WATER INDUSTRY ACT 1991, SECTION 13

PROPOSALS BY THE DIRECTOR GENERAL OF WATER SERVICES FOR THE MODIFICATION OF LICENCE CONDITION B OF MID KENT WATER PLC AND SUTTON AND EAST SURREY WATER PLC

The process

Any representation about, or objection to, these proposals must be in writing and sent to the Director General of Water Services, Centre City Tower, 7 Hill Street, Birmingham B5 4UA (fax 0121 625 3606) so as to be received by him not later than 5.00 pm on 25 January 2002. Please quote Ref LEG/32/2(p).

Explanation of the Proposed Modification and the Reasons for Them

The Licence of each water and water and sewerage undertaker in England and Wales contains a condition B. Amongst other things, that condition provides for the revision of the price limit which that Company must observe each year. Those price limits must be reset at a five-yearly periodic review. In defined circumstances, they may also be changed beween five-yearly reviews, at an interim determination.
Condition B contains detailed provisions about the circumstances under which an interim determination may be made, either on the application of the Company or on the Director’s initiative. This may only happen if a (defined) Relevant Change of Circumstances has happened, or a Notified Item is triggered. A Notified Item is something which the Director said had not been allowed for (either in part or at all) when price limits were last set.
As part of the 1999 periodic review final determination (PR99) Companies licences were modified (the PR99 modification) by inserting a new test of the financial impact of changes in operating expenditure and revenue losses attributable to a Relevant Change of Circumstances or a Notified Item. Instead of calculating the financial impact of these changes (their Base Cash Flows) over the period ending at the next Periodic Review (that is, the balance of five years), the calculation would be made over fifteen years. This new test made it more likely that changes in operating expenditure or revenues might trigger an interim determination. However, although losses of revenue might be taken into account in considering whether a material change has occurred, no equivalent provision was made concerning gains in revenues. If circumstances changed in a way that allowed a Company to recover higher revenues than was assumed in setting price limits, the Director could not calculate that impact in the same way, when making interim determinations.
This is particularly relevant to the issue of optional metering, which is treated as a “Notified Item”. Customers who choose to change to a metered supply generally do so because they will enjoy lower measured bills, which usually results in lower revenue. At PR99, price limits were based on assumptions about the likely uptake of optional meters and the anticipated impact of each Company’s revenues. If the uptake of optional metering is faster than assumed at PR99, this may result in greater revenue losses for that Company. (The opposite also applies.)
The PR99 modification was made to licences for all Companies except Mid Kent Water and Sutton and East Surrey Water who asked the Director to refer their price determinations to the Competition Commission. In September 2000, the Commission reset the price limits for those two Companies and made revised assumptions about future trends in optional metering. The Commission also recommended changes to their licence conditions for interim determinations. It agreed to the general principle of the licence modification in respect of changes in operating costs and revenues between revenues but recommended that:

the Director takes account of any revenue gains that accrue to Mid Kent Water and Sutton and East Surrey Water, if the uptake of optional metering is slower than assumed in their respective revised Notified Items; and
the Director should assume that the financial impact of each of these changes (their Base Cash Flows) will be the same in each of the fifteen years in question as in the current year.

If implemented, this modification will incorporate the first but not the second of these recommendations. It will enable the Director to deal with interim determinations on the same footing, whether the Competition Commission’s assumptions about the rate of take-up of the free optional meter by customers of these two Companies turn out to be too low or too high. If the former, this will protect their customers from having to pay higher prices than justified by the actual uptake of optional meters. If the latter, the calculation will be the same as that which applies to all the other regulated Companies in England and Wales.
Mid Kent Water and Sutton and East Surrey Water have agreed this modification. The same change was made as part of the Interim Determinations of the price limits of Tendring Hundred Water Services Ltd and Dwr Cymru Cyfyngedig (Welsh Water) in December 2000. The Director will propose the same change for other Companies which request Interim Determinations in later years.