With increasing frequency, observers and practitioners of water quality management policy are proposing water quality trading programs. For example, in a recent Regulation article, Robert Earle and Virginia Perry-Failor criticized the U.S. Environmental Protection Agency for not making trading a part of its rule for the setting of Florida water quality standards for nutrients (“How Not to Improve Surface Water Quality,” Fall 2010).

Their argument was that nutrient trading, as opposed to command-and-control regulation, could lower the costs of compliance over time and hence make meeting any standard more affordable. To bolster their argument, the authors cite publications that inventory proposed and existing trading programs for water quality management. The impression is left that the inventoried programs are reasonable efforts to implement market-like, cost-effective design principles and that trading is being successfully applied to address discharges from currently unregulated nonpoint-source pollution.

We have written on how to embed market-like features in water quality management programs, but many such programs are not market-like. They are extensions of conventional command-and-control permitting — despite the “market-like” rhetoric used to describe such programs.

Point and nonpoint sources | Regulatory authorities grant National Pollution Discharge Elimination System (NPDES) permits for a subset of discharge sources, commonly called “point sources.” Most often these are industrial and municipal wastewater treatment facilities, but NPDES permitting has been extended in recent years to include some confined-animal feeding operations and some areas of storm water runoff. These sources are required to adhere to permits that contain numeric limitations on the nutrient pollutant loads that can be discharged.

Pollution by land-based runoff from agriculture (nonpoint sources) remains outside the regulatory process, even though in watersheds across the nation agricultural discharges are often the reason water quality standards are not being met. In the event that a particular stream, lake, or estuary does not meet water quality standards, regulators have only one regulatory instrument available to achieve water quality standards: the NPDES permits on point sources.

This regulatory context first compels regulators to maximize the discharge reductions that can be realized at the point sources. Most often, this translates into imposing near limits-of-technology effluent limitations in permits (sometimes aggregated for a group of dischargers who are allocated a legally- and regulatory-binding group limit). In most cases these stringent point-source controls will be insufficient to achieve water quality standards because nonpoint-source runoff is primarily responsible for the impairment. In fact, even zero point-source discharge may not secure the ambient water quality standard.

Meanwhile, controls on unregulated nonpoint sources (typically agricultural) rely on educational and subsidy programs to encourage those sources to reduce their discharges. Enter trading as often practiced. Point-source dischargers are required, and cannot avoid, imposition of these stringent permit requirements. When the point-source effluent load limitations are technically impossible to achieve (because of technology limits or uncontrollable growth in wastewater flows), the point sources are given the option to maintain NPDES permit compliance by “sponsoring” (that is, paying for) nonpoint-source controls elsewhere in the watershed.

This form of trading has little to do with cost savings or successfully addressing the water quality impairment, and has everything to do with maintaining compliance with increasingly stringent permit conditions. At the same time, there is another expressed motivation for this form of trading: creating a new funding source for subsidizing agricultural nonpoint-source controls that would otherwise continue to be unregulated. These new funds to pay for nonpoint-source reductions are how proponents argue that trading will help address the nonpoint-source problem.

Making gains? | Of course, trading as implemented above will not produce any new net reductions because the nonpoint-source reductions just offset new point-source pollutant loads. For water quality to be improved, the realized reduction in nonpoint-source loads must be greater than — not just offset — the point-source load.

To improve water quality, regulatory authorities are increasingly considering ways to secure nonpoint-source reductions beyond what is required to offset point-source load, under the rubric of trading. For instance, the EPA recently expressed a willingness to consider requiring all new and expanding point sources to generate net reductions in watershed loads (called “net improvement offsets”) for permitted discharges to the Chesapeake Bay. The net reductions would come primarily from unregulated agricultural nonpoint sources. These new requirements would be triggered in the event that the states failed to make adequate progress toward achieving nutrient reduction goals in the Chesapeake Bay. A variation on this idea is the proposal for “retirement ratios.” In this case, a permitted discharger must buy additional offsets to generate a net reduction to the receiving waters.

Obviously, trading as a revenue source for buying nonpoint-source reductions raises fundamental issues of fairness. In many watersheds, point sources have met their NPDES effluent limits, even as these limits have been made more stringent over time. Now, trading programs demand that point sources and their customers finance reduction efforts of nonpoint sources that governments have decided not to address directly.

Perhaps more troubling is that the purpose of trading programs is increasingly to extract revenue from regulated sources in order to subsidize agricultural nonpoint-source control programs — a purpose that is explicitly stated in many programs. In such cases, trading should be recognized for what it is: a tax on regulated sources. However, it is a tax that has been created and will be levied by an administrative bureau, without explicit statutory authorization.

In summary, proponents of markets need to distinguish carefully between trading programs with market-like features and those that are really command-and-control or simply a questionable tax. Just because the word “trading” is attached to a regulatory program does not make it market-like. The burden is on those who would advocate for market-like programs to fully understand existing programs by looking past the rhetoric used to promote them and fully evaluate their purposes and operation.

Readings

  • “Achieving Nutrient Water Quality Goals: Bringing Market-like Principles to Water Quality Management,” by Leonard Shabman and Kurt Stephenson. Journal of the American Water Resources Association, Vol. 43, No. 4 (August 2007).
  • “Rhetoric and Reality of Water Quality Trading and the Potential for Market-like Reform,” by Kurt Stephenson and Leonard Shabman. Journal of the American Water Resources Association, Vol. 47, No. 1 (February 2011).