Water Quality TradingDavid Roberts28 March 06

The answer to water quality woes?

The Problem:

Continuing water quality impairment that is increasingly due to non-point source (“NPS”) pollution

The Causes

Large number of nonpoint sources (NPS) Industrialization of agriculture Differing regulatory “approaches” to point

source (PS) and NPS pollution

Leading Sources of US River and Stream Impairment

Source: EPA, 2002

Poultry Production in the 1930’s

21st Century Poultry Production

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?

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

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

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

Tradable Discharge Allowances: A Hybrid System Hung and Shaw

Social efficiency an impractical standard1. Heavy information burden on regulatory agency, or2. 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

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?

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

Units of PollutionAbated

$

MAC1

MAC2

Marginal Abatement Costs (MACs) and an Emissions Standard

0 1 32 54 7 8 1096

Emissions Standard or(Non-marketable) Permit

Units of PollutionAbated

$

MAC1

MAC2

MACs and an Emissions Standard

0 1 32 54 7 8 1096

10 9 8 7 6 5 4 3 2 1 0

$EmissionsStandard

MAC2

Firm 1 Firm 2

Units of PollutionAbated

$

MAC1

MAC2

Least-Cost Attainment of Ambient Environmental Standards:Equating MACs

0 1 32 54 7 8 1096

10 9 8 7 6 5 4 3 2 1 0Firm 1 Firm 2

$EmissionsStandard

CostSavings

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

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

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

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

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