Trading Programs Seen as Most Effective When Limited to Specific Watersheds

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By Amena H. Saiyid

Nov. 12 — Paying farmers to plant trees and install stream buffers to curb polluted runoff from their fields is gaining support among municipal and industrial dischargers as a cost-effective way to reduce nutrient contamination in nearby waterways.

Arising from the use of fertilizers and pesticides on farms and lawns and increasing stormwater runoff from development activities, nitrogen and phosphorus—collectively referred to as nutrients—are a leading source of pollution in rivers, lakes and estuaries, according to the Environmental Protection Agency.

Nutrients fuel the growth of algae, which die and decompose depleting oxygen levels and suffocating aquatic life in the Chesapeake Bay, Great Lakes, the Gulf of Mexico and other bodies of water. Some of the algae is toxic and has been known to contaminate drinking water supplies and cause widespread fish kills. This happened in August when toxic blue-green algae in Lake Erie contaminated Toledo, Ohio's drinking water supplies.

Reducing nutrient pollution, however, has proven to be a challenge for federal and state regulators because its sources—municipal, industrial and agricultural—are diverse and its impacts vary by water body. Compounding this challenge is the costly controls that municipal and industrial sources must implement that in many cases may only have marginal benefit. This is because the chief cause of impairment, according to the EPA, is agricultural runoff, which the Clean Water Act has limited authority to regulate.

For this reason, the EPA, the Agriculture Department and state regulators have been promoting trading as a cost-effective solution. Discrete trading programs have cropped up all across the country to address nutrients and maintain water temperature, reduce sediment loading and protect fish habitat.

“The agencies believe that market-based approaches, such as water-quality trading, may have the potential to achieve water quality and environmental benefits more cost-effectively and efficiently than might otherwise be achieved through single-entity regulatory approaches,” the EPA and the Agriculture Department declared in a joint water quality trading agreement signed December 2013.

What is Trading?

The EPA explains water quality trading this way: “Trading is based on the fact that sources in a watershed can face very different costs to control the same pollutant. Trading programs allow facilities facing higher pollution control costs to meet their regulatory obligations by purchasing environmentally equivalent (or superior) pollution reductions from another source at lower cost, thus achieving the same water quality improvement at lower overall cost.”

However, water quality trading has its limitations and has not been applied as broadly as its supporters had hoped, nor has it demonstrated the success of the trading program established under the Clean Air Act Amendments of 1990 (Pub. L. No. 101-549) to reduce emissions that cause acid rain.

For the most part, water trading programs must be confined to a single watershed, and trying to implement them on a broader scale poses a host of challenges, especially when a single watershed may fall within one state or span several different states, such as the Chesapeake Bay or the Mississippi River Basin, Ellen Gilinsky, EPA senior adviser to the Office of Water and a specialist in water quality trading told Bloomberg BNA.

Comparison to Acid Rain Program

While basic cap-and-trade principles are the same for both air and water, the incentives for using them are dramatically different.

In the acid rain program, the caps for sulfur dioxide and nitrogen oxides are written into the law. The acid rain program leaves it up to the facilities to decide how to meet them, and if they cut emissions more than they have to, they create a tradeable credit that can be sold. This legal specificity accounts for the acid rain program's success, while trading under the Clean Water Act has yet to really take off.

“ In water quality trading, you need to be within the confines of an ecological region.” — Mindy Selman, WRI

In water quality trading, the cap is set by the regulatory driver for a particular body of water, be it a state-adopted water quality standard for a pollutant or a federally approved total maximum daily load plan to restore that impaired water, or an effluent limit for that pollutant in a Clean Water Act permit. And trades are limited to watersheds because water bodies are varied, bounded by land, and their quality is governed by standards set by individual states, policy analysts, lawyers, and scientists tell Bloomberg BNA.

Water quality trading programs for nitrogen, phosphorus and temperature and sediment, cannot be applied uniformly to all waters in the nation.

(Click image to enlarge.)

EHS story graphic 11/14/2014

Rather, Gilinsky said, they have to be tailored to each water body or watershed.

Mindy Selman, senior associate with World Resources Institute (WRI), agreed.

“It's not like air where the place doesn't matter as much. In water quality trading, you need to be within the confines of an ecological region,” she said.

Types of Trading Programs

There are 24 discrete water quality trading programs nationwide—20 that address nutrients and four that cover temperature. Almost all are single-state projects. Only the Ohio River Basin Water Quality Trading Project incorporates players in more than one state—Indiana, Kentucky and Ohio.

Since the EPA published its water quality trading policy in 2003, many government officials have said they intend to take advantage of the program across the Mississippi Basin or the Chesapeake Bay, but those assertions have not been borne out beyond the watershed level.

At the second national water quality trading conference in 2006, then EPA Administrator Stephen Johnson said water quality trading programs can be used to address hypoxia—oxygen depletion zones—in the Chesapeake Bay and the Gulf of Mexico, which could span multiple watersheds.

Each state has different requirements for achieving water quality standards that may or may not be the same for a given pollutant.

In the Chesapeake Bay, individual states—Maryland, Virginia and Pennsylvania—have set up intrastate trading programs to reduce nutrients in order to meet the total maximum daily plan for the estuary.

To meet its obligation for reducing nutrients to the bay, the District of Columbia recently conducted its first successful trade under its stormwater program that is premised on developers and property owners earning credit for retaining stormwater at their own sites within the same watershed or at properties in the adjoining watershed.

Moving beyond individual states, Beth McGee, senior water quality scientist at the Chesapeake Bay Foundation, pointed to some of the challenges of establishing trading programs within large water basins that span multiple jurisdictions, such as the Chesapeake Bay.

One problem in trying to address nutrients on a multi-jurisdictional, baywide scale is that intrastate trading programs developed independently of each other, McGee said.

The EPA has published technical memoranda to harmonize trading programs in the bay and encourage interstate trading, but what is really missing is a “single, common currency,” McGee noted.

Gilinsky, however, clarified that the EPA technical memoranda were specific to the bay, just like the draft trading recommendations the EPA Region 10 issued in collaboration with a number of nonprofits including the Willamette Partnership and the Freshwater Trust was specific to the Pacific Northwest.

“A pound of nutrient is calculated differently in Virginia than in Maryland,” Gilinsky said.

Different State Requirements Can Hamper Programs

Another challenge with programs that span multiple states is the different state requirements, needs and approaches, according to the trading experts.

Thus, it could be difficult to write a Clean Water Act discharge permit for states with differing water quality standards, McGee said. Moreover, the water quality problems in the Chesapeake Bay may not be the same as those in the Pacific Northwest, for example. And even if they are, different states may have different priorities for addressing their water quality challenges.

Having a trading program spanning multiple jurisdictions and watersheds could result in local pollution “hot spots” owing to differing ecological, political and geological differences within a single watershed, according to Richard Moore, executive director of Ohio State University Environmental Sciences Network.

If the goal is water quality improvement in a given water body then increasing the scale of the trading operation will remove that focus, Moore said. He has been overseeing a countywide project of trading pollutants under National Pollutant Discharge Elimination System permits for the dairy industry in Ohio.

Size Shouldn't Matter

Trading programs should not be judged by the size of the watershed, but by their ability to improve water quality, according to Jessica Fox, program manager with the Electric Power Research Institute (EPRI), who is responsible for creating and managing the first interstate Ohio River Basin Water Quality Trading Project.

EPRI spearheaded the pilot Ohio River Basin Trading Project, in which farmers in Ohio, Indiana, Kentucky, and Ohio who implemented conservation practices received 9,000 nutrient stewardship credits. American Electric Power, Duke Energy and Hoosier Energy bought those credits in March and retired them rather than applying them to future permit requirements.

Bob Perciasepe, EPA's deputy administrator at the time, termed the interstate trading program a national model for credit transaction structure.

“A pound of nutrient is calculated differently in Virginia than in Maryland.” — Ellen Gilinski, EPA

Perciasepe, now president of the Center for Climate and Energy Solutions, said the principles involved in setting up the interstate Ohio River trading project should be emulated.

“What I found fascinating and what I felt was a model is how the states went about agreeing to a certification process: To make sure that the credit that was generated by a farmer would be acceptable in all three states,” Perciasepe said.

Fox said the Ohio River trading program could be scaled up to the upper Mississippi River Basin, but only if it accounts for differing social and political conditions.

Agreement Among States on Principles

In Ohio, the interstate pilot project worked because all three states agreed on the same set of rules for generating and trading credits back in August 2012.

“In order for interstate trading to be successful, all states need to start trading at the same time and their programs need to be configured at the same time,” said Gilinksy.

Gilinsky agreed with McGee of the Chesapeake Bay Foundation that Maryland, Virginia and Pennsylvania found it difficult to coordinate their trading programs for the bay because they developed independently and with different requirements and baselines.

EPRI's Fox said the key to any successful trading program is to involve as many participants and span as great an area as possible.

The challenge is to balance the desire to have a large trading program with the ecological needs of that watershed, Fox said.

“Could the Ohio River Basin be scaled nationwide? I don't think so,” said Fox, adding that “different trading programs in different regions have different contexts, fundamentals and mechanics. We structured the Ohio trading program to deal with the needs of the Ohio River Basin.”

Brent Fewell, adviser to the National Water Quality Trading Alliance, acknowledges that trading across jurisdictional boundaries presents “unique challenges” due to regulatory differences, “but such challenges are not insurmountable if we can develop a common platform and ‘currency' for market participants to trade.”

May Need to Rewrite TMDLs

Other obstacles include rewriting total maximum daily load plans that are specific to impaired waters and that can generate credits for nonpoint sources in drought-ridden areas or areas with little to no rainfall during entire seasons. “How do you generate credits for nonpoint sources if there is no runoff for months at a time?” asked Mark Kieser, senior scientist and principal with Kieser & Associates LLC, based in Kalamazoo, Mich.

According to Kieser, many of the TMDLs were drawn up before trading was even introduced and adopted as a concept. It is difficult to go back and rewrite them, but “we are seeing more and more TMDLs being developed with trading in mind,” Kieser said.

He pointed to the recently completed TMDL plan to restore clarity in Lake Tahoe, Nev., caused by fine sediment particles and phosphorus pollution from urban stormwater. The TMDL plan allows municipal stormwater agencies to trade credits earned by engaging in best management practices beyond their baseline requirements.

An aging population of farmers may be unwilling to sign contracts for trading that could last five to 10 years when they don't know what will happen in three years.

“Trading is not for everybody,” Kieser said “Those that are interested and willing to take a risk will participate.”

Differential Costs

Trading takes advantage of the fact that point sources such as wastewater utilities or nonpoint sources such as farms face different costs to reduce the same pollutant.

In general, as the EPA says, trading programs allow facilities facing higher costs to control their discharges to meet their regulatory obligations by purchasing environmentally equivalent—or environmentally superior—pollution reduction credits from another source at lower cost. The result is the same water quality improvement at lower overall cost.

Trades can occur between two or more point sources or between nonpoint and point sources.

In Pennsylvania, municipal and industrial dischargers have agreed to cap their pollution into a given water body by purchasing credits from nearby farmers in lieu of installing costly controls. The farmers in turn have earned credits that they can sell by planting trees as buffers and managing livestock and crop operations to minimize nutrient runoff.

Buying pollution credits created through the implementation of measures to reduce contamination from nonpoint sources is often much cheaper for point source dischargers than installing controls. The pollution reductions occur at a lower cost than if the point sources had installed pollution controls.

In Medford, Ore., municipal wastewater utilities are buying credits from farmers in lieu of purchasing a $16 million refrigeration unit to lower the temperature of wastewater effluent discharges into the Rogue River. The farmers generate credits by planting trees to provide shade along the river at a cheaper price, achieving the goal of lowering temperature that helps salmon thrive in the Rogue River.

Point Source Trading

Environmental groups, such as the Natural Resources Defense Council and the Chesapeake Bay Foundation, would prefer to see trading limited to point sources, such as the type occurring in Long Island Sound, because it involves credits generated by easily measurable discharges from point sources similar to trades of measurable allowances under the acid rain program.

Rebecca Hammer, a project attorney with NRDC, said her organization and other environmental groups generally favor point source to point source trading because discharges from the end of a pipe can be easily measured and verified.

McGee of the Chesapeake Bay Foundation sees great potential for water quality trading in the urban stormwater arena.

The biggest cost savings will come from municipalities that are under Clean Water Act obligations to reduce stormwater runoff. Trading stormwater credits generated by retaining stormwater onsite, such as the District of Columbia's stormwater credit trading program, can help communities meet their municipal separate storm sewer system permit requirements.

Fox and Selman of WRI and others agree that trading among point sources is easily doable and achievable, but it misses the larger opportunity presented by bringing unregulated nonpoint sources to the table.

EPA already regulates point sources and the challenge is to improve water quality, Fox said. The EPA itself has said that agriculture is the chief source of impairment “so why not engage in point to nonpoint source trading?”

Trading should bring multiple stakeholders to a table and look for ways to better improve water quality. And water quality trading provides an incentive for nonpoint sources to reduce pollutant loading into the waters, Fox said.

Risks With Nonpoint Source Trades

Involving nonpoint sources, however, not only increases overall project risks, but also transaction costs, said WRI's Selman.

The whole level of risk, and thereby cost, increases with each step involved in measuring the reductions, estimating their value in trading rations, verifying the reductions, and insuring credits generated by nonpoint sources, she said.

Insuring credits, such as tree plantings and cover crops, against weather related risks can add to overall transaction costs. Pennsylvania has reserved a 10 percent insurance, or reserve ratio for all credits generated by farms for regulated sources should any purchased credits default, according to the WRI issue brief, “Water Quality Trading Programs: An International Overview.”

McGee and Hammer are most concerned about verifying reductions achieved by nonpoint sources, particularly farms.

“We aren't happy with the level of documentation,” McGee said.

Explicit Direction

Some groups question whether trading programs are even allowed under the Clean Water Act, while others say the law offers enough flexibility to allow the EPA to provide explicit direction instead of overly broad policy endorsement.

Groups such as the Food & Water Watch have unsuccessfully sued the EPA's water quality trading program, which the agency offered as an option to states to clean up the Chesapeake Bay (Food and Water Watch v. EPA,D.D.C., No. 1:12-cv-01639, 12/13/13).

The American Farm Bureau Federation supports state trading programs, but opposes the idea of federal involvement in trading.

“There is no black letter, no authorization in the Clean Water Act involving trading whatsoever. We think the Clean Water Act is pretty clear if trading can occur, but it has to be authorized at the state level. In other words, it is a creation of state statute, not federal statute,” explained Don Parrish, senior congressional relations director for the American Farm Bureau Federation.

NRDC's Hammer agrees that the Clean Water Act is silent on the issue.

Fewell, of the National Water Quality Trading Alliance, has been advocating for the EPA to include language in the upcoming water quality standards regulation that explicitly allows states to use water quality trading to meet Clean Water Act obligations.

Fewell said the language is needed to avoid liability in potential legal challenges to trading programs.

However, Gilinsky remains adamant that EPA does not have to update its policy or make it more specific than it is already. She said the basic principles are already in place, and those can be tailored to individual states.

“Nothing in the Clean Water Act prevents trading,” Gilinsky said.

Joe Furia, senior policy director and general counsel for the Oregon-based Freshwater Trust, agrees that additional federal regulation is unnecessary “but it would help” to have a national policy document that provides more detail than the current policy.

Gilinsky maintains that the 2003 policy is general yet detailed enough to guide trading programs.

According to most analysts interviewed by Bloomberg BNA, water quality trading is one of many approaches to comply with Clean Water Act obligations. It should not be seen as a panacea for tackling pollution in all the nation's waters, Kieser said.

“If a tool isn't needed then it doesn't mean its bad. It just means its not a good fit here,” Kieser said.

To contact the reporter on this story: Amena H. Saiyid in Washington at asaiyid@bna.com

To contact the editor responsible for this story: Larry Pearl at lpearl@bna.com.

The EPA 2003 Water Quality Trading Policy is available at http://water.epa.gov/type/watersheds/trading/finalpolicy2003.cfm.

EPA's water quality trading definition is available at http://water.epa.gov/type/watersheds/trading.cfm.

The World Resources Institute issue brief, “Water Quality Trading Programs: An International Overview,” is available at http://www.wri.org/sites/default/files/pdf/water_trading_quality_programs_international_overview.pdf.