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The Five Keys to Constructing Successful Water-Quality Schemes

Tracy Stanton

Scores of water quality trading schemes are up and running around the world, and the World Resources Institute has published a 16-page study designed to identify what works, what doesn’t, and why. Mindy Selman is the lead author, and Ecosystem Marketplace caught up with her in Washington.

Scores of water quality trading schemes are up and running around the world, and the World Resources Institute has published a 16-page study designed to identify what works, what doesn’t, and why. Mindy Selman is the lead author, and Ecosystem Marketplace caught up with her in Washington.

19 June 2009 | Water-Quality Trading (WQT) schemes aim to slash the amount of pollution running into streams and lakes by enticing small farmers and other emitters to voluntarily reduce their discharges in exchange for payments from larger, regulated emitters. Advocates believe such schemes can generate deeper, cheaper cuts than can standard regulation, and scores of projects are up and running around the world.

We’ve covered these schemes extensively in Ecosystem Marketplace (for a WQT introductory, see our eight-part series beginning with Water Trading: the Basics), and last year the a href=”http://www.wri.org/” target=” blank”>World Resources Institute undertook a survey of the entire global WQT market.

The result is Water Quality Trading Programs: An International Overview, a 16-page report authored by Mindy Selman, Suzie Greenhalgh, Evan Branosky, Cy Jones, and Jenny Guiling.

The report identified 57 water quality trading programs worldwide in 2008 – of which 26 were active, 21 were under consideration or in development, and 10 were either inactive or were pilots with no plans for future trades. All but six were located in the United States, with four in Australia, one in New Zealand, and one in Canada.

The report identified Five Key Factors that stakeholders cited as being important for the successful implementation of their trading programs:

• Strong regulatory and/or non-regulatory drivers, which helped create a demand for water quality credits;
• Minimal potential liability risks to the regulated community from meeting regulations through trades;
• Robust, consistent and standardized estimation methodologies for nonpoint source actions;
• Standardized tools, transparent processes, and online registries to minimize transaction costs; and
• Buy-in from local and state stakeholders.

The team compared water quality trading programs along seven dimensions: policy drivers, allocation of caps, establishment of nonpoint-source baselines, nonpoint-source nutrient reductions calculations, use of trading ratios, market structure and trading activity.

We sat down with lead author Mindy Delman at her offices in Washington, DC, to discuss the report and its implications.

Mindy, thanks for speaking with us. Can we start by asking you to summarize your findings?

Nothing too surprising, given the information available. There are some success and some failures. One of the most significant failures is the lack of effective drivers in many of the programs we looked at. One success is the trading program in the Long Island Sound which is both interesting and successful as it is a point to nonpoint source trading programs which is not the norm.

You really mean there were no surprises?

Perhaps the number of new programs. In the US, the national drivers lead to regional programs; outside the US the drivers are local.

Can you anticipate how these activities might evolve?

The program design, implementation and monitoring tools are evolving; and modeling is becoming easier. Certainly, innovation will help future program design – perhaps most importantly in the area of risk, where newer programs are using design elements such as aggregators, banks and “insurance” ratios to mitigate risk. Also, as more watersheds suffer from eutrophication and/or hypoxia, the need for watershed-wide nutrient caps will only increase; and WQ trading is increasingly seen as an effective tool for mitigating costs and for allowing growth while maintaining the cap.

Are you able to conclude that WQT does lower compliance & abatement costs?

To answer this one requires understanding the two primary reasons that trading is utilized in the first place.

First, water quality trading can be an economic tool whereby regulated sources that are currently not meeting their cap can either choose to pay to upgrade their facility or purchase credits from another regulated facility or a nonpoint source such as agriculture. While in many instances purchasing credits may be cheaper, there are several factors besides cost that the facility weighs with this decision—for instance, risk and longevity of credits. In many instances we hear about facilities that choose the more expensive option to upgrade in lieu of purchasing credits because this option creates certainty.

The second purpose of water quality trading is to allow for new growth/new sources. Under many watershed caps, there is no allocation for new growth — meaning that a new or expanding facility must purchase offsets to equal its nutrient load to the watershed. In this instance, water quality trading is a necessary tool that allows capped watersheds to accommodate growth — it is not about lowering compliance costs, but about accommodating growth.

Any significant patterns or trends in the data?

Regulatory schemes are implemented where caps can be utilized. One lesson learned with trading under a TMDL: the early ones have not been conducive to trading — many were developed as seasonal TMDLs, or caps were set high for point sources, meaning that trading would not be necessary in the near- or mid-term.

Of the five key factors most needed for good program design, which one is most often lacking?

Idle programs often lacked a driver. For example, Great Miami and Idaho programs are still waiting for TMDLs to be developed.

In the Chesapeake Bay, however, things are different. The State of Maryland adopted water quality standards for the Bay; and then, because upstream waters couldn’t degrade downstream waters, Pennsylvania and West Virginia have to meet Maryland standards. This created a need in all of these states to develop both nitrogen and phosphorus limits for both point sources and water quality trading programs that allowed existing point sources to meet limits through trading and also allowed new and expanding sources to offset new discharges. For the most part, divers within the Chesapeake Bay will not be in place until next year, when many of the states will begin issuing permits, but we expect that trading in these states will happen both as a means to meet permit caps and to offset new development.

Which one is most critical?

Drivers are critical, and so is stakeholder buy-in. We’ve seen many of the programs flounder because they’ve lost support from key stakeholders — either the regulatory agency does not wish to support the program, or the regulating community is not interested in participating…

The pilot trading program in the Kalamazoo watershed in Michigan has not received support from the state and has struggled as a result, but programs like the Great Miami have excellent support from both the agricultural and regulated point-source communities and have been very successful with their pre-TMDL trading program, even though they’re still waiting for the TMDL to be developed.

The other critical elements we mentioned include mitigating risk to regulated community, developing standard estimations for nonpoint source loads, and minimizing transaction costs in the program. All of these, I feel, are things that have evolved throughout the short history of water quality trading.

For risk, there are now things like aggregators, reconciliation periods, insurance reserves, etc. that are being used in several programs to mitigate point source risks.

Estimation methodologies for agriculture have evolved. In addition to NutrientNet, there is the Nitrogen Trading Tool under development by NRCS. Lastly, the necessity of having registries as a means of tracking trades and also streamlining processes is being recognized. NutrientNet serves as a registry for the programs where it is used, but there are several entrepreneurial companies, like TZ1, that are exploring opportunities for creating registries in other programs.

What’s the most challenging component of establishing a WQT program? For example: establishing the NPS baseline, setting the trading ratio?

The stakeholder process is not to be underestimated. It can be costly and time consuming, but critical. The stakeholder process is where program design elements come together, but also where you can ensure support (or conversely generate skepticism) of the program.

Liability and risk management can make or break the attractiveness of a trading program. Point sources are fairly risk adverse and are often engaging in trading for the economic benefits but are still required by permit to meet certain pollution thresholds. So aggregators or insurance mechanisms can help mitigate these risks.

Determining the nonpoint source baseline is a real challenge. If the bar is set too low, it can allow bad actors to be rewarded and good actors punished. Therefore it is important to set the baseline to exclude bad actors which may make the credits more expensive but it creates and assures additionality.

Any comments on what you learned or how others may interpret those lessons?

Actually the five key factors outlined at the beginning of this discussion are the most transferrable lessons; they are germane no matter the water body or watershed engaging in trading.



Tracy Stanton is the Water Program Manager of the Ecosystem Marketplace. She can be reached at tstanton@ecosystemmarketplace.com.

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