Philip Dunne MP.

Q1 The Chair: Good morning, everybody. Welcome to this meeting of the Industry and Regulators Committee. It is the first meeting of our inquiry into Ofwat. I am delighted to welcome Philip Dunne, who, as you know, is the Member of Parliament for Ludlow and chair of the House of Commons Environmental Audit Committee, which produced a very detailed and far-reaching report with a large number of recommendations, published earlier this year.

Philip has been following the travails of the water industry for a number of years. We are delighted that he is able to join us today and share a number of his insights. We will start with one of the key questions we want to focus on, which relates to water quality and the sewage pollution that we have become accustomed to over the last few years.

Philip, could you give us your view on where the responsibilities lie? It would appear that there is, to use a collective noun, a muddle of agencies involved, and one can easily see responsibilities falling down the gap. Where do you think the primary responsibility lies? Are the responsibilities absolutely crystal clear to everybody?

Philip Dunne MP: First of all, thank you very much indeed, Lord Hollick, for inviting me to join your committee today. I really welcome the interest of your Lordships into helping find the solutions to this problem, which has achieved public prominence over the last couple of years in particular. That is largely as a result of the disclosure of data caused by the regulators requiring water companies to start to monitor the frequency and duration of spills of sewage discharges into our waterways, through the event duration monitor equipment that has been installed over the last five years or so through the Ofwat-inspired capital programme. This has given rise to an annual release of data, normally at the end of March each year, by the Environment Agency of all spillages by water company treatment assets, whether treatment centres or storm overflow pipes.

We now have three years’ worth of data, so the disclosure and transparency for the public as to what has been going on is all quite new. It is that information, and the way in which campaigning organisations, in particular the Rivers Trust, have taken it and plotted it on to readily available maps, which you can click on to quickly and readily on the Rivers Trust website, which show in very graphic and clear detail the frequency and duration of spills of assets that are being monitored near where you live. I think that is what has prompted much of the media and public interest in this challenge. It has revealed the extraordinary extent of discharges from water company assets, which hitherto I suspect have been happening for a very long time and are permitted by the regulators and the Environment Agency on the basis that they are exceptional, to cope with extreme weather events. Of course, we have learned from this release of data that it is actually being routinely done across the whole water company estate, sometimes when it is not even raining.

As a starting point in answering your question, my response would be that there are two aspects. The first aspect is who is responsible for the problem of river pollution, and the second, which I think is where you are headed in your committee, is who is responsible for sorting out and fixing the problem.

I will answer the first question from my perspective. As you rightly say, I have focused on the issue both individually as a Member of Parliament and having won the equivalent of the parliamentary lottery by getting a place high up in the ballot for Private Members’ Bills when this Parliament began after the general election in 2019. I introduced a Bill, which, thanks to the Covid pandemic, was never debated on the Floor of the House, but it led to our committee deciding to pick up the issue. At the beginning, you were kind enough to reference our report, Water Quality in Rivers, which we published in January this year. Our inquiry was happening at the same time as the Environment Bill was being taken through your Lordships’ House. We were also helpful in persuading the Government to introduce a series of amendments to that Bill, which directly go to address some of the issues that we will be discussing today about transparency and responsibility for fixing the problem and encouraging water companies to think about the capital investment that they need to make in order to stop the problem happening.

Backing up to your question on who is responsible for this, in terms of causing the problem I think many of the challenges in the state of our rivers stem from the fact that, for several decades, we as a nation have been building above ground homes and commercial premises of all sorts, creating an increasing amount of hardstanding on previously porous ground. That has led to two things.

First, it has led to an enormous increase in the volume of surface water that lands on hardstanding and has to go somewhere in order to avoid flooding properties—although of course it does flood properties. There is a surface water challenge, exacerbated by climate change and the volumes of rainfall that are landing across the UK as a result of climate change, with more frequent and more severe storms.

Secondly, there is the problem of not investing sufficiently underground in the drainage assets that deal with both surface water and the foul water that comes from an increased population and the daily ablutions that we all undertake. That has to be dealt with by investing in the foul water treatment infrastructure at broadly the same pace as we are developing above ground the facilities in which human beings live and work. That is what has not happened for the last 60 years or so, I would argue.

The Victorian plumbing system that was introduced, initially by Bazalgette and then across the country from the late 1850s onwards, was built with an enormous amount of spare capacity for the population of the day. That capacity hit its maximum level around 1960. I would go back to about 1960 to ask planners, successive Governments and local authorities ever since why they have not provided the mechanisms to allow for wastewater treatment to be expanded to cope with the volumes that have happened through their agreeing to allow development above ground. I think that is at the heart of the problem.

At the beginning of our Commons inquiry, but not in relation to it, we had the Secretary of State, George Eustice, before us in a routine meeting. He acknowledged that this problem is not going to be resolved until we have separated the surface water and the foul water drainage systems across the country. That is a mammoth undertaking. There are in the order of 600,000 kilometres of underground drainage networks. In broad handfuls, roughly a third are dedicated to surface water, about a third are pure foul water, and about a third are combined surface and foul water systems. The right to connect has existed for a long time, but the reason they are combined is that in England—no longer in Wales—as a result of the Water Industry Act 1991, on privatisation, the power was given to remove the right to connect for developers connecting the water treatment infrastructure that they put into new developments. At the moment, the right to connect allows them to connect to the nearest available passing drainage system. Unfortunately, because there were not sufficient drainage systems of both kinds, foul water was able to be connected to surface water drains if that was the most convenient and available. That has contributed to the problem.

In Wales, they abolished the right to connect. Now, you have to connect foul water to foul water systems and surface water to surface water systems. One of the recommendations of our committee is that that should be introduced across England for all new development.

The challenge of retrofitting, reworking and disconnecting those systems is enormous, and Defra is undertaking analysis to look at what it might cost to create separate systems across England. The figures that were mentioned during the course of the debate on the Environment Bill were a very wide guesstimate at the time, last autumn. I think the Minister in the Commons referred to a figure somewhere between £150 billion and £650 billion. Do not quote me on that; it would be worth looking it up. This autumn, we should expect a more reasoned analysis of the cost. That covers segregating the drainage systems and building the additional capacity that would be required to cope with the foul water if we had separate systems. A huge amount of infrastructure would be required to separate them.

That is part of my answer on responsibility for causing the problem. Water companies are not the only part of the problem. It is widely recognised that the water treatment sector accounts for 38% of river pollution. That was the figure we used in our report. The balance comes from two other sources. Agriculture accounts for about 40% of the phosphate and nitrates found in our river systems, and highways and industry account for the balance. Of course, the run-off from highways gets collected in surface water systems and some of that flows directly into rivers. The pollutants coming off our roads are much less well understood than the pollutants coming into our rivers from agriculture and water treatment, but it is a significant issue as well, and much harder to deal with because it is much more difficult to treat unless it goes through a water treatment plant, and we do not want all of that surface water adding to the problems in foul water treatment.

I will move on briefly to the other part of your question—I am sorry I have kept talking for so long because I am sure you have lots of questions that you want to ask me—on who is responsible for sorting out the problem. Since privatisation, we have two regulators. The Environment Agency is responsible for granting permits and licences to water companies for their treatment assets, and Ofwat is responsible as the economic regulator and, in essence, approves the capital investment plans of water companies. There is a question mark in my mind as to whether those two separate regulators have been as effective as they should have been in policing the water companies’ role in relation to wastewater treatment.

The Chair: Let me stop you there. Thank you very much for that. Baroness Donaghy has a direct question on the point that you have just raised.

Q2 Baroness Donaghy: Good morning, Mr Dunne. I very much appreciated reading in Hansard the debate you had in the House of Commons earlier this month. It was an extremely good introduction for me to the subject. I felt that I learned a lot about all the complexities and the difficulties. Thank you very much for leading that.

My question relates to whether you think Ofwat has the necessary powers to solve the issues relating to sewage overflows. The Environmental Audit Committee—your committee—recommended that Ofwat consider its powers in relation to executive bonuses in the sector. Are there other areas where you feel that greater powers might be necessary?

Philip Dunne MP: Thank you very much for your kind opening words, Lady Donaghy.

We made a recommendation in our report about whether Ofwat should be given more powers. We were briefly looking at the issue of bonuses. One of the difficulties of regulating the sector is that 10 of the 15 or so water companies are engaged in water treatment, and we looked at only the treatment side of their business. I know that we will come on to this in the questions, but Ofwat receives a guidance statement from the Government—a strategic policy statement—every five years. It is the way that Defra and the Secretary of State give some direction to Ofwat as to how it should conduct its business. It is focused mainly on its underlying regulatory priorities, which I am sure we will come on to.

One of the things it does as the economic regulator is, primarily, to approve capital expenditure by water companies explicitly. It does that both by approving planned capital expenditure through five-year programmes and by looking at how the water industry is financed in terms of its balance sheet capacity and its ability to operate and generate a commercial return on the investment that it makes. The use of funds, which would include both bonuses to executives and dividends, is something that I think is relevant to undertaking a full role as an economic regulator. Because the nature of the water companies’ capital structure is so variable, it is quite difficult to get a clear picture of each company’s activities.

Public companies have to make disclosure publicly through their annual report. Some of the water companies are owned by private equity companies, and their level of disclosure is somewhat less. I am not aware whether Ofwat has raised concerns about that. It would be an interesting topic when you speak to Ofwat to ask whether it feels that it has enough influence to secure information from the water companies themselves to get to a good understanding of the basis on which remuneration or dividends are paid. We may come to this later, but one has to question whether some of the very high bonuses that are paid to companies that are in breach of permits and licences from the Environment Agency are appropriate for a public utility that is providing drinking water and dealing with our effluent.

Baroness Donaghy: Are there any other powers that you or your committee would identify as useful for Ofwat to be given, or is it not, in your view, using its existing powers sufficiently robustly?

Philip Dunne MP: To be honest, we did not get into that in any detail. That is something you could usefully do. The question I would ask Ofwat is the one you just asked me and, specifically, whether or not it feels that it has full transparency on the basis on which bonus payments and dividends are calculated and made.

I was making the point about capital structures because some of the companies are more heavily geared than others, and some of the dividend streams that appear to come out of the operating company are actually paying interest, probably through group companies, to external investors. The word “dividend” can be a bit confusing, depending on the capital structure of the company itself; in fact, it may equate to interest.

Baroness Donaghy: Do organisations such as Ofwat and the Environment Agency have the necessary resources to tackle water pollution incidents and meet their objectives more broadly?

Philip Dunne MP: That is a very pertinent question, if I may say so. From about 2010, the Environment Agency moved to a system of self-monitoring of spilled discharge incidents by water companies, partly because it had fewer personnel engaged, as I understand it. I do not have the numbers to give you, but there was pressure on monitoring pollution incidents in our rivers, and the water companies were empowered to do more self-monitoring. Our contention was that that was one of the contributory reasons for the Environment Agency being much less aware of incidents that were occurring.

Since then, technology has moved forward apace. There are now far more sensors available to analyse what is happening in receiving waters than was the case back in 2010. Many of our recommendations were around increased use of technology to allow monitoring to take place remotely and in real time. The Government recognised that, and one of the key provisions and amendments that went into the Environment Bill when it was going through your House was that water assets should have monitoring devices upstream and downstream of every outfall from a treatment facility or a sewage storm overflow. That is in the order of 22,000 locations across England. That is going into the next capital plans that will be approved by Ofwat for the water companies, and will allow for monitoring to be made available to the companies themselves in—as I think the legislation says—near real time.

The water companies will be able to identify where there is a problem, as opposed to the situation at the moment where, in many cases, the event duration monitor will tell when there is a spillage but not what impact it is having on the receiving water. A small spillage into a fast and large river will have negligible impact, but a small spillage of the same volume into a small stream could have a very significant impact. Testing what happens in the water and making that available to the company, then to the Environment Agency and then to the public will transform our understanding about what is going wrong, which will allow the Environment Agency in particular to change the way it polices incidents.

We also recommended that there should be a plan for all companies to cease major pollution incidents completely by 2030. Again, that is something that is in the strategic policy statement as an objective of Ofwat, which is very welcome. There is a whole level of pollution incidents. They tend to be commercial or industrial incidents rather than routine discharges by water companies. That has been a major source of pollution in the past and is something we certainly have the technology to try to stamp out now, which is very welcome.

Baroness Donaghy: Thank you.

Q3 Lord Burns: I declare that I was chairman of Welsh Water between 2000 and 2010. I have no financial interest, but I have some residual intellectual interest.

Do you think that Ofwat’s statutory objectives are clear and consistent? How well does it manage the trade-off between objectives? In particular, thinking about the point you made earlier on the whole question of the amount of investment versus prices to the consumers, has there been too much emphasis on keeping down water prices? Has there been insufficient emphasis on trying to identify which of the investments really could make a difference to this particular problem?

Philip Dunne MP: Thank you very much, Lord Burns. I bow to your hands-on experience, which is obviously much greater than mine. You have lived through not the initial post-privatisation decade but the subsequent one, so you will have a much better handle on this than me.

I think the way the Government reset priorities every five years is quite an appropriate way to manage the regulator. That is for two reasons. It is partly because making change across a sector such as this takes years. A lot of campaigners and Members of both of our Houses call for immediate action. It is pretty easy to call for immediate action. Everybody would like to see problems resolved overnight, but it is impossible to do. It requires significant capital investment. It requires, in many cases, going through our planning system, and it takes years to resolve very significant infrastructure challenges.

The five-year period works quite well. I would like to see the ability for interventions to happen more frequently in the event of special circumstances. We have had the precedent set, although of course it will not be regarded by the Treasury as a precedent. The pandemic response by government through the green recovery fund specifically took the opportunity to invite Ofwat to invite water companies to make proposals over and above their pricing period for additional capital investment to be made using the opportunity of the Covid funding. I think this is the first time it has happened. It may have happened before but I am not aware of it.

Water companies had a short timeframe in which to come up with some proposals. Consequently, some were better prepared to do that than others. Therefore, the funding that was approved was somewhat skewed to the companies that were in a good place to do that. It was about three-quarters of a billion pounds or thereabouts, in addition to the capex that had been approved for the five-year period we are currently in. The biggest project was a £300 million scheme to replace the sewerage system in Mansfield, which was obviously the lion’s share of that capex. That was an example of going beyond the normal routine.

The second reason why I think a five-year cycle is a good one is that it allows time for the companies to be able to make plans for practical changes they wish to make and to arrange the funding, construction and implementation of those plans. The way it is done, by means of a strategic policy statement, has in the past focused, as you said in your question, very much on the twin purpose of ensuring an adequate supply of drinking water across the country and keeping bills as low as possible. It is an inflation plus or minus target provided to the water companies, and much of the focus of the negotiations every five years has been on what the plus or minus should be.

In our view, we needed to include in the reprioritisation this time the priority for investing in water treatment. The Government have made that the first item of the SPS this time round. We think that is entirely appropriate given the underinvestment over the last period. Is that consistent with maintaining low bills? It needs to be. It is a matter of prioritisation of capital.

Two weeks ago, I visited the Thames Tideway tunnel, which I am sure some of you have seen. It is very instructive in lots of ways. I will not spend a lot of time on it, but suffice it to say that it is the largest ongoing infrastructure project for water treatment. It was initiated in 2007, planning was achieved in 2014, and it is due to open operations in 2025. It is an 11-year construction project, and it is going to cost £4.9 billion to get to the operational opening. It will lead to an increase in household bills of around £20 per annum per household. That is an enormous project, given the scale over which it is operating. It will be paid for by households, which will barely notice it, at £20 a year. It illustrates that this can be done, but it also illustrates how long it takes to fix big problems.

Lord Burns: Does it not illustrate another issue? You quote the numbers for trying to separate foul water from storm water. It looks so large that it becomes an almost impossible problem. Presumably, there are ways of prioritising different parts of the network, where one could begin to look at the places where there are the greatest problems. Do you think it is important, in the end, to make some progress on separation, rather than simply looking at it and saying that the bills look too large even to contemplate doing it?

Philip Dunne MP: I think we start on separation with new developments. We should stop the right to connect. There is a debate going on within government about this issue. It sits within DLUHC. As the Levelling-up and Regeneration Bill goes through both Houses, there may be an opportunity to suggest to the Government that, if this needs legislative change, it could happen through that Bill.

I am told that legislative change is not needed because it is already in Schedule 3 to the Water Act; it is just a matter of persuading the Government that developers will have to pick up the cost. It thereby runs into the ability for developers to fund this as well as the housebuilding programme, so there is a commercial prioritisation challenge, but I think that is where we start.

The new SPS for Ofwat calls for the most egregious pollution incidents to be dealt with first, to get the water companies to prioritise their capital investment on the biggest problems. I think that is absolutely right. That is what will happen in the new sewerage and drainage plans that the water companies will have to produce. They will focus their efforts initially on where there is the biggest impact and I think that is entirely appropriate.

Lord Burns: Thank you.

Q4 Lord Cromwell: Good morning, Philip. My apologies for being invisible; it is a technical fault. I assure you that I am in a suit and tie.

I have a couple of questions. You have been talking about the objectives. From talking with Ofwat, it seems that those objectives have indeed shifted over time, from pricing and quality of water to rather more imprecise environmental objectives. Given that objectives are only as good as one’s ability to measure them and the extent to which they have been achieved, do you think that their performance can be measured against those sorts of objectives? If so, how, and what would success look like?

Philip Dunne MP: Thank you, Godfrey. The water company performance can be measured much more easily than its regulator. I have touched on the transparency and measurement of the condition of waterways, which the water companies will in future be required to do. Ofwat’s performance, I suppose, is measured more in terms of its ability to secure against its existing priorities household bills increasing at a certain level and water supply being available or not available, depending on weather and usage conditions. Water treatment hitherto has not really been measured at all. I think it is a good question for you to put to the new chair and the chief executive, who has now been made substantive for Ofwat, as to how they intend to measure their performance and to meet the new objectives of the SPS. They have not had the water treatment priority before, and how they are to measure their ability to influence that is a really good question. It might be a good question for you to put to the Minister, too.

Clearly, the system has not been working. We are getting the tools to measure the eventual outputs. The input measure, from an Ofwat point of view, has always been looked at in terms of capital markets and the weighted average cost of capital. That is the topic around which Ofwat has its debate with water companies. It is clear that that in itself is good for dealing with the pricing to consumers point, but it is not such a good measure for dealing with whether there is adequate capital in the system to be able to deal with the priorities that the water companies are being set. I would put that question to the chair.

The fact that both Ofwat and Environment Agency senior management—the chair and the chief executive of the Environment Agency—are due to change this summer provides a real opportunity. Your inquiry is very timely to be able to challenge those folk. We have a pre-appointment hearing due before the Summer Recess for the new chair of the Environment Agency, as yet not identified, and we will put some of these questions to the Environment Agency.

We have had a session with Ofwat. We have also had a session with the Office for Environmental Protection, which has now come in to replace the EU as the regulator of the regulators in this area. It is taking a particular interest in water quality. The whole regulatory environment is up for grabs at the moment.

Lord Cromwell: I look forward to asking them those questions. I will be sure to mention that you suggested I did so.

Can I sneak in one question? Going right back to what you were very helpfully saying at the beginning, what you appear to be talking about is a massive infrastructure project. Are you suggesting that the water companies, possibly through the price mechanism, can carry this out themselves, or are we looking at strategic government investment in infrastructure?

Philip Dunne MP: It is massive to fix this problem once and for all, but there are different mechanisms to do it in different ways. I was touching on new build. The Government have a very significant ambition to build new housing. New housing needs to be built alongside new investment in treatment facilities to cope with the run-off that comes from those houses, whether on the surface or underground.

I am proposing to make some amendments to the regeneration Bill to try to facilitate some of this. For example, at the moment, water companies are not able to be recipients of community infrastructure levy or Section 106 funding, which developers are obliged to provide when consents are granted by local authorities. Water companies are not even statutory consultees necessary for development consent. They need to be put in a position where, if they have to deal with the consequences of investment, where developers are making contributions they should be able to make them to help contribute to that infrastructure. That is for new developments.

For existing developments, the capital markets—although this may be changing as the economic environment changes—have supposedly been awash with capital to invest in long-term, sustainable, secure-return projects, and in particular those with a green environmental tinge. I think everybody would agree that water treatment, particularly if it is helping to improve the environment of our waterways, would qualify as green investment. I think the capital markets would be available to fund significant infrastructure projects.

The bigger qualifier for this will be the ability of the construction industry to cope with the volume of investment required in one go, which is why I think it is going to take decades to fix and why I am always cautious about people claiming that something must be fixed overnight. It is going to take 20 or 30 years to get this right.

Lord Cromwell: Thank you. That is very helpful.

Q5 Baroness Bowles of Berkhamsted: A lot of my question has been covered already, so what has already been said does not need to be said again. I wanted to ask you whether Ofwat receives sufficient strategic guidance from the Government on how to balance its objectives. In particular, has the Government’s latest strategic policy statement now ensured that Ofwat balances the need for long-term investment and the affordability of consumer bills?

More as a generality, I think you said that guidance every five years is about the right spacing. Do you think there should be more frequent interventions to make sure that it is progressing at the right kind of rate within those five years? You have given us the pandemic funding example, but, as a generality, how often could more frequent interventions be?

When looking at capital costs, how do they deal with the cost of not making the investment? Who does that fall on? If you are one of the unfortunate people whose property is flooded, you are paying for it through insurance. That is not doing the job for consumer bills if you take a wider perspective on it. How is that looked at?

Philip Dunne MP: Thank you, Lady Bowles. You ask some big questions. I have covered the strategic policy statements, as you say. We recommended that water treatment should be prioritised in the statement, and the Government have done so. I welcome that, and think they should be applauded for getting to grips with it, really for the first time under successive Governments.

On your point about frequency, I am not sure. We did not really get into it with Ofwat on the extent to which it constantly monitors water companies’ progress against the plan. I suspect they have a fairly regular dialogue, but I am not sure how formalised it is or indeed how valuable formalising it too frequently would be. You have to agree a plan and let them get on with it. But there should be some kind of reporting mechanism for the water companies to let the regulator know how they are going against the plan and, if they are going to miss it, give as much notice as possible that that might happen. There may then be an opportunity for the regulator to make some intervention. Certainly, some term or routine update against the plan is something they ought to do. They may do that; I do not know whether they are doing it already.

Baroness Bowles of Berkhamsted: Are the Government in a position to get an update as to how their five-year guidance is going? If Ofwat does not know because the water companies may not know, the Government will not know either, will they?

Philip Dunne MP: I suspect this is happening. The water companies produce annual reports. They make public a lot of the work that they are doing and where the capital investment programme is getting to. It is a good idea, now that they will be obliged to provide five-year sewerage and drainage management plans, that they are also obliged to make public disclosure of how they are doing against them, certainly with disclosure to the regulator on a regular basis, and that that should flow up to Defra. I agree that that is a good idea.

You made another point, which has just gone out of my head.

Baroness Bowles of Berkhamsted: It was on the cost of not investing and that falling on the consumer through insurance.

Philip Dunne MP: At the moment, the whole point of storm overflow systems is to allow a release valve, literally, if sewage is backing up in a treatment plant or in an overflow pipe. It goes downstream rather than back upstream, creating flooding in streets and houses. That is why they exist.

What happens when they go wrong? Take a major failing of a major pipe—I saw one in my constituency last year, where the main pipe taking about two-thirds of Telford’s sewage to a treatment works across the River Severn had a failing and collapsed. Thousands of tonnes of sewage were leaking into the river from the failure of a pipe. That was Severn Trent’s responsibility to fix and put right, because it was its asset that had failed. Most of the worst incidents happen in that kind of example, rather than the flooding of homes. Obviously, flooding of homes can happen, and it comes down to the insurer to pick that up.

Water companies have a maintenance programme. Where there are failures, as part of their routine business they have to repair their equipment to make sure that those failures are as few and far between as possible. Ultimately, that ends up on customer bills, because it is part of the routine maintenance of their assets that all companies are responsible for.

Baroness Bowles of Berkhamsted: Finally, what is your view of the Government’s draft storm overflows discharge reduction plan that is out for consultation? Are the plan’s proposals sufficient to significantly reduce the use of storm overflows?

Philip Dunne MP: I welcomed this when it was first published. I know that I came in for a certain amount of flak from some of the campaign groups, which felt that the ambition was not what they would like to see, but it comes back to practicality and the reality of how long it is going to take to fix these problems. There is no point in setting targets to reduce damage if they are completely unachievable. They have to be grounded in some sense of reality.

What was important about this was that we have a clear commitment from government to require water companies to reduce their discharges, and that that should be focused on the most polluting sites. I think that is absolutely right. One can always argue, and there will be argument between Ofwat and the water companies, about the extent and the pace at which they are able to do this. Again, that comes back to the balance about how it can be paid for, over what period and the extent to which household bills need to be kept within reason.

It is very difficult at this particular time of soaring costs of living to be arguing for increases in household bills. That is not something that any of us wants to happen, but I think we have to accept that, if we are to avoid just kicking the can down the road until the next pricing review period, there needs to be greater priority given by water companies through the directions from Ofwat and the Government, through the storm overflows plan, that will feed into the sewerage and drainage management plan under the Act to give it a higher priority. That will come at some cost, but, as I have just illustrated in the case of the Thames, it does not have to be an excessive increase in bills.

Baroness Bowles of Berkhamsted: Thank you.

Q6 Lord Agnew of Oulton: Good morning, Philip. You are to be congratulated on championing this issue because it is so important. I have a couple of interlinked questions and I want to draw on your financial background as well.

Do you think the financial models that the water sector works under are sustainable and that there is a proper alignment of interest between the consumer, the environment and the companies themselves taking an adequate but not excessive dividend from their activities? Particularly around high pay and dividends, I understand that since privatisation some £50 billion has been taken out in dividends and bonuses. Of course, there are very high levels of debt that were attractive for share buy-backs and so on, but that will, I suspect, become much more difficult as interest rates rise. That is the first bit.

Linked to that is whether you think that the fines are adequate and enough to deter or improve behaviour, or whether they are just taken as a cost of business because the fine is trivial relative to the investments that might be needed if they were adopting a more communitarian approach. Wrapped up in all that, I would be very interested in your thoughts.

Philip Dunne MP: Thank you. I think you are raising subjects that will be of great interest for your committee to look at. We did not in our inquiry get detailed, empirical evidence on the water companies’ balance sheet structure, dividend payments and bonus payments, so my comments are somewhat anecdotal rather than based on evidence. We tried to get a sense from Ofwat of what work it had done looking at those issues. It provided us with an analysis, which I think is publicly available, showing the proportion of underspend and overspend of capital by water company for each pricing period, going back 20 years. The basic trend was that there had been underspends by the water companies on capital against what their allocation had been for the first three of the four pricing periods we looked at, but an overspend in the most recent one.

As I said earlier, water company balance sheets are all rather different, depending on the ownership model and the structure of the company. Public companies have somewhat less geared balance sheets than the private equity-owned businesses. That has a direct impact on the use of proceeds from operating the business and how they are able to pay interest or dividends. As I said earlier, it would be useful to try to disentangle the interest element of dividend payments, particularly within the private equity interest. I suspect the figure that is broadly quoted as the dividend payment actually masks interest in some cases, although not in all.

There have been dividend holidays in recent years for several of the companies. Again, that information is readily available. There is sensitivity in the companies as to what they do with the profits they generate. There is sensitivity over bonuses, particularly for companies that have been subject to increasing fines.

The second part of your question was about fines. I made some proposals in my speech to the House last week. There are two things about fines; there are fines that can be levied by the Environment Agency and there are fines that can be imposed by courts when the Environment Agency takes a water company to court for breach of permit and licence.

The fines levied by the Environment Agency are generally attempts to encourage water companies to put right the wrong rather than to pursue enforcement through the courts. There have been very few examples of court procedures taken as a percentage of the total problems that the Environment Agency looks to deal with. There has been some analysis done by campaign groups. I think the Salmon & Trout Conservation group in particular has done some work to look at both the number of fines and the amounts.

By and large, the fines imposed by courts have been at a level where, I would argue, it has been a cost of doing business rather than a penalty designed to change behaviour. That changed when Thames Water was fined £20 million, I think in 2017, and Southern Water was fined £90 million in 2021. Those were meaningful; that level of fine gets board attention. Board bonuses, in my view, need to be taken into account if the company for which the executives are responsible gets fined at levels like that.

I said in my speech that I thought that those fines ought not just to go into the Treasury pot. That is circulating money from customers back to the Treasury, effectively, which is not what we should be using it for. We should think actively about having some kind of river restoration fund, whether local to the catchment or national. The Environment Minister, Rebecca Pow, said in response to the debate that she would think about that.

I think there is an opportunity. If your committee wanted to consider the issue, it would be very useful. It seems to me that, much as the Treasury hates hypothecation of any kind—Lord Burns is well placed to advise your committee about that—if fines are being introduced because environmental harm is being caused, it would be far better to be able to recycle them back into fixing the problem than their just being swallowed up in the general Treasury pot.

Lord Agnew of Oulton: Thank you very much. That is very helpful.

Q7 Lord Sharkey: Good morning. Today’s FT carried a piece about Anglian Water, pointing out that Anglian is paying a dividend of £62 million to its owners despite rising customer bills and sewage and pollution failure. Anglian has apparently been fined three times so far this year, including £300,000 this month for killing 5,000 fish in the River Wid. The FT also pointed out that Anglian has a 40 year-old plant still in service and that most water companies have slashed capital investment in critical infrastructure by up to a fifth in the past 30 years.

I know that your committee has called for Ofwat to prioritise long-term investment and incentivise the use of nature-based solutions through its price review mechanism. Is the price review mechanism too short-term in nature? You have already mentioned that raising bills to pay for investment may be difficult during the current cost of living crisis, but would you also agree that funding investment through bills can be regressive? Is there a need for a social tariff to protect low-income groups from bill increases to fund investment?

Philip Dunne MP: Thank you, John. You are ahead of me; I have not had a chance to read the FT this morning. I walked to the office and I could not read a newspaper and walk along the street.

The fines that you mention for Anglian are hundreds of thousands of pounds, and that is the level that has been applicable generally to fines. The average has been around £600,000 or something of that order. That is a routine cost of business for a company like Anglian. It is why we need to change the situation, so that water companies do not need to be fined and are dealing with problems before they arise. That is where I think the monitoring will help water companies enormously to identify problems in real time, so that they can actually stop the pollution before it kills fish.

To answer your question about the price review process, the sewerage and drainage management plans are designed to be 25-year plans. That will provide a mechanism for the water companies to be thinking much longer term than the five-year periods. It probably has been the case that a five-year period is not long enough for the kind of capital investment that we have been talking about. I have given you the Thames Tideway tunnel illustration, which was more like 15 years, and will be longer before it is finished. There needs to be a longer-term planning cycle.

I would have thought that five years is probably about right for fixing the cost of capital over a period. We did not really look into that, but perhaps you might. I did not get evidence that water companies found that a constraint to their ability to borrow or to plan. I think that is a matter for you to investigate. It is not something that I am aware was a problem.

We have just touched on the impact on consumers. Anything that goes much beyond inflation, which this year is moving into a realm that we have not been used to for 40 years, will be very challenging. That is an argument for having a five-year pricing review period because, if you fix it as a margin above inflation, it will go up and down as inflation moves.

For big capital projects, there is perhaps a case for a special pot of funding in a particular water company area, as I referenced in London. Take Mansfield, for example. Should the people of Mansfield pay specifically to fix the Mansfield problem, or should it be spread across Severn Trent Water companies everywhere on the basis that in this period it will be Mansfield but next period it will be somewhere else? Personally, I think it is probably better to use the resource of the larger customer base than to focus cost on the individual consumers who will benefit from an individual infrastructure project, because the cost could be very disproportionate over a smaller population.

As to those who struggle to pay, there is already a mechanism for social tariffs for those on low incomes. That is entirely appropriate. I do not have a figure in my head for how many people benefit from that, but it is several million households, I believe. It is slightly different for each water company; they have their own systems. Again, we have not looked at that. It is something that you would need to talk to them about.

Lord Sharkey: Thank you.

Q8 Baroness Taylor of Bolton: Philip, thank you for the information you have given us. I have found the whole session absolutely interesting. I have a very simple question. Does Ofwat receive sufficient scrutiny by Parliament? You are clearly very proactive on this, and you have this Select Committee on side, but Parliament as a whole does not always take much interest. You acknowledged that your committee looked only at the treatment side of the business and not the whole picture. Do you think there are ways in which Parliament could hold Ofwat to account more effectively? Do you think there are things that we could do to improve that?

As a supplementary, which I will ask now to save time, you mentioned that you have a pre-appointment with the new chair. Do you think any committee in Parliament should be involved in the appointment of such chairs? Should parliamentary committees ratify a new appointment such as that?

Philip Dunne MP: Thank you, Ann, for your kind words. Ofwat, like any other non-departmental body, is subject to parliamentary scrutiny at the will of Parliament. Individual committees could invite Ofwat to come before them, and I think the National Audit Committee in the Commons has some level of routine scrutiny.

The pre-appointment hearing is a Joint Committee between the EFRA Select Committee and the EAC in the Commons. I think EFRA takes the lead, because Defra has ministerial responsibility for the agency. I remember that, at the time of the establishment of the Office for Environmental Protection, both our committee and the Lords recommended that the OEP should be established with direct responsibility to Parliament, much like the National Audit Office. That was rejected by the Government.

It is not surprising that Parliament seeks to increase its degree of scrutiny and wants more responsibility. It is not surprising that Governments of all complexions often tend to resist giving more powers to Parliament for looking after government agencies. I do not think that Parliament is well placed to be involved in the appointment itself. Having the role of being able to issue a blackball, if you like, which is what a pre-appointment hearing is in theory, is a good idea. We have that in the Commons and it is the right place to be for the chair of Ofwat.

Should Ofwat have more routine scrutiny? I think our committee, given the role we have played recently in water quality, is likely to want the Ofwat team to come before us once a year or so. I am sure they would be willing to do that. Certainly, the OEP has expressed a great deal of interest in routinely appearing before our committee, and I am sure would do the same for others in Parliament.

There is a danger in being too prescriptive about this. If you make it too routine, it becomes rather less meaningful when you have such a meeting. The problem with a short answer is that there has not been enough scrutiny of the sector over the last 30 years. I think there was probably quite a lot of interest at the time of privatisation, and since then it has been on the back burner.

One of the issues that came up, which is slightly off your point, is that there has been a lot of suggestion that the era pre-privatisation was in some way a better era for managing these issues. We looked at this. In the 10 years prior to privatisation, the amount of money invested by the owner—the Government—was roughly half, on average, per year, the amount that was invested in the 10 years following privatisation. I do not think nationalisation is necessarily an answer for providing more funding to deal with these issues. As I said earlier, the capital markets are there to provide the necessary funding and it is better that that happens rather than just adding to the huge weight of general government debt and funding through the taxpayer.

Baroness Taylor of Bolton: I will not be drawn on privatisation because I was in the House when that legislation went through, and played a part in it. The whole thrust at that time was that regulation would be very significant and very effective. That is what I think we are questioning at the moment. Thank you.

The Chair: Philip, that brings to an end this session. Thank you very much for your contribution. Could I ask you to give us your sense of whether the Secretary of State is minded to follow the Welsh example and impose some sort of arrangement for the recovering of costs for new build to be attached to the water system? Is he sympathetic to that?

Philip Dunne MP: Thank you, Clive, for inviting me to join you. I have enjoyed this session and the interest from colleagues in your House.

The Defra Ministers—both the Secretary of State, George Eustice, and particularly the Environment Minister, Rebecca Pow—are absolutely apprised of the need to focus on this issue and to put in place the building blocks to fix it over the coming years. I have no doubt at all about their commitment to that.

As to your direct question about whether the Secretary of State for the Department for Levelling Up, Housing and Communities has grasped the impact of the issue yet, I would say that it has not been at the forefront of his mind until now. It has really been focused on by Defra. Later today, I hope to put down some amendments to the Levelling-up and Regeneration Bill, to try to stimulate some interest and bring it to his attention. I suspect that the debate on the challenge of meeting the 300,000 housing target will have a higher priority with the Secretary of State than the need to fix the underinvestment of the last 60 years.

The Chair: Thank you very much for that. It is just another question that we shall want to probe when we have the respective Ministers here. Thank you very much indeed, Philip.