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SUSTAINABLE DEVELOPMENT WORKING P APER SERIES 018 Water Quality Trading to Address Water Pollution from Agriculture Activities Assessing the Adequacy of the Canadian Legislative and Policy Contexts Final Report Claude Sauvé Jean Nolet Clara Whyte Richard Sanchez ÉcoRessources Consultants April 2006

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Page 1: WP 018 - EcoRessource - WQT e

SUSTAINABLE DEVELOPMENT

WORKING PAPER SERIES 018

Water Quality Trading toAddress Water Pollution from

Agriculture ActivitiesAssessing the Adequacy of theCanadian Legislative and Policy

Contexts

Final Report

Claude SauvéJean Nolet

Clara WhyteRichard Sanchez

ÉcoRessources Consultants

April 2006

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Water Quality Trading to Address Water Pollution from Agriculture Activities: Assessing the Adequacy of the

Canadian Legislative and Policy Contexts

April 2006

PRI Project Sustainable Development

Claude Sauvé Jean Nolet

Clara Whyte Richard Sanchez

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Policy Research Initiative Working Paper Series

The Working Paper Series presents ongoing analytical work developed in relation to the PRI’s horizontal projects. The papers are presented in the language of preparation only, with a summary in both official languages. They do not necessarily represent the views of the Government of Canada’s Policy Research Initiative.

Série de documents de travail du Projet de recherche sur les politiques

La série de documents de travail présente les travaux d’analyses en cours réalisés dans le cadre des projets horizontaux du PRP. Les articles sont présentés uniquement dans la langue dans laquelle ils ont été rédigés, avec un résumé dans les deux langues officielles. Ils ne reflètent pas l’opinion définitive du Projet de recherche sur les politiques du gouvernement du Canada.

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Table of Contents

Abstract.......................................................................................................................................1

Résumé........................................................................................................................................1

Executive Summary...................................................................................................................3

What Role for the Federal Government? ............................................................................6

Context........................................................................................................................................7

Introduction................................................................................................................................8

1. Tradable Permits to Improve Water Quality ....................................................................10 1.1 Basic Elements of Tradable Permits ...........................................................................10

1.2 The Two Different Types of Trading Programs .........................................................10

1.3 Using Tradable Permits to Improve the Water Quality.............................................11

2. Review of International Experiences................................................................................12 2.1 The United States...........................................................................................................12

2.2 The Dutch Nutrient Quota System ..............................................................................15

2.3 Australia ..........................................................................................................................19

2.4 Two Conceptual Models to Verify the Adequacy of the Canadian Contexts .........24

3. The Legal and Policy Issues................................................................................................25 3.1 General Review of the Relevant Characteristics of the Legal and Policy

Frameworks in Canada................................................................................................26

3.2 Is the Canadian Context Well Adapted to the Introduction of Tradable Permit Systems to Improve Water Quality?...........................................................................28

3.3 What Role for the Federal Government? ....................................................................29

Annex 1: Water Quality Trading – Review of United States Experiences ........................34

Bibliography .............................................................................................................................38

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Abstract

Water quality trading applies the concept of pollution trading to address issues of water pollution. It is based on the creation of a market where the quantity of emissions of a negative environmental externality, such as pollution, is limited. Those who are authorized to pollute – through permits or otherwise – are then allowed to trade, usually at the watershed or sub-watershed level, to meet their environmental obligations. This study:

a) reviews the international experiences in water quality trading in order to identify key characteristics of these programs that would be favourable to the development of similar systems in Canada, particularly in the agricultural sector;

b) examines the federal and provincial environmental regulations that impact on agricultural producers, to determine whether the regulations would foster or hamper the use of water quality trading; and,

c) makes some recommendations regarding the role of the federal government in supporting the development of these instruments in Canada.

The analysis tends to show that the legislative frameworks of the provinces offer the basic features of, and the necessary flexibility for, the implementation of water quality trading to address water pollution form agriculture activities. The main barriers may be institutional and linked to the fact that water quality trading departs significantly from traditional regulatory approaches in Canada.

Résumé

L’échange de crédits de qualité de l’eau applique le concept de permis de pollution transférables à la gestion des problèmes causés par la pollution des eaux. Il est fondé sur la création d’un marché où la quantité des émissions produites par des externalités environnementales négatives, comme la pollution, est limitée. Les organismes autorisés à polluer – au moyen de permis, par exemple – peuvent alors procéder à des échanges, habituellement au niveau des bassins ou des sous-bassins hydrologiques, afin de respecter leurs obligations en matière d’environnement. Cette étude :

a) passe en revue les expériences, à l’échelle internationale, des programmes d’échange de crédits de qualité de l’eau afin d’en dégager les éléments essentiels susceptibles de favoriser l’élaboration de systèmes semblables au Canada, en particulier dans le secteur agricole;

b) examine les règlements fédéraux et provinciaux en matière d’environnement qui s’appliquent aux producteurs agricoles, en vue de déterminer s’ils faciliteraient ou entraveraient les échanges;

c) présente quelques recommandations concernant l’appui que pourrait donner le gouvernement fédéral à l’élaboration de tels instruments au Canada.

L’analyse tend à montrer que le cadre législatif des provinces contient les éléments de base, de même que la souplesse voulue, pour assurer la mise en œuvre d’un système d’échange de crédits de qualité de l’eau dans le but de gérer la pollution des eaux

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engendrée par des activités agricoles. Les principaux obstacles pourraient être institutionnels et liés au fait que cette démarche s’éloigne des approches traditionnelles en matière de réglementation.

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Executive Summary

The use of market-based instruments, also called economic instruments, in environmental policy making is attracting more and more attention not only because they are more efficient than their traditional counterparts but also because they open a new field of policy innovation. This is particularly the case for water quality trading which has received a renewed interest in recent years as a means to solve water quality problems.

This study a) reviews the international experiences in water quality trading in order to identify key characteristics of these programs that would be favourable to the development of similar systems in Canada particularly in the agricultural sector, b) examines the federal and provincial environmental regulations that impact agricultural producers, to determine whether the regulations would foster or hamper the use of water quality trading c) makes some recommendations regarding the role of the federal government in supporting the development of these instruments in Canada.

Trading is based on the creation of a market where the quantity of emissions of a negative environmental externality, such as pollution, is limited. It uses market dynamics and it is based on the introduction of tradable permits to emitters, leading to negotiations among them to minimize costs. There are essentially two types of trading systems: Closed systems, also called “cap-and-trade” and open systems also called “credit or offset”.

Closed trading systems rely on the enforcement by government of an absolute cap for all sources covered by the program. The cap is chosen in order to achieve a specific environmental objective. On the other hand, in open systems, tradable credits are provided to facilities that reduce emissions by an amount that exceed what is required by regulation (or other baseline) and allow those credits to be counted towards compliance by other facilities that would face high costs or other difficulties in meeting their regulatory requirements. An offset system is a very similar system.

A combination of the two systems is increasingly used in situations where the cap-and-trade system does not capture most or all the activities contributing to a particular environmental problem and the facilities under the cap face high costs.

Only three countries have implemented some form of water quality trading programs in the world, the United States, the Netherlands, and Australia. Only one, the United States, has extensive experience in the area with more than 20 systems implemented over the past 20 years. In Canada, the South Nation watershed pilot experience in Ontario should be mentioned as an application of water quality trading.

The review of the United States experiences reveals that:

All programs are within the present legislative framework, i.e., Clean Water Act and its permit system.

All programs are encouraged and promoted by government policy to introduce more flexibility in the regulatory system and reduce compliance costs.

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Most programs involve point source/non-point source trading. The non-point sources, which are not subject to direct regulatory requirement are, in most cases, agricultural activities.

The pollutants of most concern are phosphorus and nitrogen.

The main drivers for the development of the programs are the size of the problem and the “cap”, which is defined at the watershed or basin level.

Water Quality Trading is closely linked with EPA’s Watershed approach adopted in the beginning of the 90s.

The Dutch Nutrient Quota System was created by law in 1987 as a response to dramatic manure surpluses from intensive animal production in the Netherlands. The quotas began to be “tradable” in 1994. The system proved to be complex and is now used in conjunction with other programs. The particularity of the system is that the quotas are land-based animal quotas.

The Australian experiences are similar in concept to the United States programs. The main lessons from these experiences are:

The trading concept was introduced into the policy arena by a high profile program directly involving three states and the Commonwealth government in the Murray-Darling Salinity and Drainage Strategy.

The Murray-Darling program was initiated at about the same time as state and Commonwealth governments were discussing the adoption of the National Water Quality Management Strategy. Hence, water quality trading rapidly moved up the policy agenda.

The main drivers for the development of the trading programs were the urgency of the problems and the failure of traditional command-and-control instruments to deliver the desired results.

The first successful trading program started in 1995. Its success, like the SO2 program in the United States, was an inspiration for the development of other programs.

Water quality trading is closely linked to water policy and particularly to watershed management policies and institutions. For this reason, the identification and adoption of water quality objectives on a watershed basis is crucial.

Water quality trading is now perceived in Australia as a way to engage non-point sources (particularly agricultural activities) in a cost efficient way to protect water quality.

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Probably because of the high policy profile given to trading instruments, and more generally, to economic instruments, permit trading-enabling provisions were included in the overhaul of the environmental legislation in 1997.

In the process of reviewing international experiences, the study identified the key features of the legislative and policy contexts that are essential for the development and implementation of water quality trading systems or programs. These key features were put in the form of questions to facilitate their use.

1. Are there enabling provisions within the legislations that allow for the use of tradable permit systems?

2. Are there policies, programs, regulations or any other documents that facilitate the development and use of tradable permit systems?

3. Are there legal provisions requiring emitters to monitor their discharges to the environment and report to public authorities?

4. Are there any legal, regulatory, policy, or any other type of documents that relate to the capacity to determine water quality criteria/objectives of water bodies or the soil’s assimilative capacity of certain types of nutrients?

5. How are those criteria/objectives being implemented?

6. Is the watershed approach being used to adopt and implement policies, regulations or issue permits? Are there institutions dedicated to implementing integrated watershed management?

7. How do the legal/regulatory agri-environmental provisions of the various jurisdictions interact with water quality trading?

8. Has there been a major initiative, at the government level, to promote the use of economic or market-based instruments in environmental management?

A Review of the Relevant Characteristics of the Legal and Policy Frameworks of provinces in Canada was conducted using these key features to determine their adequacy to water quality trading.

The analysis tends to show that the legislative frameworks of the provinces offer the basic features of, and the necessary flexibility for, the implementation of water quality trading to address water pollution from agriculture activities.

At least four provinces (Alberta, Ontario, Quebec and Nova Scotia) clearly possess the relevant power to introduce a tradable permit system within their territories and all the provinces have the necessary power to establish and impose water quality criteria/objectives. However, that power is generally not being used.

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The flexibility that is necessary to implement credit/offset systems within the certificate of authorization and permits systems seems to exist. The flexibility required is to be able, within the framework of the Certificate or the permit, to consider a reduction outside the facility premises of the certificate or permit holder equivalent to a reduction from the facility. The South Nation experience is an illustration of this flexibility.

As far as agri-environmental legislations and policies are concerned, the widespread use of manure/nutrient management plan prescriptions is an indication that, in addition to a United States type of system, a trading system based on the soil’s assimilative capacity of certain types of pollutants, can be implemented. The Quebec example of a prescribed limit for phosphorus on land application of manure is a clear indication of the practical possibilities for implementing a cap.

There are also some barriers to the development of these systems in Canada:

Firstly, trading systems are part of a package of economic or market-based policy instruments, which break with the traditional command-and-control approach in environmental policy-making. Even if the OECD and other prestigious institutions have promoted their use, there is a cultural resistance to their introduction. The adoption of economic instruments in Canada has been slow compared to the United States and the European Union.

Secondly, by focussing on an ambient approach, water quality trading implies a significant departure from the traditional technico-economic, end-of-pipe approach that has characterized legislative and regulatory systems to date in Canada. That is, instead of concentrating on emissions from pollution sources, the focus is placed on the in situ quality of the water bodies themselves.

Finally, it seems clear from the United States, Australia and Ontario experiences, that the development and implementation of trading systems follows a clear signal from governmental authorities and starts with pilot projects implemented with a view to building knowledge and experience, involving the populations concerned.

What Role for the Federal Government?

The basic incentive for the development and implementation of a water quality trading systems is the size of the environmental problem and its consequences on human activity. It is also based on requirements to reach ambient criteria/objectives.

Besides the basic incentive of the size of environmental problems, it is the acquisition and the sharing of knowledge and experience concerning WQT that will help overcome resistance to innovation and promote the implementation of pilot projects in the various provinces. The federal government should thus concentrate its efforts on creating the conditions for such exchanges and projects to take place.

The federal government should also promote the development and the implementation of watershed-based approaches to water management, and support the creation of institutions/organizations designed to facilitate the implementation of this approach.

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Context

On the 19th and 20th of September 2005, the Policy Research Initiative, with Agriculture and Agri-Food Canada (AAFC) and Environment Canada (EC) organized and sponsored a workshop on water quality trading (WQT) in Canada. This workshop was the second phase in an initiative dedicated to assessing the feasibility of water quality trading or trading systems to address water pollution from agricultural sources in Canada.

In that context, EcoRessources has been charged with preparing a study on the adequacy of the Canadian regulatory and policy contexts for the development and implementation of water quality trading or similar initiatives particularly in the agricultural sector. The mandate specified that EcoRessources would:

Review the international experiences in water quality trading in order to identify key characteristics of the existing programs;

Build two conceptual models of water quality trading systems;

Review the federal and provincial environmental regulations impacting agricultural producers on the basis of an inventory created in 2004 by EcoRessources Consultants to determine whether the set of existing Canadian regulations would foster or hamper the use of water quality trading; and,

Make some recommendations regarding the role of the federal government.

Going through the tasks it became rapidly apparent that the review of the regulations on the basis of the EcoRessources inventory would not allow us to meet all of these objectives. EcoRessources therefore decided to slightly expand its approach to look at the broader legislative context affecting water quality issues in order to better meet our mandate. In doing so, however, EcoRessources might not have covered all of the potentially relevant environmental regulations in depth. While further regulatory analysis might be required to fully answer some of the questions being looked at in this report, we are confident that the most relevant regulations were examined. The preliminary results of the study were presented at the Workshop.

This report presents the final results of the study. It includes a review of international experiences in water quality trading with a particular emphasis on:

The legislative and policy features which facilitated those experiences;

A typology of the key characteristics that would be favourable to the development of similar systems in Canada;

The elaboration of conceptual models allowing us to verify the adequacy of Canadian agri-environmental legislation to the implementation of WQT; and,

Recommendations regarding the role the federal government could play to facilitate the development of such an instrument in Canada. In addition, the

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study examines the adequacy of the different provincial legislative and policy contexts for water pollution control to water quality trading.1

Introduction

Water quality is a major environmental issue worldwide. Its rapid degradation could have devastating effects on humankind in the coming decades if no action is taken to mitigate the problems.

The problem is that water is a common good. As such, the management of water resources provokes a social dilemma: private individuals are encouraged to use it without caring for its preservation because there is no reason why they alone should support the cost of preserving it for the benefit of society as a whole. This is a classical example of the famous “tragedy of the commons”.

Consequently, if certain levels of water quality are to be maintained or reached, public policies that will produce the desired results must be implemented. Traditionally, governments have used what has been called “command and control” policy instruments to reach these goals. Under a command-and-control system, governments explicitly set the emission limits and/or the process or product standards for whole sectors or facilities and control their application. The past two decades have seen the introduction of market-based instruments (MBIs), also called economic instruments, which use market attributes to drive the emitters to the desired results. The increasing popularity of MBIs is essentially due to the fact that they are more efficient and less costly than their command-and-control counterpart; and furthermore, they open a new field of policy innovation. The basic rationale is that environmental problems are caused by market failures and by developing instruments to correct these failures or creating markets where none exist, environmental policies should be more efficient and sustainable.

When looking at water quality problems, we find that:

The control of point-source discharge has been the focus of environmental policy since the 1970s mainly because it was more visible and cost-effective. Many of the more straightforward and inexpensive pollution control measures have been implemented. In a number of situations, installing more stringent controls at these sources is becoming very expensive;

Non-point sources have become a major cause of water quality problems in many watersheds;

Non-point sources, mainly from land use activities (e.g., agricultural activities), have not been regulated because of the inherent difficulties of identifying and monitoring the sources of discharges;

The prospect of finding and implementing less costly ways of reducing pollution at non-point sources (resulting, for example, from agricultural activities) creates an opportunity for policy innovation; and,

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Market-based instruments, particularly water quality trading, has attracted growing interest for its possible contribution to link point sources and non-point sources in solving water quality problems. This is particularly true at the watershed level.

This is why several countries, namely the United States, Australia and the Netherlands, have started to implement such Tradable Permits systems (TPs) to reduce water pollution.

Canada is also interested in exploring the feasibility of implementing this type of instrument within the existing national legal and policy contexts, particularly to address the issue of water pollution from agricultural activities.

Given this context, this Report explores the following question:

How do the existing Canadian regulatory and policy contexts for water pollution, particularly in the agricultural sector, support or hinder the development of water quality trading or similar initiatives?

This report also suggests a few avenues the federal government could explore to facilitate the development of WQT initiatives in Canada. It is important to note that we have focused on surface water as opposed to groundwater. Most, if not all, water quality trading systems address surface water quality issues.

We begin in Section 1 with a general presentation of the basic principles underlying trading systems, and then examine how they are adapted to the specific problems of water quality. In Section 2 we review the experiences of the United States, the Netherlands and Australia to improve understanding of not only the design of the different programs, but more specifically, the legislative and policy contexts that allowed the development of these initiatives. We will also be looking at the difficulties these countries encountered in implementing these programs.

On the basis of lessons learned from international experiences, in Section 3 we develop two conceptual models of trading programs aimed at addressing pollution from agricultural activities. This will help us to build a typology of the key defining features of the legislative and policy frameworks that are crucial for the implementation of water quality trading systems or programs. We will then be in a position to evaluate both the adequacy of the provincial agri-environmental regulatory and policy frameworks as well as, more generally, the main elements of water pollution control regulations. Finally, we put forward a few suggestions regarding the role of the federal government in supporting the development of water quality trading programs in Canada.

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1. Tradable Permits to Improve Water Quality

1.1 Basic Elements of Tradable Permits

1.1.1 Tradable Permits: An Optimal Market-Based Instrument

There are two major market-based approaches that governments can adopt to manage public goods, such as water quality. The first makes use of the price system, relying on the introduction of a tax or a charge on emissions/discharges (a subsidy is considered as a negative tax) to encourage agents to reduce their levels of pollution (Pigouvian approach). The second market-based approach is based on the creation of a market where the quantity of a emissions of a negative environmental externality such as pollution is limited. This second approach uses market dynamics and is based on the introduction of Tradable Permits (TPs), leading to negotiations among agents (Coasian approach). Most economists favour the latter because the quantitative limits imposed offer more certainty on outcomes and relies on market mechanism to minimize costs.

However, most often reality does not correspond to the underlying theoretical neoclassical modelization leading to such market-based approaches. Thus, if the optimum result is to be reached, several conditions must be met. In fact, TPs might not be optimal if the following elements tamper with market operations:

Few agents have a major market power:2 These agents may be able to manipulate prices and quantities to their advantage, thus hampering a pareto-optimum from being reached;

Transaction costs are extremely high:3 It becomes unprofitable to trade the permits, which can prevent the optimal distribution of the permits and, consequently, reaching the pollution-reduction goals; there is no appropriate monitoring of emissions or discharges so the enforcement process is deficient.

Consequently, if TPs are to be successful, the preceding elements should be properly addressed in order to reach pollution reduction goals that cost the least for society as a whole.

1.2 The Two Different Types of Trading Programs

There are two different types of trading programs that can be implemented by governments. The first one is “closed” and relies on a system often called “cap-and-trade”. The second one is “open” and relies on a system of credits or offsets and is often called “open-market trading”.

1.2.1 The Closed Trading Programs: Cap-and-Trade

Closed trading programs rely on the enforcement by government of an absolute cap for all sources covered by the program. The cap is chosen in order to achieve a specific environmental objective. Authorizations to emit, or to discharge, are then allocated to participating sources (agents) and the total number of allowances cannot exceed the cap. Those allowances can then be traded among agents. Allowance trading enables sources to adopt a compliance strategy adapted to their individual circumstances while still

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achieving the target set by the cap. The programs are thus more efficient and reduce the costs of achieving a positive environmental result.

1.2.2 The Open-Market Trading Programs: Credit/Offsets

Reduction credit programs provide tradable credits to facilities that reduce emissions by an amount that exceed what is required by regulation (or other baseline) and allow those credits to be counted towards compliance by other facilities that would face high costs or other difficulties in meeting their regulatory requirements. (These programs sometimes are simply referred to as “credit-based.”) Reduction credits are created through an administrative process in which the credits must be pre-certified before they can be traded. An offset system is very similar in concept.

1.2.3 Combining Cap-and-Trade and Open-Market Trading

A combination of the two systems is increasingly used in situations where the cap-and-trade system does not capture all of the activities contributing to a particular environmental problem and the facilities under the cap face high costs. In this scenario reduction credits created by facilities not covered by the cap could be used to offset discharges from firms under the cap. However, the fact that firms creating reduction credits are not formally capped, hence the concept of “open-market”, does not guarantee the achievement of the environmental end-result, particularly when there are non-point-sources.4 This would be a problem in situations where non-point-sources (and/or their emissions) are growing in a watershed.

The Total Maximum Daily Load (TMDL) process in the United States (see Section 2.1) deals with this by establishing a cap applicable for all sources of a particular pollutant, thus including non-point-sources. Furthermore, agricultural non-point-sources are covered by a sectoral load allocation, which is not assigned to individual sources. Thus in circumstances where a TMDL applies, agricultural non-point-sources taken as a whole are, in effect, capped.

1.3 Using Tradable Permits to Improve the Water Quality

As far as water management is concerned, three types of permit exist:

1. Permits to remove water for specific uses;

2. Permits to use water-borne resources, such as fish;

3. Permits to release pollutants into the water.

Our analysis focuses on the third category, as our aim is to describe how water trading could be used to reduce pollution resulting from agricultural activities in Canada.

1.3.1 The Issue of Point-Source / Non-Point-Source Polluters

Instating TPs is not a simple task. It can become even more difficult as some pollutants are not directly discharged into water, but rather reach it by progressive diffusion through the soils. This is typically what happens with nitrates, which accumulate in the soils as a result of agricultural activities and progressively reach water bodies. To translate this reality, agricultural activities are referred to non-point sources of pollution.

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In opposition, industries that directly discharge pollutants into water (e.g., through a discernable point) are said to be point sources.

Implementing a trading system for non-point sources is a challenging task because it is more difficult to identify the source (the cause of the problem), and to assess the exact level of pollution that is ultimately discharged into the water, and thus to determine a baseline to be respected. This is especially true in the case of a credit program.

In fact, the effect of agricultural activities on water depends on many variables such as the types of nutrients used, the variability of rainfall, the complexity of the pathways through the hydrological system, etc.5 Proxies generally have to be used, such as the quantity of manure produced (and the expected level of phosphorus that will result). Because of these difficulties, non-point-source pollution is also very difficult to monitor and control.6

However, there are examples of successful water-quality trading. We shall now present some of them, and some of the not so successful experiences, in order to examine how they have empirically tackled the issues highlighted above.

2. Review of International Experiences

To our knowledge, only three countries have implemented some form of water quality trading programs, namely the United States, the Netherlands, and Australia. Only one, the United States, has extensive experience in the area with more than 20 systems implemented over the past 20 years. In Canada, the South-Nation watershed pilot experience in Ontario should be mentioned as an application of water quality trading.7

We shall now review those experiences in order to build on the lessons learnt by those countries. While reviewing the experiences we will concentrate on the legal and policy frameworks in the context of which they have been implemented.

2.1 The United States

2.1.1 The Legal and Policy Framework

Legal Framework

The primary law regulating water quality in the United States is the Federal Water

Pollution Control Act, commonly referred to as the Clean Water Act and similar state laws.

The Clean Water Act (CWA) was primarily designed to regulate point sources of water pollution, particularly through a wastewater discharge permit program: the National Pollutant Discharge Elimination System (NPDES). The law made the Environmental Protection Agency (EPA) responsible for setting national standards for the discharge of effluents on an industry-by-industry basis, considering both the state of pollution control technologies and the costs of implementation. Through the authority of Congress, the EPA can delegate the authority to implement and enforce the discharge permit program to those states with adequate programs to carry out the obligations of the Clean Water

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Act. Most states have implemented legislation and programs to carry out these obligations.

The Clean Water Act addresses non-point-source pollution indirectly. The majority of non-point-source controls over the years have consisted of recommendations from planning agencies and incentives such as grant funding, especially for areas having substantial water quality control problems. Individual states also have the mandate to develop non-point-source management programs. As a result, instead of a uniform federal program implemented by states that characterizes the point-source programs, non-point programs are state driven and therefore may vary considerably.

There are two notable exceptions to this general rule. First, the development of Total Maximum Daily Loads (TMDLs) is expected to control non-point and point sources for water bodies that are not meeting, or are not expected to meet, applicable water quality standards with existing enforceable control strategies. Second, some non-point activities have been defined as point sources in order to bring them under the control of the discharge permit authority. The Concentrated Animal Feeding Operations (CAFO)8 regulation is an example of this approach.

The requirement that states develop TMDLs is crucial to water quality trading. A TMDL is basically a process that requires states to determine the maximum load of a given pollutant that a receiving body of water, watershed or basin can tolerate.9 Section 303(d) of the Clean Water Act requires that states identify and develop a list of those waters within state boundaries that are not meeting water quality standards; the so-called 303(d) list. For each of the listed waters, states are then required to develop TMDLs for the pollutants.

Once the TMDL “cap” has been developed, the state must apportion that total load among point sources, non-point sources, natural background and a margin of safety, including considerations for future growth and feasible reductions from current sources. The EPA also emphasizes the need to establish implementation plans that control point and non-point sources of pollutants. The basic elements necessary for the development of a trading system are therefore in place.

Policy Framework

Building on the experience of the first air emission trading programs at the federal (e.g., lead in gasoline) and state levels (e.g., RECLAIM), the early 1980s saw the birth of the first effluent trading experiences in Colorado (Dillon Reservoir) and Wisconsin (Fox River).

Following the successful implementation of the SO2 trading program under the Clean Air

Act amendments of 1991, two new effluent trading programs came to light: The Cherry Creek program in Colorado and the Tar Pamlico Basin in North Carolina.

Then, in 1995, President Clinton’s “Reinventing Environmental Regulation” program was introduced. The EPA followed suit with its “Draft Framework For Watershed Based Trading” (May 1996) and five EPA sponsored trading programs.

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In January of 2003, the EPA issued the “Final Water Quality Trading Policy Statement” and the “Watershed-based NPDES Permitting Policy Statement”. These policies describe the various requirements of the CWA that are relevant to water quality trading. Furthermore, the EPA funded another set of pilot trading programs. And, to further facilitate the development of efficient programs, in November of 2004, the EPA issued its “Water quality trading assessment handbook”.

2.1.2 Experiences

Since the beginning of the 1980s, at least 40 water quality trading programs were developed at the state level.10 Some never got passed the development stage. Others were implemented but did not produce a single trade. Close to 20 produced at least one trade and, over the past two to three years we have witnessed an increase in activity.

After reviewing these experiences, we can make the following observations:

All programs are within the present legislative framework, i.e., CWA and the NPDES possess a number of attributes that facilitate the use of the trading concept;11

All programs are encouraged and promoted by government policy to introduce more flexibility in the regulatory system and reduce compliance costs. In addition to its policy statements, the EPA actively supports these types of programs and finances pilot projects to acquire experience and build capacity in using these tools;

Around 25% of cases are single-facility offsets12 and different forms of collective permits13 for point sources subject to NPDES. They do not involve the creation of a trading system per se. Essentially, these programs allow a permit holder to comply with given effluent limits for a specified pollutant by “buying” a reduction (offset) from another point source under the same collective permit or a non-point source in the same watershed;

Most programs involve point-source/non-point-source trading. The non-point sources, which are not subject to direct regulatory requirement are, in most cases, agricultural activities;

For these non-point sources, the trading system is used in conjunction with other programs to reduce the impact of specified pollutants;

The pollutants of most concern are phosphorus and nitrogen. There are also a few cases dealing with sediment and some aimed at other specific pollutants (selenium, BOD, etc.);

The main drivers for the development of the programs are the size of the problem and the “Cap” (TMDL), which is defined at the watershed or basin level;

Water quality trading is closely linked with EPA’s Watershed approach adopted in the beginning of the 90s. Since 1994, this approach has been integrated into

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the NPDES system (NPDES Watershed Strategy in 1994) and the TMDL is applied at the watershed and basin level;

We are beginning to see a few watershed-scale programs within certain state policy and legislation.

2.2 The Dutch Nutrient Quota System14

The Dutch Nutrient Quota System has greatly evolved over time due to the adaptation of legal and policy systems. For this reason, it is relevant to present it chronologically.

2.2.1 Legal and Policy Framework

Historical Context of the Experience

During the 1960s and ’70s, intensive animal production (especially poultry and pigs) expanded rapidly in the Netherlands. A manure surplus resulted, reaching dramatic levels of 16 metric tons or 19% of total manure in 1987. Groundwater quality deteriorated due to high nitrate contamination. By the mid-1980s, the maximum European Union standard of 50 mg nitrate per litre of groundwater was exceeded on 60% of agricultural land in the Netherlands.

The Dutch government first responded to this situation in 1984, by ordering a moratorium within the framework of the “Interim Law for Restriction of Pig and Poultry Farms”. The law prohibited the expansion of production in some regions and highly restricted it in others.

This Law was not sufficient, however, to resolve the problems caused by animal production and further measures were adopted as part of the National Environmental Policy Plan (1989). This three-phased plan was to help the country achieve an acceptable environmental balance within the sector by 2000.

The 1987 Manure Law

The first phase of the National Environmental Policy Plan started in 1987. It relied on the introduction of the Manure Law and the Soil Protection Act that replaced the Interim

Law. The Manure Law put into place the nutrient quota system, which aims to ensure that phosphate production does not exceed certain admissible levels.

The initial allocation of quotas was made as follows: The Dutch legislation determined that total manure production of all animals should not exceed 125 kg of phosphate per hectare of land. If a farmer produced more than that, he had to get animal-based manure production rights.

Following the introduction of the Law, each farm was grandfathered a “reference amount” based on its current manure production. This amount was estimated by subtracting phosphate removal (in products) from phosphate supply (in feed etc.) for each particular farm.

Reference amount = phosphate supply – phosphate removal

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This reference amount was then compared to the quantity of land a farm had at its disposal to treat manure. This led to the identification of both manure deficit and manure surplus farms. A deficit farm could still increase its manure production until reaching its land limits, while a surplus farm could not (except if it acquired new land).

During the initial allocation of quotas, farmers acted strategically by declaring their maximum capacity rather than the actual number of animals they had. This resulted in an over-allocation of manure quotas by an estimated 25% of total quota allocation.

At that time, and until 1993, the trading of manure production rights was quite restricted as it could only occur during the sale of an entire farm, in which case the rights were transmitted as a heritage or the lease contract for a farm was annulled (as determined under the “Relocation Decision” enacted on May 1, 1987).

The problem with this regulation was that it was too strict and did not encourage technological innovation that could help solve the manure problem.

The 1994 Manure Law

Consequently, in 1994, added flexibility was introduced through a new law making manure production rights tradable. The production rights became manure quotas. The new system introduced by this law was more complex than the preceding one and it relied on the following three elements:

1. Land-based quota = (125 kg of phosphate per ha x number of ha of land of farm)

2. Non-land-based quota = reference amount – land-based quota

The allocation of land-based or non-land-based quota depended on the type of animals being raised. Three categories of animals were created: 1) cattle and turkeys; 2) sheep, goats, foxes, nutria and ducks; 3) pigs and chickens. (In the Netherlands, pig and chicken production are non-land based).

The available land-based quota was then allocated to cattle and turkeys, then to sheep and finally to pigs and chickens until its exhaustion. The remaining difference between the farm’s reference amount and the land-based quota became non-land-based and was tradable. The tradable quotas are upwardly compatible: one can use a pig quota to raise sheep or cattle, but not the reverse.

To account for the initial quota over-allocation, a non-tradable dormant quota was also defined. It corresponded to the difference between the volume of livestock declared in 1986 and the volume of livestock found on the farm in 1998/99.

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3. Dormant quota = original reference amount – actual phosphate production

Other restrictions further complicated the trading of quotas:

With each transaction 25% of the quota was retired;

The farmers who acquired quotas had to prove that they had enough land to dispose of the referred manure for two years;

The country was divided in two regions, a deficit one and a surplus one, and trade of quotas was possible within each region, or from the surplus region to the deficit region but not the opposite; and,

A surplus farm would not get more quota from acquiring more land as part of its land-based quotas but it would automatically diminish its animal-based quota.

Box 1 - Example of the Assessment of the Tradable Animal Based Quota

CRL(9N

ApL(9

N(t

Dtr

SoPa21

Tham

Farm description: 9 hectares of land Reference amount 2800 kg P2O5, of which 800 is due to cattle/turkeys and

2000 is due to pigs/chickens/broilers Highest actual manure production in 1988-1990: 2200 kg P2O5, of which

500 due to cattle/turkeys and 1700 due to pigs/chickens/broilers

alculation Total Cattle/Turkeys Pigs/Chickens/Broilers eference amount 2800 800 2000

and related quota x125)

1125 Allocation 800 325 (1125-800)

on-land related 1675 0 1675

ctual manure roduction

2200 500 1700

and related x125)

1125 Allocation 500 625 (1125-500)

on-land related radable)

1075 0 1075

ormant (non adable)

600 600 (1675-1075)

urce: Wossink A. “The Dutch Nutrient Quota System: Past Experience and Lessons for the Future”. per prepared for the OECD workshop on “The Ex-Post Evaluation of Tradable Permit Regimes”, January -22, 2003, Paris: France, 21 p. 6.

e year the Manure Law was introduced, restrictions were also put in place on monia emissions under the Nuisance Act (today known as the Environmental

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Management Act). Thus, farmers expanding their production in manure surplus regions had to acquire not only manure production quotas but also ammonia production quotas.

The Introduction of the MINAS (Mineral Accounting System)

This quota system remained in place without change until January 1, 1998 when a nutrient accounting scheme and building requirements to reduce ammonia emissions were enacted.

The nutrient accounting scheme set strict standards for the production of phosphate and nitrogen per hectare and instated a prohibitive tax on the surpluses. It relied on a Mineral Accounting System (MINAS) at the farm level that encompassed the entire mineral cycle. Its aim was to achieve a balance between input and output of nitrogen and phosphate. Thus, the total inputs of nitrogen and phosphate on a farm were registered along with total outputs of the same nutrients. The difference between the two indicated a farm’s nutrient losses. If those losses were higher than a certain standard determined by the government, then a levy was imposed on the farm in application of the “polluter pays” principle.

At the time of its introduction MINAS was made compulsory only for intensive livestock production farms. It was imposed on all Dutch farmers in 2001.

An important issue when MINAS was first introduced was that farmers found the standard overly demanding and did not know how to comply with it. Thus, important teaching tools were developed under the “Nitrate Action Programme” in order to relay relevant knowledge and technologies to the farmers. The program was a success as, by 2002, 90% of farmers had complied with the standards.

In order to reduce the opportunities for fraud and to further limit manure production (in compliance with the European Nitrate Directives 91/676/EEC), a new tradable instrument was created in 2002: Manure Transfer Contracts (MTCs). It required farmers to obtain MTCs for their manure surplus a year in advance.

The introduction of these latest instruments was not accompanied by the elimination of the quota system, as had been initially planned. Rather, the quota system became further detailed by the separation of the pig quotas from the chicken quotas.

On September 1, 1998, a further detailed quota system was introduced for pig farming. Pig quotas were allocated on the basis of 90% of the actual number of animals on each farm in 1996, and new rules, designed to improve animal welfare, were introduced that had to be strictly respected to acquire extra quotas. It is important to note that this quota reduction was part of the Pig Farming Restructuring Act (1998) aimed at reducing pig herds and manure in the Netherlands. It was politically controversial, however, and was only actually implemented in January 2000.

In 2000 and 2001, in order to accelerate the reduction of manure production, the government created the Livestock Farm Closure Scheme by which it assisted farms that were ceasing activities. In fact, it bought their remaining quotas at a price higher than the market price and helped them pay for the final destruction of their facilities. This

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program was rather successful as it occurred at a moment when the sector was facing various crises, including the foot-and-mouth disease.

2.2.2 Lessons Learned from this Experience

The overall results of this rather unique non-point-source/non-point-source trading experience remain unclear.

From an economic point of view,

“Quotas became tradable on January 1, 1994. By December of 1994, about 2,200 transactions had taken place with a total trade volume of 1.8 million kg phosphate.15 However, this was only 1.5% of the total volume of quota available for trade. Further data from Bureau Heffingen shows that by December 1997 8.1% of all non-land based quota had been traded in the concentration areas and 9.5% in the non-concentration areas.”16

Thus, the volume of trade remained limited. According to Wossink, the limited level of exchanges observed should be related, first, to high levels of political uncertainty that created high transaction costs. In fact, these costs reached up to 17% of the average quota price in the case of pigs. The limited level of exchanges could also be linked to secondary factors such as complex administrative procedures, an initial over-allocation of quotas by 10 to 25%, and restrictive trading rules.

Consequently, it should be remembered that to encourage exchanges to actually take place on a trading market, political uncertainty should be reduced as much as possible while the design of the quotas and their allocation should be closely looked at.

Another interesting lesson that can be drawn from this case is that water trading alone will not reach environmental efficiency. In fact, the Dutch Nutrient Quota System has greatly evolved over time. Nowadays it does not function on its own but rather in conjunction with other regulations, such as the Nutrient Accounting System, that tackle other issues (e.g., waste handling and disposal etc.). Without those other regulations it would obviously not be very effective environmentally as it caps only livestock.

2.3 Australia

2.3.1 The Legal and Policy Framework

Legal Framework

The federal distribution of legislative powers in the Australian Constitution assign to the Commonwealth Parliament a specified, yet relatively limited, list of powers, leaving any unassigned powers, or “residual powers”, to be exercised by the states.

Moreover, the Commonwealth Government collects the vast majority of revenue across all Australian governments and has the power to “grant financial assistance to any state on such terms and conditions as the Parliament thinks fit” (section 96). The Commonwealth uses this constitutional power in concert with its large revenues (relative

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to the states) to exert de facto control or significant influence in areas that would otherwise be solely within the state’s legislative competence.

Protection of the environment and agricultural activities within their borders are primary responsibilities of the states.

The state of New South Wales (NSW) is by far the state most actively involved in water quality trading. Water quality protection in NSW is dealt with under the Protection of the

Environment Operations Act 1997 (POEO Act). This Act replaced the Clean Water Act of 1970 and integrates most of the other environmental protection laws previously adopted. It came into force in 1999.

The POEO Act provides a single licensing arrangement (equivalent to a permit system) relating to air pollution, water pollution, noise pollution, and waste management. The licensing arrangements use load base licensing17 and the POEO Act contains explicit enabling provisions on trading.18 It should be noted that the trading provisions do not provide an extensive use of offsets. In general, the license system applies to point sources including livestock intensive industries.19 Small-scale activities are regulated at the local level. Non-point agricultural sources are not regulated.

Policy Framework

Because of the crucial importance of water in Australia,20 watershed management is well established in states and particularly in NSW. As early as 1986, NSW adopted its first catchment (watershed) management policy and in 1989 formalized the policy with the Catchment Management Act. Since then, the Act has been modified in 1999 and more recently in 2003 with the creation of 11 Catchment Autorities21 under the responsibility of the Minister of Natural Resources. These Catchment Authorities cover most of the State territory. In parallel to these initiatives, the NSW government is establishing water quality objectives for each catchment area.

At the Commonwealth level, the National Water Quality Management Strategy (NWQMS) was introduced in 1992 as a response to growing community concern about the condition of the nation’s water bodies and the need to manage them in an environmentally sustainable way. In 1994, the NWQMS was included in the Council of Australian Governments (COAG) Water Reform Framework. One of the critical issues identified in the Framework was “ecologically sustainable water trading”.

Ten years later, in 2004, the Council of Australian governments signed the National Water Initiative (NWI), a comprehensive strategy to improve water management across the country. The NWI resulted in the adoption, by the Commonwealth government, of the National Water Commission Act 2004 and the creation of a National Water Commission that has the mandate to implement the initiative. One of the key elements of the initiative is the work being done towards the removal of institutional barriers to trade in water. It is envisioned that water-trading systems will have the widest possible geographic scope.

The Commonwealth government is also well aware of the potential benefits of market-based instruments in water quality management. Yet, it also considers that the use of

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those instruments faces serious information gaps that might impair their development and success.

Consequently, the government has included these instruments into the National Action Plan (NAP) on Salinity and Water Quality that was released in October 2000. This NAP is jointly sponsored by the Commonwealth and the Australian states and, as of May 2002, it includes a set of ten pilot initiatives to test MBIs called the National Market-Based Instruments Pilot Program.

As an active participant in this program, NSW conducted three pilot programs to examine the possibility of a more extensive use of offsets targetting non-point sources. As a result of the pilot programs, and as part of the POEO Act review, NSW is currently considering modifications to the Act to allow the use of pollution reduction initiative using offsets.22

Experiences

One of the first experiences in water quality trading in Australia was an interstate salinity trading program that started in 1988 and came into force in 1992 as part of the Murray-Darling Basin Salinity and Drainage Strategy. It is administered by the Murray-Darling Basin Commission on behalf of the states of New South Wales, Victoria and South Australia.

Interstate salinity trading is based on a system of salt credits and debits. The salt pollution rights are not freely traded by industries or individuals, but are exchanged between the governments of the participating states. Credits are earned by investing capital into projects that manage salt entering rivers.

Although credits are tradable between states, no trade actually occurred. Instead, the trading concept was used within each state to offset debits from drainage entering the river system.

Otherwise, there are two noteworthy pilot initiatives related to the use of tradable permits to ensure water quality: the Hunter River Salinity Trading Scheme and the Pilot Pollution Trading Scheme in the Lower Hawkesbury Nepean (South Creek Nutrient Offset Pilot). Both of these are in NSW.

2.3.2 The Systems

Hunter River Salinity Trading Scheme

The Hunter Salinity Trading Scheme was Australia’s first active emission-trading scheme. It operated between 1995 and 2002 as a pilot initiative allowing the approach to be refined. After this period and on the basis of extensive consultations with stakeholders, it was made permanent by the Minister of Environment under the POEO Act (Hunter River Salinity Trading Scheme) Regulation 2002.

The Hunter River covers some 22,000 square kilometres in New South Wales.

Coal mining and waterpower generation have significant impacts on the salinity of the river. In order to preserve the quality of the Hunter River water, it has been decided that

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its salinity should be kept under 900EC23 at any time. When the flow of the river rises due to significant rain, salinity also increases for a few hours and then drops to very low levels. The explanation of this phenomenon is that salt rates initially rise as the river picks up salt from the banks and pools, but then fall as freshwater run-offs dilute the salt concentration. These very low salinity levels were identified as the best time to release discharges.24

In such a context, the Hunter River Salinity Trading Scheme (HRSTS) aims at ensuring that emissions of salinity of mines and waterpower plants occur during periods of relatively low salinity levels in the Hunter River. The companies are thus, attributed “credits to discharge” that are tradable. One credit gives its bearer the right to discharge 0.1% of the daily total allowable discharge of saline water in a certain part of the Hunter River during days of low salinity rates. (In fact, to account for the fact that salinity rates vary from one part of the river to another, it was divided into blocks in which the levels of discharge are different and adapted to the local situation.)

Trading is limited to license holders in the Hunter Catchment. Therefore, trading is presently restricted to 20 mining companies and two electricity generators. It is therefore a point source/point source trading system that enables license holders to develop flexible saline water management strategies. They can either choose to improve their technologies or acquire credits or both, in the most cost effective way. They need to make sure that they always hold sufficient credits to meet their discharge needs. In order to facilitate the exchanges, an online credit exchange facility was created. What’s more, the salinity of the river’s water is measured everyday at 21 monitoring points and a daily register of Total Allowable Discharge is maintained and available online. It is a well-documented system.25

Pollution Reduction Scheme in the Lower Hawkesbury Nepean (South Creek Nutrient Offset Pilot)

South Creek faces significant water pollution problems due to human activities including agriculture and sewage discharges.

A bubble license scheme was first introduced in 1996 concentrating on Waste Water Treatment Plants (WWTP). It sets aggregate phosphorus and nitrogen load discharge limits across the three WWTP belonging to Sydney Water. The scheme was quite successful but because of growth, marginal compliance costs had become very high. In August 2003, a new pollution reduction scheme for the Lower Hawkesbury Nepean was launched. It aims at capping nutrient discharges, mainly phosphorus and nitrogen, from point sources and new facilities. Other environmental benefits such as restoring riverbanks may also be recognized under the scheme.

To date, approximately 20 activities are licensed for discharges to waterways including dairies, a slaughterhouse, swimming pools, golf clubs, etc. Their owners can choose between buying credits or undertaking actions to offset their nutrient discharges. The NSW Environment Protection Authority (EPA) releases the new credits and accepts offsets. The pilot program is one of the three projects submitted by NSW under the National Market-Based Instruments Pilot Program. It is part of the Green Offsets for Sustainable Development Initiative. Its main purpose is to test the use of offsets in the present legislative framework.

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The sellers of the credits are either the EPA itself, for new facilities, or diffuse-point emitters of nutrients such as agricultural activities.

The South Creek Scheme is a point-source/non-point-source scheme. It aims at taking advantage of the fact that at this stage reducing diffuse pollution is less costly than reducing point-source pollution. “For example, the cost of upgrading a sewage treatment plant to reduce phosphorus discharge is in the order of $10,000 per kilogram. But the cost of reducing phosphorus from some non-point sources in the South Creek catchment has been estimated at $10–$200 per kilogram.”26

The project has proven effective at providing opportunities for existing EPA licensees in the catchment to reduce pollution in a cost-effective way. The South Creek Offset Pilot is very similar to examples in the United States. It is the most notable Australian example involving nutrients from non-point-sources.

2.3.2 Main Lessons from the Australian Experiences

Even with a limited number of cases and an evolving legislative framework, the NSW experience is noteworthy for many reasons:

o The trading concept was introduced into the policy arena by a high profile program directly involving three states and the Commonwealth government in the 1988 Murray-Darling Salinity and Drainage Strategy. Even if the program did not produce direct trades per se, it became a testing ground for novel market-based ideas at the state level;

o The Murray-Darling program was initiated at about the same time as state and Commonwealth governments were discussing the adoption of the National Water Quality Management Strategy. (As we saw above, this Strategy was adopted in 1992 as a result of widespread community concerns with water quality. In 1994, the Strategy gave way to the Water Reform Framework and in 2004 to the National Water Initiative. Starting with the Murray-Darling program, each of these policy steps integrated water quality trading as a key tool to move forward. Hence, water quality trading rapidly moved up the policy agenda.);

o The main drivers for the development of the trading programs were the urgency of the problems and the failure of traditional command-and-control instruments to deliver the desired results;

o The first successful trading program started in 1995 under the old legislative framework, and only involved point-sources causing salinity problems on the Hunter River. It gave rise to a specific regulation in 2002. Its success, like the SO2 program in the United States, was an inspiration for the development of other programs;

o Water quality trading is closely linked to water policy and particularly to watershed management policies and institutions. For this reason, the identification and adoption of water quality objectives on a watershed basis is crucial. The example of NSW illustrates the importance of this link;

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o Water quality trading is now perceived in Australia as a way to engage non-point-sources (particularly agricultural activities) in a cost-efficient way to protect water quality. The latest experiences under the Green Offsets for Sustainable Development Initiative tend to demonstrate the potential of the approach and illustrate the limiting factors of the legislative framework. These experiences are very similar to those in the United States;

o Probably because of the high policy profile given to trading instruments, and more generally, to economic instruments, permit trading-enabling provisions were included in the overhaul of the environmental legislation in 1997. In NSW load-based licensing was also included as were other economic instruments. Even with these enabling provisions, the legislation still restricts the use of offsets programs. Hence, the role of pilot projects as a knowledge building process is crucial.

2.4 Two Conceptual Models to Verify the Adequacy of the Canadian Contexts

Our review of the different experiences led us to infer that there were essentially two types of trading systems to deal with the most common agricultural pollutants (nitrogen and phosphorus): The following table illustrates the main features distinguishing these two types of systems.

Table 1 – Comparison of the American Model and the Dutch Model

Theme American Model Dutch Model

Baseline/Cap Water quality criteria for certain pollutants in surface water

Soil’s assimilative capacity of certain types of pollutants (phosphorus)

Territorial Basis Watershed Regions/Whole country

Participants

PS–NSP

PS–PS

All agricultural activities

All non-point-sources

All point-sources

NPS–NPS

Certain types of agricultural activities

Nature of the system

Decentralized

Common characteristics but differentiated on a watersheds basis

Centralized

Single system

Uniform over the whole territory

Implementation

From pilot projects within existing legal framework

To policy changes

To legislative changes

New legal framework introduced and modified to adapt to evolving situation

Note: PS: Point Source; NPS: Non-Point Source

These general distinguishing features inspired us as we developed the two conceptual models and helped us verify if these types of trading system could be implemented in Canadian contexts (provincial). The table below illustrates the main features of these two

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models. Essentially, Model 1 is the United States-type model and Model 2 is an adaptation of the Dutch model to the Canadian context. The adaptation is necessary for two reasons:

a) The territorial basis: The Netherlands’ ecosystems are very different from Canadian ones when considering water resources and water quality problems. Since trading is driven by water quality problems, it is at the watershed level that these problems can best be dealt with in the Canadian context.

b) The nature of the system: Adopting a watershed approach leads to a decentralized type of system, a place-based system.

Table 2 – Two Conceptual Models for Canada

Theme Model 1 Model 2

Baseline/Cap Water quality criteria for certain pollutants

Soil’s assimilative capacity of certain types of pollutants (phosphorus)

Territorial Basis Watershed Region/Watershed

Participants PS–NSP

PS–PS NPS–NPS

Nature of the system

Decentralized

Common characteristics but differentiated on a watersheds basis

Decentralized

Uniform requirements for participating/designated regions/watersheds

Note: PS: Point Source; NPS: Non-point Source

3. The Legal and Policy Issues

In the process of reviewing international experiences, we identified the key features of the legislative and policy contexts that are essential for the development and implementation of water quality trading systems or programs. We have formulated these key features into questions to facilitate their use.

We should keep in mind that the adoption of market-based environmental policy and programs is the result of a knowledge-building process in the context of evolving policy and political agenda regarding water quality problems in a particular jurisdiction.

The conceptual models developed in the last section are used to answer the question on agri-environmental measures (No. 7). We also used the database on provincial agri-environmental regulations that we compiled for an earlier contract. 27

The questions are as follows:

1. Are there enabling provisions within the legislations that allow for the use of tradable permits systems?

2. Are there policies, programs, regulations or any other documents that facilitate the development and use of tradable permits systems?

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3. Are there legal provisions requiring that emitters monitor their discharges to the

environment and report to public authorities?

4. Are there any legal, regulatory, policy, or any other type of documents that relate to the capacity to determine water quality criteria/objectives of water bodies or the soil’s assimilative capacity of certain types of nutrients?

5. How are those criteria/objectives being met?

6. Is the watershed approach being used to adopt and implement policies, regulations or issue permits? Are there institutions dedicated to implementing integrated watershed management?

7. How do the legal/regulatory agri-environmental provisions of the various jurisdictions interact with water quality trading?

8. Has there been a major initiative, at the government level, to promote the use of economic or market-based instruments in environmental management?

3.1 General Review of the Relevant Characteristics of the Legal and Policy Frameworks in Canada

It is important to acknowledge from the outset that in water management, agricultural activities and environmental protection, the jurisdiction is shared between the federal and provincial governments with the provinces playing a leading role on the lands situated within their borders. Thus, we decided to concentrate on the legal and policy frameworks of the provinces.

Question 1: Are there enabling provisions within the legislations that allow for the use

of tradable permits systems?

Four provinces, namely Nova Scotia,28 Quebec,29 Ontario30 and Alberta,31 have specific provisions in their respective legislations that enable the government to implement economic instruments and particularly trading systems.32

Question 2: Are there policies, programs, regulations or any other documents that

facilitate the development and use of tradable permits systems?

Only the province of Ontario has adopted a specific regulation33 and introduced a tradable permit system on air pollution (NOx and SO2) in 2002. This regulation establishes a registry, the Ontario Emissions Trading Registry, for the operation of the trading system and a Trading Code to supplement the regulation.34 The development of the regulation followed the Pilot Emissions Reduction Trading Project (PERT) experience, which started in 1996.

Question 3: Are there legal enabling provisions to requiring that emitters monitor

their discharges to the environment and report to public authorities?

Most provinces have the enabling power to require, on a case-by-case basis (in a permit or certificate of approval), the necessary information on emissions/discharges and to

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regulate. Some provinces require the monitoring and reporting of that information for regulated industrial sectors (the pulp and paper sector for instance). However, only two of them have adopted general regulations specifically on monitoring and reporting: Ontario and Alberta. When done on a case-by-case basis, the information is not necessarily made public, as it often the case when a regulation is in place.

Question 4: Are there any legal, regulatory, policy, or any other type of documents that

relate to the capacity to determine water quality criteria/objectives of water bodies or

the soil’s assimilative capacity of certain types of nutrients?

Legislation in all the provinces confer on their government the power to determine water quality criteria/objectives and to use them for regulatory purposes. However, most provinces have not used this prerogative directly in their regulations addressing discharges/effluents from specified industry categories (point-sources).35 We should keep in mind that these regulations set emission or effluent standards on a technological basis (best available technology economically achievable), as opposed to an ambient basis.36

Question 5: How are those criteria/objectives being met?

Those criteria/objectives are used in the issuance of certificates of authorization or permits for activities not directly regulated37 or they are used for planning purposes. Regulated activities (i.e., pulp and paper regulation) are subject to specified standards, which are technology based.

Provincial authorities usually develop a policy incorporating the use of water quality criteria/objectives to guide the content of the certificate of approval or the permit.

Question 6: Is the watershed approach being used in to adopt and implement policies,

regulations or issue permits? Are there institutions dedicated to implementing

integrated watershed management?

Most provinces (namely British Columbia, Alberta, Manitoba, Ontario, Quebec and New Brunswick) have chosen a watershed-based approach to manage water issues within their borders. Ontario has by far the most structured approach. The Conservation Authorities are well-established institutions working on a watershed basis.

Question 7: How do the legal/regulatory agri-environmental provisions of the various

jurisdictions interact with water quality trading?

Consulting the database we recently developed for AAFC on the agri-environmental regulations in different provincial jurisdictions and referring to characteristics of the conceptual models developed, we found that the prescriptions most relevant to the implementation of a water quality trading system, or a related instrument in Canadian jurisdictions, are the following:

Manure/nutrient management plans that are prescribed within the legislations or regulations of five provinces (Alberta, Saskatchewan, Manitoba, Ontario and Quebec) and used to issue certificates of authorization in the remaining

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provinces. These nutrient management plans can be used as a base to establish a trading system like the one described in Model 2.

Ontario and Quebec have prescribed limits for phosphorus on land application of manure. Quebec has the more stringent prescriptions of the two. The Quebec case illustrates that is empirically possible to determine a cap on a soil capacity basis and manage it on a watershed scale like Model 2.

Prince Edward Island and Ontario are the only jurisdictions that regulate riparian buffer zones. Quebec’s policy is enforced at the municipal level.

Agri-environmental policies rely, in most provinces, on incentives and subsidy programs, which could interfere with a water quality trading system by creating, for example, the possibility of a double subsidy.38

Question 8: Has there been a major initiative, at the government level, to promote the

use of economic or market-based instruments in environmental management?

Most provinces have experienced initiatives in one form or another to promote the use of economic instruments as an alternative to command-and-control regulations. In some provinces, these initiatives have had sufficient impact to lead to legislative changes (i.e., Alberta, Ontario, Quebec and Nova Scotia). Ontario is particularly noteworthy, having experienced two waves of such initiatives. The first wave, under the New Democratic Party government, was at the beginning of the 1990s. The second, under the Conservative government produced Managing for the Environment in 2001 Report.39 This last wave produced the Emission Trading Regulation and gave birth to the South Nation Conservation Authority water quality trading pilot project, among a number of other initiatives.

3.2 Is the Canadian Context Well Adapted to the Introduction of Tradable Permit Systems to Improve Water Quality?

Our analysis tends to show that the legislative frameworks of the provinces offer the basic features of, and the necessary flexibility for, the implementation of water quality trading to address water pollution from agriculture activities.

At least four provinces (Alberta, Ontario, Quebec and Nova Scotia) clearly possess the relevant power to introduce a tradable permit system on their territories, and all the provinces have the necessary power to establish and impose water quality criteria/objectives. However, that power is generally not being used.

The flexibility that is necessary to implement credit/offset systems within the certificate of authorization and permits systems seems to exist. The flexibility required is to be able, within the framework of the certificate or the permit, to consider a reduction outside the facility premises of the certificate or permit holder equivalent to a reduction from the facility. The South Nation experience is an illustration of this flexibility.40

As far as agri-environmental legislations and policies are concerned, the widespread use of manure/nutrient management plan prescriptions is an indication that a Model 2 trading system, based on the soil’s assimilative capacity of certain types of pollutants, can be

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implemented. The Quebec example of a prescribed limit for phosphorus on land application of manure is a clear indication of the practical possibilities for implementing a cap. On the other hand, these prescriptions do not seem to hinder the development of a trading system, as illustrated by the South Nation watershed experience in Ontario. Note that these manure/nutrient management plan prescriptions are already present in a number of American states and they do not seem to interfere with the numerous American water quality trading experiences involving agricultural non-point sources.

There seems to be some concern with regulatory provisions on Best Management Practices, which, like buffer strips, will restrict BMP options available to farmers. Also, there is some concern about the interface between subsidy programs and water quality trading programs because of the possibility of a double subsidy.41

There are also some barriers to the development of these systems:

Firstly, trading systems are part of a package of economic or market-based policy instruments, which break with the traditional command-and-control approach in environmental policy-making. Even if the OECD and other prestigious institutions have promoted their use, there is a cultural resistance to their introduction. The adoption of economic instruments in Canada has been slow compared to the United States and the European Union.

Secondly, by focussing on an ambient approach water quality trading implies a significant departure from the traditional technico-economic, end-of-pipe approach that has characterized legislative and regulatory systems to date in Canada. That is, instead of concentrating on emissions from pollution sources, the focus is placed on the in situ quality of the water bodies themselves. While this appears to be common sense, it should be emphasized that an ambient approach to water quality regulation and enforcement is new territory.

Finally, it seems clear from the United States, Australia and Ontario experiences, that the development and implementation of trading systems follows a clear signal from governmental authorities and starts with pilot projects implemented with a view to building knowledge and experience, involving the populations concerned.

3.3 What Role for the Federal Government?

The basic incentive for the development and implementation of a water quality trading systems is the size of the environmental problem and its consequences on human activity. It is also based on requirements to reach ambient criteria/objectives.

Besides environmental problems, it is the acquisition and the sharing of knowledge and experience concerning WQT that will help overcome resistance to innovation and promote the implementation of pilot projects in the various provinces. The federal government should thus concentrate its efforts on creating the conditions for such exchanges and projects to take place.

The federal government should also promote the development and the implementation of watershed-based approaches to water management, and support the creation of institutions/organizations designed to facilitate the implementation of this approach.

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Notes

1 The legislative and policy review used for that part comes from a parallel study prepared for the Policy

Research Initiative: “Water Quality Trading to Address Pollution from Agricultural Activities in Canada: A Legislative Review”, Tri-Star Environmental Consulting, September 2005

2 Hahn R. “Market Power and Transferable Property Rights” Quaterly Journal of Economics, 99(4):753-

765. 3 Stavins R. “Transaction Costs and Transferable Permits” Journal of Environmental Economics and

Management. 29(2):133-148. 4 The assumption here is that new point sources would come under the cap. 5 Rousseau S., 2001, p. 8. 6 Rousseau S., 2001, p. 8. 7 The South-Nation watershed pilot experience is part of several phosphorus management pilot

approaches explored throughout Ontario as a component of Watershed Water Management Strategies. The experience uses the water quality trading concept to complement its water quality incentive program.

8 The regulation defines a concentrated animal feeding operation as a facility confining 1,000 or more

animal units or confining 300 animal units and causing pollutant discharge into waters. (40 C.F.R. Part 122, Appx. B. The term “animal unit” is defined in the regulations)

9 States, Territories, and Indian Tribes set water quality standards. They identify the different uses for

each water body, for example, drinking water supply, recreation (swimming), and aquatic life support (fishing), and the scientific criteria to support that use. A TMDL is the sum of the allowable loads of a single pollutant from all contributing point and non-point sources. The calculation must include a margin of safety to ensure that the water body can be used for the purposes the state has designated. The calculation must also account for seasonal variation in water quality.

10 Hanna L. Breetz, Karen Fisher-Vanden, Laura Garzon Hannah Jacobs, Kailin Kroetz, Rebecca Terry,

Water Quality Trading and Offset Initiatives in the U.S.: A Comprehensive Survey, Dartmouth College, Hanover, New Hampshire, August 5, 2004.

11 For instance: the strong requirements for monitoring, the possibility of issuing general permits and the

development of Watershed permitting. 12 Individual NPDES permit. See: Rahr Malting Company or Southern Minnesota Beet Sugar Cooperative

Permit (MN)in Annex 1. 13 There are several possible types of collective permits. One example is the Neuse River Compliance

association. See: Annex 1. 14 This part of the report owes a lot to Wossink A. “The Dutch Nutrient Quota System: Past Experience

and Lessons for the Future”. A paper prepared for the OECD workshop on “The Ex-Post Evaluation of Tradeable Permit Regimes”, January 21-22, 2003, Paris : France, 21 p. and Hubeek F. “Market Regulation and Environmental Policies: The Dutch Manure Production Quota System”. A document prepared for the workshop on “Water Quality Trading in Canada” organized by the Policy Research Initiative, Agriculture and Agri-Food Canada and Environment Canada, September 19-20 2005, Ottawa: Canada, 23 p. To our knowledge, these two articles are the only articles written in English that have been released on this interesting case.

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15 MANMF [Ministry of Agriculture, Nature Management and Fisheries]. “Wet verplaatsing mestproduktie:

Evaluatie”, The Hague, 1996. 16 Wossink A. “The Dutch Nutrient Quota System: Past Experience and Lessons for the Future”. A paper

prepared for the OECD workshop on “The Ex-Post Evaluation of Tradeable Permit Regimes”, January 21-22, 2003, Paris: France, p21, p. 11.

17 The load-based licensing (LBL) scheme, which commenced on July 1, 1999, sets limits on the pollutant

loads emitted by holders of environment protection licences, and links licence fees to pollutant emissions. See: Protection of the Environment Operations (general) regulation 1998

18 POEO Act, Part 3.5, article 69 and Part 9.3A, 19 POEO Act, Schedule 1 20 Australia is often referred to as the driest continent on earth 21 Established under the Catchment Management Authorities Act 2003 which replaced The Catchment

Management Act 1989 22 Department of Environment and Conservation of NSW and Action Salinity and Water Australia, “Green

offsets for sustainable regional development –ID-16”, Final report, August 2005 23 EC: Electrical conductivity: Indicator of water salinity 24 <www.epa.nsw.gov.au/licensing/hrsts/success.htm> 25 <www.environment.nsw.gov.au/licensing/hrsts/index.htm> 26 NSW Government. “Green Offsets for Sustainable Development” Concept Paper. Sydney: Australia,

April 2002, 16 p. 27 EcoRessources, “Inventory and impact evaluation criteria – Methodology of environmental regulations

for the agricultural sector”, Final Report, prepared for Agriculture and Agri-Food Canada, November 2004

28 Environment Act, section 15 29 Environemental Quality Act, article 31, e 1. 30 Environmental Protection Act, R.S.O. 1990, CHAPTER E.19, article 176.1 31 Environmental Protection and Enhancement Act (1992), section 12 and 13 32 The Manitoba legislation has provisions for what is called “Load-based licensing”. We have not

considered it as enabling water quality trading. See the experience of Australia in that respect. 33 Regulation 397/01, Emission trading regulation 34 See: <www.ene.gov.on.ca/envision/air/etr/index.htm> for more details on the system. 35 There are some exceptions namely, British Columbia in its Government Actions Regulations (B.C. Reg.

17/2004

O.C. 20/2004, article 6) regulations under the Forest and Range practices Act, art. 150.1 and 150.2

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36 This approach is similar to the United States approach. 37 See for example, Policy 2 of Ontario’s Water management policies, guidelines, Provincial quality

objectives of the ministry of environment 38 For example, a credit from the adoption of a Best Management Practices (BMP) in agricultural activity

could be created and be financed partly or wholly by its price on the market and an explicit subsidy program or an implicit subsidy in the form of an income stabilization program for example.

39 Executive Resources Group, “Managing the Environment: A review of best practices” Vol. 1, January

2001. 40 See: Conservation Ontario, “Watershed economic incentives through phosphorus trading and water

quality” May 2003. 41 See endnote 38.

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34

Annex 1: Water Quality Trading – Review of United States Experiences

In order to better understand the characteristics of the legislative, regulatory and policy frameworks that allowed the development of water trading quality experiences, we have reviewed a number of United States initiatives. We concentrated on practical experiences, i.e., programs that have produced at least one trade and that were more documented.

The following table summarizes the main characteristics of those systems. A more thorough description of these systems can be found in the survey prepared by Dartmouth College.1

1 Hanna L. Breetz, Karen Fisher-Vanden, Laura Garzon Hannah Jacobs, Kailin Kroetz, Rebecca Terry.

“Water Quality Trading and Offset Initiatives in the U.S.: A Comprehensive Survey”, Dartmouth College, Hanover, New Hampshire, August 5, 2004.

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EXPERIENCES POLLUTANT

TRADED

POINT (P)

NON POINT

(NP)

REMARKS

Grassland Area Farmers Tradable Loads Program (CA) Selenium TMDL NPS (close to PS)

Irrigation and drainage

Introduced in June 1998

7 Irrigation and drainage districts

Selenium collective cap allocated to the 7 districts

Selenium measured at the drainage pumps (akin to a point source system)

Bear Creek (CO) Phosphorus NPS–PS

Bear Creek Watershed Control regulation (Regulation no. 74)

There is no official trading program outlined in the Regulation; however, the Regulation does permit the Water Quality Control Division of the Colorado Department of Public Health and Environment to “allow small wastewater treatment facilities with design capacities of 20,000 gallons per day or less to discharge a total phosphorus concentration of greater than 1.0 mg/L if an agreement is made for equal phosphorus reduction at another facility”

Only 1 trade

Very limited by design

Chatfield Reservoir Trading program (CO)

Phosphorus NPS–PS

Chatfield Reservoir Control regulation (Regulation no. 73)

Specifies water quality standards to be met by both point and non point sources

Formulas and procedures to determine a TMAL

Chatfield Watershed authority act as a clearing house

7 point sources – Numerous NPS

In a State Park

Denver region

Elaborate system

Cherry Creek Basin (CO) Phosphorus NPS–PS

Cherry Creek Control regulations

Cherry Creek Basin Water Quality Authority

NP-P trading since 1989

Revised regulation in 2001 with TMAL and trading guidelines

Six (6) Wastewater treatment plants (PS)

In a State Park

Denver region

Elaborate system

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EXPERIENCES POLLUTANT

TRADED

POINT (P)

NON POINT

(NP)

REMARKS

Lake Dillon (CO) Phosphorus NPS–PS

Dillon Reservoir Control regulation (1984)

Total phosphorus wasteload cap

Allocation among 4 point sources (Public-owned treatment works, POTW)-

Offsets from NPS from residential septic systems, ski resorts, golf courses, etc.

Second oldest effluent trading program

First to incorporate NPS

In a State Park

Denver region

Long Island Sound (CT) Nitrogen PS

EPA approved TMDL for New York and Connecticut

Connecticut NPDES General Permit For Nitrogen Discharges in the Long Island Sound (January 1, 2002)

Include a Nitrogen Credit Exchange Program

Public-owned wastewater facilities (79)

New York does not participate in an interstate trading program

Lower Boise River Effluent trading demonstration project (ID)

Phosphorus NPS–PS

Demonstration project – No trades yet

Idaho is not a delegated State for NPDES Permits so the US EPA is responsible for issuing NPDES Permits in Idaho

TMDL driven

Response to a Court Order in a strict timeframe

Elaborate system supported by EPA region 10

7 POTW, 3 Industrial Dischargers, 8 Irrigation districts, Farmers

Piasa Creek Watershed Project (IL) Sediments NPS–PS

Driver: Illinois American Water Company (IL-AWC) NPDES for Alton Ill. facility

IL-AWC funds Watershed Project designed to generate sediments reductions in exchange for adjustment in NPDES permit

Great River Land Trust – Contracted to oversee the operation of the program

NPS-Farmers

Started in 2001

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EXPERIENCES POLLUTANT

TRADED

POINT (P)

NON POINT

(NP)

REMARKS

Charles River flow Trading program (MA) Water flows NPS–PS

Experience motivated by environmental interests – Charles River Watershed Association

Funding by EPA, supported by US Geological survey

Partner: Massachusetts Department of Environmental Protection

Wayland Business Center Permit (MA) Phosphorus NPS–PS NPDES driven – One permit

Relaxed phosphorus effluent limits for offsets

Rhahr Malting Company Permit (MN)

Phosphorus

Nitrogen

CBOC5

Sediment

NPS–PS

NPDES driven – One permit – Wastewater treatment plant for facility

TMDL

Offsets

Southern Minnesota Beet Sugar Cooperative Permit (MN)

Phosphorus NPS–PS

NPDES driven – One permit

TMDL

Water quality trading provisions in permit – Offsets

Passaic Valley Sewerage Commissioners Pretreatment Trading Project (NJ)

Heavy metals PS POTW

Pre-treatment trading

New York City Watershed phosphorus offset pilot program Phosphorus NPS–PS

New York City Department of environmental protection (DEP)

New York City Water supply system

Phosphorus offsets pilot programs

TMDL driver

Neuse River basin nutrient sensitive waters management strategy (NC)

Nitrogen NPS–PS

Neuse River compliance association (22 point sources)

Issued a collective NPDES nitrogen permit

North Carolina Wetlands Restoration Fund – Facilitator – Broker

New sources can pay the Fund for offsets. The Fund also collects non compliances penalty (not meeting cap0

Began in 2003

A form of private trading system.

Tar-Pamlico Nutrient Reduction Trading Program (NC)

Phosphorus

Nitrogen NPS–PS

Tar-Pamlico Basin Association (16 industrial and municipal dischargers)

Common cap for nitrogen and phosphorus

If the Association exceeds the nutrient cap, it must fund nutrient reducing BMP by paying a fixed per kilogram price to the North-Carolina Agricultural

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37

EXPERIENCES POLLUTANT

TRADED

POINT (P)

NON POINT

(NP)

REMARKS

Cost-share Program (state program)

TMDL driven

Started in 1990. PS–NPS trading started in 1995

Point sources: 7 municipal, 2 major industrial, 127 other sources

NPS: AFO

Great Miami River Watershed Water Quality Credit Trading Pilot program (OH)

Phosphorus

Nitrogen NPS–PS

New program beginning

TMDL driven

Point sources under NPDES permits

Wastewater treatment plants (4)

Agricultural producers

The pilot trading program will enable regulated dischargers to meet stricter effluent standards by purchasing credits generated through voluntary and less costly non-point source reductions rather than installing more expensive technology upgrades

Red Cedar River Nutrient Trading Pilot Program (WI)

Phosphorus NPS–PS

Two cities with POTW considering

Chapter NR 217 of the Wisconsin Administrative Code. Ch. NR 217 mandated 1 mg/L phosphorus discharge limits for municipal treatment plants with a monthly discharge exceeding 150 lb. of phosphorus and industrial sources with a monthly discharge exceeding 60 lb. of phosphorus.

Purchase of offsets from farmers’ BMP

Cumberland: engaged in trading

Chesapeake Bay Nutrient Trading Program

Phosphorus

Nitrogen NPS–PS

Federal program involving 3 states (PA, MD, VA and the District of Columbia)

TMDL driven

Chesapeake Bay Commission

No trades yet

Elaborate and complex program

Interstate cooperation

Multiple learning experiences

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40