╨╧рб▒с>■  8:■   7                                                                                                                                                                                                                                                                                                                                                                                                                                                ье┴q` Ё┐5bjbjqPqP .&::5      дшшшшшшш№Д Д Д Д Р №J╢и и и и и и и и ╔╦╦╦╦╦╦$hhвяш│и и ││яшши и YYY│vши ши ╔Y│╔YYшшYи Ь эгєyЭ╔Д ) Y╔0JY 3 YYP шй и HЁ ъY┌ ╝Ц и и и яяIи и и J││││№№№D@D№№№@№№№шшшшшш     The Need to Change Water Pricing in Scotland By Jim & Margaret Cuthbert The Water Industry Commission for Scotland is the quango responsible for setting the price of water. As the WICS website says "we set price limits Е that deliver the Scottish GovernmentТs objectives at the lowest reasonable overall cost." But does the WICS model really deliver at the lowest reasonable overall cost? We think not. Our research published this week in the Fraser of Allander economic commentary, advocates an alternative pricing model, which would mean cheaper water for business and domestic customers. The ability to rely on clean water at the turn of a tap depends on a very large ongoing capital investment programme. The WICS pricing method leads to a substantial amount of this new capital expenditure being funded direct from the pockets of customers. For example, over the period 2006-10, well over г400million of new capital expenditure is projected by the WICS to be funded by charges to customers. This will continue as long as the WICS charging method is applied. Funding large amounts of capital directly from customer charges violates basic principles of fairness. It means that customers in any one time period could be paying more than their fair share for capital goods which willаbenefitаnot them, but future generations This glaring anomaly led us to consider what would happen if the WICS pricing model were modified. Suppose customer-funded capital was considered as a notional loan from customers to Scottish Water? Customers could then earn a rebate, equal to a reasonable return on the notional loan. This approach is not merely fairer, but, it turns out, would also result in significantly lower water charges. We will spare you the algebra here, but our FoA paper shows that once the figures have been crunched, some striking benefits appear First of all, water charges in Scotland would fall rapidly. That part of water charges relating to the provision of capital assets could fall over a number of years to around 60% of its current level in real terms, with hugeаpotential benefits for the competitiveness of Scottish industry. This price reduction would be fully sustainable: Scottish WaterТs conventional borrowing would be contained well within the existing public expenditure provision in the Scottish budget. Under the present system, capital investment earns an unearned windfall for the company: this potentially distorts investment priorities. Our proposal would end any such distortion. Implementing the proposal should greatly reduce the capital charge paid by the Scottish government to the Treasury on the net assets of Scottish Water. This charge currently stands at an eye-watering г150 million from Scottish coffers. Also, under the present charging model, a significant financial surplus is likely to build up eventually within Scottish Water: indeed early signs of this may already be apparent in the grotesquely high bonuses paid to senior quangocrats, such as the г342,000 "contractual" pension top-up paid to departing Scottish Water boss Jon Hargreaves revealed in last weekТs Sunday Herald. Such a surplus would make the company a very tempting target for privatisation. Our proposal prevents the build up of such a surplus and so greatly reduces the likelihood of privatisation. Finally, our proposal would also be entirely consistent with World Bank guidelines on setting utility charges. So what are the origins of the price setting method currently used by WICS? In 1989 the water industry in England was privatised, under the regulator OFWAT, led by Sir Ian Byatt. OFWAT introduced a price setting model building upon principles of "current cost accounting" - which values asset at presentаprices rather thanаthe price they were bought for - set out in a 1986 Treasury report chaired by the same Ian Byatt. The method was introduced into Scotland when Byatt became chair of the WICS in 2006.аIt has also been introduced in other regulated utilities in the UK, for example, electricity distribution, airports, and rail. Earlier work by us in the Fraser of Allander Commentary showed that using current cost accounting to set utility charges means that the charge levied on the customer to pay for capital assets is actually larger than the funding cost of those assets. In other words, the utility operator earns a windfall profit on capital investment. In a privatised utility, these excess profits can be taken out as dividends. This indeed is precisely what has been observed in the privatised water industry in England, where it has not been uncommon to have dividend returns of 20% or 30% per annum on the equity capital actually invested in assets. The other main effect, of course, has been high prices. Anyone interested in the question of why utility prices in the UK are generally so high should startаby looking at how current cost accounting has been applied. Utility pricing is a massive economic issue for Scotland, and indeed for the UK: and it demandsаto be tackled. However, there is a major problem in that most utilities are privatised, and there is the strong vested interest of the equity owners to be overcome. But this does not apply in the case of Scottish Water: which is publicly-owned, with no equity owners. Correction Цаwe the customers are the owners. So far weаhave not been getting our due return on our investment in the assets of Scottish Water. We also have the advantage that, uniquely among all utilities, water regulation is devolved to Scotland. The Scottish Government therefore has the power to act to change the method of setting water charges in Scotland. 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