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July 23, 2015 Articles

Nutrient Trading as Clean Water Strategy in the Interstate Context

The public at large is unlikely to rank nutrient pollution among the top threats to water, but excess nutrient levels in national watersheds are a serious concern.

By Sarah T. Babcock

The public at large is unlikely to rank nutrient pollution among the top threats to water, but excess nutrient levels in national watersheds are a serious concern. The U.S. Environmental Protection Agency (EPA) has labeled nutrient pollution one of the country’s most widespread, costly, and challenging environmental problems, and views it as a major threat to clean water. While the need to reduce nutrient loads in waterways might be clear, the best way to achieve that goal is far from self-evident. In recent years, nutrient trading has emerged as a potential solution to the thorny problem of excess nutrients. As discussed below, trading is potentially well suited to play a significant role in nutrient reduction. However, whether the same is true in the interstate context remains to be seen.

Nutrients 101
In the context of the Clean Water Act (CWA), “nutrients” generally refers to nitrogen and phosphorus. In proper quantities, nitrogen and phosphorus are an essential part of the ecosystem, supporting the growth of algae and aquatic plants, which in turn provide food and habitat for fish, shellfish, and smaller aquatic organisms. Excessive nutrient levels, however, create rapid algal growth that leads to inadequate oxygen in the ecosystem, which in turn can cause illnesses or death in fish. In addition, large algal blooms resulting from rapid algal growth can also produce elevated toxins and bacterial growth that are harmful to humans. In short, the consequences of excess nutrients can be quite severe.

These consequences are seen in waters big and small. States have identified 15,000 waters nationwide with nutrient levels so high that they do not meet state water quality standards. A recent study of 647 United States coastal and estuarine ecosystems found that 47 percent had hypoxic conditions, meaning that oxygen concentrations had fallen below the levels necessary to support most aquatic life. (Nutrient Trading and Water Quality: Hearing Before the Subcomm. on Water and Wildlife of the S. Comm. on Environment and Public Works 2 (May 22, 2013) (statement of Michael Shapiro, Principal Deputy Assistant Adm’r for Water, U.S. EPA). Severe hypoxia leads to “dead zones” within aquatic ecosystems. For example, the Gulf of Mexico has such severe hypoxia that there is a dead zone of about 6,000–7,000 square miles in area. No shrimp or bottom-dwelling fish can be caught in this area.

Sources of nutrient pollution. Excessive nutrients come from several sources, primarily urban storm-water runoff, municipal wastewater discharges, agricultural livestock activities, and excess fertilizer from row crops in runoff. Treatment to reduce the concentration of nutrients in discharges from these sources can be very costly. In 1997, private point source controls were estimated at $14 billion and public point source costs were at $34 billion. The cost of treatment also varies widely depending on the type of source—point or nonpoint, wastewater treatment or other industrial facility—which can make achieving the necessary reductions in the amount of nutrients very challenging.

For example, a study evaluating costs in the Coosa River Basin in Georgia found that the average cost for wastewater treatment plants to meet a total phosphorus limit of 1 milligram per liter was $6 per pound of phosphorus removal. (Brown and Caldwell, Nutrient Trading in the Coosa Basin: A Feasibility Study (Draft), at 3-2 (Aug. 2013). In contrast, the estimated removal cost for nonpoint sources in the same region was $1.14 per pound. Id. at 5-2. Such disparate costs evince the challenge in achieving nutrient reduction, particularly in watersheds that have a lot of sources with high compliance costs. Nutrient trading has therefore emerged as a potential solution.

Trading as a Solution to the Nutrient Problem
Given the importance of reducing nutrient pollution and the challenges faced in achieving reduction, the EPA and other policymakers have sought creative solutions. Most prominent among these is nutrient trading.

Nutrient trading is a cap and trade system that allows pollution sources to buy and sell pollution credits. Like any cap and trade system, nutrient trading capitalizes on the differences in pollution reduction costs among pollution sources. As seen in the above example, the per-unit cost to reduce pollution can vary among sources. Permitting sources with high pollution reduction costs to purchase credits from sources with lower costs allows environmental goals to be achieved more cost effectively, and can even create environmental improvement if there is a trade premium (i.e., a ratio greater than 1:1).

Elements of trading. As in any cap and trade system, there are two key elements in nutrient trading: a cap and trades. The cap, in whatever form it takes, creates the market for trading by limiting how much a given source can discharge. To create a market, the cap has to be set at a level below the cost of compliance, i.e., the cost to comply needs to be higher than the cost of pollution credits. The cap also cannot be so low that compliance is impossible or the limit is not scientifically or economically defensible.

Once the appropriate cap is in place, a method for quantifying the unit traded must be developed, along with a methodology for effecting trades. To ensure that pollution reduction goals are actually met, there also have to be monitoring and enforcement components in any environmental cap and trade system.

Trading in the CWA context. Recognizing the potential for trading to assist in pollution reduction generally, the EPA issued a Water Quality Trading Policy in 2003. The policy sets out four guidelines for water quality trading: (1) water quality trading should be consistent with the CWA; (2) trading should occur within a watershed or defined area for which a total maximum daily load (TMDL) has been approved; (3) nutrients and sediments are most amenable to trading; and (4) baselines for generating pollution reduction credits should be derived from state water quality standards. The purpose of this policy is to encourage the development of voluntary trading programs by states, interstate agencies, and tribes. Notably, the trading policy does not establish a national trading program. Rather, it discusses how a state trading program can be implemented in accordance with the CWA and its regulations, in the context of the state delegation that is central to the CWA.

The EPA provided additional trading guidance to states in its 2011 Framework for Managing Nitrogen and Phosphorus Pollution. This framework emphasized the need to allow states room to innovate and respond to local water quality needs. The EPA also identified key “building blocks” for effective nutrient management programs. These “building blocks” include setting numeric reduction goals, strengthening permits for point sources, and developing reduction measures for nonpoint sources. Thus, while the EPA has identified some recommended elements of a nutrient trading program, development of the specific details has fallen to state and local agencies.

The first aspect of developing those specific details is determining both the form and level of the cap. In the CWA context, caps can be created by TMDLs, mass-based load allocations, or adoption of nutrient criteria. As noted above, the EPA has advocated the setting of numeric criteria. Regardless of the form, for a cap and trade system to work, there must be a quantifiable cap so that units of pollution credit can be generated and traded. Nutrient trading therefore requires some form of numeric criteria. This requirement and EPA’s advocacy of it add an interesting gloss to the ongoing litigation over numeric and narrative criteria under the CWA. As the EPA encourages states to adopt nutrient trading programs, the agency is also necessarily encouraging the development of some form of numeric criteria in order to implement those programs.

As for the second component—trades—these can occur between point sources, between point and nonpoint sources, or between nonpoint sources. Each type of trade requires a slightly different calculus. Point-to-point trades are fairly straightforward. Once the applicable caps are set for the watershed or point source, point sources with discharges below their limits can sell credits, generally on a 1:1 ratio.

Trades involving a nonpoint source can be more complicated. Nonpoint sources may be better positioned to reduce nutrient loads cost-effectively, but a clear baseline for their contributions must be established so that reductions can be quantified. In its 2003 Water Quality Trading Policy, the EPA identified some ways to compensate for nonpoint source uncertainty, including monitoring to verify load reductions, implementing greater than 1:1 trading ratios for trades involving nonpoint sources, using conservative assumptions for the effectiveness of nonpoint source management practices, using site or trade-specific discount factors, or retiring a percentage of nonpoint source reductions in each transaction. The appropriateness of these approaches varies by program and watershed.

Lastly, trades are possible between nonpoint sources. This type of trade is again complicated by the difficulty in quantifying the pollution reduction from nonpoint sources, which can be resolved using the approaches outlined by the EPA. Depending on the pollutant, treatment options can be fairly uniform across types of sources. As a result, the cost to reduce nutrient loads may not vary much within the type of source. Trades between point and nonpoint sources are therefore likely to be the best positioned to capture the efficiencies of trading.

In the CWA context, trades are usually implemented through enforceable state or federal permits. Individual trades can be executed through contracts between the trading parties and then incorporated into each party’s National Pollutant Discharge Elimination System (NPDES) permit. Trades can also be implemented through a group NPDES/general watershed permit that contains the aggregate waste-load allocation for all participating sources. Participating members can then effect trades among themselves. Finally, in some watersheds, a centralized entity such as a central credit bank or state-administered water quality fund can be used.

Interstate Nutrient Trading 
As is true of other types of pollution, nutrient pollution does not stop at the state line. Nutrient trading therefore implicates interstate efforts to reduce nutrient loads, and successful reduction of those loads may depend on coordinated trading efforts. In theory, such efforts would add another layer of complexity to nutrient trading schemes, but the reality appears to be that trading programs remain at the state level, with only some coordination among states in certain watersheds.

The Chesapeake Bay Program. The Chesapeake Bay provides a good example of the opportunities and challenges presented by nutrient trading in the interstate context. An early proponent of nutrient trading, the Chesapeake Bay Program developed Fundamental Principles and Guidelines for Nutrient Trading in 2001. Significantly, while the key governmental stakeholders in the Chesapeake Bay signed on to the Trading Guidelines, their endorsement explicitly states that if trading programs are developed, “each jurisdiction will need to tailor that program in a manner necessary to meet their individual needs and nutrient reduction goals and efforts.” (See the “Endorsement” page of the Fundamental Principles.)

The Chesapeake Bay has a TMDL in place, which imposes pollutant reduction requirements on the states in the watershed. In addition, the key Chesapeake Bay governmental entities—Maryland, Virginia, Pennsylvania, and the District of Columbia—signed an agreement in 1987 pledging to reduce nutrient loads by 40 percent from 1985 levels. These limits comprise the “cap” for the Chesapeake Bay trading program.

Although several states have jurisdiction over the tributaries that feed into the Chesapeake Bay, trading programs are adopted and implemented separately by each state. The fundamental principles for adoption of nutrient trading programs across the states are consistent, however. Those principles are as follows:

1. Trades must not produce water quality effects that violate water quality standards, do not protect designated uses, or adversely affect living resources and habitat.

2. Trading is allowed only within each major Chesapeake Bay tributary.

3. The trading program must be consistent with federal, state, and local laws and regulations.

4. The trading program must be consistent with the Chesapeake Bay Program’s nutrient reduction goals.

5. Each trade must result in a net reduction of nutrient loadings or contribute to maintenance of a tributary nutrient cap.

6. Sources should implement nutrient reduction actions to achieve the 40 percent reduction goal prior to pursuing a nutrient trading option.

7. Traders must be in substantial compliance with all local, state, and federal environmental laws, regulations, and programs.

8. A diverse group of stakeholders should be involved in the design and implementation of state trading programs.

While some of these principles are specific to the Chesapeake Bay, others speak to the general challenges faced in the interstate trading context. Chief among these are the geographic scope of trades and allowing trades between different source types. Given the ability of nutrients to travel across state lines and the desire to allow as many sources as possible to participate, some have advocated for larger, interstate trading programs that would address overall nutrient levels in larger bodies of water. The Chesapeake Bay Program trading principles would not permit a larger program, however; they allow trading only within tributaries and contemplate implementation of trading programs at the state level only. This restriction exists, in part, to prevent an increase in overall pollution in a particular area. If trading were allowed bay-wide, for example, several dischargers in a single area could buy pollution credits and continue discharging at levels above the water quality standards. Pollution “hot spots” could develop as a result, leading to an outcome the Chesapeake Bay Program did not want.

The Chesapeake Bay model does, however, permit trades among sources in different states, as long as the sources are within a single tributary and their respective states have adopted the 40 percent cap. Trades are initially allowed only between types of like sources, until the 40 percent reduction goal is achieved. Once that goal is met, it may be maintained through trades between sources of different types. According to the Chesapeake Bay Program, this restriction ensures that all point sources and all nonpoint sources meet their respective load allocations prior to trading across source types. This restriction also arguably reduces the cost-effectiveness of the trading program because it is often either point sources or nonpoint sources that are best positioned to reduce nutrient loads cost-effectively.

As the Chesapeake Bay Program model demonstrates, developing an effective trading program—one that creates a market for trading while decreasing the risk of uneven pollution reduction—can be challenging. As states and interstate watersheds develop tools to address these issues, including some identified by the EPA, the likelihood of successful nutrient trading programs will increase.

Keywords: environmental litigation, nutrient trading, cap and trade, Chesapeake Bay Program


Sarah T. Babcock is a senior associate in with Alston & Bird, LLP, in Atlanta, Georgia.

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