The following section sets out the Water Industry Commission for Scotland’s draft determination of charges under the Water Industry (Scotland) Act 2002, and proposes the maximum amount of charges that Scottish Water may levy on its customers.
The draft determination ensures that Scottish Water can meet the draft Objectives set by the Scottish Ministers in a manner fully consistent with the Scottish Ministers’ Draft Statement of Principles of Charging1,2.
Our final determination on 10 December 2020 will reflect the Final Principles of Charging and Objectives for the sector, which are due to be published in November 2020.
"During the regulatory control period, 2021 to 2027, Scottish Water’s total charges, in 2018-19 prices3, is limited to £8,032m. This should allow it to deliver £4.5bn in investment in 2017-18 prices, an increase of £1,095m (around 30%) from the allowed for investment in the 2015-21 regulatory control period. For the first time, it also includes a ring-fenced allowance of £133m to cover any additional costs that Scottish Water has incurred in selecting an option that has a higher net present value (NPV) after allowing for externalities such as carbon, natural and social capital than the lowest financial cost option. Scottish Water will only be able to access this ring-fenced allowance if it is clearly evidenced in an appraisal.
The charges cap includes a demanding 1% real efficiency challenge year on year in the allowed for ‘Tier 1’ expenditure (which covers PFI costs, interest, operating costs and reactive asset maintenance investment). We have also included a £150m capital efficiency challenge in our assessment of the long-term sustainable level of investment4.
The maximum amount of charges that Scottish Water can levy on its customers is set at CPI+2% for each year, on average, of the regulatory control period. Scottish Water must propose charges in its Annual Scheme of Charges that are consistent with this annual cap and/or the cumulative application of this cap.
The Commission has a statutory duty to promote the interests of customers and, in so doing, have regard to the interests of future customers. As such, within this draft determination, the Commission would expect that its charge caps would allow Scottish Water’s annual revenue in the final year of the current regulatory control period 2026-27 to be no less than £1,393m in 2018-19 prices.
This level of revenue is consistent with ensuring that future generations of customers are not disproportionately impacted by the costs of both achieving net zero emissions and of replacing a backlog of worn-out assets (with their associated additional emissions). By ensuring such a transition in revenue, Scottish Water is looking after its future customers and ensuring that levels of service to current customers are not compromised.
We would expect around 70% of the total revenue over the regulatory control period to come from households, with the remainder coming from non-household customers. This is our expectation based on our analysis of the historic costs incurred in serving household and non-household customers. The Commission will carry out further work with Scottish Water and other stakeholders to review relative cost allocations between household and non-household customers if Scottish Water considers that new evidence is available and that the current allocation is no longer broadly cost reflective."
Figure 1: Reconciliation to the February Decision Paper, Prospects for Prices
Total amount of charges over the 2021-27 period 2018-19 prices:
|Charges excluding the ring-fenced allowance||7.9|
|Ring fenced allowance (5)||0.137|
|February Decision Paper - 1.5% real charge increase||7.9|
|February Decision Paper - 2% real charge increase||8|
1 Scottish Government (2020), ‘Investing in and paying for your water services from 2021: Final Consultation’, January. Available at: https://www.gov.scot/publications/investing-paying-water-services-2021-final-consultation/
2 The Commission has the statutory duty to set the maximum amount that Scottish Water can charge its customers during the regulatory control period. This maximum amount reflects the lowest reasonable overall cost to Scottish Water of delivering the Objectives of the Scottish Ministers in a manner consistent with their Statement of Principles of Charging. It follows that if the Scottish Ministers change their Objectives or their Charging Principles, the Commission would amend its view on the maximum amount of charges required appropriately.
3 Please note that allowed for revenues are presented in the same price base as revenues reported in the charging year 2018-19. This is based on Consumer Price Index (CPI) inflation reported in October of the previous financial year. This allows for a like-for-like comparison to Scottish Water’s reported revenues of £1,217m – the last full year of revenues before the beginning of the Covid-19 pandemic. The calculation of allowed for charges from the projected money of the day is provided in the Appendix. All other numbers in this document are presented in a 2017-18 price base using Retail Price Index (RPI) inflation until 2021 then CPI inflation thereafter unless clearly labelled. The only exception is in relation to borrowing and interest payments which, given its nature, is always quoted in the money of the day. Regulators historically have used the Retail Price Index. More recently, and in line with the advice of the Office for National Statistics on measuring the Retail Price Index, Regulators have transitioned to using the Consumer Price Index (CPI). This change typically has the effect of making increases in bills seem larger and reductions smaller as RPI has consistently been higher on average than CPI.
4 It is the norm for regulators to consider the cashflows of a regulated company in real terms (without the impact of inflation). The inflation index includes an estimate of the extent to which the goods and services that we have the opportunity to purchase today are better than those of the previous year. Observed increases in prices are reduced in the reported measure of price inflation to take account of these improvements. Some industries (for example, services and technology) can improve markedly in relatively short timeframes. It is much more difficult for an asset-intensive business, such as Scottish Water, to improve at the same rate. As such, the underlying efficiency challenge for Scottish Water is to match the productivity improvement of the economy as a whole and then to exceed that economy-wide improvement by £150m a year by 2040.
5 This is the £133m ring-fenced allowance in 2017-18 prices updated for inflation.