Did flaws in the application of resource accounting and budgeting distort the Strategic Review of Water Charges in Scotland?

In August 2001, the Water Commissioner was tasked by the Scottish Executive to carry out a strategic review of water charges covering the years 2002-06. Based on revenue calculations made by the Water Commissioner in his review, Scottish Water issued its water charges for 2003-04. Since then there have been repeated arguments and complaints, particularly from businesses, that the prices charged are too high and are crippling business. For example, Peter Jones, writing in the Economist 29th May 2003, cited the example of the BP refinery at Grangemouth, where the annual water bill is now £12.7 million, as against £7 million for a similar establishment in England. This article examines the impact which the then newly introduced system of expenditure control based on Resource Accounting and Budgeting, (RAB), had on the Strategic Review. We conclude that there appear to have been mistakes in the application of the RAB system at the time of the Strategic Review, which mean that the review took an unduly pessimistic view of the water industry’s financial position. This implies that the charges set as a result of the review were potentially too high by a significant amount. There is a requirement to re-open key aspects of the arithmetic of the Strategic Review: in particular, on how the Scottish Executive set the original RAB limits and how these were then translated into the Commissioner's advice. The structure of the paper is as follows. Section 2 briefly sets the background. The main content of the paper is in section 3, where we examine how the Water Commissioner used the information given by the Scottish Executive with regard to RAB to determine how much Scottish Water could borrow, and we compare this with the figures the Scottish Executive itself produced for net borrowing. There is clear evidence of inconsistency between the Commissioner and the Scottish Executive, with the Commissioner producing in his calculations a much more pessimistic view than the Scottish Executive of the amount of net borrowing consistent with a given RAB control limit. The implications of this for the charging decisions taking during the review are potentially profound and may amount to more than £100 million per annum. We cannot establish categorically, on the basis of the available evidence, how this inconsistency arose: but it appears to relate either to revised estimates of depreciation which the Commissioner calculated during his review, or more probably, to the possibility that there is a mistake in the terms of the letter from the Scottish Executive commissioning the review of charges which has meant that a substantial element of investment has effectively been double counted. Section 4 identifies, and discusses briefly, a number of other issues which are relevant to the determination of water charges. The section concludes with the recommendations that (a) the arithmetic on the setting of existing charges should be re-opened, and (b), that there should be a more wide ranging review of charging policy