Source: Know Your Environment, Environmental Associates of The Academy of Natural Sciences

I. Introduction
II. Nutrient Pollution
III. Nutrient Trading
IV. Conclusion
V. References

I. Introduction

In the thirty years since it became law, the Clean Water Act (CWA) has been hailed as one of the most significant steps ever taken by the U.S. federal government to control water pollution (see KYE 11/2002). During that time, thanks in large part to actions spurred by the CWA, there have been major improvements in the nation's water quality. The legislation has been particularly effective in controlling the unregulated dumping of sewage and industrial wastes.

Throughout those thirty years, however, the CWA has also frequently been criticized for matters that it left unresolved. Though not foreseen at the time the law was written, a variety of issues--ranging from wetlands preservation to industry's use of cooling water--have evolved into high profile controversies. Critics have often called for legislation that is clearer, and for flexible enforcement tools that would allow both regulators and the regulated to respond more imaginatively to these new problems.

To address this, experts in the field have begun to suggest innovative policy options that might allow a broader range of solutions for complex problems. One method that has received growing attention is known as water quality trading. It is based on the similar concept (called emissions trading) that has been used with particular effectiveness in the past for controlling air pollutants.

The development of water quality trading systems has now become a matter of great interest to policy makers, garnering support from a wide group of interests, including both industry and environmental advocates. This has been especially true regarding a class of pollutants known as nutrients, a set of chemicals that are necessary for living systems to function but which, in excessive amounts, can cause a variety of environmental problems.

In the next two issues we will be looking at how the specific tool of water quality trading can be applied to the problem of nutrient pollution. Although this may seem like a very specialized topic (and, admittedly, it has some quite technical aspects) it is actually one of tremendous importance. Not only is nutrient pollution one of the major causes of water impairment in the U.S., the use of nutrient trading is now being seen as a model that may be applied to other environmental problems.

It is important, therefore, to understand the details of this subject to get an idea of what future environmental policies must look like. As market-based solutions become more popular for addressing environmental problems, it is crucial to understand both their apparent advantages and the remaining uncertainties as to their effectiveness. Only then can informed choices be made as to how appropriate is to use such solutions for particular environmental problems.

II. Nutrient pollution

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Much of the current criticism of the Clean Water Act is rooted in the law's historical emphasis on so-called "point source" pollution. As the name implies, point sources are discharges that come from a discrete point--usually a drain or an outlet--and are therefore often called "end of pipe" discharge. At the time the CWA was written, point source discharge, specifically wastewater and factory effluents, were seen as the major threat to water quality

Point sources are also relatively simple to detect and measure. The technology of the 1970's was well equipped to collect and evaluate discharges from factories and waste treatment operations. The language of the law is therefore clear on methods for dealing with such discharges, and as a result, there is a robust system of regulations and enforcement provisions in place. It is important to understand how this enforcement operates, as it remains the primary tool at the federal level for limiting water pollution.

The centerpiece of U.S. water pollution regulations is the National Pollution Discharge Elimination System (NPDES), which monitors and controls any point source discharges into any waterway. In theory such discharges are completely prohibited; in practice, they continue but are heavily regulated. With the permits issued under the NPDES, the level of contaminant that can be released is clearly prescribed and is based on the level that would be present if the best available control technologies were being used.

Buttressing the NPDES, each state is also required to assess the water quality of each waterway in it's jurisdiction. If a waterway fails to meet water quality standards, the state must set maximum allowable total levels for each contaminant that is causing the impairment. These levels are called total maximum daily loads (TMDL). Because TMDLs are determined independently of the amounts mandated on NPDES permits, it is the responsibility of each discharger on a particular waterway to share responsibility for bringing contaminant levels below the TMDL.

Although the law calls for TMDLs to be set for every impaired waterway in the U.S., it is only been recently that the Environmental Protection Agency (EPA) has begun to implement this requirement. If the TMDL for a particular body of water is exceeded, point source dischargers may be required to implement pollution controls that go beyond those prescribed on their NPDES permit. As we will see, the TMDL is also an important element of water quality trading.

This emphasis on point sources made sense at the time the Clean Water Act was written, Many of the nation's waterways were choked with municipal and industrial wastes, and the law was prompted in large part by public outcry about these conditions. Over time, these steps have became increasingly successful in lessening and regulating point source discharges. However, even as point source contamination has decreased, other water quality problems have become more pressing.

Most notable among these are the various pollutants known as "nonpoint source" discharges. Nonpoint sources, as the name implies, are more diffuse and less easily characterized. Generally, they are the result of substances such as fertilizer or highway runoff that are spread or spilled in terrestrial systems but that end up being transported into waterways by rain or melting snow. Nonpoint sources are now believed to be responsible for the majority of remaining pollutants in U.S. waterways, resulting in impairments that exceed TMDLs in many locations.

Because nonpoint source pollutants are dispersed and intermingle, it is also difficult to clearly assign responsibility for their presence. With no discrete source to collect and measure discharger, it is often impossible to prove that a particular contaminant was the result of a specific activity. Monitoring of nonpoint source pollution generally must be derived from land use data rather than identifying specific polluters.

One particular class of substances that are frequently carried in overland runoff are the chemicals known as nutrients. Though we are used to thinking of nutrients as the benign components of food, in this usage the term refers to a general set of chemicals which may or may not be associated with the nutrition of organisms. Most important among these are nitrogen and phosphorous, excess quantities of which have become a source of serious concern around the nation.

Nitrogen and phosphorous occur naturally in a variety of forms; indeed, pure gaseous nitrogen makes up 80% of the air we breath. However, both of these elements generally enter living systems combined with other substances in compound form. Such compounds include nitrates, nitrites and phosphates, combinations of nitrogen or phosphorous with oxygen that in turn bind to other chemicals. In nature, nitrogen compounds, in particular, are involved in a complex cycle of biogeochemical reactions. They are fixed by bacteria, digested by animals and incorporated in proteins, to name just a few of the steps. The cycling of nitrogen is essential for life to exist.

In nature also, there is usually a rough balance to the different forms in which the nutrients exist. Only a fraction of the total nitrogen and phosphorous in the ecosystem are available at any given time for biological reactions. However, compounds of both nitrogen and phosphorous are also produced as a result of a variety of human activities, resulting in a much larger amount of biologically active nutrients than would be available under natural conditions. These nutrient-producing activities include agriculture, industry and municipal operations. Nutrients can be discharged into waterways as both point and nonpoint sources, though the latter is now more common. As the regulations of the Clean Water Act have minimized the amount of nutrient waste from municipal sewage operations, agricultural activities--especially production of chemical fertilizers and animal wastes--have emerged as the single largest source of nutrient pollution.

In the Chesapeake Bay, for example, a third of all phosphorous and half of all nitrogen found are thought to the be result of agricultural activities in the watershed of the Bay and upstream in the Susquehanna River. A four year study in Pennsylvania found that 39% of the nitrogen and almost 69% of all phosphorous found in 85 of the state's watersheds originates with agricultural runoff. For North Carolina's Tar-Pimlico basin, 44% of both the excess nitrogen and phosphorous came from farming. (If point source pollution is considered "end of pipe" pollution, nonpoint nutrient waste is sometimes called "edge of field".)

For many readers, it may not be immediately obvious that an excess in nutrients would be a problem. We are more accustomed to thinking of nutrient shortages as a cause for concern, and indeed, shortages of nitrogen and phosphorous can also be quite dangerous for an ecosystem. Nitrogen is crucial for both plants and animals to synthesize proteins. Phosphorous compounds--especially phosphates--play a key role in photosynthesis the well known process by which plants use sunlight to produce sugar. To promote growth of crops, farmers apply chemical and natural fertilizers to offset shortages of both nitrogen and phosphorous.

Despite the importance of these elements, however, they generally need only be present in relatively small amounts in waterways to meet the needs of the organisms living there. Like many ecological processes, it is important that nutrient levels stay within a certain range. When excess amounts of nutrients accumulate in streams and lakes, there are several negative effects. Many of these are due to the fact that the nutrients stimulate the growth of microscopic plants to a level beyond what the ecosystem can process.

These plants, known as phytoplankton, (most familiar to us as the green algae we see on standing water) will grow into dense "blooms," blocking sunlight to the rest of the system and wiping out the submerged aquatic vegetation on which many of the remaining organisms depend. More importantly, as the algae die, they sink to the bottom and form large mats of decomposing organic material. The process of bacterial decomposition, in turn, consumes dissolved oxygen, drastically reducing the ability of a waterway to support life.

The results of nutrient pollution are widespread, and can approach the catastrophic. In the Gulf of Mexico for example, each summer sees the formation of a "Dead Zone"--a lifeless area several thousand square miles in size off the Louisiana coast--thought to be a direct result of nutrient pollution of the Mississippi River. In fact, according to documents released by the U.S. Congress there are "20,000 water bodies, and segments of water bodies, that remain impaired even after the installation of technology-based controls on point sources." (1) Nutrient pollution is a major cause of these impairments. Given the breadth and magnitude of its effects on the basic processes of the ecosystem, nutrient pollution is considered one of the most critical threats to water quality in the U.S.

Regulating nonpoint sources of nutrient pollution, however, has been a problem ever since the advent of modern environmental legislation. Not only is overland flow difficult to monitor and trace, the environmental impact of diffuse, rain-carried chemicals may not be immediately obvious. Although particular sources of nutrient pollution, such as farms and livestock operations, may be well known, it is difficult to prove a particular level of such contamination is the result of a particular activity. Complicating this further is the fact that the CWA provides little guidance on nonpoint source regulation. Though it is mentioned in the CWA (as well as other legislation), the enforcement remains vague or voluntary. There is no non-point equivalent of the NPDES.

Up to now, for a variety of technical and political reasons, state and federal agencies have delayed in setting TMDL levels for most waterways. In recent years, environmental advocates, pointing to the continuing problems with the quality of many of the nation's waterways, have called for the prompt and vigorous setting and enforcement of TMDLs. A series of lawsuits have resulted in rulings that the federal government is required to act promptly on the TMDL portions of the CWA. As the development of TMDLs has moved forward, the result has been a growing awareness that additional enforcement is necessary to bring many bodies of water in the U.S. into compliance with standards.

This has led to a complex controversy over how the levels of contaminants in these waterbodies might be reduced. Although the bulk of the excess may have been produced by nonpoint sources, it is unclear how these types of discharges will be controlled. TMDLs do not dictate enforcement per se, put are intended as planning tools to guide enforcement activities. The NPDES remains the primary method for enforcement. It is possible, therefore, that point source dischargers--principally industries and municipalities-- will be required to add expensive control methods beyond those already specified on NPDES permits in an attempt to improve the quality of the waterway.

Understandably, producers of point source discharges feel that they are being unfairly penalized for activities beyond their control. This is particularly true for industries that feel they have acted in good faith to follow the requirements of the law. At the same time, there is little incentive for nonpoint dischargers, such as farmers, to undertake some of the relatively simple practices that would lessen their level of discharge.

Faced with this dilemma, policy makers have begun to look at alternative ways of achieving the water quality goals mandated by the Clean Water Act. Many experts urge a "results oriented" approach that emphasizes the final condition of the waterway, rather than following a standardized enforcement regime that may or may not succeed in improving water quality. For dealing with nutrient pollution, there is broad--though by means universal--agreement that water quality trading may offer a workable solution.

III. Nutrient Trading

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In principle, nutrient trading is a simple concept. First, a maximum or "cap" is determined for the total amount of a specific pollutant that can be discharged into a given waterway. Enforcement is then based on keeping the collective discharge into a watershed below that figure. Each discharger is assigned a specific goal for maximum discharge which represents their share of the collective cap. Dischargers who reduce discharge below their goal can sell their "surplus" reduction. "Trading allows a wastewater treatment plant, factory, or other plants that discharge waste...to purchase controls of a particular pollutant elsewhere in the watershed, instead of installing tighter controls for that pollutant at their own plant."(2)

A hypothetical example will illustrate nutrient trading in its simplest form. Suppose that two dischargers who operate near the same body of water are each faced with the need to decrease their nutrient emissions by the same amount. The technology to bring about this decrease will cost the first discharger one million dollars. For a variety of reasons (e.g. differences in operations, costs, circumstances, etc.) the second discharger will need to spend just one hundred thousand dollars to achieve the same amount of reduction. Let's also say that they could achieve twice the required reduction for a cost of 200,000 dollars. (This is just an illustration, costs of pollution reduction are seldom linear.)

The opportunity here is fairly obvious - for two hundred thousand dollars the second discharger could, alone, achieve the same water quality goals that would cost 1.1 million dollars for both dischargers. There is, however, no impetus for the second discharger to spend this extra money, as they will receive no benefit from single handedly reducing the pollution of the waterway to meet the TMDL.

In a nutrient trading system, by installing the controls to higher levels than required, the second discharger would gain a "credit" which the other discharger could purchase in lieu of installing the more expensive devices. The first discharger would, essentially, pay the second discharger to go beyond their required reduction. Presumably the second discharger would make some profit off the arrangement - perhaps charging 150,000 dollars to apply the second hundred thousand dollars worth of control.

This would still be considerably less than the million dollars the first discharger would have been required to pay. Moreover, it achieves the water quality goals, earns the second discharger a tidy profit and allows more flexibility for both the regulators and the regulated than would be the case under a strictly prescriptive system.

In practice, the systems proposed for governing nutrient trading are a good deal more involved than this simplified example. Ideally, in trading systems, dischargers who earn credits by reducing effluent to levels below are allowed to trade these credits in a quasi-free market system with other dischargers. The logic is that the market mechanisms will induce dischargers to develop better methods of pollution control in order to gain a monetary advantage in this effluent credits market. In the case of air pollution, trading systems have been shown to control sulfur emissions more effectively than was the case when traditional regulation was used.

The underlying principles of water quality trading are similar to those that govern market behavior in general. It is assumed each entity will strive to maximize its own benefit; each entity will face different motivations, costs and circumstances when doing business; these differences will drive the entities to make different decisions as to how it achieves particular outcomes; and in order to maximize benefit each entity will be motivated to also maximize efficiency and cost effectiveness.

We see similar principals in our everyday lives. We all have different amounts of money available, our decisions on how we spend it are based on a variety of factors such as need, convenience, thrift, etc; we will generally--all other things being equal--make purchases based on price and cost effectiveness. These are basic principles of a free-market economy. The theory underlying nutrient trading is that these assumptions will also prove true in governing the decisions of dischargers.

According the EPA, effluent trading works only when "a water quality goal is established" and "sources within the watershed have significantly different costs to achieve comparable levels of pollution control." (3) This variation in costs and motivations is critical to nutrient trading. If every discharger paid exactly the same costs to achieve pollution control, there would be nothing to trade. Addressing these differences, it is also assumed that dischargers will be motivated to make greater efforts to develop and improve control techniques, as such improvements will translate into a better market position. Hence, it is a stated goal that dischargers will be motivated to tap into levels of ingenuity and effort that might not have been attained by simple regulatory requirements.

Because effluent trading may bypass some of the more rigid elements of traditional regulation, it has been embraced by a broad segment of society, including those interests which are often critical of regulatory programs. Nonetheless, water quality trading does not indicate an absence of regulations, nor could it operate without a clearly defined regulatory framework. Rather, it is a way of reaching the goals of existing regulations while avoiding some of the more intractable problems that might come with regulatory prescriptions.

In 2003, the EPA sought to encourage water quality trading by releasing a policy which outlined the conditions under which it may be used and the mechanisms by which it would be administered. The Clean Water Act remains the heart of the policy, and all parties using it must obtain appropriate permits. Because of this, trading plans are usually conceived as part of the NPDES process.

The watershed concept is also a key. The entire process only makes sense if, by applying trading, the overall quality of the water in a particular watershed improves. According to the EPA, trading should take place in "defined trading areas that coincide with a watershed or TMDL boundary."(4) It would not make sense for a discharger on the Delaware River, for example, to trade credits with a farmer in Iowa. The goal of trading is to address the discharges to a particular body of water for which a TMDL has been, or will be, established. This will, in turn, "ensure that water quality standards are maintained or achieved throughout the trading area and contiguous waters."

The EPA policy specifies a number of other conditions and procedures that must be used when trading is undertaken to fulfill conditions of the Clean Water Act. The following are among the most important of these.

First, critics of trading have pointed out that the practice is not applicable to substances that present a significant hazard even in small amounts or that have a tendency to accumulate in the ecosystem. Although the EPA has not completely ruled out trading in credits for such contaminants, at this time water quality trading is only supported by the EPA for controlling nutrient pollution and for lessening sediment, a related pollutant that is often the result of non-point sources. Substances that present acute toxicity or that can bioaccumulate in the environment are not traded, nor is it clear that they could be.

Second, as mentioned before, trading must be driven by prescribed standards for a given watershed. Thus, in the EPA policy "the term pollution reduction credits...means pollutant reductions greater than those required by a regulatory requirement or established under a TMDL." Where TMDL's have not yet been established, trading may be undertaken which will lessen the net amount of pollutant in a body of water, or which reduces pollution levels to a cap "supported by baseline information."

Third, the policy lays out a variety of standards that will maintain adherence to the CWA and generally make the practice convenient to manage. These include the need to obtain NPDES permits which describe the trading arrangements to be used, the opportunity for public input, regular evaluations of programs, and provisions for EPA to provide oversight. Other standards include clearly defined and regulated trading units, methods for addressing measurement uncertainties and so-called "anti-backsliding" provisions that will prevent a reduction in levels of water quality.

Finally, the policy prescribes several conditions under which trading can occur. The best defined of these is the "TMDL trading," that is trading that takes place after a TMDL has been set. This is the most likely type of trading to occur as the TMDL places requirements on all dischargers in a watershed. As mentioned, "pre-TMDL trading" may be used in waterways for which TMDLs have not yet been set; the motivating factor here, for dischargers who already have NPDES permits, is that reductions of the impairment in a waterway may forego the need for a TMDL to be set. Other types of trading are less common, such as intra-plant trading or pre-treatment trading by municipal water treatment plants. These operate under similar mechanisms to TMDL trading but are more specialized.

It should also be noted that the policy on nutrient trading does not distinguish between point and nonpoint sources (other than to acknowledge that both are eligible to participate in trading). However, while it is true that trading can take place between any two dischargers, it is likely that the greatest benefit for both parties will be with point source dischargers "purchasing credits" (i.e. paying for pollution controls) from nonpoint dischargers.

The reasons for this are simple economics. Methods for decreasing non-point source pollution are often less costly than those required for treating point source contaminants. Agricultural best management practices such as new tilling methods or planting trees in riparian zones can remove nutrient run-off at a higher rate than can be achieved by spending an equivalent amount on industrial equipment. This is consistent with the observation of the Idaho Division of Environmental Quality in assessing nutrient trading on the lower Boise: "The appeal of effluent trading emerges when pollutant sources face substantially different pollutant reduction costs. Typically, a party facing relatively high pollutant reduction costs compensates another party to achieve an equivalent, though less costly, pollutant reduction."(5)

Along the same line, it is the point source dischargers who face the strongest pressure to reduce contaminant levels as they are the ones regulated under the NPDES. It is therefore in their best interest to identify sources of contamination in a waterway that can be reduced for less cost than is often required for the "structural controls" (i.e. expensive equipment) that they would have to purchase. Often these less costly controls can be attained for nonpoint sources, and by trading, the dischargers are, in effect, achieving effluent control for a reduced price.

Because of this cost differential, however credits earned by nonpoint source dischargers, may be considered of less value than those of a point source. This will, in effect "allow tighter caps to be imposed on point source dischargers...The use of 'trading ratios' (rules of exchange that require point sources to purchase credits associated with more than one pound of nonpoint discharge reductions to offset each pound of point source discharge allowed) is also expected to reduce net discharges and improve water quality." (6)

Thus, a factory may be required to pay for two or three credits from a nonpoint discharger to compensate for each unit of pollution they are producing over the amount prescribed. This is seen by regulators as a way of leveraging greater pollution control out of the existing regulations. Even with the differential, it is assumed that the cost to the point source discharger will still be lower.

Understandably, however, point source dischargers see this differential as an inequitable arrangement and feel that they are being required to bear a disproportionate amount of the burden for contamination of a waterway. In fact, as we will see, this is seen by some critics as a major factor limiting the likelihood that dischargers will participate in trading programs. Conversely, nonpoint source dischargers note that (unlike the case with point sources) it is almost impossible to prove the degree to which their operation is causing contamination and insist that their level of contribution is overestimated. Therefore they feel that they should receive significant compensation for undertaking any control activities.

As this controversy suggests, nutrient trading is far more complex in practice than the simple examples would indicate. In fact, there are a number of different forms trading can take, and a variety of programs are currently underway that differ according to local conditions and the needs of the participants. Almost all of these programs are considered to be in the pilot phase and the amount of actual trading that has occurred thus far is limited.

King and Kuch, writing in the Environmental Law Review, contend that only 3 of the 37 nutrient trading programs identified by the EPA have actually conducted any trading. (7) Further, even when conducted, trading is only successful if each stakeholder and participant sees tangible results; thus the broad agreement seen on the concept of trading in principle may face significant differences of opinion in practice. In our next issue will look at how nutrient trading has worked thus far and some of the differences in how it should be undertaken in the future.

IV. Conclusion

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For decades, communities, industry and government have been working to develop ways to control the level of effluent discharged into the nation's waterways. The Clean Water Act provided a context for regulating direct discharges by point sources. These methods, which have proven highly effective in dealing with industrial and municipal waste, have not so far offered clear guidance on the more problematic issue of nonpoint source pollution.

In the past few years there has been considerable effort to re-invent pollution control, with nonpoint source contaminants such as nutrients receiving wide attention. Many models have been put forward to address these contaminants, but most of these have not yet been put into place. Nutrient trading is seen by many experts as being especially promising, and a number of locations have begun plans to implement trading programs.

In our next issue we will look at how these efforts have progressed and what lessons might be learned from them. As with most environmental remedies, nutrient trading is just one tool for approaching a multi-faceted problem. Making effective use of it will require an honest appraisal of both its advantages and its flaws.

V. References

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1. U.S. Congress, 2002. Hearing on Water Quality Trading - An Innovative Approach to Achieving Water Quality Goals on a Watershed Basis.House Committee on Transportation and Infrastructure, Subcommittee on Water Resources and Environment. June 13, 2002.
2. NWF, 1999. A New Tool for Water Quality: Making Watershed-Based Trading Work For You. National Wildlife Federation, Northeast Natural Resource Center, Montpelier, Vermont.
3. EPA, 2003(a). Frequently Asked Questions About Water Quality Trading: Questions of general interest about trading and EPA's 2003 Trading Policy. U.S. Environmental Protection Agency.
4. EPA, 2003(b). Final Water Quality Trading Policy. Office of Water, U.S. Environmental Protection Agency, Wash. DC.
5. Ross and Associates, 2000. Lower Boise River Effluent Trading Demonstration Project: Summary of Participant Recommendations For a Trading Framework. Prepared for the Idaho Division of Environmental Quality by Ross & Associates Environmental Consulting, Ltd. September 2000.
6. King D. and P. Kuch, 2003. Will Nutrient Credit Trading Ever Work? An Assessment of Supply and Demand Problems and Institutional Obstacles. Environmental Law Reporter, 33 ELR 10352, 5-2003.
7. King D. and P. Kuch, 2003. (Cited above.)

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