The latest response by water regulator Ofwat on social tariff guidance has highlighted the increasingly complexity of the requirement for water companies to consult with stakeholders on the price setting process and their forthcoming AMP6 Business Plans.

The latest strand in the regulator’s thinking comes in its response to draft guidance published by Defra on the introduction of social tariffs for customers. 

The water companies will already be required to conduct extensive stakeholder engagement on a wide range of issues related to their Business Plans for 2015-2020. Ofwat’s comments in this new paper do not suggest that information will be presented to stakeholders in a straightforward way. If anything, the reverse appears to be the case, with the companies themselves expressing concern that the process may be “ disproportionate". 

The response states:

“The customer engagement process gives each company the opportunity to better understand its customer base. Some companies have expressed concern that this process may be disproportionate.”

“This need not be the case as it can be part of a wider process of understanding and communicating with customers. For example, one company is currently considering combining its discussions with customers on social tariffs and surface water drainage concessions, and linking in to it explanations of other cross-subsidies to help it develop its business plans. The guidance should encourage other companies to take a similar joined-up approach.”

Ofwat duties create perverse incentives

 The response also flags up the risk that the requirement for Ofwat to approve annual charges schemes as a whole creates perverse incentives that could discourage the companies from proposing social tariffs, rather than risk all charges being unapproved.

Ofwat has suggested that moving to regulation based on compliance with rules would enable a more targeted and proportionate approach. This would have to be implemented by an amendment to the section 143A of the Water Industry Act 1999 in a forthcoming Water Bill.

The response also says that the guidance should explicitly state that Ofwat will ensure that the individual company has had regard to the guidance as part of the regulator’s  approval of the company’s charges scheme which sets prices for customers. The guidance should also make it clear that the companies’ proposals would need to be “demonstrably evidence-based.”

Greater role needed for CCWater on customer engagement

 The response also calls for clarification of the role of the Consumer Council for Water and says CCWater could play an important role in advising and agreeing that the companies’ approach to customer engagement is acceptable.

Ofwat said this would also align with the charges approval process which requires a statement from each company that it has consulted CCWater in a “timely and effective manner” on changes to the charges scheme. Ofwat would then plan to meet with CCWater before approving a company’s charges scheme to discuss any concerns and identify any risks requiring further scrutiny.

Greater clarity needed in the guidance

 The regulator said it was critical that the guidance should define the parameters under which the water companies can act and set out a clear policy framework within which social tariffs guidance could be developed. It also wants the guidance to be more explicit in the way it describes how the amount of cross-subsidy for customers with affordability problems should be calculated. Without a clear and unambiguous framework for companies to work within, there was a risk that Ofwat would be expected to make judgements which were properly decisions for government.

Other issues where the regulator wants further clarification include:

• Greater clarity on the customers who should be eligible for support – including:
• quantifying the proportion of the target group that merit assistance;
• making clear that those on assessed charges are also eligible; and
• making explicit the need to consider customers of communally supplied water – for example, through water resale and bulk meters – as potentially eligible.

The response also recommends that the guidance should stipulate who pays for social tariffs to ensure consistency and fairness, including:

• customers in the non-contestable part of the market;
• both metered and unmetered customers; and
• that only those who receive a service should be liable to pay a cross-subsidy which serves to reduce the cost of its supply.

Ofwat approval process for charges must be changed

Ofwat described its current responsibility requiring a company’s charges scheme to either be approved or rejected in its entirety as unduly rigid. On this basis, if Ofwat considers that a company’s social tariffs proposal do not comply with guidance, then it should not be approved. Ofwat is concerned that the current approach could discourage the companies from proposing social tariffs rather than risk all their charges not being approved.

The regulator wants its current duty to approve charges schemes to be replaced with regulation based on compliance which would require an amendment to the Water Industry Act. This would enable charges to be approved on the basis of a direct test of compliance with the Secretary of State’s guidance.

Ofwat also want the guidance to include a statement of what is considered to be a reasonable amount of cross-subsidy – 1.5% of the average bill as a matter of social policy. However, the regulator says that the guidance as currently drafted is ambiguous on which average bill is to be used to determine the reasonable amount and has recommended using “average water and sewerage bills for England”.

The regulator is also concerned that a new duty for it to assess whether proposed social tariffs are in line with government guidance would also impose additional costs on Ofwat if more intensive scrutiny was needed as a result.

Metered and unmetered customers should pay for affordability subsidy

The reponse says the Defra guidance also needs to be more explicit and stipulate who should pay and that it will become increasingly difficult to operate a mixed approach to payment by household and non-household customers, given the intended introduction of more competition and encouragement of new entrants. Current ambiguity around payment by metered and unmetered customers would also need to be removed. The regulator said that the guidance should stipulate that the following should pay:

• Customers in the non-contestable part of the market.
• Both metered and unmetered customers.
• Those who have the potential to be eligible for the social tariff. This would mean sewerage customers subsidising a sewerage tariff, and water and sewerage customers subsiding a water and sewerage tariff.

Final guidance must be in place by May

In terms of timescale, Ofwat is planning to publish its revised charges principles and guidelines by August 2012 to enable the companies to implement social tariffs in their April 2013 charges schemes. The response says this means guidance from Government will therefore be needed by May 2012 to enable the regulator to do this.

Click here to read the full response