Pollutant allowance trading systems offer a new opportunity for improving water quality. How enforceable are they?

By April Grippo

Despite considerable reductions in pollution since the passage of the Clean Water Act (CWA), today 40% of United States waters still fail to support one or more of their designated uses. Though the number of discrete dischargers, such as industries and municipal wastewater treatment plants, has grown substantially through the years, technology has afforded these dischargers the capacity to make large reductions in the individual levels of pollutants they output. Meanwhile, runoff from nonpoint sources, including urban development and agriculture, has also added to the sheer quantity of pollutants entering water bodies. These nonpoint sources, by "virtue" of their nonpermitted status with little or no required pollutant reduction, have simultaneously increased their share of the actual pollutant levels found in many water bodies. This is particularly true for such nutrients as nitrogen and phosphorus.

According to USEPA, excessive nutrient loading is the third leading cause of water-quality impairment in the US. Although nitrogen and phosphorus loading was formerly linked to sewage treatment plants, nitrogen from wastewater treatment plants has declined dramatically in treatment-plant effluent with the implementation of biological nutrient removal technology. Phosphate bans on such household items as detergents and cleaners have also led to influent phosphorus reductions in wastewater treatment plants. Nutrient enrichment is now principally attributed to nonpoint sources, particularly nitrogen loadings from urban development, septic systems, and agricultural facilities. This problem is exacerbated throughout watersheds as development and agriculture spreads farther into the formerly undisturbed countryside.

In an effort to reclaim nutrient-impaired waters, total maximum daily loads (TMDLs) are being developed that require considerable reductions in nitrogen and phosphorus. For areas where impairment due to nutrient enrichment is extensive, a number of approaches will be needed to yield the necessary reductions. Success in reducing nutrient loads from nonpoint-source pollution in the long run, however, will depend on development of low-cost, innovative methods that can effectively cut pollution without excessively constraining current and future land uses and development and agricultural practices. Nutrient trading is gaining popularity as a method that fits the bill.

EPA: Laying the Foundation

In 1996, EPA issued an Effluent Trading in Watersheds Policy and Draft Framework for Watershed-Based Trading. Following that, the agency funded a number of demonstration trading projects, including the Chesapeake Bay Program, believing that the lessons and methods from these programs would be valuable in other efforts to restore water quality. Although some attention was given to these projects by dischargers with high total suspended solids and other chemical pollutants, effluent trading did not advance as expected.

In May 2002, EPA renewed its support for the development of a market-based trading system with a proposed water-quality trading policy. This policy encourages states to develop trading programs that implement CWA requirements in more flexible ways. Programs are intended to be consistent within existing regulatory frameworks - including National Pollution Discharge Elimination System (NPDES) regulations and TMDLs.

What Does Trading Offer?

Pollutant allowance trading systems, specifically nutrient trading systems, offer new opportunities to improve water quality. Although trading is an important element of the nation's air-quality program, nutrient trading is a relatively new and untested approach in the water-quality program. The point- and nonpoint-source nature of water discharges and hydrologic divisions make fashioning an effluent trading program quite different from an emissions trading program. This has been one major reason that nutrient trading has been slow to take off.

As TMDL implementation and associated enforcement begin, nutrient trading is expected to increase substantially. Nutrient trading systems will allow discharge sources to exchange nutrient-control obligations to reach compliance with reduction requirements. Under a typical scenario, sources with low treatment costs and the ability to reduce their effluent beyond required amounts will convert their additional reductions into credits that can be sold to dischargers whose reductions and treatment costs are higher.

Concerning trading that involves nutrients (specifically total phosphorus and total nitrogen) and sediments, EPA maintains that water-quality trading programs establish economic incentives for creative participation by all sources, especially agriculture and urban developments. Nutrient trading provides a way to reduce nonpoint-source pollution by offering a mechanism to implement restoration and enhancement projects. It offers significant opportunities to address the most persistent and difficult-to-reduce pollutants economically, technically, and politically.

By allowing dischargers the choice of adapting their own facilities or funding reductions, associated costs can be reduced while target reductions are attained. With the array of control options provided under trading, including less expensive choices to make loading reductions, sources often achieve reductions more quickly and in greater amounts than without trading.

When, Where, and How

EPA acknowledges that trading arrangements can take many forms. In some cases, trading can be a viable method of maintaining water quality in unimpaired waters that appear vulnerable, such as areas with high projected growth. Establishing nutrient caps and encouraging the implementation of best management practices (BMPs) in anticipation of increased population might protect waters from excessive nutrient loading. Protecting water quality in this manner can also safeguard the economic value of an area by allowing for future expansions or new dischargers.

Trading can also occur in impaired waters before a TMDL is developed. Nutrient trading strategies might offer the additional benefit of avoiding a TMDL. Voluntary nutrient strategies or those initiated by a consortium of dischargers in advance of a TMDL might be sufficient to improve water quality and attain and maintain designated uses. States might be able to use the implementation of pollution control measures or BMPs to indicate there is reasonable assurance the water body will achieve compliance with state water-quality standards. In some cases, a TMDL might be developed nonetheless, but successes with voluntary nutrient reductions might go a long way in assigning more reasonable and implementable load allocations.

In areas where a TMDL has already been developed, trading can reduce the costs of implementing the allocations. According to EPA's new policy, the baseline for trading is the applicable wasteload allocations for point sources and the load allocations for nonpoint sources. Reductions greater than required by a TMDL will create a surplus allowance that can be traded or that will mitigate an expansion or a new discharge.

The Bridges That North Carolina Built

Proponents of trading frequently cite the Tar-Pamlico trading program in North Carolina as a successful example. After numerous fish kills and algal blooms in the Tar-Pamlico basin, the state's Division of Environmental Management worked on a strategy to reduce nutrient inputs from around the basin. To avoid tighter permit limits and reduce the cost of meeting load reduction requirements, municipal and industrial dischargers formed the Tar-Pamlico Association, representing approximately 90% of the point-source dischargers to the river. The association then developed and signed an agreement with the state that formalized a pioneering trading program between point and nonpoint sources of nutrients in the watershed.

Instead of individual nitrogen and phosphorus limits for each discharger, the Tar-Pamlico Association shares an overall nutrient discharge cap. The association enforces the cap by allocating nitrogen and phosphorus discharge limits among its members. The association's agreement with the state stipulates that if the collective annual nutrient caps are exceeded, a set fee for every excess kilogram of nutrients will be placed into a fund. That fund then enables farmers to pay for BMPs that reduce nutrients. The association has been successful in keeping nutrient loading well within the set discharge limits in spite of overall growth in the basin.

When faced with similar troubles in the Neuse Basin, North Carolina established a nutrient management strategy with annual nitrogen allocations for point-source dischargers greater than 0.5 million gal./day. The Upper Neuse Basin Association, representing a portion of the basin's point-source dischargers, has an allocation equal to the sum of its members' allocations. Trades may occur among association members as long as the collective limit is not exceeded. New or expanding dischargers may purchase allocations from an existing discharger or make an offset payment, thereby enabling future growth. Offsets are also required if the association or any nonparticipating discharger exceeds its annual allocation. Offset payments are made to a state fund for restoration of wetland and riparian zones, some of which serve as nonpoint-source controls.

Virginia's Efforts to Span the Divide

States are free to design programs to meet their own needs and that have bipartisan political support. In Virginia, where nutrient reduction competes with other water-quality programs for scarce funds, select municipalities are employing a cost-effective strategy that aims to create a better balance between point- and nonpoint-source projects.

By allowing developers the option of meeting their phosphorus removal requirements through the purchase of phosphorus credits from a regional stormwater management facility, Williamsburg, VA, is utilizing a form of an urban nonpoint-source trading program. The city constructs regional stormwater management facilities that generate phosphorus credits by reducing loads beyond existing conditions. The number of estimated pounds of phosphorus removed by a facility is the number of credits it generates. All of the credits are sold and cover the construction, operation, and maintenance costs of the regional control structure.

Developers have the option of meeting their discharge removal requirement either by implementing controls at the development site or by purchasing credits from a regional facility. For some developers, meeting the discharge removal requirement would cost four times more than buying credits from the city and if unavailable would stifle their projects.

The Williamsburg program demonstrates how nonpoint sources can be incorporated into a trading system. Using the same measurement procedure to quantify changes in phosphorus discharges as the conventional regulatory system, the phosphorus removal requirement and corresponding reductions are based on established relationships between land-use change and phosphorus loads. The regional stormwater facilities also reduce public monitoring costs with fewer regional stormwater management structures installed.

Reasonable Assurance Offers Safe Passage in Florida

Florida's Impaired Waters Rule (IWR) states that water segments expected to make progress toward attaining water-quality standards will not be listed on the 303(d) list of segments requiring TMDLs. The Florida Department of Environmental Protection (FDEP) must document the basis, including proposed pollution control mechanisms and expected improvements in water quality, that provides reasonable assurance that the segment will meet water-quality standards (FAC 62-303).

In response to IWR, a new initiative in the nutrient-impaired Suwannee River Basin has been formed to provide reasonable assurance to FDEP for delisting the water body. The Suwannee River Partnership is a nonregulatory coalition of government and private-industry representatives that works with local landowners to institute voluntary nutrient reductions. The partnership has addressed nitrogen loading through a nutrient management strategy that emphasizes cost share, quality assurance, and incentive programs for BMPs. In August 2002, FDEP determined that the partnership's strategy gave reasonable assurance that necessary reductions will be made. As a result, a TMDL for the Suwannee River is no longer scheduled for development.

"We feel like this nonregulatory approach will accomplish more from a water-quality standpoint," states Darrell Smith of the partnership. "Everyone involved is working for a solution."

Federal, state, and local governments; regulatory agencies; and private interests in Florida's Tampa Bay region have formed a cooperative consortium—the Nitrogen Management Consortium—to effectively manage nitrogen loading. Nitrogen contributions from stormwater have long been a cause for concern in the bay. Although no actual "exchanges" are taking place, the program is similar to a trading program: Consortium members work together to meet a shared goal of pollution reduction. The overall objective is to hold the line on nitrogen loading despite increased population growth. Using water-quality models, the consortium developed nitrogen-loading caps. Control measures address both point and nonpoint sources.

The program's emphasis is on collaboration and flexibility. Each member is able to select the most beneficial option for its community or industry as long as the overall goals are met. The group has already made considerable progress in meeting the nitrogen-loading goals. These goals will be periodically reviewed, and revisions will take into account any new sources of nitrogen that are identified. Based on these loading caps, FDEP developed a TMDL. This arrangement demonstrates "reasonable assurance" of reduction implementation by its formal structure, commitment, established timetables, and water-quality modeling.

Trading and Stormwater

The scope of trading programs might involve an individual entity, a group of nearby entities affecting the same water body, an entire watershed or basin, or an entire state. Many cooperative efforts at reducing pollution do not closely resemble the "textbook" descriptions of trading. The common denominator for all of the states' trading activities is that they provide flexibility in the allocation of pollution control responsibilities (while dischargers continue to meet any permit-mandated control requirements) so as to achieve water-quality goals more cost-effectively.

The economic benefits of trading reach beyond dischargers to consumers and communities. Trading can keep stormwater utility charges from increasing as quickly or as much as they might have without trading. Trading can also keep down costs to consumers as industry, agriculture, and business save on pollution control costs.

Any trade involving an unregulated or nonpoint source is typically directional; the regulated source will almost always buy effluent-reduction allowances, and the unregulated source will almost always sell allowances. Because these nonpoint sources have relatively low costs associated with treating pollutants, they are excellent partners for point-source traders. As regulatory requirements for nonpoint sources increase, trading among nonpoint sources will become more frequent.

A nonpoint source that has had exemplary success capitalizing on reduction credits is found in Frisco, CO. To respond to stormwater drainage problems in the 1980s, the community of Frisco constructed stormwater control structures in the form of sedimentation vaults. These structures have a phosphorus removal capability of 40-50 lb./yr. The community gained one credit (equal to 1 lb. of phosphorus discharge) for every 2 lb. that were removed. The town council is currently examining the idea of offsetting phosphorus discharge from construction of a new town golf course with the credits generated by phosphorus removal. Frisco has also netted additional credits by extending sewer lines to new areas. Credits earned were then sold to a neighboring community.

Troubles With Trading

While trading offers great promise for actual reductions of pollutants within watersheds, the activity is not without challenges to its ultimate success. The National Wildlife Federation (NWF) notes within its 1999 publication, A New Tool for Water Quality, "The challenge with trading is to allow for innovative, market-based reforms without compromising the existing safeguards in environmental protection." The publication cites four major obstacles to water-quality trading:

Enforceability. Some worry that, in allowing trading, states could sacrifice almost guaranteed pollution reductions by the point source in return for uncertain nonpoint-source-pollution reduction elsewhere. Unlike the NPDES Phase I permitting program for point-source controls—enforceable through federal citizen suits—the CWA contains no federally enforceable, permit-based program to secure nonpoint-source controls.

This concern can be addressed by effective implementation plans for TMDLs, which are required by EPA starting in 2003, as well as substantially higher trading ratios applied to nonpoint-source reductions. Typically a ratio for nonpoint source to point source is 2:1.

Monitoring. Monitoring is often desired to ensure that the projected reductions in pollution are in fact achieved. While point sources are required to self-monitor their discharge and self-report, with criminal penalties for false monitoring, monitoring for nonpoint sources is rarely required. Individuals apprehensive about trading contend that ensuring nonpoint-source reductions would necessitate broad and long-term monitoring plans. Fears are that the projected expense would make monitoring unlikely to occur.

The South Florida Water Management District (SFWMD) employs a strategy that demonstrates how to institute measurement of nonpoint-source discharge and exemplifies how this issue can be addressed in other watersheds. Nonpoint-source monitoring is currently working to effectively reduce nutrients in Florida's Lake Okeechobee. Water quality is impaired in the lake because of excess phosphorus, attributed to agricultural sources. Before the development of a phosphorus TMDL in 2001, the SFWMD instituted compulsory phosphorus concentration limits for major nonpoint-source discharges on the lake's north shore.

By requiring regular monitoring of the water in canals and ditches draining into the lake, the district calculated phosphorus discharge from individual land parcels. If a landowner violated the phosphorus standard, the district required a change in land-use practices to reduce discharges. The total phosphorus reduction from land tracts was approximated using a computer model. Negotiations between the district and the farmer led to a combination of land-use practices to result in phosphorus discharge reduction.

Hot Spots. Some are cautiously supportive of trading for fear that programs designed apart from a watershed strategy might lead to the formation of "hot spots," or highly degraded localized areas in the watershed. Such hot spots can occur when point-source dischargers in need of reducing pollutants are allowed to offset with a trade in distant water bodies, thereby not changing the water-quality issue in the immediate area.

To avoid the creation of hot spots, trading programs must be designed to consider location of potential trading partners within the watershed, size of watershed where trading can occur, compliance records of potential trading participants, enforcement, and monitoring. Trading programs need to improve not only the watershed's overall water quality but also the water quality in areas of greatest concern.

Equity and Environmental Justice. There is concern that trading proposals, especially those that allow an increase in dischargers in one location, will continue to shift the burden of pollution from wealthier communities to poorer communities.

To remedy this, just as with hot spots, paying close attention to the location of potential trading partners can guard equity and environmental justice.

Oh, the Possibilities

As the sources and levels of water-quality problems are increasingly identified, the potential for trading to become a greater part of the solution is steadily increasing. Trading programs hold promise for dealing with water-quality concerns on a local, regional, national, and international level.

The "Dead Zone" is an area in the Gulf of Mexico where diminishing aquatic life has been attributed to abnormally low levels of oxygen. Nitrogen from the Mississippi River basin has been identified as the main cause of the low oxygen. Because such serious problems arise when excess nitrogen loads reach the oceans, nitrogen trading among point and nonpoint sources along the Mississippi River might play a part in assuaging the crisis. Nitrogen trading is a real possibility for extensive reductions within larger basins or areas than at present.

Examining the issue on a national scale, the Economics Program at the World Resources Institute (WRI) has developed the NutrientNet (www.nutrientnet.org). This Web site, although currently a demonstration for specific watersheds, gives nonpoint sources of nutrients an estimate of their contribution to a watershed, reductions that can be achieved through a variety of BMPs, and the approximate cost of these activities. Because nutrient-trading approaches must be specific to watershed characteristics, NutrientNet can be adapted to other watersheds.

The WRI site includes interactive worksheets to help landowners calculate the amount of nutrients leaving the site as well as an evaluation of the options and the cost of reducing that load. Point sources can also use the site to make an initial estimate of costs associated with nutrient reductions. In addition, the Web site provides a model market for trading by allowing buyers and sellers the ability to post their nutrient credit offers.

With enhancement of water quality as the ultimate goal, states must recognize that longstanding command-and-control methods and standard technology-based regulatory approaches are not capable of effectively controlling a major contributor to water-quality problems: nonpoint-source pollution. Strict regulatory methods lack the flexibility needed to build watershed or basin approaches for attaining and managing improved water quality. They are missing incentives that nutrient trading provides for the discovery and implementation of innovative water pollution control strategies.

Nutrient trading provides a tremendous potential for cost savings, along with financial and regulatory incentives to reduce pollution beyond current limits. As the concept of nutrient trading gains greater acceptance, it will provide the most effective option for making significant improvements in water quality.

References

Faeth, Paul. Fertile Ground: Nutrient Trading's Potential to Cost-Effectively Improve Water Quality. World Resources Institute Economics Program, Washington, DC. May 2000.

Florida Administrative Code. "Identification of Impaired Surface Waters," Chapter 62-303. 2002.

Green, Butch. Frisco Sanitation District, Frisco, CO. Personal communication, September 3, 2002.

Greenhalgh, Suzie and Paul Faeth. "Trading on Water." Forum for Applied Research and Public Policy. Spring 2001.

Mandrup-Poulson, Jan. Florida Department of Environmental Protection. Personal communication, September 4, 2002.

National Wildlife Federation. A New Tool for Water Quality: Making Watershed-Based Trading Work for You, www.nwf.org/watersheds/newtool.html. National Wildlife Federation, Reston, VA. June 1999.

Smith, Darrell. Suwanee River Partnership. Personal communication, September 10, 2002

Stephenson, Kurt, Patricia Norris, and Leonard Shabman. "Watershed-Based Effluent Trading: The Nonpoint Source Challenge." Contemporary Economic Policy. October 1998.

Stephenson, Kurt and Leonard Shabman. "Effluent Allowance Trading: A New Approach to Watershed Management." Water Science Reporter. National Institute for Water Resources, Virginia Water Resources Research Center, Blacksburg, VA. 1996.

US Environmental Protection Agency. Draft Framework for Watershed-Based Trading, USEPA Pub. No. 800-R-96-001. USEPA Office of Water, Washington, DC. May 1996.

———. Water Quality Trading Policy; Proposed Policy, Notice. 67 FR 34709. USEPA Office of Water, Washington, DC. May 15, 2002.

Yandle, Bruce and Brian Mannix. Public Interest Comment on The Environmental Protection Agency's Proposed Water Quality Trading Policy. Mercatus Center Regulatory Studies Program. 2002.

Guest author April Grippo is an environmental scientist specializing in water resources with Applied Technology & Management Inc. in Gainesville, FL.

SW - January/February 2003

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