Water Bill

Earl of Selborne Excerpts

Tuesday 4th February 2014 Lords Chamber

[Viscount Hanworth (Lab)]

My Lords, I also thank the noble Lord, Lord De Mauley, for his very helpful approach in informing some of us of the intricacies of the Bill. This is a probing amendment, designed to throw some light on the arrangements regarding the so-called market operator. An electronic search of the Bill fails to reveal a single instance of the words “market operator”. We have been alerted to the intention to create this entity by an organisational flowchart entitled “How Will it All Work?”. This was provided by Defra officials in the course of a seminar that preceded the introduction of the Bill to this House. The words are to be found within a centrally located box that is connected to boxes labelled “the regulator”, “the retailers” and “the wholesalers”. I tend to view such charts from the perspective of the circuit diagrams of electrical engineering, hence I have anxieties about the dangers of short-circuiting or worse. This flowchart contravenes all the rules of electrical safety.

There was nothing in the document presented at the seminar to inform us of the role of the market operator. However, one noticed that the top left-hand corners of its pages were stamped with the logo of an organisation called Open Water. We have been told that Open Water is a programme created to support the Government’s vision for the future of water management in England and that it is to be steered by a high-level group consisting of representatives of Defra, the Scottish Government, the Welsh Government, customers, Ofwat, the Water Commission for Scotland and the water companies. Only Uncle Tom Cobbleigh is missing from the list.

An immediate question is whether this organisation is real or a mere fiction. One way of substantiating the existence of an organisation is to look for its website. The website of Open Water is readily accessible but an examination of what is there only adds to the doubts and confusion. One prominent item on the site is a question and answer file that purports to be an interview, in real time, with the programme director, Keith Fowler. It is clearly nothing of the sort and this assertion is notwithstanding the fact that the document ends by expressing thanks to Keith Fowler for “talking to us today”. I had not previously encountered this kind of bamboozlement.

A somewhat more informative document, available at this website, is titled Market Operator Target Operating Model. This purports to tell us what the market operator will and will not do. However, in places the document is curiously self-contradictory. Thus it is stated that the market operator,

“should carry out monitoring and reporting of market code compliance”,

and have delegated authority to issue,

“warnings and … financial and non-financial penalties”.

It is also stated, in a seeming contradiction, that:

“Enforcement of significant market issues should not be performed by the”,

market operator, and it is said, in an oddly confusing manner, that, if needs be, the market operator,

“should administer, but not arbitrate on, market disputes”.

Clearly, there is need for some clarification here, which is what the amendment seeks.

A further issue that needs to be clarified concerns the steering of a market operator, and its relationship to Open Water. We learn from the aforementioned document that the market operator,

“should be a company limited by guarantee”,

that will be owned and paid for by the water companies, that its set-up costs should be paid for by the wholesalers and that its running costs should be split between wholesalers,

“incumbent retailers, new entrant retailers and self-supply customers”.

A danger that may arise and that needs to be guarded against is that of regulatory capture, a process by which regulatory agencies eventually come to be dominated by the very industries that they have been charged with regulating. The terminology originated in the United States, where it has been used to describe how the intentions of the federal Government have been widely subverted. Aspersions of regulatory capture have already been made against Ofwat; we need assurances from the Minister that the Government are aware of such dangers and will take steps to avert them. I beg to move.

[The Earl of Selborne (Con)]

My Lords, I declare my interests, as I did at Second Reading, that, like the Minister, I am a farmer with an abstraction licence, although I have not been flooded—so to that extent, I do not claim the same interests.

The amendment would require Ministers to issue rules for the,

“designation of … procedures, responsibilities, status and governance”,

of a market operator. I cannot believe that such ministerial control would assist in the implementation of a successful market. In regulated utility industries, whether energy, communications or water and sewerage, the management and control of market operations is initially the responsibility of the regulator, working alongside the industry. Once the market is up and running, it becomes the responsibility of the industry, supported of course by the oversight of the regulator, which provides the framework. This approach helps to ensure that the regulator and the industry work together; the industry will need to adapt to innovation and new circumstances. We recognise that in this Bill we are promoting innovation and we have to ensure that the regulation adapts accordingly. The industry will need to adapt to innovation and these new circumstances, and it is for the regulator and industry to ensure that working practices are aligned in the regulatory framework that we are establishing in the Bill. I simply do not believe that it would be helpful to have a politician—the Minister of the day, of any party—fulfilling the role of controlling the market operator in this far-reaching way.

[Baroness Parminter (LD)]

My Amendment 95 is grouped with the amendment moved by the noble Viscount, Lord Hanworth. I wish to probe the issue to get a bit more information from the Minister on the shadowy role of the market operator. Before I do that, however, I take the opportunity on this first day in Committee to say that the truncated nature of the parliamentary process, with less than two weeks between Second Reading and going into Committee, has presented certain challenges to those of us who are trying to do our duty and give proper scrutiny to this complex Bill, as my noble friend Lord Crickhowell said. Like others, I thank my noble friend the Minister and the Bill team for the briefings and the clarity of the briefing papers, but that still leaves certain gaps in our knowledge. Noble Lords will be aware that the comments of the Delegated Powers and Regulatory Reform Committee on the Bill were published only on Friday, and we still await the Government’s response. Clearly, we have had to table our amendments before the Government have provided us with the response to important points that the Delegated Powers and Regulatory Reform Committee has made, and that is not particularly satisfactory or helpful.

--- Later in debate ---

Moved by

[The Earl of Selborne]

5: Schedule 1, page 125, line 29, at end insert “for the purpose of, or in relation to, its participation in arrangements made by the undertaker for the introduction of water into its supply system”

[The Earl of Selborne]

My Lords, I shall speak also to, I think, 32 amendments in this group. I am conscious of the fact that my noble friend Lord Crickhowell said that this Bill started hopelessly complicated, and I suspect that I stand charged by him with trying to make it ever more complicated—and I do so. This is because I am asking the Minister to ensure that the threat of moving towards de-averaging—something neither the Government nor any of us want—is not going to be advanced by the fundamental concept incorporated in the competition aspects of the Bill. That concept is the provision of a direct link between an upstream service provider, whether water or sewerage, and a retailer to non-household customers.

The position under the Bill is that the customer can contract directly with a resource provider. This may well bring lower charges to some customers, if, for example, a new entrant is able to offer a water supply at a price lower than the average price that the incumbent water company is able to charge. In a negotiated market, there will be a range of attributes that will favour one supplier over another. That is desirable and helpful. Price is one such key factor. If, as is possible here, large, non-household customers successfully negotiate on price alone—without respect to the other services that we are expecting to be provided in terms of environmentally friendly services, water savings and much else—that will favour one supplier over another. Eventually, this will result in a situation in which we will drift inexorably towards a two-tier market with the principle of average prices for all customers abandoned. It follows that smaller non-household customers and anyone located in remoter rural areas will face increased costs.

If we think that this is a remote possibility, we should bear in mind that it has actually happened already. In Wales, the Shotton case set a precedent that local costs were required to be used in a ruling in setting prices under bilateral deals. I am told that this was a one-off and that it will not happen anywhere else. However, when I hear that it has happened, and that there is a threat, I say that this is the opportunity to make sure that it does not happen again. I am sure that we shall look at other proposals as we go through the Bill to ward off the threat of de-averaging.

This is a fundamental proposal: it requires contracts to be made with the undertaker, with the other two parties participating. The purpose of the amendment, therefore, is to remove the direct link between the provider of resource services and the retailer. It would remove any opportunity for a large corporation to act in a way that was detrimental to all other customers.

Under the Bill as drafted, we could end up with non-household customers paying different prices for the same service within the same appointed area. As I have said, smaller businesses and non-household customers in rural areas are most likely to be affected. One of the charging principles that I accept in the Bill—I quote from the guidance—is the following:

“No category of customer should be unfairly disadvantaged by the way reform impacts on water charges. A fair and non discriminatory approach to sharing network costs will be critical”.

However, the guidance goes on to say:

“Ofwat has a number of tools to limit the effect of de-averaging on customer charges”,

and that it will ensure that,

“any marginal charges are introduced in a measured fashion and, above all, that they are in the overall interest of customers”.

So we are being assured that Ofwat, under the terms of the Bill—we will come to the codes and the rules later —can deal with this problem.

However, I am not entirely clear that this is the case, and I hope that the Minister can give some reassurance—remembering, of course, that already in Shotton we have seen an example of two-tier pricing that has impacted on other customers in the region. Can Ofwat really be expected to manage the impact of de-averaging to prevent any unfairness between customers, especially rural customers, when contracts for non-householders are made directly between retailers and potential upstream services?

Helpful progress was made in Committee in another place and a strong assurance was given that de-averaging would be prevented through ministerial charging guidance, which would explicitly rule it out. However, that is only a limited assurance when one recognises that if these contracts between the resource provider and the retailer were to be decided under European rather than United Kingdom competition law, the United Kingdom Government’s charging guidance would be overruled. So, much as one would take comfort from the ministerial guidance, frankly, it would not overrule European competition law.

I will say again that the purpose of the amendments is to require those with wholesale authorisation to interact with the incumbent water and sewage undertaker rather than with the retailers. I beg to move.

[Lord Moynihan (Con)]

My Lords, my name has been associated with the amendments tabled by my noble friend. He set out his eloquent and comprehensive assessment of the issue of de-averaging and said that he intends to speak further when moving his Amendment 32. There are further amendments. Your Lordships will have noticed that there is a 33rd, Amendment 61 to page 152, line 23—it is tucked away at the back—and will excuse the fact that it is not to the first part of the Bill. However, the amendment echoes the points that have been made so eloquently by my noble friend.

Of course, in many respects, these are probing amendments. However, they have at their heart the significant concern that if de-averaging were to take place some non-household customers, particularly smaller customers in rural areas, could see their charges increased markedly. This could have serious impacts on those non-householders and potential political consequences in some areas.

The prudent way through this would be to remove the direct link that exists in the Bill between the provider of the resource services and the retailer/customer, as my noble friend has pointed out.

What I would like to ask, however, is that the Minister clarify the extent of this issue. We have received advice from Scotland—the economics consultancy Oxera and Scottish Water undertook analysis into the impact on customers, were de-averaging to have taken place in Scotland. Under the Scottish Government’s rules, the policy is to rule it out. However, Oxera found that even on very conservative assumptions, many businesses could see their charges rising by at least 25% and, in a fully de-averaged scenario, some customers in Scotland could end up paying up to 10 times their current bill. That is evidence that we have received on one hand.

However, on the other hand, the Bill focuses on choice. Retail services account for something like 10% of the non-household bill—which accounts for something like 20% of the total bill—so approximately 2% of the amount would be in this sector. I would be grateful if the Minister could highlight the seriousness and impact of this issue in terms of its scale. Does he agree with the figures of Oxera put forward by our friends north of the border, who have done some outstanding work in generating competition in this sector? If so, and if that is to be borne out by the evidence, it underlines how important these amendments are.

--- Later in debate ---

[Lord De Mauley]

My Lords, these amendments, tabled by my noble friends Lord Selborne and Lord Moynihan, seek to introduce a fundamental change which would narrow the approach to upstream competition in this Bill by removing the link between upstream arrangements and retail arrangements with customers. They would mean that licensees would be able to make arrangements with incumbent water companies to provide water and sewerage services without needing to have a specific customer to consume the water or use the sewerage services through the retail market. The implication is therefore that the market might be established through incumbents tendering for new resources under a so-called single buyer model. This would be a significant change from the regime that has been in place since the Water Act 2003 and which we propose to extend through this Bill.

The current approach provides common carriage rights to licensees who want to provide their customers with water resources or sewerage treatment services using incumbents’ networks. Common carriage is the term used when new entrants are given rights to use incumbents’ networks to provide services to their customers. A single buyer approach is a very different model with decisions on tendering for water supplies or sewerage services resting with the incumbent. It provides fewer rights and less flexibility for new entrants.

The Water Act 2003 brought in a specific common carriage regime for new entrants to access the public supply system by making water supply a licensable activity. Under this regime, the same licensee that puts the water into the system must supply the retail services to the customer. The Bill reforms the existing regime by allowing different licensees to input water and provide retail services to eligible customers, but still requires there to be a specific customer. There is nothing in existing legislation that prevents incumbent water companies from making arrangements with third-party water suppliers or sewerage service providers to input water into the system or deal with sewerage disposal. Indeed, we are pleased to see that Thames Water has gone to the market to see which third parties could provide it with water in order for it to meet future water resource needs. Potential suppliers to Thames Water do not need a water supply licence to be able to make an input under this tendering process. There is no need to amend the Bill to make it possible for third-party suppliers to sell water to incumbents, should we feel this is the right way to go in the future. Clause 12 is designed to enable this. The Bill also provides for licensees to withdraw waste water and sludge from the sewerage system through the disposal authorisation in the sewerage licence. This could be used by Ofwat to introduce a similar model to a single buyer arrangement in the sewerage market if it feels that this would be appropriate.

Through the Bill, we are seeking to bring in new resources and introduce more innovation into the sector. My noble friends’ amendments would allow incumbents to dictate the future direction of upstream markets. This would reduce pressure on those incumbents to introduce efficiencies that will benefit customers and the environment because only those licensees that are able to bid for and win contracts would be able to enter the market. Incumbents rather than customers would therefore determine future upstream markets.

My noble friends have indicated that the main objective of the amendments is to remove risks connected with the de-averaging of water charges. As the noble Lord, Lord Whitty, said, that is something which we will come to in a little more detail in the next group of amendments, but I hope that your Lordships will allow me to say a few words on it now in response to the contributions that have been made. There is a crystal clear steer from the Government in our charging principles that Ofwat must not allow de-averaging that is harmful to customers. Ofwat has all the necessary regulatory tools to enable it to limit the effect of de-averaging on customer charges. Ofwat has clearly stated that it believes that these tools are sufficient. The Government’s charging principles make it plain that Ofwat must use these tools to ensure that any de-averaging or cost reflectivity is in the overall interests of customers. Two independent experts have reviewed the issue of de-averaging: Professor George Yarrow for Ofwat and Professor Martin Cave for the Consumer Council for Water. Both experts confirmed that Ofwat can facilitate upstream competition without any de-averaging. De-averaging has not happened in other regulated utility sectors, even though greater proportions of those markets are open to competition, and it is no more likely to happen in the water sector.

I stress again that the Bill puts in place a framework that enables household customers to be protected against any changes to their bills resulting from the expansion of the competitive market. Our charging guidance will explicitly say that de-averaging must occur only where it is in the best interests of customers.

My noble friend Lord Selborne raised the case of Shotton as a legal precedent to support the case that de-averaging is a real risk. It is a complex and long-running case, but I hope I can persuade him that it is a misunderstanding to describe it as a case of de-averaging. Shotton was a very unusual case and it is not appropriate to extrapolate from it more widely. For example, it concerned a discrete system that served only two customers, one of which was served by Albion Water. This is very rare. To give some context, the case only represented 0.01% of Welsh Water’s turnover. At the time of the dispute, this agreement was not subject to regulation by Ofwat. The Bill includes measures that will bring all such transfers within the scope of the regulatory regime. Ministerial guidance and Ofwat’s charging rules will therefore set out how charges between water companies and inset appointees such as Albion Water should be determined in future.

My noble friend raised the concern that EU competition law might require that indiscriminate de-averaging takes place, affecting both business and household customers. First and foremost, there is no general prohibition under competition law against the use of average pricing. In fact, it is common practice in both regulated and unregulated sectors. The obvious examples are the gas, electricity and telecoms sectors. In each of these regulated, networked sectors, regionally averaged prices have remained the norm. There is no suggestion that this approach is inconsistent with competition law.

My noble friends Lord Moynihan and Lord Crickhowell referred to parallels with the Scottish system where there is no upstream competition. In England, we have a very different market structure and a different set of resource challenges. We are learning from the example of Scotland where it is appropriate to do so but they are different systems and their regulation will accordingly be different. Perhaps we might discuss the Scottish situation in more detail in subsequent groups of amendments.

My noble friends’ amendments remove the direct risk of de-averaging but may not lead to a better outcome for customers. They could still see an increase in charges if incumbents introduced overly burdensome standards in tendering contracts or made poor decisions over which bids to accept. Ultimately, incumbents would not be incentivised to make their upstream services more efficient and would continue to be incentivised to make decisions that benefit themselves rather than customers.

Given that these amendments considerably narrow the scope of competition in the sector, I ask my noble friend to withdraw his amendment.

[The Earl of Selborne]

My Lords, I was not expecting a resounding round of applause from the Minister for these proposals, which are fairly fundamental in tackling the whole concept. Nevertheless, the Committee should look seriously at precedents, such as Shotton, which, the Minister assures me can be ignored because it is almost irrelevant. When we have an example of a court case which has determined that the price of the local supply of water should prevail, there is, I suggest, quite a threat that this could be rolled out on a larger scale. I think we should take note of that.

We are effectively being assured that Ofwat will have the ability to regulate contracts made between the wholesaler and the retailer. We will come later in other amendments to test the extent to which Ofwat has sufficient powers and codes to ensure that these contracts do not ultimately work to the disadvantage of, for example, rural communities and others. I am not entirely clear why my noble friend is so certain that this puts the incumbent in a stronger position than he might otherwise be, because you are effectively getting back to the same position, which is that Ofwat, under the Bill, has to determine any contract.

--- Later in debate ---

[The Earl of Selborne]

My Lords, I support this group of amendments and I have put my name to my noble friend Lord Moynihan’s amendments in the group. The noble Lord, Lord Whitty, is absolutely right to recognise that the more you put provisions in the Bill that help the Minister in his resolve to prevent de-averaging the better. It cannot do much harm. As you bring in competition, we see all sorts of snares and pitfalls in the way of Ofwat’s best intentions to prevent simple pricing determining the advantage. If Ofwat cannot do so—and we are still to test to what extent we find that Ofwat is capable of appropriate regulation of those individual contracts—provision such as that in Amendment 9 will clearly be helpful.

The real danger, after all, is that some retail providers could, for example, be providing excellent environmental and social services. They could be rolling out water butts, helping water harvesting and giving advice on water-saving gadgets. Those do not come free; they cost a bit. If they are competing against someone who is providing just a short, sharp service—the product in question at the cheapest price with none of those frills—we will eventually undermine those whom the Bill is intended to encourage, those with innovative practices that will lead to more sustainable use of water. Although I am all in favour of increasing the range of negotiation, we simply cannot allow the only differentiation to be on charges. That is why I think that the amendments are helpful.

[Lord De Mauley]

My Lords, before I address this group of amendments, perhaps I may answer the noble Lord, Lord Cameron, and my noble friend Lady Parminter, who asked about the truncated period between Committee and Report. I fear that these things are way above my pay grade and are decided through the usual channels. All I can do is apologise to noble Lords for any inconvenience that that may have caused and assure noble Lords that my door remains open. I will be there to answer questions between days in Committee and between Committee and Report; I hope that I can be helpful.

Turning to this group of amendments, I thank noble Lords for some articulate speeches about a complicated issue. It is one that we take very seriously. As noble Lords said in earlier debates, this is not an easy area to get one’s head around. Specifically on de-averaging, when we talk about averaging or de-averaging of costs, we are discussing how best to share the costs of sourcing and disposing of water between customers. Most providers of goods and services average their costs to some extent.

In my view, it makes sense to share the costs of maintaining the network on which all customers rely across all customers, regardless of their location. The network makes up about 90% of a water company’s assets, so when we discuss de-averaging in the context of the Bill, we are talking only about charges in the competitive part of the market, which accounts for about 10% of the companies’ activity. I think that many noble Lords agree that there could be real benefits from increasing the cost-reflectivity of charges for different sources of water to reflect the environmental costs of supply. That is especially important in water-stressed areas or for business users that use large volumes of water.

Strange as it may seem, at present, there are almost no economic incentives for businesses that use large volumes of water to seek out the least environmentally damaging source of water. Nor are there any economic incentives to encourage incumbent water companies or new entrants to the market to help businesses to identify the most environmentally efficient sources of water. The Bill is intended to change that. Our upstream reforms will encourage competition for business customers and incentivise more efficient use of resources. More efficient use of water resources must be good for customers and good for the environment.

I discussed earlier the measures in place to ensure that householders are protected. In regard to de-averaging, as I said in the debate on the previous group, we are clear in our charging principles that de-averaging must occur only where it is in the best interests of customers. In answer to my noble friend Lord Moynihan, when we issue the charging guidance we will make it clear that there must be robust boundaries on the scope of any de-averaging. In particular, Ofwat will be expected to exert control to prevent the de-averaging of network costs and any negative bill impacts that could arise from this. Any moves to enable greater cost reflectivity will be targeted squarely on water resource costs in the competitive parts of the market. This is where there may be social and environmental benefits from encouraging sharper price signals. The Government are completely committed to maintaining bill stability. Customers have made it clear repeatedly that stability is important to them. We will not permit anything that undermines that stability.

The charging rules that Ofwat makes, within the framework set by the Government’s charging guidance, will be flexible. As the situation changes over time, our guidance and the rules that Ofwat sets about charges will be able to respond to the way in which the market evolves. I mentioned earlier that it makes sense to provide a price signal that reflects important decisions about our precious water resources. Using the Bill to ban any kind of price signal would, I suggest, be disproportionate. At the same time, we want to ensure that customer bills remain stable and reasonable. The flexible framework of charging guidance and charging rules will achieve this.

The suggestion was made in the debate that customers could end up paying for stranded assets. This is a regulated sector and the important question of what costs should be borne by customers is one for the regulator. In fact, this point is less about de-averaging than about whether the investment made by incumbent water and sewerage companies is made efficiently and in the interests of customers. No one here, I suggest, would think it right that customers should have to foot the bill for inefficient investment. It must therefore be right that the regulator has the powers to protect customers from paying for inefficient investment.

My noble friend Lord Selborne asked how Ofwat can enforce rules on de-averaging. The charging rules produced by Ofwat will regulate the price relationship between the incumbent and the licensee. It will be able to set out how incumbents apportion the costs of the network and distribution. In making these decisions, it will need to take account of its duties, which include having regard to rural customers. It will also have to reflect the Government’s charging guidance. The Secretary of State can veto Ofwat’s charging rules if they do not reflect the guidance.

Noble Lords asked whether rural customers might lose out. Ofwat will continue to have a statutory duty to have particular regard to rural customers and the charging principles that the Government published recently reinforce the protections that will remain for rural customers. They require Ofwat to ensure that any greater cost reflectivity must provide benefits to customers. No customers should be unfairly disadvantaged by the way that reform impacts on water charges. The noble Lord, Lord Cameron, referred to water being a universal right and I strongly agree. Water companies are under a statutory duty to supply and the Bill will not change that fundamental requirement.

I mentioned earlier that both Professor George Yarrow and Professor Martin Cave confirmed that Ofwat has the tools to regulate the upstream market without any de-averaging. The Bill will impose a legally binding framework for the industry and the regulator regarding their approach to the averaging of prices. This view is supported by competition experts. For these reasons, I hope that the noble Lord will be reassured and be able to withdraw his amendment.

--- Later in debate ---

[The Earl of Selborne]

My Lords, I support my noble friend Lord Moynihan and welcome the tenor of the remarks of the noble Lord, Lord Grantchester.

I think that we are agreeing that common industry codes are critical. No one dissents from that. We come back to the question of the extent to which the existing codes, as written in the Bill, deliver these common codes and standards. New entrants simply cannot be allowed to be discriminated against by incumbents. Without a doubt, we have seen this in other utilities—in the rollout of broadband, for example. It is no coincidence that BT seems always to be on the inside track, so we should not be naive enough to think that the incumbent undertakers are not always going to try to ensure that they see off any competition. Later we will talk about discounts and special charges. These do happen. They need to be regulated and, in so far as these amendments help establish the principle that there should be common industry codes, I welcome them.

[Lord De Mauley]

My Lords, as noble Lords have explained, the purpose of these amendments is to ensure that access to the retail market is regulated to minimise burdens and make access to the market simpler. I agree that requiring all licensees to negotiate with each of the 21 incumbent water companies to enter the market would represent a considerable burden on the market participants and undermine what we are trying to achieve with our reforms.

Schedule 4 of the Water Act 2003 inserted current new Sections 66A(2) and 66D(2) into the Water Industry Act. These placed the incumbent water company under a duty to make a water supply agreement on certain terms agreed with the licensee or determined by Ofwat. This duty has been interpreted to mean that each individual agreement between an incumbent water company and licensee must be negotiated, or imposed by Ofwat where the parties are unable to agree. Ofwat has produced guidance to facilitate negotiations, but the parties to these agreements could ignore the guidance and come to their own agreement. This is clearly a considerable barrier to entry into the retail market in particular and one that provides unco-operative incumbents with an opportunity to delay the making of agreements, about which the noble Lord, Lord Grantchester, and my noble friend Lord Selborne have rightly expressed concerns.

New Sections 66A and 66D will be repealed by this Bill, and replaced with a requirement that agreements between incumbent water companies and licensees must be in accordance with new, enforceable charging rules and codes produced by Ofwat. This will reduce burdens and costs on all parties, and speed up customer switching when the market expands to include 1.2 million potential customers. Schedule 4 creates the same requirements for sewerage arrangements.

There has been some confusion as to the wording of some parts of Schedules 2 and 4 that might lead some to assume that a licensee will be able to enter the retail market only through a complex series of negotiations with every incumbent water company in England. For example, new Section 66DA states that codes may include provisions about procedures in connection with making a Section 66D agreement. This is not the case. We need some flexibility about allowing a certain level of negotiation in some cases, particularly for the upstream markets; negotiations might address water quality and environmental conditions specific to a locality in a water company’s area. We also want licensees to have some flexibility to negotiate innovative new ways of doing things. Market codes will be able to set out the circumstances when such negotiations would be appropriate or inappropriate. I draw noble Lords’ attention to new Section 66DA(2)(c) and (d) and new Section 117F(2)(c) and (d).

My noble friend Lord Moynihan referred to functional separation and we will discuss specific amendments on that matter in a little while, and perhaps I can address that at that point. He also referred to the regime in Scotland and the fact that it provides only for regulated access. Scottish legislation is silent on the need for WICS to produce codes to make the market work. WICS took the decision to regulate access to the retail market and Ofwat and the Open Water programme are taking the same approach. It is worth noting that there is no competition in Scotland for wholesale supplies of water. The two markets are therefore clearly not directly comparable.

I am happy to tell my noble friend that paragraph 5 of Schedule 2, which inserts new Section 66E into the Water Industry Act 1991, and new Section 117L, inserted by Schedule 4, already provide Ofwat with powers to regulate these charges between incumbents and licensees, and that Ofwat may make rules about their publication.

The Bill regulates licensees’ access to the supply and sewerage systems of the quasi-monopolistic incumbents only. We see no need to regulate arrangements between licensees themselves, as they all start on the same footing. That is competition and it will be left to market forces. I hope that my noble friend will therefore feel able to withdraw the amendment.

--- Later in debate ---

Moved by

[The Earl of Selborne]

41: Schedule 2, page 136, line 36, at end insert—
“(e) principles for determining the provisions that should or should not be incorporated into arrangements of the sort contemplated in paragraphs 5 and 8 of Schedule 2A together with a procedure for making and modifying such arrangements”

[The Earl of Selborne]

My Lords, in moving Amendment 41, I wish to speak also to Amendments 46, 58, 63 and 114.

We now come to Ofwat’s duties. Amendments 41, 46, 58 and 63 all seek to ensure that Ofwat does, indeed, have the powers and the authority under the Bill to deal with some of the issues we have already addressed. Amendment 114, which I will come to, seeks to ensure that no detriment is caused.

Amendment 41 seeks to amend Schedule 2 to the Bill by adding to the four subjects on which Ofwat may issue codes in regard to Section 66D agreements. I remind the Committee that the four provisions in the Bill allow a code to make provision about,

“procedures in connection with making a section 66D agreement … procedures in connection with varying or terminating a section 66D agreement … the terms and conditions of a section 66D agreement, including terms as to the duration of such an agreement … principles for determining the terms and conditions that should or should not be incorporated into a section 66D agreement”.

Thus the Bill sets out Ofwat’s responsibilities vis-à-vis these Section 66D agreements. Amendment 41 proposes a fifth subject for which a code should make provision and refers to the,

“principles for determining the provisions that should or should not be”,

in the Section 66D agreements.

Amendment 46 relates to the rules under new Section 66E on the reduction of charges payable under a Section 66D agreement. The amendment seeks to add the proviso that the case for reduced charges must be based on reduced costs—therefore, discounts would be allowed only where overall costs are reduced. In other words, the amendment seeks to keep the level playing field we have discussed on earlier amendments. Amendments 58 and 63 seek to introduce the same provisions for sewerage undertakers.

The thrust of these amendments is to ensure that Ofwat is under a clear obligation to set charging rules in a way that helps to incentivise water efficiency and the efficiency of other services of environmental, social and economic benefit. It is essential that Ofwat has sufficient powers to prevent discrimination against new entrants by incumbents offering them less profitable terms, poorer service levels or simply being slow to respond to their requests. There are many and insidious ways in which you can see off competition and Ofwat must have the powers to enable it to regulate and monitor these special agreements very carefully. I am confident that the Minister will say that this is already adequately covered in the Bill. However, in so far as these amendments would further strengthen the legislation and Ofwat’s hand—we have all agreed throughout our deliberations this afternoon that Ofwat is the key to this—surely they would be helpful in preventing any such discrimination.

Amendment 114 is the so-called no-detriment amendment. It seeks to put on Ofwat a specific duty to ensure that no detriment is caused to wholesale business as a result of retail activities. The amendment ensures that the wholesaler, for example, has no incentive to discriminate unfairly in favour of retailers who are less active in providing environmentally desirable services. I referred to that in an earlier amendment. We can see that if a retailer is actually managing to reduce the demand for water it might no longer necessarily be to the wholesaler’s advantage to give that particular retailer the same sort of service as somebody who was less assiduous in selling such services.

The no-detriment provision ensures that the wholesaler is indifferent to the efforts of retailers to improve water efficiency or provide other value-adding environmental services. The operation codes will go some way to setting out the rules of engagement between wholesalers and all retailers. The no-detriment provision will give added protection as it will remove all incentive to discriminate. Extending the duty of non-discrimination to Ofwat, which I accept is already there under the terms of the Bill, will ensure that no undue preference or discrimination takes place. It should help to establish that Ofwat indeed has all the duties that we would require to facilitate competition directly. I beg to move.

--- Later in debate ---

[Lord De Mauley]

My Lords, perhaps I may start by saying that our approach to retail competition is being developed jointly with the industry, along with the England and Scottish regulators, and others. This group is well placed to identify the conditions that will work best in England, capturing any lessons learnt and building on the Scottish experience.

I am not sure how a no-detriment duty would sit alongside the general duty for the Secretary of State and Ofwat to secure that licensees meet their statutory obligations and the conditions of their licences, given that these are set by the existing duties on Ofwat and Ministers. Ofwat is under a general duty to ensure that incumbents are able to finance their statutory functions. This duty enables Ofwat to create the right incentives to ensure that incumbents can benefit from investments that deliver improved water efficiency in their respective areas. It is suggested that incumbents may show preference to licensees that do not concentrate on water efficiency activities. This is addressed through Clause 23, which requires Ofwat to ensure that incumbent water companies do not discriminate in the provision of services. Ofwat is also able to address such issues through its Competition Act power, which incidentally is a power that WICS does not have in Scotland. In England and Wales, both incumbents and licensees are subject to a duty under the Water Industry Act 1991 to help their respective customers conserve water. I would not want to undermine the market for water efficiency services. I am sure that that was not an intended impact of the amendment.

Curbing the licensees’ water efficiency activities could also put them at a competitive disadvantage if a similar duty was not placed on the retail side of the incumbent’s business. Why should licensees be kept under a duty which potentially curbs their water efficiency activities, while an incumbent’s retail business is allowed to operate without this barrier? Amendments 46 and 53, in particular, may be a barrier to licensees working with customers to become more water-efficient because they impose a condition that any new arrangements designed to reduce pressure on networks must not impose any more costs on incumbent water companies. This same requirement is not being placed on the incumbents’ retail businesses through these amendments. A no-detriment clause works in Scotland due to its circumstances, having just one incumbent retailer and wholesaler. It simply will not work in the same way in England and Wales. For that reason, I ask my noble friend to withdraw his amendment.

[The Earl of Selborne]

My Lords, I shall come to the no-detriment clause in a moment. The earlier four amendments deal with strengthening the codes for Ofwat, and I am fairly confident that the more robust the powers that Ofwat has to prevent discrimination the better.

I simply do not understand why, if the no-detriment clause works in Scotland, where there is one undertaker—one company—it would not work if there is more than one. I think that the case becomes stronger, not weaker. However, I will read with some care what the Minister said because I suspect that the whole area of a no-detriment clause is something that we will want to come back to at a later stage. I beg leave to withdraw the amendment.

Amendment 41 withdrawn.

--- Later in debate ---

Moved by

[The Earl of Selborne]

44: Schedule 2, page 139, leave out lines 31 to 38

[The Earl of Selborne]

My Lords, we now come to special charges, which I have to admit were a bit of a mystery to me. I did not even realise that they existed. Clause 33(2) on page 81 of the Bill amends Section 142 of the Water Industry Act 1999 so that there is a duty on incumbents to notify Ofwat if they make an individual charging agreement with a customer that is not covered by a charging scheme. In other words, they are special agreements. Ofwat already requires information provided by incumbents about those special charging agreements.

Special charging agreements have the potential to undermine just about everything we have been talking about. Once there is a special agreement, which by its nature is not a common agreement, it flies in the face of the excellent provisions in the Bill, not least to ensure that there is a level playing field and transparency. We need to establish just how many such special agreements are in place at the moment. Amendment 106 does that. It would amend Schedule 2 to require Ofwat to review existing special agreements and assess the charges payable under these agreements. The purpose of the amendment is to ensure that such agreements that depart from the charging schemes are appropriately regulated in future. I would have thought that that was pretty uncontroversial, and I hope that the Minister agrees.

Amendment 103 requires any future special agreement to be allowed only if a customer has done, or has agreed to do, something that reduces or increases the costs incurred by an undertaker. Such agreement would have to receive the consent of Ofwat. In other words, there cannot be a deal that is specific to that particular customer. We would lose the averaging principle that we hold so dear. New Section 66E(3) is the basis on which Ofwat establishes these special charges. I am keen to ensure that Ofwat first makes it absolutely clear how many special charges exist at the moment and, above all, does not allow any future special charges, unless there is a reason that is transparent, obvious and does not undermine the averaging principle. I beg to move.

[Lord De Mauley]

My Lords, my noble friend would introduce changes to the way in which incumbent water companies’ special charging arrangements for customers operate in the reformed market. Special charging arrangements come about when incumbent water companies depart from published charges schemes to allow discounts on the wholesale element of a water charge where a customer, for example, agrees to do something to reduce pressure on a network or has made a contribution to a capital project carried out by an incumbent.

Amendment 103 would require Ofwat to approve special charging arrangements for licensees before they are put in place. Amendments 44 and 48 remove powers for Ofwat to introduce charging rules under Schedules 2 and 4 that would allow customers who receive discounts to switch to a licensee without losing those discounts. Amendments 106, 131, 166 and 169 will initially require incumbents, within one month of Royal Assent, to notify Ofwat of all existing special charging arrangements that are in place. However, Ofwat already collects and publishes information on special charging arrangements on an annual basis, which means that it is not necessary for the Bill to be changed for Ofwat to obtain details of historical agreements. The amendments would also require Ofwat to make and publish a determination about the appropriateness of these historical charges, publish details of its determination, and control the charges between the incumbent and the licensee as well as the price that the licensee can charge the customer from then on.

As part of the review of price limits for 2015 to 2020, Ofwat requires incumbent water companies to separate out the retail and wholesale components of the charges. Ofwat will be able to assess the appropriateness of such charges during this process and introduce charging rules under Schedules 2 and 4 to ensure that licensees will be able to access wholesale charges at a competitive rate and compete with incumbents on the retail element of the special charges. For example, rules can ensure that costs are properly allocated between the retail and wholesale elements of the special charge. Ministers will also be able to give their views on the content of charging rules.

Importantly, the change introduced by Clause 33 will place incumbents under an enforceable duty to report new special charging arrangements to Ofwat as soon as they are made. Clause 33 comes into force two months after Royal Assent. This provision also requires Ofwat to publish details of these arrangements in its register, which is available on its website. Taken together, Clause 33 and Schedules 2 and 4 deliver most of what my noble friend wants to achieve through his amendments. Like my noble friend, we want to increase transparency around the setting of new special charges to enable the beneficiaries to be able to switch to a licensee and still retain their discounts on wholesale charges, if appropriate. As part of the price review process for April 2015, when new price limits are introduced, Ofwat will be able to assess the appropriateness of existing special charges ahead of the retail market opening. With these assurances, I hope that my noble friend will feel able to withdraw his amendment.

[The Earl of Selborne]

My Lords, I draw some comfort from my noble friend’s response. I think we all agree that special charges represent a potential Trojan horse and are not to be encouraged. In so far as they can be transparent, reduced or even eliminated, that would surely be helpful. I should like to think that Ofwat would trenchantly make it clear that it is not in favour of special agreements, and that any special agreements would be published in a transparent and open way annually, as I understand the Minister says Ofwat does and will do. Above all, Ofwat should make it clear to the industry that it does not expect special agreements to be common practice, and should be countenanced only under exceptional circumstances. With that assurance from the Minister, I am happy to beg leave to withdraw the amendment.

Amendment 44 withdrawn.