Tradable pollution permits (C7.03)


Ensuring good water quality is an essential step towards water security. Consequently, pollution control is a big part of water resource management. Tradable pollution permits are so-called cap and trade schemes. They give companies a legal right to pollute a certain amount per fixed time span. Firms that pollute less can then sell their leftover pollution permits to firms that pollute more. The point of this is that polluting firms and public agencies differ in their ability to abate their pollution – some can do it easily and cheaply, for others it would be more difficult and costly. Consequently, tradable pollution permits can be a cost effective way to achieve a reduction in overall pollution.

The freedom to trade pollution “entitlements” gives an incentive for polluters to consider abatement (since they can sell their surplus quotas) while others face the cost of having to purchase permits. For society, the existence of tradeable permits enables pollution abatement to be achieved in the least costly manner. Over time, pollution standards can be tightened, increasing the value of the permits and the pressure on market participants. Credits are traded within defined trading areas.

Trading in pollution permits arises in the following situations: 

  • Permits to discharge into specific water bodies issued to local firms and wastewater treatment plants (e.g. Fox River, USA); 
  • Salinity Credits (e.g. for coal mining and power companies discharging into the Hunter River in Australia);
  • Nutrient trading (e.g. in parts of the USA, Canada, Netherlands, and Australia). Transactions listed under some schemes include “bubble licensing” (in which several wastewater treatment plants are considered together in applying nitrogen and phosphorous load discharge limits) and “diffuse source offsets” (in which a water authority can purchase offset credits from external sources using much cheaper ways of reducing overall nutrient pollution). 

A number of these schemes in water pollution are still in the pilot phase, and experience is still accumulating. Mainly, tradeable permits are used to manage air pollution.

Lessons learned

  • There is a need for a mechanism for initial allocation of rights (whether for water or pollution discharges) which should be seen to be fair, and be equitable and effective. Initial prices can be set by governments or determined through public auctions.
  • The decision on how long permits are valid is important if ever governments want to change the price for a pollution unit. If permits are valid indefinitely, companies can “bank” unused pollution certificates which means that later price corrections will be less effective.
  • In order to be effective, monitoring systems need to be put in place to keep track of the pollution discharges of companies and/or other users so their actual discharge can be determined and fines imposed if companies surpass the pollution levels allotted through their permits.
  • A system that relies on pollution permits as opposed to mandatory pollution cuts or limits set by the government allows companies that are wealthy enough to keep polluting.
  • It is also possible to set up a system in which credits are not just sold or given out, but also generated through environmental services or water treatment. An example of such a system is the Maryland Nutrient Trading System, where farmers can produce credits in the trading system by installing riparian buffers or covering crops. To qualify as credits, these practices must be certified and inspected by appropriate authorities.