A new report from the Government’s spending watchdog the National Audit Office is warning that water bills will continue to rise above the rate of inflation for the next 17 years.

Today’s report, Infrastructure investment: the impact on consumer bills says that large-scale infrastructure spending over ten years or more will increase consumer utility bills - but neither government and regulators know by how much or whether the bills will be affordable.

The report, which focuses on the energy, water and, to a lesser extent, telecoms sectors, recognizes that the UK requires significant investment in new infrastructure.

However, high levels of expected new investment in infrastructure which will primarily be funded by the private sector mean that energy and water bills may rise significantly from current levels. The Treasury expects that over two-thirds of the £310 billion worth of the planned infrastructure it has identified will be privately financed, owned and operated but paid for by consumers through their utility bills.

The NAO says this is likely to hit those households with incomes in the lowest 10 per cent particularly hard. The available projections suggest that increases in both energy and water bills will continue to outstrip inflation, on average, up to 2030.

The report says this is particularly concerning, given that energy and water bills have increased significantly in recent years, while incomes have not. The report points out that energy and water bills have risen faster than incomes. The latest data shows that between 2002 and 2011, energy and water bills rose 44 per cent and 21 per cent respectively, in real terms. In contrast, the average unit cost of telecoms services fell over the last decade.

No official projections of water bills available

The report also points out that there are no official projections of water bills available that take account of current regulatory and policy decisions and that the only available projection of water bills, prepared by a water company, suggests up to a 28 per cent increase by 2030. The Department for Environment, Food & Rural Affairs and Ofwat told us they have concerns about this projection because it is out of date, and does not reflect government and regulatory decisions since 2010 or the current lower cost of borrowing. 

The National Audit Office is concerned by the lack of a common approach across sectors to forecasting bills or measuring affordability and has called on the Treasury to ensure there are mechanisms to assess the cumulative impact of infrastructure investment on consumer bills, particularly those paid by low-income households.

In the NAO's view, Government has made no assessment of the overall impact of infrastructure on future bills or whether those bills will be affordable. The watchdog says that government and regulators are therefore taking decisions on behalf of consumers in the absence of full information about the situation for consumers. 

Concerns about Ofwat scrutiny

The NAO has also expressed concerns about regulatory scrutiny, saying that where regulators control prices, the effectiveness of scrutiny can vary. The report states:

"Ofgem and Ofwat are placing the onus on companies to innovate and report on results. This move underscores the importance of regulators checking what companies tell them. We reviewed Ofgem and Ofwat’s scrutiny of three large infrastructure projects. Ofgem scrutinised the two energy projects well. However, we were concerned by aspects of Ofwat’s scrutiny of the one water project we examined. Ofgem and Ofwat are changing their approach to price regulation, including giving companies greater freedom to innovate to meet consumers’ needs. It is too early to say whether these reforms will be effective. However, regulators will need to ensure there is proportionate, independent verification of costs and of physical assets. For example, regulators currently have limited assurance on whether companies have built infrastructure to the agreed specifications." 

The report says that in the water sector project, it was not clear that there was a reliable business case showing the need for the infrastructure at the time that Ofwat made its decision to approve the company’s business plan.  Ofwat believes that if it had subsequently found the infrastructure was not needed, it has mechanisms to recover the cost to consumers. Ofwat also did not investigate how much contingency the company had included in its proposed costs and we are concerned that Ofwat considers that this is a matter for companies. 

The NAO also found that neither regulator has independent assurance over whether the infrastructure had been provided to the agreed specification, commenting:

"Companies can increase their profits by providing new infrastructure more cheaply than planned, which may undermine incentives to deliver assets which have long-term resilience. 

Ofwat itself believes that water bills have the potential to fall in real terms for the period 2015–2020, reflecting the lower cost of capital, but this assumes the same level of investment as Ofwat approved for the 2010–2015 regulatory period.

Critical to know "how much is too much"

Launching the report, Amyas Morse, head of the National Audit Office, commented:

“Government and regulators do not know the overall impact of planned infrastructure on future consumer utility bills, or whether households, especially those on low incomes, will be able to afford to pay them. It seems critical to know ‘how much is too much’, based on reliable information.”

Among the NAO’s other recommendations are that the Treasury should publish the expected overall impact on consumer bills, to promote transparency and debate about new infrastructure and bill increases. In addition, departments should consider the implications for consumer bills and their overall affordability before making policy commitments influencing infrastructure. 

The NAO draws attention to the government’s National Infrastructure Plan 2012 and the associated ‘pipeline’ of investment projects, with a total estimated value of £310 billion, expected over the next decade and beyond, including £16 billion in water.

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However, the report points out that HM Treasury has acknowledged that the pipeline is not comprehensive, citing the water sector as a specific example. The pipeline only includes the expected cost of water infrastructure up to 2015 when the current five-year regulatory settlement ends, as well as the proposed Thames Tideway Tunnel. However, between 2015 and 2030, there will be three further water regulatory settlements each of which could require investment of a similar order of magnitude to the £22 billion of investment Ofwat approved for the period 2010–2015. 

The report also points out how far consumers are already paying for existing infrastructure - again drawing attention to the water sector, where it says much of the £85 billion of infrastructure constructed in 1990 to 2010 continues to be repaid via customer water bills. It also refers to the costs of maintaining existing infrastructure - maintenance costs now account for nearly half of all investment in water. 

In the run-up to PR14, the NAO's recommendation that both the energy and water regulators should consider the financial impact and affordability of proposed infrastructure before approving company revenues and charges looks set to put further pressure on the water companies. 

 Click here to download the full report