Water Quality Trading

1. Water Quality Trading Claire Schary Water Quality Trading Coordinator U.S. Environmental Protection Agency, Region 10, Seattle, WA schary.claire@epa.gov (206) 553-8514 May 5, 2005

2. What is ‘Water Quality Trading’? • A source facing higher pollution reduction costs compensates another source for achieving equivalent, less costly reductions. • Market-based tool to solve water quality problems • Voluntary, flexible, stimulates innovation • Cost-effective pollution reduction • Operates within existing programs • Value for the pollution reduction credit is created by limiting the total amount of pollution allowed.

3. Conditions Necessary for Trading • Market Driver • regulatory requirement sets limit on pollutant discharges • defines commodity and market area • Cost differential • the financial incentive for entering into a trade • must cover transaction costs • Ability • technical feasibility and adequate supply • Opportunity • tools for trading available

4. Water Quality Trading: TMDLs Are the Primary Regulatory Drivers • Total Maximum Daily Loads (TMDLs) are the most common drivers for Water Quality Trading • TMDLs set a pollutant “budget” on all sources to achieve reductions necessary to achieve water quality standards in impaired water bodies • Under TMDLs point sources are assigned individual Waste Load Allocations • Enforced in NPDES permit through specified limit • Under TMDLs nonpoint sources are assigned Load Allocation by category • State, federal cost-share programs used to encourage use of Best Management Practices (BMPs)

5. EPA Region 10’s Water Quality Trading Experience • Idaho: • Lower Boise River Water Quality Trading Demonstration Project - phosphorus • Mid-Snake River Project - phosphorus • Idaho DEQ issued Water Pollutant Trading Guidance for Watersheds based on project experience • Oregon: • Tualatin River - Clean Water Services Water Quality Trading Project – temperature trading under watershed permit. • Oregon DEQ issued “Internal Management Directive” on water quality trading • Water Quality Trading Assessment Handbook

6. Lower Boise River

8. Phosphorus Trading: Lower Boise River • Dynamic, market-based trading • Broad authorization to trade subject to trading rules • Liability remains with permit holder • PS, NPS sign private trade contracts • Environment protected • BMP List specifies acceptable practices, measurement • Location-based trade ratios applied to achieve environmentally equivalent reductions • Robust participation by agriculture • Trading driven by economic decisions • Private association oversees trading system • Mechanisms to support farm-scale and watershed scale participation

9. Phosphorus Trading: Mid-Snake R. • Trades between point sources only (not enough supply from nonpoint sources so far) • Upstream point source City of Twin Falls has surplus phosphorus reductions • Downstream point source fish farmers need to make reductions • Trade: reduction credits from Twin Falls will be used 30 miles downstream by fish farmers • Water quality is protected by • TMDL’s overall phosphorus reduction requirement, • instream concentration limits, and • upper limits in fish farmers’ permits to prevent “hot spots”

10. Theory to Practice inWater Quality Trading • Not all pollutants are tradable commodities • Trading Policy allows nutrients, phosphorus, sediment, and case-by-case for others • Issues for pollutant trading suitability: • Pollutant form: Different forms of same pollutant discharged • Impact:Fate and transport of pollutant, and its varying impact on sensitive portions of the watershed • Location of dischargers in the watershed for determining environmentally equivalent reductions • Time: Match of timing of discharge and reductions across sources; permit cycles • Quantity:supply and demand must align

11. Financial Attractiveness of Water Quality Trading • Need to determine if trading makes financial sense for one or more permittees in the watershed: • TMDL allocations affect ability to trade • Cost of required reductions based on control technology options and “lumpiness” of reduction amounts achieved • Cost of incremental reduction amounts for individual sources are what drives the demand for trading • not the same as average cost of reductions • Assess potential control costs for other point sources, nonpoint sources in the watershed and identify potential trades • Consider transaction costs, risk, and alternative compliance strategies by other sources

12. Market Infrastructure to Support Trading • Transaction costs strongly influenced by market design, regulatory constraints, and uncertainty of outcomes • Participants’ uncertainty that a viable water quality trading market will develop • Participant’s uncertainty of regulatory approval of trades • Designing a market to address these needs, while matching the market size to the volume of trading expected, helps reduce transaction costs.

13. How Can Water Quality Trading Be Used to Improve Multiple Resources? • One project can generate multiple types of credits • Depends on what is beneficial for other resources • Other types of credit markets need to define what is their baseline and then what is “surplus” for trading • Water Quality Trading Policy on baselines for credit calculations: • Must be consistent with water quality standards • Must lead to reduction amounts that are equal to or greater than those established under existing regulatory requirements or under a TMDL. • When there is a TMDL, the Waste Load Allocations and Load Allocations are the baseline.

14. Question • For credits to be established for other ecosystem services besides water quality: • What is the baseline and what is a “surplus” reduction? • How will environmental equivalency be established so the credit can be used in a different location? • Will there be sufficient demand and supply, and at the same time?