Assessing the Feasibility of Water Quality Trading to Address Agricultural Sources of Pollution in Canada - Water and Agriculture: Sustainability, Markets and Policies - page 81

can cover part of a watershed, or a whole nation (Netherlands). Trading can take place
through bilateral trades, brokered contracts between agents that do not contact each other,
or other means.

How does WQT that includes agricultural sources work?
The classic example is a watershed where municipal wastewater treatment plants
(WWTP) and farming operations are emitting regulated contaminants, such as
phosphorus. Under a traditional regulatory approach, municipalities have to reduce
nutrient discharge to meet a regulatory requirement in milligrams of phosphorus per litre
(mg/L). After a certain point, expensive investments are required to control additional
phosphorus discharges (due to city growth, for example). There is a large economic
advantage in looking for lower cost options to reduce loadings, such as other sources
discharging phosphorus within the same watershed. If farming operations in the
watershed can reduce phosphorus discharges at lower cost, it is cheaper for the
municipality to pay those dischargers to reduce pollution than to reduce emissions itself.
For such trades to be effective from the regulator's (and society's) perspective, the
environmental effect of reducing farm discharges has to be equivalent to or better than
what the municipality could have achieved through investing in a new (or renovated)
WWTP. In addition, there are usually provisions to ensure no local degradation of the
environment (hot spots).
Trading can occur if there is a large enough difference in the cost of reducing
discharges between different sources. This is a necessary but not a sufficient condition.
Overall, the cost-effectiveness of a trading system will depend on the size of transaction
costs, implementation costs and administrative costs.
To summarise, trading requires:

an environmental objective for a specified water body;

a clear definition of the commodity, i.e. the form of pollution that is to be traded as well
as measures of pollution reduction;

appropriate incentives for agents to trade, which generally consist of differences in
abatement costs and a binding environmental regulation that limits emissions for some
or all parties;

appropriate trading mechanisms and rules to ensure trades can actually reduce costs and
lead to the desired environmental objectives; and

measurement of the results of the actions taken, with some form of monitoring.

Biogeochemical considerations to water quality trading

A WQT programme requires understanding of the sources, behaviour and abatement
of the pollutant and of the watershed it affects. 5

5. This section is a summary of Morin (2005).