Ohio Water Trading: Driving without Drivers

10 June 2008 | Douglas “Dusty” Hall remembers the incident all too well.

“We’d had over 100 meetings with farmers while developing this trading program, and we had Ohio EPA, the Farm Federation, urban wastewater treatment plants, and local farmers all on the same page,” he recalls. “Then someone at the EPA said we should draw up EPA rules for this, so that their inspectors could get onto farms joining the program.”

Suddenly, the farmers stopped coming to meetings, and the wastewater plants began shifting into wait-and-see mode.

“A bump in the road,” says Hall. “Or a mountain – it took us months to get over it.”

Three years later, the Great Miami River Watershed Water Quality Credit Trading program has helped family farmers voluntarily slash the amount of fertilizer they discharge into the watershed by a whopping 650,000 pounds, but now it faces another mountain in the road, even as Hall prepares for the fifth – and perhaps final – round of funding requests.

The Funding Round

Between now and mid-July, Hall’s Miami Conservancy District office, which coordinates the trading program, will be inundated with funding requests sent in from Soil and Water Conservation Districts (SWCDs) across the watershed. Those requests will describe an array of projects – from conservation tillage to the construction of manure management facilities – but they will all have one thing in common: each will have been presented to the SWCDs by family farmers looking for money from municipal wastewater treatment plants.

The money that the plants pay to the farmers will be used to reduce agricultural discharges in exchange for credits under what is arguably the most successful Water Quality Trading (WQT) scheme in the world today – and a scheme whose future is far from assured.

The New Mountain

The program was launched in late 2005, around the time the state was supposed to begin phasing in water quality criteria that would create an incentive for wastewater treatment plants to buy offsets from farmers.

The criteria, however, haven’t materialized – and the delay in launching them has, ironically, been exacerbated by Hall’s own team, which decided to measure the amount of phosphorous and nitrogen in the water and found the levels were just a quarter of the state’s Total Maximum Daily Load (TMDL), which was to serve as a mandatory cap for one of the watersheds in the trading program.

“It was astonishing,” says Hall. “You’d go out and see the algae blooms, so you knew the water was loaded with nutrients, but the state was essentially saying that the TMDL target had been met.”

The ensuing debate temporarily left the planned TMDL in limbo, and that left the program without anything to drive the wastewater treatment plants to use it – a common problem, as the World Resources Institute (WRI) reported in US WQT: Growing Pains and Evolving Drivers.

“Many WQT programs were developed in anticipation of regulatory caps that either never materialized or were too weak to create sufficient demand for trading,” the report says. “As a result, these trading programs experienced little or no trading – and some are still sitting idle.”

Early Bird Special

The Great Miami initiative has managed to keep itself going through an innovative incentive program that gives early buyers more offset credits in later years for every pound they reduce today.

For example, if a wastewater treatment plant aggregates 20,000 credits before regulations kick in, it gets a more favorable trading ratio on the first 20,000 credits they purchase every year after regulations kick in.

“It’s like buying your way into the country club and getting cheaper greens fees after you’re a member,” says Hall, who draws a clear distinction between the Great Miami incentive ratios and traditional “trading ratios”, which give more favorable ratios to offsets carried out closer to the targeted body of water or meet other scientific criteria.

“If you get people investing early, you are environmentally reaping the benefits of improved practices now, rather than after criteria are introduced,” he says, adding that the most favorable ratios don’t apply to reductions flowing into water that doesn’t meet environmental standards.

“By requiring more credits in non-attaining waters, you get more cleanup accomplished in areas that need it the most,” he says.

The Money

The Ohio Environmental Protection Agency (EPA) is expected to put its water quality criteria out for public review later this year – about the same time Hall’s $937,807 Conservation Innovation Grant runs out in September.

That grant covers just under half the cost of the scheme, with the wastewater treatment plants putting up $1,232,960 to date.

The bulk of the funds from both sources – about $600,000 from the plants and $570,000 from the CIG – has gone into a segregated fund for agricultural project development.

The next biggest chunk is roughly $400,000, which goes to pay for the cost of automated samplers and laboratory fees, which Hall and his team utilize to monitor water quality. That cost was split between the CIG and the plants.

Roughly $360,000 of the plant money has gone to pay for hydrologists, sample-collectors, marketing, and in-house modeling carried out by the broker – Hall’s team.

Buying Credits – Not Projects

Hall stresses that the pilot program is not designed to promote or test sweetheart practices, but to see whether reductions can be turned into tradable commodities.

“The bid process is just about the numbers, and not what type of practice is being implemented,” he says. “Our primary focus is how many credits the agricultural project will generate, and how much money the producers want – that’s what makes the whole payment thing flexible.”

Conservation tillage is a case-in-point. It not only reduces runoff, but also saves on fuel. A producer may be on the brink of implementing it, but needs – or at least wants – a little extra push.

“He may decide to sell credits, and come in aggressively with his pricing,” says Hall. “He may come in at only 20% of what it would cost him to implement the change – but that’s still money that is incentivizing him to do it, and it makes the practice more sustainable, because he is committing to continue for a set period of time.”

Models Make the Commodity

Rather than measure the runoff at nonpoint sources like family farms, the scheme uses a model with nearly 30 different practices to determine how much reduction they generate.

“These models calibrate the commodity,” says Hall. “The trouble is, models can be improved over time – and there’s a chance we could find, say five years down the road, that some models over-estimate reductions, while other models under-estimate them.”

And that, he says, creates a dilemma for buyers.

“An offset is a commodity, and when wastewater treatment plants buy a commodity, they expect it to be a commodity, and they expect it to be a commodity tomorrow and ten years from now,” says Hall. “That won’t be the case if we have a clause that says this deal can change if we get new information.”

His solution: keep the door open to new models for future funding rounds, but close the door once a round is complete.

“Everybody just has to say this is how we define the commodity, and it will be what it is forever – even if we change the definition down the road,” says Hall. “The range of practices covered by the model has been expanded since the program began, because some types of animal waste practices couldn’t be addressed earlier – but that doesn’t change the terms of earlier rounds.”

Science and Reality

A chemist by training, Hall says many of his peers waste time looking for the perfect solution – and end up letting the perfect be the enemy of the good.

“Science needs to embrace the concept of adaptive management,” he says. “At some point, you have to admit what you can and cannot know.”

And then, he says, you proceed – and if you make a mistake, you learn.

“When you accept the fact that it’s imperfect but can be improved over time, that makes this all possible,” he says. “If you come through the front door saying it has to be perfect, you’ll never start because there is no such model.”

Choosing the Models

The model used to quantify credits was selected during development of the trading program. The model is run by each SWCD for each project they submit for funding. The project modeling is monitored by the Ohio Department of Natural Resources (ODNR).

Hall would like to see the maintenance of the model passed to the ODNR completely. “For now, we’re the only aggregator in town,” he says. “Eventually, we’ll see more groups like ours coming into the game, and you can’t have them all using different models.”

Additionality

Although the process makes it possible for farmers to cash in on changes they might have made anyway, Hall says credits don’t go to projects that are already getting funding from either Farm Bill conservation dollars or state dollars allocated under Section 319 of the Clean Water Act.

Interestingly, the additionality criteria were inserted at the insistence of the advisory group, which is made up of farmers and dischargers.

“The wastewater treatment plants in the program right now collectively want the program to cause incremental additive improvement,” says Hall. “They want to fund a separate set of projects than those that would otherwise be funded by other conservation programs, because they don’t think it makes sense to just be spending money without creating improvements.”

Up-Front Payment? No Thanks

One point of contention is how to pay out the projects. Currently, Hall pays the funds out to an SWCD once a deal is agreed to, but asks the SWCD to pay out to the farmer annually – and only after its inspectors have confirmed that the practice they contracted for is being implemented.

“The way it works now is that I and a representative of the wastewater treatment plants jointly issue a memo to the fund manager, who is in the finance department of the city of Dayton, to write the check to the SWCD, and we ask the SWCD to make annual payments for the duration of the project,” he says. “I prefer there’s an annual payment, because that payment is a reminder to the farmer that there is an obligation.”

All fine and good – but what if the practice is something like the construction of a manure management facility, which requires up-front costs?

“Here’s where I have a running difference of opinion with the SWCDs,” he says. “Their position has been that once the structure is in place, the farmers are going to use it and don’t need an annual incentive. My position is I still want the annual reminder and inspection.”

One probable compromise: a large up-front payment to cover initial costs, with incremental payments thereafter. “If there’s, say, a 15-year project, I can see paying 85% up-front and 1% per year annually,” Hall says.

The Advisory Group

The Project Advisory Group determines which projects go through and which do not, and Hall says it’s made up of people best suited to make the call.

“We wanted on-the-ground practitioners, and that’s what we have,” he says. “Our agriculture guys, for example, aren’t from agribusiness – one’s from a family farm, while another is a representative from the state farm bureau.”

Likewise, the wastewater treatment side has a plant operator as well as a member of their state association and a member of their national association.

“We did the same thing on conservation expertise,” he says. “We have an SWCD representative, someone from the state, and someone from the Natural Resources Conservation Service (NRCS), and on and on – just to cover the breadth of interests and ideas.”

The Reverse Auction

The so-called “reverse auction” has been a cornerstone of the pilot program, and Hall says it will be implemented in a compliance scheme – assuming criteria are put in place.

A two-step process, the compliance model will begin with wastewater treatment plants evaluating their offset needs and telling Hall what they are willing to pay. Then Hall will announce a bidding round – where farmers submit bids to SWCDs, and the SWCDs submit them to the advisory group, which in turn matches up the bids to the offers.

Buyer for Every Seller; Seller for Every Buyer

As an aggregator, Hall not only accumulates deals, but acts as a buyer for every seller and seller for every buyer.

He believes it’s critical to sever the direct link between farmers and wastewater treatment plants, and even discourages direct bilateral offsets between wastewater treatment plants and farmers.

“Some people believe that trading programs should transfer permit liability from the wastewater treatment plants to the producers who are meeting the reductions of the permit,” he says. “But producers won’t participate if there’s a transfer of liability.”

But it’s inevitable, he says, that one day a farmer will fail to make good on his obligations.

“It could be something as simple as a farm changing hands and a buffer strip getting tilled by the new owner by mistake,” he says. “It could be an honest mistake, and if the plant doesn’t get beaten up by regulators, it won’t go after the farmer. But if the plant does get hammered by regulators, it’s going to be very tempting to make some sort of breach of contract claim against the farmer.”

The consequences, he says, could be devastating.

“That only has to happen one time anywhere in the country to place all trading programs at risk,” he says. “That’s why we have no specific project that is traceable to any particular wastewater treatment plant, and we believe this provides some protection to the plants as well.”

The Insurance Pool

Once the regulatory phase kicks in, the scheme will include an insurance pool – probably holding less than ten percent of value of all risk, based on traditional failure rates provided by the ODNR.

“If we lose a project, we will substitute from the insurance pool for the lost credits, and all will be well,” he says, adding: “That’s the theory.”

Farmer-Friendly

Hall says one of the scheme’s unsung benefits is that it helps bridge the urban/rural divide.

“We’ve gone into agricultural areas that have historically been literally in combat with local urban areas,” says Hall. “Now it’s a partnership, and people recognize that water quality challenges need to be addressed on a watershed level, and that the commodity produced by the farmer is the solution to some of the urban regulatory challenges.”

The Farmers’ Rebellion

And it almost didn’t happen – thanks to the infamous Ohio EPA rules proposal and the ensuing pushback by farmers and near abandonment by wastewater treatment plants.

Hall and representatives from the Ohio Farm Bureau and the local chamber of commerce met with State Senator Larry Mumper, who chaired the state’s agriculture committee, and Senator Tom Roberts. They then worked up a draft bill that would exempt existing trading program from the new rules for a period of ten years.

“We carried that draft bill around in our hip pockets,” Hall recalls. “And it didn’t hurt that we had just gotten the $900,000 Conservation Innovation Grant.”

When the EPA finally did come up with its own rules in January, 2007, it also gave trading scheme participants a ten-year exemption.

Uncertain Future

As the pilot phase winds down, Hall expects the scheme will “go quiet” for a year or two – until regulatory drivers are in place.

Meanwhile, he’s getting calls from other parts of the state interested in replicating the scheme.

“We’re in the process of taking everything we’ve learned and repackaging our program,” he says. “It’s like now we’ve got a hardware and software package, and can offer it all out.

“That’s what pilots are supposed to do, and I think we have done that in a very successful way, regardless of the future of the program.”

Steve Zwick is managing editor of Ecosystem Marketplace. He can be reached at [email protected].

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