Investing in and paying for water services: consultation

Annex A – Revised Commissioning Letter

Energy and Climate Change Directorate
Water Industry Division

T: 0300-244 0246
E: Bob.Irvine@gov.scot

Professor Donald Macrae
Water Industry Commission for Scotland
First Floor
Moray House
Forthside Way
Stirling
FK8 1QZ

26 June 2019

Dear Donald,

Strategic Review of Water Charges: 2021-27

This letter updates and replaces my letter of 31 January 2017. It reflects a number of developments since then in the detailed approach being taken to the Strategic Review of Charges for the period 2021-27 commissioned by that letter.

The principal changes are to revise the timing of the determination in line with the Commission's revision of its methodology. The letter also takes account of developments arising from the 2018 consultation on Principles of Charging and Objectives and makes reference to the emerging longer term vision for the water industry in Scotland.

Strategic Review of Charges

The Commission is to undertake a Strategic Review of Charges for the six-year period 2021 to 2027. In their 2018 consultation Ministers also requested the Commission to give indicative profiles of prices for subsequent regulatory periods in the light of the developing understanding of continuing investment requirements.

The Final Determination of Charges should be published by the end of September 2020.

In conducting the Review, Ministers look to the Commission to work with Scottish Water, Consumer Advice Scotland and other regulators and stakeholders to build on the arrangements put in place successfully in previous regulatory periods. Those arrangements have developed and evolved over successive reviews. They have ensured stability and continuity in financing and investment planning and have created a framework within which Scottish Water has significantly improved levels of efficiency and service delivery. This has ensured that the water industry has made an essential contribution to the Government's purpose of increasing sustainable economic growth.

It will be important that these regulatory mechanisms continue to evolve. In particular Ministers invite the Commission to ensure the processes of the Review give customers an enhanced voice in the consideration of levels of charges and service priorities. Ministers also wish for a wide engagement on the final determination of charges to ensure it is widely understood in terms of the investment and services it intends to support.

Ministers also recognise that the coming regulatory period will present some important challenges to Scottish Water and accordingly invite the Commission to work with Scottish Water to ensure they are properly addressed. These include most significantly:

Capital Maintenance -Over this and future regulatory periods, Scottish Water should continue the transition to a risk based approach to maintaining the overall condition and performance of its assets so as to ensure no deterioration of service levels to customers over the long term. Ministers recognise the increasing importance of capital maintenance in achieving and maintaining service levels and statutory obligations in relation to drinking water quality and the environment and to reflect customer priorities that may affect longer term asset planning. This requires to be efficiently planned and delivered over successive regulatory periods. They wish the Commission to ensure that there is a stable and sustainable funding regime for this important part of the investment programme.

Resilience – Ministers recognise the progress Scottish Water has made in developing a strategic approach to identifying the work required to ensure the resilience of the network and requests that the Commission provides assurance that Scottish Water's approach is proportionate, fit for purpose over the long term and represents value for money for customers.

Strategic Capacity –Ministers wish to ensure that Scottish Water is properly financed and incentivised to provide water and sewerage assets in a manner that does not place a constraint or restriction on the achievement of their housing and economic development targets. To achieve this Ministers look to the Commission to ensure that finance is available to Scottish Water for this purpose over the regulatory period and that the funding arrangements for additional capacity (including the Reasonable Cost Contribution) remain fit for purpose and strike the correct balance of cost between existing customers, new customers and borrowing.

Private Finance Initiative funded Projects - Ministers recognise that 3 of the 9 PFI contracts mature in the period 2021-27. They have asked Scottish Water to consider the options and costs for the future operation and funding of these assets. They request that the Commission undertake a full examination of Scottish Water's approach to establishing the options and costs.

Partnership Projects – Ministers recognise the progress that Scottish Water has made in delivering improvements in partnership with other stakeholders, and in particular Local Authorities. They consider that, increasingly, delivering outcomes particularly in relation to the reduction of flood risk and compliance with bathing water standards will require Scottish Water to work closely with Local Authorities and communities. Ministers therefore request that the Commission ensures that the funding arrangements are sufficiently flexible so that Scottish Water can deliver to agreed timetables.

Supporting innovation – Ministers look to Scottish Water to contribute to inclusive and sustainable economic growth to which end they are encouraged to be innovative in their operation and with regards to capital enhancement and maintenance. In addition, Scottish Water is expected to support the Hydro Nation programme through their renewable energy and energy efficiency programmes and by working with communities and customers in Scotland and, through SWI, overseas. Ministers therefore request that the Commission ensures that the financing and funding arrangements for Scottish Water's regulated elements create appropriate incentives towards efficient delivery of these objectives.

Principles of Charging:

Ministers recognise that their Principles of Charging for previous regulatory periods have provided a framework which has secured significant stability and clarity for Scottish Water, its customers and stakeholders. Ministers have consulted on Draft Principles of Charging for 2021-27 and will confirm the final Principles of Charges to be applied no later than June 2020.

Ministers would wish the Commission to give priority to measures that ensure a smooth transition of customer pricing and investment activity during the final year of 2015-2021 period and the following period

Ministers will consider the advice from the Long-Term charging group on the modernisation of water charges so as to ensure that these continue to deliver the principles of cost reflectivity and cost recovery. As in previous periods, the Principles of Charging will indicate the level of finance they are willing to make available in support of the investment programme.

Statement of Objectives

Ministers consulted on their draft objectives in April 2018 and will finalise their objectives no later than June 2020.

In the light of that consultation Ministers expect that the objectives for the period 2021-27 will be broadly consistent with those set in 2014. In the time since that consultation the importance and relevance of these objectives have become clear not only through the work of the Commission, Scottish Water and its stakeholders, but the concerns of the wider stakeholder group and customers generally in relation to the challenges of climate change.

Ministers will look to the water industry to develop and work towards a coherent vision describing the longer term nature of the industry and what it can achieve. The Commission has played an important part in the development of that vision and should continue to do so.

The current objectives recognise the importance of the security of Scottish Water's physical assets, the evolution of new threats to public services requires also that, relevant security standards in relation, IT systems and personnel, as advised by Scottish Government Resilient Essential Services, should be met. They also require a fully appropriate response by Scottish Water to mitigate and adapt to the challenges of climate change.

Ministers expect that the programme of outputs identified to achieve these objectives should reflect the best possible value for money in terms of the improvement in outcome achieved for the investment made. Average annual expenditure on the investment programme should remain of a size that allows efficient delivery whilst facing up properly to the challenges the industry faces.

Ministers expect that, with advice from the Outputs Monitoring Group, a suitable governance structure be developed, to identify the outputs necessary to deliver these objectives. Consistent with Ministers' policy of continuity of investment, and the development of the longer term vision for the water industry, draft objectives for the subsequent period 2027-33 and beyond should also be developed. As for previous investment periods, these must demonstrate how they will contribute to the Government's purpose of increasing inclusive and sustainable economic growth and make progress towards delivering the longer term vision. Scottish Water will also be required to continue to meet and where appropriate exceed their statutory obligations to respond to climate change making necessary climate change related adaptations to operational practice and assets and should ensure systematic monitoring and reduction of carbon emissions.

Timetable

In agreeing the timetable for this SRC, Ministers ask that all parties ensure that, in keeping with good practice, sufficient time is made available to ensure appropriate consultation with the wider stakeholder group, communication with customers and for the Government's own public engagement.

Ministers look forward to receiving regular reports on the progress of the strategic review.

I am copying this letter to the Chair of Scottish Water, the Chair of Scottish Environment Protection Agency, the Drinking Water Quality Regulator for Scotland, the Chair of Citizens Advice Scotland and the Chair of the Competition Commission.

Yours sincerely

Bob Irvine