Optimizing the scale of markets for water quality trading

Applying market approaches to environmental regulations requires establishing a spatial scale for trading. Spatially large markets usually increase opportunities for abatement cost savings but increase the potential for pollution damages (hot spots), vice versa for spatially small markets. We develop a coupled hydrologic-economic modeling approach for application to point source emissions trading by a large number of sources and apply this approach to the wastewater treatment plants (WWTPs) within the watershed of the second largest estuary in the U.S. We consider two different administrative structures that govern the trade of emission permits: one-for-one trading (the number of permits required for each unit of emission is the same for every WWTP) and trading ratios (the number of permits required for each unit of emissions varies across WWTP). Results show that water quality regulators should allow trading to occur at the river basin scale as an appropriate first-step policy, as is being done in a limited number of cases via compliance associations. Larger spatial scales may be needed under conditions of increased abatement costs. The optimal scale of the market is generally the same regardless of whether one-for-one trading or trading ratios are employed.