An Evaluation of Nutrient Trading Programs. Yuko Ashida. Emilia Deimezis. Carla Fowler. Joe Sambataro. NTRES 318: Environmental Strategies

Transcription

1 An Evaluation of Nutrient Trading Programs Yuko Ashida Emilia Deimezis Carla Fowler Joe Sambataro NTRES 318: Environmental Strategies Steven Wolf February 24, 2003

2 2 Introduction Since the enactment of the Clean Water Act of 1972 (CWA), many of the nation s waterways have been restored and maintained for chemical, physical, and biological integrity (USEPA 2003). The goal of the CWA was to develop and implement programs to protect fish, wildlife and recreational uses of the nation s waterways. The goals of the act could be met through controls of point and nonpoint sources of pollution (USEPA 2003). Following the success of the market-based environmental policy of trading sulfur, the USEPA has recently made a Water Quality Trading Policy that involves nutrient trading to control nutrient loading into the nation s waterways. Nutrient trading attempts to use the market to reduce the nutrient and sediment loading from agriculture and storm water runoff. Nutrient trading involves the trading of water pollution rights between point to point, nonpoint to nonpoint or point to nonpoint sources (Woodward 2003 and Ribaudo et al. 1998). Under the Water Quality Trading Policy proposed by the EPA in 2003, a particular watershed will be able to reduce pollution in a cost-effective manner. For example, a farmer may use best management practices to inexpensively reduce sediments and nutrient runoff. In the same watershed, there may be a municipal wastewater treatment plant that needs to meet phosphorus and nitrogen limit that can pay the farmer to reduce his/her nutrient runoff, resulting in a net nutrient loading reduction within that watershed (Whitman 2003). Up to date, there has been no federal policy that addresses the reduction of nonpoint source pollution (Ribaudo 1998). Nonpoint source pollution contains significant amounts of nitrogen and phosphorus, which are the nutrients being considered for the nutrient trading programs being piloted throughout the nation s waterways. Elevated levels of nitrogen and phosphorus create algal blooms that can deplete the oxygen supply for aquatic organisms as well

3 3 as block sunlight from penetrating into the water (Morgan et al. 2001). The lack of sunlight leads to loss of submerged aquatic vegetation, which is a loss of habitat for many fish species. The algae will eventually die and produce excess amounts of decaying organic matter that will produce a pungent odor and discourage water use, such as swimming and boating (USEPA 2002). Other factors, such as discoloration of the water and fish kill will make the water unfit for human consumption and cause human respiratory problems from the toxin released into the air (Morgan et al. 2001). In order to evaluate the success of nutrient trading programs, we studied the Dillon Reservoir in Colorado, the Tar-Pamilco Basin in North Carolina, the Chesapeake Bay watershed, and the Kalamazoo watershed in Michigan. Each region s nutrient trading program has both successes and failures that will eventually lead other initiatives to create nutrient trading programs in other waterways that will effectively reduce nutrient loading in a cost-efficient manner. Dillon Reservoir The Dillon Reservoir is located at an elevation of 9,000 feet in Summit County embedded in the Colorado Rocky Mountains. It was constructed in 1963 to supply drinking water to Denver by containing 254,000 acres feet of water in a surface area of 3300 acres. In the 1970 s, the Dillon Lake area began to see an increase in activity as recreation seekers began to flock to the area to enjoy pristine mountain vistas and unspoiled lakes (EPA 2000). Shortly thereafter tourism became the cornerstone of economic activity for the reservoir s surrounding communities and resulted in a population surge of 232% between the years of 1970 and 1980 that coined Summit County the fastest growing county in the country (Summit County

4 4 Colorado County Government). However, the wave of visitors and settlers was having a negative impact on the water quality of Dillon Reservoir as was indicated by frequent algal blooms. A study was conducted that revealed that the half of the blooms were brought on by elevated phosphorus levels caused by human activities such as municipal wastewater effluent, agriculture, urban runoff, seepage from septic systems, and other non-point sources (EPA 2000). A group of stakeholders created the Summit County Phosphorus Policy Committee with the purpose of improving current reservoir conditions and to also protect it from future contamination through the regulation of phosphorus loading into the reservoir (EPA 2000). A Fiscal Impact Statement that was prepared for the Colorado Department of Public Health and Environment Water Quality Control Commission in the early 1980 s on the designation of a phosphorus maximum capacity requirement concluded that the implications for not maintaining the water quality of Dillon Reservoir were clearly shown in the form of revenue lost. It was estimated that the non-market value of Dillon could potentially be over eleven million dollars annually and the social and economic costs of allowing Dillon Reservoir to become eutrophic could be over two million dollars annually (Colorado 1984). Now that the problem had been clearly defined, it was time for Summit County to protect its investment by developing a phosphorus control program and the nation s first point/nonpoint effluent trading program (Environomics, 1999). In 1982, the State Commission, in a variation of the National Pollutant Discharge Elimination System (NPDES), placed a cap on total phosphorus loads that could be discharged initially from four wastewater treatment plants. In Regulation No. 71 (adopted in 1984) the Summit County Phosphorus Committee, in conjunction with the state, outlined a plan that would implement the offset of point source phosphorus discharges in excess of the cap with reductions

5 5 from nonpoint sources (Colorado 1984). This would provide an opportunity for point sources to workout costly effluent control issues and also deal with an increasingly complex nonpoint source pollution problem (Woodward). This regulation was to be reviewed triennially and the results to be monitored by frequent phosphorus level evaluations. The most recent review of Regulation No. 71 (January 2001) stipulated a phosphorus Total Maximum Annual Load (TMAL) for each of ten referenced point polluters and domestic sources on Dillon Reservoir that totaled 1,621.4 pounds per year. The goal was to maintain the water quality level as reported in 1982 that were deemed sufficient to sustain all existing long-term uses. The ten municipalities and domestic facilities are allowed to trade up to a higher daily maximum load that cannot exceed.5mg/l per day. Cap exceptions must be offset by discharge credits for nonpoint sources only, and more specifically nonpoint sources in existence prior to the regulation s 1984 inception date. However, the point sources can only trade with those nonpoint sources that do not fall under the jurisdiction of the Summit County s nonpoint phosphorus mandatory mitigation guidelines (Colorado 1984). Interestingly, there have been no guidelines adopted and they have only been ambiguously addressed by stating that point source credit requests will be determined by site-specific data for the nonpoint source (Colorado 2001). This is a confusing clause that creates uncertainty in what may actually count as a phosphorus credit. Regulation 71, in effect, states that the point source must comply with regulations that do not exist. This could be interpreted as a purposeful exclusion that allows the county to retain exclusive power over permit requests. It is not difficult to make the connection that perceived difficulty in entering the market for nutrient credits would serve to discourage new trades (Woodward). If each permit applicant must wait for a review of specific nonpoint site conditions, the anticipated wait may

6 6 discourage point/nonpoint trades. It may also discourage nonpoint sources from participating in mitigating practices when unsure to what extent they are covered by the county s restrictions. Although point source pollution has been controlled, nonpoint loads are rising as a result of development. Complicating this is the inability of nonpoint source polluters to bank their mitigation efforts for future sales. 1 As long as point sources are well within caps, the demand for nonpoint credits will be minute. In fact, only a handful of nonpoint trades have occurred and only one point/nonpoint trade. The point/nonpoint transaction began in 1997 when a developer purchased Copper Mountain ski resort and was nearing its NPDES permit discharge limits due to expansion. As a result, Copper Mountain paid part of the bill to add 80 households to Frisco s water treatment facility. The proposal saved Copper Mountain over one million dollars, provided homeowners with the benefit of the municipal water treatment plant, and led to a net reduction of 40lbs of phosphorus loaded into the lake (Woodward). Although limited trades have occurred in Dillon Reservoir, it does not mean that the program has failed. The phosphorus effluent controlling technology made available to the main four point source polluters created an opportunity for significant reductions that were well below the established 1982 maximum capacities effectively eliminating the need for trade. This occurred at the onset of the program and defies normal profit maximizing behavior. The reason for this may be that municipalities that operate wastewater treatment plants are additionally bound by civic interests and not entirely forces of the market (Woodward). If this is the case, then wishes to preserve water quality of the Dillon Reservoir are for primarily aesthetic values that serve to support the tourism activities that drive the local economy, not necessarily generate revenue for the municipality. Either way, the equipment has significantly reduced effluent and essentially eliminated the need for trades. All parties benefited from the single point/nonpoint 1 An overview of the Dillon Reservoir Trading Program prepared for the EPA in 1999 states that more than ten nonpoint source projects have generated credits that have been banked but not yet used or sold (Environomics 1999). This is contradictory to the research completed by Woodward.

7 7 trade that did occur, including the reservoir and its biota. The increase of phosphorous loads to the reservoir by both point and nonpoint sources is likely to increase as more residences and businesses settle in the valley. When point sources begin to near phosphorous loading caps, credit trading will become more useful in the brokering of creative work-outs that satisfy measures to protect Dillon Lake without inhibiting economic growth. Hopefully, the local government will allow more flexibility to allow these trades to occur. Tar-Pamlico Basin Over the past 14 years, state agencies, industry, agriculture, and environmental groups have developed and implemented a nutrient trading program in the Tar-Pamlico basin of North Carolina. This program has served as a framework for other potential markets across the country, yet has accomplished only limited success in the reduction of nutrient loading in the basin. The Tar-Pamlico Basin covers 5,440 square miles and extends 180 miles from its source in the Piedmont region to the Pamlico Sound of the Atlantic Ocean (Coffey 1994). This matrix of rivers, wetlands, and estuaries supports numerous fish species, at least nine threatened or endangered freshwater mussel species, and other aquatic invertebrates (Coffey 1994). The basin includes two national refuges, Lake Mattamuskeet and Swan Quarter, where many waterfowl species dwell and breed throughout the year. The basin is relatively rural, with 37% of the land used for agriculture, mostly row crops and intensive livestock operations (EPA 1994). The area has an estimated population of 365,000 people. Agricultural, industrial, and urban development has polluted the watershed with excessive discharge and runoff of nutrients, chemicals, and sediments. The North Carolina Department of Environmental Management (NCDEM) estimated that nutrient loading in the basin would reach 625,000 kg per year by 1994 (EPA). This influx of nitrogen and phosphorus

8 8 has led to diseased fish, extensive fish kills, phytoplankton blooms, and low dissolved oxygen (DO) levels. With a DO standard of 5 mg/l, the Tar-Pamlico Basin has declined to DO levels as low as 0.5 mg/l in some areas (EPA). This disturbed ecosystem also reduces the economic vitality of commercial and sport fisheries in the estuary. The state director of the Division of Marine Fisheries pronounced the basin commercially dead in 1989 (EDF 1997). Swimmers, recreational boaters, and the thousands of residents that rely on the basin for its water supply faced a health risk as well. In 1988, the NCDEM estimated that nonpoint sources accounted for 66% of the total phosphorus and 83% of the total nitrogen in the basin (EPA). Increasing concern led the Environmental Management Commission to classify the watershed as Nutrient Sensitive Waters (NSW) in 1989 (Coffey, Hoag et. al 1997). The NSW proposal required point sources to reduce their nitrogen and phosphorus loadings from 625,000 kg/yr to 425 kg/yr by 1994 (EPA). The estimated cost of this regulation without trading was $11.8 million, with an average cost of $56/kg/yr (Hoag et. al). As a result, point source nutrient dischargers in the region formed the Tar-Pamlico Basin Association and agreed to help fund a nutrient reduction trading program in coalition with NCDEM, the Environmental Defense Fund (EDF), and the Pamlico-Tar River Foundation (Hoag et. al). The two-phase cost-effective plan encouraged dischargers to fund nonpoint source control options in order to reach NSW requirements during the first phase from 1989 to During phase one, the Association reduced nutrient loadings by 37% to 420,000 kg/yr, surpassing the requirement (EPA). They also helped develop an estuarine model to assess different nutrient sources and their impact on water quality (EPA, Hoag). The Association and

9 9 the EPA divided the $2.72 million abatement cost of developing the Nutrient Trading Program during phase one (Hoag et. al). Phase two has had limited, if any, success from an economic viewpoint. Dana L. Hoag and Jennie S Hughes-Popp evaluate the Tar-Pamlico Nutrient Trading Program based on six guidance factors that influence the success of a marketable permit-trading program for water quality. In brevity, pollution credit markets need to have both point and nonpoint source participants, low transaction costs, low enforcement costs, a trading rate determined at the margin, an optimal trading ratio between point and nonpoint sources, and a cap sufficiently lower than current loading levels. Furthermore, the program should attempt to involve all stakeholders and polluters and address their different property rights. The NCDEM and the Association need to considerably reevaluate the nutrient trading program in order to stimulate trade and adequately reduce nutrient pollution in the Tar-Pamlico watershed. The nutrient trading market requires point source and nonpoint source participants because farmers can reduce nutrient loading at a lower opportunity cost compared to point sources. The Tar-Pamlico program has potential for point-nonpoint trades among a number of participants, making trading less difficult and costly. In terms of transaction costs, the program has successfully limited expenses. Twelve of the 18 major dischargers formed the Association to reduce such transaction costs (Hoag et. al). According to the Coase Theorem, an efficient outcome between polluters and those affected by their externalities can only transpire with little or no associated costs. Pollution credit trading theory is based on self-regulation (Hoag et. al). The Association complies with NCDEM to facilitate enforcement of the program by monitoring their release of

10 10 nitrogen and phosphorus each week and by annually reporting the data (EPA). Low enforcement costs add to the program s potential for trade. Markets fail if participants do not trade where marginal benefits equal marginal costs. This simple idea allows markets to perform efficiently, maximizing profit and utility. In terms of externalities, costs to society and the environment need to be factored into the picture as well. The program initially set the trade rate at $56 a kg in phase one and reduced it to $29 per kg in phase two based on the average cost for dischargers in the region, not the marginal costs. Hoag illustrates an example of the issue in figure 1 below: (Hoag et. al) The association s marginal cost is PS and the nonpoint source marginal cost is NPS. At average cost pricing (ACP), the two sources would clean up 7.5 units of nutrients. The ACP creates a deadweight loss of area AEF. Whereas at F, the marginal costs of the farmers and dischargers equate at the efficient level of trade and no deadweight loss occurs in this efficient market. Until

11 11 the marginal cost of point source reductions exceeds the price of a nutrient credit, there is neither economic incentive nor need to conduct point-point- or point-nonpoint source trades (Hoag et. al). Furthermore, ETP occurs at different units of nutrients removed, therefore necessitating the use of a trading ratio. The trading ratio specifies the rate at which nonpoint source abatement can be substituted for point source abatement (Malik, Letson, & Crutchfield 1993). In general, a trading ratio greater than 1:1 reduces the point sources willingness to trade with nonpoint sources. Yet, trading ratios are necessary because the sources differ in abatement and enforcement costs and there is considerable ambiguity in the level and control of nonpoint loadings. Malik, Letson, and Crutchfield develop a complicated model to determine the optimal level. The model requires accurate information on abatement costs, loadings, technology, farmer profits, risk aversion, enforcement methods, environmental damages, and other degrees of probability. The model can be generally summed in figure 2: (Malik et. al)

12 12 The ratio of marginal abatement costs (C P / C N ) is equal to the trading ratio (-t*) at the competitive equilibrium (or ETP in figure 1). This point is also at the tangency of the damage constraint ED and the social cost function SC. (For a complete explanation of the economic model, review the article). In practice, the Tar-Pamlico program set a 3:1 trading ratio for cropland best management practices (BMPs) and a 2:1 ratio for confined animal farms (Hoag et. al). Returning to figure 1, the example ETP of $6.66 has an equilibrium level of 10 units for nonpoint sources and 5 units for point sources. This ratio of 10:5 or 2:1 is the unspecified trading ratio in the example. Most likely, the program set the trading ratios with inadequate information. Even if the program applied the model for the optimal ratio, the model makes numerous assumptions and requires accurate, and often costly, information. Beyond the necessity for prices set at the margin relative to the optimal trading ratio, loading limits need to be set lower than actual nutrient loading. Without this requirement, trade will never occur because the Association does not need to reduce its nutrient loading. Phase two set the nitrogen limit at 405,256 kg/yr and the phosphorus limit at 69, 744 kg/yr for the association, both of which are higher than the 1994 loading levels (Hoag et. al). The Tar-Pamlico program also has to deal with different property rights among participants. Specifically, the Association is required to control nutrient discharges whereas farmers do not face restrictions. On a social level, farmers may be more reluctant to accept trades because they would be accepting the guilt of polluting. Why would a farmer participate in a completely voluntary program if the farmer does not face any penalties? Furthermore, point source firms may avoid trades to limit any public attention on their pollution (Hoag et. al).

13 13 The environmental damages to the Tar-Pamlico watershed led to considerable reductions in nitrogen and phosphorus loadings during the first phase of the project and fostered a potentially successful trading program. Steve Coffey, the Tar-Pamlico Basin Coordinator for the Division of Soil and Water Conservation, considers the project very successful, achieving substantial water quality improvement in the watershed (2003). No trades occur because the Association made the initiative of reducing nutrient loading below the cap, creating a win-win situation (Coffey 2003). The program may not need to lower the cap if the basin has already reached an optimal level of pollution. Yet, in economic terms, the trading program has been little more than a static foundation due to numerous errors and complications in practice. If the loading limit is lowered in the future to reduce water pollution below the watershed s threshold, than the program needs to trade at the margin and apply an optimal trading ratio. Chesapeake Bay Chesapeake Bay has 64,000 square miles of watershed that covers Virginia, Maryland, Delaware, Pennsylvania, New York, and West Virginia as well as the District of Columbia (Wiederman 2001). The Chesapeake Bay is the largest estuary in the Atlantic coast, and also one of the largest in the World. The water quality and health of the ecosystem is highly valued, as evidenced by the directive in 1976 issued by the US Congress to create a Chesapeake Bay Program (CBP) to identify the factors that contribute to the water s decline (Morgan et al. 2001). Nitrogen and phosphorus are the major pollutants in the Chesapeake Bay. The source of nutrients includes both point source and nonpoint source pollution. Wastewater treatment plants contribute point source pollution into the bay. Nonpoint source pollution includes croplands, feedlots, lawns, parking lots, streets, forests and all nutrients that

14 14 enter through air pollution, groundwater and septic systems (Chesapeake Bay Program 2001). The Chesapeake Bay airshed is a major source of nitrogen, being 6.5 times larger than the watershed. Approximately 25% of the nitrogen load to the bay is attributable to atmospheric deposition (Morgan et al. 2001). Recent observations indicate that: nutrients from septic systems are increasing with higher populations; stormwater runoff is increasing with suburban and urban sprawl; nitrogen from wastewater treatment plant is decreasing due to biological nutrient removal technology that is being used; phosphorus from wastewater treatment plants is decreasing due to the ban on phosphate detergents; runoff from farms is declining due to the adoption of nutrient management and runoff control techniques practiced by the farmers, and also because the overall farm use in the area is declining (Chesapeake Bay Program 2001). Despite some of these observed improvements to the waterways since the 1980s, the water quality problems still persist in the Chesapeake Bay, and there exists a need for a more innovative approach to reduce the nutrient loading into the waterways. In an attempt to reverse the decline of the bay, the first Chesapeake Bay Agreement was signed in 1983 by Maryland, Virginia, Pennsylvania, the District of Columbia, the US Environmental Protection Agency and the Chesapeake Bay Commission. The trans-boundary agreement made improvements to the Chesapeake Bay a high priority and recognized the need for states to share the decisions for the causes and solutions for pollution. In 1987 and in 2000, the same group renewed and expanded their commitment to the Chesapeake Bay and the agreement. One of the main goals of the agreement is to remove Chesapeake Bay from the impaired waterways listing of the Clean Water Act. To reach this goal, the 1987 agreement set a standard to reduce nutrient pollution by 40% using 1985 as a base year by The 40% reduction was not met in 2000, indicating the need to keep reducing the nutrient loads into the

15 15 Bay (Chesapeake Bay Agreement 2000, and Morgan et al. 2001). Following the signing of the first agreement phosphorus levels declined 30% and nitrogen levels declined 17%. Between 1985 and 1997, point source loads fell 16 million pounds for nitrogen and 5 million pounds for phosphorus. During the same period, nonpoint source loads fell 16 million pounds for nitrogen and 1 million pounds for phosphorus (Morgan et al. 2001). Despite the improvements seen in the nutrient load to the Chesapeake Bay since the first Chesapeake Bay Agreement the necessity for more improvement is evident in order to remove the Bay from the impaired waterways list. The Chesapeake Bay Program Nutrient Trading Negotiation Team was formed in 1998 to explore nutrient trading as an alternative policy option to decrease nutrient loading (Podar 1999). In 1999, 40 members of the Chesapeake Bay Program s Nutrient Trading Negotiation Team convened to discuss the planning of a multi-state trading program that covers most of the Chesapeake Bay watershed (Podar 1999). The proposal for a large watershed-wide nutrient trading program is the first of its kind, and the success of the Chesapeake Bay nutrient trading program may eventually lead way to large-scale nutrient trading programs for the Mississippi River in order to reduce hypoxia in the Gulf of Mexico (Ribaudo et al. 1998). In 2001, after discussing the plan for a Chesapeake Bay nutrient trading program, the Negotiation Team prepared a nutrient trading guideline for voluntary use by states. They realized that a trading program would have economic, environmental, and social benefits. The economic benefits include: Cost savings for individual sources contributing to the water problem Dischargers can take advantage of economies of scale and treatment efficiencies that vary from source to source

16 16 Reduce overall cost of addressing water quality problems in the watershed Creates market demand for innovative new technologies The environmental benefits include: Achieve equal or greater reduction of pollution Creates economic incentives for polluters to reduce emissions below minimum pollution reduction and encourages pollution prevention technologies Potentially reduce cumulative pollution loading to improve water quality and prevent future degradation Can focus on broader environmental goals within trading areas Potentially encourage pollution reduction at increased rates The social benefit proposed includes: Encouraging dialogue between stakeholders that may foster a holistic solution for watersheds with multiple sources of water degradation (The Chesapeake Bay Program Nutrient Trading Negotiation Team 2001) For the success of a watershed-wide nutrient trading program, the negotiation team prepared eight fundamental principles (table 1). Most importantly, the principles state that trades must not degrade water downstream, locally or Baywide. The principles also emphasize the need for traders and the nutrient trading program to follow guidelines prepared by the Chesapeake Bay Program, including the 40% nutrient reduction goal, as well as the need to be in compliance with federal, state and local laws and regulations. Flexibility is essential for the program to adapt to changes in local, state, and federal laws and regulations. The success of the program also depends on the involvement of a diverse group of stakeholders. Without the agreement and support of diverse stakeholders, the full potential benefit of a nutrient trading program will not

17 17 result, and in order to obtain the support of many stakeholders, public education initiatives are necessary (The Chesapeake Bay Nutrient Trading Negotiation Team 2001). Table 1: Exhibit 1.2 Fundamental Principles * Fundamental Principle #1 Trades must not produce water quality effects locally, downstream, or Baywide that violate water quality standards or criteria do not protect designated uses or adversely impact living resources and habitat. Fundamental Principle #2 Trading will be allowed only within each major Bay tributary (i.e., Susquehanna, Potomac, Rappahannock, York, James, Patuxent, Maryland Western Shore, Virginia Western Shore, Maryland Eastern Shore, Virginia Eastern Shore) among all signatory states and nonsignatory states if they adopt the appropriate allowance and are consistent with the Chesapeake Bay Program s nutrient trading guidelines and state tributary strategies. Fundamental Principle #3 The nutrient trading program must be consistent with Federal, state, and local laws and regulations, be flexible enough to adapt to future changes in these laws and regulations, and enable participation of all potential sources as determined by the market place. Fundamental Principle #4 The nutrient trading program must be consistent with the Chesapeake Bay Program's nutrient reduction goals and state tributary strategies. Fundamental Principle #5 Each trade must result in a net reduction in nutrient loadings or contribute to maintenance of a tributary nutrient cap. Net reduction in loadings or maintenance of a cap shall be calculated based upon the estimated tributary loadings at a point in time determined by the state. Fundamental Principle #6 Sources should implement nutrient reduction actions to achieve the 40% reduction goal, as well as the goals adopted for the tributaries south of the Potomac River prior to pursuing a nutrient trading option. Fundamental Principle #7 Traders must be in substantial compliance with all local, state, and Federal environmental laws, regulations, and programs. Fundamental Principle #8 The involvement of a diverse group of stakeholders must be sought in the design and implementation of state trading programs and related public education initiatives. * Please see Preamble for information on the application of Fundamental Principles. (Virginia Department of Environmental Quality 2003) The guideline outlined by the Negotiation Team identifies six major elements that are essential for an equitable, environmentally protective trading program. The six elements include identifying nutrient reduction goals, determining eligibility, performing trade administration, ensuring accountability, assessing progress and involving stakeholders. Figure A shows the Chesapeake Bay Program s nutrient trading concept map.

18 18 Figure A (Wierderman 2000) In order to achieve the nutrient reduction goal of 40%, the guideline states that sources should trade only with like sources, for example, point can only trade with point and nonpoint can only trade with nonpoint. Depending on the success or failure of the program several years after the implementation of the program, the state can determine whether cross-source trading will be beneficial. For farmers to be eligible for the trading program, they must follow state certified Nutrient Management Programs. This eligibility requirement provides an incentive for farmers to follow best management practices if trading is profitable. Trade administration for the state includes establishing policy direction, certifying credits, establishing guidance on eligible trades, registering and tracking the generation of credits, monitoring compliance, enforcing program requirements and evaluating program performance. To ensure accountability, all trades will be enforceable by the state. Assessment of progress requires states to develop a model to calculate the nutrient load in their watershed. There is a Chesapeake Bay watershed model that is used to monitor Baywide nutrient loading. In order to involve stakeholders, each state should provide broad public notification of trades as they occur (The Chesapeake Bay Nutrient Trading Negotiation Team 2001). The guideline emphasizes the need for states to concentrate significant

19 19 effort in order to implement a nutrient trading program. The cost of initially implementing a nutrient program may dissuade states from implementing a plan right away. Maryland is one of the first states in the Chesapeake Bay watershed to develop a nutrient trading program. The Maryland Department of Environment drafted a trading regulatory framework in 1996 (Nutrient Net). The Maryland nutrient trading program allows buyers and sellers of offsets to interact directly or to buy or sell through a state-administered central fund. The central fund would buy offsets from the generators; the offsets would then be banked and made available for sale (New Environmentalism and Podar 1999). The state anticipates that the trading will provide a cost-effective way to improve the water quality and to meet their commitments to the Chesapeake Bay Agreement. The draft paper for the nutrient trading policy proposes a 2:1 ratio for point to nonpoint trades (Podar 1999). The Virginia Department of Environmental Quality (DEQ) is considering the possibility of trading nitrogen for the Potomac River. The possible nutrient trading program will be based on the principles and guidelines outlined by the Negotiation Team. The Virginia DEQ emphasizes the need to create local watershed models to monitor nutrient loading before a nutrient trading program can be implemented. Although the benefits for nutrient trading are realized, the state expressed skepticism for the inequities that may exist in nutrient trading. They also stated that there would be reluctance on the part of Shenandoah Valley to trade with Nothern Virginia (Virginia DEQ 2001). Virginia s example shows that although states realize the need to reduce nutrients, and also realize that nutrient trading is less expensive than other methods of nutrient reduction, there exists some reluctance for a state to be one of the first to implement this relatively new and untested method of nutrient reduction. Once the first few states have success

20 20 in implementing nutrient trading programs, many will follow as a result of the success of the first few. The nutrient trading program proposed for Chesapeake Bay considers many factors in the guideline that are specific for the watershed. The success or failure of a watershed-wide nutrient trading program depends on how well the guideline is designed for the needs of the watershed. Programs need to take into consideration the potential problem that the watershed faces in the near future as urban and suburban sprawl become widespread due to population growth. In order for the multi-state program to occur, the states within the watershed must first realize the benefits to a nutrient trading program, gain public support for trading, and create methods of monitoring nutrient loading. Until nutrient trading takes on momentum, the success or failure of this program is yet to be seen. Kalamazoo Watershed The Kalamazoo Project was a pilot water quality trading project from to inform development of statewide Michigan Water quality trading. It was a voluntary community driven incentive-based program (Nutrient Net 2001). The goal was to improve water quality in the watershed in a cost effective way (Podar 1999). The planners sought to bring about reductions in ways not possible under current command and control techniques (The Forum for Kalamazoo 2003). Priorities were to share results with community and all stakeholders and other watersheds (The Forum for Kalamazoo 2003) and to increase awareness and support for market based environmental programs (DEQ 2003). The Kalamazoo watershed drains 2,000 sq miles in southwest lower Michigan (GLTN 2001). Land use in the watershed is 70% agriculture; 21% forest, 3% wetland, and 8% urban

21 21 areas (GLTN 2001). The watershed drains into Lake Michigan. Pollution problems include many toxics, from past and present industry, and eutrophication. This project focused exclusively on improving water quality through phosphorus reductions. As in most inland water systems of North America, phosphorus is the controlling factor for eutrophication. There are 50+ point sources registered with NPDES, consisting mainly of paper mills and municipal water treatment plants contributing to loads of 2234 lb/yr (GLTN 2001). As well as increasing the eutrophication of Lake Michigan, immediately downstream of these point sources there is nuisance growth of attached algae and dissolved oxygen levels below national standards (GLTN 2001). Previous phosphorus control has been limited to effluent permits for point sources dischargers set by local water quality standards (GLTN 2001). The Kalamazoo River water quality trading demonstration project only targeted a segment of the Kalamazoo River watershed in the city of Kalamazoo, which drained into Allegan Lake (Nutrient Net 2001). The project came about through the partnership of three main forces; The State of Michigan was conducting a feasibility study of market based trading (GLTN 2001) and needed a pilot site (Nutrient Net 2001). At the same time, Crown Vantage Paper Corporation, a point source, was seeking ways to increase production without having to install expensive pollution preventing equipment. They were joined by The Forum for Kalamazoo, a community based environmental organization seeking to increase awareness and participation in improving the River (GLTN 2001). The majority of funding for the project came from the Kellogg Foundation, Crown Vantage Paper Company, World Environmental Research Fund, the Great Lakes Protection Fund, and an EPA grant to the Michigan Department of Environmental Quality (DEQ 2003).

22 22 The trading structure was set to allow point source polluters to increase their effluent if they purchase credits created by non point source polluters in the area. The trading ratio was set at 2:1. Credits are created and stored in a credit bank. The credit-generating sites were agriculture, municipal land and industry. In all cases the majority of phosphorus reduction was created through erosion control techniques. In the case of agriculture, the program was presented to farmers similar to land retirement programs. Interested farmers contacted the NRCS, or their soil conservation district, which sent a certified planner, volunteering his time, to assess the land. If the farmer was following generally accepted agricultural management practices (GAAMP) already, any additional phosphorus control resulted in credits, if the farmer was not already following GAAMPs, he would generate credits for 50% of the phosphorus. The planner gave each farmer a list of suggested changes and the predicted phosphorus reductions resulting from each. These methods included filter strips, animal exclusion, alternative watering systems, soil fertility sampling, and fertilizer management. The farmers then chose to implement the changes that were practical and beneficial for their property and business, and they would receive compensation for each credit that their changes would create. The NRCS is in charge of follow up monitoring. This method is readily accepted by farmers for two reasons: (1) it allows them to work with agencies already trusted in the agricultural community; (2) and gives farmers to power to choose what is best for their land. After the credits were stored in the credit bank, point source polluters could buy the number of credits they needed to offset any additional effluent they would be creating. There was no phosphorus cap set on the watershed but in order to exceed point source discharges (limitations set by National Pollutant Discharge Elimination System permits), the discharger must buy credits for twice that much NP pollution reduction (Nutrient Net 2001). When the

23 23 program was set up, the Crown Vantage Paper Company was planning on increasing production, and decided that paying for nutrient credits would be more cost effective than installing phosphorus removing equipment in their plant. However, by the time the Kalamazoo project was running, Crown Vantage was laying off workers and decreasing production. This changed the nutrient market, removing the buyer, and the credits simply remained in the Bank. There are many challenges in establishing a nutrient market, such as ensuring equity and accountability. In terms of equity, there was a debate over where to set the baseline for generating credits on agricultural land. The baseline could be set at present phosphorus loads, but that would give a disadvantage to those farmers already reducing their phosphorus loads. It was decided that Best Management Practices (BMPs) was too high a baseline, making it very difficult for farmers lagging behind to participate and generate credits. A compromise was made, setting GAAMPs as the baseline. Only 50% of reductions from a non point source not using GAAMPs go towards generating credits, the other 50% is retired from the watershed. 100% of reductions from farms already at GAAMPs go to credit generation (Podar 1999). The other challenge was to create accountability to ensure the accurate prediction and monitoring of phosphorus reductions, and enforcement. The planners recognized the need institutional framework and interagency partnerships. Interagency partnerships of many agricultural agencies at the National and State level affords the program certified planning and enforcement. Agencies with established reputations and resources were able to give technical supervision and ensure that farmers would abide by program rules. Although a market was not successfully created, this program was generally viewed as a success because it reduced phosphorus in a more cost efficient manner than reductions in point source pollution. Had there been a buyer, farm phosphorus reduction would have been cheaper

24 24 than new equipment, even with the 2:1 trading ratio (figure 3). From the seller s perspective, several farmers were able to achieve a greater return on investment by trading compared to traditional subsidies (Batchelor 2001). This program was limited by its small size. In order to generate a market, there need to be multiple buyers and sellers. The program didn t fall apart when the buyer dropped out because there was a bank to store generated credits and so there was an artificial demand for credits. However, if the program was expanded to encompass the entire watershed, it would have more success, and trading would offset more of the costs to the government. Figure 3: Summary of NPS Reduction Costs: Controls 1 yr cost/lb P 5 yr cost/lb P 10 yr cost/lb P Streambank $159-$372 $32-$74 $16-$32 Stabilization Animal Exclusion $42-$53 $8-$11 $4-$6 Nutrient $3.30 $0.66 $.33 Management Grassed Swales $167-$3102 $33-$620 $17-$310 Point Source Controls $292 $58 $29 Conclusion The nutrient trading programs in Colorado, North Carolina, the Chesapeake watershed, and Michigan display different route toward a pollution credit market. There is a gap between the economic theory that drives nutrient credit trading and its actual implementation. Nutrient trading is thought of as an alternative to traditional command and control regulations that place limits on effluents, but offer no flexibility in reaching them. It ideally creates a market for pollution reduction and thereby drives firms to seek innovative solutions in the spirit of competition. But nutrient trading schemes have been largely unsuccessful in that the number of

25 25 actual trades completed is relatively small. The following are possible reasons for the low number of transactions: Limited buyers and sellers in the market Caps are set higher than current loads Unbalanced trading ratios Excessive government involvement Programs that do not allow nonpoint credit banking Lack of public understanding and/or support Ambiguous methods of monitoring nutrient loading Overall high transaction costs Exclusion of stakeholders within watershed The government needs to set the cap on nutrient loads for a region in order to create the market for nutrient credit trades. However, the market must also be allowed to operate outside the confines of these regulations. Excessive regulations that limit the parties that can trade or slow the process create transaction costs that discourage trades. Yet, guidelines help create a framework for nutrient credit trade. Although the markets for nutrient credits are largely inactive, the development of nutrient credit programs initially reduced nutrient loading in many of the cases across the US. The lessons learned from past nutrient trading programs can be applied to future nutrient trading program. Guidelines such as the new Water Quality Trading Policy proposed by the US EPA can aid new programs in other large watersheds, such as the Mississippi River Basin that have major problems with nutrient loading.

26 26 Works Cited and Consulted Batchelor, David. Allowing Farmers to Trade Environmental Credits. Congressional Testimony by Federal Document. Clearing House, March 29, The Chesapeake Bay Program Nutrient Trading Negotiation Team. Chesapeake Bay Program Nutrient Trading Fundamental Principles and Guidelines. Updated 30 January < Cited 16 February Chesapeake Bay Program. Updated Chesapeake Bay Agreement. < Cited 16 February Coffey, Steve. Tar-Pamlico River Basin Nutrient Reduction Trading Program. Updated December < Cited 8 February Telephone Interview. 18 February Colorado Department of Public Health and Environment Water Quality Control Commission. Regulation No. 71. Dillon Reservoir Control Regulation. Updated 8 January < >. Cited 13 February Environmental Defense Fund. Tar-Pamlico Pollution Reduction Program Up the Creek Without a Paddle. Updated 9 September < defense.org/article.cfm?contentid=1940>. Cited 10 February Environmental Protection Agency. Final Water Quality Trading Policy. Office of Water. Updated 13 January, < Cited 4 February Nutrient Criteria: Technical Guidance Manual Lakes and Reservoirs, Appendix B Case Studies. Updated 4 April < >. Cited 14 February TMDL Case Study: Tar-Pamlico Basin, North Carolina. Updated December < cs10.htm>. Cited 7 February Environomics. A Summary of U.S. Effluent Trading and Offset Projects. Prepared for Dr. Mahesh Podar, U.S. Environmental Protection Agency Office of Water. November < 14 February 2003.

27 27 The Forum for Kalamazoo. Water Quality Trading Demonstration Program. < Cited 16 February Great Lakes Trading Network. Kalamazoo River Water Quality Trading Demonstration Project. Updated 23 August < Cited 16 February Hoag, Dana L. and Jennie S. Hughes-Popp. Theory and Practice of Pollution Credit Trading in Water Quality Management. Review of Agricultural Economics 19 (1997): Keiser, Mark S. What we always needed to know about trading but hadn t yet asked: The Kalamazoo River Experience. Keiser and Associates. August Malik, Arun S., David Letson, and Stephen R. Crutchfield. Point/Nonpoint Source Trading of Pollution Abatement: Choosing the Right Trading Ratio. American Journal of Agricultural Economics 75 (1993): Meridian Institute. Indicators of a Healthy Community:Measuring Summit County s Quality of Life < Cited 15 February Michigan Department of Environmental Quality. Kalamazoo Project. Updated 19 February < Cited 16 February Kalamazoo Water Quality Trading Demonstration Project Summary. <deq-swq-trading- TradingDemonstration.doc>. Cited 16 February Water Quality Program Overview. Updated 20 December < Cited 16 February Morgan, Cynthia, and Nicole Owens Benefits of water quality policies: the Chesapeake Bay. Ecological Economics. 39: New Environmentalism. Effluent Trading. < Cited 4 February Nutrient Net. Introduction to Nutrient Trading. Updated < Cited 16 February Kalamazoo River project, Michigan. Updated < Cited 16 February 2003.

28 28 Podar, Mahesh Dr. A Summary of U.S. Effluent Trading and Offset Projects. United States Environmental Protection Agency Office of Water. p. 19 November Ribaudo, Marc O., Ralph Heimlich, & Mark Peters Nitrogen Sources and Gulf Hypoxia: Potential for Point-Nonpoint Trading. Economic Research Service: Washington DC. Summit County Colorado County Government. Population Statistics. < Cited 18 February Summit County Development and Planning Division. Summit County Development Code. Chapter 7: Water Quality Control Regulations. Updated 26 February < Cited 14 February Virginia Department of Environmental Quality. Updated March Draft Interim Nutrient Cap Strategy for the Shenandoah and Potomac River Basins. < Cited 18 February Wiedeman, Allison. Updated August Nutrient Trading and the Chesapeake Bay Program. < Cited 22 February Updated April Nutrient Trading for the Chesapeake Bay. Chesapeake Bay Program. < Cited 22 February Whitman, Christine. Updated 13 January Remarks of Governor Christine Todd Whitman, Administrator of the US Environmental Protection Agency, on announcing the Water Quality Trading Policy. < Cited 4 February Woodward, Richard. Lessons about Effluent Trading from a Single Trade. < Cited 15 February 2003.