Voluntary Water Markets: The Demand Dilemma

Farmers and other diffuse polluters should, in theory, welcome money from industry for voluntarily reducing their runoff – but high commodity prices and a fear of regulatory entanglement has put a lid on demand in water quality trading in the US. The Ecosystem Marketplace examines the challenge of stimulating WQT demand. Fifth in a Series

26 May 2008 | Figuring out how to encourage individuals to do something voluntarily for the greater good has perplexed philosophers for centuries, and the nascent market for Water Quality Trading (WQT) in the US is bumping up against a more prosaic version of the same dilemma.

WQT schemes aim to do for water what emissions trading schemes have done for air pollution: drive down levels of water pollutants, especially agricultural “nutrients” (nitrogen, phosphorous, and potassium), by letting emitters trade credits among themselves to find the most cost-efficient way of reducing them.

Voluntary water-trading schemes have spread in recent years, with a June, 2007, survey by the US Environmental Protection Agency (US EPA) identifying 23 WQT programs operating across the US that have traded credits at least once.

But WQT faces the same problem globally as the carbon-trading market does at present in the United States: participation isn’t yet mandatory, and polluters have different reasons for deciding whether or not to participate in local voluntary WQT schemes.

So, what’s driving them there? And will more incentives to trade bring laggards on board? For that matter, are voluntary drivers alone incentive enough to keep trading viable – or can WQT schemes fully succeed only when accompanied by strict enforcement of clear limits on specific pollutants by all emitters?

The answer appears to be somewhere in the middle.

“Pointed” Argument

Industry and agriculture typically represent the two major types of tradable water pollution. The first, called “point source”, is easily recordable from definable outflow points like discharge pipes from industry and municipal wastewater treatment plants; the second, called “nonpoint source” is spread across areas like fields and pastures and is therefore difficult to measure.

Not only that, but point sources tend to be regulated under the Clean Water Act (CWA) in the United States, while nonpoint sources are not – for reasons covered in Water Trading: the Basics.

The Meaning of the Word “Voluntary”

People often compare the burgeoning water markets to the booming carbon markets – but that comparison can be taken only so far before creating a distorted view of how WQT schemes work. Nowhere is this truer than in the use of the term “voluntary” trading.

In carbon markets, a “voluntary” offset is just that: a transaction that happens because people want to do it, and not because the Kyoto Protocol or another mandatory cap-and-trade scheme has forced compliance (although even voluntary offsets need to meet certain standards to be credible).

The 2006 Soccer World Cup, for example, was subject to no mandatory carbon cap, but went carbon neutral anyway by funding clean development projects in Africa and India that would have passed muster under the Kyoto Protocol’s Clean Development Mechanism (CDM).

Purely voluntary schemes exist in water as well. The classic example is the Vittel bottling plant’s payment to French farmers to protect the watershed feeding the aquifer that feeds the wells from which it draws its mineral water.

But that oft-cited example is the exception that proves the rule. Voluntary water transactions are rarely served up with a single entity so clearly willing – let alone able – to pay for reductions from scores of smaller entities dribbling gunk into their water.

All in the Watershed

What’s more, unlike greenhouse gas emissions, water pollution doesn’t spread itself equally across the world, but instead kills some bodies of water while sparing others. A polluter in the Red Sea does his neighbors no good if he offsets his emissions by reducing runoff into Lake Victoria (although polluters in Ohio do have an impact on, say, the Gulf of Mexico).

For now, WQT schemes focus on a single watershed, and the big focus is on promoting transactions between regulated point-source entities and unregulated nonpoint-source entities.

These hybrid point-nonpoint schemes are “voluntary” in the sense that credit sellers aren’t regulated, but the key driver is almost always a law mandating a reduction by point-source emitters. In this sense, they are analogous to the CDM: buyers of credits in a compliance regime are working with sellers of credits that are usually outside of the regulatory protocol – and in water trading, those outside the regime usually want to stay there.

In “voluntary” WQT schemes, the sellers of credits are in the same watershed as the buyers – but outside the regulatory apparatus.

Nevertheless, it is the regulatory pressure on buyers to reduce emissions that drives demand.

No Regulatory Driver, No Market

Indeed, as we saw in US WQT: Growing Pains and Evolving Drivers, many schemes that are “failing” are doing so because they were implemented in anticipation of mandatory emission limits that never materialized.

Under the types of “voluntary” WQT schemes that comprise the bulk of transactions taking place now and presumably in the future, regulated point source emitters pay unregulated nonpoint emitters to reduce their pollution. If the amount paid is higher than the cost of implementing the reduction, you’d expect farms and other nonpoint source emitters to be scrambling for WQT money.

But luring them into such schemes is proving to be more difficult than many had anticipated.

Bringing in the Nonpointers

“It’s a heck of a lot harder getting non-point sources involved in water quality trading,” said Tracy L. Stanton, Water Programs Manager with environmental consultancy Forest Trends (parent organization of the Ecosystem Marketplace). “Point sources have no choice but to meet water-quality standards and are governed by a regulatory scheme that can be quite tedious to deal with.”

The US EPA considers regulating discharges of specific pollutants a significant factor in successful WQT programs.

That works fine at places like already-regulated factory outflow pipes, where each pollutant can be easily tested for and its source held accountable. But it’s not so easy along a stream bank where the emissions of several different unregulated land users, not just the landowner, probably contribute to downstream water degradation.

“Trading works best when there is a ‘driver’ that motivates facilities to seek pollutant reductions, usually a Total Maximum Daily Load (TMDL) or a more stringent water quality-based requirement in an NPDES permit,” the EPA stated in a 2007 WQT document posted on its web-site.

Point-Point Bonanza

Not surprisingly, some of the most widely-touted success stories among WQT schemes are between one point-source emitter and another – so-called “point-point” transactions.

The EPA’s inaugural Blue Ribbon Water Quality Trading Award went to Connecticut for a much-cited WQT project that lowered nitrogen levels in Long Island Sound. Among the 79 sewage-treatment plants in the scheme, more than a third had lowered their nitrogen discharges below permit levels and were selling credits within three years.

“Nitrogen trading has accelerated the State’s schedule to meet the nitrogen targets,” the EPA noted in its award.

Why Not Regulate Nonpointers?

So, if regulation works on the point emitters, why not just regulate the nonpoint emitters?

“To have a hope of making (WQT) work, you need more regulation, not less,” says Dennis M. King, Research Professor at the University of Maryland’s Chesapeake Biological Laboratory. “For the climate around water trading to improve significantly, there must be more restrictions on agricultural pollution.”

He says that 30 percent Chesapeake Bay bay’s nutrient load is being contributed by agriculture, which contributes just 0.5% to the area’s economy. And he doesn’t think money alone will be sufficient to lure farmers into a voluntary WQT scheme that requires any documentation of their anti-pollution efforts. “Some see WQT as another way to get money to farmers, but the idea of having some verifier on their farm – they just won’t have it,” King says.

And they know how to lobby – a skill they deployed quite effectively in the passage of this year’s Farm Bill.

“Regulating nonpoint source pollution isn’t the answer,” says Carl Lucero, National Leader for Clean Water at the USDA’s Natural Resources Conservation Service (NRCS). “Instead, water quality trading offers a voluntary option for point sources to meet their water quality obligations at a lower cost than traditional ways.”

He points out that the main drivers for point sources are regulations and costs. “They want to find the cheapest way to effectively meet water quality limits set in their permits,” he says. “If water quality trading is the most efficient way, then it makes good business sense to go with it.”

In Ohio, the Great Miami River Watershed Water Quality Credit Trading Program was able to persuade farmers to join the program by assuring them in writing that they would be exempt from any regulation for the next ten years – but, as we will see later in this series, that project is in jeopardy because anticipated limits on point-source discharges have so far failed to materialize.

Bigger Fish to Fry

And even if supporting regulation materializes, it’s not clear the potential new income stream will seem worthwhile in an age of steadily rising prices for agricultural commodities and farmland – especially if that money is coming from a potential regulatory quagmire like pollution control.

“Farmers appreciate the fact that they’re not regulated and would rather stay under the radar screen than get involved in WQT,” says Stanton. “Even if you show them they can reduce pollution cost-effectively, some fear involvement now means regulation in the future.”

Bank on It

Despite what appear to be intractable issues, a WQT project manager can set policies that maximize incentives to getting polluters in to trade water quality.

The Miami Conservation District (MCD), for example, took pains to ensure that its Greater Miami River Watershed WTQ program would be “farmer friendly”. The district kept bureaucracy to a minimum by paying farmers to complete mitigation projects rather than by selling credits directly and it accumulated a pool of credits to avoid shortfalls.

Bundling Credits

Farmers might also be more amenable to trading a system that would “bundle” a credit like water quality with other environmental credits, Lucero notes. Such bundling could involve assigning different environmental credits, like WQ and carbon-offset, for single practices like cultivating vegetative buffers along streams that reduce nutrient run-off and store carbon. Those reductions or “credits” could then be sold to multiple buyers in different markets like publicly owned water treatment plants and the Chicago Climate Exchange, he adds.

Such a scheme requires help to get the timing and acceptance right, Lucero points out, and that’s where larger ‘third-party aggregators’ like local resource conservation and development councils and conservation districts can help create a stable market. He also sees financial institutions like local mitigation banks playing a role in creating WQT markets in much the same way they were created for wetlands around the country, thereby injecting more confidence into local WQT markets.

“Many are landowners themselves who know everyone in the watershed and can bring buyers and sellers together,” he said. “Some have done mitigation banking but water quality trading can be a whole new business for them.”

WQT can also encourage point sources to join the local WQT party early by dangling the right carrots at the right time. For example, setting the right ‘trading ratio’, or amount of emissions measurement allowed for each offset measurement funded – a key concern for point source polluters – at an attractive level at an early stage can establish a viable trading market more quickly. The Miami Watershed WQT scheme did so by setting trading ratios at 1:1 (2:1 in poor-quality water) for early movers, meaning wastewater plants that signed on first could buy a 1,000-pound phosphorous credit to offset 1,000 pounds of phosphorous emissions. Slower movers could only trade at ratios of 2:1, so needed twice as many credits for the same offset, and 3:1 in poor quality.

State of Play

Politics also has a way of seeping into the WQT debate, creating its own sets of incentive for participating in water trading. In a 2005 article entitled Crunch Time for Water-Quality Trading, King referred to the 2004 demise of a Chesapeake Bay project, where in 2003 a partnership of public agencies and private stakeholders drew up an agreement to launch a watershed-based WQT scheme after three years of preparation.

But one year later, the Maryland state legislature responded to public concern over water pollution with a monthly tax on urban sewer users and rural well-users to fund new discharge technologies and agricultural mitigation practices. The so-called ‘flush tax’, King noted, almost wiped out all demand from treatment facilities for WQ credits while continuing agricultural subsidies restricted supply. “With the stroke of the governor’s pen, prospects for WQ trading any time soon in Maryland evaporated,” King wrote.

Nonetheless, the Chesapeake Bay WQT project, covering an area of 64,000 square miles, is now back on the agenda and will be the subject of several environmental get-togethers over the next few months, Stanton said. But with seven states and their governments involved and not all of them seeing eye-to-eye on the issue of neighborhood water quality, she adds, nothing can be taken for granted.

“State agencies often work against other states (on water quality), and that may create different incentives and disincentives to launching a water trading scheme,” Stanton said. “The stakes are really high.”

Rob Luke has been covering markets and environmental issues for 15 years in Europe, Asia, Australia, and North America. He lives and works in Edwardsville, Illinois, and can be reached at [email protected].

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