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Trying to divine the rules

Water Profile

Facing uncertainties borne on a tide of new legislation, director general of Water Services Philip Fletcher is pushing to make life for the water industry more predictable.

Andrew Mylius met him.

Philip Fletcher could probably find his way around water industry issues blindfolded. As director general of water services - head of water regulator Ofwat - he knows the UK's 10 water-cum-sewerage authorities and 22 water companies intimately: they talk frequently, and the organisations are periodically required to produce asset condition and maintenance statements, capital investment plans and reveal their books. Any question on any issue, he can exactly and methodically provide an answer.

Except, that is, for the following.

Ask Fletcher whether spending on water infrastructure needs to increase or decrease, or whether customers' bills will go up or come down, and he is resolutely silent. He wants to muster all his information and give it proper consideration before venturing a view, he says.

He will not be receiving water companies' final business plans until spring next year, and intends to play things close to his chest until autumn.

But there is little sign that the water industry's £3bn investment programme will ease up when Fletcher makes public Ofwat's fourth asset management plan (AMP4), for 2005-10.

For starters, although huge strides have been taken to reduce discharges from combined sewer overflows (CSOs), 'point source pollution' remains an issue. Ofwat's fellow regulators the Environment Agency and Drinking Water Inspectorate want to see further improvements. 'We expect CSOs to feature in AMP 4, ' Fletcher says.

There is some potentially hard-hitting European Union legislation to watch out for, Fletcher warns. UK coastal waters are cleaner than they have been for decades, but the Bathing Waters directive will require companies to clamp down still further on the quality of river and sea discharges.

And Fletcher wants to see sewer flooding urgently tackled.

The problem is widespread, he claims and, following two winters of intense prolonged rainfall, has lodged in the public consciousness. 'Sewer flooding brings dirty water into people's homes, and a customer with dirty water in his home naturally wants something done about it. Where basic sewerage is inadequate it's reasonable for customers to signal that improving it is a very high priority.'

Capital expenditure in the last couple of years has actually been lower than expected. In part this is thanks to improved operating efficiency. But it is also that companies are having to replace fewer lead pipes than anticipated at the last review. That's because there has been a delay while the Drinking Water Inspectorate tests orthophosphate dosing - chemical treatment that reduces the solubility of lead in water.

The industry hopes that dosing will enable it to leave remaining lead pipes where they are.

Equally, however, the tests could prove a failure, requiring water companies to crack on with lead pipe replacement post-haste.

Perhaps the single biggest influence on Ofwat's determination will be the EU Water Framework Directive, due for parliamentary scrutiny this autumn. Earlier this year Fletcher described the directive as 'a breakthrough in thinking at European and national level'. He justified his claim by pointing out that the directive will require the water industry to think in terms of entire catchment systems. It requires economic analysis of how water is used within river basins; water companies will be required to gauge the cost-effectiveness of measures taken to improve water quality; and polluters will be forced to pay.

Where work to date has been financed wholly through charging customers, Fletcher thinks the Water Framework Directive will bring about a shift in who pays for what. Increasing levels of 'diffuse pollution' churned out by manufacturing and process industries, motor vehicles and what runs off agricultural land will have to be dealt with directly by the polluters themselves. Alternatively, the cost of removing pollutants will be charged to the polluters by affected water companies.

Getting a comprehensive picture of water regimes and pollution patterns in individual river basins is a hugely complex task, Fletcher concedes, but vital to successful implementation of the directive. In many cases mapping and modelling catchment behaviour will take years, or even decades. Implementing the directive in England and Wales could cost anywhere between £2bn and £9bn. Key targets, Fletcher reckons, will be to draw up an economic analysis of water use by 2004, draft river basin management plans by 2008, publish the first river basin management plan in 2009, put management programmes designed to deliver environmental objectives into operation by 2012 and, by 2015, to achieve the first of those environmental objectives.

Fletcher says that the directive is focused on outcomes rather than inputs. 'We need to get a proper handle on catchments.

We need to involve environmental groups, customers, urban planners, local authorities, statutory agencies.' As far as possible, Ofwat will gear the water industry up for the directive in AMP4, but a good deal of the work needed to comply with the Framework Directive may spill over into AMP5, from 2010-15.

Fletcher is emphatic that the directive will not involve investment for the sake of the environment at the expense of infrastructure maintenance or customer service. Ofwat has been backing a methodology to enable water companies to assess the condition of their assets, currently valued at almost £200bn. Many companies have little real knowledge about how well preserved their assets are - particularly underground infrastructure. He will be setting more stringent condition standards, he says, and wants to gauge 'whether we need to significantly increase levels of investment across industry or for individual companies'.

Water companies' spending patterns tend to be cyclical. 'The five year programme creates a rollercoaster expenditure pattern, ' Fletcher says, caused by uncertainty over what priorities Ofwat will set in the AMP.

Stop-start makes life difficult for the water industry's contractors, which in turn reduces efficiency.

He wants to tackle it 'by giving companies a very clear steer on the quality programmes of the next spending round'. This includes rethinking the five year review period. A longer period between reviews of prices and spending would help steady the spending flow.

Fletcher's bid to introduce greater certainty and more continuity into the water industry also includes proposals to extend companies' franchise periods.

'The franchise period was initially 25 years, with 10 year extensions, ' he explains. In 1990, 10 years looked like a long time, he continues, but it means that the government could give notice to terminate contracts in 2013.

Return on money invested in the water industry tends to be long-term, and with franchises guaranteeing just 10 years of operation, City investors are relatively reluctant to put up cash for maintenance or capital projects. 'It is in customers' interests to keep the cost of capital as low as possible, ' says Fletcher.

Ofwat needs government backing but is proposing to introduce 25 year rolling licenses, effectively extending companies' franchises in perpetuity.

Ofwat is also pushing the government to introduce an element of competition. The government is already willing to break individual water firms' monopolies on supply to customers who consume more than 50M litres/year.

That's less than 2,000 customers, though, Fletcher notes, and barely enough of a market to encourage real competition. 'We have suggested the government should open up the field further, to 10M litres/year.' But he is quick to point out domestic customers would continue to be served by a monopoly provider governed by Ofwat.

Meanwhile, changes are afoot in Ofwat itself. The director general of water services wields enormous power - he is effectively an industry autocrat.

Ofwat sets the water industry's agenda, and determinations by past DGs have been slated as unbalanced by water companies, customers and environmentalists alike. A board of four has recently joined Fletcher to manage and bring a broader range of viewpoints to the regulatory process.

The right stuff

Philip Fletcher, 54, was an ideal candidate to police the water industry. Before he was appointed as DG of water services in August 2000 he was Receiver for the Metropolitan Police, keeping a beady eye on the force's spending with a particular focus on improving procurement. Before that he oversaw privatisation of the government's Property Services Agency.

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