Water Quality Trading Programs

SUSTAINABLE DEVELOPMENT
WORKING PAPER 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

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

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.

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

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.
2

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
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
12

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
14

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
15

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.
16

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
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
Calculation Total Cattle/Turkeys Pigs/Chickens/Broilers
Reference amount 2800 800 2000
Land related quota
(9x125)
1125 Allocation 800 325 (1125-800)
Non-land related 1675 0 1675
Actual manure
production
2200 500 1700
Land related
(9x125)
1125 Allocation 500 625 (1125-500)
Non-land related
(tradable)
1075 0 1075
Dormant (non
tradable)
600 600 (1675-1075)
Source: Wossink A. “The Dutch Nutrient Quota System: Past Experience and Lessons for the Future”.
Paper prepared for the OECD workshop on “The Ex-Post Evaluation of Tradable Permit Regimes”, January
21-22, 2003, Paris: France, 21 p. 6.
The year the Manure Law was introduced, restrictions were also put in place on
ammonia emissions under the Nuisance Act (today known as the Environmental
17

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
18

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
19

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
20

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
21

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.
22

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;
23

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
24

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?
25

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
26

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
27

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
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
28

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.
29

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.
31

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
32

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.
33

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.

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
34

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
35

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
36

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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39

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