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Title: Market power, private information and the optimal scale of pollution permit markets with application to North Carolina’s Neuse River

Author
item YATES, ANDREW - UNIVERSITY OF RICHMOND
item DOYLE, MARTIN - UNIVERSITY OF NORTH CAROLINA
item RIGBY JR, JAMES
item SCHINIER, KURT - GEORGIA STATE UNIVERSITY

Submitted to: Resource and Energy Economics
Publication Type: Peer Reviewed Journal
Publication Acceptance Date: 2/16/2013
Publication Date: 9/1/2013
Citation: Yates, A., Doyle, M., Rigby Jr, J.R., Schinier, K. 2013. Market power, private information and the optimal scale of pollution permit markets with application to North Carolina’s Neuse River. Resource and Energy Economics. 35(3):256-276.

Interpretive Summary: Market-based approaches for controlling environmental pollution are increasingly popular as a regulation tool due to their cost efficiency. Since the 1970’s market-like methods such as tradeable pollution discharge permits have been incorporated into water quality regulation in hopes of improving water quality in a cost efficient manner. One challenge of tradeable pollution discharge permits is the potential for trade-induced concentration of pollutants within a watershed. Thus, while the total pollution reaching an outlet may be decreased in a trading scheme, localized pollution within the watershed may increase due to economic redistribution of pollution discharge. This work addresses the question of scale in nitrogen discharge trading schemes by breaking the Neuse River basin’s waste water treatment plants (WWTPs) into sets of sub-basin scale trading zones to find an optimal trading configuration that minimizes both the combined cost of reducing pollution to meet a basin-wide cap and the cost associated with increased nitrogen concentrations in surface waters. This work is the first to couple a model of in-stream nitrogen processing (SPARROW) with an economic model of trading behavior that takes into account price-manipulation by managers due to the small number of permit traders and asymmetric information. This is in contrast to a competitive scenario where managers are unable to manipulate market price to their benefit. Our results show that optimizing the trading configuration results in (1) a configuration of multiple small zones suggesting that price manipulation by mangers actually benefits overall reduction of pollution costs, and (2) approximately $1.5 million dollars per year in cost savings for the river basin when compared with the no-trade scenario (i.e., individual TMDL allocations for WWTPs).

Technical Abstract: We extend the analysis of optimal scale in pollution permit markets by allowing for both market power and private information. The effect of these considerations on optimal scale is determined by analyzing pollution of nitrogen from Waste Water Treatment Plants (WWTP) into North Carolina’s Neuse River System. An economic model of damages and abatement costs is integrated with a hydro-ecological model of nitrogen flow through the Neuse. We determine the optimal allocation number of trading zones and allocate the WWTP into these zones. For many combinations of parameters, both the market power and private information cases lead to lower total costs than competition. Under the most likely regulatory scenario, we find cost savings of 1.5 million dollars per year under the optimal market design relative to the typical 303 (d) regulation in which the WWTP are not allowed to trade.