Ofwat has commissioned five independent reports on the role of system operators in bringing more competition into the water sector. The water companies were almost all opposed to the idea which was first proposed by Ofwat in July last year.

A system operator is a term used in the utility sectors to describe an organisation that manages the network infrastructure used to supply services. System operators carry out some or all of the following functions:

• daily operation of the network
• monitoring water quality in the network
• scheduling network maintenance
• planning long-term network development
• managing new connections to the network
• administering water companies' access to the network

Ofwat has suggested that one way of promoting market-based competition, is to introduce a degree of separation between system operators and companies competing in the market. This would prevent a company controlling one part of the network and competing in the market from discriminating against other companies delivering services to their customers using that network.

Ofwat first put forward the idea of functional separation of the system operator in its 'Valuing Water' focus report in July 2010, to stimulate debate.

In the independent review he led for the Government on competition and markets in the water sector, Professor Martin Cave mentioned the possible need for such ‘functional separation’ i.e. the water companies should be required to set up divisions responsible for system operation, separate from the rest of their activities.

In their responses to Ofwat’s focus report, the existing water companies were almost all opposed to reforming the system operator functions in this way. Their criticisms included that Ofwat had provided too little evidence to back up its ideas. In response Ofwat has now asked several experts to set out the advantages and disadvantages of separating out system operator functions in the papers published today.

A brief summary of the conclusions of each paper is below:

Chris Bolt drew out lessons from the gas and rail sectors in the UK. He found that vertical separation between the network (not just the system operator) and supply functions is a key step in promoting competition and reducing concerns about discrimination.

Jon Stern argued that system operator reform cannot be considered in isolation from other market reforms. He concluded that functionally separate system operators would not have any significant positive effect. His recommendation is that Ofwat should move towards the formation of regional network-only companies which include the system operator and the network assets.

Michael Pollitt thought that if network separation was not an option, the separation of system operators would still increase efficient water trading. He considered that the net benefits of independent system operators might be negative in the short term, but would become positive in the future. There may also be a benefit in having system operators in place now to deal with extreme weather events.

Keith Harris considered that functional separation of the system operator could be done relatively cheaply, but would achieve little in terms of incentivising the system operator to be more efficient or to avoid discrimination. In his view there are alternative, less risky ways, to encourage water trading which Ofwat should consider as a first step.

Peter John looked at the specific issue of incentivising independent system operators. He identified seven options for doing so, but recommended rejecting two of them (not-for-profit and cooperative independent system operators).

Next steps

Ofwat will be reviewing the recommendations of the five papers in detail as well as the responses to itsfocus report.

In March 2011, as part of its future price limits project, Ofwat will be consulting on a preliminary model of the framework which will be used to set limits on the prices that can be charged for monopoly water and sewerage services in the future. The consultation paper will include Ofwat’s latest thinking on system operation.

Download the papers at:

Chris Bolt, 'Introducing the concept of the system operator in the water sector: lessons from the gas and rail sectors in the UK ', December 2010.

Jon Stern, 'System operators: lessons from US and EU energy industry experience and implications for the England and Wales water industry ', January 2011.

Peter John, 'Incentivising Independent System Operators (ISOs)', January 2011.

Michael G. Pollitt, 'Lessons from the History of Independent System Operators in the Energy Sector, with applications to the Water Sector ', February 2011.

Keith Harris ;'An evaluation of the potential introduction of a system operator for water in England and Wales ', February 2011.