Water Quality: Wading Into Trading

Posted on November 28, 2017 by Ridgway Hall

For over 20 years EPA has been promoting water quality trading – with particular emphasis on nutrients and sediment – as a way to improve water quality at reduced costs. Trading is based on the simple proposition that if Party A can reduce a pollutant at a lower per-unit cost than Party B, who needs to reduce its discharges of that pollutant, it is more economically efficient for Party A to reduce its discharges below what is required by law, and sell the additional reduction, or “credit”, to Party B. If the price is less than what Party B would otherwise pay and more than it costs Party A to make the reduction, B will save money and A will make money. 

The focus is on nitrogen, phosphorus and sediment because these pollutants have for many years been leading causes of water quality impairment and, in the case of nutrients, adverse effects on human health when the resulting algae blooms release toxins and harmful bacteria.  In 2016 EPA reported that nutrient-caused algae blooms were on the rise, causing fish kills, contamination of fish and shellfish, and beach closures, resulting in significant damage to local economies and impairments to human health. The biggest source of these pollutants is farming operations. Trading seems especially well-suited to help reduce polluted runoff from farms because their per unit cost of removing nutrients is far lower than for wastewater treatment plants. Finally, because farm runoff is a nonpoint discharge, it is not regulated under the Clean Water Act. Regulation is left to states. While many states require farms to have nutrient management plans, because the states have limited resources to inspect and enforce, finding incentives to stimulate a market-driven solution has obvious appeal.

So why are there so few trading programs in place? The GAO attempted to find the answers in its report Water Pollution: Some States Have Trading Programs to Help Address Nutrient Pollution, but Use Has Been Limited (October 2017). The report addresses (1) the extent to which nutrient trading programs are being used, (2) how EPA and the states oversee these programs, and (3) what factors affect participation in trading.  As of 2014, eleven states had some form of trading programs: California, Connecticut, Florida, Georgia, Idaho, Minnesota, North Carolina, Ohio, Pennsylvania, South Carolina and Virginia. Most of the trading was being done in Connecticut, Pennsylvania and Virginia, so GAO focused primarily on these programs.

All three of these states established their trading programs through legislation and implementing regulations. All three allow point-source to point-source trading, but as of 2014 only Pennsylvania allowed non-point sources to generate credits. Virginia appears to be moving in that direction through pending regulatory amendments.  Connecticut uses a general permit that allows 79 point sources in the Long Island Sound watershed to trade nitrogen credits through a Nitrogen Credit Exchange Program. Each year plants that are not meeting their discharge limits can buy credits from plants who are below their required limits.

Virginia allows trading of nitrogen and phosphorus credits between point sources.  Most but not all sales are through a Nutrient Credit Exchange Association, which is privately run in consultation with the state, and provides tracking of credit generation and sales.  Pennsylvania allows a point source to buy credits generated by nonpoint and point source dischargers. It has a credit exchange, PENNVEST, but most trades are outside it.  The state keeps a registry of credits generated, sold and used. During 2014, there were 39 trades in Connecticut, 151 in Pennsylvania, and 31 in Virginia.

Trading programs are managed by the states, with oversight by EPA to be sure that both the elements of the trading program and individual permits that incorporate trades comply with the Clean Water Act. Those who buy credits said that the benefits of doing so include reduced cost of compliance, risk management (credits can be used to address plant failures which cause noncompliance), and flexibility in timing technology upgrades. 

GAO cites two primary disincentives to trading. First, if water quality criteria are written in narrative form, permits are also often written in narrative form, so it is difficult to determine whether or when use of a credit might be helpful. While EPA has been pressing states to adopt numerical criteria for nutrients, GAO reported that as of 2017 only 6 states had them.  I believe that this problem can be mitigated by including numerical water-quality based effluent limits (WQBELS) in NPDES permits even when the criteria element of a water quality standard is narrative.  I don’t know how widely this is done, but typically a total maximum daily load (TMDL), which is required for water bodies not meeting water quality standards, is expressed in numerical terms, and that provides the basis for WQBELs. GAO observed that the Ohio River Basin Interstate Water Quality Trading Project allows trading among sources in Ohio, Kentucky and Indiana, but almost no trading has occurred because there are no numerical limits in the water quality standards or a TMDL.

The second reason given by stakeholders to GAO for limited trading is the difficulty in determining the water quality benefits of a best management practice (BMP), which is what is installed on farmland to reduce runoff. Models do exist for converting the benefits of BMPs, such as vegetated buffers, no-till farming and cover crops, to numerical pollution reduction on an annual basis, but these are only estimates, and lack the precision that a point source discharger looks for in deciding whether to buy a credit from a farmer. EPA has recommended the use of an “uncertainty factor”, such as 2:1, by which a buyer of 100 nitrogen credits would have to buy 200 credits. This could be modified upwards or downwards based on site-specific conditions. It is still an estimate, and any trading program will need to apply a dose of adaptive management if it wants nonpoint source trading to get up and running.  The potential cost savings are sufficiently great that such an uncertainty ratio would not by itself, in most cases, discourage trading.

Several other factors, not discussed by GAO, also tend to discourage nonpoint source trading. There is the uncertainty of the buyer, who will rely on the credit to meet its NPDES permit terms: what if the BMP on which the credit is based fails? This is a particular concern for public utilities, whose managers and ratepayers may not want the utility relying for compliance on a set of BMPs over which the utility has no control. On the farmer side, what if the farmer invests substantial sums in BMPs to generate credits, but there turns out to be little or no market for them? Several states and some financing institutions are exploring ways to create a market to jump start the process, and we will likely see more on that. Finally, there is an inherent reluctance to be among the first in what is still largely an experimental program – especially if it is being run by a government agency.

It is no coincidence that two of the three most active programs, Pennsylvania and Virginia, are in the Chesapeake Bay watershed, where a numerical multi-state TMDL has been in place since 2010. (That TMDL was discussed in my blog article EPA Issues Biggest TMDL Ever for the Chesapeake Bay Watershed, posted March 4, 2011.) At this writing Maryland, also in the Chesapeake watershed, is developing a trading program which will include nonpoint source trading and will be run jointly by the Maryland Departments of Environment and Agriculture.  The only way the goals of the Chesapeake TMDL will be achieved is through major reductions of the nitrogen, phosphorus and sediment released by farms. In a future post, I will explore those three programs in more detail.

New Tools for Water Quality Trading

Posted on September 26, 2016 by Ridgway Hall

For well over a decade states and stakeholders have been trying to develop water quality trading and offset programs to facilitate compliance with the Clean Water Act.  The goal of “trading” is to allow a discharger who can cost-effectively reduce pollutants to a lower level than legally required to sell the resulting “credit” to another source whose per-unit cost of reducing that same pollutant is greater. The “credit” is the amount of reduction achieved by the credit generator beyond compliance. The result is more cost-effective compliance. 

An “offset” involves using a “credit” to offset a new or increased discharge to a water body which is not achieving water quality standards (often referred to as “impaired”) for that pollutant.  Without such an offset, any new discharge to an impaired water body is illegal, because it would exacerbate the standards violation. Typically the credit or offset is incorporated into the permit of the user, and is thereby enforceable.

Recognizing these benefits, EPA supports trading, and issued a policy and guidance memo in 2003.  One of the most promising opportunities for trading is the reduction of nitrogen, phosphorus and sediment, which are causing water quality problems across the country.  Farms typically have nonpoint source discharges of all three of these pollutants, and can reduce the volume much more cost-effectively than a municipal or industrial point source, which is the typical buyer. However, efforts to establish trading programs have run into problems, such as determining a measurable “baseline” compliance level for a nonpoint source credit generator before a credit can be generated. Nonpoint sources typically use “best management practices” (BMPs) to achieve pollution reductions representing their fair share of loading allocations for the water body to which they discharge. Before a farmer can generate a credit, his “fair share”, or baseline, must be both determined and met.

Additional problems include protecting local water quality where the credit is used, verifying the implementation of a credit, and accounting for uncertainty in the amount of pollution reduction which a BMP implemented at a non-point source will actually achieve. As a result, while many states have tried to establish such programs, including the development of regulations, very few have been successful. 

To address these problems, EPA over the past 3 years has issued 8 “technical  memoranda” (TMs) which set forth EPA’s “expectations” for the contents of an effective trading program within the Chesapeake Bay watershed. This is, in effect, a pilot.  The reason for the focus on this 64,000 square mile watershed is that in 2010 EPA published the biggest total maximum daily load (TMDL) ever issued under the CWA, which sets forth pollutant loading allocations which must be achieved throughout the watershed in order to achieve compliance with applicable water quality standards. I described this TMDL in a previous post entitled EPA Issues Biggest TMDL Ever for Chesapeake Watershed, posted on March 4, 2011. Faced with huge costs to achieve the reductions, many of the states are looking at trading.

To maximize the likelihood that such trades will be carried out in compliance with the CWA, EPA issued the TMs for use by the Bay states in designing their programs. They address baseline determination, duration of credits, components of a credit calculation, protection of local water quality, accounting for uncertainty of the water quality benefit of a BMP, representative sampling, verification and certification (including inspections and public availability of all relevant documents), and accounting for growth (including need for an “offset” program). The “credit calculation” TM addresses, among other things “additionality” (the requirement that any trade must result in a net reduction of pollution) and “leakage” (when a pollutant load reduction at one location indirectly causes an increase in pollution elsewhere). These can be accessed on EPA’s “Trading and Offsets in the Chesapeake Bay Watershed” web site. They are not regulations or even “official agency guidance” (says EPA), and do not have the force of law. They do set forth EPA’s “expectations”.  EPA officials have said that each state trading program will be reviewed for consistency with these TMs.

For those around the country who are trying to design and implement trading programs, these TMs can be enormously helpful.  They are fairly brief (typically 6 to 12 pages), clear and concise.  And who among us would not support more cost-effective reduction of pollution?

Big Party for the Chesapeake TMDL Appeal

Posted on October 28, 2014 by Ridgway Hall

Many Clean Water Act practitioners will have their eyes on the Third Circuit on November 18 when oral argument has been set on an appeal from a decision upholding EPA’s issuance of a multi-state Total Maximum Daily Load (TMDL) for the Chesapeake Bay and its tributaries.  The Chesapeake Bay TMDL, issued in December, 2010, is the biggest EPA has ever set, covering parts of 6 states and the District of Columbia. As I reported in a blog article a year ago on September 13, 2013, in a 99 page decision the Middle District of Pennsylvania upheld the TMDL against numerous challenges by the American Farm Bureau Federation, other agricultural trade associations and the American Home Builders Association. Those organizations appealed, and a flurry of intervenor and amicus briefs have been filed on both sides.

The issues raised by the appellants are whether EPA exceeded its statutory authority when (1) it set pollutant allocations for nitrogen, phosphorus and sediment on a watershed-wide basis, and then, by agreement with the states, subdivided them by state and by major river basin; and (2) it insisted that states provide “reasonable assurance” that they would implement measures reasonably calculated to achieve compliance with the TMDL within agreed-upon timetables.

As described in the district court decision, the Chesapeake Bay TMDL has a long history, including more than 25 years of cooperative but unsuccessful efforts by the Bay states, working together and with EPA, to design and implement programs to reduce the large amounts of nutrients and sediment flowing annually into the Bay.  This pollution has contributed to the decimation of oysters, blue crabs and other fish, destruction of hundreds of acres of bay grasses, and significant economic, recreational and cultural losses throughout the watershed.  Because of the inherently interstate nature of the pollution, and the inability of one state to stem pollution in another state, the states in 2007 asked EPA to set a multistate TMDL, which EPA did. At the heart of the legal dispute are issues of “cooperative federalism” – the proper roles for the states and EPA and the limits of EPA authority under Clean Water Act Section 303, which gives only minimal guidance on TMDL implementation. The district court decision addressed several issues of first impression and, in upholding EPA’s actions, provided a thoughtful analysis and helpful guidance.

The precedential significance of this case has not escaped states, cities and other interested parties elsewhere in the country. Briefs have been filed by intervening environmental groups, wastewater treatment agencies and municipal authorities in support of EPA. In addition at least 10 amicus briefs have been filed on behalf of over 100 other entities. A group of 21 attorneys general, mostly from western and Mississippi Valley states, filed a brief in support of the appellants. They were joined by a group of counties, and much later by a group of 39 Congressmen.  Amicus briefs were filed in support of EPA by the states of Virginia, Maryland, Delaware and the District of Columbia (all in the Chesapeake Watershed).  Also supporting EPA are a brief by the cities of New York, Baltimore, Philadelphia, Los Angeles, Chicago and San Francisco, and a separate brief for the City of Annapolis, plus two amicus briefs by groups of environmental organizations and a brief by 19 environmental law professors from around the country.

One of the interesting features of this case is that none of the EPA actions challenged by the appellants were forced by the agency on unwilling states. The “reasonable assurance” features are contained in “watershed implementation plans” drafted by each state. The deadlines are not inflexible, cannot be enforced by EPA, and were agreed to by the states.  In fact on June 16, 2014, all 6 Bay states, the District of Columbia and EPA signed a new Chesapeake Bay Watershed Agreement reaffirming their commitment to the TMDL and the implementation measures. So stay tuned! The courtroom will likely be SRO, and I’ll be back to you after a decision.

A SWING AND A MISS -- The First Reported Challenge to Water Quality Trading is Dismissed for Lack of Standing

Posted on January 24, 2014 by Allan Gates

EPA has touted water quality trading for more than a decade as a viable tool for combating water pollution, particularly pollution due to excess nutrients and sediment.  But the Clean Water Act contains no express authority for water quality trading or offsets, and some environmental groups view trading as a “license to pollute” that violates the Clean Water Act’s promise to eliminate the discharge of pollutants into waters of the United States.

Last month a federal district court issued a final ruling in the first reported challenge to the legality of water quality trading.  The court dismissed the action without reaching the legality of water quality trading.   Instead, the court held that the plaintiff environmental groups (Food and Water Watch and Friends of the Earth) lacked standing and that EPA’s  “authorization” of trading in the Chesapeake Bay TMDL was not a final agency action.  Food and Water Watch v. EPA, No. 1:12-cv-01639 (D.D.C. decided December 13, 2013).

Although the court’s decision did not address the substantive legality of water quality trading, the case still presents four interesting aspects that may prove instructive on what to expect in future challenges.

First, environmental groups split over the question of joining the challenge to water quality trading.  It is widely rumored that Food and Water Watch actively solicited support from environmental groups involved in Chesapeake Bay issue but met with stiff resistance. It appears that the other environmental groups’ support for the Chesapeake Bay TMDL overrode any interest they might otherwise have had in supporting a challenge to the legality of water quality trading.

Second, the defense of water quality trading made for strange bedfellows.  Three parties intervened as defendants.  One was a group representing municipal point source dischargers who support the Chesapeake Bay TMDL (National Association of Clean Water Agencies).  Two were non point source groups who are actively challenging the legality of the Chesapeake Bay TMDL in another case (American Farm Bureau and National Association of Home Builders).  The non-point source representatives argued that the trading component of the Bay TMDL would be important and valuable to their members if their challenge to the validity of the Bay TMDL in the other case was unsuccessful.

Third, the court’s decision on standing, ripeness, and the question of final agency action suggests it may be difficult to litigate the basic legality of water quality trading until a program is fully established and permits allowing credit for trades are issued.  EPA argued successfully that no actual or imminent injury to the plaintiffs was caused by the Chesapeake Bay TMDL’s express reference to trading as a means for meeting the waste load allocations.  According to this argument, the TMDL did not compel any trades; it simply acknowledged that states in the Chesapeake Bay watershed might use trading as a tool in developing permits that implement the TMDL.  Carrying this argument to its logical conclusion, one could envision the possibility that there would be no basis for private party standing to challenge the legality of a trading program until after a stream has been listed as impaired, a TMDL has been performed, a trading program has been established, and permits have been issued allowing credits for trades within the program.  Litigating the legality of water quality trading at such a late stage would presumably face a significant task in unwinding the momentum of such a fully developed administrative structure.

Fourth, given the success of EPA’s standing and ripeness arguments, it seems unlikely that there will be any definitive judicial ruling on the legality of water quality trading any time soon.  The partisan division in Congress makes clarifying legislative action even less likely.  As a consequence, EPA’s success in defending against the Food and Water Watch lawsuit may have the ironic result of postponing the day when states and permit holders will have a clear and definitive answer regarding the basic legality of water quality trading.

Court Upholds Multi-State Chesapeake TMDL

Posted on September 25, 2013 by Ridgway Hall

On September 13, in a 99 page decision, the U.S. District Court for the Middle District of Pennsylvania upheld EPA’s multi-state Clean Water Act Total Maximum Daily Load (“TMDL”) for the Chesapeake Bay and its tributaries against a broad range of challenges brought by the American Farm Bureau Federation and six other farm industry trade associations. Six environmental organizations led by the Chesapeake Bay Foundation, plus four municipal water associations led by the National Association of Clean Water Agencies, intervened in support of EPA.

The Chesapeake Bay TMDL is not the first to cover multiple states, but it is by far the largest, covering 64,000 square miles in Maryland, Virginia, Delaware, Pennsylvania, West Virginia, New York and the District of Columbia.  It requires substantial reductions of nitrogen (25%), phosphorus (24%) and sediment (20%) by 2025 to  meet water quality standards.  Because of the interstate nature of the long-standing pollution problems, after more than two decades of collaborative but unsuccessful efforts, the states agreed in 2007 that EPA should develop the TMDL. It was issued in 2010 and included allocations for each of 92 tidal segments which, after consultation with the states, were further allocated among states, watersheds and sectors (such as agriculture, wastewater, stormwater, etc). During the process, each state developed its own Watershed Implementation Plan (“WIP”), specifying  wasteload allocations (“WLA’s”) for point sources, load allocations (“LAs”) for nonpoint sources, and identifying the regulations, programs and resources that would be used to achieve the required reductions. For more on this TMDL see "EPA Issues Biggest TMDL Ever for Chesapeake Bay Watershed" and ELI Environmental ForumThe Chesapeake Bay TMDL” (May/June 2011). 

The plaintiffs alleged that (1) the TMDL was an unauthorized “implementation” of  allocations by EPA, (2) requiring WIPs exceeded EPA’s authority, (3) EPA’s use of watershed and related models in setting the allocations was an abuse of discretion, and (4) there was insufficient public notice.  In addressing these challenges, the court first held (as several others have) that a TMDL is not self-implementing, but is an “informational tool”, developed collaboratively by EPA and the states under CWA Section 303(d), and implemented primarily by the states.

Turning to the merits, the court upheld EPA’s definition of a TMDL for a waterbody or segment as the sum of all WLAs and LAs plus natural background.  It also upheld  EPA’s authority to establish a multi-state TMDL,  when the affected states either fail to do so or ask EPA to do it (both occurred here), including limitations on sources in upstream states to achieve compliance with water quality standards in downstream states. It held that EPA’s “holistic” or “watershed-wide approach” was consistent with the broad national goals of the CWA to “restore … our Nation’s waters.” In reaching this result the court emphasized the collaborative efforts of the Bay states and EPA starting in 1983 to address the problems of interstate pollution, transported by rivers and tides, and their consensus that an EPA-led multistate effort was needed.

The court further held that the WIPs – new tools in the TMDL context – were authorized as part of the “continuing planning process” under CWA Section 303(e). This process is initiated by the states to achieve water quality goals, and is subject to review and approval by EPA. Because EPA had advised the states in letters what it expected in terms of general content and specificity in the WIPs, but left the details to the states, the court held EPA did not exceed its authority. The court also relied on CWA Section 117(g) - a Chesapeake Bay-specific provision - requiring EPA to “ensure that management plans are developed and implementation is begun by [all the affected states] to achieve and maintain…” the applicable water quality goals.

The plaintiffs also challenged EPA’s requirement that each WIP contain “reasonable assurances” of timely and effective implementation, and EPA’s use of “backstop” allocations where EPA determined that a WIP provision was deficient.  “Backstops” involved requiring NPDES permits from previously unregulated sources. The court held that EPA could properly require “reasonable assurance” under CWA 303(d)(1), which requires a TMDL must be “established at a level necessary to implement the applicable water quality standards.”  The court upheld “backstops”, which were only used in 3 instances, as a reasonable exercise of EPA’s authority under CWA 303(d)(2) to ensure that the contents of the TMDL are designed to achieve the applicable water quality goals.

The court upheld EPA’s use of models as scientifically supported and within EPA’s discretion.  It rejected the challenge to adequate notice and opportunity for public participation since (1) a 45 day public comment period had been provided, (2) there had been hundreds of public meetings during the more than 10 year development of the TMDL, and (3) plaintiffs showed no prejudice from the fact that some details of the modeling were not available until after the comment period.

The court held that TMDL establishment and implementation involves “cooperative federalism” between the states and EPA, and that the Chesapeake Bay TMDL properly reflects the shared responsibilities and necessary interactions, despite some bumps along the road. While EPA exerted strong leadership, the court held that it did not unlawfully usurp the states’ implementation functions. The court noted  the preserved authority of the states to implement nutrient trading and offsets, and to set or revise source-specific loading allocations.  In conclusion, there is a lot of thoughtful analysis, as well as precedent, in this decision, which makes it an excellent resource for CWA practitioners.