Hansard

I am grateful that I have been invited to attend the committee to deal with the complex and difficult matter of the water industry. We have a duty to explore all the options. I hope that the committee will be able to give us advice on the options, proposals and challenges that we face and on how best we can deal with them.

There is no doubt that this is a period of fairly substantial change for the water industry in Scotland. There are pressures on two main fronts: first, we must increase substantially our investment in water and sewerage works; secondly, competition is playing an even greater role than it used to in waste water management.

The first key point that I want to get across is that the investment needs of the industry are real and substantial. Secondly, competition already affects the industry, day in, day out—it is not something that is over the horizon—and is here to stay. We must be able to deal with that. Thirdly, there are no easy answers to the funding challenge—large sums are required. Fourthly, improving efficiency has a major role to play in the future of the water industry. The final—and probably the most important—message that I want to get across is that the Executive's role is to foster a sustainable, viable and competitive public sector water industry. Privatisation is not an option for us. I repeat: privatisation is not an option.

There is general consensus that we need to implement a substantial programme of investment in our water and sewerage networks, but the scale of that investment is perhaps not clear to everyone. European and national legislation rightly demands higher standards for the quality of our drinking water and for the treatment of waste water. The European directives demand substantial new infrastructure, in particular to meet waste water treatment standards. To that investment we must add decades of underinvestment, low maintenance and, in some cases, poor quality infrastructure, which is now coming to the end of its life.

The combined effect of those pressures is that we need to invest close to £2 billion over the next four years—a substantial investment. Those are real needs, which we have identified through a structured process that considers the outputs that need to be achieved. We will consult on the quality and standards process in the next few weeks. If we do not invest that amount of money, there will be burst mains, interruptions to supply, a risk of outbreaks of cryptosporidiosis, contamination of rivers and beaches and consequences for the tourism industry. We would run the risk of action in the European courts if we failed to meet our obligations—that is a costly financial risk; I notice that Greece is being fined £200,000 a day, plus interest. There is also the threat of withdrawal of structural funds. The financial penalties for not meeting our obligations are substantial.

We are preparing a consultation paper on how much we should invest in environmental protection and drinking water quality. It will inform the second quality and standards paper, which will cover investment from 2002 to 2006, discuss the work to be carried out by the water authorities over the period and invite comments on the different investment options to be introduced.

I want to emphasise once again that most of the investment must take place to meet European requirements. Those requirements are unavoidable, legal obligations, which set deadlines—we have no intention of failing to meet them.

Our task is to provide a framework that allows competition to function in water and sewerage services that are on the public network. However, although our task is to produce the legislation to allow that to happen, we must recognise—I made this point at the start—that a more immediate issue for the water authorities is the fact that competition already exists and is having a significant effect on them.

In the commercial and business sector, companies have been able to look for alternative, off-line solutions in the delivery of water and sewerage services. Other companies from England and further afield are seeking and winning business in those services in Scotland, with real consequences for the water authorities. The market is changing fast. For example, non-domestic or business customers are looking to strike single national contracts to manage water and sewerage services on all their sites, crossing local providers' boundaries.

Competition for services such as water management and sewage pre-treatment has an effect on the volume of demand for water authorities. That in turn reduces their revenue. If we lose business to competition or there is a reduced amount of business because of better management, the costs fall back on the rest of us—on the domestic customer—because the industry is a fixed-cost industry. It is essential that water authorities do everything they can to retain non-domestic customers, even if that means keeping charges down for them. I was reminded recently of when Ravenscraig closed down. Strathclyde Water Authority lost £1.25 million overnight, as it had a system of fixed costs, which had to be paid for by the other customers.

Competition has so far been confined to services that are not delivered on the authorities' own networks. The Competition Act 1998 will introduce new forms of competition. The act came into force in March this year and opens up the possibility of third parties competing to provide services using the authorities' networks—on-line provision—whether through common carriage or other arrangements.

There is no framework for controlling competition in the Scottish water industry. The existing Scottish water and sewerage legislation is geared to services provided by public monopolies. It makes no provision for third parties serving customers through access to, or use of, the public networks. A proposal for a new statutory framework for the Scottish water sector was therefore at the centre of our recent consultation exercise on competition, "Managing Change in the Water Industry". Such a framework is necessary to safeguard public health, the environment and social objectives, as competition develops.

If third parties are to have access to the authorities' facilities, they must share the authorities' obligations. We must be confident that those that enter the market are both financially secure and technically competent so as to safeguard the security, reliability and safety of the supply of water to the public network and to maintain the quality of waste water treatment and discharge to the environment. We intend to ensure that new entrants' obligations will include paying a reasonable share towards the cost of maintaining an accessible and affordable service for all our customers.

The Executive must help the water authorities to gear up to meet the challenge of competition and to improve their services to customers. Our job is to take on the competition and to beat it. I am fairly confident that we can do that. We will put our full weight behind the authorities' drive for significant efficiency gains in investment and operations. The water industry commissioner has made clear his belief that the authorities must become more efficient to deliver their services at competitive prices. I endorse that view.

We will work with authorities to promote their customer service levels and to respond to the changing demands of customers, not just in water but in all the other utilities. The authorities must respond to those demands as part of their strategies for retaining existing customers and winning new ones.

We will give the authorities backing to become outward-looking organisations with a commercial bent. In the interests of the authorities' long-term viability and of their customers, I want the authorities to win business where it makes sense for them to do so. That means that they will have to be imaginative and proactive in a crucial sector of the market. We are considering ways in which they can adapt. In some cases, it will make sense for authorities to work with other businesses in joint ventures. We will relax the guidelines for such joint ventures and give authorities greater flexibility to compete and to develop their expertise in new areas, such as waste minimisation. That will mean that the authorities will provide a better range of services to meet the needs of their customers.

Moving on to finance, we know that the water authorities are public sector bodies and, by definition, score in public expenditure totals. They are able to borrow from Government to provide additional resources for investment on top of the cash that they generate from their operations. Current arrangements allow the authorities to borrow to about the level at which they are adding to their assets. It would not be sensible for any organisation that operates in a commercial environment to borrow above that level, as that would add to its liabilities more than to its assets. That would be like taking out a mortgage for more than 100 per cent of a property's value, which would not make sense.

The use of resources by the water authorities scores on the Scottish assigned budget, wherever the money is raised. If the authorities were to raise their own bonds, they would merely increase their interest costs, and bonds would still be counted against the assigned budget. Subsidies that are paid directly to the authorities to reduce charge levels would also score against public spending and would contravene the rules on state aids.

There is no magic wand that would write off the debt, which would still have to be serviced and would become a burden on the Executive's budget. The cost of achieving a modern water and sewerage system cannot be made to disappear—someone will have to pay for it, and it is right that it should be paid for by those who use the services. There are no easy solutions for funding investment, the need for which, as we know, is most acute in the north of Scotland, where the problem is particularly pronounced. Borrowing can help to cushion the impact of increased investment on charges. For this year and next year, we have made some additional resources available to the North of Scotland Water Authority. However, all borrowing must be repaid and it would be irresponsible of us to build up unsustainable debt levels that would fall on future customers.

One of the keys to keeping charge rises to a minimum is for the authorities to improve their efficiency. I know that the water industry commissioner and the authorities are discussing ambitious efficiency targets. It is clear that significant gains need to be made, so that the authorities can keep their costs within manageable levels and so that they can bear comparison with their competitors from south of the border.

We strongly support the work that the authorities are undertaking to see how they can collaborate to improve services to their customers. We will do what we can to provide the right incentives for the authorities' management and staff to meet the efficiencies that are required.

Thank you, deputy convener, for indulging me in a rather long opening statement. I will conclude by spelling out our vision for the Scottish water industry.

I believe that we can shape a public sector model that is sustainable and viable, that will meet the challenge of competition—rather than ignore it or try to block it out—and that will deliver a highly modernised infrastructure that is capable of delivering a top-class service to all of Scotland. However, achieving that model means change for the authorities. They must become more efficient and more customer focused, so that they become the supplier of choice and are not forced into becoming the supplier of last resort.

That means changing the legal framework to ensure that environmental, social and public health objectives can be met. It means substantial physical changes, as the infrastructure is expanded and renewed. It means change for the Executive, as we adapt to the challenges of owning, on behalf of the public, large-scale utilities that now compete in a commercial market. All those changes are preconditions for achieving our ultimate goal—an improved service to the Scottish public and Scottish business. We want a public sector service that can compete and deliver.

Thank you, deputy convener, for allowing me to make such a long introduction.