12 October 1998 Section 56 Water Industry Act 1991 Mr E May v Cambridge Water 1. Introduction 1.1 Mr E May referred to the Director General for settlement the dispute between himself and Cambridge Water Company ("Cambridge") about the amount recovered by Cambridge for the connection of water to land at Ermine Way, Arrington, Royston, Herts. The connection was completed on 8 January 1998. 1.2 Cambridge has recovered £1,331.38 (excluding VAT and including infrastructure) in respect of connection costs. An amount which Mr May claims is in excess of the expenses incurred by Cambridge in complying with its obligations to provide a supply. 2. Details of the works length of pipe: 20m, 25mm diameter surface: grass verge work: Direct labour reinstatement: verge reinstatement only – carried out by direct labour force 3. Financial Information Supplied by Cambridge 3.1 Cambridge says that the connection charge was made by reference to the individual cost of that particular job. 3.2 Cambridge has provided the following details of the actual costs incurred in making the connection:- Connection work (including overheads) £ 914.70 Materials £ 205.68 Infrastructure £ 211.00 Total £ 1331.38 4. Mr May’s Views Mr May says he kept a record of the hours worked by Cambridge’s direct labour force having been present at the site. He strongly disputes Cambridge’s account of the time its workforce was on site. He says the job took the two men a total of 13 hours ie. 26 man-hours, over three days to complete. He says that the work involved digging two holes on either side of the road on the first day, moling under the road on the second day and then filling in the holes on the third day. He feels the charge made by the company is not representative of the true cost of the work. 5. Approach to the Determination Section 56 (5) of the Water Industry Act 1991 provides that, where no provision is made in the company charges scheme in respect of supplies of the applicable description, the Director may determine the reasonableness of a charge levied in respect of a connection to the main for non-domestic purposes. This determination must have regard to the desirability of the water company recovering the expenses incurred in providing the supply and securing a reasonable return on its capital. In making the determination the Director General has had regard to information about contractors' charges and other information about costs which has been made available to him when considering previous disputes referred for determination under Section 45 and 56 of the Water Industry Act 1991. His considerations have also taken account of information from independent reviews of contractors’ rates and suppliers’ prices for materials. These reviews were carried out in 1994, although the outcome of those reviews has been reassessed subsequently in the light of more recent information. When the company has used a contractor selected following a process of competitive tender, the Director will generally accept that the amount paid to the contractor for the work represents the expenses reasonably incurred. He will, however, query those costs where they appear to be substantially higher than might be expected having regard to other information available to him. The determination made by the Director General concerns the total amount charged, including both connection and capacity charges. However, in order to make the determination the Director General has considered the following five components, the combined costs of which amount to the total charge. These are:- (a) Connection work This includes all costs associated with excavation, pipelaying, connection and temporary reinstatement including direct pay of operatives and labour overheads (eg. National Insurance, sickness, bonuses etc) plant, transport and direct supervision. Where a contractor is employed these costs would be covered by its charge to the water company. (b) Materials The cost to the water undertaker of the materials used to make the connection. (c) Reinstatement This is the cost of the work to effect permanent reinstatement of the public roads and footpaths. (d) Overheads This covers all costs incurred when carrying out the connection work which are not covered by (a), (b) or (c) above. It includes billing and invoicing costs; planning and design costs; appointment and supervision of contractors; warning notices costs; depot on-costs; set up costs and inspection. (e) Capacity/infrastructure This covers the cost of capital expenditure committed by the company to enhance the local distribution network to meet extra demand created following the new connection and the return on such capital. 6. Consideration of Key Components of the Charge (a) Connection Work Cambridge says the connection work cost £914.70 and was carried out by its direct labour force. Cambridge says the decision to use the direct labour force is based purely on the availability of labour. The company satisfied itself that the direct labour charge is competitive with the current market rate by comparing it to the costs of contract labour. The company says the work involved digging two pits, one of 2 x 0.8m and the other of 1 x 0.5m, in the grass verges on either side of the road. The connection was then moled under the road. The company says this work took a total of 38 man-hours (including loading up and travel time) over three days, the 5, 7 and 8 January 1998. This comprised 14 man-hours on the first day, 15 man-hours on the second day and 9 man- hours on the third day. Mr May agrees that the work was completed over three days, but his records indicate that much less time was spent on the site on the 5 and 8 of January. The company agrees with Mr May’s statement that the excavation was carried out on the first day, the moling on the second day and the backfilling of the excavation on the third day. The company says the final charge to Mr May does not include a charge for loading up time, return journeys to the depot nor an initial, aborted moling attempt. Cambridge says that it encountered difficulties with the mole and the moling had to be completed in two attempts. The company has admitted responsibility for the problem although it has not specified what it was. Cambridge has charged for 32 hours 40 minutes of labour time. The Director notes the difference of opinion between the company and Mr May about the time taken to complete the connection work. The company has admitted responsibility for delays in carrying out the work and indicated that, had there been no problems, the job would have taken a shorter amount of time. In addition, Cambridge and Mr May are in broad agreement about how long Cambridge was on site for the second day when the moling took place. The length of the connection was 20m and this was moled in about 13 man-hours, including the time taken for the abortive moling attempt (approximately one man- hour). This indicates that, notwithstanding the quality of the soil, the ground conditions did not present great problems. The main disagreement appears to be about the time taken over the work carried out on the first and last days. The work on the first day consisted of excavating two pits in grass verges on either side of the road and Cambridge has said that this took 13 man-hours while Mr May says this work took six man-hours. Cambridge says there were problems because the main was deep at 1.5 metres, and clay, chalk and brick rubble were excavated. Ofwat acknowledges Cambridge’s statement that the main was deeper than expected and agrees that this would have increased the time taken to excavate the tapping pit. This would especially be the case if the ground had been harder than expected, though there is no evidence for this. However, information available to Ofwat from other disputes suggests that the pits of these dimensions should not have taken more than six man-hours to excavate. On the final day, Cambridge says its workforce took nearly seven man-hours to make the connection and backfill the excavations but Mr May says this only took four man-hours. Again, information available to Ofwat suggests that seven man- hours to complete these tasks would be excessive and that the work should have taken no more than four man-hours. It is, therefore, considered that the work undertaken on site to effect this connection should not have taken more than 22 man-hours (excluding time lost by the initial abortive moling attempt). In addition, loading up time and travelling time to the site would have taken a further four hours over the three days. Cambridge says its direct labour cost is £28 per hour. Cambridge has provided a breakdown of the costs including in its hourly rate. These include the direct pay of operatives, pension and insurance contributions, sick pay and holiday pay as well as costs associated with supervision transport and plant. However, Cambridge has also included an element to cover the costs of administration. It is not clear exactly which administration costs are included in the hourly rate but, according to section 5(d) above, these costs should more appropriately be considered under Overheads, section 6(d) below. Information available to Ofwat, including the review of contractors’ rates (mentioned in paragraph 5) indicates that £20 per hour for labour costs is reasonable. The Director, therefore, concludes that the reasonable costs of the connection work should not have exceeded £520. (b) Materials Cambridge says the costs of materials amounted to £205.68. The materials included a meter, a meter chamber and cover, assorted fittings and road stone and pea gravel. This cost included a charge of £4.88 for a council inspection fee. This item is covered under ‘Overheads’ below. Taking this into account, the total costs associated with the materials alone is £200.80. Cambridge says it uses encoded meters as these can be read remotely. However, these are more expensive than standard meters. The company also says it uses meter chambers of its own design, which are better quality than standard. The meter covers and assorted fittings were made of metal, which also increased the cost of these items. Ofwat considers that, within reason, companies should be allowed discretion over the materials they use to make connections. In this case, the cost of an encoded meter and other materials was incurred and Ofwat considers that these costs should be passed on to the customer. Cambridge has also said that it applies a mark-up of between 20 – 300% on the costs of its materials and this is included in the above total, £200.80. The Director does not consider there is any reason to allow any mark-up or profit over and above the on-costs, which are considered under paragraph 6(c) below. Cambridge has said that the costs of the materials excluding mark-up amounted to £128.53 and this is the amount under consideration in this determination. Having regard to the review of suppliers' prices referred to in paragraph 5 the Director considers that these costs were reasonably incurred. (c) Reinstatement There was no permanent reinstatement of a made surface needed. The verge was reinstated by Cambridge’s direct labour force when the connection was carried out. The cost of labour is therefore incorporated in the cost of carrying out the connection work which is considered in Section 6(a) above. The cost of the road stone used is considered under Section 6(b) above. (d) Overheads Cambridge has not provided a separate figure for overheads. Instead it includes costs associated with administration in its hourly labour rate of £28 per hour as considered under part 6(a) above. It is not clear exactly which administration costs are included in this figure. In addition, Cambridge has said that these costs cannot be split from the hourly rate. In making the determination, the Director must have regard to the actual costs incurred. Ofwat’s view is that, for a standard, single connection, overheads should not exceed £80. (e) Capacity/infrastructure In addition to the above costs associated with making the connection, Cambridge applied a standard, non-domestic availability charge of £211 to this connection. The water supply was provided for a horticultural business. The charge levied equates to the infrastructure charge for a domestic property. The company considers the likely usage of the new supply to be similar to that for a single domestic property. Ofwat considers that the charge was appropriately applied. 7. Total Charge For the reasons given above, the Director General has concluded that the total costs, which were reasonably incurred by Cambridge, should not have exceeded £939.53, calculated as follows: Connection work £ 520.00 Materials £ 128.53 Overheads £ 80.00 Infrastructure £ 211.00 Total £ 939.53 The amount of £1331.38 charged by Cambridge for the connection to Mr May’s property was in excess of this amount by a figure of £391.85.