Select Committee on Environment, Transport and Regional Affairs Minutes of Evidence


Examination of witness (Questions 1-19)

TUESDAY 30 JANUARY 2001

DR DIETER HELM

Chairman

  1. Can I welcome everyone to the first hearing of the Environment Sub-committee into the draft Water Bill, and can I just draw to your attention that we have published all the memoranda that we got in, I think, on time, and they are available, rather pricey, I think, at £13.60, but for those of you who want to save money they should be on the web by now. Can I ask you to identify yourself, as the first witness, for the record, please?

  (Dr Helm) My name is Dr Dieter Helm.

  2. Do you want to say anything, by way of introduction, or are you happy for us to go straight to questions?
  (Dr Helm) I would like to make just one, very short remark, and go straight to the questions thereafter. The scale of the challenges facing the water industry are large, and there are four key question areas which the Bill would need to address if it was to set a stable basis for the industry going forward. They are proper utility regulation, competition, the sustainable development and climate change agenda, and, very importantly, the new restructuring proposals that are coming from some members of the industry. It is my view that the Bill, as it is currently drafted, does not address adequately any of those four core questions.

  3. So you would give it nought out of ten, would you?
  (Dr Helm) As a consultation document, it is extremely helpful; but if this particular version of the Bill was to go into legislation I suspect your Committee would be considering another Bill quite shortly afterwards, to address some of these questions more comprehensively.

  4. So a missed opportunity, if it goes ahead in this form?
  (Dr Helm) Yes; it is much better if it is revised. And I would draw attention to the scale of revision that was necessary to the Utilities Act, because some of that perhaps was not as well thought through as it might have been.

  Chairman: Thank you very much.

Mr Cummings

  5. Would you tell the Committee how significant a contribution to the development of the water sector this present draft Bill represents?
  (Dr Helm) In each of the four areas I have indicated, it makes a number of helpful suggestions, and some suggestions which actually may make matters worse, but in no way is it adequate to the sorts of challenges. And if I could elaborate, just slightly, upon that, the Utilities Act came out of a utility reform proposal, which was intended to provide consistent regulation across the utility sector; it ended up being essentially an electricity trading arrangements Bill, plus merger of the regulatory offices Bill, for the energy sector, and this Bill would need to take forward substantially that utility reform agenda. There is no plan in this Bill for competition, and no clear vision of how competition might work. The Bill does not explain how the marriage between the climate change agenda and the investment requirements, on the one hand, and the concerns about poorer customers and bills might be married up, and the Bill takes general powers to address just some of the issues which would come up if the industry was allowed to restructure along some of the plans that are put forward. So I think it does not really get us very far forward, as it stands.

  6. You certainly appear to concur with certain of our witnesses who have commented on the absence from the Bill of provision relating to the introduction of competition in the water sector. So I take it then you do agree with these witnesses, who have suggested that it is impossible to consider the draft Bill in its proper context without proposals on competition?
  (Dr Helm) Competition has to be addressed through legislation. The draft Bill puts competition in the `further work' box, and, if I might suggest, `further work' is a very, very big agenda. Competition does not happen in isolation in these kinds of industries, you have to define the access terms, the property rights, the safety, drinking water type requirements. And, very importantly, the lesson from the electricity and gas industries is that a reasonably well thought out vision of where you are going, some timetables, some phased introduction of competition, to allow the process to be managed, but most of all a timetable, is essential to take this forward. And that seems to me to be wholly absent, not only from this draft Bill but also wholly absent more generally from the Government's thinking about where competition will go. And that leaves the industry and customers and competitors uncertain, they do not know whether to invest in taking this forward, or whether, in fact, it will be just one of those things which bubbles along for several years before anything happens.

  7. What other measures then do you believe should be in the Bill to ensure that it makes the necessary contribution to the development of the water sector?
  (Dr Helm) I think there should be a clear plan as to how competition is to be introduced, and there are many problems in the electricity and gas sector but in both industries there was such a plan, with deadlines, a phased introduction, and then the Bill should effect that plan and that transition so that the changes can be taken forward. But this is the wrong way round; you do not start with a piece of legislation then think what you are going to do, you start the other way round, which is to think what you want to do with competition, what sort of competition, because there are lots of different kinds of competition, what sort of competition you want, and then you have legislation to effect it. This draft Bill goes exactly the other way round, and it seems to me to be not correct, and I would have thought it is many months of hard work to come to proper conclusions on that, it is not something that can simply be a few draft provisions for the Bill and off we go.

Chairman

  8. Is competition a good idea?
  (Dr Helm) Some sorts of competition would be, I think, very desirable in this industry, but I stress the point there are many different kinds of competition; the industry already has quite a few elements of competition, there is contracting, there is an element of competition through comparator efficiency. But what I would caution against is going for a full-blown, complete commodity-type industry very quickly; the key here is to learn through a process of gradual, timetabled and set reforms which gradually open up the market, so no risks are taken on the environmental side, no risks are taken on safety, and we learn as we go along. And the point of competition is not that it follows some path we can predict, if it did, we would not need it, perfect planners could arrive at the solution; we will learn as we go through this process. So a gradual, step-by-step evolution towards more competition, with lots of opportunities to reassess where we have got to along the way and consider how further steps might unfold.

  9. I am not very happy about the idea of buying electricity from different companies, but I can accept that the electricity that comes into my house is identical, whichever company it comes from, but water is almost bound to be different, if it was really genuinely being bought from different companies, is it not? In practice, it will all come from the same supply, but how can you really have competition? If I chose to buy water from a company that operated primarily in a limestone area, primarily it would be supplying hard water, would it not? So you could never get that hard water to my taps in Manchester?
  (Dr Helm) I think there are lots of examples, across many markets, in which competition of the form you describe might take place; but the key distinction is whether you are competing to have different people trying to deliver that service to you better, or whether you are trying to choose different services. Now, in the water case, it is very unlikely that you will be choosing different sorts of water, although lots of people, surprisingly, do go into supermarkets and pay very large premiums for different kinds of water, but you are unlikely to do that; but there is no reason why you should not choose whether an alternative company could provide that more efficiently to you. And, essentially, that is what happens in the electricity and gas industries in the UK, and now increasingly in other countries. It is the same gas, it is the same electricity, but some companies can buy and sell it at better terms than others and offer you a better customer service, and you, the customer, can then choose which one you want.

Mr Olner

  10. Yes, but there are essential differences, obviously, between gas and electricity, you buy your gas, you buy your electricity, you use it, you pay for what you use; with water, it is fairly cyclical, you can buy it coming out of the tap, but then it has to go somewhere else. So would you have competition with the water supplier and then competition with the waste disposal people, or would they be the same; it is an extremely complicated cycle?
  (Dr Helm) I agree with that entirely, and I think it is very helpful to draw analogies with other industries. I was not trying to suggest that it was identical to those. But I think this clearly illustrates that, unless those issues are properly thought out and one sorts out what sort of competition one actually wants, for what sort of functions, over what time period, it is very hard to draw up legislation to effect it; and I think this discussion illustrates exactly the point that I was trying to make. But these issues have not been properly thought through, and, without a plan of how to go about it, the idea that this Bill could be suddenly and quickly amended, with a few extra powers to solve this problem, I think that is just not likely to happen.

Mrs Ellman

  11. Would the measures of this Bill increase costs to the water companies, and, if so, would those costs necessarily have to be passed on to the customer?
  (Dr Helm) I think there are aspects of this Bill which may increase, in fact, the degree of regulatory risk that the companies face, and I think may have some upward pressure on the cost of capital; and the cost of capital is incredibly important in this industry. When you are an investment industry, spending perhaps some £40 billion, just 1 per cent on the cost of capital each year is a very, very large sum of money; it is not like electricity and gas where investment is quite low and one is interested in just the operating costs. Now how might the risk be effected; well, I have tried to argue, over a long period of time, that there is a connection between regulatory risk and cost of capital, and that the regulatory risk derives from two sources. One is that the powers are invested in the individual, and that leads to personalisation of regulation, and that one is always at risk that the regulator may have different views from his predecessor, or her predecessor, and may use that discretion in different ways; that makes for uncertainly. Secondly, the duties of the regulator are very general, and, indeed, this Bill makes them even more general, they just have to look after consumers. What does that mean? How are the balances to be struck between all the different components? That is left at the discretion of the regulator, subject to guidance. But those two things, to me, increase the regulatory risk, and in that regard I advocate, first, that there should be a board and not a Director-General, following the model of Ofcom, as proposed in the consultation paper and the new Gas and Electricity Markets Authority. And, secondly, if these duties are to be made so general then the companies must have a clearer view of what financing the functions means, which is the protection they have, that if a regulator increases the burdens on them investors will have some degree of protection. And the Bill, as it stands, weakens the finance and functions duty, by making it one amongst several, and so investors, who have already reacted very negatively to the last price review, are going to reflect that in their cost of capital going forward. And cost of capital going up is a bill that, in the end, we all will have to pay; and the example I have in mind is that the regulator in the rail industry has now had to agree an 8 per cent cost of capital for the rail industry, in order to sustain investment in that industry. These are very, very large sums, and we need to try to bear down on the cost of capital, not bear up on it, and this Bill, I think, does not help us solve that core problem. And that was the core problem at the heart of the Utilities Reform Green Paper and was not properly carried through in the Utilities Act 2000.

  12. Is it inevitable that increased costs of capital, which may come about because of increased regulation, have to be borne by the consumer, is that something inherent in a privatised industry?
  (Dr Helm) Absolutely. In the very short run, you can raid shareholders; if you could drive the share price down to one pence for each company. The share prices of these companies are already below the value of the regulatory asset base, at least for a significant number of them. But, in the end, if the Government wants investment to be carried out by the private sector, if it is doing what I call inventing a private sector borrowing requirement, it is using private companies' balance sheet rather than the Treasury to finance these investments, then that comes with a price. You cannot force investors to invest in these industries. And if the cost of capital is driven up, and this risk is measured every single day in capital markets, you can look up the share price every day and see how people react to the risk that is there, if that price goes up and if people want the investment, and if the Government is not going to do it itself, then that price, in the end, will be borne by customers.

Mrs Dunwoody

  13. So they have the choice of either paying through their taxes or paying through their bills, but either way the people pay for it as opposed to those who are making profit out of it?
  (Dr Helm) The question might be turned back onto the first ten years of the industry.

  14. I know the questions, Dr Helm; what interests me are the answers?
  (Dr Helm) Yes, I was going to answer it, if I may, please, by virtue of illustrating your point about profits. In the first ten years, this industry, arguably, made higher returns than was strictly necessary to finance its functions, but they did make those returns and that has now happened. But, looking forward, if you want the investment, you cannot extract that from previous shareholders, what you have to do is to say, is it the case that the sums of money required in this industry can be raised, and at what cost, from the market; and, by looking in the Financial Times every day, or whichever you like to look at, you can see the price that investors are demanding to invest in these shares. And it turns out that the market value of these companies now looks to be less than just the value of the regulatory asset base, and that tells you that investors do not think these companies are going to make abnormal profits in the future; on the contrary, what the current price of shares tells you is that investors think that the profits will be less than the cost of capital they have provided.

Mrs Ellman

  15. So the question could possibly arise whether privatisation is a suitable vehicle for the public utility which meets regulatory standards which are required by the public?
  (Dr Helm) I think it is a very good question, and it seems to me to turn on this. It is true that the public sector could, in principle, borrow at lower rates than the private sector. We know the Treasury can borrow at virtually the riskless rate. But we also know that the Treasury, in the past, has not been prepared to borrow, and that privatisation is a process by which the Treasury has shifted very substantial borrowing requirements, for the rail industry, the water industry, etc., to the private sector.

Mrs Dunwoody

  16. In theory.
  (Dr Helm) Now if it has transferred those thing to the private sector then it is not unreasonable to say that if it goes to the market and asks for that capital it will have to pay the price the capital market offers, investors have lots of choices of where to put their money. Now if the response to that is to say, "The price is too high, we ought instead to do it through the state," then there are costs to doing it through the state, and the past performance of the industry and its investment is put in that frame. What I am trying to argue is that this Bill should try to lower the regulatory risk the companies face, in order to lower the price that we, as a society, have to pay private investors to carry out this investment. And my argument is, this Bill does not address that question. We ought to be able to borrow from the private sector at pretty low costs of capital, because these ought to be pretty low-risk businesses; after all, they are monopolies, lots of their activities are in that form, and likely to continue in that way for some time to come. This Bill, to an important extent, not a massive extent but an important extent, goes in the wrong direction in not lowering that regulatory risk.

Mrs Ellman

  17. Would you say that the various regulatory authorities are co-ordinated, in any way, under the provisions of this Bill, or are they likely to be in conflict with one another?
  (Dr Helm) I think this Bill is a step in the wrong direction, in as far as many people argued, myself included, in the mid 1990s and thereafter, that what we needed was consistency between the regulatory bodies, and that required a fairly common approach to calculating things like costs of capital, asset values, lots of the technical components of regulation, and the Utilities Bill was a major attempt to create that cross-utility consistency. What we have instead now is a series of sectoral Bills, a Transport Bill, a Communications Bill, a Water Bill, and the Utilities Act itself was, in fact, an Energy Bill; that is a step in the wrong direction. Now it is argued, in the draft Bill, that this Bill takes forward consistency; it does not, the other bodies are having boards, not director-generals, for example. Nobody else is having an advisory panel; it is proposed in this Bill that the water industry should have an advisory panel. These sorts of issues ought to be addressed in a consistent fashion, and it seems to me important that where there is a deviation from the pattern that is being adopted elsewhere, and where it works elsewhere, there ought to be a good explanation of why to do it, and there is no explanation in the draft Bill as to why an advisory body is better than a board, for example.

Mr Blunt

  18. Dr Helm, your evidence so far has been very refreshing and very clear. How long do you expect to be Chairman of the Department of the Environment's Academic Panel, given the fact you appear to have taken ...
  (Dr Helm) I have always expressed my views in a clear, I hope, and independent fashion, and my views to this Committee are expressed in my capacity as a Fellow of New College, in Oxford. The Academic Panel is nothing more than a panel to discuss a variety of largely economic issues that come up in the environmental area, and I think it would be a great disservice to the Department if its Panel was comprised of people who were not prepared to set out their independent views.

  19. I quite agree; it does credit to the Department that it has you as the Chairman of the Panel. I hope that that position will be sustained. I just wonder why, in framing the Bill and the consultation, they appear to have taken no notice of your views at all?
  (Dr Helm) The Academic Panel meets, I think, three times a year, it has a very general agenda, we do not discuss all the issues in relation to the DETR, and indeed we have not discussed this one. But I think it would be fair to say that I try to make whatever views I have on utility regulation, which I have formulated over the last ten years, as widely known as I can, and I am sure they are aware of what those views are, and I have published them on a number of occasions, so there is no new departure in my evidence to you from anything I have already put in the public domain.


 
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