Price limits are the amount by which average bills can change each year. We set companies' price limits. Companies do not all have the same price limits.

The formula that limits the charges that water companies can make for their services is laid down in the Licence under which each company operates. The formula is RPI plus k but k can be a minus figure.

The RPI used in the formula is the retail price index in the November before the year beginning on 1 April to which charges apply.

Example If the price limit in a year is 1% and the RPI increase in the 12 months to the previous November is 1.5% then the average increase in charges can be no more than 2.5%.

Are all company charges covered by the price limits?

No. Price limits cover the basket of charges listed below.

• Charges for unmeasured water supply.
• Charges for measured water supply.
• Charges for unmeasured sewerage services.
• Charges for measured sewerage services.
• Charges for reception, treatment and disposal of trade effluent.

Some charges are not covered by the price limit, for example infrastructure charges. We set infrastructure charges at price reviews. We do not set limits on other charges, for example connection charges, but we expect these charges to be reasonably related to costs. We have powers to decide whether the costs are reasonable in the case of a dispute between a customer and the company. Our decisions are binding on both parties.

Do all customers' bills change by the same amount?

No. Because price limits apply to the average change in charges, all customers' bills are unlikely to change by the same amount. Companies can change different charges by different amounts. For example, a company could decide to increase measured water charges by more than unmeasured water charges. Or it could alter the balance between standing charges and variable charges. Companies must not do this unfairly and we check that charges for groups of customers are reasonably related to costs.

Since the Water Industry Act 1999 came into force we must approve all companies' charges schemes. The charges scheme includes important customer information such as level of charges and timing and method of payments.

Who sets the price limits?

Price limits were initially set for ten years by the Secretaries of State for the Environment and for Wales in 1989. We took the earliest opportunity available to reset price limits in July 1994, at a periodic review of price limits. A further periodic review took place in November 1999, to set price limits for the period 1 April 2000 to 2005. Periodic reviews take place every five years. Price limits will be set again in 2004 for the period 1 April 2005 to 2010.

At a periodic review we review the companies' business plans and assess their future revenue needs. The price limits set for the companies reflect assumptions about what they need to spend to meet their capital expenditure programmes and to finance their operations. We also make assumptions about the cost of borrowing, capital charges, companies' operating costs and about future operating and capital efficiency savings.

Do companies have to charge the maximum allowed by their price limits?

No. Individual price limits reflect what we consider companies need to spend to fulfil their statutory obligations. Price limits are a ceiling on what companies can charge. They are based on the assumption that companies will achieve substantial increases in efficiency. If companies are able to achieve their obligations at lower costs than assumed in price limits they may choose to share these benefits with customers by charging less than their price limits.

What is Ofwat's role in monitoring price limits?

We are responsible for ensuring that companies' price limits continue to reflect the assumptions we made when limits were first set. In certain specified circumstances we can adjust price limits between price reviews. These are known as interim determinations.

What can prompt an interim determination?

The circumstances under which we can make an interim determination are set out in Condition B of companies' Licences.

An interim determination can only cover changes set out in the Licence. It is not a mini–price review.

Usually companies must apply to have an interim determination, but we can also decide to review their price limits. Companies must request an interim determination by 1 October of the year before the charging year for which they are seeking revised price limits. The charging year begins on 1 April each year.

We examine applications against the criteria set out in Condition B. We make a determination for each of the companies that apply. An interim determination will lead to either:

• a revision to a company's price limits; or
• no revision to price limits because the materiality threshold (10% of the company's turnover) has not been met.

What circumstances can be taken into account in an interim determination?

Condition B sets out the circumstances in which an interim determination may be sought. These are either 'relevant changes of circumstances' (RCC) or 'notified items'. RCCs are:

• a new or changed 'legal requirement' (RCC1). Condition B defines the legal requirements. These include regulations made by the European Union or subordinate legislation made by the Secretary of State amongst other items;
• variations in the proceeds of land disposals from what was assumed when we last set price limits (RCC2);
• failure to achieve outputs for which funding was allowed when we last set price limits (RCC3);
• for three companies (Anglian Water Services Ltd, United Utilities Water plc and Yorkshire Water Services Ltd) changes in the movement in the construction price index relative to RPI from that assumed when we last set price limits (RCC4).

• A variation in the number of customers requesting meters, free of installation charge, compared to the numbers we assumed when we set price limits.
• Changes in the level of customers' debt and the costs of managing customers' debt, as a result of the companies no longer having the ability to disconnect domestic customers for non-payment of bills.
• Companies' increased administrative costs resulting from the operation of the statutory scheme to abate metered charges for domestic customers that are members of vulnerable groups.

If companies are unhappy with the price limits we set they can ask us to refer their determination to the Competition Commission. This applies at either a periodic review or at an interim determination. Appeals to the Competition Commission must be made within two months of us making our decision. The Competition Commission aims to make its decision within six months, but can seek an extension of a further six months.

For further information
Contact our Library.
Telephone: 0121 625 1361
E-mail address: enquiries@ofwat.gsi.gov.uk