Cathryn Ross, Chief Executive at Ofwat, has told MPs that the regulator is fit for purpose and doing its job – despite its own report published last week acknowledging that a skills gap, lack of financial control and accountability had led to Ofwat budgetary failures in 2013.

The Ofwat chief was appearing before the House of Commons Public Accounts Committee last week, alongside Keith Mason, Ofwat's Senior Director of Finance and Networks, Nick Fincham, Director of Strategy and Regulation at Thames Water, Andrew Wright, Ofgem Interim Chief Executive and  Dr John McElroy, Director of Policy and Public Affairs, RWE/npower.

The Committee was taking oral evidence following on from the National Audit Office Report in November on Infrastructure investment:the impact on consumer bills which focused on the energy, water and, to a lesser extent, telecoms sectors and the £310 billion investment needed in new infrastructure for the UK. The Treasury expects that over two-thirds of the planned infrastructure identified will be privately financed, owned and operated but paid for by consumers through their utility bills.

Ofwat fit for purpose

Responding to a number of issues raised by Stephen Barclay MP relating to the skills gaps flagged up in the regulator’s recent report , Cathryn Ross said that Ofwat was both fit for purpose and could do its job.

She also explained to the Committee that the periodic review process took 12 months from the time business plans were received to the final determination, largely because of the time and effort Ofwat put into scrutinising, understanding and challenging the information. Ofwat looked across the industry, which with 18 different companies, provided “quite a lot of information from comparing and contrasting different water companies” and enabled the regulator to spot outliers —things that looked odd. Ofwat also brought to bear information from other sectors and from other industries. “For example, a lot of what water companies do relates to construction of things. Water companies are not the only people who construct things, so comparisons can be made there." “What we are trying to do—and you can see it from a lot of what I have said—is put the onus on the company really to understand its customer base and reflect that in its plan.”

She also made the point that the customer challenge groups put in place by Ofwat as part of the price review process were not a substitute for engagement from the company with customers directly - they were a means to provide assurance to the regulator that that direct engagement had been good.

On the question of the extent to which Ofwat was individually verifying the data coming from company Boards on the water companies’ business plans, the MP appeared unsatisfied with Ross’s comment that it was absolutely imperative that boards assure the quality of the data they provide to the regulator. Stephen Barclay said:

“Of course it is—but to what extent do you question it? You don’t need to look at many sectors to know that boards sometimes don’t report as accurately as they might.”

Does Ofwat think dividends are too high?

Cathryn Ross also faced some tough questioning over dividends paid to investors. Ross made no direct reply to a question from Austin Mitchell about whether Ofwat considered the dividends paid were too high and whether it considered “how much companies are splashing out in dividends at all”. Instead the Ofwat chief told the MPs that Ofwat made an assumption about the companies’ capital structure, based on what it considered to be an efficient capital structure, and allowed them to recover that element of financing costs in their prices.

Replying to Austin Mitchell’s comment that if a company was "reining itself down with debt", it was imperilling its existence and its future ability to serve the consumer, she said that if a company took a decision to adopt a different financial structure, the company was at risk from that. It might make money from doing it, but it also bore the risk associated with the change in financial structure - not the customers. “Bear in mind that these companies that provide these essential public services, ….do so on the basis of statutory undertakings……If that gets flaky because of their financial structure, the owners of the company are on risk for that, customers are not.” she said.

Thames Tunnel – how to ensure customers “not going to be paying over the odds?”

Nick Fincham from Thames Water was separately the target of a grilling about the utility’s levels of debt, which currently stand at £7.3 billion. He was unable to clarify how much of that was owed externally to the group and how much of it was intra-group debt, agreeing to write an explanatory note for the level of the interest rates paid so the Committee can see a profile of the entire debt - both internal and external.

On the £4.2 billion Tideway Tunnel project, the Committee also asked how the company ensured that consumers were “not going to be paying over the odds” for this amount of infrastructure investment. “where is the consumer voice in the big investment decisions you are making that they have to pay for?”

Fincham explained that the consumer’s voice was represented through the five-yearly regulatory review process and that Thames had undertaken an extensive engagement process through a variety of different media with about 30,000 customer contacts. However, he added:

“You have got to be pragmatic about what can be drawn from those engagement exercises. If I were to give you the headline conclusion we drew from all that engagement, it is that our customers do not want to see any deterioration in the safety and reliability of the service that we provide. They want to switch on the tap and they want to get safe and clean water. They also want to flush the loo and for the contents to go away and never come back again.”

Where is consumer voice in big infrastructure developments?

Asked how much confidence the regulator had  that the consumer’s voice was being heard in very big infrastructure developments, Cathryn Ross said that Ofwat was “absolutely on board with the need for the customer voice to be part of the decision-making process around infrastructure investment.”

Committee Chair Margaret Hodge MP expressed concern about customer engagement in relation to the Thames Tideway tunnel, saying that basically what customers cared about is the price they pay, commenting:

“The cost of water in the UK is one of the highest. The figures I saw showed that we are one of the highest in Europe. We are higher than Japan. We are higher than the USA. We are higher than France. So we are not doing very well on that. You set their prices every five years. I cannot understand the logic for that.”

“One of the examples I came across was that you set cost of debt for 2010-15 at 3.6%, so United Utilities, which was the example given to me, walks away with a wonderful windfall of £300 million because over that period it got an index-linked loan from the EIB at 1.2%. That is hardly in the consumer’s interest.”

Margaret Hodge was strongly critical of the Tunnel, describing it as “a gold-plated solution that will lumber London water tax payers with an £80-a-year extra bill.”

Asked whether she agreed with the decision to press ahead with the Tunnel, Cathryn Ross said it was a policy decision by the Government and “it is not for me to say….our job is to make sure that the solution is delivered most efficiently and brings the greatest value for money for customers.”

However, she added that Ofwat had done “quite a lot of work to challenge” the Tunnel estimate and that at the moment the regulator was satisfied that £4 billion represented “a robust cost estimate.”

In reponse to the Chair’s comment that Ofwat had to look beyond the statutory five-year period and consider affordability in view of the longer-term time frame of the Tunnel project, Cathryn Ross said she “completely accepted the challenge” that Ofwat  needed  to look longer term about bill impacts and affordability and that there was more the regulator can and should be doing to look long term on bills.

“Regulators don’t take overall affordability into account”

Ross rejected the Chair’s assertion referring to the NAO Report which said that Ofgem looked at affordability and Ofwat didn’t, explaining that the issue was important to Ofwat and considered in the context of assessing the business plans both in terms of their financeability and affordability.

Austin Mitchell disagreed, commenting that neither the energy nor water regulators took into account the effect of prices in each sector on the overall cost of living. Instead they only considered the affordability of water or energy on an individual basis without taking into account the effect of prices for other utilities on the consumer.

Cathryn Ross accepted that there was “some truth in that”, acknowledging that Ofwat was not “consciously looking across expected energy bill prices, expected rail fares and all the rest of it” with regard to final determinations for prices.

Commenting on consumer views on infrastructure investment, Andrew Wright from Ofgem made the key point that the regulators recognised the shortcomings in that “consumers do not necessarily themselves have a full view of all the pressures on bills that may be coming down the road at them, particularly when looking at long-term infrastructure investments, where impacts on consumers’ bills are being locked in for many years in the future. You can only realistically take account of how consumers feel today.”

"UK-owned water cos distribute 76% of profit, while non-UK-owned water cos distribute 116% of profit. Why?”

Margaret Hodge also questioned Cathryn Ross on dividend payouts, asking:

“ One intriguing thing that I found in water was that between 2008 and 2011, UK-owned water companies distributed 76% of their profit after tax as dividends—they probably didn’t pay any tax, so it was just their profit paid as dividends. Non-UK-owned companies distributed 116% of their profit as dividends. My worry….is that the money that ought to be used as investment to improve the infrastructure flows out.”

“Why is there a difference? UK-owned water companies distribute 76% of the profit, whereas non-UK-owned water companies distribute 116% of the profit. Why?”

In reply to Ross’s comment that Ofwat takes its responsibility to protect customers “extremely seriously, and you can see that in the fact that bills are a third lower than they would have been without our challenge”, the Committee Chair asked her how Ofwat knew that bills are a third lower than they would have been. When Ross replied “ Because we know what the companies asked us to put through in prices” Hodge continued : “They are bound to ask for more than they get…..If I were bidding with you, I would put in a high bid to start with.”

When the National Audit Office report was first published, Margaret Hodge commented:

“£310bn worth of investment is needed to ensure that UK infrastructure meets the country’s needs. Two thirds of that is expected to be funded by consumers, yet neither the government nor regulators have any real understanding of how this will impact on utility bills. Households up and down the country are already struggling to cope with rising water and energy costs.”

“I have serious concerns that Government is taking decisions on infrastructure, banking on hard-pressed consumers to foot the bill, without knowing whether households will be able to afford to pay.”

“Government needs to work with regulators and private companies to ensure they have robust information on the long-term impact of planned infrastructure on consumers. They need to work together to ensure that consumers do not find their bills become increasingly unmanageable, particularly those on the lowest incomes who are hardest hit by price rises.”

The Committee hearing has undoubtedly raised some interesting questions that both Ofwat and the other utility regulators will now have to take on board.