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Paying for Water Services 2006-2010

SECTION 1: PROPOSED PRINCIPLES OF CHARGING

12) The Executive sets out below, and invites views on, a number of possible principles that might be applied in setting charges. The suggested principles are:

Charging for the services provided: public good and commercial service

13) Scottish Water provides public water and sewerage services to households, industry, businesses and a wide range of other customers, such as hospitals, universities, sports clubs and voluntary organisations. These services contribute towards sustainable development by helping to safeguard public health and the environment and by supporting social and economic development. In that sense, they are a public service and there is a case for their provision to be funded out of general taxation. However, individual customers, whether households, businesses or other organisations, consume water services in the same way as other utilities services for which direct payment is made.

14) Despite the wider public service that Scottish Water provides, the Executive considers that Scottish Water’s main function is to serve customers. It considers that the right approach to funding Scottish Water is through charge income from customers, rather than through general taxation. Therefore, the Executive proposes that its principles in respect of charging should be based on customers as a whole continuing to meet all the costs that Scottish Water incurs in providing public water and sewerage services.

15) However, the Executive qualifies this principle by distinguishing between services to households and those provided to other customers. The former include a significant element of public good in that they are essential for the well being of individuals and also for the protection of public health and the promotion of social inclusion. The latter are little different from any other commercial service necessary in running a business or any other form of undertaking. In the case of the latter, customers should be expected to pay for the service in the same way as for any other utility service that contributes towards the overheads of the undertaking. In the case of the former however, the essential nature of which is reflected in legislation prohibiting its disconnection, the Executive considers that the interests of public health and social inclusion require that household charges are affordable for low-income groups. The Executive proposes that the objective of affordability should be a key factor in the arrangements for charging households.

Harmonised charges

16) A key objective in the creation of Scottish Water in 2002 was the introduction of harmonised charging across Scotland, so that customers in the same category would pay the same rate for the same service, wherever they were in the country. The Executive considers that this objective remains valid. Scottish Water provides a national service and it is right that its customers should pay for this service on a consistent basis across the country. The alternative would be prices that reflected regional or local costs of providing services, as was the case under the three former water authorities, and before them the regional and island councils. That would risk customers that cost least to serve, by virtue of their position on the water and sewerage networks, seeking charges that reflected these lower costs, with those costing more to serve paying charges that reflected the higher costs.

17) The Executive has recognised this risk in the context of competition developing in the provision of water and sewerage services. The Water Services etc. (Scotland) Bill includes provisions to address the possible impact of competition generally by prohibiting common carriage on Scottish Water’s infrastructure and anyone other than Scottish Water from serving households. It requires anyone wishing to provide non-household customers with retail water and sewerage services to be licensed and to buy wholesale services from Scottish Water at rates set in charges schemes. To avoid these licensed retailers "cherry picking" the most lucrative customers (i.e. those that cost least to serve), the Bill requires all of Scottish Water’s charges, including its wholesale charges, to be set on a harmonised basis.

18) In these circumstances, the Executive proposes that harmonisation be treated as fundamental to the maintenance of a nationally provided public water service and that this should be a guiding principle of charging policy.

Cost reflectivity

19) In the interests of keeping customer charges as low as possible, Scottish Water has been given a remit to manage its business on properly commercial lines. In normal circumstances, this would include setting charges to customers in a manner, at least in broad terms, which reflected the costs of providing a particular service. That is to say, there would be no deliberate policy for one group of customers to subsidise through their charges the cost of serving another group. In practice, of course, prices for a wide range of generally available goods and services contain numerous unintended cross subsidies, given that the cost of providing different customers with the same service will vary frequently from customer to customer and that it would never be feasible to try to capture all variations in costs by setting prices or charges specific to each customer.

20) In the case of water, the achievement of cost reflectivity would be constrained by the application of the principles on affordability and harmonisation that are outlined above. The achievement of affordable charges for low income households requires a measure of cross subsidy from other customers; and harmonisation involves those in cheaper to serve areas subsidising those in areas that are more expensive to serve.

21) The Executive considers that these principles should take precedence over the achievement of full cost reflectivity. Nevertheless, it is arguable that a proper understanding of where Scottish Water’s costs lie is crucial for the effective management and regulation of the business in the interests of its customers as a whole. The Executive proposes therefore that Scottish Water’s charges should be set to reflect the costs of providing particular services to particular groups of customers across the country. The Executive recognises that such an approach contains a presumption in favour of a charging regime that reflects the relatively high proportion of fixed costs borne by Scottish Water. These account for about 80% of Scottish Water’s costs and reflect the industry’s heavy reliance on capital assets, such as reservoirs, underground pipes and treatment works, which have long lives. Such assets once built place a cost on Scottish Water that varies relatively little in response to changes in consumption patterns.

22) A charging regime that reflected the industry’s high fixed costs would mean that where customers’ supplies were measured, they would pay relatively high fixed charges and relatively low charges for each unit consumed. There are two common criticism of this approach. First, many customers, particularly those who consider that they use relatively small amounts of water, believe that they should pay by reference to the amount that they consume. They pay for other utilities in this way and they are reluctant to pay for water in any other way. Secondly, there is concern that it would provide only a modest incentive for consumers to conserve water, and to reduce demands on Scottish Water, which in turn would ease pressure on water resources and reduce Scottish Water’s consumption of chemicals and electricity by requiring it to treat and distribute less water. Addressing these concerns would mean moving to a regime based on low standing charges and high unit costs.

23) There is an important obstacle to such a move. In sharp distinction to all other utilities, supplies, only a minority of (mainly large industrial and business) premises are metered at a present. The great majority of customers are unmeasured, and pay a flat rate charge based either on Council Tax band, in the case of households, and rateable values, in the case of non-household premises. At present therefore, there is no practical means of charging all customers by reference to their actual consumption. For such an approach to be possible, it would be necessary to install meters in those 2.2 million premises that are un-metered at present, at a minimum cost of £150 for each property, to read these regularly and to replace them every five or six years. These costs would result in a further addition to customer charges over and above those necessary to fund the quality improvement programme.

24) The Executive recognises the desirability of encouraging conservation and also the concerns of those who use modest amounts of water. It notes that in England and Wales charges are set with a more significant volumetric element. This reflects the genuine pressure on water resources in parts of southern England and the need either to encourage conservation, or to develop new reservoirs to meet ever increasing demands on existing resources. That is not a significant consideration in Scotland. In the absence of such a compelling justification the Executive considers that the cost of extensive metering could not be justified at a time when customers generally will be asked to meet the substantial costs of future quality improvements.

25) Instead, the Executive proposes continuing with a charging regime that is based on a flat-rate charge for the majority of customers and that contains a relatively high standing charge for those on measured supplies

Making changes to charging structures

26) An approach to charging based on these fundamental principles would be likely to result in some customers’ contributions to Scottish Water’s costs increasing relative to those of others. A criticism of previous changes in charging policy has been that they have been introduced without sufficient notice and over too short a period, with some customers unable to cope with the impact that change has had on them. The present consultation and the process by which proposed charge limits are to be set will be the subject of consultation before the charge limits are made final. This should ensure that there is adequate notification of any changes. To enable customers to accommodate any change, the Executive proposes that changes arising from the application of these principles should be phased over the life of the review, and where any changes would be particularly significant, that consideration be given to phasing them over the life of two reviews.

Summary of principles of charging

Consultation point 1: You are invited to comment on the principles outlined above that the Executive proposes should underpin charge limits and charges schemes in the period 2006-10. In particular do you are asked to indicate whether you agree that:

• Charges should be set to recover the full costs incurred by Scottish Water in providing public water and sewerage services.
• Charges for households should be set with a view to ensuring that they are as affordable as possible for low-income households.
• All charges should be set on a harmonised basis, so that customers in the same group and using the same services should pay for these services at the same rate, irrespective of where they are in the country
• Subject to making charges affordable for low-income households, harmonised charges to a particular group should be set to recover as closely as possible the fixed and variable costs of serving that group.
• All significant changes in charge levels arising out of the application of these principles should be introduced gradually during the period 2006-10, and beyond in the most significant of cases.

Consultation point 2: If you do not agree that the principles outlined above provide an appropriate basis for setting charges, which principles would be appropriate and why?

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