THE STRUCTURE AND PRACTICE OF WATER QUALITY TRADING MARKETS1

ABSTRACT: The use of transferable discharge permits in water pollution, what we will call water quality trading (WQT), is rapidly growing in the U.S. This paper reviews the current status of WQT nationally and discusses the structures of the markets that have been formed. Four main structures are observed in such markets: exchanges, bilateral negotiations, clearinghouses, and sole source offsets. The goals of a WQT program are environmental quality and cost effectiveness. In designing a WQT market, policy makers are constrained by legal restrictions and the physical characteristics of the pollution problem. The choices that must be made include how trading will be authorized, monitored and enforced. How these questions are answered will help determine both the extent to which these goals are achieved, and the market structures that can arise. After discussing the characteristics of different market structures, we evaluate how this framework applies in the case of California's Grassland Drainage Area Tradable Loads Program.