ࡱ> 8Root Entry` F`Sey`v`WordDocumenty ve ;p((`@,oCompObj(`v jSummaryInformationv A(`y :  !"#$%&'H?ABCDEFGIJKLMNOPQRSTU9@)@0 @dF@>+v+՜.+,0HPt|  Dell Computer Corporation] Slide 1 FMicrosoft Word Document MSWordDocWord.Document.69qOh+'0 ( P \ h tSlide 1Preferred CustomerNormalPreferred Customer12Microsoft Word for Windows 95Root Entry` F`SeyVv`WordDocumenty ve ;p((`)qtCompObj(`v jSummaryInformationv A(`y :(  !"#$%&'1*+,-./0234567;<=>VWXYZLPT1 ,,0000<WX?EHE N  "#&'(KL*0##:$D$02!244 55555@AVAVAVAAAVAVAAVA!AVAKAWA@AWAAgAW@AW@AA"AWAWAW@WAWAc@@AW@A,WAOA2WAAA3W@AbV@&ArV@?'A3A|V@5@BW@7ACW@7@7@71Times New Roman Symbol &Arial"qh{C1Z&S +rt, J.R., Cuthbert, M: How the Strategic Review of Charges 2002-06 Casts a Long Shadow over Future Water Charges in Scotland: Fraser of Allander Institute Quarterly Economic Commentary, Vol 30, No.4: (2006). This paper identified five specific errors in the strategic review for 2002-06, and showed that the near 1 billion overcharging over the period 2002-10 can be assigned to the following factors. Failure to adjust RAB limit for inconsistency in basis of depreciation in SR2001154.3mError in Calculation of Infrastructure Renewal180mExpensing Infrastructure Balances Error172.8mError in Double Counting IRE in the RAB Limit180mSR 2006-10 Financeability Adjustment253.7mTotal940.8m It is not our intention in this paper to go into the technicalities of these factors- full details can be found in the paper, which can be accessed at www.cuthbert1.pwp.blueyonder.co.uk. 5. For a picture of what is going on, it is worth looking at the following chart.  The upper line in the chart shows water revenues for Scotland as projected in the two strategic reviews. The lower line in the chart is labelled RCV, corresponding to Regulatory Capital Value. To understand the chart we need a short digression on the RCV method of setting regulated utility prices. A version of the RCV approach is used by OFWAT to set water prices in England and Wales, and this has been adopted in Scotland to provide the basis for strategic review 2006-10, although actual charges for Scotland 2006-10 were substantially above those implied by this basic RCV model. The version of the RCV approach used by OFWAT and in Scotland says that charges should be set to cover operating costs current cost depreciation a return on the capital employed by the industry. We will show that this version of the RCV method in itself implies very substantial over-charging. 6. From the chart, we can see how a). even relative to the RCV method, the actual path of water revenues in Scotland involves substantial over-charging: in fact, the cumulative gap between the two lines in the chart amounts to some 660 million. b). the Scottish Executive have attempted to claim great credit from the stability of water charges in Scotland over the period 2006-10. But we can see that this stability simply amounts to allowing past over-charging (relative to the RCV method) to be worked out of the system: and once revenues are back on the RCV track by 2010, prices will rise sharply again. 7. Now let us look at some of the consequences of this situation. a) Overcharging - as already noted there has been over-charging by approaching 1 billion over the period 2002-10. b) Water as a new Tax: The over-charging has meant that the Scottish Executive has been able to redeploy substantial amounts of public expenditure provision from the water budget to other programmes: the exact amount is unknown, but is probably 500 million. In effect, the Scottish Executive has been using high water charges as a new form of taxation to fund other programmes. c) Restrictions on Capital Investment: Because of the transfer of provision, (that is, borrowing consents), out of the water budget, much new capital expenditure now has to be financed from charges: so if price rises are to be restrained, (as they have been in the strategic review for 2006-10), capital expenditure must be restricted. d) An industry ripe for privatisation, where the public sector model is perceived as failing, because of high charges, now and in the future the constraints on housing and industrial development, and other problems like inappropriately sited sewerage works, all of which are related to restrictions on capital. Reaction to our Findings 8. It is very instructive to look at the official reaction to our papers. But first and foremost it is important to note that none of our specific charges has ever been individually rebutted. The official response has involved the following assertions:- net new capital formation is funded from borrowing - but the outturn figures contradict this. the charging regime in SR 2002-06 was dictated by the available public expenditure - but this has been disproved by subsequent transfers of public expenditure provision out of the water budget. the Treasury, in a letter, said the Scottish Executive had applied Resource Accounting and Budgeting (RAB) correctly in the 2002-06 strategic review of charges - but the Treasury subsequently admitted that the letter did not apply. the charges in strategic review 2002-06 were justified by the need to meet a sensible target on a particular financial ratio, the interest cover ratio - but we subsequently established there had been a mistake in the calculation of this ratio. charges in SR 2006-10 are justified by the need to meet OFWAT targets on certain key financial ratios - but, given that for a publicly owned body such as Scottish Water different sources of funding are available than those available to private firms, private sector ratios cannot be translated unmodified to a public sector body. The Flaws in the RCV Method, Leading to Pressures for Privatisation 9. While the Scottish Executive has not been able to disprove any one of our points, the tone of outraged innocence in their denials in itself tells us that basically they believe that they are doing the right thing, by implementing the RCV method as used by OFWAT. Perhaps they might think that there was a bit of an initial wobble, but now things are back on track: and that all they have to do now is hold tight and everything will settle down. If this is the Scottish Executives basic position, then it neglects two important points:- a) in the short term, there is a very difficult corner still to turn, as water prices inevitably start to rise faster than inflation after 2010. Public dissatisfaction will be open to vested interests pressing for privatisation. b) but more fundamentally, they are neglecting the basic problem with their version of the RCV method, which is that high charges, and unjustifiably high returns on capital, are inherent to the application of this approach. A proof of this, based on financial modelling, can be found in the paper Cuthbert, J.R.: How the RCV Method Implies Excessive Returns on Capital Expenditure on our website and on the OFGEM website. In effect, the RCV method as applied in Scotland, or by OFWAT in England and Wales, inevitably turns the water industry into a huge cash cow. 10. The fact that this particular variant of the RCV method of utility pricing turns utilities into cash cows can also be demonstrated by looking at the performance of the water industry in England and Wales, where this method has been applied since the mid 1990s. The table below shows how much the private owners of the water companies in England and Wales have been able to take out in dividends each year, as a percentage of the amount of capital they originally put in. The returns, as can be seen, are totally disproportionate. Water and Sewerage Companies in England and Wales Dividends as percentage of amount of capital available to companies because of issue of shares. 1996/9722.2%1997/9834.5%1998/9932.4%1999/200018.6%2000/0119.3%2001/0213.9%2002/0323.5%2003/0418.4%2004/0518.6%source: derived from OFWAT, Financial Performance of the Water and Sewerage Companies 11. In Scotland, however, there is no private owner to take out these large profits: but as long as the Scottish Executive insist that the current method of RCV pricing is applied in Scotland, customers will be overcharged, and a huge financial surplus will steadily accrue within Scottish Water. The Executive will obviously be very keen to get their hands on this- but their options are, in fact, limited. They will be able, in due course, to further run down Scottish Waters borrowing consents: but since these borrowing consents are only 182 million per annum at present, there is actually limited provision here for the Executive to pocket. If the Executive starts paying itself cash dividends, customers will rapidly realise that water is being used directly as a new tax- and they, and probably the Treasury too, will have something to say about this. So at some point, the Executive will inevitably yield to the temptation of cashing in by selling off Scottish Water to the private sector: by doing this they will secure a one-off payment of several billion pounds. The private sector will be only too willing to oblige: they will then be able to profit from the excess returns guaranteed by the RCV approach, in the same way as currently happens in England. The losers will be the Scottish public, who will face a future of unnecessarily high charges for water, and will lose control of an asset which is becoming increasingly vital both economically and socially. 12. One argument which has been put forward is that the Scottish Executive will have inadequate resources to afford to maintain Scottish Water in the public sector in the longer term. This argument is in fact precisely the opposite of the truth: financial modelling shows that Scottish Water is emminently affordable in the long term as a public sector body, well within the Executives current level of public expenditure provision for water. The long-term pressure for privatisation will be the temptation for the Executive to cash in on the financial surplus which Scottish Water will generate. 13. So how, in the light of this gloomy scenario, can privatisation be avoided? The key will be to mobilise public opinion against the excesses of the RCV approach as it is currently being implemented in Scotland and England. This will be no easy task, given the powerful vested interests, and the profits, that will be threatened. But perfectly acceptable alternatives do exist to the flawed version of the RCV method currently applied in Britain: and the rewards of a successful campaign against the RCV approach will be substantial- in the shape of lower water charges, both in Scotland and in England and Wales- and also in the shape of guaranteeing the continuance of the water industry in Scotland in public ownership. PAGE  PAGE 5  .AF:d >?9-#77     T  """)))UUUMMMBBB999|PP3f333f3333f3ffffff3f̙3ff333f333333333f33333333f33f3ff3f3f3f3333f33̙33333f333333f3333f3ffffff3f33ff3f3f3f3fff3ffffffffff3ffff̙fff3fffff3fff333f3f3ff3ff33f̙̙3̙ff̙̙̙3f̙3f333f3333f3ffffff3f̙3f3f3f333f3333f3ffffff3f̙3f3ffffffffff!___www45'  Arial$- Arialri-"Systemn-'- T -'- T - "-  $` `  "-` `  "--""SS` ))44??JJUU` ` "---'--- C ---'--- a ---'--- m - "- 'H9)*4)4G?BJPU` .?JU` - '1 HR(>9)C3/*44> * $ $  $() $)3)4 $4 >!*!4 G?- "-  TL<4 "- G?=5G?QIG?Q5G?=IBJ "- OW7? "- BJ8@BJLTBJL@BJ8TPU "- ]bEJ "- PUFKPUZ_PUZKPUF_` "- m U "- ` V ` j ` V ` j .? "- ;L#4 "- .?$5.?8I.?85.?$I.?$?.?8?J "- W? "- J@JTJ@JTJJJJU "- bJ "- UKU_UKU_UUUU` "- m U "- ` V ` j ` V ` j ` ` ` ` ---'--- a ---'--- T ----'--- 9 6  N2 H/Revenues from Strategic Reviews, and RCV Method0%%%))%%)<-%%)%0%%%5%%))00-9%)))---'--- T ---'--- T ----'--- T   2 700 2 750 2 800 2 :850 2 l900 2 950 2 1000 2 1050---'--- T ---'--- T  2 2001/02 2 2002/3+]+]$?Slide 1Preferred CustomerPreferred Customerܥhc ,e7qt4bbhhhhhijhiiijj"is16j6j"XjXjXjXjXjXjxmzmzmzm=mQopsX2t? qhXj,-XjXjXjXj qjhhXj6jjjjXjXhXjhXjxmVvh 4h6hhhhXjxmjj Water: The Birth of a Cash Cow. Why water privatisation in Scotland is inevitable unless we rethink the basis of utility pricing. Jim Cuthbert Margaret Cuthbert Introduction 1. In this paper we show how mistakes which have been made since 2002 in setting charges for the publicly owned water industry in Scotland, together with the introduction of an inappropriate model for setting water charges in the future, have turned the water industry in Scotland into a virtual cash cow, and have unleashed forces which will make water privatisation in Scotland almost inevitable. The inappropriate model being introduced in Scotland is in fact a version of the model used to determine water charges in England and Wales and that method too shares the fundamental flaws we have uncovered. It will therefore be difficult to change the model in Scotland without instituting a basic rethink on how utility prices should be set. This will have major implications not just for Scotland, but for the rest of the UK and quite possibly for some other countries. But it is our view that without such a fundamental rethink, Scotland is on a track which will inevitably lead to water privatisation. Background 2. Let us start with a little background: this is important, because we need this background to understand how there is something very peculiar about water finance in Scotland. It is a normal rule of thumb as regards the funding of capital expenditure that a) depreciation, that is, the using up of capital assets, should be funded out of current charges on consumers. b) the rest of capital investment, that is, net new capital investment, should be funded out of borrowing. Gross departures from this rule of thumb, in either direction, should set alarm bells ringing:- If the first rule is breached, that is, if depreciation is funded by borrowing, there is a danger of a runaway cycle of borrowing. But if the second is breached, that is, if substantial amounts of new capital assets are being funded out of todays charges, then this amounts to asking todays customers to subsidise tomorrows consumers. There is then a risk of unjustifiably, and damagingly, high prices today, and the principle of inter-generational equity breaks down. 3. In early 2003, there was considerable disquiet in Scotland about high water charges. We have looked into the arithmetic of the Strategic Reviews of Charges for 2002-06, and 2006-10, and found that there was clear evidence that the second principle in the previous paragraph was being breached. On the basis of outturn figures for the period 2002-2006, and of the projections in the Strategic Review of Charges 2006-10, almost 1 billion of net new capital creation will have been funded out of revenue, that is from current customers, over the period 2002-10. In other words, there is a good prima-facie case for saying that water customers will have been overcharged by about 1 billion over this period. The Original Mistakes 4. In the course of our investigation, we found that basic mistakes had been made by the Scottish Executive in the strategic review for 2002-06 in the application of a new system of financial control, called Resource Accounting and Budgetting, (RAB). The definitive account of what went wrong with strategic review 2002-06 is given in our paper, Cuthbe 2 2003/4 2 2004/5 2 2005/6 2 2006/7 2  2007/8 2 2008/9 2  2009/10 ---'--- T ----'--- '  Arial$- 2 "m- ---'--- T - MX Arial- 2 g SR 2002-06-0%%%%%%----'-- - T - 2 * SR 2006-10-0%%%%%%----'-- - T A?-  2 N]RCV00-----'-- - T - --'- T -'- T --' T  '  -4'exploitation by Executive under the current RCV method 5 .Atwo factors have combined to . These factors are, first, the and secondly, .,forBudgeting between 2002 and 2010while , from the chart 5 .Ac rBdw? Q!!0"1"2"6"7"""##$Z((p++,,77777777777777bVrV|VVVVVVVVVVVWWWWWWWWWuPaP uDPuD8UV^U^Z!^ m  &'OWXl >"(+RSvKo>wxQz z *z *z *z z z z z z z z z z z z *z `z z z z  S 4  4l >" ,,HP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1 ,,6262622#$N$X$26255"5#5'5(5)5pDocumentSummaryInformation8 @ O!!1"""##$%;& 'J((Y)Z)p+++, ,,z *z *z *z Ez `z *z Ez Ez Ez `z z z z z z z z z z z z z v 4  4  4,,, ,!,),/,0,:,@,A,I,O,P,X,^,_,g,m,n,v,|,},,,,,,2255777777777vvvvvvvvz z z z z z xz `%l  F(K@Normala c"A@"Default Paragraph Font@TOC 1a  @ Footer 9r )@ Page Number48!!!!! ,@)4o bV,,7-./0 !! %%%%0044447VWCWz qbVp&qrVp?'p|Vp5pVp7qVp7p7p71Times New Roman Symbol &Arial"qh{C"SS }r*\+_$?Slide 1Preferred CustomerPreferred Customerܥhc e7,o5bbffffffjf"ffff f"fdn1ff"ffffff.j0j0j0j=mjlmnXn?mff,-ffffmfgfffffgfgfgf|ffff.jf 4f6fffff.jfgfg Water: The Birth of a Cash Cow. Why water privatisation in Scotland is inevitable unless we rethink the basis of utility pricing. Jim Cuthbert Margaret Cuthbert Introduction 1. In this paper we show how mistakes which have been made since 2002 in setting charges for the publicly owned water industry in Scotland, together with the introduction of an inappropriate model for setting water charges in the future, have turned the water industry in Scotland into a virtual cash cow, and have unleashed forces which will make water privatisation in Scotland almost inevitable. The inappropriate model being introduced in Scotland is in fact a version of the model used to determine water charges in England and Wales and that method too shares the fundamental flaws we have uncovered. It will therefore be difficult to change the model in Scotland without instituting a basic rethink on how utility prices should be set. This will have major implications not just for Scotland, but for the rest of the UK and quite possibly for some other countries. But it is our view that without such a fundamental rethink, Scotland is on a track which will inevitably lead to water privatisation. Background 2. Let us start with a little background: this is important, because we need this background to understand how there is something very peculiar about water finance in Scotland. It is a normal rule of thumb as regards the funding of capital expenditure that a) depreciation, that is, the using up of capital assets, should be funded out of current charges on consumers. b) the rest of capital investment, that is, net new capital investment, should be funded out of borrowing. Gross departures from this rule of thumb, in either direction, should set alarm bells ringing:- If the first rule is breached, that is, if depreciation is funded by borrowing, there is a danger of a runaway cycle of borrowing. But if the second is breached, that is, if substantial amounts of new capital assets are being funded out of todays charges, then this amounts to asking todays customers to subsidise tomorrows consumers. There is then a risk of unjustifiably, and damagingly, high prices today, and the principle of inter-generational equity breaks down. 3. In early 2003, there was considerable disquiet in Scotland about high water charges. We have looked into the arithmetic of the Strategic Reviews of Charges for 2002-06, and 2006-10, and found that there was clear evidence that the second principle in the previous paragraph was being breached. On the basis of outturn figures for the period 2002-2006, and of the projections in the Strategic Review of Charges 2006-10, almost 1 billion of net new capital creation will have been funded out of revenue, that is from current customers, over the period 2002-10. In other words, there is a good prima-facie case for saying that water customers will have been overcharged by about 1 billion over this period. The Original Mistakes 4. In the course of our investigation, we found that basic mistakes had been made by the Scottish Executive in the strategic review for 2002-06 in the application of a new system of financial control, called Resource Accounting and Budgetting, (RAB). The definitive account of what went wrong with strategic review 2002-06 is given in our paper, Cuthbe 2 2003/4 2 2004/5 2 2005/6 2 2006/7 2  2007/8 2 2008/9 2  2009/10 ---'--- T ----'--- '  Arial$- 2 "m- ---'--- T - MX Arial- 2 g SR 2002-06-0%%%%%%----'-- - T - 2 * SR 2006-10-0%%%%%%----'-- - T A?-  2 N]RCV00-----'-- - T - --'- T -'- T --' T  '  -4'exploitation by Executive under the current RCV method 5 .Ac rBdw? Q!!0"1"2"6"7"""##$Z((p++,,77777777777777bVrV|VVVVVuPaP uDPuD8UV^U^K!^ m  &'OWXl >"(+RSvKo>wxQz z *z *z *z z z z z z z z z z z z *z `z z z z  S 4  4l >"@ O!!1"""##$%;& 'J((Y)Z)p+++, ,,z *z *z *z Ez `z *z Ez Ez Ez `z z z z z z z z z z z z z v 4  4  4,,, ,!,),/,0,:,@,A,I,O,P,X,^,_,g,m,n,v,|,},,,,,,2255777777777vvvvvvvvz z z z z z xz `%l  F(K@Normala c"A@"Default Paragraph Font@TOC 1a  @ Footer 9r )@ Page Number48!!!!! ,@)4o bV,,7-./0 !! %%%%0044447V)5V!!!!! ,@+))5o;#0$92)5z z  V,,7V-./02 !! %%%%0002625*5Preferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.doc@HP DeskJet 870C SeriesLPT1:HPRDJC03HP DeskJet 870C SeriesHP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1 WW,W2W3WBWCWDW]WuPa5DW!    ] C,)5Zo!^_jlH+F G ] S'LM;&'#$/$25z z z z z z z  z z z z z z z z z z z  z z z z z z z z z z z z z z z z z z z  W]W,3,7CW-./02 !!_ky | Vd%%%%45Preferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.docPreferred Customer3C:\My Documents\Water\neo liberal talk 8 9 2006.doc@HP DeskJet 870C SeriesLPT1:HPRDJC03HP DeskJet 870C SeriesHP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1 ,,HP DeskJet 870C Series7 d,,HP DeskJet 870C Series