Environmental Credit Trading: Can Farming Benefit?
Marc
Ribaudo
Robert Johansson
Carol Jones
Courtesy of NRCS
Environmental regulations often
require firms that emit pollutants to limit emissions
to a set level or to install specific emission-reducing
technologies. While fairly straightforward, this
command-and-control approach can be costly both
to the firms and to society. Firms with high costs
of pollution reduction and those with low costs
are required to meet the same requirements, which
may waste resources. Environmental credit trading,
an alternative to command-and-control regulations,
is a market-based approach to comply with regulations
that could achieve pollution abatement goals at
lower costs to society. Environmental credit trading
allows regulated firms to meet their obligations
by purchasing pollution abatement services (credits)
from lower-cost providers. For example, the 1990
Clean Air Act amendments established a trading program
between power plants to cut sulfur dioxide (SO2)
emissions by 50 percent from 1980 levels to control
acid rain. The trading program has been a success,
with emissions reductions exceeding the goal by
30 percent and annual cost savings estimated at
$1 billion.
Trading programs have been created
for environmental issues other than air quality,
such as water quality, wetlands protection, and
greenhouse gas emissions. Even though agriculture
per se is not subject to most environmental regulations,
farmers can participate in these credit trading
programs by generating pollution-reduction credits
and selling them to regulated firms. Farmers can
benefit if the cost of generating credits is less
than the price they command. Farmer participation
in trading programs has been limited to date, but
USDA has recently committed to promoting farmers’
participation in trading programs. The success of
these programs will rest on several key design elements
and their ability to generate the economic incentives
needed to encourage both the regulated firms and
farmers to participate.
What Does It Take For Credit Trading
To Succeed?
For a credit trading program to
be successful, there needs to be a demand for credits
as well as a supply of credits. Demand is generally
created by a regulation or other cap on emissions
or other activity that degrades the environment.
In the case of water quality, the Total Maximum
Daily Load provisions of the Clean Water Act set
a discharge cap for point sources in impaired watersheds,
creating a demand for pollution-reduction credits.
Firms required to meet a discharge cap will be willing
to pay for credits from other sources as long as
the credits are less expensive than their own abatement
costs. Forty trading programs have been established
across the country for such pollutants as nitrogen,
phosphorus, selenium, dissolved solids, and heavy
metals.
In the case of carbon and other
greenhouse gases, demand for credits in the U.S.
originates with some local, State, and regional
regulations (there are no Federal regulatory limits).
Oregon was among the first States to impose a performance
standard for power plants. Companies can either
meet the standard with new technology and increased
efficiency, or pay $0.85 per ton of excess emissions,
which the Oregon Climate Trust then pools to buy
credits from emission reduction projects in the
U.S. and abroad.
Wetland conversion is governed
by a Federal “no-net-loss” policy that
essentially functions like a cap. The policy requires
that wetlands converted to other uses be offset
by the creation or enhancement of other wetlands
that “possess the physical, chemical and biological
characteristics to support establishment of the
desired aquatic resources and functions,”
according to Section 404 of the Clean Water Act.
This policy effectively caps the supply of land
for development in certain areas (e.g., in the construction
of roads, housing developments, shopping malls).
Wetland mitigation banks have been set up in many
States to allow private developers to purchase wetland
conversion rights (credits) from farmers, who have
established or restored wetlands on their farms.
Current values of wetlands banked can depend on
their location and/or expected environmental benefits.
For example, in Minnesota, the value of wetland
credits to public transportation authorities ranged
from $4,000 to $35,000 per acre, depending on proximity
to the Twin Cities metro area.
The supply of credits comes from
those who can produce credits at a cost lower than
the expected market price for credits. Suppliers
can be regulated sources that can produce credits
at a lower cost than other regulated sources, or
unregulated sources that by design are allowed to
participate. Farmers can supply environmental credits
by, for example, reducing the runoff of regulated
pollutants, reducing greenhouse gases, or restoring
wetlands (see box, “Farmers
as Suppliers of Environmental Credits”).
These actions are conditional on farmers providing
environmental services at a lower cost than that
of regulated firms in meeting pollution regulations.
In addition to lowering the overall costs of meeting
environmental goals, subsequent credit trading could
provide financial opportunities for farmers and
leverage private sector funds for conservation.
Once a market has been established, the price for
environmental credits could be determined by market-style
trading similar to a commodities exchange, if there
are sufficient numbers of buyers and sellers. However,
even with only a few buyers/sellers and prices set
by a managing agency, program participants can still
benefit, because the costs to comply with environmental
regulations are allocated more efficiently. In Minnesota,
the Rahr Malting Co. has achieved its discharge
requirements through trades with only four farmers.
Rahr purchased water quality credits for its new
wastewater treatment plant by funding upstream reductions
in nonpoint-source phosphorus discharges. The annualized
cost of the trades was $2.10 per pound of phosphorus,
but without the trade, it would have cost Rahr as
much as $4-18 per pound of phosphorus to achieve
its requirements.
For a successful trading program,
the environmental equivalence between the location
where a pollutant reduction is made and the location
where that reduction is purchased or used must be
established. For example, drained wetlands must
be replaced with wetlands with equivalent wetland
functions in order to comply with Section 404 of
the Clean Water Act; otherwise, there will be a
net loss in environmental quality. This is also
the case with water quality trading. Credits produced
by farmers implementing conservation practices should
be assessed where a point source discharges (e.g.,
into a stream), not at the edge of the field. Equivalence
is not an issue for pollutants with geographically
uniform impacts. For example, sequestering carbon
anywhere in the world has the same environmental
impact on the atmosphere.
Willingness to participate is crucial.
Those obligated to comply with an environmental
restriction or cap must see an economic opportunity
to reduce compliance costs by purchasing credits
from others. Those offering credits must believe
that they can produce credits at a cost less than
the expected market price for credits. Environmental
credit trading will be more likely when the economic
opportunities are clear to all participants.
Farmers as Suppliers of Environmental
Credits
By adopting certain types
of conservation practices, farmers can become
suppliers of environmental credits while
reducing the negative environmental impacts
of farming. Specifically, farmers can generate
credits by undertaking measures to reduce
pollutant runoff into water bodies, reduce
greenhouse gas emissions, or restore wetland
functions.
Reduce pollutant
runoff—Point sources regulated
by the Clean Water Act (CWA) discharge directly
into water bodies from an identifiable location
(e.g., end of pipe). Nonpoint sources, such
as agricultural fields, generally do not
discharge directly into water bodies from
an identifiable location; runoff occurs
in a more disperse manner above and below
ground. Water quality trading allows a point-source
discharger to meet CWA obligations by acquiring
“credits” from other sources
(point or nonpoint) that take measures to
reduce the regulated pollutant. The Total
Maximum Daily Load (TMDL) provision of the
CWA prompted a recent surge in interest
in point/nonpoint trading. Nutrients (nitrogen
and phosphorus) are the predominant pollutants
in point/nonpoint markets, since both point
and nonpoint sources are major sources.
Forty water quality trading programs have
been started in the United States to date.
Twenty-two allow trades with agricultural
nonpoint sources. Most of these trading
programs are for nutrient reductions, but
others address selenium discharge, sedimentation,
and water flow.
Reduce Greenhouse
Gas Emissions—Most proposed
strategies to mitigate global climate change
focus on reducing the dominant source of
greenhouse gas (GHG) emissions to the atmosphere--combustion
of fossil fuels, which releases carbon dioxide
(about 80 percent of U.S. GHG emissions
in 2001). But the agricultural and forestry
sectors can provide low-cost alternatives
to energy emission reductions by shifting
land use to forestry or wetlands, or adopting
best management practices such as conservation
tillage. At this point, GHG trading is limited
because the Federal regulatory program does
not impose mandatory restrictions on GHG
emissions.
Restore wetland
functions—Wetlands are complex
ecosystems, providing ecological, biological,
and hydrologic goods and services. In the
U.S., an estimated 100 million acres of
wetlands (45 percent of the initial base)
were converted between 1780 and 1990, mostly
for agricultural production. Farmers can
contribute to the “no-net-loss”
goal by restoring some chemical and biological
wetland functions on agricultural land.
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Some Obstacles Could Hinder Trading
Though opportunities to trade
credits exist, very few farmers have taken advantage
of them. Demand for credits from agricultural sources
may be low because of uncertainty over the credits
it can produce. Water quality is a good example.
Much of agricultural pollution is considered nonpoint
in nature, that is, many agricultural pollutants
arrive via dispersed and unobservable transport
mechanisms, whether through runoff, groundwater
leaching, or the atmosphere. Therefore, it is difficult
to predict with certainty the amount of discharge
reduction (or production of credits) the implementation
of management practices will produce at the point
in the watershed where credits are measured. This
may discourage demand for agricultural credits by
regulated firms that are legally responsible for
meeting discharge limits. Uncertainty could be reduced
by more intensive monitoring, but that may be expensive.
Such transaction costs could negate the benefits
of trading. One reason why the SO2 trading program
is so successful is that the cost of measuring emissions
is low.
Uncertainty over the production
of credits affects the supply side as well. Because
of the nature of pollution from agriculture, and
the need to assess credits at the point where regulated
sources actually discharge, farmers may be unaware
of the number of credits they can actually produce,
or what price they should ask for them.
Farmers may also be reluctant to
participate in a program that is partly regulatory,
even with compensation. Some have suggested that
farmers are afraid that information about their
contributions to water quality and costs of pollution
abatement on farms could eventually be used to develop
regulations for agricultural pollution. In addition
to farmer reluctance to participate in a regulatory
program, uncertainty over the number of credits
farmers produce and lack of enforcement of the environmental
regulation have proved to be deterrents to trades.
Another supply-side issue is the
treatment of credits generated on farms through
publicly funded conservation programs such as the
Conservation Reserve Program (CRP) and Environmental
Quality Incentives Program (EQIP). Since credits
from conservation programs are already partly or
fully funded, some trading programs do not allow
them to be traded. A farmer participating in a conservation
program would have to implement additional conservation
measures to participate in a trading program. This
would raise the cost of credits, making them less
attractive to those wishing to purchase credits.
USDA Can Facilitate Market-Based
Stewardship
Under its new policy on market-based
stewardship, USDA has committed to encourage participation
by farmers in environmental credit markets. USDA
has outlined three sets of actions that can help
overcome some of the demand and supply side problems
facing farmers’ participation in trading programs.
One action is to develop and evaluate the necessary
tools and methods for estimating the environmental
credits a farmer can produce. Accounting procedures
for quantifying the environmental benefits of conservation
practices are necessary in order to establish the
environmental equivalence of credits and to reduce
uncertainty.
USDA recently implemented the Conservation
Effects Assessment Program to quantify the impact
of conservation practices on water quality and other
resources at the watershed scale. This program will
standardize approaches for estimating the value
of environmental goods and services generated by
conservation systems. In addition, USDA’s
Agricultural Research Service has implemented a
national program on global climate change and is
conducting research on carbon sequestration of different
cropping systems. USDA has also developed new accounting
rules and guidelines for reporting greenhouse gas
emissions and carbon sequestration as part of the
U.S. Department of Energy Section 1605(b) Voluntary
Greenhouse Gas Reporting Registry. The revised program
enables agricultural and forest landowners to quantify
and maintain records of actions that reduce greenhouse
gas.
Another action is to educate farmers
on the potential benefits of participating in trading
programs. USDA’s promotion of trading could
alleviate farmer uneasiness about dealing with regulatory
agencies. USDA’s Conservation Innovation Grants
were initiated as a component of the 2002 Farm Act
provisions for the Environmental Quality Incentives
Program. In 2004 and 2005, seven different projects
received over $4.1 million to establish credit trading
programs to improve water quality, establish wildlife
habitat, and sequester carbon. Information developed
by these programs could help USDA provide outreach,
education, technology transfer, and partnership-building
activities to facilitate credit markets. This information,
coupled with education of farmers about the economic
opportunities of selling credits and technical/financial
assistance for establishing credit generating activities,
could reduce farmer concerns about trading with
regulated sources and alleviate some of agriculture’s
own environmental impacts.
USDA’s credit trading policy
also calls for cooperation with other agencies to
remove programmatic barriers to farmer participation.
One such barrier is the treatment of credits produced
through conservation programs such as EQIP, CRP,
or the Grassland Reserve Program. Creating synergies
between program-generated credits and newly tradable
credits could benefit both agriculture and regulated
sources.
Economics of Water
Quality Protection from Nonpoint Sources: Theory
and Practice, by Marc O. Ribaudo, Richard D.
Horan, and Mark E. Smith. AER-782, USDA, Economic
Research Service, November, 1999.
ERS
Briefing Room on Conservation and Environmental
Policy
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