Pennsylvania Water Deal: Blip or Boom?

Alice Kenny

Two lean years after setting up shop, Pennsylvania water credit aggregator Red Barn Trading cut a dream deal enabling the town of Fairview to slash both emissions and costs by helping chicken farmers manage their animal waste. Red Barn itself, however, is struggling to make the business pay – and some say the state’s entire water quality trading scheme will have to be overhauled if the success is to be replicated. Sixth in a Series

3 June 2008 | Self-described manure trader Peter Hughes – chicken manure, that is – employed his specialty to transform Pennsylvania’s nutrient trading plan from concept to reality, helping the state become the first to fully embrace this new ecosystem market.

Lofty as the goal may be, Hughes’ enterprise is, well, straightforward. He scoops up dried, nutrient-laden manure from henhouses on 22 farms, trucks it out of the Chesapeake Bay watershed, and dumps it onto nutrient-deprived strip-mined land. Then he sells credits for the nutrient reduction of phosphorus and nitrogen to wastewater treatment plants that are required to lesson their nutrient load within the Bay’s watershed.

“This is a turn I never thought my life would take,” said the 34-year old dean of dung and president of Red Barn Trading Company, a nutrient credit provider based in Lancaster, PA.

Of course, working with dung is never tidy. And making it work with this innovative trading scheme has proven particularly tricky. His challenges echo those being faced by many dabbling in this new market: farmers fearing regulatory entanglements, industry lacking a clear regulatory driver, and looming anxiety over who gets blamed if a credit doesn’t deliver on its regulatory promise.

Can It Pay?

While prospective investors congratulate Red Barn for turning manure into money, nearly none have followed Hughes into the nutrient-trading market. This is because, many say, the key elements for a market’s success – potential for profit and assurance that what you pay for is what you get – are missing in Pennsylvania’s current nutrient-trading set up.

“Red Barn took an incredible risk, and I hope it pays off for them,” said Matt Ehrhart, executive director of the Chesapeake Bay Foundation’s Pennsylvania office, a nonprofit environmental organization focused on cleaning the Bay. “But people are asking for an overall trading system that better manages risk: a bank, in other words, rather than a stock market.”

Nutrient Trading 101

Much like the scheme in which they trade, the “nutrients” of the Chesapeake Bay Watershed hold out the potential for a balance that they do not always achieve.

Nitrogen and phosphorous emitted from human and animal waste are used as fertilizers that provide essential nutrients for crops and can help restore the strip-mined mountains where Red Barn dumps manure. But excess nutrients degrade water quality, spawning vast algae blooms that promote bacteria growth and consume the water’s oxygen. They literally suffocate the Bay, killing fish off in nearly half its waters.

The Chesapeake 2000 Program, an offspring of the Clean Water Act, assigns Pennsylvania and six other states a deadline of 2011 to cut by forty percent the levels of nitrogen, phosphorus and sediments that leach into the Bay.

The Pennsylvania Scheme

Pennsylvania, by far the largest emitter and with its back against the wall, launched its nutrient and sediment trading policy in December 2006. Similar to wetlands or sulfur dioxide trading, nutrient trading offers farmers, communities and industries another tool to help them meet state and federal water-quality goals.

Sewage treatment plants can upgrade their plants to minimize their discharges. Or, with nutrient trading, they can offset excess discharges by purchasing credits from other upgraded plants or from farms that reduced their nutrient inputs beyond mandated requirements.

Farmers can choose from any of nearly two dozen best management practices to reduce their nutrient outputs, from trucking manure out of the watershed as Red Barn did to planting cover crops and vegetative buffers that prevent nutrients from reaching waterways. Hughes works as an aggregator, matching treatment plants looking for offsets with farmers that have credits to spare – and, perhaps most importantly, assuming liability in case the deal somehow turns sour.

In theory, trades could prove cheaper and achieve the same effect as sewage-plant upgrades. After all, blue crabs, oysters and shad struggling to survive in the Bay don’t care how reductions occur, only that they occur.

Promoting Efficient Reductions

The estimated cost of upgrading all 184 regulated treatments plants, which discharge 14 percent of Pennsylvania’s excess nitrogen and 22 percent of its phosphorus into the Bay, could reach $1 billion, said John Brosious, deputy director the Pennsylvania Municipalities Authorities Association. In comparison, 40,000 farms in the basin cumulatively contribute more than twice as much nutrients as wastewater treatment plants. They could conceivably reduce nutrient discharges at a lower cost than treatment plant upgrades.

By facilitating trades between regulated wastewater treatment plants (called “point sources” of pollution) and farmers (usually called “nonpoint sources”, and often unregulated), Pennsylvania became the first state to embrace point-nonpoint transactions on a wide scale, said Stephanie Showalter, Director the National Sea Grant Law Center at the University of Mississippi.

Point-nonpoint transactions are seen as the holy grail of water trading. They provide an incentive for unregulated farmers to reduce their water emissions. Larger farms, however, often face similar regulations to point source factories and waste treatment plants.

Enter Red Barn

This new trading format crawled forward – thanks, largely, to the persistence of Peter Hughes, his wife, Molly, and their now-16-member staff.

A farm boy-turned biologist, Hughes made his living providing nearly 500 farmers with agricultural and environmental engineering services. When he heard about nutrient trading, it sounded like a natural extension of his work, he said.

Red Barn began by cutting deals with two developers stymied by Chesapeake 2000’s prohibition against adding any additional nutrients to the watershed. The developers could use technology to remove most nutrients from their wastewater treatment plant’s discharge, but no technology yet exists to remove them all.

Getting Started

Red Barn negotiated its first deal in August, 2006, with Dunn Lake, a new 35-cabin subdivision in Susquehanna County. By moving manure out of the Bay’s watershed, Red Barn provides the treatment plant with the 223 pounds of nitrogen credits and three pounds of phosphorus credits that it needs to get down to a compliant nutrient load.

The company closed their second deal in January, 2007, with a commercial subdivision called Buffalo Crossing. Red Barn provides this new treatment plant with 1,592 credits of nitrogen and 73 pounds of phosphorus credits for five years.

But the deal for which Hughes says he feels the most pride, his third and largest nutrient trade, was just completed in April. It represents Red Barn’s first trade with a municipal authority.

The Bid Deal

The way Hughes tells it, he and Fairview Township’s wastewater treatment plant’s engineer, Bob Stanley, were making conversation in a parking lot after attending a large meeting with the Department of Environmental Protection (DEP). Stanley complained about expensive plant upgrades and asked, in jest, how much it would cost to buy credits from Hughes.

When Hughes replied “five bucks a credit,” Stanley said “we gotta talk.”

Thanks to their subsequent trade, the Fairview Township Municipal Authority sent a notice to its customers containing words few taxpayers ever read. It told customers to disregard an earlier notice informing them that a $6.2 million plant upgrade would increase their bills by $22 per calendar quarter. Because the township avoided this costly upgrade by instead purchasing credits from Red Barn, it saved 75 percent of its planned expenditure or $4.6 million. The municipal authority passed the savings on to their customers, increasing their quarterly rate by $9 instead of $22.

Making It Happen

Small farmers, however, enjoy unregulated status and fear that such programs could open their properties to inspection by regulatory agents. Convincing them that they should get involved was not easy, Hughes said.

So he worked only with large farms already required to meet baseline nutrient reduction standards and accustomed to the DEP’s annual visits. This also ensured that any manure Red Barn carted off resulted in additional nutrient reductions. Moreover, as an aggregator, he acts as the fall guy if anything goes wrong. If, for whatever reason, a farmer does not deliver on promised manure, Hughes can dig into the thousands of pounds he already aggregated and has on stand by from other farmers.

Winners All Around, Well, Almost…

At first glance, the deal appears to be a win-win for all parties concerned. Farmers were paid for manure they did not want. The township saved upgrade costs. Strip mined land would become once again fertile. And the Chesapeake Bay was protected.

The only guy who came up short was Hughes. He paid farmers between $15 and $30 per ton of manure, the going rate for the nitrogen inside this potential fertilizer. But he was only able to sell the manure to the former mine site for $5 per ton. After he shelled out cash to cover the cost of the front loaders, tractor trailers, drivers, labor and gas, the 20,000 credits he sold to Fairview left him at a wash.

Because of this and other uncertainties fundamental to this market, there have only been four nutrient trades since the system was enacted. Three of them have been facilitated by Red Barn.

A persistent optimist with 10,000 more tons of dried manure accumulated and no immediate demand, Hughes said that “this is a breakeven venture for something that has a lot more potential.”

From Broker to Bank

For nutrient trading and Red Barn to reach their potential, a fundamental overhaul of the system is required, say spokespersons for all major stakeholders.

The current scheme may work for new treatment plants that otherwise would not obtain necessary permits because of the state’s prohibition against introducing any new nutrients to the watershed. Also, discounting Hughes’ inability to pocket a profit, it may work for trades involving small treatment plants where the cost of factoring in upgrades appears prohibitive such as Red Barn’s trade with Fairview Township. After all, as Ehrhart said and many echoed, Red Barn’s efforts produced “solid nutrient reductions no matter how you look at it.”

But overall problems remain with the trading system that, stakeholders say, can be broken down into two major categories.

The Not-so-High Cost of Reducing

First, the cost of trades is not always cheaper than the cost of treatment-plant upgrades. Larger plants, required to reduce their nutrient output but not get it down to zero, have found that when upgrade costs are amortized over time they may be equal or less than that of the cost of purchasing nutrient credits, Ehrhart said. Meanwhile, upgraded treatment plants become more valuable and never again need to concern themselves with credits purchases.

Worse still, the trading scheme provides no guarantee that “credits municipalities purchase today will result in their ability to claim reductions,” said John Bell, government affairs counsel for the Pennsylvania Farm Bureau. He gave the example of a treatment plant that could buy credits from a farmer instead of an aggregator, such as Red Barn. The farmer may plan to reduce runoff by planting cover crops on his bare winter fields. But if wicked winter weather destroys the cover crop, nutrients will leach into the Bay, leaving the treatment plant owner holding the bag and responsible for making up the difference.

“Our guys run sewage treatment plants,” said Brosious. “We don’t want to have to make sure Farmer Brown’s doing what he says to ensure that at end of the year the credit we bought actually exists.”

Legislative Response

Responding to these concerns, State Representative Scott Perry introduced a legislative bill last month that would convert the current ad hoc nutrient trading scheme into a regulated ecosystem banking system. If passed, the bill, backed by every stakeholder group from farmers and environmentalists to builders and wastewater treatment plant owners, would create a nutrient-credit trading bank that guarantees credit availability over a 20-30 year time period and at a fixed cost.

A government agency would certify and the insure credits. And funding would be authorized to subsidize farmland nutrient reductions so that farms could generate credits at potentially lower costs than the cost of treatment plant capital upgrades. The system would protect farmers and wastewater treatment plant owners. And it would promote the work of Red Bank while inspiring other ecoinvestors.

The problem is that so far the state has resisted assuming this additional economic and regulatory responsibility.

“We’re in the crosshairs”, said Hughes. “The trick is finding that sweet spot where it makes economic sense.”

Alice Kenny is a prize-winning science writer and a regular contributor to the Ecosystem Marketplace. She may be reached at [email protected].