The Q&A: Sheila Olmstead

With each issue, Trib+Water brings you an interview with experts on water-related issues. Here is this week's subject:

Sheila Olmstead is an environmental economist and associate professor in the University of Texas at Austin's LBJ School of Public Affairs. She is the co-author of a recent study evaluating water pollution trading programs, which are similar to greenhouse gas cap and trade programs. The study found, however, that there aren't many active water pollution trading programs in the United States. These programs, for example, might involve an industrial plant that needs to reduce water pollution and seeks to do so by compensating farmers who reduce theirs. 

Editor's note: This interview has been edited for length and clarity.

Trib+Water: Let's start by defining point source pollution and nonpoint source pollution. What do they mean, and how do they differ in terms of how much they’re regulated by the EPA?

Sheila Olmstead: If you think about what the words themselves imply, then it would suggest point source pollution is pollution that comes from an identifiable source. But that’s not necessarily what the legal definition or the definition as far as the environmental statutes go. Really, point source pollution in the United States is either industrial point source pollution — an electric power plant or a manufacturer — some facility that has a pipe that goes into a water body, a river or stream or lake, and that pipe has to be permitted under what’s called the National Pollution Discharge Elimination System, or NPDES, under the Clean Water Act. So that’s either for industrial point source or a municipal point source, a publicly owned treatment works or municipal sewage treatment plant. Those are the two kinds of sources, both of which have an identifiable pipe or set of pipes that goes into a receiving water body. What comes out of those pipes is regulated under the Clean Water Act by the NPDES system.

Nonpoint source pollution is really the biggest remaining pollution problem in the U.S. We’ve had standards for point sources going all the way back to 1972 with the Clean Water Act and beforehand. And with nonpoint sources, regulators have really struggled with whether and how to deal with pollution coming from what are considered to be more diffuse sources in the landscape. So the big ones there would be agriculture.

There are some agricultural operations like combined animal feeding operations where there is actually a pipe, and it goes into a receiving water body. But with the exception of those cases, agricultural operations are largely excluded from those regulations and are lumped in with nonpoint source pollution. Generally, urban runoff is nonpoint source pollution, although there are some exceptions. And then another big truly nonpoint source is atmospheric deposition, where you have, for example, a power plant or automobile emitting nitrogen oxide and eventually some of that nitrogen makes its way back into water bodies through rain or snow and contributes to a nutrient problem in receiving water.

Trib+Water: So what are these water pollution trading programs that you studied? Who are the parties trading and what do they trade?

Olmstead: There’s a lot of diversity in these kinds of programs. Ideally, what you’d want from an economic perspective, is you want to have parties that are trading that have very heterogeneous abatement costs. For it really to be be a successful trading program, I have to have a bunch of folks in there that are trying to emit that pollutant and have different costs for reducing it. If they don't have very different costs for reducing it, I’m not going to get real gains from trade there.

In the existing programs, what you’d really like to see is those agricultural nonpoint source polluters and the point sources like urban municipal sewage treatment plants and those kinds of sources trading with each other. It tends to be true that those point sources have much higher marginal abatement costs than nonpoint sources. That’s true for various reasons, but one of the big ones is that point sources have been regulated pretty stringently and increasingly stringently over the past several decades, whereas the nonpoint source polluters have not. So there’s more cheap abatement opportunities among the nonpoint sources than among point sources.

So you’d like to see that real mix, and there are some programs that have that kind of a mix. An example is some of the Chesapeake Bay trading programs. There’s a total maximum daily load regulation, a pollution budget, that’s been issued for the Chesapeake Bay by the EPA. All of the surrounding states have been allocated a pollution budget, and then within each state, the state kind of decides how each kind of source is going to cut back.

Three of those states, at least, have started trading programs that involve exactly what I mentioned before — both point sources like urban stormwater utilities and municipal sewage treatment plans and also the more diffuse nonpoint sources like agricultural entities. It’s a little tricky, so what you see in some of the bigger programs like in Pennsylvania, one of the challenges in including any kind of these agricultural nonpoint sources into a trading program like that is they’re all kind of diffuse. So it’s hard to think of what’s the tradable commodity between municipal sewage treatment plants — a pound of nitrogen coming out of that — versus whatever might be flowing off a farm field and how that might change if all of a sudden the farmer plants a buffer strip between his cows and the stream.

So there are brokers that have arisen like in the market in Pennsylvania that try to aggregate these land management practice changes that the agricultural folks are engaging in and sell those as packages to the point sources that are looking for some cheaper abatement opportunities. Those, I think, work pretty well. There are others where they’re exclusively point to point source. An example of that would be in Connecticut, the Long Island Sound nitrogen trading program that exclusively includes dozens of municipal sewage treatment plants in the state that are all under the gun to reduce their nutrient emissions.

Trib+Water:  How widespread are these programs, and what have been the biggest challenges in getting them started?

Olmstead: In terms of the numbers, they’re pretty widespread. You’re going to find dozens of examples of programs that are pilot programs and programs that are trying to get started. But as my co-author and I found, there really aren’t very many that have robust trading, that have very active markets with lots of trades taking place. So there are a lot of them. They’re quite widespread, but there are not very many that are successful.

There are several challenges. One of the biggest ones is the one we just mentioned, that there is this de facto property rights distortion. So with greenhouse gas emissions trading, for example, you can imagine if you took the European Union and the countries in the European Union all made sort of enforceable commitments to reduce their emissions under the Kyoto Protocol in 1997, and there are a lot of developing countries that didn't make those kind of commitments.

Yet in the European Union, all of the polluters would very much like to reduce carbon emissions in cheaper places because there are existing regulations in Europe that make it more expensive to reduce emissions than elsewhere. So they look for these kind of opportunities through these offset programs where they might invest some money and reduce deforestation in a developing country or change the technology that’s being used by an industrial facility in China.

So you do see that, but in the countries that don’t face the tax, it becomes hard to know if that change was additional, if somebody would’ve engaged in it anyway even without the trading program. And the same thing happens in the U.S. when we talk about water quality trading with agriculture. They don’t really have a binding legal requirement to reduce their emissions. But municipal sewage treatment plants or an industrial point source that does have a binding legal requirement to do that wants to purchase some reductions from one of these non-binding sector participants. Then, that’s kind of a really hard thing to do. What's the liability structure? Who's responsible?

So that is, I think, one of the biggest remaining challenges. This big, very important source of remaining pollutions, agriculture, that's not included within the cap in most of these individual trading systems, and yet because of all the cheap abatement opportunities the participants would very much like them to be included. That’s a real challenge.

I think some of the other big challenges are purely having to do with water science. So in carbon dioxide emissions, you can emit a ton of carbon dioxide in Montana, you can emit a ton in Texas, someone else can emit a ton in Beijing and all of those tons have the same marginal impact on the thing that we care about, which is concentration of CO2 in the upper atmosphere and the future of climate change. But if I'm talking about a pound of of nitrogen that’s emitted in the Missouri River versus down on the Mississippi Delta, those have very different impacts on hypoxia in the Gulf of Mexico, for example.

That spatial location of emissions matters very much in the water quality context for what the eventual damages are. So when folks set up these trading programs, and they do it right, they have to set up these complicated systems of exchange rates between the different participants based on their location and how big the receiving water body is that they’re emitting into and how those flows there affect the flows at the ultimate point that you care about, where the water quality problems are occurring.

With the science stuff, I think we’ve done really well, actually. The designers of most of the modern current water quality trading programs have worked very carefully with water quality modelers to understand exactly those kinds of spatially differentiated impacts and set up exchange rate systems that seem to work quite well. That’s a challenge and has been a challenge, and I’m not going to say it’s easily overcome, but we certainly have the technology, and there are plenty of systems that would suggest it’s a problem that can be overcome.

Trib+Water: What are the other characteristics of these more effective or robust trading programs?

Olmstead: One of the things I think you notice is there has to be some kind of a regulatory prompt. If you look for parallels between the successful U.S. programs that we talk about in that paper, it seems like the establishment of those pollution budgets is an important precursor, not a necessary condition, but it seems to be a helpful condition.

There are actually numerous cap and trade programs with the Clean Air Act, different types of regional programs. On the water side, though, the Clean Water Act is just not as well designed. There are a lot of signs that suggest the Clean Air Act isn’t well designed for that, either, but it has been adaptable to allow for incorporating market-based approaches. The Clean Water Act is just a tough nut to crack. The original Clean Water Act said we would eliminate all emissions of pollutants to water bodies in the entire United States by 1986. We didn’t meet that deadline. It was not a goal that was designed with the cap and trade set of policy instruments in mind.

What has tended to be true is there’s a part of the Clean Water Act that says if you have all of these different point sources that have these permits, and the receiving water body like the Gulf of Mexico or Chesapeake Bay is still not meeting the standards that are required for the types of uses that people make of that water body, like recreation or fishing, then the EPA is required to come up with one of these pollution budgets. It’s called the total maximum daily load, allocating loads to contributing states or the contributing parties.

When the EPA has gone through that exercise, it has tended to give birth to some of these more effective water quality trading programs. Partly that’s because if you think about what they’re doing — what they’re required to do under the law and what they do subsequently — it’s kind of like you would need to do to set up a cap and trade program. I know what my cap is, and I know who the contributing parties are. I know what they're responsible for, and I know what I’d like them to reduce their emissions by. And so certainly in the Chesapeake Bay programs, without that TMDL, those programs would not have been established. That seems to be one promising thing. As EPA is required to do more of these TMDLs, we see more of these trading programs taking place.

Trib+Water: One of the things you brought up in the study is farmers get compensation in these trading programs, but some have been skeptical to participate. Why might that be?

Olmstead: My co-author has done prior work on this with grad students that’s really interesting, where they did interviews with farmers and and tried to unpack the reason for non-participation. I think it’s hard to say why, because on paper, it would seem that if you’re a chicken farmer in Maryland, it would be financially in your best interest to take these potentially very significant payments from point sources to reduce your emissions of nitrogen and phosphorus to the Chesapeake Bay in return for these payments.

But the context is also one in which that the EPA doesn’t currently regulate that chicken facility. Regulators don’t come onto that property and see what they’re doing, what kind of facility they’re running. It may just be that these non-participants sort of see it as the camel’s nose under the tent and say, "If I join this, there has to be some liability. There has to be some documentation, some monitoring and enforcement. And that might just open the door to future regulations of me, and I’m just not comfortable with that." There may be some of that going on.