Watershed Services: The New Carbon?

Amanda Hawn

Now that carbon markets are beginning to take off, people all over the world are looking to markets in the water-related services of ecosystems as the ‘next big thing’. But markets in watershed services are very different from markets in carbon. Can these services be traded, and if so, how? The Ecosystem Marketplace takes a look at these and other questions.

Now that carbon markets are beginning to take off, people all over the world are looking to markets in the water-related services of ecosystems as the “next big thing”. But markets in watershed services are very different from markets in carbon. Can these services be traded, and if so, how? The Ecosystem Marketplace takes a look at these and other questions. Mention eucalyptus and pine to many in the US and they will tell you about the bracing benefits of clean fresh air. Mention the trees to your average South African and you will induce a bristle. Spider Gum, Australian Wattle and Monterrey Pine are three of the most widespread invasive tree species in South Africa and, as it turns out, South Africans have reason to dislike them. Studies show that invasive species suck up 7% of the country’s annual run-off – 3,300 million cubic meters of water that might otherwise fuel healthy watersheds and slake the thirst of millions of people in a dry land. Faced with these numbers when he took over the new South African Ministry of Water Affairs and Forestry in 1994, Kadar Asmal went to the drawing board and came up with an innovative program called Working for Water. Asmal built his program on the recognition that impoverished South Africans needed at least two things flowing into their homes as they struggled to overcome the economic legacies of Apartheid: water and income. Addressing both of these, in 1995, Working for Water began paying people to clear invasive species out of river catchments where the thirsty plants were locking up valuable water. Today the program employs over 20,000 people and is the largest conservation effort on the African continent. Municipalities throughout South Africa are beginning to adopt Working for Water’s approach, and so are private companies. Recently a platinum mine needing water to process its ore approached the Department of Water Affairs and Forestry about hiring people to clear invasive plants from its local watershed. And in Hermanus, a coastal town known for its whale-watching and pretty second homes, a new water billing system (charging low rates for basic water use and premium rates for high use) generates enough revenue to pay people to hack down invasive trees in the region. In South Africa clear links are being made between water, environment, economy, and jobs. A Unifying Principle “When you talk about conserving a rare species of Panda,” says Marta Echavarria, Founder and Director of EcoDecisií³ ®   ©n Ecuador, “people think ‘Oh, that’s nice’ and then they move on, but when you talk about water, it is a unifying element? everyone cares, so people are willing to work to conserve it.” The notion that ‘water is life’ is the shared tagline of Bolivian demonstrators protesting water privatization and NASA scientists scouring satellite photographs of our neighboring planets. So it comes as no surprise that water should be a powerful organizing principle. And yet, more than a billion people in the world still lack access to safe drinking water. As populations expand and dissatisfaction with the historic command-and-control approach to water management grows, people are looking for new ways of protecting and distributing the world’s precious water resources. Business relationships like that embodied by Working for Water are among the most promising emerging solutions to both water-scarcity and environmental degradation. Many of the world’s urban populations live downstream from watersheds that provide them with valuable services including water purification, sediment control, and the regulation of flow patterns. And, because watershed management may be cheaper than alternatives like dams and filtration plants, logic dictates that both upstream and downstream actors may want to work out a system in which the latter pays the former to conserve the ecological integrity of a watershed. South Africa isn’t the only country to have picked up on the idea. Throughout the world, innovative private deals, trading schemes, and government programs have been structured around the concept that watersheds provide valuable services which, if marketed correctly, might help watershed conservation pay for itself. After benzene was found in Perrier Vittel’s bottled water in 1990, for instance, the company (now owned by Nestle) discovered it would be cheaper to invest in conserving the farmland surrounding their aquifers than to build a filtration plant. Accordingly, they purchased 600 acres of sensitive habitat and signed long-term conservation contracts with local farmers. Across the Atlantic, factories in the United States pay farmers to reduce their pollution emissions along a river so that the factory, in turn, can operate within overall pollution caps in a watershed. In effect, the factories are purchasing pollution permits from farmers at a market price that is amenable to both parties. Such ‘cap-and-trade’ systems, many argue, allow communities to meet pollution standards in the most cost-effective way possible. A final example may be found in Costa Rica where a revolutionary law tacking an environmental tax onto the sale of fossil fuels was passed in 1996. The revenue generated from the tax is used to compensate landowners whose conservation efforts sustain a forest’s ecosystem services, namely its biological richness, carbon sequestration and watershed protection. These conservation efforts provide real world examples of the ‘users pay’ approach many scientists and economists advocate for managing and marketing the services provided by the world’s watersheds. Based on their success, the approach that some call the “Payment for Ecosystem Services” (or PES) model seems capable of creating innovative win-win watershed deals. People who have taken note of the idea are touting watershed services as the next big environmental market, akin to the carbon markets now under development around the world. Are they right? According to pioneers in the field, the answer is both yes and no. Stefano Pagiola, a Senior Economist with the World Bank’s Environment Department, stresses that PES models are, “Not a solution that will work everywhere or all the time.” The niche-tailored elegance that makes conservation finance mechanisms so effective locally, also prevents them from being scaled up too broadly, or too quickly, when it comes to larger markets. “Progress has been gratifying but slow,” says Randy Curtis, The Nature Conservancy’s Director of Conservation Finance and Policy. Thus, while pilot projects look promising, the men and women behind them caution that, when you are working across the various hydrological, legal and socio-economic terrains that distinguish each watershed from the next, one size does not fit all. Paying people to rip up pine trees – as is done in South Africa – is hardly the way to go if you want to protect a watershed in Utah. Similarly, cap-and-trade systems – which might work in Utah – make little sense on a South African river entirely devoid of factories. Unlike carbon credits, watershed services are not fungible and so must be traded on a watershed or sub-watershed level, effectively limiting the size and scale of resulting markets. The nature of the users-pay model, say experts, is such that you have to implement it on a case-by-case basis. That does not mean that interested parties must continually reinvent the wheel. Al Appleton, one of the chief architects behind a much publicized watershed deal which saved New York City billions of dollars, stresses that, while all business transactions are different, the lessons learned in each can be tailored and applied to the next. “The dress business is common,” says Appleton, “but every woman is an individual.” Hoping to streamline the process of moving PES models out of the boardroom and into the forest, scientists and economists are identifying the questions that must be answered at each stage of a project in order for it to work. The answers themselves are going to be specific to a site, their logic runs, but the questions that prove germane to one project also should be relevant to the next. For now, there appear to be four big questions that must be asked of any watershed-project – be it a private deal, a regulated trade, or a government effort. Under the umbrella of each of these questions float many more, and in their matrix, scientists and economists, buyers and sellers, governments and businesses are highlighting the hidden challenges and opportunities so crucial to making markets in watershed services, and the watersheds themselves, work in the coming century. Four Key Questions (1) What is the problem you are trying to solve? This is the first and most important question facing watershed managers. Hydroelectric companies generally don’t care about the drinking quality of water when using it to power their turbines. They worry about water quantity and sedimentation loads because these are the factors influencing their business. A little benzene won’t slow down electricity production, but mud will. New York City water wonks, on the other hand, are tasked with supplying 9.5 million New Yorkers with clean, healthy water. They understand that benzene running from the tap is unlikely to garner appreciative smiles in Manhattan, so they care about water quality just as much as they do about water quantity. In short, figuring out who needs what from a watershed requires more careful analysis than many realize. It also requires good science. To date, this has been one of the biggest challenges facing conservationists and economists interested in marketing watershed services. The qualitative impacts of a healthy watershed on water quality and flow generally are understood. Contrary to popular myth, healthy watersheds usually do not increase water quantity (the South African example and cloud forests are exceptions), but they do improve water quality, control flooding, and regulate water temperature. The water they give up, in other words, is better. Unfortunately, just how much better is still up in the air. “Sometimes PES programs have been developed around somewhat shaky science,” notes Sandra Postel, Director of the Global Water Policy Project. The topography, soil and climate of every site varies, so the real lesson from early efforts is that projects must be designed with flexibility in mind. The good news, says Brian Richter, Director of the Nature Conservancy’s Sustainable Rivers program, is that scientists are, “Right on the precipice of some real breakthroughs.” As long term datasets on development patterns and water flow finally begin to align themselves, Richter predicts that we will know a whole lot more about the link between land use and the hydrological cycle within the next five years. (2) Once project managers identify the problems at hand and the land use patterns likely to solve them, they must roll up their sleeves and start wrangling deals. Mark Keiser, the Acting Coordinator of the US Environmental Protection Agency’s Environmental Trading Network (AC of EPA’s ETN if you prefer acronyms to tongue-twisters), stresses that the secret is to start with the demand side of the equation because markets for watershed services tend to be thin and somewhat ill-defined. The second big question that watershed managers must ask themselves, then, is, ‘How do you transform the beneficiaries of watershed services into buyers of watershed services?’ Two projects highlight the mechanisms behind this little bit of magic. In 2000, Quito created a water fund to pay for conservation in two of its major watersheds. The city’s municipal water company contributed one percent of its water sales to get the fund started and the municipal electric utility and a local beer company now kick in annual payments to keep it growing. (See profile of Marta Echavarria, one of the deal’s architects, click here). The fund currently stands at $1.7 million and will soon generate enough annual interest to bankroll conservation projects upstream of the city. When asked why he thought Quito’s water users chose to invest in the ecological integrity of their watershed, Nature Conservancy’s Curtis responded, “When you walk out into the streets of Quito, you can see the snowcapped peaks surrounding the city. In a place like that, you know where your water is coming from and, as a result, watershed services are very visible to people there. This isn’t the case in a lot of cities where water is piped in from faraway.” Echavarria is a little more skeptical that the water source is so obvious to the residents of Quito. “You really have to point to the snow-capped peaks and say ‘that’s where you get your water.'” Education, she says, is important when it comes to getting the message across. Walking out of Penn Station onto 34th Street, any New Yorker who looks up will see concrete and neon, taxi-lines and donut shops. The forested slopes of the Catskills, some of the city’s main watersheds, lie roughly eighty miles to the north; they are very much out of sight and, usually, out of mind. Nonetheless, New York’s water municipality, much like its counterpart in Quito, decided to invest in the protection of its watershed. While not visible to the average New Yorker on the street, the ecosystem services that the Catskill watershed performs are clearly understood by the water system’s managers. For this reason, people like Al Appleton began to pay close attention to the Catskills when increased pollutants were compromising the drinking water piped down from upstate in 1989. At that time, the EPA ordered the city to build a filtration plant at a projected cost of $6 to $8 billion, a chit that proved hard for New York to swallow. After looking into property values and forging alliances with Catskill residents, the city came up with an alternative proposal. Instead of building the costly plant, they would buy back land, finance reforestation projects, create buffer areas along important streams, and sign conservation easements with farmers to protect the natural filtration process of the watershed. The total cost of this plan, they calculated, was in the neighborhood of $1 to $2 billion. In a city where money talks, several billion dollars speaks volumes to New Yorkers, mountain-view or no. Visibility and tangibility determine viability when it comes to marketing watershed services. In areas less topographically accommodating than Quito (and even in them) project managers must make services visible. Again, demonstrable scientific evidence is needed to link land use to water quality. Equally important, managers need a reliable means of assigning tangible monetary value to the services they are marketing. As in the New York City example, the easiest way to do this, to date, has been to estimate the avoided cost of providing clean, reliable water sources using reservoirs and filtration plants. Unfortunately, this methodology doesn’t take into account the long-term social and biological benefits of conserving the ecological integrity of a watershed. Experts thus stress that economic models aimed at capturing the full value of watershed services still need to be refined in order to convert beneficiaries into buyers in the most effective manner possible. “Conserving a watershed,” says Appleton, “is a long-term approach with some immediate spin-offs.” (3) So you have wrestled the buyers to the table, now you must figure out how to turn upstream residents into land stewards. Asking a watershed’s residents to ‘deliver ecosystem services’ is like teaching someone to drive by pointing to your car. Watershed residents won’t know where to begin. After all, few projects will have stewardship requests as easy to understand as ‘please rip out invasive species,’ but they should. Identifying land use programs that represent attractive, sensible options for rural communities is crucial to the success of any watershed project and, according to veteran project managers, there are some rules of thumb about how to develop them. Above all, managers must recognize the substantial opportunity costs assumed by watershed residents who, in order to join a conservation scheme, forego the chance to do something else with their land. “When you are talking about a living landscape,” says Curtis, “you need to bring all of the actors to the table.” This can be particularly difficult in developing countries, where the stakeholders include the poor with no title to their land, as well as those more powerful, more politically savvy, or more prosperous. One good way to ensure the poor can participate is to keep transaction costs low. If start-up agreements get overly bogged down in the fine print of complicated contracts, everyone walks but the lawyers. Buyers can’t afford to pay steep transaction costs on a large scale and sellers can’t afford to gain entré ¥  to the market. The lack of market infrastructure to match sellers with buyers is also seen as one of the biggest obstacles to designing effective conservation finance mechanisms for watershed services. At the same time, collapsing payments for environmental services into a poverty alleviation strategy is a dangerous trap. “There are likely to be very good synergies between the PES approach and poverty alleviation,” says Pagiola, “but too often the situation gets distorted by prioritizing poverty alleviation to the point that you loose track of the original objective, which was to provide a service.” If services aren’t delivered, he notes, the whole system falls apart. Similarly, if payments aren’t made to land stewards, they likely will revert to cutting down trees and dumping sewage when and where profitable. Long-term incentives targeted towards specific actions from individuals are the key to success, so payment and service delivery structures must be designed accordingly. (4) How do you monitor the success or failure of your program? This is the final question facing managers trying to use economic incentives to promote watershed conservation. Conservation finance models have a major leg up on strict regulatory schemes when it comes to monitoring results since all involved have a vested interest in keeping tabs on what’s happening. Downstream beneficiaries will keep an eye on whether or not their payments are generating the desired services, and upstream land stewards will report their actions to ensure that they are fairly and continually compensated for their efforts. Fortunately, when there is money on the table, there is accountability. That said, real-world monitoring efforts of the users-pay approach are, in the words of one scientist, “Just beginning to happen.” Most watershed conservation efforts using payment systems are in their infancy, so it is especially important for managers to check back with each other early and often regarding the scientific, social, and financial impacts of their efforts. One year after Hermanus instituted its innovative billing and conservation programs, water consumption was down by 30%, revenues from water sales were up by 20%, and water was more affordable to the poor. Moreover, 96% percent of residents approved of the changes. Such evidence suggests that re-thinking watershed management using innovative incentive structures just might be working. Making Heads and Tails of It Wealth or poverty, public health or widespread disease, biological diversity or mass extinction, international cooperation or conflict – every one of these coins is in the air as we head into the 21st century. Management of the world’s freshwater will play an important role in determining how each of them lands. As mankind adds another 1 to 2 billion people to the world in the coming decades, the equitable distribution of water poses a larger problem to society than ever before. Fortunately, in areas where the potential for water conflict is greatest, a countervailing potential for cooperation also exists. This cooperative impetus stems, on the surface, from the desire to avoid political and economic conflict. On a deeper level, however, it is based on the innate recognition that water is essential and valuable to us all. Markets for watershed services are incredibly powerful because they capitalize on this recognition. By aligning the interests of upstream and downstream users, conservation finance mechanisms create a sustainable solution to watershed management that does not depend on the whims of donors. Their innovative approach is beginning to transform water problems into community opportunities throughout the world. And so, as we take note of their early success, we wonder again: can watershed services become the world’s next big environmental market? For now, the jury is out, but if we take the time to ask the right questions, say the experts, we will soon find out?one project at a time. Amanda Hawn is a regular contributor to the Ecosystem Marketplace. She is an evolutionary biologist and science writer currently living in Minneapolis. She has written about science and the environment for a variety of publications including The Economist, Sierra Magazine, and others.

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