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Letters to Regulatory Directors
RD 18/08 22 September 2008 Resetting metered and unmetered tariff differential targets The purpose of this letter is to inform you about our plans to reset metered and unmetered household tariff differential targets (the differential targets) with effect from 2010-11. Our plans only relate to the differential targets. They do not affect the calculated differentials. The formulas which we set out for these in annex A of RD 02/04 will remain unchanged. Currently, the differential target is composed of the following elements: A. Customer-related costs of metering
2. cost of the meter and its installation and replacement; 3. cost of meter reading; and 4. the additional cost (compared with that of serving an unmetered customer) of billing and account management.
6. value of occasional meter under-registration; 7. value to customers with internal meters of supply pipe leakage; and 8. value of rebates to customers with external meters for water that leaks from their supply. Why the change We aim to make the differential target: 1. more company-specific; and 2. more reflective of current cost levels. This is so that companies' differential targets will better reflect the differences between the cost of the services that they provide to their metered and unmetered household customers. As part of their PR09 cost base submissions, companies have updated some of the information that we used to estimate the company-specific values of components 1 and 2. These updates should be reflected in their differential targets. Companies have also provided further information in their retail cost analysis in response to our access code guidance(1) . We believe these can be used to provide reasonable company-specific cost estimates for component 3 (and potentially component 4 in future years), specifically the information in lines R2 and lines R1, R3, R4, R5, R6, R8, R9 and R10 of table A3.1(2). A definition of these lines can be found here. Differential target methodology Following on from RD 02/04, companies reset their differential target with effect from the 2005-06 charging year. In annex B of that letter, we set out the methodology that we used to estimate the values of each of the components of the differential target for that year. The methodology used company specific information as well as industry-wide assumptions. In annex D of the same document, we set out the methodology that companies should use to estimate the value of each of the components in subsequent years. For the first four (the customer-related costs of metering) and the eighth components, the methodology simply involves adjusting the previous year's estimated values by the tariff basket RPI for the year in question (RPI). For the remaining components, the methodology involves calculations using updated June return (JR) and charges data and RPI. We think that the two methodologies outlined in annex B and annex D of RD 02/04 largely remain fit for purpose. But in line with the aim we have set out above, we will change the basis for estimating the values of components 3 and 8. What we will do We set down below our intended changes for each of the components of the differential target. Components 1 and 2 We will use the revised cost base data to reset the estimated values of these components for 2007-08, which is the reporting year for table C2.2 of the cost base 2008 submission, and adjust the results by successive RPIs to charging year prices. We will apply the cost of capital set in the final determinations for PR09 from 2010-11. Component 3 We will use the information that companies provide in table A3.1 of their retail cost analysis (row: line R2; column: household customers < 1 Ml/yr) to estimate company-specific values for this component. (Two companies did not provide any information.) The results (minimum: £0.25 and maximum: £10.45 in 2006-07 prices) vary considerably between companies, with some falling well outside the range that we currently consider appropriate for this service, which is £1-£4. If any company has updated information that it wants us to take account of in a revised estimation of this component, we would be willing to do so, provided: 1. the updated information is robust and consistent with JR data; 2. the company updates table A3.1 of its retail cost analysis with the new information; and 3. we receive the information by 14 October 2008 (this is for PR09 timetable purposes). We will re-estimate the value of this component again for each company after the deadline, if we receive new information. If any company's result falls within the range that we consider appropriate, we will use that estimate for the company in question. Otherwise, we will default to the existing industry-wide value (£2.66 in 2007-08 prices). But if that company can provide a robust defence of its figures, then we will apply that company's own estimated values. We will adjust the estimates by successive RPIs to charging year prices. This arrangement will remain until we next reset the differential target. Component 4 We will continue estimating the value of this component for the industry as a whole. For 2007-08 this was £5.86. This figure will be adjusted by successive RPIs to charging year prices. This arrangement will remain until we next reset the differential target. We had originally intended to use company-specific cost estimates for this component, which we think can be reasonably derived by using the cost information in lines R1, R3, R4, R5, R6, R8, R9 and R10 in table A3.1 of companies' retail cost analysis. The estimation process will involve calculating the average of these costs for metered and unmetered household customers and taking the difference between the two. We have carried out this calculation. The results vary considerably between companies. Some are less than zero, which appears to suggest that some companies do not incur any additional billing and account management costs for metered customers, and one is as high as £14. We will engage with companies with a view to arriving at more robust cost estimates which will facilitate the use of company-specific estimates for this component when we next reset differential targets. Components 5, 6 and 7 We will not reset these components because they are re-estimated each year with updated JR and charges data. Component 8 We will partially move away from the industry-wide estimate to a more company-specific one. We will do this by applying the company-specific prior year water (and sewerage) volumetric rate to our assumption of the average volume of water that corresponds to the average supply pipe leakage rebate per metered household. We have assumed this volume to be 1.5m3. This is based on information provided by companies on the amount they pay to customers as leakage rebates. Indicative differential targets for 2007-08 and possible effect on bills Table 1 compares what the reset values of the differential target components would have been in 2007-08 (Table 1a) and what they actually were (Table 1b). We have not included details of components 3 and 4 because of the confidentiality under which they were submitted. Note that components 5, 6 and 7 are the same under both scenarios. In the calculations for component 1, we assumed a cost of capital of 6.3%, which is the same as in RD02/04, but used company-specific asset lives for household meters provided by companies in table B7.9 of their DBP. We did not change any of the assumptions that we used to calculate component 2. It is clear that that the effect of the changes on the differential targets, and the consequential rebalancing between metered and unmetered bills, will vary from one company to the other. If, for your company, this effect results in one set of bills increasing on average by more than your company's WACI, we will allow you to phase the increase over a two-year period. The current practice where we allow companies to take, as a matter of course, some amount of flexibility (±£1 for water and ±£1 for sewerage) will continue. And so will the additional flexibility that companies can take in the event of atypical unmetered consumption in the weighting year. Effect on the tariff basket model for PR09 The effect of these changes on the tariff basket model will be minimal. We will input the numeric values of the differential target components for your company in the model in time for your final business plan. We will of course share the figures with you before we do this. Next steps If companies have any queries about these changes or want to send revised data, they should contact Samuel Okyere in the first instance, either by post or by e-mail at samuel.okyere@ofwat.gsi.gov.uk. Please send any such queries by 14 October 2008. Yours sincerely Lynne Currie Head of Customer Charges (1) Water Act 2003, Water Supply Licensing, Access Codes Guidance, July 2007. (2) Please note that we are consulting on changes to the access codes guidance. Among other changes, we are proposing to restructure the guidance. Under current proposals, table A3.1 will become table 14.  |
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