Northumbrian Water Limited, R (on the application of) v Water Services Regulation Authority [2023] EWHC 2410 (Admin)

“(1) This section shall have effect for imposing duties…on the Authority as to when and how [it] should exercise and perform the powers and duties conferred or imposed…by virtue of any of the relevant provisions. (2A) …the Authority shall exercise and perform the powers and duties mentioned in subsection (1) above in the manner which…it considers is best calculated – (a) to further the consumer objective; (b) to secure that the functions of a water undertaker and of a sewerage undertaker are properly carried out as respects every area of England and Wales; (c) to secure that companies holding appointments under Chapter 1 of Part 2 of this Act as relevant undertakers are able (in particular, by securing reasonable returns on their capital) to finance the proper carrying out of those functions;… (e) to further the resilience objective. (2B) The consumer objective mentioned in subsection (2A)(a) above is to protect the interests of consumers, wherever appropriate by promoting effective competition between persons engaged in, or in commercial activities connected with, the provision of water and sewerage services. (2C) For the purposes of subsection (2A)(a) above…the Authority shall have regard to the interests of – (a) individuals who are disabled or chronically sick; (b) individuals of pensionable age; (c) individuals with low incomes; (d) individuals residing in rural areas; (e) customers…whose premises are household premises but that is not to be taken as implying that regard may not be had to the interests of other descriptions of consumer… (2DA) The resilience objective mentioned in subsection (2A)(e) is – (a) to secure the long-term resilience of water undertakers’ supply systems and sewerage undertakers’ sewerage systems as regards environmental pressures, population growth and changes in consumer behaviour, and (b) to secure that undertakers take steps for the purpose of enabling them to meet, in the long term, the need for the supply of water and the provision of sewerage services to consumers, including by promoting – (i) appropriate long-term planning and investment by relevant undertakers, and (ii) the taking by them of a range of measures to manage water resources in sustainable ways, and to increase efficiency in the use of water and reduce demand for water so as to reduce pressure on water resources… (2E) …the Authority may, in exercising any of the powers and performing any of the duties mentioned in subsection (1) above, have regard to – (a) any interests of consumers in relation to electricity conveyed by distribution systems (within the meaning of the Electricity Act 1989); (b) any interests of consumers in relation to gas conveyed through pipes (within the meaning of the Gas Act 1986); (c) any interests of consumers in relation to communications services and electronic communications apparatus (within the meaning of the Communications Act 2003), which are affected by the exercise of that power or the performance of that duty. (3) Subject to subsection (2A) above,…the Authority shall exercise and perform the powers and duties mentioned in subsection (1) above in the manner which…it considers is best calculated – (a) to promote economy and efficiency on the part of companies…in the carrying out of the functions of a relevant undertaker;… (ba) to secure that no undue preference (including for itself) is shown, and that there is no undue discrimination, in the doing by such a company of –… (ii) such things as relate to the provision of services by a water supply licensee or a sewerage licensee;… (e) to contribute to the achievement of sustainable development. (4) In exercising any of the powers or performing any of the duties mentioned in subsection (1) above in accordance with the preceding provisions of this section,…the Authority shall have regard to the principles of best regulatory practice (including the principles under which regulatory activities should be transparent, accountable, proportionate, consistent and targeted only at cases in which action is needed)… (5A) In this section – “consumers” includes both existing and future consumers; and “the interests of consumers” means the interests of consumers in relation to – (a) the supply of water…; and (b) the provision of sewerage services... (7) The duties imposed by subsections (2A) to (4) above…do not affect the obligation of the Authority…to perform or comply with any other duty or requirement (whether arising under this Act or another enactment, by virtue of any retained EU obligation or otherwise).”

“Challenges facing the sector and Ofwat’s strategy Water companies provide essential services that no-one can live without. As part of our strategy we want water companies to provide the very best service for customers, protecting the environment and improving customers’ quality of life by providing reliable water and wastewater services, both now and in the future. The water sector faces profound challenges such as climate change and population growth. Some have also questioned companies’ licences to operate. Customers’ demands are changing and the services water companies provide must keep pace with them while remaining affordable for all. Companies must also make sure they meet customers’ diverse needs, particularly those of customers in vulnerable circumstances. To meet these challenges will require a step change in company performance, customer service, efficiency and a more resilient and reliable supply of water, and an increased focus by companies on delivering public value. In achieving these goals we will meet the strategic priorities and objectives of both the Welsh and UK Governments. Without this step change, we risk a deterioration in service, unaffordable price increases and continued environmental damage. The 2019 price review (PR19) sets the price, service and incentive package for water companies for the period 2020-25. It is the single most significant regulatory lever in driving the step change in the industry. To do this, in PR19, we are: · setting stretching but achievable performance commitments on the outcomes that matter to customers and the environment; · challenging companies to go further on cost efficiency;… · providing more funding for new investment and innovation; and · reducing the allowance for the return on capital, reflecting prevailing market conditions. In combination this allows us to improve outcomes for customers and the environment and build more resilient services, while reducing customer bills by 12% before inflation...” “Background There are 17 monopoly water and wastewater companies. These provide end-to-end services from securing water resources, water treatment and distribution through to retail. Water companies are natural monopolies, with high infrastructure costs in particular across distribution networks. Without regulation and competitive pressure, water companies would be able to increase prices and reduce service quality. Water bills are material to customers, particularly those on low incomes, with an average household combined water and wastewater bills of £405 in 2019-20. Water companies are also sizeable companies with the total revenue across 17 companies for around £11.6 billion per year for the 2020-25 period (all figures in 2017-18 prices)… Following privatisation in 1989, real (before inflation) customer bills increased over the first 20 years, followed by period of bills being relatively stable. As a result of PR19, bills are forecast to fall from 2020. By 2025, bills will return to the level that they were in 1999-2000…Affordability is an important issue for the sector – water is an essential service and around 3 million customers struggle to pay their bills.” “Our overall approach to PR19 The PR19 performance commitments set the service levels each of company is expected to meet, while the revenue allowance is derived from efficient total expenditure (or totex) and an allowed return on the company’s regulatory asset base. The combination of the stretch from performance commitments and the cost efficiency challenge together provide the overall level of challenge for companies… Outcomes performance commitments cover key service areas and set out what companies will deliver to customers over the 2020 to 2025 period. Building on experience with PR14, we set 15 common performance commitments that apply to all companies… Companies were asked to develop a set of bespoke performance commitments that reflect local circumstances and customer priorities. In a number of cases, companies have specific performance commitments to encourage the timely delivery of large enhancement schemes - schemes which will deliver significant improvements to customer service, the environment or resilience. Customers demand good service from their water and wastewater companies. We intervene to make sure that outcome performance commitments are stretching but achievable. For…water supply interruptions, we set out our expectations in the PR19 methodology that stretching performance commitment levels should be based on the forward-looking upper quartile service level. That is the level of performance companies forecast will be achieved by 25% of companies in the future. These areas reflect important priorities for customer service and the environment. For [these] performance commitments we consider that all companies should be able to achieve the same common performance levels by management and operational improvements. Consequently the level of stretch will be higher for poorer performing companies. We do not consider it is acceptable for some customers to continue to experience lagging performance due to poor operational or management practices…” “Balancing risk and return Our determinations aim to incentivise companies to deliver stretching levels of service and deliver services efficiently while meeting their obligations and commitments to customers. Through the use of incentive mechanisms and the allocation of risk to the party best able to manage it we aim to ensure companies will be incentivised to deliver the best outcomes for customers in 2020-25. Our mechanisms ensure that where companies underperform for customers, their returns will be reduced; if they outperform, they will earn additional returns”

“Two companies (Northumbrian Water and Anglian Water) consider there should be greater consistency in how we set caps and collars. Northumbrian Water does not accept our decision to remove the underperformance collar for supply interruptions. It claims that it is the only company without such a collar when it is a common performance commitment, so it would expect a consistent approach. The company does not accept our argument that these underperformance payments are not material – the company considers its underperformance rates are now consistent with the industry range, and an extreme weather event could expose the company to a very high level of underperformance… Our Response: …where the vast majority of companies have caps and collars it may suggest that there are underlying reasons that all companies should have caps and collars. There are five comparative performance commitments that have a vast majority of companies (>70%) have caps and collars. • Supply interruptions… We do not have clear reasons why a few companies do not have caps and collars, while most do. For these…performance commitments we apply collars and, where outperformance is possible caps, to all companies where performance commitments are not covered by early certainty.”

“to incentivise companies to minimise the number of and duration of supply interruptions”

“to incentivise the company to reduce the amount of lengthy interruptions that customers experience”

“to minimise the number of supply interruptions of shorter duration”

“Objective The purpose of this document is to derive a metric for supply interruptions that consistently calculates the performance of water companies in terms of the average number of minutes lost per customer for the whole customer base for interruptions that lasted 3 hours or more. This guidance seeks to enable companies to monitor and compare consistently derived and common performance measures for Supply Interruptions… The adoption of this metric across the industry does not preclude any company electing to have other supply interruption Performance Commitments with company specific definitions or continued reporting against the previously reported DG3 or KPI Dashboard (post 2011) metrics. Exclusions The default position is that the water company manages the risk of supply interruptions and there are no exclusions. This measure covers planned and unplanned interruptions. The cause of the interruption is not relevant to the calculation of the reported figure. That is, asset failure caused by third parties would be treated the same as the failure of the company’s assets and planned or unplanned interruptions are the same. Companies may make a representation to Ofwat for an exception to be granted on the basis of a civil emergency under the Civil Contingencies Act 2004, where the supply interruption is not the cause of the emergency [(“the CE exception”)]... Measure Definition Calculation of the Performance ∑ [=] (𝑃𝑟𝑜𝑝𝑒𝑟𝑡𝑖𝑒𝑠𝑤𝑖𝑡ℎ 𝑖𝑛𝑡𝑒𝑟𝑟𝑢𝑝𝑡𝑒𝑑𝑠𝑢𝑝𝑝𝑙𝑦 ≥ 180 𝑚𝑖𝑛𝑠) × 𝐹𝑢𝑙𝑙𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛𝑜𝑓𝑖𝑛𝑡𝑒𝑟𝑟𝑢𝑝𝑡𝑖𝑜𝑛 𝑇𝑜𝑡𝑎𝑙𝑛𝑢𝑚𝑏𝑒𝑟𝑜𝑓𝑝𝑟𝑜𝑝𝑒𝑟𝑡𝑖𝑒𝑠𝑠𝑢𝑝𝑝𝑙𝑖𝑒𝑑 (𝑦𝑒𝑎𝑟𝑒𝑛𝑑)…”

“Unplanned outage (sic) arising from changes in raw water quality beyond the normal water quality operating band shall be excluded as this is not a measure of asset health. Exclusions must be evidence based including evidence to show what the normal water quality operating for that production site is…”

“The default position is that the water company manages the risk of mains bursts and there are no exclusions. The cause of the mains burst is not relevant to the calculation of the reported figure, with the following exceptions and points of clarification: • Any work that is not undertaken on the main e.g. solely on a ferrule, hydrant or valve and clamps associated with these ancillaries, which does not involve a repair on the main shall be excluded. Clamps used to repair the main shall be included. • All third-party damage should be excluded where costs are potentially (rather than actually) recovered from a third party.” • Any work that is not undertaken on the main e.g. solely on a ferrule, hydrant or valve and clamps associated with these ancillaries, which does not involve a repair on the main shall be excluded. Clamps used to repair the main shall be included. • All third-party damage should be excluded where costs are potentially (rather than actually) recovered from a third party.”

“Ofwat has confirmed that the output of this project will not impact on PR14 performance commitments and ODIs, but is intended to form the basis of public reporting from 2020/21 and to inform the development of PR19 Business Plans and Water Resource Management Plans.”

“The guidance document for the consistent reporting of supply interruptions is included in the appendices. The calculation and assumptions to be applied have been made as simple and as customer centric as possible in order to achieve consistency of reporting and increase customer trust. There was clear consensus for a metric for supply interruptions that consistently calculates the performance of water companies in terms of the average number of minutes lost per customer for the whole customer base for interruptions that lasted 3 hours or more.”

“Exclusions A key area of simplification was the reduction or elimination of circumstances which would be acceptable as exclusions. Exclusions are to be kept to a minimum and shall be consistent with the reasonable expectations of an affected customer.”

“We have worked to embed resilience in the common performance commitments. For example, the definitions for performance commitments at PR14 often excluded events such as extreme weather, which are precisely the events we want the sector to be resilient to. We have worked with the sector on the definitions of the common performance commitments to ensure that they do not include any such exemptions.”

“9.4(1) In respect of…Network Plus Water Activities…the Water Services Regulation Authority shall determine [a Price Control] in accordance with this sub-paragraph (having regard to all the circumstances which are relevant in the light of the principles which apply by virtue of Part I of the Water Industry Act 1991 in relation to the Water Services Regulation Authority’s determinations including, without limitation, any change in circumstance which has occurred since the last Periodic Review or which is to occur)… 9.6 Each Price Control determined under sub-paragraph 9.4 pursuant to a Periodic Review shall be set: (1) for the five consecutive Charging Years starting on 1 April 2020; and (2) thereafter for each period of five consecutive Charging Years starting on the fifth anniversary of the first day of the period in respect of which the immediately preceding Periodic Review was carried out.”

“12.1 This Part 3A applies where the Water Services Regulation Authority has notified the Appointee by 31 December in the Charging Year before the Review Charging Year that a Price Control determined under sub-paragraph 9.3 in respect of the Appointee’s Retail Activities or sub-paragraph 9.4 in respect of the Appointee’s Water Resources Activities, Bioresources Activities or Network Plus Activities may be adjusted to reflect the Appointee’s performance in relation to a specific Performance Commitment… 12.5 Under this Part the Water Services Regulation Authority may determine the question of whether there should be a change to the revenue allowed under, or, as the case may be, the level of, any Price Control determined under sub-paragraph 9.3 in respect of the Appointee’s Retail Activities or sub-paragraph 9.4 in respect of its Water Resources Activities, Bioresources Activities or Network Plus Activities for the following and any subsequent Charging Year and, if so, the amount of such change… 12.7 In making a determination pursuant to this Part, the Water Services Regulation Authority shall: (a) consider the Appointee’s performance in relation to each relevant Performance Commitment in the period for which performance is being assessed and, in deciding for which Charging Year or Charging Years an adjustment to a Price Control should be made, shall consider both that and the Appointee’s expected performance in the current year or one or more future years up to, but not including, the next Review Charging Year; and (b) take account of the adjustments to the relevant Price Control which the Water Services Regulation Authority notified to the Appointee under sub-paragraph 12.1 above in relation to each relevant Performance Commitment in question.”

“Storm Arwen has been widely recognised as having been an exceptional event. It has been acknowledged as having been one of the most powerful and damaging winter storms of the last few decades, with several unusual features that exacerbated and intensified its impact. As has been widely reported in the press, over one million trees were felled due to the Storm and around 16 million in total were damaged causing significant transport disruption; three people were killed; and fallen power lines resulted in one million homes experiencing electricity disruption… The unprecedented nature of the storm, its impact on the energy networks and their response triggered reviews by: Ofgem; the Department for Business, Energy & Industrial Strategy (BEIS) (through the Energy Emergencies Executive Committee); and the Scottish Government. The Jacob’s Report set out, amongst other things, details of the unique features of Storm Arwen, including:… b) the highest (non-mountain) gust speed in England was 98 mph, recorded at Brizlee Wood in Northumberland. A wind gust as high as this is exceptional for this area. These exceptionally strong winds triggered a rare Met Office “red” warning for wind in the North East of England and the East of Scotland; c) …When analysed by wind direction the northerly Storm Arwen winds recorded in and around Northumberland are estimated to have return periods between 1 in 20 years to greater than 1 in 50 years;… In NWL’s Northern Supply Area Storm Arwen led to two councils declaring major incidents. This triggered a multi-agency response to a civil emergency which was co-ordinated through the Local Resilience Forums (LRFs). The response included the deployment of military personnel to conduct door-to-door checks on vulnerable people in their homes and to provide any additional support required. Storm Arwen affected NWL’s ability to supply water to customers and maintain wastewater treatment processes. Based on the analysis that has subsequently been carried out by NWL’s staff, supported by Jacobs and by Crowders, we have identified that in 98.8% of cases the interruption to NWL’s supply was due to power outages that had been caused by Storm Arwen. Those outages affected 55 of NWL’s sites across the region and also caused a loss of communications. In total, circa 1,000 assets within NWL’s network were affected by the loss of power. The other 1.2% of interruptions were caused by direct damage to NWL’s water supply… …As a result of Storm Arwen and the loss of power NWL experienced 40 category three pollution incidents, and a further 15 category four incidents…[A]ll of these events were excluded from the assessment of NWL’s pollution-related performance by the Environment Agency (EA). The power outages also hampered NWL’s ability to respond to the impact of Storm Arwen on supplies. The loss of power caused a widescale failure of both fixed and mobile telecommunications systems. This prevented and/or hampered communications between remote sites (such as the operational assets) and our Regional Control Centre (RCC) which is used to coordinate the operational activities and response Other factors that affected our ability to respond to the situation included the fact that NWL was given no advanced warning from the energy companies to begin to prepare our response, despite BEIS having suggested to Northern Powergrid (NPg) that it start preparatory actions from 24 November…Also, access to sites was initially disrupted by fallen trees and unsafe travel conditions, especially in the light of the cold temperatures that came on the back of Storm Arwen…In light of these circumstances, we recognise the efforts of our staff members that went above and beyond to try and maintain supplies to customers… …[T]he scope of the power outages was beyond anything NWL could reasonably have prepared for, and simply having more generators would not have been a solution given the complexity of the challenges posed by the storm… Given the range of challenges posed by the storm, and the inherent reliance upon the remedial actions of NPg, the electricity distribution network operator responsible for all of the affected areas in our region, a full restoration of supply took some time. Data analysed by our teams after Storm Arwen indicates that water supply interruptions peaked at approximately 8,000 properties at 14:00 on 28 November 2021. More than half of these interruptions were restored within eight hours by 22:00 on 28 November 2021. By 9:00 on 30 November 2021, interruptions were being experienced by fewer than 1,200 properties. All interruptions were restored by 12:00 on 7 December 2021. …[A]round 280,000 of NPg’s customers had lost power as a result of network faults and damage by 27 November…[T]he majority of NPg’s customers were reconnected by 29 November (a day later than NWL’s restoration of supply to the majority of its customers) but that still left 30,000 customers without power at that point, and it reportedly took 13 days for all customers to have their supply restored… To date, NPg has paid out £20.08m to consumers in a mixture of mandatory and voluntary compensation to customers… [Guaranteed Standards Scheme (“GSS”)] payments [by NWL to customers whose supplies were interrupted were made by NWL] amounting to c.£680k. It is significant to note that the GSS payments were made despite the fact that GSS Regulation 17F para 6(a)(i) expressly allows companies to withhold payments where supply is interrupted due to “severe weather”.”

“(4) Northumbrian Water Limited (NWL) is consistently in the upper quartile of performers against water supply interruptions and has a track record of responding well to severe weather incidents. Over AMP6 we were the best performing company in two of the five years and had one of the lowest interruption targets in the sector. During Beast of the East in 2018 we were also amongst the best performers with only 0.05% of customers experiencing an interruption longer than four hours. In its “Out of the Cold” report, Ofwat identified us as an example of a company exhibiting industry leading practices, further indicating our resilience and robustness when it comes to managing interruptions. This strong performance has continued during AMP7. In the year ending March 2021, we had the second lowest average interruption impact in the industry in terms of the common water supply interruptions performance commitment… (8) The overall impact of Storm Arwen meets the criteria for a civil emergency…In order to protect businesses from unreasonable penalties as a result of extreme events, Ofwat allows companies to make an application to exclude interruptions caused by civil emergencies. The storm therefore appears to us to represent precisely the event that Ofwat must have included the exemption in the PC for. (9) The exemption appears to have been designed for precisely this type of event and would allow us to reasonably exclude the full impact of the storm. We note that energy networks have similar exclusions in place for extreme weather events. The Environment Agency has already offered a full exemption for pollution events incurred during the same storm on very similar grounds. (10) Although this would allow us to apply for an exemption for the full impacts, we consider there is room for us to improve in some specific instances and propose a partial penalty. We are therefore proposing a penalty of £3.375m. This is in addition to the c. £1.9m of costs incurred by NWL in responding to the storm, including GSS payments. (11) We consider a partial exemption is in the interest of customers and preserves incentives to manage service efficiently and effectively in extreme events: • Applying such a penalty would set poor precedent and be bad for customers over the long-term. It would effectively render the exemption included at PR19 null and void and would place an asymmetric risk into the regulatory process. This would both set an incentive for companies to focus on low probability event mitigation and uneconomic investment to mitigate those risks rather than other service improvements that customers would prefer. It would also drive an increase in the cost of capital to address that asymmetric risk which would result in material additional costs to customers. • The partial exemption importantly retains the incentive properties to minimise supply interruptions. It means customers do not pay for service areas that could have been improved. The ex-post approach also retains the incentive during an event to return customers to service as fast as possible as any exemption needs to be adequately evidenced and justified. • The counterfactual of not applying an exemption in contrast would push costs onto customers through higher cost of capital or uneconomic investment to mitigate the risk of an ODI penalty for events that are extreme. This would not be in the customer interest and have an opportunity cost to other service areas. (12) The final penalty we are eligible to pay fits within the balance of risk determined by the PR19 price control. If the ability to make representations for civil emergencies was not in place, then the penalty we would be facing would be more severe than any ODI penalty for supply interruptions incurred since the beginning of PR14. At the same time the full penalty would represent a far greater financial penalty than has been incurred by any of the Distribution Network Operators following the Ofgem and BEIS reviews of the storm. Those companies had far greater numbers of customers off energy supply and the absence of power was clearly the material cause of the supply outages for us. Such a penalty would be disproportionate to the scale of the harm. (13) Civil emergency events are rare occurrences. As a result, NWL’s specific exemption application does not set a broader precedent to be applied to other events due to its rarity. This coupled with the need that any exemption needs to be adequately evidenced and justified provides an overarching level of customer protection…”

“Although we believe the full impacts of the storm could be excluded via the allowances provided for in the PR19 reporting guidance, we are proposing an ODI penalty which reflects those aspects of our response which could have been more robust. Notwithstanding the fact that in practice it is near impossible to achieve a perfect response to such challenging events. Therefore, we are proposing an ODI penalty relating to Storm Arwen of £3.375m.”

“The final penalty we are eligible to pay fits within the balance of risk determined by the PR19 price control. If the ability to make representations for civil emergencies was not in place, then the penalty we would be a clear outlier when compared to industry wide ODI penalties for supply interruptions incurred since the beginning of PR14… What is also clear is that the potential penalty NWL faces as a result of Storm Arwen will be bigger than any penalty for interruptions given over this period. As well as not being in line with the ODI definition (which explicitly allows for exclusions relating to civil emergencies), this would be drastically disproportionate. Especially considering our strong performance both throughout the rest of the year, and during the storm event.”

“The removal (or failure to grant) of the exemption for civil emergency events alters the downside risk faced by companies in the event of a severe weather event… Under certain circumstances, a business might be exposed to downside risk that does not have a commensurate upside i.e., there is asymmetric risk. If the assumed cashflows are not appropriately adjusted for such downside events, the un-adjusted cost of equity will not be adequate and will have to be appropriately uplifted to reflect expected losses on a mean probability-weighted expected basis. For example, where regulatory mechanisms incorporate ex-post review regulatory discretion as in this case, these truncate return distributions because, at best a company will not be exposed to risks from civil emergency, but Ofwat has significant discretion to apply a penalty when these risks occur… The risk associated with civil emergency events is downside only, i.e., there is no scope for NWL to outperform under these conditions – when they occur there is only downside exposure. Theremoval of the exemption for civil emergency events would result in an expectation that NWL would be exposed to losses (associated with ODI penalties) associated with these types of events in the future, with no corresponding upside... The introduction of asymmetric risk arising from non-application of the exemption in this case would result in an expected loss which would need to be priced to ensure that the price control represents, all else equal, which would result in a requirement for a higher cost of equity… If the exemption is allowed, then this mitigates the asymmetric risk and negates the requirement for pricing of the risk. Additionally, it is important to consider that the removal of the exemption could reduce the predictability and stability of the regulatory framework and how this is perceived by investors and lenders in the sector...The removal of the exemption for civil emergency events could undermine perceived stability of the regulation and increase the cost of capital required in the sector and hence also increase costs to customers – over and above the premium for asymmetric risk set out above. In summary, the removal of the exemption for civil emergency events would result in increased risk for NWL and other companies in the sector. This increased risk would be primarily asymmetricin nature and would need to be priced in future controls. This change in the risk profile for thecompany and investors would ultimately lead to an increase in costs to customers”

“To maintain an appropriate risk balance Ofwat included an exclusion in the SI PCs at PR19. This allows companies to exclude specific extreme circumstances & ensures that damaging penalties are not incurred for situations that are beyond reasonable preparation or control. These exclusions also ensure companies are not driven to provide uneconomic levels of resilience, incurring costs that are ultimately borne by customers. In its reporting guidance on supply interruptions for PR19, Ofwat included an allowance for companies to apply for an exemption on the basis of a civil emergency. The Civil Contingencies Act (2004) (CCA) states that an emergency is an event or situation which threatens serious damage to human welfare in the UK or in a Part or region. NWL commissioned TupperSLaw to consider whether Storm Arwen would constitute a “civil emergency” under the CCA and, if so, whether that can be relied upon to seek an exception to the reporting requirements under NWL’s ODIs relating to supply interruptions. The report examined factual data on whether Storm Arwen met the criteria for a Civil Emergency including both the impact of the storm and the classification response. The report concluded: “Based on the circumstances surrounding Storm Arwen, its impact and the response it required from the Category 1 responders, it satisfies all applicable limbs of the legal test for being categorised as a civil emergency under the CCA.””

“With climate change these storm events are becoming more frequent. Without an exclusion for these events, the consequential financial impacts on companies can be both very material and asymmetric where we are exposed to downside risk only. Left unmitigated this would result in a higher cost of capital paid for by customers to mitigate this risk and companies being incentivized to invest uneconomically to reduce the impact of extreme weather events rather than improve day to day service. To manage these issues Ofwat included an explicit opportunity to request an exemption in the PR19 Final Determination which applies across these ODIs. That exemption allows for representations to be made where a civil emergency is triggered under the Civil Contingencies Act 2004. Ofwat can then make an informed decision, flexibly, on the strength of the evidence”

“We consider that the CE exception applies to exclude all impacts associated with a qualifying civil emergency from the calculations under the three SI PCs. We did, however, carry out detailed analysis of our preparedness for such an event, as well as the extent and appropriateness of our response. We wanted to understand the extent to which any of the supply interruptions experienced by our customers could be attributed to factors that are reasonably within our control. To the extent that they are, it is reasonable for our customers to expect us to bear the risk for our failure to invest in appropriate mitigations. …[W]e [therefore propose] a partial penalty of £3.375m, in addition to the c. £1.9m of costs incurred by NWL in responding to the storm, including GSS payments to customers.”

“Executive Summary …[W]e consider that…Ofwat has misapplied the CE exception by finding that the establishment of the existence of a civil emergency simply leads to an open-textured discretionary decision - i.e. Ofwat has sought to exercise a level of discretion that is not provided for in the context of the guidance in which the CE exception is set out and how the exception is intended to operate… Ofwat does not have any discretion in the application of the CE Exception Ofwat confirms that we have satisfied the relevant criteria under the CE exception for showing the existence of a civil emergency… However, rather than proceeding to assess our evidence about the causal link between the Qualifying Emergency and our reported supply interruptions, Ofwat instead states that it must consider: “whether, in light of our duties and policy objectives, we should exercise our discretion to depart from the outcomes that would ordinarily flow from operation of the ODIs to make changes to payments”… The default position…should be that all of the resulting interruptions to supply should be excluded from assessment of our performance against the three SI PCs. On the PCs, and the Qualifying Guidance, properly construed, there is no discretion at all: the relevant events are simply excluded from consideration and all material calculations… Appendix 1 Legal framework and history of the CE Exception …Interpretation of the CE Exception For the CE exception to apply a company must establish that: • an event has occurred that constitutes a civil emergency within the meaning of the Civil Contingencies Act 2004 (CCA 04) (a CCA Civil Emergency); and • the supply interruption is not the cause of the emergency (limb 2). For the purpose of this response, such a scenario is referred to as a “Qualifying Emergency”… The Reporting Guidance does not specify any other criteria that must be met, or tests which might be applied, in order for such an exception to be granted. It simply provides that a company may choose to request Ofwat to make an exception if it can show a Qualifying Emergency has occurred… On its face, therefore, the CE exception is intended to, and does, operate by providing that if it can be demonstrated that a Qualifying Emergency has occurred, the interruptions to supply that can be attributed to it will be excluded, as an exception, from the assessment of performance against the SI PCs. It does not support Ofwat’s assertion that the relevant test is whether Ofwat “should exercise our discretion to depart from the outcomes that would ordinarily flow from operation of the ODIs”

“Our regime does not, therefore, aim or profess to insure companies against all risks outside of their control. Just like in a competitive market, there will be some risks that regulated companies bear the consequences of, even if the cause was not their fault. However, the flip side of the regime is that there are instances where companies benefit from improved performance when the circumstances are more favourable and may gain outperformance payments as a result. For example, if there is a wet summer, per capita consumption, one of the performance commitments we measure, will be lower than normal, even without any company action, as people tend to water their garden less. Our price review determinations recognise that companies bear risk, including some external risk, and so have a degree of variability in their returns that is outside of their control. What is important is that the upside and downside risks for an efficient company are broadly balanced so that it anticipates a “fair bet” on a forward-looking basis. Although we consider companies should bear some risk, we limit the extent of this through a range of protection mechanisms. This includes cost sharing, which means that customers bear a portion of any company overspend (generally 50%). It also includes collars on ODI payments to protect companies against large underperformance payments on specific performance commitments, as well as caps to protect customers against unexpectedly high payments…”

“Although not necessarily determinative in this case, wider factors we take into account when considering our duties include the factors set out above [(i.e. in relation to risk – see above)] concerning how the overall outcomes framework is intended to operate…We are also mindful of the natural information asymmetry between companies and regulators that favour companies in identifying circumstances that have a negative financial impact on them but makes it harder to identify circumstances which provide fortuitous benefits...”

“In relation to whether to adjust the company’s reported underperformance payments, the company argues in its response to our draft determination that our consideration should focus on the impact of the event on the performance commitments in question, rather than look at the wider performance by the company on all performance commitments in the reporting year and the control period to date. Having considered the company’s arguments, we agree that in these particular circumstances, we should consider carefully the specific financial impact of this event on the performance commitments in question… …[A]lthough Storm Arwen’s impact on ODI payments averaged over the [five year PR19] period is within the expected risk and return range in the company’s overall price review package, we recognise that it was relatively significant, particularly viewed in terms of the single year figure (-1.59%) [(i.e. below the bottom of the range of the return NWL was expected to obtain)]…Taking together the fact that there was a qualifying emergency, which the performance commitments expressly refer to, and that the size of impact on the company was relatively significant, we have considered the appropriate level of underperformance payment… … We have considered carefully and weighed the points made by the company, including those about the extreme nature of the impact of Storm Arwen and the steps the company took to mitigate its impacts on water customers; the potential impact on the overall PR19 package of risks and incentives; and the need to ensure that there are continuing incentives on companies to respond and mitigate adverse impacts on customers even in the face of a qualifying emergency. We have also borne in mind that the in-period regime generally operates annually and is not intended to be as burdensome as a full price control. In this case, we have reviewed evidence from the company that demonstrated that it worked hard to mitigate the impact on customers. …[W]e consider it appropriate and proportionate to exercise our discretion in favour of a broad sharing of risk (risk-sharing being an approach we adopt in other parts of our regime such as totex, to maintain incentives while sharing burdens between companies and their customers). In our judgement, in the specific circumstances of this case, the appropriate share for the financial impact of the event is 50:50 between customers and the company. This means for each of the three performance commitments in question we are excluding 50% of the impact on reported ODI payments. As such, customers will still receive some underperformance payments, which acknowledges customers’ services were severely disrupted. We consider this achieves an appropriate balance between the interests of customers and the company, retaining incentives on the company to continue to strive to deliver the best possible service and response to supply interruptions and is in line with the risk and reward package…”

“…where regulatory mechanisms incorporate ex-post review regulatory discretion as in this case, these truncate return distributions because, at best a company will not be exposed to risks from civil emergency, but Ofwat has significant discretion to apply a penalty when these risks occur…”

“Ahead of its CMA redetermination NWL undertook a detailed review of Ofwat’s final determination for PR19 to both understand whether it could accept Ofwat’s decision on specific issues, as well as in the round, and also to identify the basis for any case that could be made to the CMA. I was involved in that review as an external advisor. NWL identified a number of features of the PR19 package it wished to challenge. As part of that review the PCs, their definitions and the associated reporting guidance was reviewed and it was decided that the business could accept them. This included the SI PCs, the SI Reporting Guidance and the CE exception. NWL concluded that the risk allocation it contained, namely that [water companies] should not be penalised under SI PCs for interruptions caused by truly exceptional weather that constituted a qualifying emergency, was acceptable… …NWL did not raise any concerns about the SI PCs or the SI Reporting Guidance in the context of the CMA’s redetermination of the PR19 price controls. This was because NWL did not have any concerns about the CE exception, based on how it had been drafted and how NWL expected it to be applied…”

“…the effect of spreading a penalty of £3.375m across our circa. 2.1 million customers would be that each customer benefits by around £1.62 each off their annual bill…”

“It is appropriate to state briefly the relevant principles on which the court is to act in judicial review proceedings when a challenge is made to a decision by a person on whom decision-making powers are conferred by the legislature. Where the Act has conferred the decision-making function on the Director [(i.e. Oftel)], it is for him, and him alone, to consider the economic arguments, weigh the compelling considerations and arrive at a judgment. The applicants have no right of appeal: in these judicial review proceedings so long as he directs himself correctly in law, his decision can only be challenged on Wednesbury grounds. The court must be astute to avoid the danger of substituting its views for the decision-maker and of contradicting (as in this case) a conscientious decision-maker acting in good faith with knowledge of all the facts. As Lord Brightman said in R v. Hillingdon London Borough Council, ex parte Puhlhofer: “Where the existence or non-existence of a fact is left to the judgment and discretion of a public body and that involves a broad spectrum ranging from the obvious to the debatable to the just conceivable, it is the duty of the court to leave the decision of that fact to the public body to whom Parliament has entrusted the decision-making power save in a case where it is obvious that the public body, consciously or unconsciously, is acting perversely.”

“These documents are to be read fairly and in bonam partem. If reasons are given in general terms, the court should not exclude reasons which fairly fall within them: allowance must be fairly made for difficulties in expression. The Secretary of State must be given credit for having the background to this situation well in mind, and must be taken to be properly and professionally informed as to educational practices used in the area, and as to the resources available to the local education authority. His opinion, based, as it must be, upon that of a strong and expert department, is not to be lightly overridden.”

“The intensity of the review of the decision under challenge depends on the subject-matter. This decision was taken in an area of socio-economic policy, a paradigm example of something falling within the remit of the Executive, and a matter with which the Court will not lightly interfere, especially where the policy has been endorsed in primary legislation. Moreover, the decision involved the exercise of predictive judgment by the Secretary of State as to how best to realise that policy, coupled with value judgments on matters such as the seriousness or significance of the departure from the Code. It therefore falls within an area where a wide margin of appreciation is to be afforded to the decision maker”

“The courts in conducting statutory interpretation are “seeking the meaning of the words which Parliament used”: Black-Clawson International Ltd. v. Papierwerke Waldhof-Aschaffenburg AG [1975] AC 591, 613 per Lord Reid. More recently, Lord Nicholls of Birkenhead stated: “Statutory interpretation is an exercise which requires the court to identify the meaning borne by the words in question in the particular context.” (R v. Secretary of State for the Environment, Transport and the Regions, ex p. Spath Holme Ltd. [2001] 2 AC 349, 396.) Words and passages in a statute derive their meaning from their context. A phrase or passage must be read in the context of the section as a whole and in the wider context of a relevant group of sections. Other provisions in a statute and the statute as a whole may provide the relevant context. They are the words which Parliament has chosen to enact as an expression of the purpose of the legislation and are therefore the primary source by which meaning is ascertained. There is an important constitutional reason for having regard primarily to the statutory context as Lord Nicholls explained in Spath Holme, p.397: “Citizens, with the assistance of their advisers, are intended to be able to understand parliamentary enactments, so that they can regulate their conduct accordingly. They should be able to rely upon what they read in an Act of Parliament.”

“The task of the court is often said to be to ascertain the intention of Parliament expressed in the language under consideration. This is correct and may be helpful, so long as it is remembered that the “intention of Parliament” is an objective concept, not subjective. The phrase is a shorthand reference to the intention which the court reasonably imputes to Parliament in respect of the language used. It is not the subjective intention of the minister or other persons who promoted the legislation. Nor is it the subjective intention of the draftsman, or of individual members or even of a majority of individual members of either House…Thus, when courts say that such-and-such a meaning “cannot be what Parliament intended”, they are saying only that the words under consideration cannot reasonably be taken as used by Parliament with that meaning.”” “The task of the court is often said to be to ascertain the intention of Parliament expressed in the language under consideration. This is correct and may be helpful, so long as it is remembered that the “intention of Parliament” is an objective concept, not subjective. The phrase is a shorthand reference to the intention which the court reasonably imputes to Parliament in respect of the language used. It is not the subjective intention of the minister or other persons who promoted the legislation. Nor is it the subjective intention of the draftsman, or of individual members or even of a majority of individual members of either House…Thus, when courts say that such-and-such a meaning “cannot be what Parliament intended”, they are saying only that the words under consideration cannot reasonably be taken as used by Parliament with that meaning.””

“We have received extensive submissions and citations from recent judgments of this court on the correct approach to interpretation. Most relevant in that context is Trump International Golf Club Scotland Ltd v. Scottish Ministers [2016] 1 WLR 85. An issue in that case related to the interpretation of a condition in a statutory authorisation for an offshore wind farm, requiring the developer to submit a detailed design statement for approval by Ministers. One question was whether the condition should be read as subject to an implied term that the development would be constructed in accordance with the design so approved. In the leading judgment Lord Hodge JSC, at paras.33–37, spoke of the modern tendency in the law to break down divisions in the interpretation of different kinds of document, private or public, and to look for more general rules. He summarised the correct approach to the interpretation of such a condition, at para.34: “When the court is concerned with the interpretation of words in a condition in a public document such as a section 36 consent, it asks itself what a reasonable reader would understand the words to mean when reading the condition in the context of the other conditions and of the consent as a whole. This is an objective exercise in which the court will have regard to the natural and ordinary meaning of the relevant words, the overall purpose of the consent, any other conditions which cast light on the purpose of the relevant words, and common sense.”

“[Counsel] submits that the court should follow the approach which Sullivan J adopted to planning conditions in Sevenoaks District Council v. First Secretary of State [2005] 1 P & CR 186 and hold that there is no room for implying into condition 14 a further obligation that the developer must construct the development in accordance with the design statement. In agreement with Lord Carnwath JSC, I am not persuaded that there is a complete bar on implying terms into the conditions in planning permissions… “While the court will, understandably, exercise great restraint in implying terms into public documents which have criminal sanctions, I see no principled reason for excluding implication altogether.”

“…I see dangers in an approach which may lead to the impression that there is a special set of rules applying to planning conditions, as compared to other legal documents, or that the process is one of great complexity.”

“Any such document of course must be interpreted in its particular legal and factual context. One aspect of that context is that a planning permission is a public document which may be relied on by parties unrelated to those originally involved…It must also be borne in mind that planning conditions may be used to support criminal proceedings. Those are good reasons for a relatively cautious approach, for example in the well established rules limiting the categories of documents which may be used in interpreting a planning permission…But such considerations arise from the legal framework within which planning permissions are granted. They do not require the adoption of a completely different approach to their interpretation.”

“The “duty of prescription” point. It is a recognised feature of public law that there are contexts in which it is legally necessary for public authority powers to be circumscribed by means of the issuing of prescriptive policy guidance. In HRA cases, this need for “prescription” familiarly falls within the “prescribed by law” (and equivalent) formulations found in the Convention rights. But a similar “duty of prescription” can arise at common law. As Lord Dyson said, in the context of statutory powers of executive immigration detention, in R (Lumba) v. Secretary of State for the Home Department [2011] UKSC 12 [2012] 1 AC 245 at para.34: “The rule of law calls for a transparent statement by the executive of the circumstances in which the broad statutory criteria will be exercised”

“under principles of public law, it was necessary for the Home Secretary to have policies in relation to the exercise of her powers of detention of immigrants”; “[t]his necessity springs from the standards of administration of public law requires”; “[u]nless there were uniformly applied practices, decisions would be inconsistent and arbitrary”

“It is axiomatic in modern government that a lawful policy is necessary if an executive discretion of the significance of the one now under consideration is to be exercised, as public law requires it to be exercised, consistently from case to case but adaptively to the facts of individual cases”

“I agree with Lord Dyson JSC that, under principles of public law, it was necessary for the Secretary of State to have policies in relation to the exercise of her powers of detention of immigrants and that those policies had to be published. This necessity springs from the standards of administration that public law requires and by the requirement of article 5 that detention should be lawful and not arbitrary. Decisions as to the detention of immigrants had to be taken by a very large number of officials in relation to tens of thousands of immigrants. Unless there were uniformly applied practices, decisions would be inconsistent and arbitrary. Established principles of public law also required that the Secretary of State’s policies should be published. Immigrants needed to be able to ascertain her policies in order to know whether or not the decisions that affected them were open to challenge.”

“The situation where the common law recognises a “duty of prescription” is where there are broad discretionary powers needing a statement of criteria, in order to secure appropriate consistency, to protect against arbitrariness, to allow informed representations and to facilitate informed challenge…”

“…[I]t is necessary to read both the decision of the Ombudsman and the reasoning of the [first instance] Judge fairly, in context and with a view to understanding what they meant rather than sedulously picking and criticising individual words or phrases.”

“It makes no sense to rely on “fortuitous benefits” in assessing the CE exception in principle where (a) the size of the (downside) risk involved in [civil emergencies] is much greater than ordinary (upside and downside) risks in the PR19 package generally; and (b) the idea of such benefits is speculative and based on highly occasional events…”