Water Quality Trading with Lumpy Investments, Credit Stacking, and Ancillary Benefits

Abstract

This paper studies the economics of a water quality trading market in a predominantly agricultural watershed, and explores the effects of credit stacking in such a market when buyers and sellers of pollution credits can only reduce pollution with large, discrete investments that yield discontinuous supply and demand. The research simulates hypothetical water quality trading markets in the corn‐belt area of Illinois, where wastewater treatment plants (WWTPs) can pay farmers to reduce nutrients by installing wetlands and farmers may or may not be allowed to earn payments for multiple services from one wetland. We find that wetlands are a more cost‐effective way to mitigate nitrogen pollution than abatement by WWTPs. Stacking credits may improve social welfare while providing more ecosystem services if there is enough demand for the primary credit in the market (nitrogen) to cover most of the cost of installing the wetland but the supply of nitrogen credits is not exhausted. However, in the presence of lumpy pollution reduction activities, the effects of allowing stacked credit sales are idiosyncratic and not necessarily positive; stacked payments may or may not satisfy additionality. The results imply that credit trading for nitrogen is likely to make society better off, but the effects of allowing farmers to receive multiple payments from a single wetland depend on details of the situation.

Policy Utopias for Nutrient Credit Trading Programs with Nonpoint Sources

“…The U.S. Environmental Protection Agency estimated that allowing trading between PS and NPS could reduce the cost of implementing Total Maximum Daily Load standards for water quality nationally by $140‐235 million annually (USEPA, ). In addition to cost savings by regulated sources, the conservation measures used to produce NPS credits often produce ecosystem service co‐benefits, such as improved air quality and wildlife habitat (Lentz et al ., ).…”

Assessing the Accuracy of Soil and Water Quality Characterization Using Remote Sensing

“…It is estimated that 2 billion people lack access to safe and affordable water (WHO 2013). Water scarcity is exacerbated by: (i) pollution from agricultural runoff, (ii) the virtual water trade, which refers to the trade in water embedded in food or other products across political boundaries, or (iii) drought (Arnold et al 2012;Lal 2013;Lal et al 2012;Lentz et al 2013;Mattikalli and Richards 1996). Phosphorous (P) being less soluble compared with Nitrogen (N), is mainly lost through runoff and erosion, thus affecting surface water.…”

“…WQT is a market based "cap and trade" legal mechanism for reducing water pollution, which authorizes facilities that exceed the allocated credits to purchase credits from other facilities that emit less (U.S. Environmental Protection Agency 2004). WQT is only allowed within the precincts of the watershed or a defined area for which the permit was issued (Lentz et al 2013). However, the success of WQT is questionable, because of the difficulties and uncertainty in estimating the spatial distribution of NPS pollutants (Mariola 2012;Newburn and Woodward 2012).…”

“…Runoff from urban and agricultural land contain nutrients that stimulate the growth of algae and other aquatic vegetation, which later decompose and deprive waters of oxygen creating hypoxic zones that kill aquatic habitat, or causing eutrophication (Uriarte et al 2011). Contaminated water resources devastate the environment and public health by: (i) escalating the cost of drinking water treatment, (ii) causing diseases from water-borne pathogens, (iii) reducing biodiversity, and (iv) degrading recreational locations (FAO 1996;Lentz et al 2013). High concentration of NO 3 and NO 2 in water can cause methemoglobinemia a lethal blood disorder that can sicken newborn infants.…”

The Economics of Conservation and Finance: A Review of the Literature

“…Woodward (2011) tackles the issue of stacking in a general theoretical framework with continuous marginal benefit and marginal cost functions, and finds that stacking of payments for pollution abatement leads to the best outcome for society if (but only if) all sources of the pollutants are covered by the programs and the pollutant caps are set optimally. Lentz et al (2014) and Robertson et al (2014) find in the case of payments for wetland services, stacking of payments for multiple services may or may not improve welfare depending on idiosyncratic details of the situation. It seems that no general prescription exists for whether social welfare is increased by letting PES programs stack payments.…”