In last month’s BioCycle, Part I of this article discussed how regulation of nonpoint source runoff under the Clean Water Act (CWA) can lead to a nutrient credit trading (NCT) program, and how such programs present the opportunity for certain anaerobic digestion (AD) projects to generate an additional revenue stream. Part II takes a detailed look at the CWA-to-NCT process through examination of USEPA’s regulation of the Chesapeake Bay and its entire watershed. Other examples of nonpoint source regulation that have led (or are leading) to NCT opportunities elsewhere in the U.S. also are discussed, along with a framework for valuing nonpoint source generated nutrient reduction credits.
While the main takeaways for AD project developers and owners may very well be the new markets and potential value to be captured, it is important to understand the process that leads to these opportunities in order to be prepared to act if and when a NCT program goes online. AD developers and owners can thus track the CWA-to-NCT process and carry out their analytics and preparations in parallel, thereby enabling them to take advantage when the opportunity occurs.

Chesapeake Bay Watershed

The Chesapeake Bay is the largest estuary in the United States. For years, it has suffered from nutrient over enrichment that has led to large algae blooms and the resulting “dead zones” that they create. Sources of the excess nutrients include agricultural runoff, urban and suburban (sub/urban) storm water, wastewater treatment and industrial facilities. Decades of effort to bring the problem under control have finally culminated in the Chesapeake Bay Total Maximum Daily Load for Nitrogen, Phosphorus and Sediment (Bay TMDL), the final version of which EPA released in December 2010. For reference, a TMDL establishes the level of pollutants that a water body can bear and still maintain its health, according to best available science. A point source is a pipe or discrete conveyance from which pollutants are discharged. A nonpoint source is anything not considered a point source from which pollutants originate.
Since 1983, the Bay states (Maryland, Virginia, Pennsylvania, Dela-ware, West Virginia, New York, and the District of Columbia) have been working together with the EPA, the Chesapeake Bay Foundation (a nongovernmental, nonprofit organization), the Chesapeake Bay Commission (a tristate legislative commission created in 1980 to advise the General Assemblies of Maryland, Virginia, and Pennsylvania on Bay-related matters), and many other stakeholders to restore the Bay to a healthy ecosystem. Prior to the Bay TMDL, all of the Bay states’ cooperative participation was voluntary in nature, and progress was minimal at best.

EPA’s TMDL Order

Discussions among the Bay states and EPA regarding a TMDL began in 2005, with an agreement in 2007 that EPA would propose and pass a final rule to establish and enforce limits on the discharge and runoff of nitrogen, phosphorus and sediment. The Bay TMDL’s key milestones are reflected in Table 1. Watershed Implementation Plans (WIPs) are explained below. The Bay TMDL also included reduction targets for each major river basin within each state, targets which EPA updated in August 2011 based on the Bay states’ request for changes to the Chesapeake Bay Program Watershed Model. These updated target goals are shown in Table 2. Baselines (current loadings) were established for the primary pollutants, as were the ultimate allocations. If each state meets their allocations, the water quality of the Chesapeake Bay will be restored.
The allocations in Table 2 are in aggregate for each state and river basin. The waste load and load allocations discussed in Part I are the more detailed breakdowns that states and localities will ultimately assign to the respective source sectors and entities, a process that begins with the state/locality dividing their larger/aggregate allocation among the various source sectors and subbasins.
The baseline calculation for nutrient credit generation is indeed a crucial issue, and as such is one that garners much focus and attention. The typical baseline calculation for nonpoint sources involves measuring: 1) Nutrient content of the animal waste that would have otherwise been directly land applied (within the existing rules for doing so); 2) Scientifically accepted runoff levels based on the level of direct land application of that particular waste (or those wastes); and 3) Field samples attempting to verify that the theoretical runoff levels are jibing with actual measurements.
The baseline levels against which the aggregate reductions are set are the result of measurements and modeling throughout the Bay; aggregate allocations are divided ratably, based on existing loads. Within its own allocation, each state can determine whether to set aside a reserve for growth or instead fully distribute its allocation and force new development to offset its loading.

Compliance

Despite uncertainty regarding the expected level of enforcement, along with the possibility of an adverse judicial decision (see Box), the Bay states are nonetheless generally following the TMDL’s required processes and progressing along the path forward. Phase I WIPs, submitted in December 2010, show how the states will meet their reduction goals and provide reasonable assurance that such will be the case. The states paid particular attention to the primary pollutant sources — wastewater treatment and industrial facilities, agricultural runoff, and sub/urban storm water.
The Phase II WIPs, submitted in March 2012, present a more up-to-date and detailed explanation of the states’ current implementation efforts, local allocations for each source sector, coordination regarding local compliance strategies, and the still-existing barriers preventing the level of implementation required for ultimate compliance. Importantly, the Phase II WIPs also include information related to states’ systems for tracking, verifying and reporting nutrient reductions and associated credits. Common Best Management Practices to meet the allocations include nutrient management plans, conservation tillage, cover crop maintenance, riparian buffers, tree planting and bioswales.

Enforcement

Depending on the sufficiency of state efforts and in order to encourage compliance, EPA is authorized to exercise, with respect to each source sector within each state, either ongoing oversight, enhanced oversight or backstop authority. Ongoing oversight involves continuing to monitor and work with the states on their own self-directed compliance. This baseline level of enforcement is least burdensome on the states and how EPA presently oversees a majority of the source sectors within each state.
The decision to exercise enhanced oversight for a particular source sector puts a state on notice of EPA’s concerns regarding the adequacy of the state’s progress. Under enhanced oversight, EPA more carefully scrutinizes details of the state’s nutrient reduction strategy and tactics for the deficient source sector and offers more specific actions the state can and should take.
Finally, if it believes that a state’s efforts are insufficient to achieve the target reductions, EPA will resort to its backstop authority to ensure that the state is put on a path to compliance. Backstop authority could include (but is not limited to) pursuing the designation as a concentrated animal feeding operation (CAFO) for an entity not previously regulated as such, increasing enforcement of CAFO permits, assigning more stringent NPDES permit requirements and increasing permit enforcement for wastewater treatment plants, and increasing enforcement of storm water permits. The trading of nonpoint source nutrient reductions is one method for achieving compliance and avoiding EPA’s backstop authority.
Based on its review of the Bay states’ Phase II WIPs, EPA will engage in enhanced oversight over Pennsylvania’s agricultural sector and its NCT program, Virginia’s sub/urban storm water sector, and West Virginia’s agriculture sector. Additionally, EPA will rely on its backstop authority with respect to Pennsylvania’s storm water sector to ensure that the necessary strategies are put in place and appropriate tactics carried out to reach the target reductions. The remaining source sectors in these and the other Bay states will remain subject to EPA’s ongoing oversight.

Nutrient Credit Trading

As discussed in Part I, NCT programs present a cost-effective mechanism for regulatory compliance in the aggregate. Most of the Bay states have recognized this benefit and taken action to implement these programs accordingly. Table 3 highlights the extent to which each of the Bay states has incorporated NCT into its Bay TMDL compliance strategy. In Virginia, for example, the Virginia Nutrient Credit Exchange Association (VNCEA) was formed in 2005 in response to the initial NCT program by those entities wishing to participate (i.e., the WWTFs and other point sources). Under this system, credits are sold to and purchased from the association. Moving forward with nonpoint source credit trading, the mechanism at present is for arm’s length negotiations and transactions among credit generators, aggregators and regulated entities.
From the perspective of an AD project developer or owner, the NCT market is most economically appealing when the greatest number of regulated entities are allowed to use nonpoint source credits to satisfy their compliance burdens. Digesters are operating at a number of dairy/bovine facilities that are not considered CAFOs (which are categorized as point sources). AD serves as an alternative to direct land application of the waste, thus making nonpoint source credit generation relevant as well. Even though trading among point sources is far more common at present, the trendline from evolving NCT frameworks shows increased use of nonpoint source credits by both point and nonpoint sources.
Currently, limiting NCT to point sources for compliance results in a low price for the credit — with low demand relative to the supply. For example, in mid-June, PENNVEST (Pennsylvania) held a forward auction where 20,000 lbs of 2012 point source N reduction in the Susquehanna Basin sold for $3.75/credit, and 3,000 lbs of 2014 point source N reduction sold for $3.54/credit. As illustrated in the hypothetical example below, a significant increase in the credit’s potential value occurs when nonpoint sources are added to the demand side of the equation.

NCT Activity Elsewhere

While the Chesapeake Bay Watershed is home to the largest multistate TMDL, it is by no means the only area where NCT has emerged as a solution to nutrient over-enrichment water quality problems. Examples of some of the more active geographies for NCT include:
Ohio River Basin Trading Project (ORBTP): Covering large portions of Kentucky, Ohio, Indiana, West Virginia and Pennsylvania (plus smaller areas of four other states), the ORBTP is the product of collaboration chiefly between the Electric Power Research Institute and the Ohio River Valley Water Sanitation Commission, along with cooperation from EPA, USDA, wastewater treatment facilities, agricultural operators and environmental interests. Authorized in 2011 after more than four years of planning, this NCT project intends to begin pilot trading (on a voluntary basis) in 2012-13 and will allow point sources to use nonpoint source credits for compliance. The goal is to operate a fully functioning market by 2015.
Idaho: Idaho passed a NCT guidance framework into law in 2003, and state policy is to contemplate using NCT in conjunction with the development of a nutrient-related TMDL. Even with this foundation, however, NCT has not yet taken hold due to a lack of nutrient-related TMDLs for which trading would be a compliance option. Nevertheless, there is cause for optimism — EPA recently succeeded in imposing stringent new phosphorus discharge limits on the City of Boise’s two wastewater treatment facilities. As a result, Boise City is actively considering a form of NCT as a cost-effective compliance option.
Oregon: Oregon’s water quality trading activities presently involve the generation and use of thermal load credits for temperature related water quality problems. NCT for nutrient-related impairment is also part of the state’s Internal Management Directive for Water Quality Trading, and Oregon is working with regulated entities and outside non-profit organizations to further develop NCT opportunities.

Valuing Nutrient Reduction Credits

As could be expected with any commodity, credit price depends on supply and demand. Unlike other commodity types, however, credits are purely the creation of legislation, which itself was designed to implement a specific policy.
Policy, therefore, has a direct impact on supply, demand and (accordingly) price. If policy limits use of nonpoint source credits only for offsetting point source growth, then the market price for nonpoint source credits will be lower than it would be if policy allowed trading among nonpoint sources, too, as the latter significantly increases the demand pool.
As trading among nonpoint sources represents the broadest scope of NCT — and most likely to be of interest to AD developers/owners — consider the following hypothetical example of an AD project and a city dealing with sub/urban storm water reduction requirements:
• City (pop. ≈76,000) needs to reduce nitrogen (N) loading from its sub/urban storm water by 44,000 lbs per year by 2025.
Estimated cost of sub/urban BMPs (conventional (gray) and green infrastructure) is $350 million (i.e., $8,000/pound of perennial N reduction, plus up-keep).
• Poultry litter AD project receiving 100 tons/day (at baseline cost $8-$10 million) can generate 90,000 lbs/year of N reductions with additional nutrient recovery equipment (for an additional $4- $5 million).
• Assume sale of 90,000 annual credits to City at $50/credit/yr for 20 years.
NCT programs often require a two-to-one ratio for compliance using nonpoint source generated credits, hence the assumption of selling 90,000 credits to satisfy the 44,000 lbs/yr reduction requirement.
• City’s cost over 20 years is $90 million (compared to $350 million for traditional BMPs).
• AD project generates $4.5 million in annual revenue (i.e., one-year pay- back for nutrient recovery equipment).

Key Is Enforcement

The goal of this two-part article has been to increase awareness of a potential additional revenue opportunity for AD projects — by explaining how the opportunity arises, discussing ways AD project developers/owners can take advantage, and presenting a framework for valuation. As is the case for any policy-driven market opportunity, however, whether the opportunity actually comes to fruition will depend in large part on how strictly the policy is enforced.
It is still unclear at present whether the Chesapeake Bay TMDL and associated state legislation will be enforced at the level necessary to encourage regulated entities to take compliance seriously. The same goes for other NCT programs across the country — regulatory enforcement will be crucial, and it is too early to tell if the existing enforcement strategies will be sufficient. Nevertheless, if the policy is enforced, and as more regulators come to recognize the cost-saving benefits of NCT, additional opportunities will continue to arise for AD project developers/owners to expand and diversify their revenue streams.
Douglas Ross is the head of the biogas practice at Cleantech Law Partners, a boutique law firm that caters to the unique legal needs of renewable energy developers and other clean technology companies. He can be reached at dross@cleantechlawpartners.com.