Licence modifications

All water companies have been engaged throughout 2012 in discussions surrounding Ofwat’s proposals for licence modifications, to facilitate separate price controls for wholesale and retail.

Ofwat’s original section 13 notice was served and published in December 2011. The response from the sector was overwhelming  -  with the exception of one new entrant, all companies declined to consent to Ofwat’s proposals.

Industry-wide and company-specific discussions were held during 2012 as Ofwat sought to understand the basis for such widespread opposition, leading to the service and publication in October 2012 of a revised section 13 notice.

Generally the changes made are felt to have improved the situation, but not such that all areas of concern for water companies have disappeared.

Whilst Ofwat has confirmed that the price control for the wholesale function will continue to be linked to RPI, Ofwat wants to have the ability to move activities out of wholesale, which would remove the protection. Ofwat has also confirmed that it will continue to use the Regulatory Capital Value (RCV) as the main mechanism for cost recovery within the wholesale function, and allocate all of the RCV to the wholesale function.

Ofwat is however seeking broad flexibility to enable it to alter the price review process in future. This is a cause of concern for companies and for investors, who dislike uncertainty and have little reason to be comforted by Ofwat’s words.

Companies have until 23 November 2012 to decide whether to consent to the proposed modifications. If consent is not given, Ofwat must make the decision whether to refer the matter to the Competition Commission, which must decide if the current licence conditions operate against the public interest.

Legislation

There have been a number of legislative changes and proposals over recent months, some of which we summarise below.

Most significantly, the draft Water Bill was published in July 2012. Much has already been said about its contents, and about what it does not contain. At the time of writing, the EFRA Select Committee is receiving evidence from stakeholders as part of the pre-legislative scrutiny promised by Defra when publishing the draft Bill. Refer to our earlier bulletin, dated 18 July 2012, for a summary of the draft Bill.

Most of the provisions within the draft Bill deal with proposed market reforms for business customers. South West Water has warned, in a written submission to the EFRA Committee, that allowing business customers to switch water supplier will add costs to bills for other customers, possibly adding as much as £10 on household bills.

Also relevant in the context of market reforms, the Enterprise and Regulatory Reform Bill will repeal the in-area ban which currently prohibits a licensed water supplier from providing water supplies within the area of an associated water undertaker. This will allow licensed suppliers to offer services to customers across the whole of England and Wales. The Bill has its second reading in the House of Lords on 14 November 2012.

The Water Industry (Financial Assistance) Act 2012 came into force on 1 July 2012. It allows Government to provide financial assistance to reduce the charges payable by the customers of an English water company. This power will be used to alleviate the bills payable by customers of South West Water, addressing a perceived unfairness that has existed since water privatisation in 1989. The Act also allows Government to give financial assistance in connection with the construction of exceptionally large or complex water or sewerage infrastructure in England (for example the Thames Tunnel – see also the reference below to the Waste Water Transfer and Storage Order).

Two private members’ bills have been introduced into Parliament by Thomas Docherty, MP for Dunfermline and West Fife, namely the Water Companies (Minimum Tariffs) Bill and the Water Companies (Social Tariffs) Bill. The Minimum Tariffs Bill would require water companies to provide the cheapest available tariff to customers aged 75 or over; the Social Tariffs Bill would require water companies to provide social tariffs for low income families. Both bills received their first reading in the House of Commons on 25 June 2012, and are scheduled to have their second reading on 18 January 2013. Whilst the Bills will almost inevitably fail, they do demonstrate the high level of concern around affordability of water bills. See also our comment below on Defra’s guidance to water companies and Ofwat on social tariffs.

The Public Bodies (Water Supply and Water Quality Fees) Order 2012, currently in draft, will allow DWI to recover the costs of its regulatory work in relation to drinking water quality from water companies. This is due to take effect from January 2013.

The Infrastructure Planning (Waste Water Transfer and Storage) Order 2012 came into effect in June 2012. It adds to the meaning of nationally significant infrastructure projects by including infrastructure in England for transfer or storage of waste water for treatment with a capacity exceeding 350,000 cubic metres. In November 2012 Defra issued a consultation on draft regulations to enable the financing and delivery of large or complex high-risk water or sewerage infrastructure projects to be carried out by infrastructure providers that are competitively tendered by water companies. If a project were to be classified as a special project, the water company concerned would be prohibited from undertaking the project itself. The consultation paper states that the only project anticipated to be specified under the proposed regulations in the next 10 years is the Thames Tideway Tunnel.

Environmental

Compliance with a statutory permit will no longer prevent a private nuisance claim

The recent Judgment of the Court of Appeal in the case of Barr & Ors –v- Biffa Waste Services Limited [2012] EWCA Civ 312 highlights the difficulties faced by businesses operating close to residential housing or other sensitive sites. In particular, companies operating waste water treatment facilities which have the potential for off-site odour impact, should take note.

Biffa operates a waste disposal site near to a local housing estate. Problems started in 2004 when the site started accepting pre-treated waste. Complaints began within a week and the site was prosecuted by the Environment Agency in 2005. Problems continued, eventually culminating in a group action claim for odour nuisance, brought by 152 local households in 2011. The residents initially claimed compensation for disturbance and an injunction to prevent further alleged nuisance. However, the situation had improved sufficiently by the court case, so an injunction was not needed.

Biffa defended the case. The Judge commenting that it was somewhat of a test case for Biffa, given its other sites. Biffa successfully argued in the lower court that it should not be liable under the current tests for private nuisance –  it had been complying with its permit and it had not been negligent. Compliance was evidence that it was acting reasonably, and so any inevitable disturbance was not actionable. Biffa argued that the availability of private remedies should take into account the strict statutory regime in which it operates (in relation to environmental and waste controls). The Judge was sympathetic to these arguments. He determined that nuisance claims should “march in step with” the modern system of regulatory controls.

Unfortunately for Biffa, the Court of Appeal disagreed. Lord Justice Carnwarth commented that this was a simple dispute based on settled principles of law. There is no requirement for a claimant to prove breach of a statutory permit or negligence. “If there is a problem...within the existing legal framework, its solution must rest with the legislature.”

So where does this leave businesses? For companies operating a private waste water treatment facility, the previously established principles of nuisance claims still apply. If a defendant can show it is a “reasonable user” of its land, then it will not be liable - but compliance with an environmental permit or other statutory controls is not sufficient to show it is a reasonable user. If the defendant is not a “reasonable user” then it will be liable for foreseeable harm, even if it has exercised reasonable skill and care to avoid it.

In the Biffa case, it was accepted that Biffa did not have any statutory immunity for its activities and the claimants also accepted that it had not been negligent. In contrast, statutory undertakers under the Water Industry Act do have statutory immunity for nuisances arising from an exercise of their statutory duties - they will only be liable if the activities have been carried out negligently and the claim is not inconsistent with the statutory framework. The case of Hanifa Dobson –v- Thames Water [2011] EWHC 3253 (TCC) emphasises that statutory undertakers can still be found liable in private nuisance when these criteria are met.

In all cases therefore, strategically, any such claims must be carefully managed. Individually, a private nuisance claim will usually attract modest damages, but collectively they can become more substantial if the dispute grows to include a large group of claimants. Legal costs can also become significant. In the Biffa case, damages for the 30 test case households is thought to be in the tens of thousands - whereas each side has now incurred approximately £3 million pounds in legal costs taking the case to the Court of Appeal.

There is much that a business can do to manage the risk of such claims arising. Proactive early management can go a long way to diffusing neighbours’ concerns and so avoid issues escalating. Working with residents to understand their concerns, holding residents’ meetings, and following up on issues identified, when done appropriately, can go a long way to manage matters. In addition, careful document management is a good example of where early control is beneficial. We have seen examples of wide disclosure of material to the Environment Agency - which has subsequently been obtained by claimant law firms under Environmental Information Regulations and then used to launch a civil claim. Complaints therefore need to be on the radar of EHS managers and in-house lawyers in order to avoid issues developing. The message is simple: if a prosecution or civil claim is on the horizon, early strategic management is essential.

Ofwat’s comments on leakage reporting

At Water UK’s Leakage Conference in October 2012, Ofwat outlined possible changes to the manner in which leakage control is regulated. These included:

  • Leakage targets in a range rather than a single figure
  • Companies might propose the appropriate target range, following customer engagement
  • More ambitious companies might have a wider target range
  • Leakage performance figures might be normalised to remove the effect of variable factors such as weather conditions
  • Leakage reporting to move away from financial year, to a different 12 month period, to avoid having heavy leakage control activity arising from winter weather conditions just before the end of the reporting period
  • Leakage targets might be set over a longer period as well as yearly
  • Companies might be incentivised financially, both +/ve and -/ve, on leakage performance

These possibilities remain under discussion – no decisions have yet been taken.  Ofwat will be producing a methodology paper, a draft of which should appear in December 2012 ahead of a final version in spring 2013.

Mergers and ownership changes

Reform of the water sector’s special merger regime was flagged up in the Water White Paper. The draft Water Bill includes clauses which would allow the OFT not to refer a merger situation to the Competition Commission if the merger would not prejudice the ability of Ofwat to regulate the sector through comparative competition, or even if the merger would prejudice Ofwat’s ability but the prejudice is outweighed by benefits to customers. Customer benefits could be lower prices, higher quality or greater choice of goods or services, or greater innovation, which would not accrue without the merger.

In addition, the draft Bill would allow the OFT to accept undertakings from the parties to the merger in lieu of a referral to the Competition Commission. The OFT will also be required to keep the current merger referral threshold of £10m under review.

The measures within the draft Bill do not go far enough to satisfy some commentators, who claim that a significant reduction in the number of water companies is required to deliver substantial efficiencies. Furthermore, water resource issues in the south east are highlighted as an example where the number of relatively small water companies hinders efficient water resource management.

Shortly beforehand, the Competition Commission granted unconditional clearance, for the first time, to the merger of South Staffordshire Water and Cambridge Water. The loss of a comparator was felt to be outweighed by the increased probability of the merged group becoming a benchmark with other small water companies, enabling Ofwat to set higher targets.

Veolia’s 3 UK water companies have had their licences merged into 1 licence, linked to the sale by Veolia of a 90% stake in the businesses, which was sold to Rift Acquisitions, a consortium of infrastructure funds. The price paid was said to represent a 30% premium over the regulated asset value. Ofwat subsequently announced on 8 November 2012 that the ownership change does not raise any issues which require regulatory action.

It remains to be seen whether the recent merry-go-round of ownership changes in UK water companies is set to continue. Relaxed merger controls would suggest yes, but Ofwat’s proposed licence modifications, and in particular the possible removal of RPI linkage from price controls, may make water stocks less attractive.

Capital programme roller-coaster

As the industry begins to think about the run-up to the next price review, PR14, inevitably thoughts turn to the ramp-up/ramp-down roller coaster of capital expenditure that traditionally marks the end of each AMP and the beginning of the next.

In timely fashion, the CEO of Infrastructure UK has called on water companies to manage their supply chains better. He stated, “It is in everyone’s interests to improve the investment process.” Infrastructure UK fears that supply chain contractors might exit the water sector if the usual cyclicality continues, adding that this is partly about Government trying to bring regulators together to act such that economic growth is not prohibited through inefficient investment practices.

Will we see any difference? Whilst there is a desire from all stakeholders to smooth the investment profile, only clearly targeted action will achieve results.

Social Tariffs

In June 2012 Defra published its guidance to water and sewerage undertakers and Ofwat on social tariffs, i.e. reduced charges for individuals who would otherwise have difficulty paying water charges in full. Section 44 of the Flood and Water Management Act 2010 enables water companies to include social tariffs in their charges schemes, thereby allowing companies to provide for cross-subsidisation of lower income households  by other customer groups. Government wants each water company to consider the inclusion of a social tariff within its suite of charges. When framing a social tariff, a water company is required to have regard to the guidance. A social tariff which complies with Defra’s guidance will not of itself amount to undue preference or discrimination, and will not therefore fall foul of Licence Condition E; furthermore there will be a presumption in favour of approval by Ofwat. Government believes that water companies are best placed to decide on whether and how to introduce a social tariff, taking account of local circumstances and needs, and the views of their customers.