FI/S2/04/3/A

FINANCE COMMITTEE

AGENDA

3rd Meeting, 2004 (Session 2)

Tuesday 27 January 2004

The Committee will meet at 10.00 am in Committee Room 1 to consider the following agenda items: 1. Scottish Parliamentary Building Project: The Committee will consider the

latest monthly report from the Presiding Officer and related correspondence. 2. Scottish Water: The Committee will take evidence as part of its investigation

into Scottish Water from—

Jim and Margaret Cuthbert, Analytical Consulting Limited 3. SPCB Ombudsman Memorandum of Understanding: The Committee will

consider a draft protocol between the SPCB, Public Services Ombudsman, Scottish Information Commissioner and the Finance Committee.

4. Committee work practices: The Committee will consider an issues paper. 5. Items in private: The Committee will decide whether to consider the draft

reports into the Antisocial Behaviour etc. (Scotland) Bill and Local Governance (Scotland) Bill Financial Memoranda in private at its next meeting.

Susan Duffy

Clerk to the Committee

FI/S2/04/3/A

The papers for this meeting are: Agenda Item 1 Cover note and correspondence from Paul Grice, dated 9 December 2003 Correspondence from the Presiding Officer – to follow Agenda Item 2 Cover note, paper from Analytical Consulting Ltd, briefing note and correspondence from the Deputy Minister for the Environment and Rural Development, dated 19 January 2004 Agenda Item 3 Paper by the Clerk and draft Memorandum of Understanding Agenda Item 4 Paper by the Clerk

FI/S2/04/3/1

FI/S2/04/3/2

FI/S2/04/3/3

FI/S2/04/3/4

FI/S2/04/03/1

Finance Committee

3rd Meeting 2004 - Tuesday 27 January 2003

Scottish Parliamentary Building Project –Monthly Report

1. The latest monthly report from the Presiding Officer will be issued to members as

soon as it is available. This report will provide an update on the progress of the Holyrood Building Project.

2. Also attached is a copy of a letter from Paul Grice, dated 9 December 2003, 3. Members are invited to consider the latest monthly report and related

correspondence. Susan Duffy Clerk to the Committee

Additional Paper – FI/S2/04/3/1

Des McNulty Convener Finance Committee The Scottish Parliament Edinburgh EH99 1SP

January 2004 Dear Des HOLYROOD REPORT, JANUARY 2004

This is the sixth monthly report on Holyrood, providing the Finance Committee with the latest information on the Project cost and programme.

With the turn of the year, we are now into the last lap with Holyrood. We are determined to enforce a “completion culture” on architects, builders and parliamentary staff in 2004. In the final months of the project everyone must now be programme-driven. This is where the whole strategy comes together: construction completion, migration, testing and finally full occupation.

Key points this month: 1. There is no change in the overall cost reported in November. The

previously reported breakdown of risk figures into their subheadings of construction reserve and programme contingency has been adjusted to take account of past delays and the cost sits at £396.5m plus a programme contingency of £4.6m.

2. Since the November report, £2.8m has been moved from the risk and

programme reserve into construction commitment. Details of this are given in the attached cost breakdown at annex A.

3. There is no change in the strategic programme reported in November. Progress on site in December and January includes: • A key milestone has been reached with the Chamber crash deck removed

21 days ahead of the required deadline by authorising overtime working at

Additional Paper – FI/S2/04/3/1

a cost of £28,000. This has enabled contractors to focus on other areas of work, such as internal walls and window linings.

• The floor is now nearing completion in the Debating Chamber; building

services are well advanced and the next stage will see the installation of internal wall linings.

• The high level crash deck in the problematic lightwell area has seen

excellent progress in accordance with the key milestone timetabling set out in my November letter.

• The MSP building is complete, and final snagging is progressing well.

Telephone systems are installed and working. • In Queensberry House all building works are complete and are also being

snagged. The next phase is for IT and other fit-out works to progress. • Horse Wynd is complete and was re-opened to traffic by the City Council

on 4th January. • Glazing is installed to the back wall of the public entrance hall. • A solution has now been found to the problem of the ‘extruded garden’ on

the Canongate which will ensure that its completion will not threaten achievement of the strategic programme.

• 90% of the windows in Towers 1 and 2 have been handed over for internal

finishings. The completion strategy The strategy of HPG and HPT is still to close down areas of work wherever possible in order to focus resources on key places and allow client IT and fit-out works to progress. The completion of MSP and Queensberry House has made a significant impact in releasing resources to other parts of the site. Progress has been excellent on the key Chamber and Lightwell milestones. In particular, the lightwell is no longer a cause for concern. As we reported in November, there has been slippage, principally on the work both inside and outside the Tower buildings. The massive windows and complex applied stone panels have taken longer to install than was planned due to the number of interfaces with other trade packages and complex setting out arrangements. As a result, the internal finishings have been delayed by the time taken to complete window linings as well as some necessary amendments to floor box positions.

Additional Paper – FI/S2/04/3/1 Bovis are currently reviewing the programme to address these delays and complete by the target date in July. This has been the time to resolve any remaining construction difficulties; for example, the problem of the extruded garden on the Canongate has now been solved by adopting a new, lightweight solution and the architects have also amended the pattern of the stone ‘quotation mark panels’ in order to speed up installation. I am very pleased at the constructive and practical approach taken by the team to sorting these problems and clearing the path to completion. Bovis will be presenting their revised strategy for completion by July to the HPG by the end of January and to SPCB by mid-February and I will of course report on that in next month’s letter to you. Cost The February letter will also include details of DLE’s estimate of what it will cost to complete by July. £4.6m remains unallocated against works packages in the contingency fund, but the prolongation on the towers and the need for some acceleration measures in these areas is likely to mean that this figure will need to be reviewed in time for my February letter. Once the cost consultant has seen how Bovis intend to complete, he will be able to make an accurate estimate of exactly how much is required. As discussed at your last Committee meeting on Holyrood, the Project Director is making available to the Committee the detailed package cost plan in order to allow members to cross-reference the construction cost figures included in the financial summary attached to this letter. I am sure that she would be happy to take on board any further suggestions from the Committee in relation to the presentation of this information. Finally, you will note that while the overall costs remain unchanged, we have adjusted the allocation of risk figures in the financial report between the construction reserve and the programme contingency. Since DLE do not routinely report draw-downs separated into these two different categories, we have asked them to revisit the reserve and contingency sums as part of the current review of costs and to estimate how much of the recent draw-downs are attributable to disruption and delay. The results of that exercise show that £7.2m of the programme contingency sum has now been allocated into commitment. DLE have agreed to report to HPG against these headings on a monthly basis from now on, rather than providing it as a retrospective exercise. Progress in other areas this month: • MSPs’ offices All parties have now been allocated areas within the MSP building. Allocation of individual offices is a matter for the parties themselves but I understand that

Additional Paper – FI/S2/04/3/1 this is progressing well. Many MSPs have been to the site to see the layout of the offices and decisions about individual requirements for furniture will be sought shortly. • Landscape strategy Enric Miralles said that the Parliament, “sits in the land” and the process of making that a reality is about to start. The decant of contractors’ accommodation has been accelerated and the first of the site huts will go at the end of January in order to allow the landscaping of that area to progress. Yours sincerely

GEORGE REID Encl: financial summary annex and progress report.

The Scottish Parliament Building, Holyrood Quantity Surveyors Report Nr 79 to the Progress Group (extract)

PACKAGE 1 2 3 4 5 6 7 8 9

Cost Adjusted Cost

Plan Trade Contract Approved Current Estimated EFC Difference Change At

Plan and Inflation Value

Change Orders Commitment

Change Orders

Including Inflation

This Report

A1510 TOWER CRANAGE 1,906,300 2,002,000 1,768,495 2,733,505 4,502,000 4,502,000 2,500,000 SELECT PLANT HIRE LIMITED (30-SEP-99) A1520/1521 SCAFFOLDING TO QUEENSBERRY HOUSE 599,725 614,725 1,451,938 4,548,062 6,000,000 6,000,000 5,385,275 LYNDON SCAFFOLDING (28-FEB-00) MSP BUILDING (FEB-02) AND ASSEMBLY A1993 SURVEY WORKS 2,000 2,110 2,110 2,110 2,110 0 DOIG AND SMITH (OCT-99) A2010 QUEENSBERRY HOUSE DEMOLITION / RECONSTRUCTION 3,100,000 3,450,000 3,239,615 1,010,385 4,250,000 4,250,000 800,000 BALLAST PLC (6-NOV-00) A2011 Q HOUSE SUNDRIES PACKAGE 100,000 0 A2013 LIME CENTRE INVESTIGATIONS 19,000 19,000 19,000 19,000 19,000 0 (VIA BOVIS)

A2015 QUEENSBERRY HOUSE INVESTIGATIONS ETC 81,000 85,000 69,963 8,418 78,381 78,381 (6,619) KINSLEY AND BOLTON (02-JUN-00) A2018 (refer to A2605) TENEMENT FAÇADE RETENTION O'ROURKE SCOTLAND LTD A2045 WELL PROBING 30,000 31,500 23,923 5,370 29,293 29,293 (2,207) WIMTEC ENVIRONMENTAL LTD (21-JUL-99) A2046 WELL DRILLING 97,500 102,375 80,700 15,455 96,155 96,155 (6,220) RITCHIES (25-OCT-99) A2048 STONE STORAGE (OFF SITE) 15,000 15,750 6,400 9,350 15,750 * * * WATSON STONECRAFT (APR-99) A2080/A2100 RETENTION + PILING 1,570,486 1,668,320 908,006 760,314 1,668,320 1,668,320 0 AMEC CIVIL ENGINEERING LIMITED (16-APR-99) A2091 ASBESTOS/PIGEON REMOVAL QUEENSBERRY HOUSE 200,000 210,000 23,972 176,028 200,000 200,000 (10,000) CHAMIC (15-NOV-99) A2200 SUBSTRUCTURE CONCRETE WEST 3,164,000 3,312,000 3,073,290 (73,790) 2,999,500 2,999,500 (312,500) O'ROURKE SCOTLAND LIMITED (28-SEP-99) A2205 SUBSTRUCTURE CONCRETE EAST AND SECTION D-H 6,452,000 7,361,732 6,885,366 358,805 7,244,171 7,244,171 (117,561)

O’ROURKE SCOTLAND LTD (10-JAN & 07-MAR-01) A2300 BULK EXCAVATION 833,490 878,490 722,773 108,366 831,139 831,139 (47,351) BARR CONSTRUCTION (07-JUN-99) A2600 MSP CONCRETE FRAME 5,395,000 5,645,000 4,222,749 1,338,122 5,560,871 5,560,871 (84,129) O’ROURKE SCOTLAND LIMITED (14-FEB-00) A2605/A3235/A3805 ASSEMBLY BUILDING CONCRETE FRAME 16,846,635 20,242,214 19,310,867 20,179,133 39,490,000 39,490,000 19,247,786 O’ROURKE SCOTLAND LTD (23-JAN-01) A2940/A7101 GENERAL BUILDERSWORK 546,467 627,896 805,372 1,353,464 2,158,836 2,158,836 1,530,940 OGILVIE (15-AUG-02) A3000 MOCK UPS A3521/3522/3531 - MSP ROOM (NOW REMOVED) 107,140 107,140 107,140 870 108,010 108,010 870 A1390 - MSP ROOM FINISHES

MSP TOILET QH PO ACCOMMODATION TESTING CAITHNESS STONE 11,150 11,150 11,150 11,150 11,150 0 TESTING PRECAST PANEL 7,326 7,326 7,326 7,326 7,326 0 TP3235 SAMPLE PANELS 8,000 8,000 8,000 8,000 8,000 0 GLULAM NODE 11,920 11,920 11,920 11,920 11,920 0 COMMITTEE ROOM CEILING 13,191 13,191 13,191 13,191 13,191 0 MIVAN (JUNE 02)

REMAINDER 141,273 141,273 * * * (10-NOV-99 AND SUBSEQUENTLY)

A3001 - CHAMBER SECTION 22,402 22,272 44,674 44,674 44,674 BABCOCK (OCT-01)

CHAMBER DESK 3,000 3,000 3,000 3,000 BEN DAWSON

A3002 BLAST TESTING 30,050 192,130 222,180 222,180 222,180 ADVANTICA (06-MAR-02) A3235 (see A2605) PRECAST CLADDING 0 0 O’ROURKE SCOTLAND LIMITED (28-SEP-01) A3320 FOYER ROOF AND GLAZING 1,525,000 1,844,945 5,836,400 1,528,600 7,365,000 7,365,000 5,520,055 MERO (OCT-01 & MAY-02) A3350 SPECIALIST GLAZING 1,862,534 2,363,369 7,187,500 3,812,500 11,000,000 11,000,000 8,636,631 MERO (21-MAY-02) A3525 ASSEMBLY WINDOWS 2,647,670 3,246,573 3,877,258 9,122,742 13,000,000 13,000,000 9,753,427 DRAWN METAL (29-NOV-01) A3527 (see A1521) STONE CLADDING 4,707,099 5,694,648 2,927,891 2,072,109 5,000,000 5,000,000 (694,648) WATSON STONECRAFT (25-OCT-01) A3519 MSP EAST ELEVATION STEELWORK 559,415 706,150 406,185 598,815 1,005,000 1,005,000 298,850 MILLER FABRICATIONS (14-MAR-02) A3519 PLANTROOM DOORS 57,651 57,651 * * *

MILLER FABRICATIONS (OCT-03) GENERAL ASSOCIATED WORKS TO TP4600 290,275 290,275 (290,275) A3520 MSP CLADDING 713,685 854,067 854,067 854,067 854,067 0 FLOUR CITY (26-JAN-01) - IN LIQUIDATION; DRAWN DOWN AS FOLLOWS: A3523 MSP MULLIONS, LOUVRES & GARGOYLES LESTEROSE (10-JUL-02) 1,011,517 1,283,514 1,406,934 693,066 2,100,000 2,100,000 816,486 A3524 MSP STONE CLADDING 1,204,117 1,519,957 1,284,287 715,713 2,000,000 2,000,000 480,043 WATSON STONECRAFT (14-MAR-02) A3526 MSP S/S VENT PODS 642,687 815,506 2,233,831 649,282 2,883,113 2,883,113 2,067,607 COVERITE (02-APR-02) A3528 MSP BAY WINDOWS 1,504,302 1,844,575 2,655,339 695,000 3,350,339 3,350,339 1,505,764 BAYDALE (DEC-01) A3528 ESCAPE BLAST DOORS 508,000 508,000 * * * BAYDALE (JUL-03) A3528 ASSEMBLY RAINSCREEN CLADDING 163,000 163,000 163,000 163,000 BAYDALE (NOV-03)

A3528 REIDS CLOSE COPING UNITS 130,000 130,000 130,000 130,000 BAYDALE (NOV-03) ENTRANCES 80,000 91,800 * * * A3529 MSP WINDOWS & S/S CLADDING 1,007,170 1,271,351 1,698,558 1,100,000 2,798,558 2,798,558 1,527,207 MERO (21-MAR-02) A3580 Q HOUSE WINDOW REPAIRS / REFURBISHMENT 139,150 180,866 237,745 52,255 290,000 290,000 109,134 BALLAST PLC (24-APR-01) A3640 MSP ROOFING - COVERITE 716,756 857,742 842,977 180,000 1,022,977 1,022,977 165,235 COVERITE (30-JAN-01) A3645 ASSEMBLY BUILDING ROOFING 4,361,242 5,347,755 5,993,762 1,506,238 7,500,000 * * * COVERITE (11-OCT-01) A3646 ASSEMBLY ROOFLIGHTS 244,658 300,000 589,191 1,310,809 1,900,000 1,900,000 1,600,000 SPACE DECKS LTD (5-AUG-02) A3646 LIGHTWELL CLADDING 115,000 115,000 * * * SPACE DECKS LTD (SEP-03) A3805 (see A2605) BOUNDARY WALL 0 0 O’ROURKE (OCT-02) A4100 Q HOUSE EXTERNAL RENDER 381,680 289,570 354,405 25,595 380,000 380,000 90,430

BALMORAL STONE (13-MAR-01) A4302/A4802 Q HOUSE PARTITIONS / CEILINGS 839,516 557,220 471,227 773,773 1,245,000 1,245,000 687,780 45,000 RD CEILINGS AND PARTITIONS (03-OCT-01) A4300 (see A4600) MSP CEILINGS / PARTITIONS 0 0 ULTIMATE (13-AUG-01) A4305 (See A5110/20/30) ASSEMBLY BUILDING CEILINGS/PARTITIONS 0 0 A4460 SCREED / STONE FLOORS 210,494 1,670,250 1,381,657 421,185 1,802,842 * * * VETTER (07-FEB-02) A4415/A4525 (See A5110/20/30) ASSEMBLY FLOORS 0 0 A4520 MSP & QH TIMBER/LINOLEUM FLOORING 895,915 1,182,312 1,171,091 1,150,000 2,321,091 2,321,091 1,138,779 MIVAN LTD (19-OCT-01) A4600 - see Page 17 MSP CARPENTRY & JOINERY 2,163,360 2,632,689 2,184,554 1,355,895 3,540,449 3,540,449 907,760 ULTIMATE (15-MAR-01) A4600 BUILDING COCOON (CHADBOURNE) 66,717 100,000 166,717 166,717 166,717 A4602 - see Page 17 Q HOUSE CARPENTRY & JOINERY 268,760 613,539 525,249 406,751 932,000 932,000 318,461 MIVAN LTD (15-NOV-01) A4605 (See A5110/20/30) ASSEMBLY CARPENTRY & JOINERY 0 0

A4700 (see A4600) MSP METAL DOORS 0 0 A4702 Q HOUSE METAL BLAST DOORS WINDOWS 262,800 885,461 884,261 345,739 1,230,000 1,230,000 344,539 128,000 DRAWN METAL (25-SEP-01)

A4705 (See A5110/20/30) ASSEMBLY METAL DOORS/SHUTTERS 0 0 A4750 (See A5050) MSP ARCHITECTURAL METALWORK 0 0 MIVAN LTD A4755 (See A5110/20/30) ASSEMBLY BUILDINGS ARCHITECTURAL METALWORK 0 0 A4800 (see A4600) MSP DECORATIONS 0 0 ULTIMATE (30-MAY-02) A4802 (see A4302) Q HOUSE DECORATIONS 0 0 RD CEILINGS AND PARTITIONS A4805 (See A5110/20/30) ASSEMBLY DECORATION 0 0 A5050/A4750 TOILET/FITNESS/CHANGING FIT-OUT 934,963 1,717,608 1,493,814 1,446,707 2,940,521 2,940,521 1,222,913 MIVAN (11-JAN-02) ALL TEA POINTS (add to A5130) 0 0 ULTIMATE (01-OCT-02)

A5110/20/30 MULTI TRADE ZONAL FINISHES 11,009,923 A5110 ZONE 1 FIT OUT 6,387,495 11,012,849 3,100,000 14,112,849 14,112,849 7,725,354 MIVAN (15-AUG-02) TEMPORARY TOWER WINDOWS CLOSURES 382,843 382,843 382,843 382,843 ENVIRONMENTAL CONTROL HEATING EQUIPMENT 211,993 211,993 211,993 211,993 TEMPORARY POWER INSTALLATION 36,369 36,369 36,369 36,369 FORTH ELECTRICAL SERVICES A5120 ZONE 2 FIT OUT 3,685,080 6,519,523 1,360,000 7,879,523 7,879,523 4,194,443 MIVAN (4-SEP-02) A5130 ZONE 3 FIT OUT 1,376,397 2,540,138 400,000 2,940,138 2,940,138 1,563,741 ULTIMATE (01-OCT-02) A5130 TIMBER LINING TO ROOFLIGHTS 350,000 350,000 350,000 350,000 ULTIMATE (NOV-03) A5300 BACK OF HOUSE CATERING EQUIPMENT 437,570 614,993 582,002 582,002 * * * SCOBIE MCINTOSH (26-FEB-02) A5305 FRONT OF HOUSE CATERING EQUIPMENT 84,450 106,601 145,921 145,921 * * * DESIGN COUNTERS (26-FEB-02)

A5320 CANOPIES 77,980 98,949 129,907 129,907 129,907 30,958 VENTMASTER (EUROPE) LTD (MAY-02) A5370 (See A4605) BAR & RESTAURANT FIT-OUT 0 A5500 AUDIO VISUAL EQUIPMENT 0 A5700 SIGNAGE 115,000 134,228 191,171 191,171 191,171 56,943 WOOD AND WOOD (FEB-03) A5930 CLEANING CRADLES 50,000 57,375 * * * A6010 MECHANICAL & PLUMBING WEST 1,822,226 1,700,000 1,457,336 842,664 2,300,000 2,300,000 600,000 SKANSKA (15-MAR-01) A6015 MECHANICAL & PLUMBING EAST 6,408,715 7,354,000 5,746,059 3,368,646 9,114,705 9,114,705 1,760,705 ROTARY (NOV-01) A9100 HARD LANDSCAPING POOL EQUIP 335,000 335,000 335,000 335,000 O’ROURKE (5 AUG-02) A6500 FIRE ALARM & PROTECTION 861,000 987,998 946,083 400,000 1,346,083 1,346,083 358,085 ADT (AUG-01) A6520 (add to A5110) FIRE EXTINGUISHERS ETC 43,600 50,031 50,031 (6,431) 43,600 43,600 (6,431)

MIVAN (JUN-03) A6900 BMS 1,603,485 1,839,999 1,546,194 628,806 2,175,000 2,175,000 335,001 HONEYWELL (AUG-01) A6950 COMMISSIONING MANAGEMENT 167,500 192,206 256,908 180,000 436,908 436,908 244,702 COMMTECH LTD (19-DEC-01) A7010 WEST ELECTRICAL 2,419,262 1,798,262 1,164,652 1,145,043 2,309,695 2,309,695 511,433 ROTARY (15-MAR-01) A7011 ELECTRICAL ENABLING WORKS 1,738 1,738 1,738 1,738 1,738 JAMES SCOTT A7015 (see A5110) EAST ELECTRICAL 6,068,635 7,764,129 4,200,838 3,825,310 8,026,148 8,026,148 262,019 FORTH ELECTRICAL SERVICES (25-SEP-01) UNALLOCATED - - A7101 (see A2940) BWIC SERVICES 0 0 OGILVIE (15-AUG-02) A2905 BASEMENT PLANT AREAS WALLING 0 450,695 607,057 56,943 664,000 664,000 213,305 LESTEROSE (OCT-01) A7500 LIFTS 1,086,730 1,217,767 1,153,718 84,049 1,237,767 1,237,767 20,000 OTIS (26-SEP-00)

A7700 STRUCTURED CABLING 500,000 573,750 563,556 292,245 855,801 855,801 282,051 STIELL NETWORKS (2-JUL-01) A7800 SECURITY 1,677,058 1,924,424 1,068,108 315,942 1,384,050 1,384,050 (540,374) HONEYWELL (28-SEP-01) A7805 BOMB DETECTION 75,000 75,000 * * * A8000 UTILITIES 725,000 725,000 186,396 186,396 * * * A9001 STABILISE WEST TOWER 18,000 18,000 18,000 18,000 18,000 0 (VIA BOVIS) A9002 BOILER STRIP OUT Q HOUSE 3,760 3,994 3,994 3,994 3,994 0 (VIA BOVIS) A9100 / A9200 (see A3805/2605) HARD & SOFT LANDSCAPING 0 0 BOVIS ORGANISATION 2,310,000 2,900,000 2,900,000 2,900,000 2,900,000 0 INTERIOR DDA COMPLIANCE AND INTERIOR DESIGN (See A5110/20/30) 0 0 TOTALS £108,000,000 £126,667,965 £134,675,653 £78,802,250 £213,477,903 £2,334,672 £215,812,575 £89,144,610 £173,000

Italicised figures above transfer to single sheet report as follows:

£215,812,575 minus £2.9m Bovis site organisation costs = £212.9m

£173,000 change at this report

Current figures

(£m) Change at this report Materialisation of risk sums:

MAIN PROJECT Risk drawn down from 'Construction Reserve':

QBH carpentry and joinery 100,000

Site, demolition and archaeology 5.7 Mechanical and plumbing 53,595

Fit Out 19.5 Timber/lino flooring 250,000

Current construction commitment 212.9 plus £2,830,401 Building Management system

178,806

Fees (capped lump sum) 50.3 Toilet fit-out 400,000

Site organisation costs 17.5 QBH Blast Doors 128,000

VAT on current commitment 37.3 Total 1,110,401

Construction reserve 32.4 minus £1,110,401 Estimated VAT on reserve

5.7

Risk drawn down from 'Programme Contingency': Total 381.3 QBH carpentry and joinery 140,000

Timber/lino flooring 350,000 Toilet fit-out 100,000

LANDSCAPING QBH ceilings and partitions 380,000 scaffolding 750,000

Muster room transfer 0.5 Total 1,720,000 Land purchase 0.3 Construction works 7.8

Fees (including site mgt) 1.9 Construction reserve 2.7 VAT

2.0 Total 15.2

SUBTOTAL 396.5 Programme contingency (incl. VAT) 4.6 minus £1,720,000;

FI/S2/04/03/1

Des McNulty MSP Convener Finance Committee The Scottish Parliament EDINBURGH EH99 1SP

Clerk/Chief ExecutiveEdinburghEH99 1SP

Tel: 0131-348-5255Fax: 0131-348-5259

paul.grice@scottish.parliament.uk

9 December 2003 FINANCE COMMITTEE MEETING: 25 NOVEMBER 2003 When we last appeared before the Finance Committee, colleagues and I undertook to provide some additional information on issues raised. Self Insurance Robert Brown undertook at column 623 to confirm for Fergus Ewing whether the House of Commons was insured. I can confirm that Westminster do exactly as we do i.e. they are self insured and carry no commercial building insurance. Report Format Sarah Davidson undertook at column 625 and 626 to amend the format of the next report to the Committee. This will address Jim Mather’s point on trade packages and Ted Brocklebank’s point on broad areas where there has been an increase. This will be done in the next report to you. Opening Ceremony I undertook at column 636 to check for you that there was a sum included in contingency for an opening ceremony. I can confirm that we do have a budget for an opening ceremony within our contingency. I trust that this additional information is helpful. P E GRICE Clerk/Chief Executive

FI/S2/04/3/2

Finance Committee

3rd Meeting 2004 - Tuesday 27 January 2004

Scottish Water – Paper by Analytical Consulting Ltd

1. As part of its consideration of issues surrounding Scottish Water, the

Committee will take evidence on a paper which has been produced by Analytical Consulting Ltd.

2. This paper is attached, as is a briefing note which has been based on

advice provided by the Committee’s budget adviser and a letter to the Convener from the Deputy Minister for Environment and Rural Development.

Susan Duffy Clerk to the Committee

FI/S2/04/3/2

Did Flaws in the Application of Resource Accounting and Budgeting Distort the Strategic Review of Water Charges in Scotland.

by Jim Cuthbert and Margaret Cuthbert,

Analytical Consulting Ltd. Introduction 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.

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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. Background Up until 1996, the water industry in Scotland was the responsibility of the Regional and Islands’ councils, with pricing policy being a matter for each Council within government policies on service, investment and borrowing. From 1996 until 2002, the industry was run by North, East and West water authorities: these authorities were merged in April 2002 on the formation of Scottish Water. Since 1999, a fundamental role in determining charging policy for water has been played by the Water Commissioner for Scotland. Acting within parameters set by Scottish Ministers, the Commissioner conducts periodic reviews, to produce advice for Ministers on the charging policies which the industry should adopt. The most recent such review was commissioned by Ministers in August 2001, (reference Commissioning letter 21st August 2001), and related to charging schemes for the period 2002-03 to 2005-06. Among matters which the Minister asked the Commissioner to take into account in his review were a. the implications of the planned merger of the three water boards: b. the required environmental and water quality targets: c. the intention to completely harmonise charges for domestic water users

across the whole of Scotland by 2005-06: d. the implications of a new system of public expenditure control on the

water industry, based on RAB, which had come into effect in April 2001. The Commissioner conducted his review in Autumn 2001 and published his conclusions in November 2001. (Strategic Review of Charges). As well as the harmonisation of domestic water charges, the Commissioner also advised that non-domestic charges should be harmonised across Scotland. The Commissioner’s advice was accepted by Ministers and underlay the new charges which were introduced from 2002-03. The Implications of the Introduction of Resource Accounting and

Budgeting Up to and including the year 2000-01, the government’s main financial control on the water industry was through setting a cash limit on annual new borrowing. The industry’s only sources of finance to cover its expenditures are revenue and new borrowing: thus, the amount the industry has to borrow is the difference between what the industry spends and what it gets in as new revenue. In any given year, the industry spends money on operating

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expenditure, (that is, current expenditures in running the service, including any PFI charges); investment, (in other words, all expenditure on creating fixed assets, that is, gross investment); and payment of interest on outstanding debt. Net borrowing is then essentially given by the formula: Net Borrowing = Operating Expenditures + Investment + Interest - Revenue …..(1)

The first line of Table 1 gives the net borrowing limits as set by the government up to 2001-02. Table 1: Financial Limits: £ million, cash terms. Year 98/99 99/00 00/01 01/02 02/03 03/04 04/05 05/06 Borrowing Consents (1) 202.3 221.9 209 223.4 Implicit Borrowing Limits (2)

229 199.4 163.7 83.5 67.8

Sc. Exec. Borrowing figures (3)

216 (a)

256 (b)

277 (b)

260 (b)

Sc. Exec. Borrowing Consents (4)

249.7 190.8 195.8

(1) Investing in You, 2000, Table 7.13 (2) Derived from section 7, Chapter 32, Strategic Charges Review, November 2001 (3)Scottish Executive Data: (a) The Scottish Budget, pub.2001; (b) The Scottish Budget, pub.2002; (4) Actual Borrowing Consents, The Draft Scottish Budget 2003-04. (The derivation of the figures in the later lines of Table 1 is explained below.) In April 2001, the government changed its control over the financing of the water industry, in line with its general introduction of resource accounting and budgeting (RAB)1. The rationale of RAB was to move to a more accruals based system, (that is, recording expenditure as it is incurred, not when it is paid out), and to recognise the non-cash costs of government activity - e.g., the using up of capital (depreciation) even though this might not be matched by any actual financial payment in the year. Another non-cash element covered in resource accounting is a charge relating to the cost of capital, that is, the cost of holding assets, which was originally assessed at 6.5 per cent of net assets. By bringing in these non-cash items relating to assets, the government hoped to improve overall management of the asset base: this was one of the main differences from the previous method of cash accounting. For the water industry in Scotland, the government replaced the former borrowing limit by a control measure based on RAB: the RAB control limit. The values of the RAB control limit, plus detailed notes on its definition, were set out in the Commissioning letter of August 2001. From Tables 32.1 to 32.6 of the Strategic Review, it can be deduced that the measure of RAB expenditure which the Water Commissioner counted against the RAB limit given to him by the Scottish Executive, was effectively:

1 see HM Treasury website for general principles on RAB.

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RAB expenditure = Operating Expenditures + Investment + Depreciation + Capital Charge Element - Revenue …..(2) (To satisfy the RAB controls, RAB expenditure has to be no greater than the RAB control limit as set by the Scottish Executive). In this formula, the definitions of operating expenditure, investment and revenue are the same as in formula (1) above. The definition of depreciation is the total depreciation charge on both infrastructure and non-infrastructure elements of the system and includes actual expenditure (e.g., on replacement of pipes), required to maintain the functionality of the infrastructure. The capital charge element is the increase in capital charge above the 2003-04 level, where the capital charge represents the need of the industry, under RAB, to generate a return of 6.5% on its asset base. We stress that formula (2) is, apart from minor items like the effect of working capital, the definition of RAB expenditure which underpins the Strategic Review. We shall return later to the question of how sensible this formula is, particularly in its treatment of investment and depreciation. From a comparison of formulae (1) and (2), it follows that Net Borrowing = RAB expenditure - Depreciation - Capital Charge element + Interest ….(3) So, if we know what the RAB expenditure is, it is possible to work back, by subtracting depreciation and the capital charge element, and adding in interest payments, to the figure for net borrowing required. The Strategic Review of Charges shows calculations by the Water Commissioner, linking new borrowing and the corresponding RAB expenditures, for years 2001-02 to 2005-06. Table 2, which is based entirely on figures from Tables 32.4, 32.5, and 32.6 in the Strategic Review, shows the reconciliation between the RAB control limit, (the maximum limit on RAB expenditures) and net borrowing as assessed in the Strategic Review. Table 2: The Relationship Between the RAB Control Limit and Net Borrowing in the Strategic Review: £ million Year 01/02 02/03 03/04 04/05 05/06 RAB Control Limit (Table 32.6) 302.3 314.3 299.7 299.7 299.7 less planned margin (Table 32.6) -9.4 49.2 61.3 37.1 73.5 = RAB expenditure (Table 32.6) 311.7 265.1 238.4 262.6 226.2 less depreciation (Table 32.6) 260.4 260.5 285 356.8 364.7 less capital element (Table 32.6) 0 0 0 11.3 21.1 plus interest (Table 32.5) 142.7 150.6 153.8 154.9 152.9 plus working capital (Table 32.6) 44.4 -5.0 -4.9 -3.1 0.9 = New Borrowing 238.4 150.2 102.3 46.3 -5.8 Line 1 gives the RAB control limits as set by the Scottish Executive. Line 2 is the margin which the Commissioner built in to allow for flexibility in the face of, for example, unexpected shocks. Line 3 gives the resulting RAB expenditure forecast to which the Water Commissioner was working.

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Line 4 shows the total depreciation. Line 5 shows capital charge movements, which only became relevant in 2004-05. Line 6 shows interest payments to be made by Scottish Water on outstanding loans Line 7 corrects for movements in working capital. The derived figure for new borrowing in the final row of this table exactly equals, (apart from a maximum difference of 0.1 for rounding), the new debt figure in Table 32.4 of the Review. Given the Commissioner’s figures on depreciation, capital charge element, interest and working capital, then the maximum amount of new borrowing possible under the RAB control limit would be the sum of the lines for new borrowing and planned margin in the above table. It is this sum which is shown as the implicit limit on borrowing in line 2 of Table 1 above. Finally, the Scottish Executive itself publishes each year the financial control totals which it sets for the water industry. In 2001 and 2002, the control totals were on the new RAB basis. At the same time, the Scottish Executive published the figures for new borrowing which it calculated were consistent with the RAB controls: however, no detail was published on how these figures were derived. These borrowing figures are shown for 00/01 to 03/04 in line 3 of Table 1. In its budget for 2003, the Scottish Executive abandoned the RAB control total for water, and went back to setting a control total directly in terms of new borrowing. These figures for 2003-04 onwards are shown in the final line of Table 1. To summarise, therefore, Table 1 shows, in its first line, borrowing control limits before the introduction of RAB; in its second line, the borrowing control limits implicit in the financial modelling undertaken by the Water Commissioner for the purposes of his strategic review, consistent with the RAB limits set by the government; and finally, the figures published later by the Scottish Executive as their view of the borrowing levels consistent with their expenditure controls. The contrast between line 2 and lines 3 and 4 is very striking. For example, in 2003-04, the figure in line 2 is almost £100 million less than that in line 3: and in each of the next two years, the difference between line 2 and line 4 is over £100 million: as the discussion in the next paragraph makes clear this is a genuine inconsistency, and not an artefact of comparing figures from different documents. To put this another way: when the Water Commissioner was carrying out his strategic review on charges, he was implicitly taking the view that the expenditure controls exercised by the Scottish Executive were imposing a very tight squeeze on the funding of the water industry - reducing the annual borrowing ceiling from £229 million in 2001-02 to £67.8 million in 2005-06. This contrasts sharply with the figures published later by the Scottish Executive which indicate that, over the same period, the annual borrowing

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ceiling would start at a higher figure of £256 million and reduce only to £195.8 million, implying a very much milder financial squeeze. The contrast between the Commissioner’s figures and the Scottish Executive’s figures in table 1 is hugely significant from the point of view of the charging decisions made during the review. How could it have arisen that the Commissioner, at the time of the review, was taking a view about the maximum availability of funding to the water industry through net borrowing which was, by the end of the review period, some £130 million more adverse than figures which the Scottish Executive published later in its Annual Expenditure Report? There is strong evidence that what underlies this apparent inconsistency is that the Scottish Executive and the Commissioner take different views on how the RAB control limit relates to net borrowing. Overwhelming evidence for this is shown in Table 3 below. The first two lines in this table are repeated from Table 2 and Table 1 above. The bottom four lines are derived from the Scottish Executive’s Annual Expenditure Report (AER) for 2003-04 published in April 2002. Table 3: Comparison Between Strategic Review and Scottish Executive View on Relationship Between RAB Control and Net Borrowing: £million 2001-02 2002-03 2003-04 Strategic Review RAB Control Limit 302.3 314.3 299.7 Implicit Borrowing Limit 229 199.4 163.7 Scottish Executive AER Resource Budget -159.2 -159.7 -178.3 plus Capital Budget 461.5 462 478 = RAB Control Limit* 302.3 302.3 299.7 Net New Borrowing 256 277 260 * This figure is not published as such in the Annual Expenditure Report, but the figure for 2003-04 appears in the commissioning letter, and that for 2002-03 is only £12 m less than that in the commissioning letter. It is not possible to extend this table into later years because the Scottish Executive had abandoned RAB control for later years. But it is clear for this period, for which a direct comparison is possible, that the Scottish Executive were assessing a different relationship between net borrowing and the RAB limit than the Commissioner had done while he was conducting his review. We do know that part of the difference is due to different assumptions on interest charges: (the interest payments assumed by the Scottish Executive exceeded those assumed by the Commissioner by -£11.7 million, +£6.4 m., and +£26.2 m. in the three years in question). But these differences in interest charges are relatively small compared to the differences in overall net borrowing, starting from RAB limits which are virtually identical. Unfortunately, other than interest payments, the Scottish Executive does not publish the required detail which would enable their RAB and net borrowing

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figures in Table 3 to be further reconciled. It seems clear, however, going back to the reconciliation of the Commissioner’s figures in Table 2 above that the only other element which could account for the discrepancy between the Commissioner and the Scottish Executive relates to the handling of depreciation: (the only other candidate is working capital, which is small). There are two possible explanations which could account for depreciation having a differential impact in the Scottish Executive and Commissioner’s assessments. The first possibility is that the Commissioner simply used a different assessment of depreciation from that used by the Scottish Executive. We do know, from the Strategic Review, that the Commissioner did revise his assessment of depreciation during the conduct of the Review, both by revaluing the asset base at current prices, and by adopting more prudent depreciation and infrastructure renewal models. The Commissioner notes that both these factors had the effect of increasing his estimates of depreciation: (see Section 7, Chapter 32 of Strategic Review). Such a revision could account for the Commissioner’s estimates of depreciation being higher than the estimates available when the original RAB limit was set. However:(a) the Scottish Executive figures quoted in Table 3 were produced after the Strategic Review. If the Commissioner had significantly revised upwards depreciation for the water industry, why had the Scottish Executive not taken these estimates on board in producing their later figures? (b) if the Commissioner did revise his estimates of depreciation significantly up, why was consideration not given to revising the new RAB control limits up, rather than squeezing the borrowing finance available to Scottish water down? After all, when the Treasury introduced the new RAB system of control in 2000, it was specifically stated that non-cash costs like depreciation would, for a trial period, be included in Annually Managed Expenditure (AME) rather than in the DEL: that is, such elements would not count directly against cash limits for an initial period, and leeway should therefore have been available for revisions. To quote from Treasury advice on RAB from the Treasury website. “Under a transitional resource budgeting regime introduced in the 2000 Spending Review, the non-cash costs introduced by resource accounting and budgeting, (cost of capital charges, depreciation and impairments, and accounting based provisions to meet future expenditure) were included in AME rather than DEL. This decision was taken in order to allow departments to gain more experience in monitoring and forecasting these items following their inclusion in budgets. These items were moved into DEL in the 2002 Spending Review.” In the light of this Treasury advice, which was in force when the commissioning letter was issued in August 2001, it appears to us that there should have been scope to adjust the new RAB limit upwards if the Commissioner significantly increased his depreciation estimates. We also question why the commissioning letter from the Scottish Executive refers to the RAB control for the water industry as setting “absolute limits” - even though they incorporate a depreciation element which, on the basis of the Treasury advice, should have been in AME.

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Whether or not different depreciation figures were used, (and the position certainly needs to be clarified), there is a second hypothesis. This hypothesis is, that there is a mistake in the relationship which the Commissioner has used for relating the RAB control limit to net borrowing: that is, that there is a mistake in the logic underlying the reconciliation of the RAB limit and net borrowing given in Table 2. Consider formula 2 above, which shows the formula for RAB expenditure which was effectively used by the Commissioner in carrying out his review. In this formula, investment is gross, that is it includes expenditure on infrastructure renewals. The depreciation used in the formula also includes expenditure on infrastructure renewals. This means that formula 2 counts expenditure on infrastructure renewals twice. Because of this double counting, therefore, formula 2 actually overstates the use of resources by the water industry, to the extent of actual expenditure on renewal of infrastructure. A “correct” version of formula 2, which truly represented the organisation’s usage of resources would be given by replacing gross investment in formula 2 by investment net of infrastructure renewals. Subtracting formula 1 from this amended version of formula 2 would give the following relationship between net borrowing and RAB expenditure: Net Borrowing = RAB expenditure - Depreciation - Capital Charge element + Interest + Infrastructure renewal expenditure …(4) If, effectively, the Commissioner has been using formula (3), while the Scottish Executive were using formula (4) in preparing their annual expenditure report, then this could explain how the two parties are taking a consistently different view of the relationship between RAB and net borrowing and how the Commissioner has taken a much more pessimistic view of the net borrowing implications of a given RAB limit. Just as with the first hypothesis, however, there are some very puzzling features about this second hypothesis: - (a) If the Commissioner and the Scottish Executive were using different formulae, this would imply a surprising lack of co-ordination between these bodies. (b) Secondly, the approach used by the Commissioner is in effect determined by the terms of the commissioning letter from the Scottish Executive. This specifies, for example, that for 2003-04, the RAB control on the water industry is that the industry’s capital budget should be less than £299.7 plus profit: where the capital budget is specified in terms of gross capital expenditure and where profit is as calculated in the water industry published accounts. In the water industry published accounts, profit is calculated after deducting full depreciation, which includes infrastructure renewal. This effectively determines that the RAB measure used by the Commissioner must be defined as in formula (2). If the second hypothesis held, therefore, this would imply that the advice in the commissioning letter from the Scottish Executive is inconsistent with the principles used by the Scottish Executive in compiling their 2003-04 annual expenditure report. What does seem clear, however, is that the

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commissioning letter involves a definition of RAB which overstates the true use of resources by the water industry. We are therefore left in the unsatisfactory position that: (a) there is clear evidence that the Commissioner assumed a much more pessimistic relationship than the Scottish Executive about the net borrowing consequences of a given RAB limit. (b) both of our possible hypotheses to account for this embody puzzling features: although we do not have the evidence to say which is correct, there does not seem to be any other plausible explanation for the observed inconsistencies. (c) however, if either, or both, hypothesis is correct, then the charging decisions taken during the review were taken against the background of a misleadingly negative assessment of the net borrowing which would actually be available to the water industry. If hypothesis 1 holds, then, under the Treasury guidance then current, changes in depreciation should not have counted against a rigid control limit. If hypothesis 2 holds, then the net borrowing possible under the Strategic Review should have been recalculated using the corrected formula (4), leading to net borrowing figures much closer to those produced by the Scottish Executive. We conclude that there is now a clear requirement to re-open the arithmetic of how the Scottish Executive set the RAB limits in the commissioning letter and how these were then used by the Commissioner. The inconsistency between the Scottish Executive and the Commissioner on the level of net borrowing consistent with a given RAB control limit must be resolved. The implication of the conclusion at paragraph 3.12(c) above is that, whatever the explanation for this inconsistency, the borrowing figures in the strategic review were probably too low, (and the revenue caps correspondingly too high). For the borrowing figures, the amount in question in each of the later years of the review period is well in excess of £100 million: (and this could approach £200 million if a less conservative view were also taken about the need for the planned flexibility margin which the Commissioner built into his calculations). If it turns out that the borrowing figures used in the strategic review are indeed substantially too low, then this raises further questions which it would be for Ministers to consider. Namely, would they have taken the same charging decisions on the basis of the advice given in the strategic review if they had known that there was substantial additional borrowing headroom available to the water industry within the overall RAB limits. Furthermore, will they re-open their decisions, particularly now that the damaging consequences of high water charges for Scottish industry are becoming clear. Other Issues, and Recommendations The implication of what we have argued is that charging decisions will need to be re-opened. In doing that, other important issues need to be taken into account as well, some of which relate back to questionable decisions taken during the 2001 Strategic Review. Overall, the issues which need to be covered include: redressing the problems caused by the harmonisation of

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business rates; ensuring an appropriate balance between fixed and variable charges; addressing the need for flexibility in charging policy in the light of underspending on capital; ensuring that appropriate policies are operating on effluent charges; and importantly, ensuring that mechanisms are in place which will give an incentive rather than a disincentive towards achieving improved efficiency. At the same time, any review needs to take account of the wider objective of utilising to the full the potential of Scotland’s water resources as a source of competitive advantage both to indigenous businesses and for attracting foreign direct investment. We now discuss each of these points in a little more detail. Harmonisation of Business ChargesThe decision to harmonise business charges was taken by the Commissioner in the course of the Strategic Review: the Commissioning letter to the Commissioner referred only to Ministers’ wish to harmonise domestic charges. It is very doubtful whether the complete of harmonisation of business charges is desirable, for the following reasons. (a) If business charges are harmonised then there is no incentive for business to locate in areas where supply and/or treatment is cheapest. There will therefore be a sub-optimal location of industry. (b) As some units locate in high cost areas there will inevitably be an increase in the average cost of provision of water services; hence affecting the profitability of industry in Scotland. (c) The policy will also inevitably sterilise one of Scotland’s premier potential comparative advantages, namely the ability to attract high water-use industries to low cost locations. Fixed ChargesThe paper by Sawkins and Dickie (2003) makes clear how high the fixed cost burden is in Scotland relative to England. A high fixed cost regime like this is potentially severely damaging. One effect is that small users pay particularly high average charges per unit of water consumed. This results in an entry barrier to setting up in business, damaging the economy precisely where we are wanting it to be stimulated. Second, a high fixed charge system combined with low unit cost provides no incentive for economies in the use of water: this leads to the inefficient use of water and ultimately to higher expenditure. Flexibility in Light of UnderspendPast performance of the Water Boards shows that capital programmes are likely to be underspent in any given year. In determining charges from year to year, any underspend should be taken into account, so that the customer can potentially benefit from reduced charges, rather than, say, the industry having a financial cushion which it can use to support existing inefficiency. There therefore needs to be a readiness, which seems to be lacking at present, to adjust charges pragmatically from year to year, and not just at the periodic Strategic Reviews. The Mogden FormulaThe Mogden formula is the basis for trade effluent charges throughout the UK, (Sawkins and Dickie). The charge to the firms reflects both the volume and

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quality aspects of that firm’s trade effluent in the calculation of its final charge. Now that firms are subject to EU water directives and paying for substantial improvements in their effluent, there is a need to ensure that the Mogden formula adequately reflects the reduced costs of dealing with semi-treated effluent, otherwise there is a danger that some firms will be paying twice over for effluent treatment. Efficiency It seems clear from the investigations undertaken by the Commissioner that there is a significantly higher level of inefficiency in the water industry in Scotland compared to that in English water companies. There are however a number of difficult issues surrounding the question of efficiency. First of all, how robust are the Commissioner’s estimates of the efficiency savings possible? Secondly, how best can adequate incentives be built into the charging and funding arrangements to ensure efficiency targets are met? In this context it is worth remembering that the effects of the last Strategic Review were possibly quite perverse: high charges were set on the basis of low borrowing potential whereas in the event higher borrowing potential materialised: the financial cushion which this represented would have acted as a positive disincentive to the achievement of efficiency gains. RecommendationsIn the light of the above, our two principal recommendations are: a) The arithmetic of the Strategic Review, carried out in 2001, should be re-opened to resolve the inconsistency between the Commissioner and the Scottish Executive on the level of borrowing which was consistent with the given RAB control limit. b) There should be a review of water charges, (as also recommended by Sawkins and Dickie), taking into account the conclusions arising from (a), and also addressing the other issues raised in this section. References. Commissioning Letter, (2001): “Water Industry Act 1999: Advice on Charges”, letter from Ross Finnie to Water Industry Commissioner, 21 August 2001. “Strategic Review of Charges, 2002 -2006”: Water Industry Commissioner for Scotland, November 2001. “Annual Expenditure Report of the Scottish Executive”: The Scottish Budget 2003-04, 2 April 2002. Sawkins, J.W., Dickie, V.A., (2003): “Principles of Charging for Water and Wastewater”, Water Customer Consultation Panels.

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Finance Committee

Scottish Water Paper by Analytical Consulting Ltd

Tuesday 27 January 2004

1. The paper by Analytical Consulting Ltd was referred to the Committee’s budget adviser for his guidance on the technical detail of borrowing limits. This paper is based on the advice which has been received.

2. The paper seeks to address two related concerns – the gap between

the Executive’s borrowing limits and the Commissioner’s figures with reference to the Capital Budget, raised by the Analytical Consulting Ltd paper – and the gap between planned and actual expenditure as raised by members in the Committee meeting on 2 December 2003.

3. The paper by Analytical Consulting Ltd makes a hypothetical argument

that the £100m gap they calculate between the borrowing limit set by the Scottish Executive and the “implicit borrowing limits” in the WIC’s Strategic Review of Charges was due either to differences in provision for depreciation costs, or double counting the element for infrastructure renewal under Resource Accounting and Budgeting (RAB). It is argued in the paper that the figures suggest that the Water Industry Commissioner (WIC) took a more pessimistic view of the borrowing capacity available to the industry.

4. In practice, the two sets of figures have different purposes, the

Executive provides a maximum limit for borrowing for budgetary control, whilst the WIC provides a figure which is in effect a financial target.

5. In addition, the commissioning letter made it clear that there were

significant sums available, in terms of both borrowing limits and from profits – and that these were separate controls, not a single control total as is inferred by the Analytical Consulting Ltd paper.

6. The evidence from Scottish Water to the Committee confirms that for

2002-03 it bettered its RAB target by £21.7m, and only £51m extra was needed in net borrowing, as capital spending was around £100m below the forecast in the Strategic Review.

7. Members have also expressed concern over the gap between the

Executive’s borrowing limits and actual borrowing by Scottish Water. There has been significant underspending of the water budget. In the EYF announcement of June 2002, some £188m was reallocated to other programmes, and attributed to efficiency gains from reorganisation. In the current year, the underspend was £148m, as in

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the Minister’s letter to the Convener of 29 September 2003, mainly from the 2001-02 budget.

8. Members may wish to ask the Minister why these gaps between actual

and planned capital expenditure are so big, as they seem to suggest that financial planning can be improved. However, members should be aware that the Treasury “golden rule” of borrowing to invest prevents borrowing being used to limit charges increases – the rationale being that this would cost more in the long term.

9. The Committee may also want to consider the problems of

transparency in the current system, both in terms of the financial information under RAB, and in terms of accountability. The WIC’s role is largely advisory, and final responsibility lies with the Minister. The financial modelling which underpins these choices is not an exact science, and judgements have to be made over the scope for efficiency gains, depreciation allowances, capital investment needs etc. These are in the final analysis matters for political judgement, and the committee will want to be confident that clear lines of accountability to the Minister are in operation.

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_____

Deputy Minister for Environment & Rural Development Allan Wilson MSP Des McNulty MSP Convener Finance Committee Room 2.1, Committee Chambers George IV Bridge EDINBURGH EH99 1SP

Pentland House 47 Robb’s Loan Edinburgh EH14 1TY Telephone: 0131-556 8400 scottish.ministers@scotland.gsi.gov.uk http://www.scotland.gov.uk January 2004

Thank you for your letter of 3rd December to the Minister for Environment and Rural Affairs regarding the financing of Scottish Water, and in particular, the allegations made in the paper “Did Flaws in the Application of the Resource Accounting and Budgeting Distort the Strategic Review of Water Charges in Scotland” written by Jim and Margaret Cuthbert. I am replying in Mr Finnie’s absence. As I have said previously, there was no error in the application of the public expenditure rules known as RAB (Resource Accounting and Budgeting), nor was there any misunderstanding by the Water Industry Commissioner of the levels of public expenditure available. It is the case that public expenditure rules are complicated and changed in recent years, and coincidently at the same time as a major reorganisation of the water industry in Scotland. For the former Water Authorities and subsequently Scottish Water, there was a change from a cash-based to an accruals based system in 2001-02 and then back to a cash-based system in 2003-04. This meant that from Autumn 2000, documents published by the Executive would have been shown on an accruals basis. From Autumn 2002, following further changes in the rules, all figures for the water industry will have been shown on a cash basis. You will, of course appreciate that public expenditure rules are a reserved matter. The important point is that none of the changes in the public expenditure rules reduced the levels of borrowing available to the industry. I can therefore reassure you that charges were not adversely affected by these changes. I note that your Committee raised the issue of the inconsistency in the levels of borrowing given by the Water Industry Commissioner in his Strategic Review of

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Charges 2002-06 and the Scottish Executive. Although the Water Industry Commissioner’s assessment of the borrowing required for the water industry does differ from the Executive’s budget for water, there is no inconsistency. The difference reflects the fact that Parliamentary budgets are absolute limits that cannot be breached, whilst the WIC’s figures are targets that Scottish Water needs to meet if it is, in the interests of all customers, to achieve financial sustainability. The Strategic Review of Charges 2002-06 makes quite clear that the targets will only be met if Scottish Water meet the WIC’s efficiency targets in full. As is also clear from the Water Industry Commissioner’s Strategic Review of Charges and his comments made at your committee on 2nd December, the level of public expenditure available has not been a constraint on the industry. What is a constraint is how much it is prudent for Scottish Water to borrow in the interests of today’s and tomorrow’s customers who must pay interest on any borrowing. As was made clear at the Committee, the aim, over the four-year period of the current Review, is to place Scottish Water on a financially sustainable footing where charges are sufficient to cover the annual costs of the business – operational, maintenance, tax and interest costs – and new borrowing is for enhancing the asset value of the business. As you know, I am keen that Scottish Water is an efficient and effective business. I therefore believe that the route to keeping water and sewerage charges to the minimum necessary is not higher levels of debt but higher levels of efficiency.

ALLAN WILSON

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Finance Committee

3rd Meeting 2004 - Tuesday 27 January 2004

Ombudsman Memorandum of Understanding

1. A draft Memorandum of Understanding to regularise the administrative arrangements to be observed in connection with the annual budgeting process between the SPCB, the Finance Committee and the Scottish Public Services Ombudsman (Ombudsman) and the Scottish Information Commissioner (Commissioner) has been produced. The draft has been approved by the SPCB and has been sent to the Committee for its approval.

2. The draft Memorandum of Understanding is attached. While the draft

refers specifically to the Ombudsman, an identical agreement will be produced for the Commissioner once this draft is agreed.

3. The Acts providing for the establishment of the offices of the

Ombudsman and the Commissioner provide that the SPCB will pay the salaries of the office holders and their staff and all expenses incurred by the office holders in carrying out their functions. The draft Memorandum of Understanding is designed to set out the responsibilities of the parties and provide a framework to allow for the proper scrutiny of the Ombudsman/Commisioner’s budget proposals in the annual budgeting process.

4. The Committee is invited to consider and approve the draft

Memorandum of Understanding. Once it is approved, it will require to be signed by the Convener on behalf of the Committee.

Susan Duffy Clerk to the Committee

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BUDGETING PROCESS AGREEMENT BETWEEN THE SPCB, THE FINANCE COMMITTEE AND THE SCOTTISH PUBLIC SERVICES OMBUDSMAN 1. The purpose of this Memorandum is to set out the an understanding between the Scottish Parliament Corporate Body (SPCB), the Finance Committee of the Scottish Parliament and the Scottish Public Services Ombudsman (the Ombudsman) [there will be an identical protocol for each of the commissioners] in relation to administrative arrangements to be observed in connection with the annual budgeting process. This is not intended to create any legal rights or obligations on any of the parties. Background 2. Schedule 1 of the Scottish Public Services Ombudsman Act 2002 provides that the SPCB will pay the salaries and allowances of the Ombudsman, the Deputies and their staff and all expenses of the Ombudsman in the exercise of her functions. The SPCB has designated the Ombudsman as Accountable Officer and the Ombudsman is required to submit annual accounts to the Auditor General for Scotland for auditing. 3. As Accountable officer, the Ombudsman will be required to account for and answer separately to the Parliament for the budget allocated to her. SPCB’S Role 4. The SPCB shall scrutinise the annual budgetary proposal from the Ombudsman prior to forwarding it to the Finance Committee for consideration as part of the SPCB’s overall budget. 5. The SPCB may call on the Ombudsman to give evidence to them in support of her budget proposals. 6. The SPCB may consider a request for additional in-year funds from the Ombudsman on a case by case basis and if the request cannot be met from SPCB resources, shall put forward a Budget Revision to the Finance Committee for consideration as part of the annual budget process. Finance Committee’s Role 7. The Finance Committee will consider the Ombudsman’s Budget as part of the Committee’s scrutiny of the SPCB’s budget. The Ombudsman will give evidence in person to the Committee if required. 8. If the SPCB proposes changes to the budget which in the Ombudsman’s opinion could affect her ability to discharge her functions, the Ombudsman will notify the Finance Committee in writing. The Finance

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Committee is required to consider any such matter and make recommendations for resolution to the Parliament. Ombudsman’s Role 9. The Ombudsman has responsibility for ensuring compliance with Parliamentary requirements in the control of expenditure. Funds should be applied only to the extent and for the purposes authorised by the Parliament in the Budget (Scotland) Act then in force. 10. In order to meet the programme of the SPCB’s budget, the Ombudsman’s indicative bid for resources must be submitted to the SPCB for scrutiny 15 months in advance of the start of the financial year in question with a more detailed formal bid being submitted 9 months before the start of the year. 11. The Ombudsman must seek approval from the SPCB in all case where it is required for any expenditure not covered by any standing authorities delegated to the Ombudsman’s office. It is also required before expenditure is incurred in excess of the amount allocated to the Ombudsman in the SPCB’s Budget Proposals, even if savings may be available elsewhere and the nature of the expenditure falls within the delegated authority of the Ombudsman. 12. Where a bid for additional funding is required, the Ombudsman must submit at the earliest opportunity a comprehensive case for additional funding to the SPCB who will scrutinise the request and if necessary, submit a Budget Revision to the Finance Committee for approval as part of the annual budget process.

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Finance Committee

3rd Meeting 2004 - Tuesday 27 January 2004

Committee working practices – Dealing with the media

1. The work of the Committee will frequently be publicised. This paper outlines the instances where media work may be required and sets out a protocol that the Committee may wish to adopt.

2. It is often the case that the press will seek comments from the

Committee on issues it is pursuing and will normally contact the Convener as the person the press recognises as speaking on behalf of the Committee. As a result, the normal practice has been for the Convener to comment on behalf of the Committee. Other Committee members comment as individual members or as party spokespersons but not as a spokesperson for the Committee.

Is the Committee content with this approach?

3. Generally, press releases are issued when Committee reports are

published, when calling for general evidence on particular important issues (such as a major inquiry). Meetings which are held outside Edinburgh and any Committee visits are generally publicised locally by press release.

4. The usual practice is that the media office in conjunction with the clerks

prepare drafts of press releases. It is up to the Committee whether it wishes to delegate authority to the Convener to approve the final draft or whether to consider the draft release in Committee. However, it is recognised that because of deadlines to which media necessarily have to work, it may be more practical to delegate authority. If authority is delegated, then the Convener would undertake to circulate routine press releases prior to be issued to the media, to members for their information. However, where the Convener judged that a release related to a controversial issue then this release would be circulated to members, prior to finalisation, for their comment on the substantive issues.

The Committee is invited to agree the approach it wishes to adopt.

5. The Committee may decide to hold a press conference when it

considers that a particularly newsworthy report is being published. Such conferences may be given by the whole Committee or by selected members representing the political mix on the Committee or by the Convener, as determined by the Committee on a case-by-case basis..

Is the Committee content with this approach?

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Susan Duffy Clerk to the Committee