Can This Regional Experiment Offer a Template for Cross-Border Crediting?

In today’s economy, transactions in one part of the world often impact ecosystems far away.   Ecosystem markets, however, tend to be strictly local.   Now the   Willamette Partnership is experimenting with mechanisms that can at least deliver uniformity across borders, which will make for more efficient markets – and mitigation – down the road.

7 March 2011 | Devin Judge-Lord and Bobby Cochran have spent much of the past eighteen months crisscrossing North America’s Pacific Northwest.   They’ve been working with watershed groups along the Spokane River in Washington state and throughout the Klamath River basin, which stretches from eastern Oregon to the California coast; they’re also working in the Rogue River basin in Southwestern Oregon, and in the Yakima basin in Washington. In total, they’ve reviewed thirty-three watersheds to see if methods they’ve developed in Oregon’s Willamette Basin can be applied there.

Both of them work for the Willamette Partnership, a non-profit environmental coalition centered in Oregon that aims to “shift the way people think about, value, manage, and regulate the environment,” according to its web site.    

Over time, the Partnership has established itself as a pioneer in the use of financing mechanisms aimed at preserving nature by recognizing the value of ecosystem services.   Its specific niche has been the development of mechanisms designed to recognize several ecosystem values on one piece of land. This enabled the creation of a multi-credit marketplace   in the Willamette Basin.

Now Judge-Lord, Cochran, and their colleagues are looking to see if these ideas can be scaled up and out – to larger-scale environmental restoration with clear outcomes for habitats and water quality.

Think of a real-estate developer required to mitigate his new project’s impacts on wetlands by restoring or creating new wetlands somewhere else. At best, his efforts will be small-scale and fragmented. At worst, his lack of ecological restoration experience will result in him buying a field and then flooding it.

Instead, a landowner or wetland bank can restore a large area of wetland and generate habitat credits to sell on the market. This wetland is far more likely to protect threatened species than a low-functioning created wetland on the corner of a business park lot, disconnected from wildlife corridors – and the larger wetland offers the side benefits of landscape-level water filtration and stormwater regulation. This is the promise ecosystem service markets hold out: conservation can be both smarter and larger-scale.

That means not only scouring the Pacific Northwest for ecosystem credit market potential, but also pursuing closer working relationships with regional groups across the country, including in the Chesapeake Bay, Mississippi River basin, and US Southeast. Everyone is asking the same question: how can we spread the ecosystem service market model? In some ways, it’s trickier than it looks.

The Partnership’s work aims to rectify the need for scale with the basic reality that ecosystem service market growth is constrained by, well, ecosystems. Since ecosystem services themselves are often by definition local services (in the sense that their benefits diminish the further away you move from the source of provision) how can you scale up? For the Partnership, the answer has to do with precisely what can be scaled up.

“Our vision is shared regional infrastructure with unique local markets,” explains Judge-Lord, who is the Partnership’s Ecosystem Market Specialist.   He goes on to explain that he believes it’s possible to build a national network of regional coordinators supporting ecosystem service marketplaces around the country, sharing market infrastructure and expertise with one another, while trading itself stays local.

Limits to Growth

For most markets, growth is simply a question of attracting more buyers, more sellers, and more investors. But a market for ecosystem services is a bit of a different animal. Think, for example, of the difference between a carbon credit and a water quality credit. A pound of carbon emitted in Berlin is comparable to a pound of carbon emitted in Tokyo, since it all ends up in the atmosphere. That fungibility allows the carbon markets to span the globe. To a buyer, it doesn’t matter where mitigation happens since the benefits of mitigation are more or less the same anywhere.

Now consider a credit representing reduced phosphorus loading into a river system. Water quality markets let entities meet their pollution reduction targets by buying these credits. For example, a municipal sewage treatment plant that has exceeded the regulated limit on phosphorus discharges can pay a nearby animal feeding operation, which discharged less than its phosphorus allowance, for the unused portion. The total amount of pollution still meets water quality standards, and mitigation is more cost-effective, because entities that can easily and cheaply ‘go above and beyond’ regulation now have an incentive to do so.

But a watershed is not like the atmosphere. Reducing pollution in the San Diego watershed doesn’t improve water quality in the Chesapeake Bay. If a regulated party wants a water quality or wetland mitigation transaction to count toward compliance, it has to happen within the same catchment. Similarly, conservation banking must take place within an area defined by regional wildlife or habitat recovery plans. Otherwise, regulators won’t recognize the trades as genuine mitigation. Of course, voluntary buyers don’t have this constraint, but since most trading is compliance-driven, most buyers need trading to happen within the ‘ecologically significant area’.

Moreover, since the good being traded on the market is essentially a healthier environment, most buyers and local regulators don’t want the benefits going somewhere else. This came through loud and clear in a survey the WP conduced in the summer of 2010 of potential buyers: buyers generally don’t mind mitigating environmental impacts off-site, just as long as it’s not too far off-site.

The Aggregation Problem

The non-fungibility of ecosystem service credits, while crucial to guaranteeing genuine mitigation, has contributed to an ongoing problem in ecosystem service markets: low transaction volumes. Most markets around the country have seen a very small number of actual trades over the years. Ecosystem Marketplace’s State of Watershed Payments report, for example, found that water quality markets in the US only posted fourteen trades in 2008, worth $10.8 million.

This is known as the ‘aggregation problem’, and it’s especially worrying because setting up an ecosystem service market can be a very long and expensive process. Before trading even begins, you can spend years developing protocols for generating credits, rewriting regulatory permits, building a credit registry and trading platform, and running pilot transactions. Once the market is active, every trade carries additional transaction costs, related to the time and expense of connecting buyers and sellers, negotiating, and maintaining a system for credit accounting.

The Willamette Partnership has already taken on part of the aggregation problem with their multicredit marketplace model. By letting buyers and sellers deal in multiple credit types (currently the Partnership market offers four: wetland, water temperature, salmonid habitat, and upland prairie habitat), market participation increases. An integrated marketplace also means lower transaction costs, since you don’t need to build multiple markets and redundant market infrastructure for every single ecosystem service credit type.

Even so, if trading is restricted to the ‘ecologically significant area’, the number of interested buyers and sellers may still be relatively small. It’s hard to justify the time and expense of setting up a market when the outcome is only a handful of trades. Ecosystem service market advocates find themselves in a conundrum: for the model to really take off, they need to figure out ways to increase volume and lower costs. But how can they scale up if ecosystem service credits are spatially constrained?

If You Build It, They Will Come

For the Willamette Partnership, the answer lies in the idea that even if you can’t trade credits beyond a certain geographical area, that doesn’t mean you can’t share market infrastructure and best practices at a larger scale.   Their efforts in the Pacific Northwest focus on giving market developers the tools they need to move up the learning curve much faster, Judge-Lord explains.

“We’re seeing people going from no knowledge of these markets at all, to market design, at quadruple the speed, because they have workable models to point to,” he says, holding up the Partnership’s own Counting on the Environment stakeholder process as an example.

Sharing as much as possible – including process design, infrastructure like software platforms, and protocols for generating credits – means less time and resources without sacrificing ecological quality.

“A regional coordinator can handle all of the elements that are the same across markets – software development, accreditation, verification, paperwork templates,” says Cochran, who is the Partnership’s Executive Director.   “This leaves the local administrators to really focus on what’s specific to their area, like local conservation priorities, adapting different metrics to their given areas, day-to-day project operations, and working with stakeholders.”

Assistance is expected to eventually work both ways.

“We want to support local people building their own capacity, so that in creating their own markets they develop tools that we all can use,” says Judge-Lord. “We think this approach is going to pay off.”

The regional extension efforts are still in their early stages. The Partnership conducted viability assessments of over thirty watersheds in the Pacific Northwest and narrowed it down to five, where they’re exploring market feasibility, looking at things like regulatory drivers and possible program designs.

“What we’ve really accomplished thus far is getting the conversation going,” says Judge-Lord. “We’re talking to people about things they didn’t realize were possible under our current regulatory regime.”

He mentions challenges like getting a supportive regulatory framework in place to facilitate trading, which can be a slow process.

“Agencies are understaffed,” he says. “There are permitting delays, and everyone’s facing budget cuts.”

Existing laws tend to favor ‘gray’ infrastructure over ‘green’ infrastructure, driving regulated entities toward technological fixes instead of ecological restoration.

From the Local to the National

Just as local markets can share policy tools and infrastructure under a regional umbrella, regional groups are increasingly working with one another to coordinate work that benefits nascent ecosystem service markets everywhere in the country.

“We don’t have the resources to push forward on every element,” says Cochran. “We’re working a lot with other regional groups on piloting new models that can inform new national-level guidance. For example, folks in the Southeast can take the lead on voluntary pre-compliance conservation banking for long-leaf pines, and develop their work in a way that we can adapt it to the Willamette or Puget Sound prairie system. Meanwhile, we can concentrate on developing software that we can transfer to them.”

The Partnership has been comparing notes with groups around the country to figure out what works.

“Conversations between regional coordinators are helping to move forward best practice in developing metrics, in verification, in validating tools,” says Judge-Lord.

Better coordination can also aid in large-scale restoration efforts. For example, the Partnership is working with a stakeholder group in the Klamath River basin, which has sub-basins in both Oregon and California. To maximize the potential of ecosystem service markets, they are promoting coordination among regulators and other government entities.

“There’s a need to coordinate laws across state lines, and especially in transboundary cases,” says Judge-Lord.

Consider the newly-issued Chesapeake Bay TMDL. The Eastern Shore basin, which has loading caps on nitrogen, phosphorus, and sediment under the TMDL, falls under four different states’ jurisdictions. The Potomac River basin: five.

“The regional coordinators that we’re talking with, they all see that isolated local efforts are not going to add up to significant conservation,” says Cochran. “If we’re going to have significant conservation, we’re going to have to figure out ways to connect together on it.”

Bringing in the Big Guns

So what’s the next big breakthrough in the evolution of ecosystem service markets? For Michael Van Patten of Mission Markets Earth, who’s written extensively on linking traditional finance to ecosystem service markets, footprint-conscious businesses are a veritable goldmine of untapped demand.

“Regulated entities like point sources will continue to be a source of demand,” he says, “but the big growth – the shot in the arm you’re going to get – is from the race to be transparent.”

A wave of companies like Wal-Mart, the Gap, and Patagonia are looking to reduce their environmental impacts, he points out, and environmental offsets will be a crucial part of that strategy.

Of course, catering to the corporate crowd is going to require that an offset credit purchased in Portland is comparable to one in Baltimore – one more reason, Van Patten says, why coordination between market administrators is important.

“That’s the only way I can see growth,” he says. “If you have a few common standards and metrics that people accept, and that can be embedded into a business process.”

This might mean that, at some point and in some measure, we might want to relax the non-fungibility constraint.

“There are ways you can create, say, a US water quality certificate,” he explains.

Such a certificate would work by letting local ecosystem service credits be converted into a more fungible product that could be traded anywhere in the country. For the moment, Van Patten says, “we’re not there yet.” Coming up with a standard set of metrics that can deliver high-quality restoration anywhere in the country won’t be easy.

“Ecosystem services look more like real estate than carbon,” says Van Patten. “Some areas have more value than others.”  

Cochran agrees.

“A national standard that’s consistent but customized to a specific local area – that’s a conversation we’re starting to have, but we’re not there,” he says, pointing out that the interested buyers the Partnership are hearing from are still mostly local compliance-driven point sources, not footprint-conscious corporations. But he agrees that a more unified market would have the flexibility to satisfy both kinds of buyers: the local buyer interested in investing in local benefits, and the entities with no preference about where offsets take place.

“If you had a cooperative of regional market coordinators in the Pacific Northwest, the Southeast, the Great Lakes, and so on, all agreeing to the same standards, and a company said, ‘I want to offset my water footprint, and I don’t care where I get the offsets’ – I would feel perfectly comfortable with that, as long as the quality is there,” he says.

These Roots Go Deep

Big things may be on the horizon, but for now the Partnership is focused on establishing a solid foundation that can support ecosystem service market growth, whatever that may ultimately look like.

“There’s still a lot to learn about what the best model for scaling up is,” says Cochran.   “Building the local and regional base is where our strength is.”

No matter how widespread the model becomes, or how much volume markets ultimately attract, ecosystem service markets are local at heart, Judge-Lord points out. At the end of the day, an ecosystem service market’s fortunes rise or fall with the level of community buy-in.

“It’s extremely important,” say Judge-Lord. “We can come in and act as advisors, but you have to have the local momentum.”

In the meantime, the Partnership is counting on other players in ecosystem service markets to be similarly leveraging their own strengths.

“Each watershed seems to be a totally different animal. Which is better – scaling up from the bottom versus creating a national standard? I really don’t know. My guess it’s a combination of both, and if peoples’ strengths are in developing standards pushing down to the local area, then they do their thing, and we do our thing, filling in the pieces from the local areas up,” says Cochran. “Hopefully we can meet somewhere in the middle.”

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