The Consumer Council for Water has told MPs that the water sector regulator has been “overly generous” to water companies and “consumers have overpaid” - and criticised Ofwat for having become “increasingly reliant on water companies self-regulating.”

The criticism comes in evidence given by CC Water to the current House of Commons Environment, Food and Rural Affairs Select Committee inquiry into the regulation of the water industry.

CC Water told the Committee that while regulation had delivered many positive outcomes for consumers and the environment, it believed that water consumers have overpaid, as the industry had consistently made returns “well above those appropriate for such a low-risk sector.”

Analysis of water companies’ finances showed that returns had been well above the stock market index, even though the level of risk to investors in the water sector is comparatively low.

CC Water commissioned economic consultants, ECA, to examine the long-run returns by the listed water companies compared to average returns over the period 1989 – 2013. This revealed that returns to water companies over the period exceeded the FTSE, except for some points between 1997 and 2003. The water watchdog said that as a low-risk and largely monopoly sector, returns had been generous compared to the FTSE, commenting that water sector regulator Ofwat had been “too generous to water companies” and that as “a result of Ofwat’s previous generosity, water customers’ bills are higher than they should be.”

Commenting on customer input, said that while consumers have had a greater influence in both the 2014 and 2019 Price Reviews, outcomes had not fully met their needs on affordability, value for money and important aspects of service.

CC Water said that regulation could be simplified to put a greater focus on consumers and the areas of service they value the most and that the regulatory system should strongly incentivise companies to improve consumer satisfaction on value for money, fairness and service. Research showed that consumer perceptions of value for money is a key driver of their trust in water companies,

For each of the last three years, the perceptions have trailed overall satisfaction with the water supply by around 20%, while perception of value for money of sewerage services trails overall satisfaction with sewerage services by around 13%.

The consumer watchdog warned the EFRA Committee that the funding ‘pot’ for social tariffs, which are funded by customers and are now supporting almost 400,000 households, is in some cases running dry and do not cover all that need help.

CC Water wants the water companies and Government (ideally through a tax and benefits scheme) to contribute towards the funding of these schemes.

"Freeze/thaw’ event raised questions about whether regulation has sufficiently addressed resilience 

Commenting on the ‘freeze/thaw’ water supply interruptions in early March 2018, CC Water said the event had raised questions about whether regulation has sufficiently addressed resilience issues across all water companies, or had driven the right behaviours within companies to plan appropriately.

In total, around 200,000 properties were without water during the incident, suggesting that the problems lay not just with infrastructure investment but with companies’ general preparedness.

CC Water also wants to see the Environment Agency’s policy direction provided to water companies on the Water Industry National Environment Programme (WINEP) to come earlier in the price review process to enable it to be better reflected in customer and stakeholder engagement activities. Delays hampered companies’ abilities to prioritise their plans and test them with consumers.

Details had changed significantly through the 2019 Price Review (PR19), with some companies seeing a doubling of required environmental spend between one iteration of WINEP and the next.

CC Water called for more transparency in the process by which the cost-benefit of environmental investment is determined, with a role for consumers in this process.

Focusing on demand side won’t resolve risks posed to water consumers by severe droughts

In response to the Committee’s question of whether the water industry was adequately delivering a “twin-track approach” of increasing water supplies and reducing water demand, CC Water said that focusing on the demand side would not resolve the risks posed to water consumers by severe droughts.

There had not been enough progress in building resilience to severe drought conditions in already water-stressed areas. The water companies needed to make this a priority and make the right investments to increase resilience to drought in the short and longer term. This was likely to require new, more strategic water resource developments that could benefit the wider South East region.

For companies with large future water supply deficits, it was clear that "demand-side measures alone" would not be enough and new sources of water would be needed.

Unclear whether PR19 methodology will drive innovation in a way that delivers better outcomes for consumers

Replying to the question of whether innovation could be increased in the water industry, CC Water said it was unclear whether the focus on innovation in Ofwat’s PR19 methodology would drive innovation in a way that delivered better outcomes for consumers. Innovation should not place undue risk on consumers, now or in the future.

It went on to warn that the water companies appear to have become “increasingly reliant on their supply chains and on academic institutions for innovation” and that there seemed to have been “few examples of ‘game-changing’ innovation in the sector in recent years.”

CC Water also criticised Ofwat in turn for having become “increasingly reliant on water companies self-regulating” – as a consequence Ofwat was becoming “further removed from what is happening on the ground.” Citing the recent freeze / thaw incident as an example, Ofwat might therefore only become aware of significant issues after they had happened.

Penalties and enforcement mechanisms had not driven better corporate behaviour or encouraged water companies to take full responsibility for consumers’ views of their legitimacy. Historically, companies had mainly been penalised by Ofwat for providing incorrect data or failing to comply with statutory requirements, but there had been no control around financial performance, gearing and special dividends.

Too early to say whether current ODI mechanism had improved performance in a way that was acceptable to consumers

CC Water went on to comment that it was too early to say whether the current Outcome Delivery Incentives (ODI) reward / penalty mechanism - introduced at PR14 - had had the desired effect of improving performance in a way that was acceptable to consumers.

“We have concerns based on our research that customers might view price increases as unacceptable because they view certain improvements as being the water companies’ ‘day job’ (e.g. reducing leakage and supply failures)”, CC Water said. Research carried out in 2013 showed some customer support for the use of financial penalties to prevent service quality from deteriorating - but very little, if any, support for financial rewards for meeting performance targets.

Ofwat’s current penalties and enforcement mechanisms did not currently encourage responsible behaviour, particularly in the area of water company finances. Overall gearing within the sector had increased and some companies have been employing opaque financial structures.

Companies had opted to increase gearing to take advantage of lower cost debt financing, often paying significant special dividends to shareholders and effectively pushing more risk from shareholders to customers.

CC Water told the Committee it welcomed Ofwat’s current initiative to ensure that the financial benefit associated with cheaper debt financing and higher gearing are shared with customers.

However, while some companies had outperformed their targets and would receive financial rewards, the extent of the rewards and their impact on customers’ bills was not yet fully known – and in some cases would not be known until 2020.

“There is a risk that sizeable bill impacts from ODIs and possibly from inflation could further erode consumers’ confidence in water companies.” the customer watchdog’s evidence concluded.