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


Examination of witness (Questions 20-32)

TUESDAY 30 JANUARY 2001

DR DIETER HELM

  20. You have just said that there should be consistency between the regulatory regimes for the different utilities; why? Is it not consistency for consistency's sake? Is not water sufficiently different from electricity and gas to justify a different regime?
  (Dr Helm) It is important to be clear which areas one wants consistency in. Clearly, one does not want water treated as if it was electricity, or if it was trains going up and down the track, or not; but there are certain things where consistency is very important. The capital market regularly chooses between investing in water stock, in electricity stock, in telecom stock, etc., and there is no good reason, for example, as to why the methodology for calculating the cost of capital should be different between regulators. After all, the riskless rate is the riskless rate, we may disagree about it, there is no reason why that should be used differently in different contexts, the equity premium is the same across these sectors. Now the particular risk of the companies should be taken separately into account; but the broad framework should be one that can be seen to be predictable, predictable by customers, predictable by people investing, and, from your Committee's perspective, particularly people investing in the environmental areas, and consistency so investors can make choices on the performance of these industries, and not simply on whether one regulator takes a particular view about an exogenous factor which is common to all of them.

  21. You have talked about the disadvantages of having the personal risk associated with a single regulator; is there not a corresponding advantage in that, in as much as the accountability rests in one area, and it is a much more transparent system of regulation than a board?
  (Dr Helm) I do not see why a board should be any less transparent than a director-general. I would have thought that either of them could be held to account. There are many boards in the public sector where the chairman, or whoever, appears but the board is responsible for its decisions. But the main argument for a board is one of corporate responsibility, it makes it necessary for a group of individuals, led by a chairman, or chief executive, to make decisions, once they have been considered. And, very importantly, in a board structure, when something goes wrong, or there are substantial disputes, then a board is a much more reliable way of dealing with those situations as they arise.

Mrs Dunwoody

  22. Like Railtrack?
  (Dr Helm) I was thinking of the regulator, and I precisely had the rail example in mind. I wonder whether the conduct of the rail regulator would have been the same in a board structure as opposed to individually; and I wonder whether the tensions that arise between SRA and ORR would have been quite the same had ORR had a board which was corporately responsible for the track access charge regime, etc.

  23. It is quite a narrow point of view, is it not, Dr Helm, you disappoint me slightly, it is rather a narrow attitude, that all utilities should have a common denominator which consists almost entirely, if I am to take you correctly, of the way that they calculate their assets and their access to capital as being the most important thing in the way that they operate? And you are also suggesting that it is only if you surround a regulator with people who will necessarily act as a break, or some kind of an alteration, that they will be capable of carrying out their services. That seems to be, forgive me, a rather narrow point of view? But then I am very ignorant, so I probably do not understand.
  (Dr Helm) I am sure you are not. Let me try to unpack your comments, because there are several there. It is, of course, not the only thing that matters in the water industry as to how it is financed, but it is extremely important, when an industry is in an investment phase of its activity, that it is financed in the cheapest way, and that is not for the interests—

  24. Precisely; but that is not entirely what the Bill deals with?
  (Dr Helm) And it is not so much that it is in the interests of the investors, the question is that it is in the interests of customers, because customers, in the end, are going to pay for this. When we have used all the balance sheets of all these privatised industries, at some point the debt will have to be repaid, and, in the meantime, it will have to be serviced, and that is a significant part of the bills of customers, that is why I put emphasis upon it, but there are, of course, many other things that are very important. On the board structure, I do not actually think that a board would result in less boldness on the part of regulatory agencies, I think, in fact, the support of a board for decisions which look to be controversial would give a lot more power and support to the activities of regulators, rather than an individual who is very exposed, from comments from other players within the industry; that is why I wanted the powers vested in a board. Now it is true that sometimes an individual may do something which is highly questionable, and in such circumstances, just like a chief executive might, or whatever, that is what part of a function of a board is to do, which is to check situations where they go wrong, in either direction.

Mr Blunt

  25. Dr Helm, have we got the worst of all worlds here, because what is proposed is a sort of hybrid between a board and the responsibility sitting solely with a director-general, with a statutory Water Advisory Panel and a statutory Consumer Council for water, is not that the worst of all worlds, or is it rather better than the system we have at the moment?
  (Dr Helm) No, I think it is much worse than having either a director-general, in the clear sense in which we have them at the moment, or a proper board along the lines of the Ofcom, gas and electricity markets model. I cannot see what these advisers are going to do. Are they to give independent advice? Are they to check what the regulator is doing? What are their powers? What is the relationship? So I tend to agree with you. And, in the circumstance in which they are going to be potentially companies limited by guarantee, with membership of 200, or whatever, the corporate governance situation will get worse in this particular framework than it is currently set out.

  26. I imagine you have made it clear that you do not believe the statutory objectives of regulation are correctly framed in the draft Bill?
  (Dr Helm) I do not; but I accept that, given that the overarching consumer objective has been used now widely across the utility sector, the sensible thing to do is to clarify the relationship between that and the financing functions part of the duties. I do not think that an additional environmental objective should be given to Ofwat, because I think the relationship between the Environment Agency and Ofwat should be sorted out, and the Environment Agency is the proper location for deciding environmental issues. The role of Ofwat, as I point out in the paper, should be clarified with respect to the environmental area, carrying out the task of ensuring that the agreed environmental programmes are properly implemented and financed, rather than, as happened in the last Periodic Review, for Ofwat to stray into the area of trying to suggest how much of an environmental programme there should be in the first place.

  27. So, let me be clear on this, Ofwat should have no environmental duty, say, for sustainable development, placed on them, but it will be for the regulator, whether it is a board, the hybrid we are being offered, or the system we have currently got, should be responsible for balancing responsibilities to the consumer and to cost of capital of the industry, for example, and the financial viability of the industry?
  (Dr Helm) That is right, and the environmental issues should be sorted out by the Environment Agency, which is the proper body to do that, and there should be a clarification of the relationship between the Environment Agency's position and the duties and obligations of Ofwat to carry out whatever those programmes turn out to be; and that was the initial model that was set up with the National Rivers Authority and Ofwat. The previous Director-General invented the notion of affordability and started to shape what the size of the environmental programme ought to be. Now it is very important that debate takes place, but it is not clear to me that Ofwat is the right body to make the judgement about what the size of the environmental programme ought to be. And there was that, should I describe it as a game, at the end of the last Periodic Review, where Ofwat apparently was deciding what the price limit might turn out to be, and while the Environment Agency was trying to sort out what the environmental obligations might turn out, in the end, to be. And that is why we are in a world in which the answer is about RPI minus 0, and the environmental requirements turn out to be what can be fitted within that framework, rather than starting the other way round, which is to decide what environmental improvements are necessary and then work from that towards the bills. So there is a lack of clarity. But I think it is a mistake to tell the Environment Agency and Ofwat to do the same thing, by giving them general duties which they can then use their discretion to interpret, rather than making it clear, "That's what we have an Environment Agency to do, and we have Ofwat to do the very difficult and more technical regulatory work concerned with efficiency, execution of investment programmes, within a framework where they are properly financed in the most effective way."

Chairman

  28. Do you not think that Mr Byatt, in a sense, by his style, managed to get much more public debate about the issues than an authority would be able to do, where it would be much less represented by an individual?
  (Dr Helm) I do not think there would be any less public debate, but I would give due credit to the previous Director-General, he did get a debate going. But, at the end of this process, you have to ask yourself, is the outcome of the last Periodic Review one which properly represents the interests, and does it provide a stable basis for going forward. If it had all worked out well, we probably would not have needed much discussion about a draft Water Bill. The truth is that it did not work out very well, that the industry finds itself in a position where, as the Environmental Audit Committee pointed out, it is in some difficulty with regard to maintaining and renewing the assets, yet, as I pointed out, valued by the market at a discount to even its regulatory asset base. And many people in industry are looking for ways out, of which the proposals to mutualise are essentially rather like giving the keys back to your mortgage company, and these may be extremely detrimental. So I suspect that the outcome of that debate was not one which has provided what I would regard as a stable basis of going forward.

  29. So do we need sticking-plaster on this draft Bill, or major surgery?
  (Dr Helm) It is quite clear that we need major surgery, and we need to make sure that the substantive issues, like restructuring of the industry, mutualisation, and so on, are properly taken into account, and competition is taken into account, and the environment is taken into account, and there is some consistency on that regulatory front.

Sir Paul Beresford

  30. You were talking about a step-by-step approach; do we want a step-by-step approach with the legislation?
  (Dr Helm) No. I think this is one of those moments, ten, 11, 12 years after the structure was changed, when one needs to take a more fundamental look at what the framework is in which this performs. And there is a cost to taking an incremental approach; it is not as if the industry is going to stand still, this is an industry that is not in equilibrium, that needs to change its assets, its practices, its attention to environmental detail, in quite fundamental ways. And to have this Bill, in a sort of sticking-plaster fashion, go forward and then wait for two, three, four years till there is some parliamentary time to address some of the other points, I think would not be in the interests of customers, and I do not think it would be in the interests of the environment either.

Mrs Dunwoody

  31. But you are saying, in effect, that some of the companies got their predictions totally wrong, they did not understand that they were able to make big profits, in some ways, initially, but would not be able to continue to do so, and that what we need in this Bill is not what we have got at all but to go back to square one and reassess the entire basis on which the industry is to be organised in the future?
  (Dr Helm) No, I do not think it is a question of reassessing the entire basis of organisation. To me, what a piece of legislation is about is setting the framework within which this industry will develop.

  32. Certainly, but if you were to suggest mutualisation and/or the existing system has to be involved in the Bill, presumably, as alternatives for the companies at a certain level, depending on their problems with the capital markets, then you really are saying that this Bill will not do and needs to be totally rejigged on a completely different basis?
  (Dr Helm) Let me be absolutely clear, I think mutualisation is a very, very big mistake, and I think that if we go down the Glas-type route, which is a form of mutualisation, then there will be very significant things in regulation that will have to be done. I hope that the Director-General will decide, tomorrow, or whenever, that this is not a plan to be proceeded with. But if that does go forward then I think we really have got a very substantial change to the regulatory regime, because effectively what we will have done is placed the risk on customers, there will not be any shareholders to carry the risk. This will be a `rate of return' type regime, eventually. There is an initial five-year period in which all sorts of little fixes are put in place, a bit of equity to glide yourself out, a broad-based fund to make sure that things are looked after, but in five years' time this is a very different kind of model, and, to my view, it is not a model which reduces risk, it just shuffles it round elsewhere. And I think it is a very good thing that there is equity in these companies which leads to some risk being placed on shareholders which creates the incentives to manage these capital programmes efficiently. And the history of the management of capital programmes in the public sector and in the private sector is not a good one, and the difference between an efficient capital programme and not having one will live with the next generation, these are very long-lived assets.

  Chairman: I think I will have to stop you at that point, but it was a very interesting piece of evidence to start us off. Thank you very much indeed.


 
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