SUBGROUP ON ECONOMIC ISSUES
Thursday 7 December 2006
Members present:
Mr Wells (Chairman)
Mr Dawson
Ms Gildernew
Dr McDonnell
Mr McNarry
Mr P Robinson
Subgroup advisors
Mr Hewitt
Mr Smyth
Witnesses
Mr Sterling Department for Regional Development
Mr McCormick Department for Regional Development
Mr Pengelly Department of Finance and Personnel
Mr Simpson Department for Regional Development
The Subgroup met at 2.00 pm.
(The Chairman (Mr Wells) in the Chair.)
The Chairman (Mr Wells): Welcome gentlemen, and thank you for coming along. I am sure that you know most of the folk around the table. We would like you to make a brief opening statement, and then members will put questions to you.
Mr Sterling: I apologise that we have only been able to bring our presentation with us owing to pressure of work. I understand that we have 10 minutes for our presentation in order to allow the subgroup plenty of time for questions.
The subgroup asked us to consider the potential Budget deficit in the event that the water reform legislation and other revenue-related issues do not proceed or are deferred. We want to cover three issues. We will give the subgroup a very quick overview of the strategic and public expenditure context; we will talk about how we might set about estimating the impact of delay, and we will deal with questions at the end.
Mr Pengelly will set the scene as regards the fiscal outlook.
Mr Pengelly: I will spend a few minutes on the context and financial environment in which water reform will be taken forward over the coming years. At the moment the Treasury is leading the work on the comprehensive spending review, and its forecast for the coming three years is that public expenditure growth at UK level will be at a maximum of 2% per annum in real terms.
Application of the Barnett formula effectively sets an upper limit in respect of the implications for Northern Ireland. At best, if we are fully comparable, we can get 2%. However, some of that 2% growth will go into areas that are not comparable, such as the Ministry of Defence and the Home Office, or into areas that are only partially comparable.
Our expectation is that if a significant element of UK-level funding goes into areas such as health and education, we could be looking at real terms growth of between 0·5% and 1% for Northern Ireland via the Barnett formula.
Northern Ireland’s starting position is that it has a significant per capita lead in funding for services over England. Thus a population-based share through the Barnett formula means that per capita growth in Northern Ireland will always be less than the position in England.
Drilling that down to the next level, much of any consequentials that we get come through health and education. However, there are no Barnett consequentials for water because that sits outside the public sector in England. The extent to which we then need to fund water through the use of Barnett consequentials means that those consequentials coming in through areas such as health and education cannot go into health and education in Northern Ireland. This position, on top of the fact that we are starting from a position in which we cannot sustain comparability, further compounds the problem.
Mr Sterling: The water reform objectives that Ministers are pursuing are largely designed to address the problem we have with water; namely that we get nothing through the Barnett formula for water and sewerage services and that, therefore, we have to use our share of general taxation for water services.
The Government’s reform objective, as you probably know, is that the new company that they are planning to set up from next April should be self-financing by 2010. However, it is not just about financing. There is a desire to improve environmental and water-quality compliance; to improve customer service; and to do this by levying charges that are fair and affordable in comparison with elsewhere.
This, they believe, is a solution that will be cost effective in public expenditure terms and will produce an efficient business model as well. One of the by-products of the reform agenda is that as the new company starts to charge, the public-expenditure resources no longer needed will be available for allocation to other public services.
I now want to move to the meat of the presentation. It is difficult to give a straight answer as to how much a delay would cost, because we have not been planning for a delay in the introduction of charges and therefore it has not been precisely costed. Furthermore, we have not developed alternatives. There are major differences in how public expenditure rules apply to the existing agency and the way in which the new public corporation would be financed. That makes it difficult to cost alternatives.
In the existing agency the operating costs score as resource departmental expenditure limit, and the capital costs score as capital departmental expenditure limit. Non-cash charges, such as depreciation and cost of capital, are accounted for in annually managed expenditure. In other words, they do not affect the spending power of Northern Ireland Departments. However, that is a concession from the Treasury, which will run out if new domestic charges are not introduced by next April.
In contrast, the Government-owned company (Go-co) will score in public expenditure in a different way. The only thing that will score in resource departmental expenditure limit will be subsidy. Net lending — what the company borrows to fund capital investment, minus what it repays through borrowing — will score in the capital departmental expenditure limit. We will show how that works as we proceed with our presentation.
Mr P Robinson: What does the word “subsidy” mean in that context? Do you mean reliefs?
Mr Sterling: In that context, there would be three types of subsidy. First, there is the subsidy that will pay for the affordability tariff — the reduced tariff that will be available to low-income customers. Secondly, there is a pegging subsidy. As members know, the Government will peg the tariffs during the first three years to the average charge in England and Wales. Thirdly, there is a phasing subsidy — the charges will be phased in, with customers paying one third in the first year of charging and two thirds in the second. The term “subsidy” encompasses those three separate elements during the first three years of charging.
The way in which certain company costs will be calculated will differ because the company will be a Go-co, which, in public expenditure terms, will be classified as a self-financing public corporation. Capital investment, capital maintenance and the depreciation cost of capital charges will be calculated differently to the way in which those charges and costs are currently calculated because of the organisation’s current status as an agency within the Department for Regional Development.
The Government have concluded that the potential for efficiencies is much greater through the Go-co compared to running the service as an agency within Government. That conclusion is based on the strategic financial review of Water Service, which found that the organisation is much more likely to be efficient if it is outside Government and can enjoy commercial freedoms and flexibilities.
There will be some additional costs involved in setting up the new company, which the organisation does not incur now. For example, the new company will have to set up a new pension system and will have to purchase insurance rather than carry its own insurance as it does now as part of a Government Department.
The company will need to procure new internal systems to manage human resources, personnel, finance, and charging and billing. The affordability tariff is, in a sense, a new cost, and other transformation costs will be required to set up the new company and put it on the path to greater efficiency.
The table in our presentation shows the revenue sources for the organisation as an agency. The first line shows the resource departmental expenditure limit, which is going into fund the operating costs of the company. The next line shows the capital departmental expenditure limit being provided to the company for capital expenditure. The departmental expenditure limit subtotal is important, because it shows the amount of spending power available to the Northern Ireland Departments that is currently being consumed by the Water Service.
The next line below shows annually managed expenditure, which is not subject to annual control but is demand led. That expenditure covers depreciation and the cost of capital charges. At the moment, it does not affect the spending power of the Northern Ireland Departments, however, as Mr Pengelly has just said, it is a concession offered by the Treasury up to the point at which the company is set on the path to becoming self-financing. If we do not set up the company on a self-financing basis from April 2007, the concession will end, and the depreciation and capital charges will score in our departmental expenditure limit.
The next line shows the tariffs currently being paid by non-domestic customers, and there is a total for public expenditure requirements. The final lines show what we currently collect in the regional rate, broken down by domestic and non-domestic sectors.
The next table shows the current Budget allocations for the new company. The resource departmental expenditure limit, which is £153 million, covers the subsidy to the company in 2007–08. The capital departmental expenditure limit line shows the amount that it is projected the company will need in net lending. There is nothing shown in the annually managed expenditure line. The projection is that total tariffs collected next year will be £133 million. That is a combination of the approximately £40 million already coming from non-domestic customers, plus the new domestic and non-domestic charges.
The next table provides a comparison between what people in Northern Ireland pay in taxes and charges with what is paid in England, Wales and Scotland.
As regards the consequences of delay — I emphasise that we have not estimated exactly what the costs would be, for a variety of reasons that I will deal with. If the project is deferred, we would lose between £85 million and £90 million in revenue — the new revenue collected from domestic and non-domestic customers. Clearly, if there were to be a delay of more than a year, there would be knock-on consequences in subsequent years.
There is a strong likelihood that we would lose the reinvestment and reform initiative (RRI) borrowing concession, which allows Northern Ireland to borrow up to £200 million a year for investment in infrastructure. The company would stay within the Crown immunity regime; the European Commission has already begun infraction proceedings against us because the Department of the Environment (DOE) cannot regulate the company properly. The DOE’s advice is that if the company is not set up in April 2007, there will be a heightened risk of those infraction proceedings leading to infraction fines.
Any deferral could lead to constrained investment in the infrastructure, and other benefits to water customers and to other public services would be delayed.
Mr McNarry: What is the reason for the delays pending the threat of European infraction fines? Those fines were going to be imposed a few years ago, and they were to be hard-hitting. Why have they not been imposed?
Mr Sterling: The previous infraction proceedings concerned the non-compliance of a number of wastewater treatment works; the new infraction action was launched within the past six months. The European Commission has taken action against the UK Government because the environmental regulator — the DOE — is unable to regulate effectively. The primary reason for that is that, because the company is part of government, it enjoys Crown immunity.
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Mr McNarry: Have you a ballpark figure as to how much the fines might be?
Mr Sterling: I would not like to predict the amount, although I have heard numbers. I will not estimate how much they will be, nor will I estimate how long the infraction proceedings might take. As members of the subgroup will know, those proceedings can run on for several years.
Mr McNarry: Would DOE know the figure?
Mr Sterling: The DOE might have a better idea, but the Department for Environment, Food and Rural Affairs (DEFRA) takes the lead on the handling of infraction proceedings on behalf of the UK. However, if the subgroup so wishes, I will try to get a better estimation of the time risks and the risk of potential fines.
I would now like to refer to some of the nugatory costs that would arise if the reform was delayed. As the Government have been planning that Northern Ireland Water Ltd (NIWL) will be set up from next April, they have had to put a number of measures in train. A contract has been awarded for billing and charging, and a new contact centre has been established, recruitment to which has started. By next April, up to 200 staff will have been recruited to deal not only with billing and charging but with all contacts between Water Service customers and the company.
The Northern Ireland Authority for Energy Regulation (NIAER) is planning to appoint 15 new staff by next April, and the Consumer Council has already appointed five new staff to deal with water complaints. Major transformation and restructuring are ongoing in the Water Service, and, again, those are predicated on NIWL becoming a Go-co. Procurement procedures are under way to buy the corporate systems that I mentioned.
Slide 14 is titled “Time taken to develop alternatives?” It is difficult for DRD to estimate the public-expenditure implications of the delays without knowing how long they will last, and what alternatives, if any, might be advanced. For example, if the delay were to be for one year only, and it was intended to proceed with the reforms as planned, the accrued loss would be the sum of the lost income in the first year, plus nugatory costs, plus any delayed or deferred benefits, plus whatever might happen with the RRI borrowing concession.
If it were decided to abandon water reform and maintain the status quo, the costs would be factored in through, perhaps, a material increase in the rates and/or a reduction in spending on other services.
If the delay were to allow a review of policies and the introduction of different, although not radically changed, policies, new legislation would need to be developed. It might also require new consultation and impact assessments to be conducted. That could lead to uncertainty around the timescale for that.
Therefore, each scenario would result in different public expenditure and cost consequences, possible loss of the RRI borrowing power, the cessation of the Treasury concession, whereby non-cash costs score in annually managed expenditure (AME), and, perhaps, significant implications for rates.
It is worth highlighting that the Treasury has stated that funding the Water Service through the rates, rather than through direct charges, will result in capital charges scoring in the departmental expenditure limit. Perhaps Mr Pengelly can confirm that.
Slide 15 outlines an indicative timetable that speculates as to how long the legislative process might take if the Executive wished to review the policies and develop new proposals that required fresh legislation and consultation. I reiterate that the timetable is indicative, but it suggests that it could take two or more years to introduce reforms by a different means.
In conclusion, the Government are committed to introducing the charges on 1 April 2007 because of the current public-expenditure context, and because of the environmental and other benefits that they believe customers will get.
It is worth pointing out that it would be open to the Assembly to amend that policy in legislation, if it were able to finance any new proposals. Even with existing legislation, there is plenty of scope to amend policies by changing the Regulations.
The Chairman (Mr Wells): That has been helpful. Will you confirm that the three-stage charges that were announced last week, the household rebates for pensioners and the right to a water meter are all in line with what is in your presentation, and that, if they all go through, there will be no slippage?
Mr Sterling: That is correct.
The Chairman (Mr Wells): If you get your way, there are no implications for budgets.
Mr Sterling: That is correct. If the House of Lords passes the legislation on Monday, we will be on track to have the reforms, as I have described them to you, in place from next April — subject to finalising the business plan for the company. We are not projecting the public-expenditure consequences that are set out here.
Dr McDonnell: What if the legislation does not go through the House of Lords?
Mr Sterling: My understanding is that the Government have one shot at this. If the legislation fails on Monday, that is it. They would then have to try to take the draft Water and Sewerage Services (Northern Ireland) Order 2006 through Parliament again, but they would not be able to do so in time to have the new arrangements in place for next April. The Government’s prime objective is to have devolution in place by 26 March, in which case it would be up to the Assembly to decide what it wished to do with the legislation.
The Chairman (Mr Wells): Assuming that the legislation goes to the Privy Council, when will the various provisions commence?
Mr Sterling: Some provisions will commence at the beginning of January 2007. They are provisions to set up the company to prepare to operate from 1 April 2007. Other provisions must commence, too, to enable us, for example, to develop the affordability tariff, so that people who are entitled to it can do so by 1 April. A small number of provisions will commence on 1 January, but the vast majority will not commence until 1 April.
Mr P Robinson: Referring to the legislative timetable in slide 15, I notice that you have a very short period for consultation. I assume that two years is required for any piece of legislation?
Mr McCormick: Two years is considered to be optimistic. That is a better guide to the minimum timescale.
Mr P Robinson: Thereforeit would be optimistic to expect an Irish language Act in place before March.
I wish to return to the fiscal backcloth that Mr Pengelly was painting, and in particular the forecast for UK growth and what may happen in Northern Ireland. I am confused as to where the Chancellor’s £35 billion fits into this. What assumption on growth has been made with that £35 billion? What difference would a variation of 0·5% make? You cited 2% growth for the UK as a whole, but that might only be 1·5%.
Mr Pengelly: The Chancellor’s £35 billion is predicated on flat growth in real terms; therefore, flat or zero growth in real terms for Northern Ireland.
Mr P Robinson: That was very generous of him.
Mr Pengelly: That is in the context of the Chancellor’s announcement of early settlements for some Whitehall Departments in March of this year, such as the Department for Work and Pensions (DWP) and the Chancellor’s own Departments that settled on a 5% reduction per annum in real terms. The Home Office has settled at flat cash, which is a reduction of about 2·7% per annum. Growth of 2% depends on where the money goes at UK level. If the bulk of that 2% real-terms growth, which is about 4·7% cash growth, went into areas such as health and education, Northern Ireland would expect to have between 0·5% and 1% growth in real terms.
However, that is by no means a given. International events mean that a great deal of that money may need to be skewed towards areas such as defence spending and towards the Home Office to combat international terrorism and crime. If money went there rather than to health and education, a Barnett formula could result in reductions in real terms for us. The Chancellor’s package offers a guaranteed minimum of standing still in real terms.
Mr P Robinson: The other question related more to what happens if we look at new policies. Can I suggest a “for instance”, so that people can bounce consequences back to me? If, for instance, the proposed system were retained, but a very generous relief or benefit system were put in place — with perhaps 50% or 75% of average bills to be paid out of the departmental expenditure limit — what would be the implications, particularly for the RRI? Could the RRI still be accessed under existing rules, and would the AME advantages be retained in those circumstances?
Mr Pengelly: We have never had complete clarity from the Treasury on that. However, we can define the two ends of the spectrum. At one end, the Treasury says that access to borrowing and the AME concession is conditional on moving to self-financing status. If self-financing status is total, it defines itself. There is acceptance that there may be some form of reliefs for low-income and affordability tariffs at the margins. However, we have never had a definitive engagement about the point at which it is no longer considered close enough to self-financing status for those concessions and that access to borrowing to be in place.
Mr P Robinson: What would happen if you decided to phase it in over seven years? You would still be moving towards self-financing status, although perhaps more slowly than the Chancellor might wish.
Mr Pengelly: Our interpretation is that the Treasury has accepted the phasing as currently structured. Treasury officials would see anything beyond that as a step backwards, away from the current agreement to move to self-financing status within a defined period. That would open up the question of access to borrowing.
Ms Gildernew: How was the figure of £1 billion reached for the regulatory asset base? The dividend of 5·8% proposed for the Go-co is above the allowed rate of return set by the regulator across the water. How can that be the case if Go-co carries less risk than a private company? Why has the dividend been set higher than the normal rate? What implication does that have for the relatively high local percentage of families on low incomes?
Mr Sterling: The Government carried out a strategic and financial review to look at the way in which the company might be set up and what its financial structure might be. That report was published last February, alongside the Government’s decisions on the report’s recommendations. The Government decided to value the company at set-up at £1 billion — the regulatory capital value (RCV) to which you referred. That will be the level of the Government’s investment of their resources in the new company.
DRD must comply with the public-expenditure rules set down by the Treasury. These require the Department to ensure that there is a rate of return for Government companies. The weighted average cost of capital or rate of return that has been prescribed in Government is 5·8%. You are quite right; the OFWAT rate of return is 5·1%. The justification is that there is a higher risk in the new company, and that higher risk justifies a higher rate of return.
You referred to the dividend. Within the rules for public corporations, DRD puts the investment into this company on behalf of Government.
We are required to extract a dividend from the company that is equal to the rate of return that it is allowed to charge on its capital investment. Therefore that dividend will be 5·8% of £1 billion, which is £58 million, and that is the Government getting their return on the investment that they have put into the company. I will look to Richard in case I get this wrong, but essentially the way in which the dividend rules work is that, if the company underperforms and finds itself unable to pay its dividend, or part of its dividend, the risk falls to the Department for Regional Development.
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In those circumstances, we would either have to approach the Department of Finance and Personnel (DFP) for more money to cover that shortfall in the dividend, or we would have to cut other services in DRD. Underperformance by the company in those circumstances would not have an immediate impact on customers.
You mentioned low-income customers. Government policies for dealing with those customers are contained in the affordability, or reduced, tariff, which is the guarantee that households should not spend more than 3% of their household income on water charges. That is why a special tariff, capped at £180 at the full amount, has been set. Those who are eligible would pay that tariff.
The Chairman (Mr Wells): Peter wishes to ask a supplementary question on that issue.
Mr P Robinson: I do not think that we got an answer — or at least a satisfactory answer — to the two specific questions that were asked. The first question concerned the figure of £1 billion.
Mr Sterling: Do you mean why the value of the asset was set at £1 billion?
Mr P Robinson: I presume that that figure was simply plucked out of the air.
Mr Sterling: The strategic and financial review recommended that the asset valuation should be £1 billion.
Mr P Robinson: Based on what?
Ms Gildernew: That does not answer the question.
Mr Sterling: It was based on analysis that the review team had conducted. The review team was a consortium that was led by Union Bank of Switzerland (UBS), the investment bank.
Mr P Robinson: Can we see that analysis? I rather suspect that the figure was plucked out of the air.
Mr Sterling: The'Financial and Strategic Review of Water Service' has been published and is available on the Internet.
Mr P Robinson: Can the breakdown of the Water Service’s assets be found in the review?
Mr Sterling: Nigel, perhaps you can answer that question.
Mr P Robinson: I am not simply talking about somebody saying, “This is the valuation”, and putting it on the Internet. That does not impress me at all. I want to see a breakdown of the facilities that are available to the Water Service that arrive at that figure.
Mr McCormick: The strategic and financial review reviewed the business, the assets and the business risks of the Water Service becoming the Go-co. It then considered how those business risks might materialise, and what capital might be required to ensure that the business continued to be financially sustainable. It examined all the issues surrounding the type of capital structure that would be required to enable a business to be self-financing.
The 'Financial and Strategic Review of Water Service' is quite an extensive document. It could not be easily summarised in a couple of sentences; quite a lot of analysis is required. As I have said, a consortium led by UBS undertook the strategic and financial review. That consortium identified a high-to-low range of regulatory capital value (RCV) for the Go-co. In its judgement, that valuation was about £1 billion. That does not answer directly every specific question that you have asked, but I probably could not do that in a couple of minutes.
Mr P Robinson: The Department clearly did not really challenge how unhelpful that valuation was.
Mr Sterling: We are here under strict instructions to explain Government policy. We cannot state a departmental view. I am sorry that I cannot be more helpful than that.
Dr McDonnell: Chairman, was Government policy not to challenge something that was inaccurate? I have had somebody assess the asset value of the Go-co, and I have put that assessment on the table, and it would have been more appropriate for the figure to have been set at £350 million, which is a little over a third of the Go-co’s current valuation. That valuation is as good as the valuation of £1 billion, for the Department would still receive a third of the £58 million dividend from it. Sorry, Peter.
The Chairman (Mr Wells): You interrupted a question.
Ms Gildernew: I agree with Peter — that did not answer the question. I still do not really know whether we have heard a fair assessment of where we are at. If the dividend is there to provide the Department with a return, the public are going to have to pay for that entire dividend. If the 5·8% dividend brings in £58 million, ultimately the Department will have put nothing into the company. It will have put in the initial funding, and then withdrawn it from the public coffers. It will reap the benefit without having to pay anything. The Government are taking no risk.
Mr Sterling: DRD is taking a big risk. If the dividend is not paid in full, the Department will have to make up the shortfall, either by asking the DFP to bail us out or by cutting services elsewhere; for example, in roads or public transport.
Ms Gildernew: I still do not understand how it has been calculated that £58 million must be clawed back from the public. You are talking about the risk to the Department — the risk is still with the public. The public will have to carry the cost.
Mr Sterling: The Department is a manifestation of, and represents, the taxpayer. The £58 million is the return that Northern Ireland taxpayers will receive for their £1 billion investment in the company. Perhaps Mr Pengelly can explain this better.
Mr Pengelly: The Go-co is valued at £1 billion, and that amount is being invested in the water company. Given a different set of ministerial decisions, that money could be taken from the water company and invested elsewhere. The company must generate a return, but that return is available for the Government to redeploy.
Mr Sterling talked about the implications of underperformance. However, if the company over-performs to the tune of, say, £10 million, that sum would become available to Ministers for reallocation to other public-service priorities in Northern Ireland. There is a risk to services, but there are also rewards.
Ms Gildernew: However, such a reward will not go towards a water-charges rebate.
Mr Pengelly: That would be a decision for Ministers. They could decide to spend it in that way, or they could invest to offset pressures in health, education or other public-service priorities.
The Chairman (Mr Wells): Mr McClarty and Dr McDonnell want to ask further questions. Sorry; I meant to say Mr McNarry. Have the possible effects of non-compliance — a withholding campaign or non-payment of water charges — been factored into the figures?
Mr P Robinson: They will not get Bob’s money.
Mr Sterling: DFP is working with the Water Service to develop a strategic business plan. In that plan, we will be making assumptions on levels of bad debt, and so on. We have not yet finalised that.
The Chairman (Mr Wells): That plan would be based on normal levels of bad debt that any utility might expect. Has the effect of a campaign for withholding payment been considered?
Mr Sterling: We must take account of political realities. However, through the affordability of the reduced tariff, we will be providing considerable protection to the 200,000 least well-off households in Northern Ireland — one third of all households. It is very hard to predict what the impact of a non-payment campaign might be, but we are taking into account all the factors that we believe to be relevant.
The Chairman (Mr Wells): Mr McNarry has a question.
Mr McNarry: Thank you, Francie. That is kind of you.
Slide 5 of your presentation mentions “anticipated pressures”. I must ask a hypothetical question: if there were to be efficiency savings in education, what relief would those have on the pressures that are being talked about? Correct me if I am misinterpreting the Chancellor’s pre-Budget speech yesterday, but if he did say that education here were to receive an extra £6 million — without conditions — would that have an impact on the pressures on education? The reason why I ask that is that the pitch being made to the subgroup is based on pressures. Good management would strive to alleviate those pressures as far as possible.
If those two factors were to kick in, what effect would they have? Would it amount to small beer, or is it the argument that such a contribution is necessary from the public because the pressures are so strong?
Mr Pengelly: Rather than going through the specifics, we are dealing with matters on a more strategic level. The key points at the strategic level in the health sector in particular are —
Mr McNarry: Skip health for a minute and stick to education.
Mr Pengelly: As part of our work on the 2007 comprehensive spending review, we are actively seeking efficiencies in education and all other sectors to the tune of approximately 3% per annum. That is initially designed to remove the hard edge from some of those pressures.
However, we know that the demographics of the education service, and other services, will create pressure as we proceed. At the same time, declining pupil numbers and rationalisation of the schools estate will create opportunities for savings. There is scope to lever out efficiency savings that will make a contribution.
Mr McNarry: Do you have some figures on efficiency savings? You refer to making efficiency savings, so can you tell me what the figure is?
Mr Pengelly: I cannot give specific figures. As a general approach to the strategic management of public expenditure, we are trying to squeeze out all possible inefficiencies from all services. That will apply as equally to education as it will to health services and to DRD services.
Mr McNarry : Is it not possible to put a figure on the cost of turning around the inefficiencies of the Department of Education? Turning those inefficiencies around would make that Department more efficient and would make a saving. Are you telling me that you have some figures that say that the Department is inefficient to the tune of £X?
Mr Pengelly: We certainly cannot quantify the extent to which a particular service is inefficient, and we are not saying that any one service lacks efficiency. However, there is scope for all services to become more efficient without us making a judgement call as to how efficient or inefficient they are.
Mr McNarry: It was wishful thinking on my part for some figures to be available.
Mr Pengelly: Looking at the strategic level, many of the efficiency savings in education will flow from fundamental infrastructural changes. However, those savings cannot be captured quickly, because they are medium- to long-term savings.
I apologise for going back to health, but demographic issues apply to that sector. In particular, an ageing population will put massive pressures on funding for health services. Given that health expenditure accounts for more than 40% of the block, there are implications for education, roads, water and all other services.
Mr McNarry: Am I right? Did the Chancellor say yesterday that £6 million will be available unconditionally for education? What difference would that make?
Mr Pengelly: Are you asking what difference that would make overall? That sum applies for just one year.
Mr McNarry: You are making a pitch on pressure; what difference would £6 million make to that pressure?
The Chairman (Mr Wells): You need to stick to the issue of water; we are drifting a bit.
Mr McNarry: I am discussing water issues. Mr Pengelly is saying that those reforms are being introduced to alleviate pressure on health and education spending.
Mr Pengelly: Those reforms are designed to alleviate pressures in the long-term strategic view. Yesterday’s pre-Budget report dealt with 2007-08; however, the reforms and the pre-Budget report do not necessarily deal with the same issues.
Mr McNarry: What billing arrangements have been made? Have any contracts been agreed or entered into? Are there any associated costs?
Mr Sterling: Yes. A seven-year contract has been agreed. It will provide billing, charging and customer-contact-centre services for domestic and non-domestic customers. If a decision were taken not to proceed with domestic charging, costs would be incurred, in that the contract would have penalty clauses that the company could cite.
Mr McNarry: Would there be provision for metering in that contract?
Mr Sterling: Yes.
Mr McNarry: Is the metering aspect of the contract written in general terms only?
Mr Sterling: Government policy is that, from April 2007, a meter will be installed in all new properties and for all new connections. Pensioners — those who are aged 60 or over — will be able to choose whether to have a meter. If a meter does not suit their circumstances and they let us know within a year, they will no longer be metered.
The Government have also said that there should be another review in two years’ time to define how metering should be rolled out further. The Government’s overall policy is that there should be a long-term transition to widespread or universal metering.
Mr McNarry: I picked up on what was said about new contracts and new builds. For some years now, developers of new builds have made provision for metering. Will that be taken up? Will people who can have access to a meter use it? Technically, everything is provided: people just need to have it connected. I understand that there are thousands of homes in that position.
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Mr Sterling: That is correct. I believe that all new builds since 1994 have contained that provision.
The Chairman (Mr Wells): We must be careful. The subgroup is not tasked with having a general discussion on water metering or bills; its task is to work out whether there will be any shortfall in public expenditure if there is a delay in introducing water reform. I knew that this would happen, because it is an emotive issue. However, the subgroup must keep within the confines of what it is here to identify.
Mr McNarry: If there were a failure to proceed with the existing legislation that is before Parliament, would that result in a loss on RRI borrowing?
Mr Pengelly: As Mr Sterling said in the presentation, we have not planned for deferral. Our position is that of a couple of years ago when the Treasury made it explicit that access to RRI borrowing was absolutely conditional on the introduction of water charging.
The Government’s position is that water charging will be introduced in 2007-08. If there were to be any slippage, we would be obliged to have a discussion with the Treasury. Its position has always been that any deferment would have serious implications for access to borrowing. However, we have not had a definitive conversation on that, as we are not planning for deferment.
The Chairman (Mr Wells): Surely you should be able to identify a figure, because you know what borrowing entitlement the income figures being discussed would achieve.
Mr Pengelly: It would affect access to the full £200 million. The Treasury line is that, at present, Northern Ireland can access £200 million. The ability to access any of that money would lapse were we not to proceed with water charging.
The Chairman (Mr Wells): Therefore it is £200 million.
Mr McNarry: We knew that it was £200 million.
The Chairman (Mr Wells): Is it no more than that?
Mr Pengelly: It is limited to £200 million.
Dr McDonnell: Much ground has been covered. Forgive me if I digress slightly, but it is very hard to stick to a single dimension of an issue. If one tries to probe at all, one tends to probe a little bit further.
I wish to return to the point about the valuation of the company, and what one can infer from that. I remain deeply concerned about the company being overvalued. Has any comparison been made with the privatisation of electricity here?
Mr Sterling: Not specifically. However, the consortium that dealt with the valuations examined those of other water companies, certainly in England and Wales, and, I believe, in Scotland.
Dr McDonnell: Was that valuation in respect of pipe work only or were elements such as goodwill taken into account?
Mr Sterling: RCV is a valuation of the business in its entirety rather than of its assets. Water Service’s accounts show that its assets are valued at a replacement cost of £5 billion to £6 billion. However, that, in a sense, is not a valuation of the business. The RCV is an estimation of the value of the business, and the rate of return is the determination of what is a reasonable amount that that business should earn.
Dr McDonnell: You said that, from April 2007, all new houses and pensioners would have access to metering. If I want to have access to metering from April 2007, can I have it?
Ms Gildernew: Yes; he is over 60.
The Chairman (Mr Wells): I am sure that he is not. Are you, Dr McDonnell?
Dr McDonnell: Chairman, I probe the issue because it will have an impact. If I were to install a water meter, I want to know whether that will cut my charge if I use very little water.
Mr McNarry: If somebody reads your meter.
Mr Sterling: The reason why meters might be attractive to pensioners is that they tend to have smaller households of one or two persons who would have lower-than-normal water usage. In those circumstances, a meter is likely to result in a lower bill. However, whether an average family would save money with a meter would depend on the value of the property in which they live.
The Chairman (Mr Wells): We must stop discussing such matters, because you will be appearing before a separate subgroup.
Mr Sterling: We are to attend next Wednesday, I believe.
The Chairman (Mr Wells): That subgroup will ask you identical questions about the mechanics of water rating, how meters will be read and whether rating is good value for money. Those issues have nothing to do with this subgroup.
Mr Sterling: I apologise.
The Chairman (Mr Wells): I realise that you are concerned, Dr McDonnell, but you should ask your colleague on that subgroup to raise those issues.
Dr McDonnell: Chairman, you are being very harsh and very cruel.
The Chairman (Mr Wells): I am, but we will be meeting next Thursday to spend hours going through the same process with the same people. We are only giving the officials some practice.
Dr McDonnell: Can I ask another question?
The Chairman (Mr Wells): Does it concern slippage?
Dr McDonnell: Are implications for staff outside this subgroup’s remit?
The Chairman (Mr Wells): Again, that belongs in the remit of the subgroup that will be looking specifically at water reform. The issue of redundancies, and so on, has nothing to do with the specific issue that we are discussing today.
Dr McDonnell: I was considering the issue only in the context of the valuation being a guesstimate.
The Chairman (Mr Wells): You can ask about the public expenditure that will be incurred by redundancies, which is within our remit, but not whether it is right or wrong that there will be redundancies.
Dr McDonnell: That is my point. I am not querying the rights or wrongs of redundancies but the cost of redundancies and the cost of the transition. Will public servants who currently work for the Water Service be moving to the Go-co? Will they still be public servants? Is there a significant cost implication?
Mr Sterling: Water Service staff are currently civil servants. On the date of transfer, which is 1 April next year, those staff will transfer to the Go-co under The Transfer of Undertakings (Protection of Employment) Regulations 2006 — the TUPE arrangements — and lose their status as civil servants. On the numbers question, we are still working on the strategic business plan, which will set out the financial parameters, and so on, for the first three years of the company’s existence. Such issues will be discussed as part of the business plan’s formulation.
The Chairman (Mr Wells): We can ask questions about those issues next Thursday.
Mr Dawson: I want to return to the valuation question and the figure of £1 billion. Did the consortium specifically recommend that figure or was a range of figures offered from which somebody had to choose?
Mr Sterling: My colleagues can keep me right on the detail, but the consortium’s view was that the company would be financially sustainable between £650 million and £1 billion. However, the consortium recommended that the valuation should be £1 billion. That is contained in the report, which, as I have said, is available on the Internet.
Mr Dawson: Therefore the company could have been sustainable at a figure of £650 million, had that decision been taken?
Mr Sterling: It could have.
Mr Dawson: That would have been a better scenario for consumers.
Mr Sterling: There are arguments for and against.
Ms Gildernew: Either £1 billion is paid back or just over half that amount is paid back.
Mr P Robinson: What answer is there other than yes?
Mr McCormick: The consortium’s concern was to ensure that the company was a financially sustainable business. The consortium’s view was that the figure of £650 million carried too much risk to ensure that it would be. If the business is not financially sustainable, that means that there is some sort of —
Mr P Robinson: Is a business more financially sustainable if it costs more?
Mr McCormick: Yes. If the business suffers some sort of financial shock, a new injection of capital is needed if it is not financially sustainable. The consortium said that, if the business were to be self-financing and sustainable, an RCV in the region of £1 billion was required. That was the consortium’s judgement.
Mr McNarry: Nice business if you can get it.
Mr Dawson: It sounds like the electricity issue all over again.
Slide 7 referred to the potential for greater efficiencies under the Go-co option. Those efficiencies seem to have been reflected in the costs. What are those efficiencies?
Mr Sterling: Do you mean the quantum of the efficiencies or how they are made?
Mr Dawson: I want to know the specific efficiencies and the cost to each.
Mr Sterling: I cannot give you the cost to each, but we expect efficiencies to be delivered in various ways, such as through better procurement, more efficient working practices, or simply by taking different approaches to doing things. There is a range of different ways in which we believe the company should become more efficient.
Mr Dawson: Are the Government prevented from choosing those different options in the current model?
Mr Sterling: The evidence shows that it is much more difficult to deliver that level of efficiency in Government, especially the closer a body is to Government. A body cannot be much closer to Government than to be a Civil Service agency. That is at one end of the continuum, with completely privatised companies at the other end.
The strategic and financial review concluded that the further the company is from Government and the greater the private-sector involvement, the greater the likelihood that the optimum level of efficiency would be delivered.
Mr Dawson: Have you included those efficiencies in the figures in slide 9, which give a total cost of £436 million?
Mr Sterling: Those allocations were determined in the 2005 Budget, so they do not necessarily reflect all the up-to-date work. However, by and large —
Mr Dawson: Based on that figure, is there £300 million of efficiency savings or difference in cost?
Mr Sterling: I hesitate to draw that conclusion, because we are not comparing like with like.
Mr Dawson: What conclusion would you like me to draw?
Mr Sterling: The main differences between the figures for 2007-08 and the figures for 2006-07 are as a result of the different public expenditure treatments — one shows the Water Service as an agency and the other shows it as a public corporation.
Mr Pengelly: The figures in slide 8 show £319 million for AME. AME is driven by an organisation’s asset base. As an agency, it has an asset base of £7 billion; as a Go-co, it is worth £1 billion. That is the biggest component.
Mr Dawson: Discounting that, what is the value of the efficiency savings that are reflected in the figures?
Mr Sterling: I am not sure that I have the figures to hand.
Mr Dawson: We are very clear about the difference as regards AME, so what are the efficiency savings?
Mr Sterling: Until the beginning of this year, the company had delivered about £18 million of efficiency savings against its 2003-04 baseline. By the end of this year, subject to meeting its targets, it will have delivered £25 million of efficiency savings. We have not yet finally settled the strategic business plan for 2007-08 to 2009-10, so the exact efficiency target that will be put on the company has not yet been determined.
Mr Dawson: Fine.
The Chairman (Mr Wells): You have lost me. I could, for example, create and build up a company and hand it to my son, telling him that it is worth £1 million. However, I may then decide that it is not worth £1 million; rather it is worth £600,000. Why would that company be any more or less viable as an entity because I decided that it was worth £600,000 rather than £1 million? Obviously, the knock-on effect of what DRD is doing is crucial because the decision that has been taken on the valuation of the assets is costing the taxpayer an extra £20 million a year in water charges. Why would the company be any less attractive or less viable if it was valued at £650 million rather than £1 billion?
Mr McCormick: It is not so much about whether or not it is attractive; it is about trying to establish a capital structure that would allow the company to be financially sustainable.
The Chairman (Mr Wells): Why would it be any less or more sustainable if I decided to value it at £650 million as opposed to £1 billion?
Mr McCormick: If, for example, its future revenues were considerably less than anticipated, it would need to have sufficient capital resources to draw on to enable it to continue trading without a new capital injection. In the case of a Government-owned company, such an injection would mean a call on public expenditure.
Mr Dawson: It would mean a call on public expenditure anyway. If it does not produce the £58 million dividend, you will have to fund it anyway.
Mr P Robinson: Does that mean borrowing against the value of the company?
Mr McCormick: No. Normally, when a company experiences a financial shock, ordinarily it must seek further investment to keep the company financially sustainable, and that would involve a call on public expenditure. The work on the strategic and financial review tried to establish a capital structure that would allow a company to continue trading after a financial shock without the need for a capital injection.
Mr P Robinson: I thought that it was supposed to be self-sufficient. Surely the call would not be on public expenditure but on the consumer.
Mr McCormick: That was the point: to ensure that the company would be financially self-sufficient so that it could absorb any financial shocks itself.
Mr P Robinson: I do not follow that logic.
Mr Wells: I am lost, but we have experts here who can no doubt explain the logic of this to us.
If Members have finished asking questions, I will ask our two advisers, Victor Hewitt and Michael Smyth, to enter the discussion.
3.00 pm
Mr Hewitt: The layperson will find the whole subject completely baffling due to a combination of public-expenditure rules, the way in which the company has been set up, the models that have been used, and so on. Therefore, I will attempt to clarify some points.
In your presentation you set out the differences between the agency and Go-co set-ups. As regards the Go-co, there is no reference to a capital charge against the Department. Is there no such charge against the Department in respect of the company?
Mr Pengelly: Do you mean a cost-of-capital charge?
Mr Hewitt: Yes.
Mr Pengelly: There is, but it does not appear in the presentation because it nets to zero. The cost-of-capital charge against the Department is offset by the extraction of the dividend.
Mr Hewitt: The dividend, therefore, will cancel out the cost-of-capital charge, and that is why you need the dividend to be paid across.
Mr Pengelly: Yes; and the extent to which the dividend cannot be paid would have to be met through the increased subsidy. Therefore, it is captured in that item.
Mr Hewitt: OK. In your presentation you provided a comparison of public expenditure requirements. Public expenditure is calculated net of receipts. However, you have included a tariff line in the table you have provided: are those not receipts?
Mr Pengelly: Yes.
Mr Hewitt: Should there not, therefore, be a negative against them?
Mr Pengelly: The table aims to show the full cost of running the Water Service.
Mr Hewitt: So, are we talking about gross cost rather than public expenditure cost?
Mr Pengelly: The figures on the first two lines of the table show the net departmental expenditure limit costs. The table is showing the full cost.
Mr Hewitt: Would the tariffs net off those departmental expenditure limit costs?
Mr Pengelly: A departmental expenditure limit resource cost of £118 million allows expenditure of £160 million.
Mr Hewitt: It appears that the Treasury is setting the rules in order to make the existing situation look extremely expensive for Northern Ireland and make the proposal for the Go-co attractive in public expenditure terms.
In a sense, therefore, retaining the agency format is being made to look like the worst-case scenario for the Province. Going down the other route is being made to look sweeter by such things as riding down the asset base from £5 billion or £6 billion to £1 billion, which you are charging on in the AME line in your table. Of course, you will be taking those charges through to the customer, which you are not doing at present.
Mr Pengelly: I have a contextual point to set against that — as regards the figure of £717 million and the agency context. That figure grows every year by a percentage uplift, however, we get nothing through the Barnett formula. That means that an annual uplift of 5%, 6% or 7% — where nothing is coming into the block grant to fund that increase — is the worst-case scenario, but that is because of the mechanics of the way in which Northern Ireland is funded.
Mr Hewitt: There was an interesting revelation that access to the borrowing requirement now depends on the introduction of water charges. Interestingly, the Northern Ireland Audit Office (NIAO) this morning published its analysis of the RRI in ‘Reinvestment and Reform: Improving Northern Ireland’s Public Infrastructure’. Helpfully, in appendix 1 to that report, the formula used to determine the RRI borrowing power has been published for the first time. No mention was made in the report that access to the borrowing requirement now depends on the introduction of water charges. Was the NIAO aware that that condition has now been imposed on top of the other conditions?
Mr Pengelly: I cannot say definitively. However, given the NIAO’s access to a range of papers when producing that report —
Mr Hewitt: So,they simply did not bother to mention it.
Correct me if I am wrong, but it appears that the consortium that advised on the Go-co considered it as though it were a private sector company. They asked themselves what asset base the company would require in order to be credible in the market situation. As Mr McCormick said, it serves as a buffer against bad times. It is a case of the shareholder picking up the tab by putting assets into the company. The question is whether it is an appropriate model to be applying in these circumstances.
It has been stated that the taxpayer is putting £1 billion into the company. As it stands, the taxpayer has put £5 billion into the agency. Short of privatising the agency and selling it off as a company, there is no way in which the taxpayer can recover any of that money. In what sense are the Government putting £1 billion into the company and applying private-sector required rates of return?
Mr Pengelly: With regard to the point that the investment capital is already there — that there is a current asset base of £7 billion, which is coming down to £1 billion, I agree that there is not £1 billion of additional money going in at this point. However, there is £1 billion of taxpayers’ equity in this organisation.
Mr Hewitt: Which one cannot get out, short of actually selling it.
Mr Pengelly: Regardless of that, in the UK public expenditure context, the fact that £1 billion of UK capital is tied up in an organisation means that there must be a return, to reflect the fact that the capital is sitting in that place as opposed to another.
Ms Gildernew: But taxpayers here paid that money. It is not as though it was a handout from the Exchequer. We pay taxes too.
Mr Pengelly: Yes, but it was funded from UK general taxation — the funding was made available to Northern Ireland through a formula. The £58 million, which is the return on that funding, will come from the people who will pay water charges in Northern Ireland. That money will come to Northern Ireland and will be available to Northern Ireland.
Mr McNarry: Are we allowed to ask if this is a set-up for privatisation? It looks ripe for that.
Mr P Robinson: Are you expecting to get an answer to that question?
Mr Sterling: David Cairns would want me to say this. He would want me to repeat —
Mr McNarry: He told Stephen Nolan all this. I heard that.
Mr Sterling: He said that it was unthinkable that this company would be privatised within five years. In saying that, he took account of the fact that he could predict only for the next three years. The Labour Party is only going to be in power for three years before there is a general election. That comes on top of the Secretary of State’s statement in which he said that it would be unforeseeable that there would be privatisation and that he has no plans for privatisation.
Mr McNarry: That is not what I asked. I just asked if the company was being set up for privatisation.
The Chairman (Mr Wells): Mr Cairns did not say what was going to happen in year six.
Mr Smyth: I have a couple of questions. First, you mentioned that the dividend of 5·8% was set higher than that of similar water companies in Britain because of the higher risk involved. It is not immediately obvious why that should be. How can you justify such a high dividend when the Go-co must be less risky than a private company?
Secondly, could water charges be construed as a new income stream with respect to the RRI? If so, would it be possible to borrow against those for investment purposes instead of investment having to be funded from the block grant?
Mr McCormick: As Mr Sterling said earlier regarding the business risk, there is the setting up of the new company and its income streams. A lot of what is happening is new, and the business risk is reflected there.
Additionally, the financial and strategic review of Water Service identified the regulatory risk. That would be higher here because there would be a new, untested regulatory regime. The conclusion was that, overall, there would be a premium for risk here in comparison with England and Wales because of the local circumstances in which we find ourselves, both for the company and for its regime. That goes some way to explaining the difference between the figures of 5·1% and 5·8%.
Mr Pengelly: The position is that access to RRI borrowing is conditional on what is called “qualifying revenue”. The policy in Northern Ireland is that only rates increases count as qualifying revenue — water charges do not.
Mr Smyth: Says who? Was that negotiated in 1998 under the RRI, or has that been subsequent evolution?
Mr Pengelly: The position has been clarified in the last few years. There was a lot of uncertainty, when the RRI was first negotiated in 1998, about the introduction of water charges. Subsequent to the policy on the clear-path introduction of water charges, the Treasury has clarified the position.
Mr Smyth: There might be a case for revisiting that and arguing that this is a new income stream.
Mr Pengelly: The policy at the moment is that it does not count for qualifying revenue purposes.
The Committee Clerk: Mr Sterling provided a note clarifying the date on which the change took place at the behest of the Treasury. Was it in 2004 that water was added?
Mr Sterling: Yes, I believe so.
The Committee Clerk: The note did not include a rationale for the addition.
Mr P Robinson : Were they not attempting to be helpful by adding water reform at that stage — so that it would count for qualifying revenue purposes? RRI funding could not be accessed unless the gap between the increases here and those in Great Britain was met. Was adding water reform not supposed to narrow that gap?
Mr Pengelly: When the RRI borrowing power was negotiated, the correspondence was predicated on closing the revenue gap between Northern Ireland and Great Britain. In 2004 it was clarified that, for the purposes of RRI borrowing, the revenue gap should be defined purely by reference to rates and council tax as opposed to rates and water charges.
Mr P Robinson: That is not the question that I wanted to ask. Since there are no Barnett consequentials for water, why is the Treasury charging anything? Surely the issue is one for a Northern Ireland Government. The Treasury pays nothing towards water here.
Mr Pengelly: In the overall context of UK public expenditure the Barnett consequentials —
Mr P Robinson: There are no Barnett consequentials for water; we get no money from the UK Exchequer towards water. Is that not right?
Mr Pengelly: That is right. However —
Mr P Robinson: Therefore it is ours.
Mr Pengelly: The UK Exchequer looks at the unhypothecated nature of the Barnett consequentials: it was UK public expenditure that put the asset base in place, therefore, it is still an asset of the UK taxpayer. According to the UK public expenditure system, it must generate a return.
Mr P Robinson: In fact, it was Northern Ireland Government expenditure that put the infrastructure in place. How far back do we go? The asset is one over which the Northern Ireland Government have control, because no money comes from the Exchequer towards it. Why does the Exchequer control whether the asset value of the Go-co is £650 million or £1 billion? Surely that should be our decision. Is that decision flexible? Can it be changed?
Mr Pengelly: I am not sure of the position post-restoration. At present, the valuation of any public expenditure asset is subject to Treasury ratification.
Mr P Robinson: Can it become a devolved matter?
Mr Pengelly: I would need to confirm that definitively, but my view is that the Treasury would regard the matter as primarily a fiscal one in which there would be a reserved element and in which the Treasury would continue to have an interest.
Mr P Robinson: Responsibility forwater is devolved, as is responsibility for our finances. Why should water revenue not be a devolved matter?
Mr Pengelly: If an Executive were to lower the valuation from £1 billion to, say, £500 million, the loss of £500 million would be a hit against the resources available to the Executive.
Mr P Robinson: If the issue were deferred, for example, for six months, the decision to proceed with a Go-co would be taken by a Northern Ireland Executive, would it not?
Mr Pengelly: Yes. The Executive could decide on a lower valuation. However, the decision to reduce the valuation from £1 billion to, say, £600 million could affect resources available.
Mr P Robinson: However, we are not talking about real money, are we?
Mr Pengelly: That is an entirely different debate.
Mr P Robinson: What I mean is that you could have chosen a figure of £650 million and not £1 billion.
The Chairman (Mr Wells): By how much would a valuation of £650 million on the asset base reduce water bills? Would the £58 million dividend go down to £32 million a year, which is what, roughly, the figure would be, given that asset base? Would that not take £20 million off water rates bills in Northern Ireland? Would it not wipe out a significant proportion of those bills?
Mr Pengelly: I am not sure about the proportion, but I agree that that would take £20 million off the cost base of the organisation, and that, as it is to be self-financing, would take £20 million off bills.
The Chairman (Mr Wells): That equates to £20 for every adult in the Province: the first year’s bill could be as low as £30. If that simple economic measure were taken, what would be the impact on people’s bills?
3.15 pm
Mr Hewitt: The impact would be to increase the subsidy required from the Department to the company. It would be like a carousel in which they pay a dividend to you, but you pay a subsidy back to them.
Mr Dawson: Are the subsidy and dividend not exactly the same amount?
Mr Hewitt: No. The subsidy would be higher than the dividend.
Mr Pengelly: That will be the case in the first year.
Mr Hewitt: Therefore if the company brings in less money and is constrained in what it can do with its charges, would it not require a higher subsidy to maintain itself?
Mr Pengelly: If, instead of starting with a value of £1 billion, the starting point were at £650 million, the Department for Regional Development would require a rate of return of 5·8% on £650 million. Therefore the requirement on the Go-co would be lower, with the result that there would be an impact on bills — because the cost base of the Go-co would be reduced.
The Chairman (Mr Wells): Therefore, one of your options would have reduced the bills to the public substantially.
Mr P Robinson: It is bound to.
Mr Hewitt: Yes.It is inevitable that that would have happened.
The Chairman (Mr Wells): Therefore, this is just a paper exercise. You could have chosen the option of £650 million, which was available and which was entirely within Treasury guidelines. However, you went for the neater figure.
Mr Sterling: It was not an option for us.
Mr Dawson: The range was set, though.
Mr P Robinson: The option was available to the person who took the decision.
Mr Pengelly: That is correct.
The Chairman (Mr Wells): However, you went for the neater and easier to remember figure of £1 billion because that would get you £58 million a year as a dividend.
Ms Gildernew: That is also the bigger figure.
Dr McDonnell: Most of the points that I wanted to discuss have been probed already. However, taking a slightly different angle; is there the option to review the £1 billion figure a year or two down the road or is it fixed for ever? When the mistake in valuing the asset at £1 billion has been realised, can it be revalued at £500 million or £600 million?
Mr Sterling: The regulator could review it in the pricing — or periodic — review in 2009. However, if the regulator decided the value should be reduced, we understand that that reduction in valuation would be an impairment on our accounts and, therefore, would result in a cost to us. For example, if we wrote it down by £200 million, there would be a cost to us.
Dr McDonnell: Does that mean that we are locked in at the £1 billion figure?
Mr Sterling: That is my understanding.
Dr McDonnell: Not to play games: I feel that the company is grossly overvalued at £1 billion.
Mr McNarry: Is the point not that —
The Chairman (Mr Wells): Please let Dr McDonnell finish.
Mr McNarry: I am sorry; I thought that he had finished.
Dr McDonnell: What is the argument against a handover to the Go-co at zero-asset value and allowing it to build up the asset value? There is a very strong argument for that, and other members have picked up on it.
There has already been investment in the assets over the years — the infrastructure already exists; it is in the ground and cannot be dug up. Theoretically, in a virtual situation, it could be claimed that the assets are worth £1 billion. However, rather than fiddle around with a phased-in system, surely the honest thing to do would be to say that the company has a zero valuation, and as such its value could increase, and people could be charged X amount for water. Effectively, that would mean that the assets would be given to the Go-co at zero value. What is the argument against that?
Mr Sterling: The value of the asset helps determine how much the company can collect from its customers. The lower the asset’s value, the lower the amount that can be recouped to recover the cost of the company.
Dr McDonnell: You are therefore telling me that the value of the asset will set the dividend to the Government, and that that dividend will set the cost of the water charges? That means that this is a virtual exercise, which is largely similar to what happened with the electricity companies. The overvaluation of those companies set the price of our electricity for 15 or 18 years. The artificial and excessive valuation of the water company at £1 billion will set the price of water at a much higher level than it should be.
That is all that I wanted to know; you have probably answered the question. Much of this relates to the valuation that is put on the company.
Mr McNarry: Following on from that simple question, would a new Executive be able to restructure the Go-co?
Mr Sterling: Yes. However, DFP would make the call on the extent to which Treasury rules apply during devolution.
Mr Pengelly: The Executive would have significant flexibility. The provision of water and sewerage services would be a devolved matter and the Executive would be the primary body taking decisions on those services.
However, the limiting factor is the extent to which those decisions have public expenditure consequences within the public expenditure framework as defined by the Treasury. The Executive would have to deal with those consequences also. They would have the flexibility to restructure, but the issue would be about managing the implications.
The Chairman (Mr Wells): Would that require primary legislation?
Mr Pengelly: It would depend on the extent of the change.
Mr McNarry: Have we reached this point because the person who wanted to take the decision, did so, and dismissed other options? In so doing, has that person bound the Treasury to a level that it will be very difficult to get it away from, were a new Executive to be formed? According to what was said earlier, there is now a query about what might be devolved and reserved matters.
Mr Pengelly: To make it clear, the provision and structuring of water and sewerage services in Northern Ireland would be a devolved matter, and the Executive would deal with that exclusively. The reserved matter is the UK public expenditure framework.
Mr McNarry: However, restructuring the Go-co might involve restructuring the equity.
Mr Pengelly: There would be a transitional implication from the point of transition from the structure that already exists to one that an Executive would establish.
Mr Sterling: Again, much would depend on what the Executive would want to do.
Mr McNarry: Will we be getting a copy of the Hansard report of this session?
The Chairman (Mr Wells): Yes.
This has been a useful session. Have efficiency savings been built into the system so that they can be used to offset bills?
Mr Sterling: Efficiency savings, and the tariffs that flow from them, will be built into the cost structure of the company. Those elements are being developed through the strategic business planning process.
The Chairman (Mr Wells): To what extent are we locked into this situation once the legislation goes through the Privy Council? I would like to know that, and our researchers could possibly help the subgroup with that question. What scope would the Executive have if they were to come to the Assembly on the issue? Any primary legislation required would take quite a long time to be enacted, and the system will have been up and running for several years by then. It would be interesting to know what scope is available before we start making promises that, technically, we may not be able to keep.
Are there any other questions?
Mr Hewitt: I have a point of clarification. The Chairman mentioned efficiency savings. Are those not linked to the dividend issue? In a sense, requiring the company to pay a dividend while simultaneously capping what customers can be charged pressurises the management of the company to make efficiency savings within the company in order to balance the books. Therefore all aspects are interconnected: one element cannot be removed without having an influence on the others. Reducing the dividend reduces the pressure on the company to become efficient; increasing the dividend increases the pressure to become efficient. Is that a correct interpretation?
Mr Sterling: Yes.
The Chairman (Mr Wells): Is everybody happy? Perhaps the correct question is whether everybody is finished.
Mr Dawson: Moving on from the water issue, I have a question for Mr Pengelly about the Chancellor’s £35 billion figure. I think that he said that it was a no growth figure.
Mr Pengelly: It is flat real growth.
Mr Dawson: If real growth of 0·5% or 1% is assumed, what would the four-year projection for Northern Ireland be vis-à-vis the £35 billion?
Mr Pengelly: I do not know the exact projection off the top of my head.
Mr Dawson: Would you come back to the subgroup on that?
Mr Pengelly: Yes, I will reply very quickly.
Dr McDonnell: Is there any perspective on the innovation fund or how it might work? Part of the information on that was vague.
Mr Pengelly: We have heard nothing beyond the Chancellor’s letter of 13 November.
Dr McDonnell: Does that mean that you cannot put any parameters on that?
Mr Pengelly: Yes.
The Chairman (Mr Wells): Thank you. The discussion was illuminating and interesting, if somewhat quirky at times. The subgroup will be seeing some of your team next Wednesday for a much more intensive question-and-answer session on the whole principle of water charging.
Adjourned at 3.25 pm.