ECONOMIC INSTRUMENTS IN RELATION TO WATER ABSTRACTION: A CONSULTATION PAPER

EXECUTIVE SUMMARY

INTRODUCTION

MAIN RESEARCH FINDINGS

CHARGES

TRADING

IMPLEMENTATION

SUMMARY OF CONSULTATION PROPOSALS

APPENDIX A: The current water abstraction charging scheme

Water abstraction charges are based on the maximum quantity licensed to be abstracted, rather than the amount actually abstracted. The charges are set at a level which enables the Environment Agency to recover, year on year, the costs of carrying out its water resources management functions (see paragraph 3.1).

This consultation paper considers the case for increasing abstraction charges above the cost recovery level. This would amount to an environmental tax and would require a change in the law to be made through a Finance Bill. There might be two reasons for doing this. One would be to make abstractors bear more of the true costs of the effects of their abstractions on the environment. However, the research summarised in Chapter 2 indicates that this would be unlikely to result in the specific abstraction reductions which would be necessary fully to curtail damage (see paragraph 3.8).

The other reason for increasing abstraction charges above cost recovery level would be to reduce the overall amount of water abstracted for economically low-value uses. But the research indicates that this would take tenfold increases or more. These would have widespread effects, notably upon public water supply prices. The paper points out that legislation already provides direct means to curtail abstractions, and that licence trading may have an important role to play in redistributing water resources. It therefore seeks comments on the view that increasing charges specifically in order to reduce abstraction would not be justified (see paragraphs 3.12 to 3.19). But the paper recognizes that there may be scope for re-balancing cost recovery-based charges to reflect differing water resources positions (see paragraph 3.22).

The research indicates that markets for trading licences can be created where there is currently unmet demand for water resources. The paper invites comments on the Government’s view that, in principle, abstraction licence trading should be promoted as an effective means of achieving the optimal distribution of water resources within and between different sectors of use and thus contributing to sustainable development (see paragraph 4.2). The paper also asks respondents to consider how trading could influence competition in the public water supply industry (see paragraph 4.3).

The paper goes on to restate the Government’s view, expressed in a June 1998 consultation paper, that an economic instrument relating to water abstraction must operate together with both regulatory and voluntary measures. The paper emphasizes in particular that licence holders will have to be clearly identifiable at all times. It follows that the Environment Agency, as the licensing authority, will continue to be involved in licence trading and thus able to regulate according to need. Some of the intended changes to the licensing system, announced in Taking Water Responsibly, will be particularly relevant to licence trading (see paragraphs 4.4 to 4.9).

The paper continues by considering the various types of licence trade which could occur and how they would operate in the changed system (paragraphs 4.10 to 4.25). Many trades would involve the buyer in applying for either a new or a varied licence of his own so that he could use the licence he acquires. The insertion into the buyer’s licence of an "acquisition curtailment condition" is identified (in paragraphs 4.20 to 4.22) as a significant aid to trading. This would enable the buyer to replace another licence-holder’s abstraction with one from his own abstraction point, but without the need for the seller’s licence to be formally varied or ended. This would be because the "acquisition curtailment condition" would allow the buyer to abstract only when he is assured that the seller is not abstracting. This proposal opens up the possibility of very short term trades between two abstractors who each have a reasonable annual need for water, but whose needs peak at different times.

Some types of licence trading could, at first sight, lead to the activation of "sleeper" licences". These are licences, sometimes for significant quantities of water, under which there has been little or no actual abstraction for several years. Actual abstraction of the licensed amounts might prove unsustainable in some areas. But, in paragraphs 4.27 to 4.33, the paper puts forward for comment the view that since, in practice, the Environment Agency would have to vary the conditions of most of these licences for them to be of use, the Agency will be able to control undesirable increases in abstraction.

Another concern about licence trading is that it might lead large companies to hoard licences. The paper points out that this could be deemed anti-competitive behavior, for which there are remedies under the Competition Act 1998 (see paragraph 4.36). The Environment Agency will have additional powers to deal with hoarded licences that become "sleepers". Another way of combating licence hoarding might be for the Environment Agency itself to enter the market to buy up licences for subsequent re-distribution, but the paper, at paragraph 4.41, asks for comments on the view that the Agency, as a regulator, should not trade in this way.

The paper invites views on whether an auctioning process may have a part to play in the allocation of water resources within the changed abstraction licensing system (see paragraph 4.45). It goes on to seek views on the part played by the Environment Agency’s obligation to consider the reasonable requirements of applicants for abstraction licences (see paragraph 4.49). The paper also asks for comments on the Government’s view that trading should be able to operate between different sectors of water use, not confined to the same sectors (see paragraph 4.51).

The paper points out that the Environment Agency will need efficient administrative processes if it is to encourage licence trading and seeks views on where the Agency might improve. Some commentators have suggested that licences might be "pre-approved" as suitable for trading and the paper seeks comments on that idea. But it points out, in paragraphs 4.57 to 4.62, that the Environment Agency is developing Abstraction Management Strategies under the Taking Water Responsibly changes. By presenting a detailed picture of the water resources situation in each catchment, these should help abstractors to identify the scope and limitations of trading for themselves.

Readily available information on what trades have already taken place, and on prospective buyers and sellers, would also encourage licence trading. In paragraphs 4.64 to 4.74, the paper seeks views on a proposal that the Environment Agency should develop a web site on which all this information could be displayed, and on how the Agency’s costs in operating such a site should be recovered. The paper asks for views on whether a more active form of licence trade "brokering" is likely to emerge and, if so, on how, if at all, that should be regulated.

Arrangements for implementation of the consultation paper’s proposals are discussed in Chapter 5. A full list of all the questions to which the consultation paper seeks responses is given in Chapter 6.

1.  

INTRODUCTION

1. The use of economic instruments in relation to water abstraction was discussed as part of a wider consultation paper addressed to England and Wales and published in June 1998. That paper set out the Government’s view that price signals provided by economic instruments may help ensure efficient allocation of bounded, sometimes scarce water resources. The principal options discussed were incentive charging and the trading of abstraction authorizations. The paper also made clear the Government’s continuing view that economic instruments will need to complement regulatory and voluntary measures in order to provide an overall framework in which allocative efficiency is achieved whilst safeguarding the environment. The consultation paper went on to describe a number of ways in which the existing regulatory system could be both streamlined and sharpened to reduce regulatory burdens, to facilitate the promotion of economic instruments and to encourage a responsible, voluntary approach by abstractors to abstraction management.
   
2. In March 1999, the Government published its decisions following consultation in Taking Water Responsibly This set out the changes it proposes to make to the water abstraction licensing system. Some could be achieved by administrative means, but others will need primary legislation. The latter will be set out in a draft Water Bill to be published later this year.
   
3. In briefly summarising responses to the consultation paper discussion of economic instruments, Taking Water Responsibly said that `the mixture of responses reflected the complexity of the subject and the paucity of the available information on some aspects of abstraction’. It went on to say that the Government would consult on any further proposals regarding economic instruments which arose from research it had commissioned.
4. The research was carried out by Risk & Policy Analysts Limited ("RPA" hereafter),under the supervision of DETR and with the guidance of a steering group comprising representatives of DTI, Welsh Office, HM Treasury, MAFF, Ofwat, English Nature and the Environment Agency. The report of this work was finalised in March 2000. The report is being made publicly available to coincide with the publication of this consultation paper. It can be obtained from the DETR web site, http://www/detr.gov.uk/, or, in hard copy, from the DETR at the address given in paragraph 1.7. Extracts are reproduced within the remainder of this paper. Although DETR and the steering group are satisfied with the report, neither its publication in this way nor the direct quotations from it in this consultation paper should be taken to imply that the Government endorses every detail of the conduct or conclusions of the research.
5. The research was founded upon an examination of the existing literature, discussions with interested groups and supported by responses from a total of 187 abstractors in selected catchments – seven in England and one in Wales. The Department is very grateful to those abstractors for making this research possible.
6. This consultation paper starts by summarising, in Chapter 2, the findings of the research, using extracts from the report’s Executive Summary. It then goes on to consider the scope for incentive charges (Chapter 3) and trading (Chapter 4) in the light of that research. Chapter 5 discusses how the proposals might be implemented and considers regulatory impact, making the important point that the proposals in this Consultation paper do not impose any new regulatory burden on anyone. Chapter 6 draws together all the consultation questions which appear in Chapters 3, 4 and 5 in bold font.
7. Reponses to those questions, and any other comments, should be sent, to arrive by 10 July 2000, to:

Stephen Ryman

Department of the Environment, Transport and the Regions

Water Supply and Regulation Division

3/G17, Ashdown House

123 Victoria Street

London SW1E 6 DE.

E-mail: stephen_ryman@detr.gsi.gov.uk

 

8. Respondents in Wales should also copy their responses to:

Carys Clarke

National Assembly for Wales

Environment Division

Cathy Park

Cardiff CF1 3NQ

E-mail: carys_clarke@wales.gsi.gov.uk




9. This paper is available on the DETR web site, http://www/detr.gov.uk/ . (Click on the Environment Protection icon). The June 1998 consultation paper and Taking Water Responsibly are similarly available, but hard copies are available from DETR at the address above.
   
10. The Government may wish to publish responses to this Consultation paper in due course, or deposit them in Departmental libraries. If this is done, all responses received will be published or deposited, unless a respondent specifically asks the Government to treat their response as confidential. Confidential responses will, nevertheless, be included in any statistical summary of numbers of comments received and views expressed. Should you not want a copy of your reply made available to the public please make this clear in your response. Those who have previously sent formal representations on water abstraction licensing should also make clear whether or not they wish that material to be made publicly available.

 

 

 

2.  

The objective of this study was to provide an understanding of the economics of water

abstraction in a number of case study areas and to determine how economic instruments, specifically incentive charges and tradable permits, might operate in practice. The work undertaken in meeting this objective was divided into four phases:

• literature review and identification of case study areas;
• data collection and consultation;
• modeling of case study areas; and
• advising on policy options.
  

The literature review enabled lessons to be drawn from world-wide experience in the

application of incentive charges and tradeable permits. Eight case study catchments

were then selected to represent a range of characteristics that could be significant to

the impacts of economic instruments. Within the case study areas, a sample of 740

abstractors with authorisations to abstract over 200 m³/day were surveyed, to collect

data for modelling likely abstractor responses to incentive charges and permit trading.

The survey data was supplemented by discussions with a range of trade associations

and other organisations, and supplemented and confirmed by existing literature. The

information was then used to model the potential impacts of a range of incentive

charging and permit trading scenarios within the catchments.

1.  

CHARGES

Preamble

1. Water abstraction charges are made annually on the basis of the maximum quantity licensed to be abstracted, rather than the amount actually abstracted. The charges are limited to a level which enables the Environment Agency to recover, year on year, the costs of carrying out its water resources management functions. Those functions go wider than abstraction licensing, embracing, for example, the operation of water transfer schemes and an extensive monitoring network. Changes to the charging scheme have to be approved by the Secretary of State (in consultation with the National Assembly for Wales) after proposal by the Environment Agency and the Agency itself has first to consult `persons likely to be affected’ about its proposals. Appendix A gives further details of the current charging scheme, introduced in 1993. The level of the `standard unit charges’ within it is approved by Ministers each year.
   
2. The research looked at four scenarios. The Environment Agency could set abstraction charges simply to recover its water resources management costs (scenarios A or B). It could also set them to reflect the likely cost of any environmental damage associated with particular abstractions (scenario D), or some other approximation to the environmental benefit of in-stream flows or groundwater levels. The Agency might also use charges to reduce abstractions for general water resources management purposes. This may go beyond what is needed just to protect the environment, unless they only apply to specific abstractions (Scenario C).

Cost recovery

3. At the moment, the Environment Agency recovers its water resources management costs. If it didn’t, the Government would have to increase the Environment Agency’s grant-in-aid. The Government will therefore continue to ensure that abstraction charges cover those costs year-on-year. It will continue to require the Environment Agency to demonstrate that its costs incorporate challenging but realistic efficiency savings. At the same time, the Agency must make sure that it maintains and develops the high technical, administrative and communication standards demanded in Taking Water Responsibly.
4. In Taking Water Responsibly, the Government confirmed that the Environment Agency must be prepared to use its powers to curtail abstractions which are causing environmental damage and to pay compensation accordingly (although it proposes to bring forward legislation which would end entitlement to compensation in such circumstances from July 2012).
5. The Government also confirmed that the costs of compensation must be reflected in abstraction charges. To provide an appropriate framework for the recovery of compensation costs, the Environment Agency will probably need to propose a new charging scheme for approval by the Secretary of State, having first consulted with those likely to be affected by it. But a new scheme would be necessary in any case to take account of the changed scope of the abstraction licensing system if Parliament approves the changes set out in Taking Water Responsibly.
6. Just as compensation costs are difficult to predict, so is their effect on abstraction charges. On the one hand, the Environment Agency should not accumulate significant funds through the charging scheme to meet compensation costs that may or may not actually arise. On the other hand, it should try to defray costs actually incurred in future years in such a way as to minimise sharp variations in charges.
7. The RPA research gives some illustration of how increased charges might affect the behavior of abstractors, and this should assist the Environment Agency in designing and operating a new charging system. The key conclusion of the research in this regard was that `abstractors on the whole are unlikely to respond to increases in charges unless those increases are significantly higher than current rates; however, a doubling of charges may eliminate some of the lowest value uses of abstractions and lead to a reasonable portion of unused licences being retired’. Although there has to be separate consultation by the Environment Agency on a new abstraction licensing charging scheme, the Government would welcome further views, in the light of this research, on how water resources management costs significantly increased by compensation payments should be recovered through the abstraction charging system.

Reflecting environmental damage

8. The discussion of incentive charges in the June 1998 consultation paper pointed out (at its paragraph 2.18) that abstraction charges should in principle be based on the monetary valuation of the environmental benefit of not abstracting the water. However, within the limitations of the existing valuation methods and information for the three catchments studied in this research, it appears that the inclusion within abstraction charges of environmental damage costs would be unlikely to result in the reductions in abstraction which would be necessary fully to curtail damage.
   
9. If that is generally the case, the remaining benefit of charging would be the application of a continuing "penalty" on troublesome abstractions which could notionally be deployed in achieving some other environmental benefit or used to mitigate the damage caused by continuing abstractions. However, the abstractor’s continued willingness to pay the charge would simply mean that the value of the abstracted water is equal to or greater than the monetary valuation of the environmental damage caused by the abstraction. It would mean that the abstractor’s business can bear the costs (or pass them on to customers).
   
10. The implication of RPA’s research - that the value of a unit of water to the user is higher than the cost of the environmental damage caused by abstracting it - should be treated with caution. For the purpose of benefit assessment, data problems meant that RPA estimated average values for environmental damage in each sub-catchment. In practice, the benefits of curtailing the most damaging (or marginal) abstraction will be significantly above average. Therefore, there will be cases where the environmental damage is greater than the value of water to its user, which the research systematically does not identify. This will be especially so where the value of a special environmental feature, such as an SSSI, has not been properly captured or is subsumed within the averaging process.
    
11. Where the charge levied does not lead to a sufficient reduction in environmental damage the Environment Agency will need to undertake an appropriate cost-benefit appraisal of any abstraction licences before deciding to revoke them, except where the statutory need to protect SSSIs provides an overriding justification for action. Only by assessing both the economic and environmental implications of its actions, can the Environment Agency ensure that water resources are used in a way that is consistent with the Government’s sustainable development strategy. Licences should only be revoked where this action is justified, and once it has been established that economic and environmental objectives cannot be met together.
    

Reducing abstraction

12. The outcome of the researchers’ modelling under scenario C gives some idea of how charge increases may influence abstraction levels. It also suggests that reducing overall abstraction by means of a charging instrument alone is likely to raise various difficulties.
13. The first would be to decide what reduction is actually necessary. If the objective is to free resources for other abstractors with a higher-value use for the water, a simple catchment-wide reduction target may be enough. But the Environment Agency would have to be able to justify it, both at the outset and by the subsequent uptake of freed resources.
14. In practice, demand for water is likely to vary considerably even within an individual catchment. However, if the objective is to reduce stress or damage to the water environment, it is probable that particular abstractions within the catchment would need to be targeted and the research indicates that even larger charge increases for these would be needed.
    
15. In both cases, there are two ways to determine the increase. Either the Environment Agency gathers detailed information for each catchment, just as the researchers did, or it demonstrates that it could extrapolate information from another catchment. Either approach would be a significant technical challenge and an additional administrative burden for the Environment Agency.
    
16. Another conceivable approach would be to apply a standard increase irrespective of individual catchment characteristics, but that would not necessarily achieve objectives and would accentuate still more the other difficulties. For example, it may lead to dead-weight losses as abstractors are "priced out" even though their individual abstractions are not causing environmental damage or restricting another potential abstractor.
17. Once the Agency has determined the charge increase, it would need to consider the way in which it would achieve its objective. The research indicated that spray irrigators and fish farmers would be more likely than water companies or industry to reduce abstractions. They might even close down entirely. The Environment Agency should consider possible consequences for local economies.
    
18. Water companies would be less likely than other abstractors to reduce abstractions in response to charge increases. This is not only because of their duty to maintain public water supplies, but also because they would be largely able to pass increases on to their customers. The Director General of Water Services would have to determine the extent of any price increases. But they might be significant, especially for disadvantaged customers (although the Water Industry (Vulnerable Groups) Regulations 1999 would give them some protection). It would be difficult to design an incentive which delivered a programme of environmental improvements by the water companies more efficiently than the targeted improvements reflected in the recent Periodic Review of water prices.
    
19. Rather than apply a uniform increase to all abstractors in a catchment, the Environment Agency could increase charges more for some uses and less for others. This could safeguard particular interests, but would inevitably affect others more. This would add further complexity to determining and applying the charge. The economic argument would also be weak as, ideally, low-value users should be priced out regardless of their business. This is because they use water that higher value-added abstractors might otherwise use.
    
20. In view of these difficulties, the Government considers that a charging scheme set above cost-recovery levels with the intention of reducing abstractions would be unwieldy in operation and imprecise in effect. Changes proposed in Taking Water Responsibly will, if Parliament approves, increase incentives for reductions. And, as discussed in the remainder of this paper, licence trading may have an important role to play in enabling unmet demand for water resources to be satisfied. Respondents are invited to comment upon the Government’s view that increasing charges beyond cost-recovery is unlikely to be the best way to reduce water abstraction.
    

"Incentive" charging


21. The previous paragraphs illustrate the derivation of the Government’s view that, whilst the idea of increasing abstraction charges beyond "cost recovery" – and thus elevating them to an environmental tax – is not attractive, as significant and intractable issues would be likely to arise. These stem from the localised nature of abstraction problems and the consequent difficulty of equitably targeting the charges. Even if the charges could be targeted equitably (that is to say, on the abstractions which need to be curtailed), significant social and economic considerations may arise.
    
22. The Government recognises that any increase in abstraction charges made necessary by compensation costs may have the effect of causing some abstractors to reduce or abandon their abstractions. The Government also recognises that there may be scope for re-balancing cost recovery-based charges so as to reflect differing water resources positions. Under the current legislation for its charging schemes, the Environment Agency is required to consult on proposals for a new scheme with `persons likely to be affected’ before submitting the scheme for approval to the Secretary of State (who consults with the National Assembly for Wales). The Government expects the Environment Agency to launch such a consultation by June 2002 at the latest. Nevertheless, the Government will be grateful now for general views on how incentives for reducing abstractions can be made more apparent within a cost-recovery based system of abstraction charges.

Licensed or actual quantity?

23. The research modelled the effects of charging on the basis of both actual and licensed amounts. Responses to the June 1998 consultation paper showed considerable support for the actual amount abstracted to become a part or the entire basis of abstraction charging. In Taking Water Responsibly, the Government confirmed that the Environment Agency should continue to promote the installation of meters suitable for "actual amount" charging, not only for that purpose but also to improve the accuracy of water management data, but said that any decisions about changes must await a more detailed consideration of the possible use of a charging instrument.
24. The research indicates that, in the simple "cost-recovery" Scenarios A and B, the benefit of the very limited reductions in abstraction which "actual amount" charging might encourage would have to be weighed against the significant (estimated £25 million) capital costs of equipping all abstractions with a suitable meter and the continuing administrative costs of meter reading and bill preparation. Those costs would, of course, be recovered through the charging system, but there would need to be a clearer justification for them than has so far emerged. The design of such a charging system would also need to take account of the greater uncertainty about its ability to recover costs fully in the face of water demand changes which can never be fully predictable.
25. The research also indicates that, in a "cost-recovery" scenario, the current "licensed amount" basis for charging provides even less incentive for reducing actual abstractions than would "actual amount" charging (although neither would deliver a significant incentive). However, it is the licensed amount of existing abstractions which determines whether new abstractions are acceptable.
26. Charging according to licensed amounts provides some incentive, however small, for abstractors to reduce their licence to an amount closer to the amount they actually abstract. The research indicates that abstractors obtain much less value from any portion of their licences than from the whole. This means that, for a given quantum of revenue, a charge targeted on licensed quantities would elicit a bigger behavioral response. This may be important given the significant quantity of licences that are not fully utilised at present, and the risk to the environment that their potential uptake entails. Therefore, the Government would be grateful for any further views, in the light of this research, on the justification for "licensed amount" as a basis for cost-recovery charging.

"Reliability" charging

27. The researchers considered whether the Environment Agency’s Surface Water Abstraction Licensing Procedure (SWALP) would provide a basis for incentive charging. This Procedure, which is still under development and not yet implemented throughout the organisation, bands abstractions from a given river stretch according to their susceptibility to interruption by flow constraints and is primarily designed to distribute water amongst different abstractors according to their preparedness to accept constraints.
28. The Government sees some merit in basing abstraction charges on the reliability of abstraction. However, although licences allow abstraction up to the specified quantity of water, they do not guarantee that water is available in the first place. That does not have to be a fundamental obstacle. But the Environment Agency would need to make abstractors understand that it could not guarantee any estimated abstraction. It would also need to ensure that this was understood in licence trading, as discussed in paragraph 4.24.)
29. Based on modelling for two of the catchments studied, the researchers found that linking abstraction charges to SWALP bands offered some prospects for voluntary reductions. But they also indicated that this approach may involve the Environment Agency in considerable effort in determining and implementing the charges within an overall cost-recovery charging system. Moreover, with the SWALP methodology not yet in use throughout the Environment Agency, it would take a significant effort to establish a common base for designing ‘reliability-banded’ charges. The Government does not want a piecemeal approach.
30. So the Government considers that, although the Environment Agency should continue to develop and implement the SWALP methodology, the revised charging scheme which would need to be proposed to accommodate other intended licensing changes should not incorporate "reliability-banded" charges. If the Environment Agency wishes subsequently to propose a further adjusted scheme with reliability incorporated, the public consultation which the Environment Agency is obliged to carry out will provide full opportunity for comment. In the meantime, the Government will be grateful for general views on "reliability-banded" charges as proposed in the research as a basis for charging in the longer-term.

 

 

 

2.  

TRADING

Preamble

1. Trading in abstraction licences is already possible. The June 1998 consultation paper listed how abstractors can already trade licences and the RPA research examines five real examples.
   
2. The RPA research indicates that markets for trading licences can be created in catchments where there is currently unmet demand. It identifies several factors which may need to be addressed if trading is to be facilitated equitably and with full protection for the water environment. But the overall outcome of the research is such as to encourage the Government’s view that, in principle, abstraction licence trading should be promoted as an effective means of achieving the optimal distribution of water resources within and between different sectors of use and thus contributing to sustainable development. The Government wishes to see licence trading take place openly, with a minimum of administrative and technical burden on existing abstractors, would-be abstractors and regulators, but with full protection for the water environment. The Government would be grateful for comments on these statements of principle.
3. The Government believes that increasing competition in the water industry in England and Wales is desirable, as this should lead to greater efficiencies, lower prices, innovation and better services to the benefit of consumers. This needs to be arranged so that key public health, environmental, and social considerations are safeguarded. Increased competition could also lead to a reduction in the levels of economic regulation needed in the future. The Government published on 13 April 2000 a consultation paper on this matter, seeking responses to a wide range of questions by 13 June 2000. The facilitation and promotion of abstraction licence trading would assist the development of competition although, since trading is already possible, the scope for increased competition is not crucially dependent on that. Nevertheless, respondents to the present paper may wish to consider how the proposals regarding licence trading which are presented in this chapter could influence competition in the water industry.

Regulation

4. The Government’s proposals for promoting licence trading are founded first on its view that an economic instrument in relation to water abstraction must operate together with both regulatory and voluntary measures. This view was made clear in the June 1998 consultation paper. In deciding the changes to the current abstraction licensing system, announced in Taking Water Responsibly, the Government included several measures that give effect to that view. The following paragraphs look at those changes. Many of them would need primary legislation. The Government will publish a draft Water Bill later this year, which would bring forward those changes.
5. A vital feature of the abstraction licensing system in both its present and proposed forms is that all abstractions above a threshold amount require a licence, except those for exempt purposes. Under the reformed system, there would be a reduced range of exempt purposes and the threshold amount would be generally 20 m³/d (although it could be varied). Licences have to record their holder, who is thus legally responsible for compliance with the licence conditions, for payment of licence charges, and for meeting any civil action arising from the alleged effects of the abstraction. Any trading arrangements will therefore have to be such that at all times a licence holder is clearly identifiable for every licensed abstraction. The Government does not intend to allow or condone any trading which does not maintain that clarity. It follows, therefore, that the Environment Agency, as the licensing authority, will continue to be involved in all licence trading and thus able to exert regulatory control according to need.
6. Other features of the reformed abstraction licensing system with significance for trading would be that:
1. applicants for abstraction licences would need only to demonstrate that that they have rights of access to the intended abstraction point;
   
2. new abstraction licences would not specify the land on which the water is to be used;
   
3. new abstraction licences would need to state the broad purpose of use for the water (according to guidelines to be drawn up by the Environment Agency);
   
4. some new abstraction licences may need to include conditions in relation to the return of water to the environment after use;
   
5. conversion of existing licences to time-limited status would not require advertisement; and
   
6. all new abstraction licences are to be time-limited.

 

7. A further key feature of the reformed system would be that, when an existing licence changes hands with no alteration to the abstraction quantity or other licence conditions, the Environment Agency would only need notification of the new holder. Provided the new holder has rights of access to the abstraction point, they could continue to abstract water up to the same licensed amount and for the same purpose for as long as the licence remained valid. Administering that process would be simple and quick.
   
8. If a new holder required any change to their licensed purpose, amount or any other condition, they would have to apply for a licence variation. Changes with no adverse implications for the environment or other abstractors would not need to be advertised and so would be administratively straightforward. Examples might include a reduction in licensed amount or a changed purpose that does not significantly change the water’s return route. But, as now, the Environment Agency might refuse to grant the variation, or might decide to grant it only with other provisions attached.
9. In that way, the Environment Agency would be able to intervene in any licence trade that involved anything more than a transfer from one holder to another. This would be subject to any appeal to the Secretary of State, however (or, in Wales, to the National Assembly for Wales). In the event that an existing licence was unsustainable, the Environment Agency already has powers to deal with it. The reformed system would both make trading easier wherever possible and also ensure it respected the environment. Put another way, the reformed statutory framework would have within it the basic "rules" which would govern all licence trading. More specific information on trading limitations and opportunities would be provided by the Environment Agency within its Abstraction Management Strategies (see paragraph 4.62).

Types of trade

10. There are two broad types of licence trade, distinguished by the range and depth of the issues which, in general, need to be considered before approval can be given:

E - trade of a licence for abstraction from an existing abstraction point; and

N - trade involving the curtailment or revocation of licensed abstraction at one point in favour of a corresponding new or varied abstraction at another point.

- abstraction at the same point

11. Type E can be broken down into two distinct categories:

EV "virtual" trade, where the licence remains with the original holder, but in a changed form which enables him to supply, or make available, water to users other than himself; and

EF "full" trade, where the licence passes from one holder to another on either a short- or a long-term basis.




12. For trades in the EV category, a licence variation will be required to authorise the supply of the abstracted water to others. The Environment Agency would need to consider other licence conditions and the time limit of the licence to be varied in the context of the Abstraction Management Strategy. Conditions relating to the return of used water might be needed in some cases. None of those changes would normally be regarded as contentious to others and so would not require advertisement.
13. Once issued, the replacement licence would be freed from the ‘land’ restriction. Its holder could sell water to the highest bidder, provided that bidder met any licence conditions about returning used water to the environment. The licence holder would of course still be legally obliged to comply with the licence and its conditions, to pay the annual licence charge, and to meet any civil liabilities. If the licence holder were not prepared to accept the varied terms, his existing licence would continue, but he would be limited to the original purpose of the licence.
14. The same would apply to trades in the EF category. There would of course be the added need for the Environment Agency to satisfy itself that the new licence holder had right of access to the abstraction point. It would be open to the trading partners to include reversion clauses in their trading contract, but that would not be a matter for the Environment Agency provided the clauses were consistent with the licensing legislation. Conditions relating to the return of used water might be needed in some cases.
15. The administration of "EF" trades would be very simple, and would present no obstacle to licences changing hands frequently to meet short term needs. But even greater simplicity of administration would result if in fact the licence itself did not change hands. That could be the case if the licence holder were prepared to grant the "buyer" access to the abstraction point and use of the pump or other abstraction machinery so that the buyer could take the water directly for himself if he were able to convey it to his point of use. The licence holder would, of course, remain responsible for ensuring compliance with licence conditions and for facing the consequences if they were not, so it would be advisable for there to be a legally-enforceable agreement between the "buyer" and the licence holder that the former would abide by those conditions. But, so far as the Environment Agency is concerned, there would be no change to the licence and so no need for its involvement prior to the trade taking place (although the proposal set out in paragraph 4.66 below would require it to be notified of the trade).

- abstraction at a different point

16. Type N trading can also be broken down into two categories:

NS replacement with abstraction at a new point which does not differ significantly from the old in hydrological terms and in its environmental effects; and

ND replacement with abstraction at a new point which is significantly different from the old in hydrological terms, or which has other significantly different environmental effects and consequences.

17. These categories cannot necessarily be distinguished by the geographical distance between the two points although, generally, the closer the points are to one another, the more likely the trade to be in the NS category.
    
18. Where there is no valid licence for abstraction from the new point, trades in both N categories would inevitably involve the full process of application for a new licence on the part of the buyer, and that licence would be time-limited and quantity-limited in accordance with the Environment Agency’s Abstraction Management Strategy. The Environment Agency would be expected to take all possible steps to expedite the process where the traders could show an urgent need.
    
19. However, trades in either N category may not always involve the buyer in applying for a new abstraction licence. The buyer may already have a licence for abstraction at the "new" point, but may wish to increase its licensed quantity by, in effect, transferring the licence he acquires from its original location to that "new" point. That would involve him seeking a licence variation. His application may still need advertisement, but the overall process of granting a variation to an established abstraction is likely to be shorter and simpler than that for a completely new licence, provided the Environment Agency is satisfied that the seller’s licence will be correspondingly curtailed and that additional abstraction at the "new" point is sustainable.
    
20. Regardless of whether the buyer in an N category trade seeks a new or a varied licence, the Environment Agency could insert into his licence what might be called an "acquisition curtailment condition" which would forbid his "new" abstraction from being made until the seller’s abstraction is curtailed. It would be for the buyer, in drawing up a trading agreement, to establish the means whereby he can assure himself that the seller’s abstraction really would be curtailed. Various means are available. One extreme would be to insist that the seller’s licence be revoked, and/or that the seller’s abstraction pumps be disabled or removed.
    
21. Another, more flexible, means of curtailment assurance would be to establish an operating agreement, legally binding upon both trading parties, which would allow the seller to abstract under the terms of the "traded" licence when the buyer is not abstracting under his "new" licence. The Environment Agency exceptionally might wish to insert a corresponding condition into the seller’s licence to provide added resilience to such an agreement. But whatever the means, it would remain the buyer’s responsibility to see that the licence he acquires is appropriately curtailed, and to face criminal prosecution if the "acquisition curtailment condition" in his licence condition were contravened.
    
22. The concept of an "acquisition curtailment condition" being inserted in a buyer’s licence in a category N trade is significant, for it would open up the possibility of very short term trades between two abstractors who each have a reasonable need for water on an annual basis, but whose needs peak at different times. Once the buyer’s new or varied licence is in place, abstraction could be traded between buyer and seller at will for the duration of the buyer’s licence. The specification of the curtailment condition (which might also extend to the return of the water after use) would be for the Environment Agency to determine, in consultation with the trading partners. The Agency would not need to be involved in making the agreement between buyer and seller about how compliance with the condition is to be assured, although it may reasonably require details of the agreement to be supplied as an aid to its licence enforcement function. The Government will be particularly grateful for views on whether the concept of a "acquisition curtailment condition" would indeed provide short-term licence trading opportunities whilst maintaining necessary environmental protection.
23. The NS and ND categories will generally differ in the extent of the information which the buyer would have to provide and which the Environment Agency would have to consider. Trades in the ND category would generally require more, especially where "upstream" trading is involved. This should provide an incentive for trades to lead to new abstractions which impose less of a burden on the environment than the abstractions that they replace.
24. In all types of trade, the trading partners need to recognise that an abstraction licence does not guarantee that there will always be enough water for them to be able to take the full licensed quantity. This will be particularly important where surface water abstractions are concerned, and it may influence trading terms if reliability is much more important to a buyer than to a seller. The Government would expect the Environment Agency to provide - wherever possible and without any guarantee - information on the likely reliability of licensed abstractions, but it would be for the buyer to consider whether he would need to take financial or operational steps to insure his water-using activity and to reflect those in the trading price.
    
25. Trading partners must bear in mind that, in many cases, they may need to obtain a new or varied consent for discharging water after use. The Government would expect the Environment Agency to develop administrative procedures to handle discharge consent applications linked to abstraction licence trading efficiently and rapidly.

Trading propositions

26. In summary, this brief consideration of the processes likely to be involved in trading leads to the general propositions, on which respondents are invited to comment further, that:
1. the necessity, in many trades, for the issue of a varied or completely new licence provides the means by which the Environment Agency can guard against environmentally-damaging trading consequences, such as the activation of "sleeper" licences or unsustainable "upstream" trades, while also facilitating both short and longer-term abstraction trading;
2. administration of the licence changes which would be necessary for trading should, in many cases, be significantly less burdensome and time consuming than at present as a result of the proposed legislative changes; and
3. the Environment Agency should be able to approve trades that obviously benefit the environment faster and with fewer information demands than in circumstances where there may be a threat to the environment.

However, some aspects of these general propositions require further comment.

"Sleeper" licences

27. Unlike the other types of trade discussed above, trades in the "EF" category need not involve any changes to the existing licence if the new holder is content to abide by all its conditions and to operate within the authorised quantity. In such cases, significant concerns may arise if the prior holder has been actually abstracting quantities generally well below those authorised, but the new holder is able - and proceeds - to use the licence to its maximum with no need to seek any variation in its conditions.
28. However, the nature of those concerns needs further examination. If the overall effect of increased abstraction at the "traded" point is to reduce actual abstraction elsewhere in the catchment, then, provided there are no deleterious effects in the immediate vicinity of it, the trade will have worked to environmental advantage. Similarly, if the effect is to make water available, albeit indirectly, to those in the vicinity to whom the Environment Agency cannot grant their own licences because they would derogate the previously underused authorisation, the activation of the "sleeper" will bring some benefit, so long as the "traded" abstraction remains sustainable even when operated at its authorised limit.
29. The extent of the benefit to those who are enabled to gain access to water resources in this indirect way will depend on the price which the supplier charges for the water he abstracts. Unless the supplier is a water undertaker, there will be no regulation of that price. But the Competition Act 1998 provides protection against pricing or other behavior which inhibits competition or amounts to the abuse of a dominant position.
30. As part of the package of changes proposed in Taking Water Responsibly, the Environment Agency would be able to revoke without compensation licences which have remained effectively unused for four years, rather than the present seven years. In that way, the Environment Agency would be better able to deal with "sleepers" before any problems arising from trading begin. And, although that leaves the potential problem of trading in licences covering abstractions which, while not dormant, have been used well below the authorised quantity over several years, it is likely that compensation for the enforced curtailment of the unused portion would be commensurately small if the Environment Agency considered that further pre-emptive action against possible "sleeper activation" were required.
31. Nevertheless, the prospect remains that some trades of existing abstraction licences, by activating "sleepers", could individually or collectively cause environmental stress to the local area or in the catchment as a whole. Particularly as it develops its Abstraction Management Strategies, the Environment Agency should be able to identify areas where trading involving activation of "sleepers" would cause significant difficulties. The Environment Agency is already able to offer advice in particular cases, and abstractors who wish to demonstrate that they recognise their responsibilities should take and heed that advice when considering such a trade.
32. If nevertheless a trade – or, indeed, any other factor –activates a "sleeper" to such an extent that it causes significant environmental damage, the Environment Agency will need to curtail it using its existing powers. Although, for at least the next 12 years, use of those powers would probably result in a compensation payment, the amount of compensation might be reduced if the Environment Agency could show that it had advised against the trade which had led to the need for curtailment. While the Government does not propose to make it a requirement for those seeking to trade in this way to seek the advice of the Environment Agency, the brokering arrangements proposed in paragraph 4.64ff of this paper should mean that, in most cases, the Environment Agency will have the opportunity to make its views known before trades take place.
33. The previous paragraphs set out the Government’s views on the extent to which difficulties might result from trading involving "sleeper" licences and how those difficulties could be overcome. The Government will be grateful for other views.

Licence hoarding

34. Difficulty could possibly arise as a result of trades in which licences are acquired without change but then receive little or no use. This might be termed "knock-out" trading and could be attractive if the abstractor wishes to build up a reserve of abstractions upon which he can call to meet some future demand. He might also want to acquire them speculatively in the hope of being able to trade them on at a higher price. It is also possible that some organisations might want to acquire licences more literally on a "knock-out" basis to minimise abstraction which they consider is harming their business interests or environments which they seek to protect.
35. In many cases, the need for a new or a varied licence and the consequent consideration by the Environment Agency of whether the proposed use of the water amounts to `reasonable requirements’ (see paragraph 4.47ff) may prevent the more extreme forms of "knock out" trading. But, where this is not the case, simple economic theory would suggest that, if market conditions are such as to make "knock-out" trading worthwhile, then it should take its course without interference. However, water resources are relatively scarce in some areas, so such cornering of the market may result in abstractions available for trading being priced out of the reach of some persons who have a reasonable need actually to abstract water. If that were to happen in a catchment already at the limit of its ability to sustain licensed abstraction, such persons would have no means of gaining access to water resources.
36. However, conduct of this sort may constitute activities against which the Competition Act 1998 provides protection and recourse. In particular, the Act prohibits:

• agreements, decisions or concerted practices which have the effect of preventing, restricting or distorting competition in the United Kingdom; and
• conduct which amounts to the abuse of dominant position which may affect trade within the United Kingdom.
  

1. Within England and Wales, the Director General of Fair Trading and the Director General of Water Services have concurrent jurisdiction under this Act, extending to all commercial activities connected with the supply of water or securing a supply of water, whether or not those activities are carried out by water companies or by other undertakings. In guidance published in January 2000, the Director General of Water Services specifically addresses licensed access to water resources. He points out that an abstraction licensee’s conduct in exploiting or seeking to protect its licences could constitute a breach of the prohibitions, and goes on to say that he will consult with the Environment Agency in order to determine the most effective means of bringing any breach to an end. Respondents to this consultation paper are invited to give views on the part the Competition Act 1998 may play in guarding against licence hoarding.
2. Where hoarded abstraction licences become "sleepers", the Environment Agency would be able to take action. But the demonstration that the licences were sleepers would itself take at least four years, by which time there might already be undesirable consequences. One solution would be for the Environment Agency itself to be able to enter into the trading market by acquiring potentially troublesome licences so that it can "redistribute" the water.
3. Whilst intervention in this way has some attractions, the Government considers that it may also present considerable difficulties. The fundamental is that of adding to the Environment Agency’s regulatory functions an essentially commercial one which would have to be kept rigorously "ring-fenced" in order to avoid any accusations of impropriety. Even if that fundamental difficulty could be overcome, the Environment Agency would still face a considerable difficulty in developing and subsequently defending a clear policy for determining the circumstances in which trading intervention would be appropriate and the level of payments which would be justified.
   
4. The Government considers that the Environment Agency, with its existing powers to curtail licences, already has sufficient powers to intervene in order to achieve a more satisfactory distribution of water resources. By using those powers, the Environment Agency’s decisions about redistribution of water are potentially open to public scrutiny at a local inquiry if the licence holder appeals to the Secretary of State (or, in Wales, to the National Assembly for Wales) about the curtailment. If the Environment Agency’s proposals are upheld, compensation then becomes payable. The Environment Agency would be expected to reach agreement with the licence holder on what the amount should be, but disputes would be resolved by the Lands Tribunal, thus ensuring that the amount is reasonable. In the particular case of licences which received very little use – "drowsers", as they might be called – it is reasonable to suppose that any compensation determination would reflect the lack of use.
5. With the foregoing discussion in mind, respondents are invited to comment on the Government’s view that it may not be appropriate for the Environment Agency to seek to perform its water resources management duties by itself entering a licence trading market as a trader.

Allocation of abstraction licences

6. Another form of market activity would be for the Environment Agency to auction abstraction licences which it actually or notionally has at its disposal. Similar issues arise to those discussed in paragraph 4.39. But there are also practical constraints from the way in which the abstraction licensing system operates in order to provide protection for the environment and existing abstractors.
7. Actual licence availability would arise only in areas where existing licensed abstraction is sustainable and then only either when an existing licence holder has volunteered revocation, or, exceptionally, when the Environment Agency has itself secured revocation in order to redistribute the water. Neither circumstance is predictable. Furthermore, an existing abstraction licence is not like a used car, which can be auctioned on the basis that the new owner can simply drive it away. To use his acquisition, the successful bidder for an abstraction licence has either to gain access to the existing abstraction point, or to be able to construct a new abstraction point. Securing either of those assurances would require potentially extended negotiation on the part of the prospective bidder, in the former case with the previous licence holder, or with the Environment Agency itself in the latter case. A prospective bidder lacking those assurances would be inhibited in participating in a formal auction.
8. The Environment Agency notionally has abstraction licences available wherever it is satisfied that additional abstraction from a body of groundwater or surface water would be sustainable. But the practical availability of those licences again would depend upon the ability of prospective bidders to gain access to land from which to make the abstraction (and often also on the ability to gain planning permission for the abstraction works). Even though additional abstraction may be generally sustainable, the Environment Agency may need to place geographical constraints on the location of the abstraction points because of its duty not to licence abstractions which would derogate those already existing. So, as for "actual" licences, an auction of "notional" licences would be constrained by the need for bidders to undertake extensive negotiations beforehand.
9. These practical considerations, taken with the Environment Agency’s essentially regulatory position, lead the Government to consider that formal auctioning of abstraction licences by the Environment Agency may be neither desirable nor generally effective. Where licences already exist, the Government considers that making trading easier will enable the water to be distributed amongst competing users in an economically efficient manner.
10. For unlicensed, sustainably-available water resources, the Government considers that the existing "first past the post" system, although arguably not ideal, continues to represent the best approach. It is founded on the assessment by the Environment Agency (or, on appeal, by the Secretary of State or, in Wales, by the National Assembly for Wales) of the reasonable requirements of the applicant, thus enabling some discretion over fatuous proposals for abstraction. The regulatory need for that assessment would in any case influence an auction process. And trading mechanisms can come into play at any time after a new licence is granted. However, the Government would be grateful for views on whether an auctioning process may have a part to play in the allocation of water resources within the regulatory framework provided by the water abstraction licensing system .
    

`Reasonable requirements’ for water


11. As indicated in the previous paragraph, the Environment Agency’s duty, under section 38(3)(b) of the Water Resources Act 1991, to have regard to the `requirements….in so far as they appear to the [Agency] to be reasonable requirements’ of an applicant for a new or varied abstraction licence, may have a significant influence on licence trading. In fact, the issues involved are not peculiar to trading, since they are just as likely to arise in licence applications unconnected with trading.
    
12. Where an application is made in order to meet the applicant’s immediate demand for water, the Agency generally will only need to assess whether the quantity involved is commensurate with the stated purpose – whether, for example, the quantity is consistent with the area and type of a crop to be irrigated, or with the population to be supplied. The Agency has established procedures for those assessments. But more difficult questions arise if the application is to meet some projected need. For example, if the need is linked to essentially speculative development of a business park, how certain is it that the need will actually arise? And if the basic need is certain, how justified is the projection of the actual quantities that will be required? What period would be justifiable between the grant of a licence and the commencement of abstraction? Should the grant of a licence which will at first be a "sleeper" be conditional upon its holder making that known so that other abstractors have the opportunity of opening trading negotiations with the holder for short-term use?
    
13. It will be for the Environment Agency to devise answers to questions such as these, and to apply the answers consistently and rapidly so that they provide no significant impediment to the speedy determination of licence applications. Its development of Abstraction Management Strategies is likely in any case to raise such issues. But the Government will be grateful for views at this stage on how the Environment Agency’s interpretation of `reasonable requirements’ for water should facilitate licence trading whilst still providing the protection against improper use of water resources to which that duty contributes.
    

Sector restrictions


14. Any type of trade may involve trading partners operating in the same or different sectors of water use. The main sectors are significantly different in their general characteristics. For example, the public water supply sector is currently exclusively the domain of 26 water companies. Although these vary considerably in size, they all (with one exception) hold multiple abstraction licences (some 2,100 in total), some of which are for very large quantities of water and which authorise a total annual abstraction of nearly 10 million megalitres. By contrast, the agricultural sector accounts for some 35,000 licences, with many abstractors having only one licence each, which authorise a total annual abstraction of just over 0.4 million megalitres. It may be considered that differences such as these, and differences in the financial resources generally characteristic of these and the other sectors, imply a serious difficulty in opening up trading between sectors.
15. However, whilst recognising those differences, the Government takes the view, borne out by the research, that it would not be appropriate to manipulate the market by confining trading to within-sector opportunities. To do so would be to restrict the ability of the trading instrument to achieve a truly efficient allocation of water resources, and would thus be contrary to the principle set out in paragraph 4.2. The Government would be grateful for comments on this view and on its consequent view that licence trading should operate amongst all existing and potential abstractors without sector restrictions.
    

Encouraging trading

16. Even though the Government does not consider that the Environment Agency should itself become a licence trader or auctioneer, the Environment Agency undoubtedly has a key role to play in encouraging acceptable trading. That role will be characterised by a mixture of:
1. efficient and speedy administration of licence trading processes;
2. timely identification of unacceptable licence trades;
3. promotion of the general idea of licence trading; and
4. brokering trades.




17. The mixture will determine whether the role is seen as purely passive, or as signalling a more active espousal of the concept of licence trading.
18. The Government considers that the Environment Agency’s administration of licence trades must be speedy and efficient, regardless of whether the overall Environment Agency role is passive or active. The RPA research provides some evidence that this has not always been the case hitherto. More generally, the responses to the June 1998 consultation paper indicated some concerns about the administration of the abstraction licensing system and the package of changes announced in Taking Water Responsibly is intended to allow those concerns to be addressed.
    
19. The Government does not consider that any further changes to the legal or administrative framework will be necessary in order to deal specifically with licence trading. But, as part of those changes, it will expect the Environment Agency to make rapid progress in enabling applications for new or varied abstraction licences to be submitted and processed electronically. Succession arrangements, where all that will be needed is for the name and address of a new licence holder to be notified, should be particularly easy to accommodate in this way. If the Government were to promote licence trading, it would consider setting the Environment Agency clear and challenging targets for trade administration. The Government will be grateful for further views on how the administration of abstraction licence applications can be improved, particularly with reference to the other proposals in this consultation paper, and on what targets should apply to the Environment Agency’s administration of licence trades.
20. When proposed trades involve changing the licence in any respect other than the details of the licence holder, the Environment Agency’s determination of the application provides the immediate and specific means of identifying and acting upon an unacceptable trade. It would be open to the Environment Agency simply to refuse the application; the reasons it (or, if rejected upon appeal, the Secretary of State or, in Wales, the National Assembly for Wales) would give might enable the traders themselves to develop an acceptable alternative without further involvement from the Environment Agency. But the Government considers that, where a seriously-intentioned trade had to be rejected in this way, the Environment Agency generally should itself at the time offer to work with the traders to find an acceptable alternative arrangement, thus taking a more active approach to the encouragement of trading.
21. The Government envisages that, as Abstraction Management Strategies are developed and refined, it should be possible for the Environment Agency to identify in them any general limitations to trading. For example, a common limitation might be that trading in a particular area will only be acceptable if the seller reduces his licensed abstraction to the historical actual quantity abstracted or, in exceptional cases, beyond. Another example might be limitation to downstream trading where surface water abstractions are concerned.
22. Publishing general limitations would constitute a more ‘active’ role for the Environment Agency. It would help traders to avoid spending money on proposals that would very probably be rejected. Considering proposals which it then rejects costs the Environment Agency money as well as traders, so the Agency should try to be as clear as possible about general limitations.
23. However, the Government would expect the Environment Agency to apply such general limitations only where it is clearly appropriate to do so. The presumption should be that trading may be possible in most areas, albeit with a need to impose changed or additional licence conditions in some cases. The consultation with abstractors and others with an interest which will be a part of the Abstraction Management Strategy process should provide some restraint, if necessary, against the Environment Agency drawing up excessive trading limitations. In any case, the existence of a general trading limitation within an Abstraction Management Strategy will not prevent a trading application being made even so.
24. Still greater clarity about what trades might be unacceptable could perhaps be provided by requiring the Environment Agency to examine individual existing licences to determine whether there would be trading limitations. It would probably be necessary to restrict that obligation to cases where the licence holder requests such an examination, but even then the task may have considerable resource implications for the Environment Agency. There would also be some understandable anxiety that such an examination would overlook or inhibit innovatory trading possibilities which licence holders might identify if left to consider the possibilities themselves. Even if those anxieties could be allayed, the resulting "pre-approval" for trading – for that is what the outcome of such an examination would be taken to provide – would not remove the need for formal application for a new or varied licence which would be required in most forms of trading.
25. So the Government’s view is that the Environment Agency’s Abstraction Management Strategies, taken with the general guidance about abstraction licence applications which it already provides, would enable potential traders to make a reasonable judgement themselves on whether particular trades are likely to be acceptable. However, the Government would be grateful for views on whether a licence-specific "pre-approval" for trading should be offered by - or required of - the Environment Agency.
    
26. On the positive side, the preparation and dissemination of Abstraction Management Strategies should provide an effective means by which the Environment Agency can draw attention to the scope for licence trading and the benefits to abstractors and the environment which could result. The scope and benefits will vary considerably between catchments, although the ability of trading to deliver environmental improvements and economic gains is likely to be highest in catchments that are currently stressed.
    
27. The precise means by which the scope and benefits are identified and communicated will vary between Abstraction Management Strategies. It is therefore not appropriate to propose further details of approach in this consultation paper, but the Government would be grateful for any general views on the part which Abstraction Management Strategies can play in promoting licence trading. Respondents should note that the Environment Agency launched on 10 April 2000 a consultation on the form that Abstraction Management Strategies should take. As noted above, each individual Abstraction Management Strategy, to be prepared on a catchment basis, will itself be the subject of consultation in a process beginning by April 2001.

Brokering

28. It may be that no more than this is necessary to promote licence trading to the point where a healthy market is established. However, there may be a case for a more specific vehicle for promoting licence trading, such as some form of brokering arrangement. The RPA research suggests quite strongly that brokering will be necessary, making the point that in any market, a well-informed participant requires information on:
1. what prices have been bid, offered and transacted;
   
2. what volumes have been traded; and
   
3. what buyers and sellers are currently in the market place and on what terms they would be likely to trade.
   
29. The Government accepts these information needs, noting in particular that transparency on prices should curb any excessive manipulation of the market to the detriment of those less able to participate. The Government considers that the Environment Agency should gather and disseminate this information, to stand alongside its register of all abstraction licences which is already publicly available. The information is relevant to the Environment Agency’s water resources management duties and the Government sees no merit in giving the task to any other private or public sector organisation.
30. So the Government proposes that, whenever an abstraction licence is traded, the trading partners should be obliged to notify the Environment Agency of the trading price (or the monetary equivalent if the trading incentive is provided wholly or in part in some other way). The Environment Agency will in its turn be obliged to post this information on a specially-allocated portion of its Web site, together with details of the licensed quantity traded and the sub-catchment area(s) in which the trade took place. The information will be accompanied by broad classification of the type of trade, perhaps using the four designators proposed in paragraph 4.10ff above (ie EV, EF, NS and ND), and a statement of whether groundwater, surface water or (exceptionally) both water types were involved. Information on the precise location of the trade and the identities of the trading partners would also be included unless either partner requested otherwise.
31. Abstractors could post details of quantities and locations of licensed abstractions which they want to trade on the same web site. Would-be abstractors could post details of abstractions they would like to buy. Buyers and sellers would generally be left to decide how much detail to include, but sellers would be required as a minimum to state the time limit of their licence, to summarise licence conditions, and to give details of any relevant general trading limitation stated in an Abstraction Management Strategy .
32. In maintaining such a web site, the Environment Agency would not be expressing any view on trading prices, nor on the acceptability of any trade. There would be thus be no conflict with its regulatory duties. Indeed, there would need to be a regulatory base for the requirement for information on trades and the Government would take steps to provide this if present powers are insufficient. The Government does not envisage that the Environment Agency would set up a paper-based version of the proposed web site, since it considers that all those with an interest in trading would have access to the Internet. This would be reflected if necessary in the regulatory base.
33. The Government considers that the Environment Agency must establish a licence trading web site even if it takes an otherwise passive role in promoting licence trading. In any case, the Government considers that a web site could be construed as part of a more active role, in that it will make trading opportunities easier to identify, both by direct access and also through links to other sites. The Government would be grateful for views on its proposals that the Environment Agency set up a licence trading web site.
34. Once the Environment Agency has set up the web site, it should find it relatively easy to maintain, since traders would supply all the information. They would even insert much of it themselves. The Environment Agency could recover any additional costs as water resources management costs. They could be recovered through the abstraction licensing charging system.
35. However, to the extent that the costs of setting up and maintaining the licence trading Web site are at all significant, there may be a case for recovering them wholly or in part only from those who benefit directly. This could be done by levying a charge on completed trades, perhaps at a uniform percentage of the trading price. It would also be appropriate to levy charges in cases where work has to be done by the Environment Agency to facilitate a particular trade which is significantly greater than would normally be involved in determining licence applications. Such cases would all be expected to fall within the "ND" category (see paragraph 4.16), involving the curtailment of one abstraction and the authorisation of another in a different location.
36. The precise form of what would amount to the Environment Agency’s "brokering charges" would need to be determined by the Environment Agency and incorporated in a charging scheme which, under section 42 of the Environment Act 1995, would be the subject of public consultation by the Environment Agency before submission to the Secretary of State for approval (in consultation with the National Assembly for Wales). Nevertheless, the Government would be grateful for initial views on how the Environment Agency should incorporate brokering charges for licence trading within a charging scheme limited to the recovery of the Environment Agency’s overall water resources management costs. In particular, respondents are asked to consider the suitability of a standard percentage charge by the Environment Agency on the trading price of completed trades, and what that percentage should be.
37. There would be no bar to anyone using information from an Environment Agency Web site set up in this way. It would therefore be possible for another organisation or individual, acting on the basis of that information, to broker trades more actively if buyers or sellers saw a need and were prepared to pay fees accordingly. Brokering services would probably be self-regulated by competition on performance and charges amongst those offering them. The Government would be grateful for views on whether a need for more active brokering is likely to emerge and, if so, on whether any regulation of that activity would be required.
38. Although the transparency about trading prices provided by the Web site should provide some moderating influence, trading in licences may generate considerable incomes for sellers. However, subject to the recovery of brokering costs as discussed above, the Government does not envisage making any levy upon those incomes other than those provided within general taxation law. The environment will be properly protected by the various means already discussed in this consultation paper. On that basis, it will be for the market to determine the level of gross trading incomes, without additional intervention by the Government. The Government will expect trades to take place only in cases where there is no clear detriment to sustainable development, in line with the responsible attitude towards water which the Government wishes to see all abstractors adopt.

1.  
2.  

IMPLEMENTATION

1. In the light of the research carried out by RPA and the considerations set out in the previous chapters of this consultation paper, the Government takes the view that economic instruments may be applied to water abstraction in the following way:
   
1. abstraction charges should remain limited to recovery of the Environment Agency’s water resources management costs, but should be increased to the extent necessary to meet licence curtailment compensation costs when, but not before, these are incurred, thereby providing incentive for low-value users of water to reduce their licences voluntarily;
   
2. trading in licences should be encouraged in such a way that it delivers environmental benefits together with economic gains, within the regulatory requirements of the abstraction licensing system as it will be following the changes which the Government set out in Taking Water Responsibly last March and which it will bring forward in a Water Bill when Parliamentary time allows;
   
3. the Environment Agency should actively encourage abstraction licence trading with a general presumption that trading may be possible in most areas, and in particular by:
   

• ensuring that its licensing administrative processes operate speedily and efficiently, making full use of E-mail and other electronic means;

• clearly identifying, within its Abstraction Management Strategies, the scope for trading and any unavoidable limitations to particular types of trades;

• establishing an Internet site on which prospective buyers and sellers can record their interest in trading; and by

• requiring trading prices and other details of completed trades to be placed on the same Internet site.
  
  

1. The Government will consider these views further in the light of responses to this consultation paper and will publish its firm intentions in due course thereafter. Much of the envisaged framework within which the Government’s present views have been formed is already being put in place by the Environment Agency under existing powers or being developed as proposed primary legislation by preparation of a draft Water Bill. That process will continue, irrespective of final decision on economic instruments, as part of the Government’s delivery of its commitment to improve the water abstraction licensing system.
   
2. The Environment Agency will need to take account of responses to this consultation paper and the Government’s decisions following it as it revises the abstraction charging scheme. But, as stated in paragraph 3.22, the Government expects the Environment Agency to consult on changes to the charging system by June 2002 at the latest. That way, any changes approved by the Secretary of State (in consultation with the National Assembly for Wales) can be implemented from April 2003. However, this should not stop the Environment Agency from bringing forward a revision sooner if necessary, nor dissuade it from proposing further changes in the following years.
3. The Environment Agency’s development of "brokering" arrangements for licence trading on a web site should await the outcome of this consultation. It should also await the development of any other administrative or publicity systems specifically required by the proposals in this consultation paper. However, the Environment Agency should bear the present proposals in mind as it rolls out its programme for producing Abstraction Management Strategies and considers general progress towards "electronic commerce" facilities for abstraction licence applications.
4. When it publishes its intentions regarding economic instruments in the light of consultation, the Government will set out clear targets for the implementation of those intentions by the Environment Agency. These targets will take account of general progress with the implementation of the measures already announced in Taking Water Responsibly and of the Environment Agency’s resources. But they will also take account of the general need and prospects for the introduction of the chosen instruments, and in particular the level of interest and enthusiasm shown by respondents to these proposals. Respondents are therefore asked to say how quickly they think these proposals should be implemented, and whether they would wish to see any of them introduced on a catchment-prioritised basis rather than uniformly throughout England and Wales. Meanwhile, the Government expects the Environment Agency to respond constructively to licence trading proposals brought forward by abstractors within the present framework.

Regulatory impact

5. The proposals in this Consultation paper do not impose any new regulatory burden on anyone. So far as the proposals concerning abstraction charges are concerned, the legislative framework is already in place (see paragraph 3.1). The proposals regarding licence trading will affect only those who wish to participate: there will be no obligation upon anyone to trade. However, trading will be facilitated by the changes to the licensing system announced in Taking Water Responsibly. A Draft Regulatory Appraisal of those was included in the June 1998 consultation paper. An update of that Appraisal will accompany the proposed Water Bill. If, as a result of this Consultation, a need for additional regulatory modifications should emerge (although none is presently envisaged), their impact will be considered when the Government announces the outcome of consultation.
   
6. The Government recognises that, although exposure to the licence trading systems proposed in this Consultation paper is optional for current and would-be licence holders, it is essential that those systems should not present unavoidable perceived or real barriers to those who wish to trade. Several of the consultation questions reflect that concern. But the Government will be grateful for any more general views on whether the package of trading proposals provides the lightest possible burden, consistent with the underlying regulatory requirements of the licensing system, on those who wish to participate in abstraction licence trading.
   

1.  

SUMMARY OF CONSULTATION PROPOSALS


1. The Government would welcome further views, in the light of the RPA research, on how water resources management costs significantly increased by compensation payments should be recovered through the abstraction charging system (see paragraph 3.7).
2. Respondents are invited to comment upon the Government’s view that increasing charges beyond cost-recovery is unlikely to be the best way to reduce abstraction (see paragraph 3.20).
   
3. The Government will be grateful for general views on how incentives for reducing abstractions can be made more apparent within a cost-recovery based system of abstraction charges (see paragraph 3.22).
4. The Government would be grateful for any further views, in the light of the RPA research, on the justification for "licensed amount" as a basis for cost-recovery charging (see paragraph 3.26).
5. The Government will be grateful for general views on "reliability-banded" charges as proposed in the RPA research as a basis for charging in the longer-term (see paragraph 3.30).
6. The Government would be grateful for comments on its view that, in principle, abstraction licence trading should be promoted as an effective means of achieving the optimal distribution of water resources within and between different sectors of use and thus contributing to sustainable development (see paragraph 4.2).
7. Respondents to this consultation paper may wish to consider how its proposals regarding licence trading could influence competition in the water industry (see paragraph 4.3).
8. The Government will be particularly grateful for views on whether the concept of a "acquisition curtailment condition" would provide short-term licence trading opportunities whilst maintaining necessary environmental protection (see paragraph 4.22).
9. Respondents are invited to comment further on the general propositions (see paragraph 4.26) that:
1. the necessity, in most forms of trading, for the issue of a varied or completely new licence provides the means by which the Environment Agency can guard against environmentally-damaging trading consequences, such as the activation of "sleeper" licences or unsustainable "upstream" trades, while also facilitating both short and longer-term abstraction trading;
2. administration of the licence changes which would be necessary for trading should, in many cases, be significantly less burdensome and time consuming than at present as a result of the proposed legislative changes; and
3. the Environment Agency should be able to approve trades that obviously benefit the environment faster and with fewer information demands than in circumstances where there may be a threat to the environment.

 

10. The Government will be grateful for other views on potential difficulties arising from trade in "sleeper" licences and on how difficulties could be overcome (see paragraph 4.33).
    
11. Respondents to this consultation paper are invited to give views on the part the Competition Act 1998 may play in guarding against licence hoarding (see paragraph 4.37).
12. Respondents are invited to comment on the Government’s view that it may not be appropriate for the Environment Agency to seek to perform its water resources management duties by itself entering a licence trading market as a trader (see paragraph 4.41).
13. The Government would be grateful for views on whether an auctioning process may have a part to play in the allocation of water resources within the regulatory framework provided by the water abstraction licensing system (see paragraph 4.46).
14. The Government will be grateful for views on how the Environment Agency’s interpretation of `reasonable requirements’ for water should facilitate licence trading whilst still providing the protection against improper use of water resources to which that duty contributes (see paragraph 4.49).
15. The Government would be grateful for comments on its view that it would not be appropriate to manipulate the market by confining trading to within-sector opportunities, and on its consequent view that licence trading should operate amongst all existing and potential abstractors without sector restrictions (see paragraph 4.51).
16. The Government will be grateful for further views on how the administration of abstraction licence applications can be improved, particularly with reference to the other proposals in this consultation paper, and on what targets should apply to the Environment Agency’s administration of licence trades (see paragraph 4.55).
17. The Government would be grateful for views on whether a licence-specific "pre-approval" for trading should be offered by - or required of - the Environment Agency (see paragraph 4.61).
    
18. The Government would be grateful for any general views on the part which Abstraction Management Strategies can play in promoting licence trading (see paragraph 4.63).
19. The Government would be grateful for views on its proposals for the establishment by the Environment Agency of a licence trading web site (see paragraph 4.69).
20. The Government would be grateful for initial views on how the Environment Agency should incorporate brokering charges for licence trading within a charging scheme limited to the recovery of the Environment Agency’s overall water resources management costs. In particular, respondents are asked to consider the suitability of a standard percentage charge by the Environment Agency on the trading price of completed trades, and what that percentage should be (see paragraph 4.72).
21. The Government would be grateful for views on whether a need for more active brokering is likely to emerge and, if so, on whether any regulation of that activity would be required (see paragraph 4.73).
22. Respondents are asked to say how quickly they think the proposals in this Consultation paper should be implemented, and whether they would wish to see any of them introduced on a catchment-prioritised basis rather than uniformly throughout England and Wales (see paragraph 5.5).
23. The Government will be grateful for any more general views on whether this package of trading proposals provides the lightest possible burden, consistent with the underlying regulatory requirements of the licensing system, on those who wish to participate in abstraction licence trading (see paragraph 5.7).

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