Cleaner rivers, beaches and drinking water must all be achieved while prices to the consumer are being cut, the companies were told by John Prescott, Secretary of State for the Environment, and his deputy Michael Meacher, who set the target as a framework for the companies' investment programmes in the first five years of the new millennium.
Meeting both elements would mean an end to the "bonanza" of directors' pay and shareholder dividends seen in recent years, they said, which had come about because water prices had been set too high.
The water companies said they could "face difficulties" in combining a price cut with increased investment, and share prices fell on the announcement.
The proposed programme of accelerated sewage treatment schemes, tighter drinking and bathing water standards and protection for a long list of wildlife sites threatened by sewage or water abstraction delighted environmental groups.
Mr Prescott said the 1989 water privatisation by the Tories had given away public assets and created ideal conditions for making a lot of money. "This is our first chance to get back some of that public investment. Most people will feel prices have been too high for five years and when connected to high profits, they want to see change." The Government believed a 10 per cent cut was possible, he said.
Spelling out the list of environmental improvements on which the Government was insisting, Mr Meacher said the discharge of raw sewage into the sea would be completely stopped. This would improve the quality of bathing water quality, enabling many more British beaches to meet the European Union's Blue Flag standard.
The spreading of untreated sewage sludge on land would be halted, and lead levels in drinking water would be cut by a massive programme of replacing old pipes. Added protection would also be given to sites of special scientific interest .
The Government's announcement came in the form of official guidance to the water regulator, Ian Byatt, who is reviewing prices for the period 2000-2005. Mr Prescott said he had miscalculated when setting prices for the current five-year period, in 1994, allowing them to be too high.
Responding to the announcement, Brian Duckworth, chairman of Severn- Trent Water and also of the industry's umbrella body, Water UK, said: "We're happy to increase the pace of environmental improvement, but there's a cost attached. If a price cut hits our ability to invest, then we could face difficulties."
The companies were given a sharp warning by Lord De Ramsey, chairman of the Environment Agency, which will oversee the programme. He said: "We will make sure that the full programme of improvements is delivered by the companies by 2005. Slippage will not be acceptable."
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