability of “commercial” Pennon. On these figures it would obviously have been financially beneficial for Pennon shareholders (and perhaps, even for South West Water customers) if the Pennon commercial operations had never been attempted.

The Ofwat regulator has a statutory duty to secure that companies are able to finance the proper carrying out of their functions. What is questionable is whether the support of such a lame duck operation as “commercial” Pennon is really one of the proper functions of a licensed water and sewerage monopoly.

Return to -
List of appendices Murkywater home page Top of this section

Complaints to CCWater March 2008

The following complaints were lodged with CCWater by letter dated 17 March 2008.

1.     The Ofwat claim that the 2005-10 price increases were necessary to finance the £16.8 billion capital investment programme for 2005-10 is shown to be incompatible with their own published costs for the 2000-05 programme and the 2005-10 programme that replaced it. According to Ofwat, the average annual cost for the 2000-05 programme, in England and Wales, was £135 per property whilst that for the 2005-10 programme is £148. (The equivalent figures for South West Water are £213 and £216 respectively.) Having been caught out in this untruth, Ofwat should be required to publish the detailed annual financial projections on which the price determinations for the years 2000-01 to 2009-10 were based.

2.     The £2.5 billion taken by parent companies as special “restructuring” dividends in 2006-07 cannot be attributed to the exercise of the functions of a relevant undertaker and should never have been permitted by Ofwat. Ofwat should be required to explain how the companies could afford such huge payments when facing a five year capital investment programme budgeted at £16.8 billion. Unless a satisfactory justification can be given for these dividends, which does not conflict with Section 2 of the Act, there should be full refunds to the licensed companies. Ofwat should also be required to produce figures to show how these restructuring dividends have reduced the cost of borrowing as they claimed.

3.     On 15 February 2006, Pennon’s shareholders made a decision on “the return of £200 million of cash to shareholders”. Only eight days later, on 23 February 2006, “in order to optimise the capital structure” of South West Water, the Directors of the licensed company (obediently?) approved a special interim dividend payment of £200 million - £145 million was duly paid to Pennon on 15 March 2006 with a further £55 million payment on 31 May 2006. This £200 million special dividend is included in the £2.5 billion referred to in 2 above. The decision on this dividend, if the Pennon annual report is to be believed, was apparently made by Pennon shareholders and is therefore completely out of order. South West Water should be required to explain why they agreed to this dividend and how it could be afforded. Again, unless a satisfactory justification can be given for these payments there should be full refunds.

4.     The £150 million loan from Pennon at 10.625% seems unnecessarily expensive and gives the appearance of simply another device to transfer funds from South West Water to Pennon. South West Water should be required to explain the circumstances behind this loan and whether its parent company was the most economic source. Again, unless there is a satisfactory explanation, there should be an appropriate refund.

5.     South West Water should also be questioned regarding the economics behind this loan redemption charge of £50.2 million (including associated advisors’ fees). A full account of the charge should be required together with details of the advisors concerned and a proper explanation for such an enormous charge between associate companies. Again, as appropriate, refunds should be made.

Note 1.
 
In each case the refunds should be taken into account and customer
prices reduced accordingly at the next price review.
Note 2.
 
 
Each of the above complaints concerns the disregard of at least two
of the main duties of the Ofwat regulator for customer protection as
detailed in the 2005 Water Bill. These duties include -
=>
 
to promote economy and efficiency in the carrying out of the
functions of a relevant undertaker;
=>
 
 
to ensure that customers are also protected as respects any
activities which are not attributable to the exercise of functions
of a relevant undertaker, and
=>
 
in particular, by ensuring that the company maintains and presents
accounts in a suitable form and manner.
Return to -
List of appendices Murkywater home page Top of this section

Return on Capital

In the original submission to the review, the comments under this heading
were given as a footnote to the covering letter.
This arrangement is better suited to the website presentation
but the text remains unchanged.

In justifying and excusing high water charges, Ofwat have made frequent use of the statutory requirement that companies "are able (in particular, by securing reasonable returns on their capital) to finance the proper carrying out of their functions". However, that no special emphasis is intended in the use of the phrase "return on capital" is confirmed in the May 2002 DEFRA report "Water Bill, Consultation on Draft Legislation, Government Response". As reported in paragraph 96 of that report, in the drafting of the 2003 Act it was initially proposed to remove the requirement that companies are able to secure "reasonable returns on their capital". However, Ofwat and the companies apparently believed that this would "increase regulatory risk and undermine the ability to finance their functions". The Government response to the dispute is given in paragraphs 97 and 98 of the same report as follows.

97. The Government has considered the water companies' concerns carefully. In principle, the removal of these words does not have a real impact on the Director General's statutory duty to ensure that companies can finance their functions. His primary duties would still require him to act so as to secure that the companies can adequately finance their functions. A reasonable rate of return is implicit in this.

98. However, the Government recognises the importance of perception in the financial markets. There is a risk that the industry and the markets would see the removal of a specific reference to a reasonable rate of return as a negative signal, downgrading its importance. For this reason the Government has concluded that this element of the Director General's duties should not be altered.

As guidance regarding "reasonable returns on their capital" these paragraphs 97 and 98 are not very precise. However, as paragraph 97 makes quite clear, the regulatory duty is to secure that the companies can adequately finance their functions in which the reasonable rate of return is incidental. There is obviously no suggestion or intention that the "reasonable return on their capital" should be in addition to simply financing their functions.

Return to -
List of appendices Murkywater home page Top of this section

South West Water seek 2010-15 price increases

    South West Water have announced that the increases they are seeking for 2010-15 amount to an increase in average household bills of only 7.4% over the 5 years. Unfortunately, these figures are purely notional and in fact will not apply to any individual customer. Unless customers change tariff, they will be on either the unmeasured or the measured tariff and their bills will increase by either 12.9% or 40.4% as shown below.

Average household bills for water and sewerage
2009-10 2014-15 2010-15
Average measured household bill £373.18 £421.17 12.9% 
Average unmeasured household bill £677.46 £952.19 40.4% 
Average household bill £461.69 £495.70 7.4% 

    The lower increases for the combined average are based on the assumption that a huge number of customers will achieve savings by a transfer from the unmeasured to the measured tariff. However, these savings are by no means assured. The main reason for the low average charges on the measured tariff is the particular benefit it gives to households with low usage such as childless couples and holiday homes. Households with several children are unlikely to be able to achieve significant savings without strict control of water usage. At 2008 prices the standing charge on the measured tariff (for water and sewerage) is £40.48 with each cubic metre of water on the meter charged at £4.25. A household of 6 therefore, with the not excessive usage of about 25 gallons a day per person, might expect an annual measured tariff bill of about £1,100. With the South West Water proposed price increases this could be expected to rise to about £1,250 by the year 2014 with an extra charge of about £200 for any additional members of the household.

Return to -
List of appendices Murkywater home page Top of this section