HL Deb 08 November 1988 vol 501 cc590-612

6.10 p.m.

Lord Ezra rose to ask Her Majesty's Government whether it is their intention to introduce a measure of competition in the water industry on privatisation.

The noble Lord said: My Lords, I wish to raise the Question on the Order Paper because I believe that it is now a relevant issue for us to be discussing the impending privatisation of the water industry. Before proceeding further I wish to declare that I am chairman of an energy company in which, through another company, a French water company has a major interest. I should add that I am not involved in the water industry.

The privatisation of public utilities has raised many issues. The privatisation of telecommunications raised the issue of competition. There is a limited amount through Mercury. There have been problems with the quality or the service from that enterprise since it has been privatised. With the gas industry, there was recently a reference to the Monopolies and Mergers Commission, which criticised the exercise of monopolistic powers in the industrial and commercial markets. In the case of the electricity industry, on which legislation is expected, it is understood that a measure of competition is to be introduced.

In the case of the water industry, introducing competition is especially difficult because, of all the utilities that have been or are likely to be privatised, it is the one which is the most obvious natural monopoly. It is no doubt for that reason that the Government have devised a fairly complex system of control and regulation. It is so complex that one wonders whether the enterprises will be able to work as effectively as they have in the past.

When the whole subject of privatisation was originally considered by the Government, they proposed to privatise the water authorities on the river basis upon which they presently operate. It was soon realised that in private hands that would create an anomaly because they would have regulatory functions. Those therefore have been taken away, one might argue quite properly, and have been given to the National Rivers Authority. However, in addition to the National Rivers Authority, which will be concerned with resource planning, quality, pollution control, land drainage and other matters currently the responsibility of water authorities, there will be the Director General of Water Services, who will be concerned with prices and service standards. Certain powers will be reserved for HM Inspectorate of Pollution. The Department of the Environment will retain certain regulatory powers. The Ministry of Agriculture, Fisheries and Foods, the Monopolies and Mergers Commission and finally the European Commission in Brussels will also be involved.

The first question one might ask under the proposed privatisation measure is whether those newly privatised bodies will not be submerged under a welter of regulations. But, secondly, regulation is not the best answer to safeguarding the consumer interest under a privatised system. A far better answer would be to introduce some measure of competition, however difficult that might be.

I am encouraged to raise the issue because one of the duties to be given to the Director General of Water Services will be to enable effective competition to take place. It is proper for us, before we see the Bill, to consider what type of competition he could enable to take place.

In preparation for the debate I have talked to a large number of people connected with and operating within the water industry to try to see, despite the monopolistic nature of the industry, what measures of competition could be introduced. I have come up with the following which I should like to mention and to comment upon. I hope that when he replies the noble Earl will let us have the Government's views on them.

The first measure of competition in the privatised water industry which has been mentioned in the literature on the subject is competition by comparison. Competition by comparison is of course something which already exists. The water authorities publish their annual reports and comparisons can be made. It is argued that that would be an important element of competition. I have my doubts about it. I was for many years concerned with running a large public enterprise; namely, the coal industry. We had a number of areas operating mines. We tried to compare their results one with another, but it was extremely difficult to do so because the conditions were so different, the geology was so different and the problems of marketing the product were so different. In the end, we had to look at each case on its merits, and the comparative data were of relatively little use for management purposes.

There is obviously some merit in competition by comparison, but it is limited. If it is to have any merit it must be based on the publication of large amounts of information. It cannot be done on the basis of limited information.

It is then argued that the capital market could exercise some competitive pressure on the privatised companies; and that those which were most efficient would be the most successful in raising money. That too is a limited area of competition. Generally speaking, the Stock Exchange and investors tend to look at sectors rather than individual firms in sectors. Today, for example, the oil sector might be the favoured sector, or it might not; and tomorrow it could be the water sector, the steel sector, the retail sector, or whatever. The interest goes by sectors. Any suggestion that there could be an effective measure of competition from the attitudes of those who provide capital is again overemphasising that approach.

It is argued that competiton could be achieved by pressure from shareholders. Many of us, I presume, have been involved in companies of various types. We know that on the whole shareholders come together in limited numbers only at the annual general meeting and that if everything is going normally the attendance is fairly sparse and the contributions to the discussions virtually nonexistent. So long as a company ticks over and there are no scandals or problems, the pressure from shareholders, in my experience from having been involved in a number of companies, is limited.

We are told that there could be competitive pressure through the threat of takeover. This can certainly make an impact but the question of takeovers raises all sorts of other issues. For example, how far can one let the takeover process develop? One would be left with a very limited number of independent companies in this sector. The pressure of takeover certainly has an impact. I have been involved in takeovers of one sort or another in recent years. I know that one is galvanised into action and generally speaking one tries to defend oneself against this situation, if one is on the receiving end. Nevertheless, that in itself is a fairly blunt instrument which cannot be carried too far if we want a sufficient number of individual firms to survive.

We are told that there is a greenfield site possibility; namely, that when a new water supply is required and can be obtained, there could be freedom for new enterprises to take over that operation. This is perfectly true, but on the other hand, to the extent that the new operators will need to make use of the existing network in order to link their new greenfield site into it, that could raise problems with the existing operators. In any case, I think the number of greenfield sites is likely to be fairly limited.

These are the four or five forms of competition which have been mentioned in the discussions arising from the proposals for privatisation. While they will exert some competitive pressure, 1 doubt whether it will amount to very much. I think, however, there is another form of competition which is well worth consideration. In the water industry, price competition will be virtually impossible except by comparison. There is no way in which one could choose to buy one's water more cheaply from one authority than another.

However, cost competition opens up some interesting possibilities. Cost competition can be introduced by contracting out a proportion of the core business. I mean the water supply business, the water treatment business, the sewage treatment business. There it is a real possibility. I have seen it in operation in my coal industry days. That was precisely the way in which we ran the opencast operation. I hesitate to mention opencast coal in the presence of my old friend, the noble Lord, Lord Mason, but I am merely talking about the ways in which we did it.

That was done on the basis of contracting out. The operation of an opencast site was contracted out on a competitive tender basis. That very quickly created cost yardsticks which enabled us to compare one operation with another. The payment was made and I presume still is made on the basis of the coal supplied. Conditions had to be met: the way in which the coal was produced, the quality to be produced, the restoration of the site after the operation was complete. The payment was made as the operation went ahead on the basis of the coal supplied.

I suggest that this contracting out operation could introduce a healthy element of competition within the privatised water industry. Let me indicate how I think it could work. Perhaps we may take the case of a sewage operation which was inadequate for the purposes for which it had originally been constructed. Let us say that it serves a growing conurbation. It requires refurbishment and enlargement. Instead of the water company doing that itself, it could put the operation out to competitive tender. The tenderer would have to undertake to invest in the new installation. He would have to build it and to operate it and would then be paid on the basis of the amount of sewage treated. If there were a number of these contracted out operations which could relate to sewage plants, water treatment plants,or networks within the area of each of these natural monopolies, in my opinion that could introduce an interesting measure of cost competition.

I have no doubt that in replying the noble Earl will say that the companies will be perfectly at liberty to do this if they wish. However, I shall take this a stage further. I suggest that there should be an obligation to contract out a proportion of the core business over a period of time, let us say 10 per cent. That would have to be done in order to introduce competition in the only part of the business where I think it can be introduced. That is at the cost end, because there is no way of introducing it except by comparison at the price end.

Those are the suggestions I wish to make on this very important issue. Let me now try to sum up my brief remarks. Water is a natural monopoly— more of a natural monopoly than any other of the utilities which have been or are about to be privatised. The water industry in Britain, as at present organised, has worked well under the river basin system which was introduced by the Water Act 1973. It has become something that the rest of the world admires.

Unfortunately, for the reasons I have explained and which are well known, this form has been deemed inappropriate under a privatised system, so it has been broken up. In its place we shall have a heavy and complicated regulatory system. I feel that so far too little attention seems to have been devoted to competitive safeguards. As the Director General of Water Services has this duty to provide for competition, I have felt it appropriate to go through the various forms of competitive pressure which could be introduced into this newly privatised sector. I hope very much that noble Lords who are kindly taking part in this debate will add their views on the subject. Then when the noble Earl comes to reply, he will be able to advise us on the extent to which the Government will try to introduce a measure of competition in the privatised water industry.

6.30 p.m.

Lord Elliott of Morpeth

My Lords, we are all grateful to the noble Lord, Lord Ezra, for raising this subject at such an opportune time. We expect legislation on the subject of water soon to be before us. I listened with great interest, as I am sure did everyone, to what the noble Lord said about the possibilities of competition in the water industry. I think we were all particularly interested in his suggestion on cost competition. We realise that he has enormous industrial experience, particularly in the sphere of the coal industry. I am sure we shall study further what he said on cost competition.

When the noble Lord said that water was a monopoly, that is something on which we all agree. The water industry is in a position of absolute monopoly. Water is an essential commodity. There are no alternatives. The nature of water as a product is that it is heavy and bulky. This means that alternative supplies for customers are wholly impossible. Therefore, unlike customers in other industries, the customer in the water industry is not protected even partly by competition in its normal sense. The customer is stuck with the quality of the water which he receives and with the supplier whose pipes lead into his premises.

Water is a monopoly, but it is unfair to say that no competition is possible in the industry. I believe that the competition, which the Secretary of State has rightly called comparison, is there. There is comparison in the industry. I should declare an interest. I am chairman of the Newcastle and Gateshead Water Company. It is one of 28 statutory water companies. There are, of course, in the country 10 regional water authorities.

Again, I wholly agree with the noble Lord, Lord Ezra, that the water industry in England and Wales has worked extremely well since the Act of 1973. I believe that that is so. I am sad that it is necessary to change the industry at this time. Nevertheless, it is to be changed. And so we must look at the possibilities that come before us within that change.

I should like to assure noble Lords that comparison has been there all the time and that it is present at this time. It has been present in the water industry particularly since the Act of 1973. Each water company is very conscious of its need to keep up standards and to make sure that its performance compares favourably not only with other companies but with the 10 regional water authorities.

I declare a further interest. I had the privilege for some years to be president of the Water Companies' Association. That body is representative of the 28 statutory water companies. I assure the noble Lord, Lord Ezra, that every year in the month of July, at the association's annual general meeting my presidential address was always based on the suggestion that the companies must be efficient and be seen to be efficient, or they would go out of existence. Therefore, I suggest that we have had competition by comparison.

Part of the Government's proposals, we understand, will deal with the new system of regulation which will of course be necessary to protect the customer against abuse of the monopoly in a situation where profits could be unconstrained. That regulatory system will, as I see it, put the existing competition between undertakers, by comparison on standards and charges on to a formal basis. The preparatory work, we understand, is being done to gear the industry up for the transition to the new system. It is made very clear that comparisons between undertakings will play a most important part. It is that comparison which we shall have to depend upon for competition.

From the information which the regulator—he is known as the director general of water services—will collect, benchmarks of effectiveness and efficiency in terms of cost and service are to be established. We are to have the "K" factor. Undertakings will be compared against those benchmarks. I see that bringing in a significant degree of competition. If the regulator considers that a move towards a benchmark is appropriate, then presumably, in the interest of customers, he will encourage that movement. So it would seem that undertakers, with these benchmarks and the standards which are to be set, will have to keep up to a certain standard.

I am sure that the new system will work very well if it contains this comparative content. I pause for one moment here and suggest that the new regulatory system is replacing a system already in existence which the statutory companies know. I still regret very much that Her Majesty's Government are, it seems, inclined against the statutory model for the 10 regional water authorities which are to be privatised. Here, we have regulation by statute. Here, we have regulation without a new quango body. But it seems that that is not to be. I hope therefore that it will be possible to have comparative competition by means of a new system.

The proposal in its way is quite sensible and encouraging, even though I would have much preferred the alternative.

In the short time that I propose to speak, I should like to suggest to my noble friend and to Her Majesty's Government that comparison within the water industry can only mean anything at all if there are enough undertakings to compare one with another. The great fear in the water industry as we approach privatisation is that there will be fewer water undertakings than there are at present. We live in an era when takeover is a word often used. And it is used a great deal at the present time with regard to the water industry.

It would be a great pity if there were too few water undertakings because, as I see it, competition by comparison is the only possible real competition that one can know in the water industry. I hope that when he replies my noble friend will recognise that if we are to have any kind of competition and a healthy water industry, there will need to be enough companies to compare one with another.

6.35 p.m.

Lord Mason of Barnsley

My Lords, I believe the pending water privatisation measure is a distinctly different privatisation measure from those that have gone before. The privatisation of gas, British Telecom, Rolls-Royce and others revealed strong party political differences. They revealed such conflicts as the Left versus the Right and trade unions against the Government. All those privatisations were highly political. Major political parties with strong, extreme standpoints come into conflict. However, a vast grey area of indifference existed between the different views.

This proposed privatisation measure however, moves into a more sensitive sector. To some it is the sacred sector, next to taking over the air we breathe. The difference, I believe, on this occasion, apart from the political fight over privatisation as such, is that there exists this time a vast body of opinion representative of many different groups in between the political extremes. Now the environmentalists, the greens, all the angling associations, all the water users as well as a considerable number of ordinary people are really concerned and anxious about the water they drink, its quality, its content and its cleanliness. They are also concerned about pollution control and other matters.

This time the privatisation is not just a clear-cut political Left versus the Right issue. It is not seen by many people simply as a political squabble. Instead the whole populace, for a variety of reasons, feels involved.

There is one word of credit due to Her Majesty's Government on this matter. Although I am not in favour of the Government's obsession with privatisation, especially privatisation in this sensitive sector, when the Government put forward their initial plan it incurred the wrath of so many interested groups—some of which I have already mentioned, plus an alliance of the Confederation of British Industry, the Country Landowners' Association, the National Farmers' Union and the Council for the Protection of Rural England; a most powerful lobby—that it was changed. They decided to introduce a major public element into their proposed legislation; namely, the National Rivers Authority. That is a public body with a national board of authority at the head of 10 public regional boards.

The National Rivers Authority is a new public authority, accountable to Ministers and to Parliament. That means that water, its quality, its purity, the problems of pollution in our rivers, lakes, reservoirs and the seas round our shores will have a higher profile than ever before. The National Rivers Authority is subject to accountability via Ministers. It is subject to parliamentary scrutiny, questions, statements and debates on every aspect of water activity from the quality of tap water to polluted rivers, dirty seas, floods and major accidents.

The National Rivers Authority will have to set standards. That will form the basis of the competition between the National Rivers Authority and the private sector. The National Rivers Authority will have to set a standard of operations that is efficient and professional. It will set a public image to be judged by standards not set and achieved by profit. The public and indeed the nation—everyone will be involved and will be watching—will put the privatised sector, the 10 public limited companies, on test. The National Rivers Authority will have to set a standard for the public and Parliament to accept. The private sector will be forced to compete so that there will be some competition. There is the NRA's image, its national responsibility, its duty to the public and, as the noble Lords, Lord Ezra and Lord Elliott of Morpeth said, competition by comparison.

The aim of the National Rivers Authority will be to achieve a noticeable improvement in our water quality from the tap right through to the North Sea, and, with it working alongside Her Majesty's Inspectorate of Pollution, there is bound to be a major progressive drive for a clean-up. However, improvement measures will be costly and will take time. There is no doubt, with so much to be done to satisfy the consumer, the pressure groups and the European Community standards, that water in all its forms of usage will become more expensive.

The National Rivers Authority not only will be the recognisable national body with national policies for river management and water quality but it will also be responsible for environmental quality and pollution control. It will have the national and statutory responsibility for land drainage, flood protection and catchment management; that is, the control of our water resources especially on the issue of abstraction licences. It will also cover fisheries, recreation, conservation and navigation and will be publicly accountable in all those areas of water activity. The establishment of the NRA could be a power for good.

With 10 public limited companies—the proposed new private sector—being established in the pending legislation and 29 existing private water companies there is bound to be some competition between them, particularly bearing in mind the flurry of foreign activity and interest in investing and buying into the present private water companies, and the distinct possibility of mergers and takeovers beating the Bill before it becomes law. Twenty-five per cent. of the control of Britain's water is already in the hands of the 29 private water companies, with foreign interests and shareholders on the increase. I believe that the foreign element will grow rather than recede, so there will be some competition.

The privatised sector will be responsible for the utility functions of water supply, sewerage and sewage treatment and disposal. This is a very large proportion of the water authority's business, which has a turnover of £3 billion a year. These services are in constant and growing demand. The profit. incentive will surely be the motivating force, just as the privateers want it. There will no doubt be some competition too, but I hope not to the detriment of the consumer.

The private sector will be looking for quick, easy and lucrative rewards from its freedom. In this respect I am afraid that beautiful and attractive stretches of unspoilt countryside in reservoir catchment areas may well be sold to developers. As to competition, land sharks will be fighting to compete for these rich pickings. 1 sincerely hope that the legislation will protect all these water catchment areas, or vast expanses of our most beautiful countryside may well be under threat.

Consumers may be concerned about whether the National Rivers Authority will be sufficiently independent of the private sector. I think that the Anglers Co-operative Association of Great Britain and the National Anglers Council will want to be assured. We shall have to await the legislation to be certain of the powers to be granted to the NRA, and especially of its independence of the public limited companies.

I can only quote from a speech delivered by the noble Lord, Lord Crickhowell, chairman of the NRA advisory committee, of which I am a member. When addressing the national water conference on 12th October 1988 he said: I see no reason at present to doubt that the NRA will be given adequate powers by Parliament, and I am confident that it will be able to act with total independence in enforcing the laws and regulations that Parliament approves. I am certain that we will have access to all the information we require; that, working with Her Majesty's Inspectorate of Pollution, we will be able to set standards based on the very best possible scientific advice; that we will be able to sample independently of the plcs and other dischargers; and that the arrangements that we propose for laboratory services will enable the NRA to monitor adequately effluent discharges and water quality". We may therefore feel satisfied that the NRA will get the independence that it requires to satisfy consumer and fishing interests.

Incidentally, and somewhat oddly, although trade union leaders may well oppose this privatisation measure—and rightly so—from my visits and talks on water privatisation and its future I find that trade unionists and workers—some workers not being in any trade union—are not banding together to oppose privatisation of their industry. They are keen to purchase preference shares in the private sector.

In the private sector the workers will expect them. In the NRA they do not have the same claim but, they say, they too have been responsible for placing the water industry in a position where it could become an attractive proposition for privatisation and therefore they should have some preference shares. They are saying, in other words, that they are not really opposing the measure but they want a share of the spoils. If the Bill goes through, it may well be an ironic challenge for the trade unions and the trade union leaders to try to establish the claim for preference shares for the NRA sector. I believe that to be a novel sign of the times.

I conclude by thanking the noble Lord, Lord Ezra, for giving us an opportunity to debate the question of privatisation and competition in the water industry. No doubt both Houses will soon be up to their necks in water, but I am sure the Government will make certain that their water Bill does not become waterlogged.

6.48 p.m.

Earl Russell

My Lords, your Lordships may be aware that I have a certain occupational bias towards the view that there is nothing new under the sun. These issues have been before both Houses before. The first time that water was debated in the other place as far as I know was in 1572 when one Member said that the proposers of the Bill could not possibly have taken so much trouble for anything so unimportant as water. Your Lordships may not be surprised to learn that your Lordships' House took a rather more balanced view of the matter.

The issue of competition in the water industry was before your Lordships' House on 30th January 1641, on which occasion a memorandum was submitted by the New River Company defending its monopoly of the water supply to London, which I regard as one of the ablest defences of a monopoly in a public utility that I have ever read. The New River Company argued that the competition for sources of water might lead to a temptation to use polluted sources. It also discovered one of the more unsavoury forms that competition by comparison might take by industriously spreading reports that its rivals were using a polluted water supply. It argued that competition, by diminishing the level of profits, would diminished the incentive to invest. It argued that the criss-cross laying of pipes for two different water companies in the same place would create a rather confusing cat's cradle and it said, which I think was the clincher of the argument, that if there were a burst main and flooding, no one would know whose pipes to dig up. For whatever reason, your Lordships' House decided that it agreed with the view expressed by my noble friend Lord Ezra that water is a natural monopoly, and the New River Company remained in possession.

It is a view for which I have found further support in more recent times by observing the privatised water industry in the United States. Perhaps your Lordships are not aware that in the State of New Jersey there are 640 water authorities. In the State of Connecticut there are slightly fewer. They are all extremely small and do not have any competition because proverbially water tends to find its own level and a small water company does not run a pipe over the top of a hill or even through the middle of it in order to supply half a dozen consumers in another company's area. So we have a host of small companies which do not compete with each other and—this is the point to which I want to draw the attention of the noble Earl—because they are small they have very inadequate reserves for coping with drought. New Haven in Connecticut has an average rainfall of 44 inches a year, which one does not think of as drought conditions. Nevertheless in any dry summer a water emergency is liable to be declared. Companies on such a small scale simply cannot afford the capacity to carry the reserves.

I also remember 1976. Your Lordships may say that such a situation will not happen again, but that is what we said in 1975. With a service of such importance, it is vital to have some spare capacity in order to keep the country alive during another period of drought. I want to raise this question. Under privatisation will such spare capacity exist and, if so, who will pay for it? An important point and one of which I am not always sure that the Government are aware is that the purpose of industry is to make profits. It is not the purpose of industry to conduct philanthropy. So I do not think that it is reasonable or legitimate to expect a private water company to make provision for drought unless it is in its interest to do so; in other words, that it expects to make a profit out of it.

One does not expect to make a profit out of providing for conditions that occur once every 100 years and I think that it would be an unreasonable burden to place on a privatised water industry unless the Government in identifying a social objective were also prepared to meet the cost of it. It is a subject on which government thinking is quite frequently inconsistent. I can remember the then Mr. Anthony Wedgwood Benn instructing electricity boards not to cut off pensioners who were in arrears with their bills. That was a very laudable social objective. However, the right honourable gentleman expected the electricity companies to pay for it. In fact, the right honourable gentleman conspicuously failed to put his money where his mouth was. That is an inconsistency which I think we should try to avoid.

If the Government intend to identify an objective of provision for drought, they should be prepared to pay for it. They may perhaps say that this is not their business and it is simply the responsibility of private companies. However, no doubt the noble Lord, Lord Callaghan of Cardiff, with whom the buck stopped in 1976, will confirm that when water is running out people expect the Government to do something about it, and if people expect action it might be wise of the Government to think about it sooner rather than later.

6.55 p.m.

Viscount Hanworth

My Lords, I think it must have been more than 20 years ago that when I was talking to the Leader of the then Opposition, he gave me this advice: "Never speak on a subject on which you are not fully informed". However, he added, "We politicians unfortunately often have to". I have tried to follow that advice. I am not personally informed about what is happening in the gas industry and how far privatisation, with limited statutory control, may be being abused. However, on the broad issues which also affect the privatisation of the electrical, generating and distribution industries, I have no hesitation in speaking in support of the noble Lord, Lord Ezra.

As I get older it frequently strikes me that we lurch from one extreme doctrine to another, apparently never taking into account the lessons that we ought to have learnt in the process. It now ought to be apparent that nationalised industries, where competition is impossible, often tend to be inefficient. It is partly due to the dead hand of the Treasury and parliamentary control. Strangely, however, it is even more difficult to ask questions in Parliament about nationalised industries than would otherwise be the case, which is hardly in keeping with the social idea of national ownership.

At this point let me make clear that I am not against either privatisation where appropriate or the retention of some nationalised industries. Surely in the latter case there are halfway positions where the Government could retain a measure of oversight without preventing the marketplace and commercial considerations from taking a competitive and cost-effective approach. Not so long ago it was fashionable to talk about the unacceptable face of capitalism. From some of the Government's remarks one would think that the marketplace solves every problem in the best possible way. The Victorians pursued that policy and accepted the appalliing exploitation of, for example, child labour. Potentially capitalism and the marketplace are short-sighted and often have other major defects.

What is absurd in the present Government's approach is that they seem to believe that privatisation without adequate competition is per se an improvement which will lead to greater efficiency and lower prices and that it is in the national interest. When there is no competition and there is a captive market, until Parliament intervenes a privatised industry can charge what it likes for the benefit of its shareholders. To prevent that happening the Government have tried to produce formulae governing charges made by the privatised industry. But such simple control cannot ensure that adequate sums are spent for new equipment and, most importantly, renewal of old water mains which are now leaking over 20 per cent. of their throughput, as well as for unsafe sewage mains.

The problems of necessary capital expenditure vary greatly from region to region and cannot be controlled easily if at all by government legislation. If wider powers are taken to deal with the situation, it means at best quite arbitrary judgments and at worst a bureaucratic stranglehold which is little different from the worst in communist states. I earnestly ask the Government to think again on their doctrinal policies. I also ask them whether they are prepared to accept foreign control of some of the water utilities. Such outside foreign control may be justified and even beneficial in fully competitive manufacturing industries where foreign capital and expertise may help the nation, but surely not in this instance.

The solution that the French have adopted may be a good compromise. In France the local authorities have a statutory obligation to supply water to the consumer but they subcontract much of the responsibility and work to contractors under competitive tender. I shall not again suggest the several reasons for the Government's policy on privatisation. Suffice it to say that they usually state the reason for privatisation as consumer interest. That, I am afraid, is only a pious hope in many cases and a small part of their real motivation. What about more open government?

7 p.m.

Lord Grimond

My Lords, I cannot speak with any expert knowledge of the water industry. However, we are all consumers of water. So it is on behalf of consumers that I should like to say a few words. We are indeed most grateful to the noble Lord, Lord Ezra, for having raised the matter. There is no doubt that water is a natural monopoly and an absolutley vital one. It has normally been held to be almost impossible to control such monopolies by competition. We shall be interested to hear whether the Government believe that it can be done in this case.

From the consumer's point of view I should have thought that there is much to complain about. My water rate has risen over the last 11 years from £12 to £138. That is a multiple of 11 or so, far beyond anything justified by inflation, and, I suspect, beyond anything that has been done in the way of improving the capital works. It is also at the cost of declining services. The water companies now carry out no repairs.

I do not believe that the consumer in general is well satisfied with the present position. If he is to be saved from being exploited by a monopoly, to my mind the natural course would be to bring the industry more directly under the control of a Minister in Parliament. In my experience the two factors that keep prices down and efficiency up are real competition and a Minister's fear of losing his job. That is a sanction in which the Minister is rather involved. But we are going in the opposite direction.

I share the doubts of the noble Lord, Lord Ezra, about the competition which has been suggested. I very much doubt whether comparison is either possible or likely to he very effective. I was, however, greatly interested in two suggestions that were made. The noble Lord, Lord Ezra, suggested that there might be competitions in cost by contracting out. I have no doubt that the Minister will tell us more about that. My difficulty is that I do not see what the sanction is. 1 understand that the company will he under a statutory obligation, but if the contracting out fails what sanction can be applied to the company?

One sanction mentioned by the noble Lord, Lord Ezra, and by the noble Viscount is the possibility of takeover. That is a very real possibility, including takeover by foreign companies, as the noble Viscount remarked. It would be interesting to know the Government's view. For my part I would be rather doubtful about our water industry being owned largely abroad. I am not at all clear that takeovers always benefit the consumer. They benefit the shareholders and sometimes the directors. However, I am interested in the consumer. I am not clear that the possibility of takeover alone will protect him from exploitation of this natural monopoly.

I come to the conclusion that however many regulatory bodies and consumer councils are set up we shall not see what the consumer wants—which is a better and cheaper supply of water. He can stay alive no doubt by buying bottled water. Hence, the boom in the purchase of Perrier and some Highland spring water. And like some of your Lordships, he can, alas, take to alcohol. However, for washing, for flushing the loo, and so forth there is no substitute so far for water.

This matter is of prime importance. As has been said, it is in quite a different category to other privatisations that we have seen. I hope that the Government will explain whether competition is possible, and, if so, how. If they cannot do so, then I question whether this is a suitable industry for the type of privatisation which so far has very much benefited the City—there is no doubt about that—and may temporarily have benefited the public service borrowing requirement. To my mind those are not sufficient reasons for privatisation.

Privatisation can only ultimately be justified if it assists the ordinary consumer. Do not let me be told that the water authorities have done excellent things in opening up their reservoirs to speedboats. When I consider the couple of spinsters who live in the house next to me and I see at the bottom of their bill that they are charged extra for recreation, I wonder what recreation the authority has in mind. I doubt very much whether they are to be seen water-skiing; and even canoeing is a little beyond them.

There are many people in this country who are beginning to feel the pinch of the public services and who want cheaper and more straightforward public services. They are very doubtful that privatisation as experienced so far, in particular with British Telecom, has given them what they want.

7.7 p.m.

Lord McIntosh of Haringey

My Lords, it is customary from this Dispatch Box to thank the noble Lord who asked the Question and made possible the debate. In one respect I do so wholeheartedly. It is always good to have an opportunity to hear the thoughtful and lucid speeches of the noble Lord, Lord Ezra. In another respect, I am more doubtful. This is a subject which will become very much clearer for debate when the Bill is published in a relatively short time. I was always brought up not to shoot until one saw the whites of their eyes. I certainly do not propose to take this opportunity to expose all the arguments that we have prepared, ready loaded and cocked, against the final publication of the Bill.

However, I shall take advantage of the opportunity that has been given to us by the noble Lord, Lord Ezra, both in his expert demolition of the arguments put forward by the association of water authorities for the case that there can and will be a real measure of competition in the water industry when it is privatised, and, secondly, his own ideas about how to achieve competition. I found his remarks extremely interesting and worthy of very careful attention. I hope that the Minister will be able to give those views careful attention.

I have great confidence in the Minister's ability to respond on his own since I see that his officials arrived only half way through the debate. They cannot have heard what the noble Lord, Lord Ezra, said, and there is little that they can say to him which can be of any value to him.

The demolition job performed by the noble Lord, Lord Ezra, was extremely effective. The noble Lord looked at the various arguments which have been put forward. He analysed them in a way with which I largely agree. He considered the argument about comparative competition. It is certainly true that comparative competition in the circumstances of the privatised WS PLCs—the lovely set of initials that we have to apply to them—will be very largely controlled by regulations. It is nothing to do with price because price will be controlled by inevitably detailed formulae which the OFWAT—another very nasty set of initials—will have to lay down under any legislation that we are likely to see.

The problem of competition by comparison is that as we understand it the price formulae will be different for different water authorities. I believe that in the circumstances that is probably inevitable, but it makes realistic comparisons between one water authority and another extremely difficult.

Another difficulty is that it is only the managers rather than the shareholders, OFWAT or the general public, let alone the consumers, who have the realistic data on which to base these comparisons. If we move on from the comparative competition formulae and consider the argument that it is the capital markets which will provide a measure of competition, the argument falls down. The theory is that the managers will produce cost savings which in turn will satisfy the shareholders who will want capital appreciation as well as dividends.

The argument goes on that if a water authority has a poor performance the shares will be at a discount and there will be a danger of takeover so that the existing shareholders will lose out. The noble Lord, Lord Ezra, has much more experience with shareholders than I have, but my guess is that they would be more likely to hold on in hope of a higher offer rather than to dispose of their shares. That would be unlikely to result—even if takeovers were allowed with great freedom, which on the whole is politically unlikely—only in the kind of flexible capital market which can provide the measure of competition which noble Lords seem to want.

Neither the capital markets themselves nor indirectly the share prices will provide any useful measure of competition. The noble Lord correctly paid scant attention to the argument that any significant measure of competition was likely through supply to greenfield sites. He might have paid, equally correctly, scant attention to the argument that in areas of the water industry alternative supplies are possible, for example big customers who have the clout to negotiate industrial effluent contracts. After all, one can only have one contract of such a kind, and if discounts are to be achieved by trading around between different local water companies, that can only be to the disbenefit of the consumers who do not have that clout and cannot carry out those negotiations.

The noble Lord went on to the interesting argument that one could achieve competition by contracting out services. He gave examples of sewage treatment or water treatment as services which could be contracted out. He expressed the hope that there might be an obligation in the Bill for water companies to be obliged to contract out, let us say, 10 per cent. of their core business. That is an interesting idea, but there are a number of real difficulties.

The first major difficulty is that, like all other parts of the water business, it will be dominated by the price control formula. Any measure which may be adopted successfully for a particular contracted-out part of the business will be affected overwhelmingly by the interpretation of the price formula regulations which are set down by the Office of Water Supplies.

The other major difficulty that I see is that in any case it will be difficult to make comparisons between one water company and another because of the huge differences in external influences—what economists call externalities or exogenous variables. The differences are between one water company and another in terms of the quality of the water they have to treat before making it available to the consumers, and therefore the degree and expense of treatment which will be required—the differences between them in the physical condition of their capital assets. This is a capital intensive business, not a labour intensive business like most contracted-out businesses. There will be differences between them in the workforce which they have to control and in the environmental responsibilities which they will be obliged to adhere to.

All these differences are great even for relatively large water companies covering large areas. Imagine how much more different and how much more dominating they will be in smaller contracted-out services. These will be almost entirely dominated by external circumstances which will make comparisons between one contracted-out service and another or between one contractor and another virtually impossible. I am seriously doubtful about this aspect of the noble Lord's proposals.

Lord Ezra

My Lords, if I may briefly intervene, the point about contracting out was, as I suggested, that it could enable a particular company to make comparisons within its own company area of contracted-out services in some cases and its own provided services in other cases. It is not a question of trying to find comparisons between one company and another but of a company being able to test its own ability against an external contractor. That is what I had in mind.

Lord McIntosh of Haringey

My Lords, I am glad that the noble Lord has anticipated my next objection, which is that the testing of which he speaks can only be testing to destruction. This is not a matter like the contracting out of a school meals service or the contracting out even of refuse services in the London Borough of Wandsworth, where it is well known that it very often does not work and the services have to be taken back again. One cannot risk the water supply not working. One would have to rescue any contractor who took on the responsibility and failed to maintain the service. The service is so ancillary to the core of the business, which is the provision of water, that it is difficult to see how it could have the kind of impact that the noble Lord anticipates.

I am afraid that I am no more convinced by that argument than I was by the previous arguments, much as I should like to see competition in the water industry, privatised or not. That is not the concept I am against.

The fact is that a public limited company in a truly competitive industry can set its own prices. It can decide on its investment levels and vary them if necessary. It can decide on the quality of the product it wants to sell and vary that if necessary. It can refuse to supply if its wishes to any individual or group of customers. It can merge with other public limited companies or divest itself of part of its activities. It can dispose of its assets as it thinks fit. It can go bankrupt. None of these basic business options is available in any circumstances that I can see to a water supply company plc, or at least without the most drastic constraint from the Office of Water Supplies. When the differences between the companies operating in this naturally monopolistic market (as every single noble Lord who has spoken has emphasised) are so much greater than those which apply in truly competitive markets, I find it very difficult to see how we can have genuine competitive considerations.

I come to the conclusion to which I am forced and to which we shall return as we debate the Bill itself: that the motivation for the privatisation of water supply is political and not economic. There is no justification in economic terms for the privatisation programme which the Government have announced and are set upon. Since we believe it to be a political matter and—despite what my noble friend Lord Mason says—that those working in t ie industry are not only well informed but are deeply opposed to the proposals, we shall be opposing the Bill when it comes, whatever variation appears to be possible on the Government's plans as so far announced.

7.20 p.m.

The Earl of Arran

My Lords, I have listened with great attention and not inconsiderable interest to the debate that has taken place this evening. I know that the House will be grateful to the noble Lord, Lord Ezra, for providing an opportunity to examine carefully one of the central issues of the coming privatisation of the water industry. There have been expert contributions from all sides of the House. As a newcomer to the topic, I reply with some diffidence and a consciousness of the long experience in the water industry of some noble Lords who have spoken.

As I hope to assist my noble friend the Minster in future debates on the subject, one might call this a "baptism of fire", except that the element which we are discussing is more appropriate for a baptism. I look forward to my imminent and total immersion and I do not step back with any apprehension at the thought and prospect of the noble Lord, Lord McIntosh, seeing the whites of my eyes.

This has been something of a Second Reading debate without a Bill. I do not propose to give a detailed account of the legislation which is in preparation. As the noble Lord, Lord McIntosh, has said, there will be an opportunity for the House to discuss that soon enough. The Question tabled by the noble Lord, Lord Ezra, is a good one and well deserves a separate debate, although in the time available it will be something in the nature of a prelude.

The water industry is a classic natural monopoly and a monopoly in private hands gives rise to some very justifiable questions which merit the closest possible attention. We believe that in preparing the details of our legislation the challenge of this central fact of the industry—that there can be little choice at the tap—has been faced squarely and constructively. Although the product of the industry is in many ways a monopoly we do indeed intend to inject a full and stimulating measure of competition wherever the circumstances make that possible. Our emphasis must be to ensure that there are pressures on the industry to be efficient and dynamic. It will be my submission this evening that our privatisation proposals will put in place a sound and constructive framework which will enable the industry to deliver improved standards—I may say, exacting standards—effectively, efficiently and well. It will be very far from the complacent and exploiting monopoly which has been described this evening.

We have heard repeated again tonight the charge that there are no real arguments for privatisation, a charge levelled by the noble Lords, Lord Ezra and Lord Mason. I shall give you the central argument, and it is this. The privatised industry will be in a much better position than now to do its job effectively, and to see that the public gets the water quality standards, the standards of service and the environmental benefits which we all agree are vitally important. We believe that progress in improving these standards will be faster as a result of privatisation. This will be due in no small part to the end of one sort of competition from which the industry will at last be spared. I refer to the competition with other public services for public sector resources.

Improvements in drinking water quality, the drive to set and achieve higher standards for the quality of water in our rivers, the need to clean up bathing beaches all come down in the end to a large and sustained investment programme. I know that noble Lords opposite will argue that that is no reason for privatisation. They say that the money should be found, that the Treasury should be put in its place and that the industry need not leave the public sector in order to achieve a sustained and adequate investment programme.

Lord McIntosh of Haringey

My Lords, will the Minister permit me to intervene? I sympathise with a great deal of what he has said about the need for investment. Will he remind the House that at the moment over 90 per cent. of the investment in the water industry comes from revenue sources rather than from borrowing?

The Earl of Arran

My Lords, I shall come to deal with that point in a moment. Returning to the argument with which I was dealing, perhaps I may pick a hole in it by pointing out what has happened to the level of investment in the water industry over the past 15 years. Since 1979 my right honourable friend and his predecessors have fought the industry's corner pretty well. Investment by the 10 water authorities in England and Wales has already grown by 50 per cent. since 1980-81. Plans for a further 20 per cent. increase were announced by my right honourable friend the Chancellor in the Autumn Statement last week. Noble Lords opposite may wish to know how this compares with the preceding five years. I shall tell them. There was a 30 per cent. decline in capital spending in real terms from 1974 to 1979. So much for putting the Treasury in its place.

I say that not to make a party political point in any way, but to illustrate how rare it is for a public sector industry to be able to plan a long-term and stable level of investment so that it can get on with the job that needs to be done and spend what it needs to spend in the way that management considers best calculated to achieve its objectives. After privatisation it will be for management to manage the water industry. We shall see profitable private investment in objectives which we all agree to be crucially important. That is one of the most exciting prospects in the privatisation exercise, and I hope noble Lords will agree that it is good news.

The framework, then, is in some senses a simple one. The public sector will set standards. The privatised water and sewerage plcs with have the task of ensuring that the standards (which will be properly enforceable) are met. In what sense can a measure of competition be introduced into that task?

I believe that the Government have made their intentions consistently and plainly clear ever since we first introduced our proposals in the White Paper, Privatisation of the Water Authorities in England and Wales, in 1986. In the first section of that White Paper, under the heading, "Why Private Ownership?" we set down 11 reasons for believing that privatisation of the water authorities would benefit customers and their employees. Three of those reasons bear directly upon this debate. We said, first, that the financial markets would be able to compare the performance of individual water authorities against each other and against other sectors of the economy. This will provide the financial spur to improve performance. Secondly, we believe that private authorities will be better able to compete in the provision of various commercial services, notably in consultancy abroad. Thirdly, we suggest that privatised authorities will be better able to attract high quality managers from other parts of the private sector.

Before I expand upon these various facets of competition I should like also to bring to your Lordships' attention two other facets of competition: the first is alternative supplies and the second competition for appointments to supply and service green-field sites. There are thus significant ways in which competition will be fostered in the privatised water industry.

I should like to dwell for a short time upon each of these elements of competition. First, under the heading "Financial Markets", there will be 10 privatised water authorities which will be directly comparable with each other in the services they provide, and those 10 companies will additionally be comparable in the provisionof water supplies with 29 statutory water companies. The financial markets provide what is, in effect, a running commentary on performance on what has happened and what is expected to happen in the future. The share price will move in accordance with shareholders' expectations and, other things being equal, the companies which make more efficient use of their resources will be distinguished by their higher ratings and in a virtuous circle will have cheaper access to capital.

The better run companies will be able to expand more readily and the benefits of good management will become self-reinforcing. There will be competition for the ownership of companies. The pressures to displace weak management and the returns for shareholders in well-managed companies will be a constant spur to efficiency and improved performance. The noble Lord, Lord McIntosh, asked whether shareholders will sell if shares go down. Whether or not they sell them there will be pressure on the board and the noble Lord would be unwise to underestimate that pressure to do better.

Another facet of comparative competition will be the ability of the companies' customers, and perhaps most importantly the Director General of Water Services, to make direct comparisons between companies as to their standards of service, their efficiency and their potential, with the consequential effect in the system of regulation which will operate on the customer's behalf.

Secondly, as regards diversification, when we presented our White Paper in February 1986 we singled out competition in the provision of consultancy services abroad as a commercial service that would paticularly benefit. We should not forget that the water industry embraces many forms of expertise. The privatised authorities will be well placed to compete, for instance, in the provision of plumbing services; they could offer special treatment processes for water to be supplied or wastes to be treated; and they are expert in the field of chemical analysis and some forms of biological analysis to give just a few examples. And their expertise can be used as a springboard for new enterprise.

Several noble Lords, including the noble Lord, Lord Grimond, expressed concern about the intervention of foreign buyers. We have heard worries about the interest of French water companies in some of our statutory water companies. No doubt we shall be debating in future the pros and cons of special shares and the form of other controls on mergers and takeovers in the privatised industry. Noble Lords would not expect me to go into the policy options now. But it would be blind indeed to ignore the lesson for the future of English water companies in the size, strength and diversity of those successful French water companies.

They have an annual turnover in some cases of the order of £5 billion. Their interests are worldwide. They have diversified from their initial business interests into other municipal services, into housing, into communications, into cable television and into various forms of manufacture and construction. It does not need a wild imagination to see a similarly exciting long-term potential for the privatised English water industry in England and Wales. Let there be no mistake that the French companies are successful because they spring from a home base where the structure of the industry has encouraged enterprise, diversity and competition.

These are opportunities which have simply not been available to the nationalised water authorities or the statutory water companies. Equally, the water industry will be able to benefit from services offered by the competitive commercial world and will have to justify to its shareholders its decisions on whether to provide in-house services or to buy in services.

At this point the noble Lord, Lord Ezra, and the noble Lord, Lord Grimond, commented on the cost of competition and contracting out. Water companies will be free to contract out services or to use their in-house services. They will have a strong incentive to choose the most efficient solution.

As regards competition for staff, these new commercial pressures will also bring a challenge into the management of the water industry and if it is to succeed it will have to pay a competitive price for managers who are able to cope in the commercial world.

It has often been said that the water industry is the natural monopoly par excellence. That is true in the sense that it will be wasteful and disruptive to lay down systems of pipework to give domestic consumers a choice at the tap. But the industry will find that not all its potential customers are bound to accept its services. Many industrial companies are able to turn to alternative supplies: triey provide a spur to the privatised water industry. That is my fourth reason for competition.

Fifthly, as regards competition for greenfield sites, Professor Littlechild's report in 1986, in an interesting chapter on the scope for competition, identified the opportunities for direct competition between water services plcs, for example on development sites along the borders of two companies where there is to be a new town, a shopping centre, an industrial estate or a factory development. In such areas it seems to the Government that it would be feasible for a new company to bid for the right to provide the services. We are therefore developing the concept of inset appointments for greenfield sites. We see this as a means of ensuring competition in development areas. We intend to encourage such competition in a way which recognises and does not discourage the need for sensible planning and anticipating investment by the established company in each area which will hold the main appointment.

The noble Lord, Lord Mason, expressed concern and made considerable mention of the National Rivers Authority. The Government's efforts to introduce competition will not be confined to the water utilities. In the Statement on the National Rivers Authority which we published in December 1987 we made it clear that the NRA would be expected to maximise the amount of work which it contracted out consistent with the effective discharge of its functions. It will not be just the utility companies that will be encouraged to tender: other firms in the private sector will also be invited to tender for NRA business. In no sense will the NRA be abrogating its responsibilities: it will have to ensure that the work is performed satisfactorily and in some cases, such as the routine analysis of samples, the NRA may need to exercise control on a day-to-day basis. This encouragement of the NRA to contract out what work it can follows the principle that public bodies should use competitive tendering to increase efficiency.

I should tell the noble Lord, Lord Mason, that the NRA will be given effective powers to do its job. It will be an important advance that environmental standards will be policed by an independent national body and not by the water authorities themselves.

A number of noble Lords have pressed the case for privatisation of the water authorities to be in the model of the statutory water companies, perhaps combined with efficiency audits, arguing that a public service should not be making profits to benefit shareholders but should plough money back into the business for the benefit of customers. But the Government believe that their mechanism for charges control through appointments monitored by the Director General of Water Services will provide the same protection for customers as they have now and the operation of the capital market will provide a permanent discipline for the privatised utilities which will be much more effective than any system of efficiency audits. I know that statutory water companies have sought efficiency, and I do not wish to disparage the achievements of the better companies.

Before my closing remarks, I am aware that there may be some points which I have not been able to pick up this evening. However, I should like to dwell on a few points made by noble Lords. My noble friend Lord Elliott of Morpeth was concerned that there may be too few water undertakers. If there appears to be a danger of over-concentration, it will be possible to make a reference to the Monopolies and Mergers Commission.

The noble Earl, Lord Russell, was concerned about spare capacity and the possibility of drought. We intend to carry forward existing provisions for drought and expect companies to plan ahead. It also makes sense to maintain arrangements to transfer bulk supplies between undertakers and for water resources to be carefully managed. I hope that when the Bill comes to your Lordships' House the noble Earl's fears will be allayed.

The noble Lord, Lord Grimond, mentioned that the consumer wants better and cheaper water. It has already been made clear in another place by my right honourable friend the Secretary of State for the Environment that better water and higher standards of water and sewerage services will cost money and charges must rise irrespective of inflation.

Another point made by the noble Lord, Lord Grimond, concerned bringing the industry under the direct control of a Minister. The advantages of giving the job to a strong and independent watchdog with teeth—the Director of Water Services—is that the industry will be free from variable political interference but will be supervised in a way which protects the interests of consumers.

As I said, I apologise if I have been unable to cover all the points raised this evening. However, I hope that I have gone some way towards persuading those of objective mind that there are real and lasting advantages to come from privatisation and that the planned machinery of regulation and standard setting is well designed to prevent any natural dangers in the privatisation of a natural monopoly. Those who remain to be persuaded can rest assured that these arguments can be revived both here and in another place when the major legislation which will give effect to our proposals is presented. The answer to the Question of the noble Lord, Lord Ezra, is a confident yes, and we look forward to further debate.

House adjourned at nineteen minutes before eight o'clock.