Bay Journal

Plan for nutrient trading to pay for agricultural BMPs an illusion

  • By Kurt Stephenson Alyse Schrecongost and Leonard Sh on February 01, 2010

Many people have recently embraced nutrient trading (including former skeptics), thinking it will be a rich new funding source to pay for reductions in agricultural nutrients, the main source of nitrogen and phosphorus to the Bay.

A Chesapeake Bay Foundation press release says that trading is a way to "save taxpayer money and provide vital income to farmers while dramatically reducing water quality pollution locally and regionally." A World Resources Institute analysis concludes that trading programs will yield revenues of as much as $300 million each year to pay farmers to install best management practices. And last fall, Sen. Benjamin Cardin, D-MD, introduced the Chesapeake Clean Water and Ecosystem Restoration Act (Senate Bill 1816), which authorizes a nutrient trading program for the Bay watershed.

During testimony on the Cardin Bill, Chesapeake Bay Commission Executive Director Ann Swanson captured this recent enthusiasm, "we believe that a Chesapeake Baywide trading program would generate revenue to farmers comparable to existing federal and state agricultural conservation funding while at the same time achieving cost savings for municipalities."

These advocates imagine a system in which sources where nutrient discharges that are currently regulated-wastewater treatment plants and some urban stormwater systems-willingly pay unregulated agricultural nonpoint sources to install various best management practices. They believe payments for the predicted nutrient reductions from those BMPs, called credits, will be a less expensive way for regulated sources to meet their obligations and that the regional nutrient trading program would become a new funding source for agricultural sector controls.

This logic is factually flawed and conceptually misleading.

First, the facts: There are likely to be relatively few buyers of agricultural nonpoint source credits.

Regulatory permitting programs, by design, typically limit the opportunity to pay for nonpoint source reductions by the very parties who are supposed to be the buyers, wastewater plants and urban stormwater permittees (developers). Wastewater treatment plants are required to meet limits of technology concentration limits in their own outflows. Emerging stormwater programs require developers to exhaust feasible on-site controls first. These regulated parties typically are not given the option to shift these obligations to agricultural sources through trading, regardless of the cost advantages.

In cases where regulated sources might be allowed to buy credits, these sources will compare paying for agricultural BMPs to other compliance options. New research finds that the payments for agricultural nonpoint source credits may be more expensive than frequently portrayed.

In Virginia, agricultural nonpoint source credits may cost buyers more than $100 per pound of nitrogen, far more than what the WRI and other papers report. Estimated costs are high in part because of required trading ratios to account for the uncertainty about the effectiveness of BMPs.

Also, agricultural sources must first implement lower-cost BMPs to meet certain performance thresholds before they are eligible to trade. As a result, tradable credits must be created with higher-cost BMPs.

Further, the often reported costs do not account for the premium that farmers will likely demand for forgone farm income and linking their farm operations to a regulatory program. High costs for agricultural credits will drive the limited number of prospective buyers to other alternatives.

In addition to cost considerations, point sources will favor options that avoid paying third parties to help meet their permit obligations. For example, Virginia wastewater treatment plants are investigating and implementing gray water reuse as a means to maintain compliance with stringent load caps. Others are exploring the use of constructed wetlands and biomass harvest (oysters, algae) as compliance strategies.

The claim that trading can generate hundreds of millions of dollars annually to fund agricultural nutrient mitigation is wildly out of line with nearly 15 years of national trading experience. The EPA and the states have been promoting nutrient trading since at least 1996 and several different types of nutrient trading programs have been put in place across the nation. All of the cash transfers from regulated sources to agriculture from all of the existing programs over almost 15 years of experience do not add up to the lowest amount "estimated" by the WRI analysis for just one year.

Given the evidence above, we can find no compelling reason why a future regional Chesapeake Bay trading program would diverge so radically with past national experience.

Conceptually, nutrient trading is a system for sources to achieve compliance with a pollution load cap or regulatory obligation-it is not a revenue-generating program for nonpoint sources. If trading is envisioned, and then designed as a mechanism to generate revenue for agricultural nonpoint sources, it becomes a de facto tax on regulated parties, albeit one levied by an administrative program.

If additional revenue for nonpoint source reductions is desired, one can imagine a whole variety of tax systems that can generate more revenue for rural land managers that would be easier to administer and would provide far greater transparency on who pays the tax than a nutrient trading program.

Trading as a revenue source for buying nonpoint source reductions also raises fundamental issues of fairness. Control obligations on regulated sources in the Bay region are expected to approach limits of technology levels. Using trading to generate large amounts of funds for nonpoint sources under these programs, however, would require setting even more stringent requirements, perhaps even zero discharge, on regulated sources.

In both Virginia and Maryland, point sources have been required to reduce nutrient loads by a greater proportion than other categories of sources. For instance, the point source cap in the Virginia portion of the Potomac basin represents an estimated a 57 percent reduction in nitrogen loads from the 1985 baseline.

In many watersheds, point sources are the only group of sources to have achieved these goals. Now, through trading programs, we may be demanding that point sources and their customers finance reduction efforts of nonpoint sources that state governments have decided not to regulate directly.

The EPA has recently threatened the Bay states' regulated sources with more stringent point limits if the states fail to reduce loads from unregulated nonpoint sources. From the perspective of regulated sources, extorting funds from a compliant source to pay for reductions at a noncompliant one is hardly fair.

Limiting agricultural nonpoint source loads while maintaining a viable agricultural and rural economy is a vexing problem for the Bay Program, but hoping nutrient trading will generate millions for agricultural nonpoint source reductions will only postpone progress toward addressing the real problems.

The fundamental problem with the discussion now under way is equating trading with ways to generate revenue. We believe in, and have written elsewhere, that it is possible to design programs that use marketlike principles to secure meaningful and certifiable reductions in nonpoint source loads and improvements in Bay water quality. A variety of explicitly created taxes can create nutrient reducing incentives, raise funds and effectively deploy those new funds for real results. Trading programs can also be revised to encourage more cost-?effective options for regulated parties.

The focus on trading as a revenue source is an unfortunate diversion from the real opportunities to employ market-like programs for water quality management.

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About Kurt Stephenson Alyse Schrecongost and Leonard Sh

Kurt Stephenson is a professor in the Department of Agricultural & Applied Economics at Virginia Tech. Leonard Shabman is a resident scholar at Resources for the Future.

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