In a recent decision, the High Court dismissed Northumbrian Water Ltd’s (“NWL”) application for judicial review of Ofwat's decision to only partially relieve NWL from a reduction in  prices because of NWL's underperformance relating to water supply interruptions, which occurred as a result of Storm Arwen. 

The decision confirms that Ofwat has discretion on whether to relieve a water undertaker from price reduction consequences if it fails to fulfil its water supply commitments in instances of civil emergencies such as extreme weather events.

Background 

Ofwat has particular duties under section 2 of the Water Industry Act 1991, including furthering the long-term resilience of water supply systems through promoting undertakers to make appropriate investments. To fulfil this duty and broadly mimic a competitive market, Ofwat imposes five-year price control settlements. PR19 set Performance Commitments for 2020 to 2025, which included the following mechanisms (known as Outcome Delivery Incentives or ODIs): 

• undertakers would be subject to a reduction in the amount they could charge customers in the following year if they underperformed in any one year; and
• if they outperformed, they would be entitled to charge customers increased prices. 

Undertakers are required to report annually to Ofwat with details of any supply interruptions. Where there are supply interruptions, the default position is that water companies manage and bear that risk (as the party best able to manage it), whether planned or unplanned.

Under the Civil Contingencies Act 2004 an exception can, however, be granted to undertakers on the basis of a civil emergency (the "CE exception"). Using the CE exception, undertakers can make representations to Ofwat where a civil emergency has occurred and the interruption in water supply was not the cause of the civil emergency.

NWL underperformed during 2020 - 2021 due to the supply of water in the northeast of England being seriously disrupted by Storm Arwen. There was no dispute that Storm Arwen was a civil emergency within the meaning of s.1 of the Civil Contingencies Act 2004. NWL had to report the water supply interruptions that resulted as instances of underperformance of NWL's supply interruption Performance Commitments as part of its annual return to Ofwat for 2021-2022, which was required for Ofwat's in-period determination for that year. The effect of this underperformance was that, by default (and subject to the operation of the CE exception), NWL would have to reduce the prices it could charge its customers by £25.79 million. In those circumstances, NWL made a representation to Ofwat that the CE exception should operate. 

In their initial consultation draft, Ofwat refused to grant the CE exception and intervene to relieve NWL of the Storm Arwen price reduction, noting the default position and explaining that it existed in order to incentivise undertakers to minimise the impact on customers.  

NWL responded to the consultation draft, addressing the grounds of Ofwat's determination, and concluded that the CE exception operated automatically when underperformance was associated with a civil emergency to exclude all the impacts of that underperformance. NWL claimed that giving no relief to NWL under the CE exception would risk inefficient investment.

In its final determination, and whilst rejecting the proposition that giving no relief to NWL under the CE exception would itself risk inefficient investment by water companies, Ofwat agreed that in the particular circumstances the specific financial impact of Storm Arwen on the performance commitments in question should be considered. 

As a result, Ofwat considered it appropriate and proportionate to exercise its discretion in favour of a broad sharing of risk.  The appropriate share for the financial impact of the event was 50:50 between customers and the company, which meant an overall price reduction of £12.894 million in the following year. Ofwat determined that this conclusion would allow NWL to make resilience improvements and was in line with PR19. 

The Case

By way of judicial review, NWL challenged Ofwat’s final determination on the following bases:

1. Ground 1 - There is no discretion when applying the CE exception. Once applied, and Ofwat is satisfied that the preconditions for the operation of the CE exception are met, undertakers should be fully relieved of any consequences of underperformance caused by a civil emergency. 
2. Ground 2 - There is no published policy on how Ofwat’s discretion should be exercised, and the duty of prescription applies.
3.  Ground 3 -
   1. Ofwat took into account irrelevant factors, and
   2. Ofwat acted irrationally in concluding that the final determination would ensure undertakers remain incentivised to invest efficiently to minimise the impact that extreme weather has on water supplies. 

HH Judge Klein refused the application, dismissing all grounds. 

As to the first ground, he held that the whole purpose of PR19 and the combination, and setting, of Performance Commitments and Outcome Delivery Incentives was to allocate risk to the party Ofwat believed best able to manage it (in the case of weather, the water companies) and to improve water company performance and resilience in the water supply network. The clear direction of travel in PR19 (including the Reporting Guidance) was, unlike in earlier price control settlements, to limit reporting exceptions, particularly water supply interruptions relating to severe weather. The existence of a CE exception discretion was consistent with that purpose and Ofwat had made no error of law. Moreover, Klein J. found that the absence of discretion would lead to a degree of absurdity.  

Klein J. was equally unpersuaded that this was a case where the duty of prescription applied. The situations 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 and to protect against arbitrariness, and facilitate informed challenge (R (ZLL) v. Secretary of State for Housing, Communities and Local Government [2022] EWHC 85 at 45 (Admin)). 

Although Ofwat had not published a policy relating to the application of a CE exception discretion, Klein J. found that the discretion is not completely unbounded. The discretion must be exercised in accordance with Ofwat’s statutory duties, the ambit of which provide a sufficient template for consistency in decision-making. Nor was this a case where multiple private individuals are subject to decisions in similar circumstances by one of many caseworkers. NWL’s final determination was made by a very senior, identified Ofwat official and the Judge saw no reason why future decisions would not be taken by equally senior officials. Further, the draft determination was published and was consulted on, with further contributions open not only to NWL but more generally, so that NWL had the opportunity to challenge Ofwat’s thinking about its particular case. 

Finally, grounds 3(a) and 3(b) were dismissed in brief terms.

NWL claimed that Ofwat was only permitted to take into account NWL’s performance of the supply interruption Performance Commitments in relation to Storm Arwen. Because it took into account other matters, the final determination must be quashed. Klein J. explained that, in making an in-period determination, Ofwat must comply with all its statutory duties, which require Ofwat to further objectives much broader than might justify a single-minded focus on NWL’s performance during Storm Arwen. For that reason, ground 3(a) was dismissed. 

As for NWL’s irrationality claim, Klein J. concluded that Ofwat had not acted irrationally or disproportionately. 

NWL had argued that Ofwat acted irrationally in concluding that the final determination retains incentives on NWL to continue to strive to deliver the best possible service and response to supply interruptions, because there was nothing more NWL could reasonably have been expected to do. Ofwat had also failed to take into account that there are already ample incentives for efficient investment to address extreme weather. Klein J. held that the submission was an attempt to resurrect NWL’s first ground of appeal, meaning, in applying the CE exception, it could only be applied in one way (in favour of NWL). That had already been rejected. In any event, Ofwat's overall conclusion that the financial impact of Storm Arwen should be split 50:50 between NWL and its customers would support resilience improvements by NWL. Ofwat was entitled to make such an economic predictive judgment in light of the wide margin of appreciation afforded to it.

NWL submitted finally that the relief Ofwat granted NWL by the final determination – relieving it of only £12.894 million of the £25.79 million Storm Arwen price reduction – was manifestly disproportionate, and so irrational. NWL relied, in this regard, on the response to Storm Arwen of other regulators; in particular, the Environment Agency, which relieved NWL of all the consequences NWL might have otherwise faced for pollution incidents relating to Storm Arwen, and Ofgem in relation to Northern Powergrid. 

In recognising that the Storm Arwen price reduction to which NWL continues to be subject following the final determination is a significant sum of money, Klein J. held that it did not follow that the final determination was manifestly disproportionate. In addition, just because other regulators may have responded more generously to their regulated companies than Ofwat may be said to have done as a result of Storm Arwen, it did not follow that the decisions of those other regulators were necessarily proportionate or that, comparatively, Ofwat's decision was disproportionate.

As the UK braces itself for winter and inevitable extreme weather events, this judgment serves as a timely reminder and a strong signal to water companies that Ofwat will not apply the CE exception generously. It is a clear that water companies must bear the brunt of the risks associated with water supply disruption in extreme weather events. 

Read the full judgement here.

This case report was written by Victoria Barnes and Carys Cox.