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Key departmental publications, e.g. annual reports, budget papers and program guidelines are available in our online archive.

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Environmental Incentives:
Australian Experience with Economic Instruments for Environmental Management

Environmental Economics Research Paper No.5
Consultancy report prepared by: Dr David James, Ecoservices Pty Ltd
Commissioned by Environment Australia
Commonwealth of Australia, 1997
ISBN 0 642 26850 9

10. Tradeable discharge rights

10.1 General application

Tradeable discharge rights consist of quantity and/or quality permits on emissions and/or effluents. The mechanisms are relatively simple. The control authority determines the total load to be borne by the environment for a particular catchment, river segment, water body or airshed, and issues a set of discharge rights (permits or entitlements). These rights may then be traded in a market, subject to any special conditions specified by the control authority.

In principle, tradeable discharge rights should be effective in meeting environmental management objectives, since the environmental tolerance is (or should be) built into the design of the system. They should also be economically efficient by leading to an equalisation of abatement costs by all dischargers trading in the market.

Various provisions may be made by the control authority for tightening the total constraint - reduction of the allowable quotas when trades take place, uniform cutbacks on a prescribed time schedule for all owners of rights, or buy-backs by government entering the market.

Tradeable discharge rights have various advantages and limitations. The main advantage is that permits are converted to a capital asset that can be bought and sold by companies, individuals and government authorities. In principle, the assimilative capacity of the environment will be allocated to its highest valued uses. An interesting prospect is that of allowing recreational users or environmental groups to enter the market and purchase rights.

Tradeable rights may have a number of practical limitations. One of the most important considerations is whether a market can be established and whether sufficient trades would occur to achieve efficiency gains. This is sometimes described as the 'thinness' or 'thickness' of the market. The costs of maintaining the market are known as 'transactions costs'.

It is possible that in some markets government agencies may dominate the market and distort the prices at which trades take place, preventing the equalisation of marginal abatement costs that is required to achieve maximum efficiency gains.

Trading between point and diffuse sources may be required to achieve both an active market and significant cost savings. Efficiency gains may be achieved by introducing zoning restrictions, special trading ratios between sources, and 'bubbles' for total loads or ambient concentrations in specific areas (James 1990).

Tradeable rights do not normally yield revenue to the control authority or government. However, there is no reason why an annual fee should not be imposed to cover administration costs. The level of the fee can be expected to affect the capital values of rights traded in the market.

Funds can also be obtained by auctioning rights or calling for tenders. This raises questions, however, about the most appropriate mechanisms for the initial allocation of rights. As well as auctions and tenders, rights can be distributed according to existing levels of discharge. The equity aspects of the allocation system may present problems. If rights are simply allocated to existing dischargers, the gains will be distributed to incumbents.

Equity problems are unavoidable with any allocation system. If rights are allocated by 'grandfathering' them to existing activities, capital assets will be allocated to incumbents, and new entrants to the market will have to pay the price to achieve rights to discharge. (In addition, there may be a 'rush' by existing dischargers to maximise their initial allocations, possibly adding to environmental problems. This effect is similar to the 'sleeper' effect that may take place with tradeable water entitlements.)

If auctions are used to allocate rights, a double investment outlay by dischargers may be required. The reason is that the formerly 'free' use of the assimilative capacity of the environment would have been capitalised in the initial investment value (purchase price) of the activity.

A number of Australian States are considering tradeable discharge rights, and the New South Wales Environment Protection Authority (EPA) has introduced a pilot system for salinity control in the Hunter Valley. Tradeable rights have also been introduced for the Murray-Darling Basin, providing for salinity trades between New South Wales, Victoria and South Australia. New South Wales is adopting a supplementary scheme, but it is limited in scope and potential impact.

10.2 Hunter River Salinity Trading Scheme

Problem Identification

The Hunter River is characterised by naturally saline conditions. Many tributaries have high salt loads resulting from natural processes. The salinity problem is exacerbated by discharges of saline waters to the river by coalmines, power stations, irrigation and other industry in the catchment, which impose external environmental costs on various groups in the community. It has been estimated that for each unit increase in salinity, measured in terms of electrical conductivity (EC), a $10,000 loss occurs throughout the catchment per annum from reductions in agricultural yield and increased costs of water supply and treatment (New South Wales EPA 1994a).

Under the provisions of the Clean Waters Act 1970, the EPA has licensed 11 coalmines to discharge saline waters to the Hunter River. The licences specified (i) a limit on the maximum allowable increase in conductivity in the river of 700 EC units after the discharge, and (ii) a limit on the maximum allowable increase in conductivity of 40 EC units caused by the discharge. This kind of discharge is described as 'trickle' discharge.

Pacific Power, which operates two large electricity generating stations at Liddell and Bayswater in the Hunter region, was also subject to EPA licence conditions. Pacific Power was permitted to discharge up to 700 megalitres per day from Lake Liddell to the Hunter River when the flow at Jerry's Plains was less than 2,000 megalitres per day, provided the salinity level in the Hunter River did not increase to more than 700 EC units. When the flow exceeded 2,000 megalitres per day, Pacific Power was permitted to discharge up to 700 megalitres per day with no salinity restrictions.

Instrument Selection

After investigating the prospects of using economic instruments to control salinity in the Hunter, the EPA decided to introduce a system of tradeable salt discharge credits. The system was developed in consultation with the Department of Land and Water Conservation, the Coal Industry Association, the Hunter Catchment Management Trust and Pacific Power.

Description of Instrument

Details of the scheme are available in a number of documents published by the New South Wales EPA (1994a, 1994b, 1995a).

The scheme was developed from the existing licensing system and was introduced in 1995 on a trial basis. The broad objectives of the scheme were to:

The scheme was designed to:

The following new features were introduced with the scheme.

The scheme has been initially limited to coalmines and Pacific Power. It is expected that diffuse sources will be brought into the scheme in the longer term to ensure effective control of salinity levels.

The total allowable load is calculated in relation to conductivity levels and, indirectly, is related to river flows. Salinity becomes a problem mainly under low-flow conditions. In high-flow periods, the river is least sensitive to discharges and irrigation usually ceases under these conditions, thus there is no need to restrict discharges.

For the purpose of determining discharges, the river is divided into three sectors - upper, middle and lower. Each licence holder is associated with a relevant sector. Water flowing in the river is divided into 'blocks', with each block consisting of the body of water that passes the Singleton gauging station during any 24-hour period in 1995. Thus in 1995 there were 365 blocks.

Each credit entitles the holder to discharge 0.1 per cent of the total allowable discharge for each block. There are 1,000 credits, each of which has a unique registration number which remains unchanged regardless of who owns the credit.

After determining the total credits available, a fixed proportion was allocated to individual mines and to Pacific Power. The EPA retained 20 per cent of the credits as an environmental buffer.

The number of credits allocated to each discharger was determined by means of a 'merit formula' which takes into account:

The environmental performance score is derived from:

Trades must be for whole credits and for whole blocks. Holders of credits are free to trade with other credit holders, but all trades must be registered with a Credit Register and a River Register. The EPA reserves the right to refuse approval of a trade if it detracts from the effective environmental operation of the scheme.

A bonus entitlement may be earned by a discharger if they purchase a special release of water from the upstream storage operated by the Department of Land and Water Conservation. The extra discharge allowed in conjunction with such releases is determined in relation to the dilution achieved, subject to the constraints that 'normal' discharge opportunities are not reduced and that the sector thresholds are not transgressed.

Monitoring is required at discharge points during discharge, for volume and conductivity. Real time monitoring must also be conducted upstream and downstream of the discharge point in the Hunter River, and upstream and downstream of discharge points in tributaries, where relevant. The permit holder is responsible for these functions. All monitoring data must be submitted to the EPA.

Permit holders must prepare and submit quarterly reports to the EPA, and keep records for two years. The EPA will conduct regular audits of the scheme. All requirements and conditions of the scheme are set down in a rule book for use by participants in the scheme (New South Wales EPA 1995a).

Assessment Against Criteria for Evaluation

A recent paper by Gilligan, Hannan and Smith (1996) documents experience with the scheme, which has now operated for more than a year. In its first year, it performed well and gave considerable promise for its continuation. In general, conductivity levels in the river remained within the targeted limits. Due to extended dry periods, it was decided, following a public consultation process, to test the scheme for another year. It was also agreed that the threshold at which discharges could occur should be reduced from 3,000 to 2,000 megalitres per day.

In the second year, only about 35 per cent of the total potential discharge opportunity was used and this subsequently led to an accumulation of wastewater by some mines. The stored water was later discharged to the river during a flood flow period.

Thus far, several dischargers have offered to sell their entitlements, but only one trade has taken place. The reasons for this are that dry conditions have created water shortages rather than a need to discharge; most mines are not prepared to trade because of uncertainty about long-term needs; and there are also uncertainties regarding the value of entitlements and arrangements for longer term allocations (Gilligan, Hannan & Smith 1996).

The EPA considers that the scheme has been superior to the previous system of licences and expects it to operate more fully after 1997. Industry has not taken maximum advantage of the provisions of the scheme and has been somewhat cautious about relinquishing options for discharge. However, industry still strongly supports the scheme and is evaluating the relevant financial costs and benefits.

There have been some difficulties with data collection and monitoring, and operation of the system is not yet fully automated. It is expected that these problems will be overcome within the coming year.

It is not possible to conduct a full assessment against the relevant criteria. However, it is possible to report that the stakeholders have been willing to participate in the scheme and trades have already taken place.

Concluding Evaluation

The scheme is a successful example of what can be achieved through an effective consultation and consensus process regarding environmental objectives and outcomes. Dischargers have more flexible options for meeting environmental targets, with a high degree of accountability.

Since the scheme is still in an evolutionary phase, it is difficult to assess its success in terms of efficiency gains. Further refinements and a widening in its scope of application can be expected in the future. The incorporation of non-point sources of salinity in the scheme, if that can be achieved, will be a major innovation in water quality management in Australia and internationally.

10.3 Murray-Darling Basin salinity scheme

The system of tradeable rights in salinity for the Murray-Darling Basin came into force in 1992 as part of the Murray-Darling Basin Salinity and Drainage Strategy. The administering agency is the Murray-Darling Basin Commission. Participation in the scheme at present is limited to New South Wales, Victoria and South Australia. Trades are permitted in terms of salt concentrations, measured in EC units.

'Salt credits' can be generated by investing in capital works to manage salt entering the river system and enhance river flow. Credits are tradeable between States, but are generally applied within each State to offset debits from drainage entering the river system. New South Wales has a credit of 6.15 units; and Victoria a credit of 5.92 units. South Australia and the Commonwealth have also earned credits, but it is not contemplated that they will be used to offset debits. In South Australia, salinity has been reduced by 50 EC units.

The salinity and drainage strategy is a limited form of tradeable discharge rights. The rights are not freely traded by industries or individuals, but are exchanged between governments within a constrained strategic framework. Greater flexibility is intended to be introduced to the scheme within the next five years.

New South Wales is about to introduce its own system of tradeable salinity rights for all water users contributing saline drainage to the Murray-Darling and for all water users diverting dilution flows from the Darling Basin. The rights will be issued by grandfathering. The total amount of rights initially will be 15 EC units as measured at Morgan on the River Murray in South Australia. The system is separate from the Salinity and Drainage Strategy. Only a small bundle of EC credits will be involved, and market interactions are not expected to be significant.

10.4 Bubble licences for the Hawkesbury-Nepean River system

Problem Identification

The Hawkesbury-Nepean river system is experiencing significant environmental stress as a result of high nutrient loads, mainly phosphorus and nitrogen. This has led to algal blooms and eutrophic conditions, especially during low-flow periods. Sewage treatment plants are a major source of nutrients, although discharges occur also from other point sources and non-point sources in the catchment.

Instrument Selection

Over the last two years the New South Wales EPA, in consultation with Sydney Water, has been developing a bubble licence incorporating a number of Sydney Water sewage treatment plants within the Hawkesbury-Nepean river system. The framework is being developed by operational, economics and environmental policy staff from the EPA and Sydney Water (Izmir & Shepherd 1995; New South Wales EPA 1995c). The scheme has aimed to help reduce nutrient loads in the river in a cost-effective manner.

The EPA has decided to introduce a bubble licence, designated the South Creek Bubble Licence, incorporating the St Mary's, Quakers Hill and Riverstone sewage treatment plants which discharge into South and Eastern Creeks. The New South Wales EPA (1996b) recently published details of the proposed scheme.

Licence conditions associated with the scheme have been applied to Sydney Water's licences from 1 July 1996 for the 1996-97 licence period. The bubble pollution control licence is underpinned by a strong regulatory framework, which is essential for effective functioning of the economic instrument and to ensure attainment of environmental management objectives.

Description of Instrument

The term 'bubble' is used to describe an imaginary bubble placed over a number of discharge points. The main attribute of a bubble licence is that the regulator controls the aggregate load generated within the bubble, rather than controlling emissions or effluents from individual sources. The advantage of such a scheme over more traditional regulatory approaches is that the operator is given more flexibility in finding cost-effective solutions, while ensuring that the overall discharge targets set by the regulator are achieved. Environmental gains can be made at lower costs because relatively greater reductions can be undertaken by plants with lower abatement costs.

Bubble licences involve the regulatory authority setting a limit (that is, imposing a bubble) on the aggregate discharge load for a discharger or group of dischargers, allowing free choice in how the limit should be met (New South Wales EPA 1995c). The advantages of such a system over the traditional command and control approach are that:

The following management issues were addressed in developing the scheme:

A number of potential configurations of plants that could provide the basis for a bubble licence were investigated. The sewage treatment plants considered are major contributors to water quality problems in particular stretches of the river; have the technical capacity for significant reductions in discharges; and have varying abatement costs for further reductions in nutrient discharges.

One of the key tools used in the analysis of potential bubble configurations was the Hawkesbury-Nepean Nutrient Management Model developed by the New South Wales EPA (1995c). This is a compact environmental-economic model which was used to assess the potential for abatement at different sewage treatment plants, the cost of abatement and the corresponding impact on river quality.

The aim of the scheme is to reduce high nutrient loads within the creeks and the main stem of the river. It is estimated that the three sewage treatment plants currently contribute around 60 per cent of the phosphorus load and around 75 per cent of the nitrogen load in the section of the Hawkesbury River at Wilberforce Reach, downstream of the junction with South Creek. High nutrient concentrations occurring in this stretch of the river are causing eutrophication problems. The environmental outcomes to be achieved by the bubble licence are reduced potential for excessive growth of algae and other water plants, and improved protection of aquatic ecosystems.

The aggregate load limits for the bubble licence for phosphorus and nitrogen are to be reduced significantly over an eight-year period. Load targets specified for the year 2004 will result in an 83 per cent reduction in predicted phosphorus loads and around a 50 per cent reduction in predicted nitrogen loads. Interim targets are also set to ensure continuous environmental improvement. The nitrogen target is to be reviewed at the end of 1997, following a period of monitoring and research. While annual load limits will restrict the load discharged to the environment, additional regulatory control in the form of maximum concentrations are to be set for each sewage treatment plant to ensure that any operating difficulty at a particular plant is promptly recognised and rectified.

Assessment Against Criteria for Evaluation

It is not possible to fully assess the scheme at present, as it has only just been introduced. However, it is estimated that cost savings from the bubble licence scheme, compared to uniform discharge concentration limits, are in the order of 10 per cent to 20 per cent. The load-based licensing aspect of the scheme is also expected to provide considerable incentive for Sydney Water to investigate innovative alternatives to traditional technologies, which could result in additional savings in abatement costs.

Concluding Evaluation

The South Creek Bubble Licence is the first of its kind to be applied to water quality management in Australia. While it is currently being applied only to sewage treatment plants in Sydney Water's sub-catchment, there is also scope for incorporating other point and non-point sources at a later date. Other point sources include sewage treatment plants at McGraths Hill and South Windsor, which are operated by Hawkesbury Shire Council.

10.5 Management of ambient sulphur dioxide concentrations in the Kwinana Industrial Area

Problem Identification

The Kwinana area, south of Perth, is heavily industrialised. Emissions of sulphur dioxide were a major form of air pollution in the 1970s. Ambient concentrations declined with the advent of natural gas from the North West Shelf, but this was not enough to guarantee acceptable air quality in the future. The Western Australian Department of Environmental Protection (DEP) decided to take pre-emptive action and established an Environmental Protection Policy designed to control air quality in the Kwinana area.

Instrument Selection

The instrument selected by the DEP is based on the bubble concept, which limits emissions from point sources, subject to meeting ambient concentration targets for specified air pollutants. The Kwinana scheme applies to sulphur dioxide and total suspended particulates.

Description of Instrument

The scheme has been described by the Western Australian EPA (1992). The material presented here draws on a paper by Rayner (1995).

The targets for controlling sulphur dioxide in the area, specified as standards and limits, are shown in Table 10.1. 'Standard' is defined as the concentration of atmospheric waste which it is desirable not to exceed, and 'limit' as the concentration of atmospheric waste that shall not be exceeded.

The areas referred to in the table are different land zonings:

Table 10.1: Sulphur dioxide standards and limits (micrograms per cubic metre) for specified averaging periods

Region 1-hour 24-hour Annual
Area A
standard 700 200 60
limit 1,400 365 80
Area B
standard 500 150 50
limit 1,000 200 60
Area C
standard 350 125 50
limit 700 200 60

Source: Rayner (1995)

Dischargers in the area are responsible for controlling emissions so as to comply with the ambient standards and limits. DEP assists them by using a dispersion model to estimate the contributions to ambient concentrations from each source. Industry has agreed to comply with the emission constraints, in the expectation that it will be able to optimise their operations in a cost-effective manner.

The steps taken in implementing the scheme are as follows.

This procedure ensures feedback between the predictions of the computer model and the environmental performance of industry. It also allows for flexible trade-offs in emissions from individual sources while complying with the overall standards and limits in the area. Although industry does not have ownership of the rights to discharge, it nevertheless has ownership of the final result.

The scheme involves a number of complexities. A major point source is the Alcoa refinery, which has the capability of switching between oil and gas as a source of fuel. When oil is burned, sulphur dioxide emissions from Alcoa are higher than when gas is burned. Two different patterns of adjustment are thus required by other dischargers in the area, according to Alcoa's choice of fuel. Cement works in the area are also a significant source of sulphur dioxide emissions. Special negotiations are being undertaken with cement works to help reduce total loads.

Another aspect of the scheme is that the predictive capability of the dispersion model in relation to the effects of sea breezes could be improved. The CSIRO Division of Atmospheric Research is working to improve the performance of the model.

The Kwinana Industries Council represents industry's views and negotiating positions with DEP. The council conducts monitoring operations for ambient sulphur dioxide concentrations on behalf of all participating industries and shares its data with the results of monitoring undertaken by DEP. Stack monitoring has not been required from all dischargers.

Assessment Against Criteria for Evaluation

The scheme has gained general acceptance by industry in the area and has led to a sense of joint ownership of the management regime between industry and DEP. There is cost sharing for compliance and monitoring. Negotiations among individual dischargers, and between dischargers as a whole and DEP, appear to be working smoothly.

Further refinements of the dispersion model and more extensive model simulations are expected to show that there is still room, within the prescribed standards and limits, for further industrial development within the area. This represents a potential economic gain at no expense to the environment or to industry, assuming that the standards and limits have been appropriately set.

Concluding Evaluation

The scheme adopted for the Kwinana industrial area is inherently flexible and allows for the prospect of agreements among individual dischargers that are cost-effective and commercially practicable. Its requirements for monitoring and compliance indicate that it is also effective in meeting air quality standards. The scheme could easily be extended to a system of tradeable permits for sulphur oxide emissions.


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