EPAs Water Quality Trading Policy

CRS Report for Congress
EPA’s Water Quality Trading Policy
Claudia Copeland
Specialist in Resources and Environmental Policy
Resources, Science, and Industry Division
On January 13, 2003, the Environmental Protection Agency announced a Water
Quality Trading Policy intended as an innovative approach to assist industry and
municipalities in meeting Clean Water Act obligations. Trading allows one source to
meet regulatory requirements by buying credit for pollutant reductions from another
source that has lower pollution control costs. The policy revises a 2002 proposal which
reflected lessons learned from a similar trading policy issued by the Clinton
Administration in 1996. Water quality or effluent trading projects have occurred in the
United States since the early 1980s. The new policy is generally supported by industry
groups, state and local governments, and agriculture groups. Environmental groups are
split on the concept. Some argue that it is not lawful and are critical that the Bush
Administration policy lacks a number of details that they regard as necessary. Others
support the concept, with adequate safeguards, as a valuable tool in cleaning up
waterways. Congress has conducted some oversight of water quality trading and could
continue doing so as the new policy is implemented. Legislation to codify a water
trading policy in the Clean Water Act could be considered, as well. This report provides
background on water quality trading and the EPA policy. It will not be updated.
What is Water Quality Trading?
The Clean Water Act (CWA) provides a two-tiered approach to water quality
protection. At a minimum, all point source dischargers (i.e., industrial facilities and
municipal sewage treatment plants) must attain technology-based requirements to limit
pollutant concentrations in effluents. These requirements take the form of nationally
uniform standards which are incorporated in discharge permits issued to individual
facilities. The Act also requires that point sources meet more stringent effluent
limitations in certain circumstances. If technology-based controls are insufficient to attain
state-established ambient water quality standards for specific waterbodies, these standards
serve as the regulatory basis for developing more stringent effluent limitations to be
applied to point sources or other dischargers through additional control measures.
Since enactment of the CWA in 1972 (P.L. 92-500), the nation has made much
progress towards the Act’s water quality goals through its program of technology-based
effluent limits for industrial and municipal point sources. However, as the Environmental

Congressional Research Service ˜ The Library of Congress

Protection Agency (EPA) and states have succeeded in regulating and reducing pollution
from point sources, the relative importance of nonpoint source pollution to water quality
has increased. Overall, data indicate that almost 40% of waters evaluated by states do not
meet applicable standards and are impaired for one or more desired uses. Nonpoint
pollution (rainfall runoff from urban, suburban, and agricultural areas, for example) is
believed to be the dominant cause of remaining water quality impairment in many areas,
but is subject to much less Clean Water Act regulation than is point source pollution.
Policymakers now seek new policy approaches to continue progress towards water
quality improvements. Increasingly, many are interested in market-based alternatives to
traditional regulation. Water quality trading is one of the market-based innovations of
interest. The basic theory behind effluent trading is that certain dischargers may be able
to achieve the same degree of control as others in the same area, but at lower expense.
Under a trading program, some dischargers could avoid a costly treatment upgrade by
paying for, or otherwise arranging, equivalent or greater reductions in discharges from
other facilities or sources that discharge into the same receiving waters. The attraction
of trading is that it reduces the total cost of compliance for the regulated community and
provides monetary compensation for those who exceed minimum requirements for
reducing pollutants. The common denominator is providing flexibility in allocating
pollution control responsibilities so as to achieve water quality goals more cost-
effectively. Trading is a supplement to, not a substitute for, core regulatory programs.
Water quality or effluent trading concepts have long been advocated by academics
and economists as a means of achieving environmental objectives cost-effectively.1 A
few projects were initiated in the early 1980s by local groups who were searching for a
means to avoid additional, and increasingly expensive, restrictions on point source
discharges. In the area of air quality, trading received significant endorsement in 1990
with enactment of Clean Air Act amendments; Title IV of that act authorized a formal
program for electric utilities to trade sulfur dioxide emissions, which cause acid rain and
affect human health. The acid rain program is widely believed to be one of the most
successful environmental programs of recent times.2
During the 1990s, the Clinton Administration pursued a number of initiatives to
reform the management of environmental programs. As part of that effort, in January
1996, EPA issued a policy statement to encourage effluent trading in watersheds.3 Soon
thereafter, the Clinton EPA issued a Draft Framework to implement that trading policy.
It identified a series of conditions necessary for trading and a template of regulatory,
economic, and technical issues to facilitate evaluation of trading opportunities.4 Although
this document was never released as a final framework, it served to encourage

1 See, for example, Faeth, Paul. “Market-Based Incentives and Water Quality.” World Resources
Institute, 1999. Available at: [http://www.igc.org/wri/incentives/faeth.html]
2 Burtraw, Dallas and Byron Swift. “A New Standard of Performance: Analysis of the Clean Air
Act’s Acid Rain Program.” Environmental Law Reporter, vol. 33, August 1996: 10411-10423.
3 U.S. Environmental Protection Agency. “Effluent trading in watersheds policy statement.”
Federal Register, vol. 61, no. 28, Feb. 9, 1996: 4994-4996.
4 U.S. Environmental Protection Agency. “Draft Framework Document for Watershed-based
Effluent Trading, May 30, 1996.” [http://www.epa.gov/OWOW/watershed/framework.html]

development of a number of new trading projects around the country, some partly
supported with EPA grant funding and technical assistance. Since the 1980s, there have
been about 35 trading programs or activities (including studies and pilots) in the United
States. Trades have been approved for about one-third of these, but actual trades have
occurred in only a few.5
In 2002, the Bush EPA proposed a new water quality trading policy, building on the
1996 policy statement and lessons learned from activities over the last two decades. The
final policy, superseding the 1996 statement and 2002 draft, was issued January 13, 2003.6
Summary of the New Policy
The new EPA policy is intended to guide and encourage states, interstate agencies,
and tribal governments in developing trading programs and projects. It identifies a
number of objectives, such as to establish economic incentives for voluntary pollutant
reductions from point and nonpoint sources within a watershed, and to reduce the cost of
compliance with water quality-based requirements. It describes several basic
characteristics for trades that occur under the policy. For example, it states that trading
must be consistent with the CWA and should not result in violations of water quality
standards. EPA does not support trading to achieve technology-based standards; that is,
a source that has not yet attained regulatory or permit requirements may not trade some
of those requirements with other sources in the watershed. The policy endorses trading
of credits for nutrients and sediment loads, but trading of other pollutants that pose a
higher environmental risk may only be considered on a case-by-case basis. The Agency
does not currently support trading of persistent, bioaccumulative, and toxic chemicals
(PBTs) and plans to conduct future pilot projects to obtain information on trading of
PBTs. The policy states that trading should occur within a watershed or similar defined
area. Thus, facilities may not purchase credits from an unrelated geographic area to meet
a pollutant reduction to address a local water quality need.
Under the new policy, trades should have certain common elements, including:
appropriate legal authority; clearly defined units of trade; standardized protocols to
quantify pollutant loads, reductions, and credits; mechanisms to determine and ensure
compliance; and periodic assessments of the environmental effectiveness (e.g., monitoring
or studies to quantify pollutant reductions) and economic effectiveness (in terms of the
number and types of trades, transaction and administrative costs). The policy states that,
in the case of trades between point and nonpoint sources, the point source permittee shall
have ultimate responsibility for compliance. Specific trades may be identified in
discharge permits, the policy says, but it is flexible in how this might occur. A permit
might, for example, contain general conditions that authorize trading, or it might set
variable permit limits to be adjusted up or down based on credits generated or used. EPA
says that, in general, it will not exercise higher scrutiny of trading than it does of other
CWA programs (i.e., EPA approval of individual trades will not be required). One aspect
of oversight, however, is public involvement: trading programs should require public
participation from the earliest point, the policy says.

5 Environomics. “A Summary of U.S. Effluent Trading and Offset Projects.” U.S.E.P.A., Office
of Water, November 1999. 47 p. [http://www.epa.gov/owow/watershed/trading/traenvrn.pdf]
6 See: [http://www.epa.gov/owow/watershed/trading/tradingpolicy.html]

Five distinct water pollution trading scenarios have emerged:
!Under point/point source trading, designated point sources trade
permitted discharge allowances only among themselves, with one point
source negotiating to buy a portion of the loading allocation of effluent
allowances from another point source in the trading area.
!Under point/nonpoint source trading, regulated point source
dischargers are allowed to pay for reductions in nonpoint source control
within their watersheds in lieu of upgrading their control technology.
!Nonpoint/nonpoint source trading provides a mechanism to achieve
nonpoint source reductions beyond those obtainable through
point/nonpoint source trading. It may be appropriate where new nonpoint
sources enter a watershed and are subject to stricter erosion or runoff
standards under state and local law than are existing nonpoint sources.
New nonpoint sources may be able to meet requirements at least cost by
a combination of on-site controls and off-site controls acquired through
trades with existing nonpoint sources in that area.
!Industries that discharge wastes to a municipal sewer system for
treatment at a publicly owned treatment works (POTW) facility are often
required to pretreat certain of their wastes which could interfere with the
POTW’s operation. Pretreatment trading allows industrial dischargers
in a community to allocate control efforts among themselves, so that the
total quantity of a pollutant entering the POTW either would not change
as a result of trading or could be reduced overall.
!Under intra-plant trading, a single point source allocates its total
allowed pollutant discharges among its outfalls in a cost-effective
manner. Existing clean water regulations for the iron and steel industry
specifically allow intra-plant trading to meet regulatory requirements.
Trading and TMDLs. Trading finds considerable support from many in
connection with implementing the Clean Water Act’s Total Maximum Daily Load
(TMDL) program. A TMDL is essentially a budget to allocate additional pollutant
reductions which are needed to attain standards in waters that remain impaired even after
application of technology-based controls by industry and municipalities. Implementation
of the Act’s TMDL program has recently been propelled by judicial and administrative
actions across the country; EPA estimates that as many as 40,000 TMDLs need to be
developed for over 20,000 waterbodies where standards are not being met. (For
information, see CRS Report 97-831, Clean Water Act and Total Maximum Daily Loads
(TMDLs) of Pollutants.)
Trading is viewed as offering flexible approaches to improving water quality in the
many areas where TMDLs will be required. One prominent example is in Long Island
Sound. EPA has approved a TMDL that will require a 58.5% reduction of nitrogen from
sources in New York and Connecticut. Most of the nitrogen that reaches the Sound is
from municipal sewage treatment plants. Connecticut adopted legislation authorizing a

general watershed permit to regulate all of the nitrogen discharged by 80 of these plants
and setting annual nitrogen limits. If a facility removes more than its annual limit, it has
credits to sell, and if a facility does not meet its limit, it must buy credits. State officials
estimate that sewage treatment facilities will save $200 million in capital construction
costs as a result of using trades to attain nitrogen limits.7 In other watersheds where
TMDLs are being developed, many supporters hope that trading opportunities will bring
nonpoint sources more fully into the process of achieving water quality improvements.
Issues of Concern. Many state and local governments, as well as industry and
wastewater treatment groups, support the new EPA policy, especially as a possible
mechanism to meet TMDL requirements. Agriculture groups also are supportive, so long
as nonpoint sources can continue to participate in trading voluntarily and will continue
to generally be outside the jurisdiction of CWA enforcement, including litigation.
Environmental groups are somewhat split on the issue of water quality trading.
Some argue that trades are not legal under the Clean Water Act, saying that there is no
provision in the law that contemplates a point source buying what amounts to displaced
compliance from another source.8 Environmental critics fear that trading will be used as
a way to avoid regulatory requirements of the Clean Water Act, even though EPA points
out the policy prohibits any trade that would violate water quality standards. These
groups are critical of what they view as a number of significant loopholes in the policy.
The policy is flawed, they say, because it does not entirely prohibit trading of toxic
discharges and thus could result in toxic “hot spots”; fails to mandate a reliable method
for calculating discharges from nonpoint sources and requiring ratios of better than 1:1
for trades between point and nonpoint sources, to account for the uncertainty of nonpoint
sources in achieving and maintaining pollutant reductions over time; and gives no
guidance as to how caps on discharges should be set and decline over time. Thus, while
the EPA policy supports pre-TMDL trading in impaired waters to achieve progress
towards standards, critics say that trading in impaired waters should only be allowed after
TMDL pollutant caps have been established and after sources in the watershed recognize
the pollutant reductions that are needed in order to achieve standards.
Some environmental groups, such as the National Wildlife Federation, believe that
trading can be a valuable tool in cleaning up waterways, provided that it is done with
adequate safeguards. Another group, the Environmental Defense Fund, has participated
in developing trading projects in several locations, including the Tar-Pamlico nutrient
reduction trading program in North Carolina. Still, environmental groups that support
such activities identify several necessary safeguards to ensure that water quality is
protected. These include TMDLs as a prerequisite, good compliance records by
participating sources, having adequate trading ratios, setting pollutant limits in discharge
permits, EPA oversight, public participation, and ensuring sufficient monitoring both to
establish baseline conditions for trades and to assess pollutant reductions. For trades
involving nonpoint sources, enforceability is a critical issue for environmental advocates.
This is because, unlike the CWA permitting program for point source controls, the Act

7 Statement of Thomas Morrissey, Connecticut Department of Environmental Protection.
Hearing held by the House Transportation and Infrastructure, Water Resources and Environment
Subcommittee, June 13, 2002.
8 Statement of Rena Steinzor, on behalf of the Center for Progressive Regulation. Ibid.

contains no federally enforceable, permit-based program to secure nonpoint source
controls. While point source controls are enforceable through citizen suits, nonpoint
source controls are not.9
The new EPA policy opens the door to increased trading; whether this occurs will
depend on many factors. EPA has acknowledged that trades are very site-specific and
require a number of important conditions, including: there must be a sufficient number
of sources that contribute a significant portion of the total pollutant load in the watershed;
there must be a water quality goal for the watershed that necessitates action; there must
be accurate and sufficient data with which to establish targets and measure reductions;
there must be economic gains from the trade (in terms of the marginal cost of pollutant
reductions); and there must be an institutional structure to facilitate trading and monitor
results.10 Further, it is unknown whether the flexibility that EPA attempted to incorporate
in the policy (which some environmental advocates view as loopholes) will be sufficient
to encourage new projects. Industry groups–while generally supportive–might have
preferred not including some of the environmental safeguards that the policy contains,
such as the prohibition on trading to achieve technology-based standards or the bar on
trading across watersheds, if the policy is to offer significant incentive to trading.
Congressional Interest in Water Quality Trading
Congressional interest in these issues has been limited. Trading is not currently
addressed in the Clean Water Act, but EPA officials have long held the view that it is
already allowed under the law. As noted above, some environmental critics believe that
water quality trading is unlawful, and even some advocates agree that articulating such
a policy in the Act would be beneficial. In the 104th Congress, the House passed a
comprehensive CWA reauthorization bill (H.R. 961) with a provision that would have
authorized modification of discharge permit requirements for conventional or toxic
pollutants to allow for trading between sources. The Senate did not consider this House-
passed bill. No other legislation dealing with water quality trading has been proposed
since then. In the 107th Congress, the House Transportation and Infrastructure
Subcommittee on Water Resources and Environment held a hearing in June 2002 to
examine EPA’s efforts to foster innovative market-based approaches to improving the
nation’s water quality. In the 108th Congress, Members and committees may pursue
additional oversight of water quality trading, especially as EPA, states, and others
implement the new policy. Legislation to codify a water trading policy in the Clean Water
Act could be considered, as well.

9 National Wildlife Federation. A New Tool for Water Quality, Making Watershed-Based
Trading Work for You. June 1999. 56 p. [http://www.nwf.org/watersheds/newtool.html]
10 U.S. Environmental Protection Agency, Office of Water. Incentive Analysis for Clean Water
Act Reauthorization: Point Source/Nonpoint Source Trading for Nutrient Discharge Reductions.
April 1992. 1 vol.