Point-nonpoint Trading – Can It Work?

Water quality trading between point and nonpoint sources is of great interest as an alternative to strict command and control regulations on point sources for achieving water quality goals. The expectation is that trading will reduce the costs of water quality protection, and may speed compliance. The United States Environmental Protection Agency has issued guidance to the States on developing point-nonpoint trading programs, and United States Department of Agriculture is encouraging farmer participation. However, existing point-nonpoint trading programs have resulted in very few trades. Supply side and demand side impediments seem to be preventing trades from occurring in most trading programs. These include uncertainty over the number of discharge allowances different management practices can produce, high transactions costs of identifying trading partners, baseline requirements that eliminate low-cost credits, the reluctance of point sources to trade with unfamiliar agents, and the perception of some farmers that entering contracts with regulated point sources leads to greater scrutiny and potential future regulation. Many of these problems can be addressed through research and program design. (KEY TERMS: water quality trading; nonpoint sources; point sources; Clean Water Act.) Ribaudo, Marc O. and Jessica Gottlieb, 2011. Point-Nonpoint Trading – Can It Work? Journal of the American Water Resources Association (JAWRA) 47(1):5-14. DOI: 10.1111 ⁄ j.1752-1688.2010.00454.x Agriculture has significant impacts on water quality. Runoff and leaching of pollutants from agricultural chemicals and manure, and the runoff of sediment have contributed to widespread water quality impairments. Farmers and ranchers, for the most part, have little incentive to improve water quality. The primary United States (U.S.) water quality law, the Clean Water Act (CWA), only regulates pollution from point sources (factories, sewage treatment plants, some large confined animal feeding operations). Voluntary approaches for controlling pollution from agriculture are the mainstay of federal and state water quality improvement efforts. But benefits from water quality improvements occur mostly off the farm, and as these benefits generally have the characteristics of public goods, few producers are willing to voluntarily incur the costs of adopting management practices that improve water quality. Water quality trading is currently of much interest as a market-based approach for improving the efficiency of water pollution control allocations among and between point and nonpoint sources in the U.S. Under the CWA, point sources (e.g., factories, sewage treatment plants) are regulated through a nontradable permit system. A permit specifies how much of a particular pollutant the permit holder can discharge. Traditionally, permittees were required to meet their permit obligations through their own Paper No. JAWRA-09-0139-P of the Journal of the American Water Resources Association (JAWRA). Received September 8, 2009; accepted February 5, 2010. a 2010 American Water Resources Association. No claim to original U.S. government works. Discussions are open until six months from print publication. Respectively, Agricultural Economists (Ribaudo, Gottlieb), Economic Research Service, 1800 M St. NW, Room 4194-S, Washington, D.C. 20036-5831 (E-Mail ⁄Ribaudo: [email protected]). JOURNAL OF THE AMERICAN WATER RESOURCES ASSOCIATION 5 JAWRA JOURNAL OF THE AMERICAN WATER RESOURCES ASSOCIATION Vol. 47, No. 1 AMERICAN WATER RESOURCES ASSOCIATION February 2011 effluent reductions. The United States Environmental Protection Agency (USEPA) policy guidelines on water quality trading now allow points sources to meet their Water Quality Based Effluent Limitation requirements through discharge reductions from other sources under certain conditions (USEPA, 2004). Under the USEPA policy guidelines, these sources may be regulated point sources or unregulated nonpoint sources. The guidelines encourage states to consider agriculture as a source of offsets in water quality trading programs, and a number of states are either implementing or considering water quality trading programs that allow point-nonpoint source trading. The United States Department of Agriculture (USDA) is also very interested in water quality trading. In 2006, the Department announced a new policy on market-based environmental stewardship with the goal of broadening the use of market-based mechanisms for providing environmental and ecosystem services, such as credit trading (USDA, 2006). Such markets could provide a source of income to farmers and reward them for engaging in conservation activities. Farms can create offsets or credits for the market by implementing management practices such as conservation tillage, nutrient management, and buffer strips. As the price is determined in the marketplace, payments are not based on the costs of the practice, as in most traditional conservation programs. Farmers can also receive a payment for a much longer period of time than the two to five years of a standard conservation program contract. There appears to be ample opportunity for pointnonpoint trading programs to be established. Almost 7,000 waters impaired by nutrients (pollutants produced by both point and nonpoint sources) have been listed under Section 303(d) of the Clean Water Act (USEPA, 2009). To date, over 4,000 total maximum daily loads (TMDLs) have been developed to address 5,000 of these impaired waters. As discussed below, the presence of a TMDL is a basic requirement for a trading program. However, point-nonpoint trading has not been very successful to date, in terms of the number of pointnonpoint trading programs and number of trades (Breetz et al., 2004; USEPA, 2008). Only 15 trading programs have been developed since 1980 that allow point-nonpoint trading for nutrients, and very few trades have occurred in these programs (Table 1). Much has been written about various issues related to point-nonpoint trading that may hinder market development and function, including uncertainty, trading ratios, transactions costs, and validation issues (Hoag and Hughes-Popp, 1997; Woodward and Kaiser, 2002; King and Kuch, 2003; Kieser and Fang, 2005; King, 2005; Ribaudo and Nickerson, 2009). These issues can prevent trades from occurring, or increase the risk that trades will not be able to meet the water quality goals of the program. This paper discusses demand-based and supply-based issues facing point-nonpoint trading markets, and identifies steps that government can take to increase the changes necessary for point-nonpoint markets to succeed.