There is scope in 2000 and beyond for substantial reductions in customers' bills in England and Wales, while maintaining the ability of water companies to finance a large investment programme bringing benefits to the environment and improvements in services to customers, the water regulator, Ian Byatt said today.

Ministers have set out their plans for the largest investment programme ever for the water environment. This programme could cost some £8.5 billion. But there is still considerable uncertainty over the regional implementation of many of these environmental obligations. Ministers will make their final decisions by next March, taking account of local environmental priorities while avoiding unacceptable impacts on water prices.

In Prospects for Prices, published today, the regulator sets out for consultation the strategic issues to be decided between now and July next year when he will publish his draft determination of new price limits to run from 2000 to 2005. His final decisions on price limits will be made in November 1999. The paper sets out ranges for bills that reflect the current uncertainties, as well as the options for improvements to services, the maintenance of adequate supplies of water and the impact of the Government's proposals on water charging. These are considered in the light of the results of recent consultation at both national and local level with customers on their priorities.

Ian Byatt said:

"The scale of past efficiency shows that bills could come down substantially - by more than has so far been recognised. At an industry level we could be looking at a reduction of as large as £40 to £50 (15 to 20 per cent) in April 2000 from the expected average household bill of £245 in 1999-2000. But the scale of the whole environmental programme that Ministers have outlined would push bills back up again - at a national level to some £215 to £240, approaching current levels. While many customers could continue to benefit from lower bills, some, particularly in coastal areas, could be paying higher bills in 2005 than now.

"The doubling of investment that has taken place since privatisation has been financed by rising then broadly stable prices in real terms. To finance a continuation of this investment programme on the scale envisaged by government, within a framework of falling prices, will not be easy. Companies have become much more efficient and can raise capital more cheaply than was thought possible ten years ago. Nevertheless, it would give a real challenge to the companies both in raising money and in operating and investing efficiently."

In Prospects for Prices, Ofwat invites views on a number of key issues including:

Profile of bills

• Should efficiency savings be passed back to customers immediately, even if that means prices having to rise again to meet the quality improvements, or should the initial reduction be softened so that bills could thereafter be broadly stable over the five years?

• Ministers have said they are concerned that a large price cut followed by subsequent increases could be confusing to customers. There are, however, good business reasons for an early cut in bills. Otherwise the companies would be earning higher returns in the early years than necessary to finance their functions. This could weaken incentives for efficiency. Customers may feel that they would prefer to keep the money in their pockets rather than paying in advance for improved services.

Scale of environmental improvement programme particularly where there is choice as to scope and pace

• How can EC objectives be implemented and other environmental objectives be established in such a way as to avoid excessive impacts on water prices, while reflecting local environmental priorities?

There is also uncertainty about the definition of some of the obligations and the costs associated with all of them, especially about their distribution across companies.

Maintaining incentives for companies to become more efficient

• Incentives to reduce costs create the scope for future price reductions for customers. The Director suggests that companies rated as less efficient should be expected to catch up quickly with the more efficient ones. He is also consulting on whether, in addition, companies who outperform and are efficient should retain some benefits after the price review in order to maintain incentives for them to continue to set the pace for the rest of the industry.

Government's charging proposals

• Ministers' recent proposals on charging could raise bills for some customers, in some cases substantially.

• Balancing supply and demand

• Ofwat recognises that where abstraction is restricted for environmental reasons, bills may need to rise. It may also be necessary to finance, on a modest scale, some investment in demand management. Where companies propose investment to reduce the frequency of hosepipe bans, should they introduce tariffs that enable these improvements to be paid for only by those customers who want this, rather than imposing the additional costs on all customers?

Incentives to maintain and improve services

• The Director is proposing to adjust final price limits to reflect companies general performance in delivering services to customers and protecting the environment. His initial view was that such an adjustment might be in the range of plus or minus 0.5 per cent on bills each year. He is considering increasing the penalty on poor performers to one per cent a year and he welcomes views.

The cost of capital

• The cost of capital is a major factor in the water industry because of the need to finance the large investment programme. The Director's current assessment of the cost of capital for all but the smallest water companies is 4 per cent to 5.5 per cent in real terms after business taxes. This assessment is lower than in 1994 principally because of material changes since then - in the real cost of borrowing and in the risk premium for equities. Companies are also able to sustain higher levels of debt finance.

Uncertainties remain. In particular, the effect of the recent global market turbulence is unclear and difficult to quantify. Because of the uncertainties, a cautious figure of 5.25% has been used to define the ranges of bills set out in Prospects for Prices.

The consultation on Prospects for Prices runs until 4 January 1999. The Director has asked the Customer Service Committees, who have the statutory responsibility to represent the views of all customers, to consult widely on these issues.

During January and February, the regulator will hold formal meetings with each of the companies to discuss the public responses to the paper. This should help each company draw up its Business Plan, due for submission to Ofwat in April 1999.