Water Quality Trading David Roberts 28 March 06

1. Water Quality TradingDavid Roberts28 March 06 The answer to water quality woes?

2. The Problem: • Continuing water quality impairment that is increasingly due to non-point source (“NPS”) pollution

3. The Causes • Large number of nonpoint sources (NPS) • Industrialization of agriculture • Differing regulatory “approaches” to point source (PS) and NPS pollution

4. Leading Sources of US River and Stream Impairment Source: EPA, 2002

6. Poultry Production in the 1930’s

7. 21st Century Poultry Production

8. A Brief Introduction to Water Quality Problems and Solutions • Goals of the Federal Water Pollution Control Act Amendments of 1972, commonly known as the Clean Water Act (CWA) • “ . . . restor[ation] and maint[enance of] the . . . integrity of the Nation's waters” • elimination of “discharge of pollutants into navigable water . . . by 1985” • prohibition of discharge of “toxic pollutants in toxic amounts” • How to achieve goals • PS and NPS reductions necessary • NPDES permitting system for PSs • Call for timely development and implementation of measures to curb NPS emissions • Can marketable discharge permits help make this process cost-effective without altering the current regulatory structure?

9. The resource and its users • Is water quality a resource? • Can it be used up/degraded? • Nutrient/sediment assimilative capacity of water can be exceeded • Point source polluters face regulatory standards • Non-point sources are un-regulated (with few exceptions), and have lower MAC • Water’s assimilative capacity remains open access resource for most users (Property right poorly defined) • Social trap • Congestion

10. Why trading? • Coase “The Problem of Social Cost” • Presents rights as factors of production (right to pollute, right to have clean water) • Economic agents reciprocally harm each other through externalities • Confectioner’s production requires noise, doctor’s practice requires peace and quiet • Imposition of either condition harms the other agent financially • Bilateral negotiations could optimally allocate the right to silence and the right to noise between the two • Who pays who determined by original allocation of rights (which are sometimes not well defined) • Amount of payment determined by relative values of the agents’ products

11. On Regulation • More Coase • More economic agents, greater transactions costs – harder to work out a deal • Factory produces foul black smoke • All citizens of the town harmed by smoke • All want compensation, or all willing to pay for decreased emissions • Who gets what share of the pie? • Impasse – no negotiations – social welfare not optimized • Government regulation in place of negotiation • Effect reductions in discharges even when socially beneficial trades would be precluded by transactions costs • High administrative costs to government as well as great control costs to polluters • Social welfare not optimized

12. Tradable Discharge Allowances: A Hybrid System • Hung and Shaw • Social efficiency an impractical standard • Heavy information burden on regulatory agency, or • Negotiations hindered by transactions costs • Cost-effectiveness a more practical standard • Meet regulatory abatement requirements at lowest cost (The goal of WQT) • Government sets maximum allowable aggregate discharge levels, making polluters reciprocally harm each other by using up discharge limits • Negotiations between different polluters, rather than between polluters and individuals • Reduced set of negotiators • Reduced transactions costs

13. A Potential Market Driver in Development • CWA empowers EPA to establish system of total maximum daily loads (TMDLs) • “Pollutant budgets” in which the total allowable discharge is allocated across PSs and NPSs • Makes pollutant assimilative capacity of water a scarce (valuable) resource • Developed only for waters not meeting ambient water quality standards after implementation of PS technology-based standards • Recommend load reductions from sources deemed to be contributing • PSs frequently assigned current discharge levels • NPSs usually collectively assigned some percentage reduction, but what about implementation?

14. EPA Endorsement of WQT • Draft Framework for Watershed-Based Trading (1996) Supports “offset” trading • PSs remain regulated, NPS abatement voluntary • Regulated polluter purchases required discharge reductions from another polluter • Offsite reductions inserted into regulated PS polluters’ NPDES permits • Liability of PS for NPS reductions • Contractual arrangements and transactions costs • Technology-based discharge limits still binding on regulated polluters • Limitations • Nutrients, sediment and “oxygen-related cross-pollutants” only • Not a “cap-and-trade” system but can function similarly in watershed-based markets

15. Marginal Abatement Costs (MACs) and an Emissions Standard Emissions Standard or (Non-marketable) Permit MAC2 $ MAC1 Units of Pollution Abated 0 1 2 3 4 5 6 7 8 9 10

16. MACs and an Emissions Standard Emissions Standard MAC2 MAC2 $ $ MAC1 Units of Pollution Abated 0 1 2 3 4 5 6 7 8 9 10 8 6 5 4 2 1 0 10 9 7 3 Firm 1  Firm 2

17. Least-Cost Attainment of Ambient Environmental Standards:Equating MACs Emissions Standard MAC2 $ $ Cost Savings MAC1 Units of Pollution Abated 0 1 2 3 4 5 6 7 8 9 10 8 6 5 4 2 1 0 10 9 7 3 Firm 1  Firm 2

18. Issues faced by WQT policies • Not all discharges are created equal • Impacts of different polluters differ based on • Geographical distance from impairments • Hydrological factors (flow conditions) • Impacts of same polluter can vary seasonally • PS discharges are easily measured and controlled • NPS discharges • Difficult to measure • Vary with weather • Effectiveness of control technologies varies by site and weather

19. NPS control technologies • Agricultural best management practices (BMPs) designed to reduce agricultural nutrient loadings • 23 foot switchgrass buffer reduced • Sediment by 95% • Total nitrogen by 80% • Total phosphorous by 78% (Lee, Isenhart, Schultz) • Strawberry farmers in Elkhorn Slough watershed in California would have net gains from installing buffer strips (Rein) • Precision agriculture reduces nutrient use • Terraces • Cover crops • Excluding livestock from streams • Phosphorous based applications of manure

20. WQT sounds good, but does it work? • More than 15 major pilot project at some stage of implementation • Trading between point sources is common • PS:NPS trades somewhat limited in general • Risky for PS • Often high transactions costs

21. Notable Water Quality Trading Programs • Tar-Pamlico Nutrient Reduction Trading Program • PS discharger association • Has collective caps on nitrogen & phosphorous • Has authority to allocate capped discharges among member dischargers • Can purchase NPS credits by paying government operated BMP fund • Has been able to remain below cap • Has banked NPS credits for future use • Problems: • NPS payments based on average cost, not marginal cost • No trading ratios to equate impacts of site-specific reductions/increases

22. Notable Water Quality Trading Programs • Lower Boise River Effluent Trading Demonstration Project • EPA-endorsed offset variety • Trades in total phosphorous emissions • Allows PS:PS, PS:NPS, NPS:NPS trading • PS:NPS trades require • Water quality contribution • Installation and inspection of BMP and verification of load reductions prior to approval of trades • BMPs installed post-1996 can create salable credits • No trades as of 2006, despite development of TMDL expected to drive the market