1. Water Quality Trading Claire Schary Water Quality Trading Coordinator U.S. Environmental Protection Agency, Region 10, Seattle, WA 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 Market-based tool to solve water quality problems Voluntary, flexible, stimulates innovation Voluntary, flexible, stimulates innovation Cost-effective pollution reduction Cost-effective pollution reduction Operates within existing programs 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 regulatory requirement sets limit on pollutant discharges defines commodity and market area defines commodity and market area  Cost differential the financial incentive for entering into a trade the financial incentive for entering into a trade must cover transaction costs must cover transaction costs  Ability technical feasibility and adequate supply technical feasibility and adequate supply  Opportunity tools for trading available 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 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 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) 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 Lower Boise River Water Quality Trading Demonstration Project - phosphorus Mid-Snake River Project - phosphorus Mid-Snake River Project - phosphorus Idaho DEQ issued Water Pollutant Trading Guidance for Watersheds based on project experience 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. Tualatin River - Clean Water Services Water Quality Trading Project – temperature trading under watershed permit. Oregon DEQ issued “Internal Management Directive” on water quality trading 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 Broad authorization to trade subject to trading rules  Liability remains with permit holder PS, NPS sign private trade contracts PS, NPS sign private trade contracts  Environment protected BMP List specifies acceptable practices, measurement BMP List specifies acceptable practices, measurement Location-based trade ratios applied to achieve environmentally equivalent reductions Location-based trade ratios applied to achieve environmentally equivalent reductions  Robust participation by agriculture Trading driven by economic decisions Trading driven by economic decisions Private association oversees trading system Private association oversees trading system Mechanisms to support farm-scale and watershed scale participation 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, TMDL’s overall phosphorus reduction requirement, instream concentration limits, and instream concentration limits, and upper limits in fish farmers’ permits to prevent “hot spots” upper limits in fish farmers’ permits to prevent “hot spots”

10. Theory to Practice in Water Quality Trading  Not all pollutants are tradable commodities Trading Policy allows nutrients, phosphorus, sediment, and case-by-case for others 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 Pollutant form: Different forms of same pollutant discharged Impact: Fate and transport of pollutant, and its varying impact on sensitive portions of the watershed 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 reductionsLocation of dischargers in the watershed for determining environmentally equivalent reductions Time: Match of timing of discharge and reductions across sources; permit cycles Time: Match of timing of discharge and reductions across sources; permit cycles Quantity: supply and demand must align 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 TMDL allocations affect ability to trade Cost of required reductions based on control technology options and “lumpiness” of reduction amounts achieved 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 Cost of incremental reduction amounts for individual sources are what drives the demand for trading not the same as average cost of reductionsnot 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 Participants’ uncertainty that a viable water quality trading market will develop Participant’s uncertainty of regulatory approval of trades 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 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 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 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. 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. 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? 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? 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? Will there be sufficient demand and supply, and at the same time?