Posted on Friday 16 October 2009 byUlster Business
Economist John Simpson takes a look at the provision of water and sewerage services in Northern Ireland and asks if the Utility Regulator is setting difficult targets for Northern Ireland Water.
Businesses already pay a commercial price for the use of water and sewerage services. Soon domestic households must expect to face the introduction of charges.
If the Utility Regulator, Iain Osborne, has his way and if Northern Ireland Water (NIW) can function within the budget that the Regulator would like to set, then the cost of domestic water and sewerage charges when they come will be lower than they would be today. The Regulator has made a first bid for an 11% reduction in the projected revenue needs of NIW below what was an already decreasing bid.
"There is a 'considerable scope for additional efficiency given that the current efficiency gap requires close to a 50% reduction in operating expenditure ..‚' Draft Determination p.40
Over the next three years, within a newly set price control framework, the Regulator proposes that NIW's annual operating costs should fall from £228m in 2009-10 to £166m in 2012-13 - a 30% reduction in three years! Intuitively, the Regulator risks undermining public confidence in NIW by raising expectations too high!
If the Regulator sets realistic but ambitious targets, that is a sensible challenge: the Regulator pushes the service provider. If the Regulator is too ambitious, the service provider can be on 'a hiding to nothing'‚ and the Regulator becomes a critic, possibly an unfair critic. In a first ever price control arrangement, a charge of excessive targets should be avoided.
NIW in its own proposals suggested that operating costs might be reduced by 13%. The Regulator added a further 11% reduction and made the challenge even greater by restating the baseline figure for 2009-10, in what looks like an unrealistic movement of the goal posts by taking a further 5% out of the calculation..
The Regulator has published his draft determination of the costs of the operating and capital programmes that he would wish to approve for the years from March 2010 to April 2013. Naturally, as a Regulator, his ambition is to push for a more efficient set of services whilst improving standards and coping with changing demand.
NIW, just as naturally, whilst having the same ambitions, does not wish to be asked to do the impossible. NIW has been finding its feet in a tense political arena and has been pilloried for the failings of the inherited civil service organisation which was very inadequately prepared for a fully commercial environment.
One of the important lessons learnt in the last five years is that Northern Ireland was living with water and sewerage services that were increasingly inefficient, undercapitalised and enjoying a public perception of good quality services that was sometimes unjustified. The debate about water charges was, and is, important as a political question but it had the effect of disguising the serious questions about improving efficiency.
The creation of NIW as an accounting entity, whether a GoCo or quango, was a necessary step but had the effect of focusing on the political choice of the institutional arrangements and taking it away from the difficult commercial questions. NIW has had a baptism of fire where politics, organisational efficiency, performance criteria and regulatory imposts in the EU-based legislation have fallen on an emerging new organisation.
Now, just as NIW has shown its capacity to survive and build a credible Business Plan, the Regulator arrives and sets the challenges so much higher. Of course, the Regulator believes that he does have good reason for the tough challenges.
To set the standards for performance in the next three years, the Regulator has not just completed an internal efficiency audit from inside NIW. The standards have been developed mainly from a comparative analysis with performance in other water authorities coupled with adaptations allowing for the impact in a small region with a dispersed population.
Perhaps the most critical evidence used by the Regulator to underpin his budget estimates comes from comparisons with other UK water companies. Two features are central to his conclusions. First, NIW is:
".. at the bottom of the league table for UK water companies.."
and second that in an overall performance assessment in 2007-8, whilst NIW generated a score of 98 which attracted the attention of the Regulator:
'Our challenge to the company ... is to outperform the predicted score of 201 by 2013.'.
This comparison with other water companies is so central to the ambition of the Regulator that it is surprising that in the document for public release, none of the comparative figures is quoted. The Regulator has used econometric analysis to build the argument. Professionally interested stakeholders are asked to access other documents on the Regulator's website to test the validity of the most critical statement in the published proposals.
NIW will presumably challenge the Regulator‚Äôs proposals. That is in the nature of the Regulation process. The challenge can be expected to centre on excessive expectations on the ability to reduce operating expenses and also on the level of capital spending.
Capital spending, and the methods by which it is financed, has increased substantially since NIW was established. The Regulator is questioning the scale and efficiency of the capital spending plans. If the Regulator's opinion prevails, the capital expenditure proposed by NIW of £622m in three years would be cut, with other adjustments, to £520m.
The Regulator argues that £80m (13%) can be taken out, based on (what is described as) a scope and challenge review and a further £59m taken out following a benchmarking and econometric modelling analysis. Some additional items are included to allow for the speeding up of the delivery of some essential wastewater treatment works.
Controversially, the Regulator and NIW are at odds as to whether capital investment can be expected to be completed at prices lower than elsewhere in the UK. NIW suggested that like-for-like projects might cost 7% less than an English average. The Regulator is working on a 17% lower cost base.
Since many recent contract prices are available, this difference is too important to ignore and is susceptible to quantification. When the final price control is agreed, this uncertainty should be removed.
Water charges for households
The Regulator has made an extra contribution to the public debate about water services by setting out the statistics on the probable level of an average household charge for water services, if separate charging is introduced. Of course the document is politically neutral in that the statistics are presented for information and not as a recommendation.
Under the regime proposed, the average annual household charge at 2009 prices would be £369 but, with the transfer of the amount notionally included in today's regional rates, this would be an extra household payment of £209.
Of course the Regulator can argue that, thanks to a tough price control, these costs are significantly lower, over £40 pa, than might otherwise have been the case.
That gives the Regulator the last word. He has been tough, even too tough, in the expectations from NIW but, ultimately, his motives are consumer orientated!