United States 

Environmental Protection Agency 

Region 10 

(EMI-163) 

EPA 910-B-03-003 

July 2003 

Water Quality Trading 

Assessment Handbook: 

EPA Region 10’s Guide to Analyzing 

Your Watershed 

Prepared Under EPA Contract 910-B-03-003 
Water Quality Trading Assessment Handbook.....................................................................
.....................................................................Water Quality Trading Assessment Handbook 

i 

Preface 

Water quality trading can be a business-like, cost-effective, local solution to problems 

caused by pollutant discharges to surface waters. Generally, water quality trading (WQT) 

involves a party facing relatively high pollutant reduction costs who compensates another 

party to achieve a less costly, pollutant reduction with the same or greater water quality 

benefit. The concept of using “market-based” innovations is not entirely new, but there 

have been relatively few successful trades in the U.S. While trading is not a panacea, it 

can be a useful tool for water quality enhancement in the right circumstances and some 

dischargers will welcome the flexibility it can provide. 

All markets evolve to help fulfill the demands of consumers. Consumers provide 

producers an opportunity to earn a profit for altering their behavior and attending to the 

market’s constantly changing demands for goods and services. Until a consumer 

decides she “needs” a soda, and is willing to pay someone to produce it, there is no 

market for sodas. 

Total Maximum Daily Loads (TMDLs) are the leading market drivers for WQT markets 

today because they potentially create the “need” to alter behavior by reducing pollutant 

loadings discharged to waterways. TMDLs and similar frameworks are sometimes 

described as “budgets” for the introduction of pollutants into watersheds. Scientific 

studies estimate the volume of discharge a specific watershed, or segment of the 

watershed, can assimilate without exceeding the water quality standards enacted to 

protect the watershed’s designated beneficial use(s). This “pollutant budget” is then 

allocated across point sources and non-point sources located in the watershed. The 

allocation of discharge limits forces sources in the watershed to analyze current practices 

to see if they need to alter their discharging behavior and the associated costs to do so. 

The United State Environmental Protection Agency’s (EPA’s) Region 10 office has taken 

an active role in exploring the mechanics of water quality trading and developing water 

quality trading markets in hopes of lowering the cost of improving water quality. For 

example, working with the Idaho Department of Environmental Quality and a wide variety 

of stakeholders, Region 10 has been helping dischargers to the Lower Boise River create 

the detailed knowledge, regulatory framework, and techniques for cooperation needed to 

achieve phosphorus reductions through trades. Region 10 has also supported trading in 

the Middle Snake River by preparing model NPDES permits that would facilitate trading 

by the City of Twin Falls and a local business. In Washington and Oregon, Region 10 is 

supporting assessments to identify opportunities for individual trades or broader trading 

markets. 

Careful analysis is required to identify watersheds with the combination of characteristics 

to support cost-effective trading. Region 10 encourages stakeholders to be active in 

identifying potential new trading markets. To that end, this Handbook is designed to 

provide you, the watershed participant, with an efficient means to assess your 

watershed’s water quality trading potential and the attractiveness of trading for particular 

dischargers. 

 

Such an assessment involves several types of analysis. Water quality specialists may 

need to call on specialists in engineering, finance, and/or regulatory interpretation. This 

Handbook is intended to help you identify what you need to know, with whom you need to 

consult, and where you may find the information you need. 
Water Quality Trading Assessment Handbook.....................................................................

ii 
.....................................................................Water Quality Trading Assessment Handbook 

iii 

Table of Contents 

Introduction .........................................................................................................................1

Pollutant Suitability..............................................................................................................4

Purpose ...........................................................................................................................4

Approach .........................................................................................................................4

What is needed for a pollutant to serve as a “tradable commodity” that dischargers can 

buy and sell in a given watershed? .................................................................................5

The Six Step Suitability Analysis.....................................................................................5

Step One: Create a Watershed Discharge Profile......................................................6

Step Two: Identify Type/Form of Pollutant Discharged by Sources...........................9

Step Three: Determine the potential environmental equivalence of different 

discharge points.........................................................................................................12

Step Four: Determine the potential for aligning the timing of load reductions and 

regulatory timeframes among dischargers ................................................................16

Step Five: Determine if the supply of and demand for pollution reduction credits is 

reasonably aligned within the watershed...................................................................18

Step Six: Review the results of Steps One through Five to Complete the Pollutant 

Suitability Determination............................................................................................20

Financial Attractiveness ....................................................................................................22

Purpose .........................................................................................................................22

Approach .......................................................................................................................22

What Makes Water Quality Trading Financially Attractive? ..........................................23

Stage 1: Calculating Incremental Cost of Control for a single source......................24

Stage 2: Examining the Watershed .........................................................................30

Stage 3: Analyzing the Results................................................................................32

Market Infrastructure.........................................................................................................40

Purpose .........................................................................................................................40

Approach .......................................................................................................................40

Considerations: Market Sizing......................................................................................42

What Is Driving the Market?..........................................................................................42

What Are the Essential Functions of a Water Quality Trading Market?........................43

1. Defining marketable reductions.......................................................................43

2. Communicating among buyers and sellers .....................................................44

3. Ensuring environmental equivalence...............................................................44

4. Defining and executing the trading process ....................................................45

5. Tracking trades................................................................................................46

6. Assuring Compliance with Clean Water Act and state/ local requirements ....47

7. Managing transaction risk among parties to a trade .......................................47

8. Providing information to the public and other stakeholders ............................48

Current Market Models..................................................................................................49

A Private, Non-profit Co-operative Facilitating Pre-Approved, Dynamic Trading......49

A Public Authority Banking and Managing Phosphorus Credits................................54

A Nitrogen Credit Exchange ......................................................................................59

Stakeholder Readiness.....................................................................................................65

Purpose .........................................................................................................................65

Approach .......................................................................................................................65

Identifying and Prioritizing Potential Participants.......................................................65

Recruiting Essential Participants ...............................................................................68

Benefits of Water Quality Trading..............................................................................68

Likely Participant Needs and Interests Relating to Water Quality Trading................69

Stakeholder Participation in Market Infrastructure.....................................................72

Glossary ............................................................................................................................75
Water Quality Trading Assessment Handbook.....................................................................

iv

Appendix A........................................................................................................................77

Water Quality Trading Suitability Profile for Phosphorus ..............................................77

Trading Suitability Overview ......................................................................................77

Key Trading Points.....................................................................................................77

Appendix B........................................................................................................................81

Water Quality Trading Suitability Profile for Temperature.............................................81

Trading Suitability Overview ......................................................................................81

Key Trading Points.....................................................................................................82

Appendix C........................................................................................................................86

Water Quality Trading Suitability Profile for Sediments ................................................86

Trading Suitability Overview ......................................................................................86

Key Trading Points.....................................................................................................87

Appendix D........................................................................................................................91

Capital Cost Annualization Factors ...............................................................................91

Appendix E........................................................................................................................93

Participant Pollutant Management Options Characterization........................................93
.....................................................................Water Quality Trading Assessment Handbook 

1 

Introduction 

In January 2003, the United States Environmental Protection Agency issued a Water 

Quality Trading Policy enabling and supporting the adoption of market-based programs 

for improving water quality. The policy acknowledges that the progress made towards 

restoring and maintaining the chemical, physical, and biological integrity of the nation’s 

waters under the 1972 Clean Water Act (CWA) and its National Pollutant Discharge 

Elimination System (NPDES) permits has been incomplete.1

 When the policy was 

issued, 40 percent of rivers, 45 percent of streams, and 50percent of lakes that had been 

assessed in the United States failed to support their designated uses.2

 Faced with CWA 

statutory obligations to achieve their watershed’s designated uses, stakeholders have 

been looking for innovative, supplementary ways to achieve federal, state, tribal, and 

local water quality goals. The policy specifically enables and endorses the use of “water 

quality trading” to accelerate compliance. 

Water quality trading can be a cost-effective solution to local problems caused by 

pollutant discharges to surface waters. A party facing relatively high pollutant reduction 

costs might elect to compensate another party who can achieve an equivalent, though 

less costly, pollutant reduction with similar water quality benefits. The flexibility offered by 

water quality trading is one of its strongest selling points 

This Handbook is designed to provide you, the watershed participant, with an efficient 

means for assessing your watershed’s potential to capitalize on this innovative “trading” 

policy. The viability of trading, as discussed in this Handbook, depends on conditions 

discussed in EPA’s Water Quality Trading Policy, including: a market structured around 

the current CWA regulatory framework; voluntary participation; a suitable pollutant; and 

public participation. 

Today, several trading markets are already helping to reduce the cost of improving water 

quality. Experience with these markets offers insights into the opportunities and 

challenges trading may present in your watershed. Experience teaches that success in 

water quality trading markets will be influenced by several factors, including: 

 the pollutant in question; 

 the physical characteristics of the watershed; 

 the cost of pollution control for individual dischargers; 

 the mechanisms used to facilitate trading; and 

 the ability and willingness of stakeholders to embrace and participate in trading. 

This Handbook will help you assess the environmental, economic, and technical factors 

that will influence your ability to create and sustain a water quality trading market. During 

the assessment, you will focus on each of the individual factors that make trading viable. 

As these factors are examined, you will organize disparate types of information into a 

comprehensive view of relevant local conditions. You will need to obtain some 

information from other stakeholders in your watershed. Your efforts will be much simpler 

if most stakeholders speak a common language. This Handbook will help provide that 

common language, giving you a methodology for organizing critical information into a 

logical, easy-to-follow format. 

 

1

 Water Quality Trading Policy (EPA, January 2003) 2

 Ibid. 
Water Quality Trading Assessment Handbook.....................................................................

2 

The first chapter of the Handbook—Pollutant Suitability—addresses whether a "common" 

or “tradable” commodity exists that is important to the water quality goals for the 

watershed. Certain pollutants and watershed conditions are more suitable for trading 

than others. Pilot projects in Region 10 and elsewhere have demonstrated that nutrients 

can be successfully traded. Less information is available about trading other pollutants. 

After reading the Pollutant Suitability chapter and examining your own pollutant 

characteristics and watershed conditions, you will be better able to decide whether to 

pursue trading. 

The second chapter—Financial Attractiveness—addresses how to evaluate the 

economics of a pollution trading market through consideration of the financial viability of 

potential individual and aggregate trades. The financial attractiveness of trading depends 

on whether the incremental costs of trading are less than the incremental costs of control 

options otherwise available to an individual. Incremental cost (essentially a hybrid of 

marginal and average cost) is the average cost of control for the increment of reduction 

required to meet compliance obligations. Incremental cost represents a good 

approximation of the upper-bound of a source’s willingness to pay others within their 

watershed to alter their discharging behavior. For trading to be financially attractive, the 

difference in incremental costs between dischargers must, at a minimum, be sufficient to 

cover trade transaction costs and offset any sense of increased (non-compliance) risk. 

Assessing the incremental cost spreads associated with specific transactions provides 

information on whether trading - in practice - will be financially attractive to potential 

market participants. After reading the Financial Attractiveness chapter, exploring the 

example provided, and employing the tools/methodologies discussed, you will be able to 

make a more informed decision about whether to pursue trading. 

The Market Infrastructure chapter will help you determine whether the market 

infrastructure needed to facilitate trading can be built. The analysis will not provide a 

specific blueprint for creating a market, but will highlight likely challenges and identify 

ways in which your watershed can benefit from lessons learned in other markets. After 

reading the Market Infrastructure chapter, exploring the examples provided, and 

reflecting on the lessons from the first two chapters of the Handbook, you will better 

understand the watershed’s unique market infrastructure needs, possible mechanisms 

suited for the watershed, and the commitment level likely needed to create a market. 

Finally, the Stakeholder Readiness chapter addresses the level of stakeholder interest 

and support needed to pursue water quality trading. If you decide to pursue trading 

opportunities, you will need to work with other potential participants and stakeholders in 

the watershed. They may need to be convinced that the time they spend exploring 

opportunities will lead to worthwhile, currently unavailable options. Parties with the 

greatest potential to produce and/or consume reductions are necessary participants. In 

addition, there must be a reasonable level of support from non-discharging stakeholders, 

including citizen’s groups and regulatory authorities concerned with water quality issues 

in the watershed. After reading this chapter, you should have a better understanding of 

how to engage other stakeholders.

The Handbook offers common themes that are important to your assessment and market 

creation efforts. Among these is the recognition that water quality trading involves a 

variety of risks and market development costs. Potential trade participants will face the 

possibility that, despite their hard work, the market they desire will not emerge. Friction 

around regulatory issues may emerge as the federal, state, and local regulatory 

framework, as well as necessary stakeholder involvement, add costs or complicate 

market design. After the market emerges and trading begins, transaction costs will be 
.....................................................................Water Quality Trading Assessment Handbook 

3 

associated with information gathering, trade execution, and compliance efforts. The 

attractiveness of pollution trading markets will be affected by these cost and uncertainty 

factors. Higher development and transaction costs, market uncertainty, and regulatory 

impediments can suppress market activity to the point where trading will not occur. 

Lessons learned from other markets and discussed in this Handbook will help you assess 

whether costs and friction can be managed in your watershed to support a viable market. 
Water Quality Trading Assessment Handbook.....................................................................

4 

Pollutant Suitability 

Purpose 

This chapter is intended to help you assess your watershed and associated pollutants for 

water quality trading potential. The first step is to review the pollutant characteristics and 

the watershed conditions. Certain pollutants and watershed conditions are more suitable 

for trading than others. 

This chapter considers: 

 What factors determine a pollutant’s suitability for water quality trading in a particular 

watershed? 

 Do the watershed conditions and pollutant characteristics warrant consideration of 

water quality trading in the watershed? 

Pilot projects have demonstrated that nutrients, such as phosphorus and nitrogen, can be 

successfully traded. Less information is available about trading other pollutants, although 

pilot projects have explored sediment, ammonia, and selenium trading. The EPA Water 

Quality Trading Policy specifically supports nutrient (e.g., total phosphorus and total 

nitrogen) and sediment trading. However, the policy indicates that other pollutants, such 

as metals and pesticides, will require more scrutiny to ensure that trading can lead to 

meeting water quality standards. EPA will support trading of these pollutants only under 

limited conditions as part of a pilot project. For temperature, total dissolved gas, 

BOD/Ammonia, and bacteria, this Handbook cannot provide a clear “yes” or “no” answer, 

but this chapter should suggest whether to continue consideration of water quality trading 

using the following chapters. 

Approach 

This chapter discusses conditions needed for a pollutant to serve as a commodity that 

can be bought and sold in a trading system. Common commodities, like wheat, can be 

traded easily because buyers and sellers understand and can clearly compare the 

characteristics of the product. For example, with wheat, all market participants have a 

common understanding of the meaning of a bushel of hard, red winter wheat. For water 

quality trading opportunities to exist, dischargers in a watershed must establish a 

common understanding of the commodity that is being bought and sold, including the 

effects of trading on water quality. 

The chapter then suggests a process for analyzing the suitability of trading a particular 

pollutant in a particular watershed. To enrich your understanding of the conditions that 

enable trading, the Handbook employs a hypothetical watershed to illustrate key points 

and highlight potential trading opportunities. 
.....................................................................Water Quality Trading Assessment Handbook 

5 

What is needed for a pollutant to serve as a “tradable 

commodity” that dischargers can buy and sell in a given 

watershed? 

A condition for water quality trading is identification of a pollutant commodity that can be 

sufficiently controlled, measured, and traded by sources (possibly including both point 

and nonpoint sources) in the watershed or targeted market area. The four key trading 

suitability factors – Type/Form, Impact, Time, and Quantity – are related to inherent 

pollutant characteristics, watershed conditions, and the compliance regime. 

 Type/Form: Potential trading partners must not trade “apples and oranges.” 

Generally, they must identify a single pollutant, in a common form. For example, 

dischargers could trade Total Phosphorus, but might not be able to trade soluble for 

non-soluble forms of phosphorus. In some cases, different pollutant types (e.g., Total 

Phosphorus and Dissolved Oxygen) can be traded using a defined translation ratio 

based on the quantities of each that have an “equal” overall effect on water quality. 

 Impact: There must be environmental equivalence between the discharge points of 

purchase and sale to ensure that the water quality impact will be at least equivalent 

to, if not in excess of, established water quality-based requirements. For example, 

participants must predict the water quality effects of a one pound phosphorus 

reduction as required by a TMDL at one point in a watershed compared to a 

reduction of one pound (or more or less) at another point downstream. 

 Time: Participants must consider and work to align two time dimensions to support a 

trade. First, purchased reductions must be produced during the same time period 

that a buyer was required to produce them (e.g., during the permit compliance 

reporting period or during the same season when the permit limit was applicable). 

Second, TMDL compliance deadlines must reasonably align as sources consider 

their options for meeting future reduction obligations. 

 Quantity: Overall supply and demand must be reasonably aligned. The total 

amount and increments of reductions available must reasonably align with the needs 

of potential purchasers. 

For water quality trades to occur, potential trading partners must be able to align all four 

suitability factors. 

The Six Step Suitability Analysis 

This section will help you examine the four trading suitability factors. For each factor – 

Type, Impact, Time, and Quantity – this section provides additional background 

information and examples in the form of six steps. Each step involves a series of 

questions to evaluate whether potential trading partners will be able to establish a 

tradable commodity. To help answer the questions, the inherent characteristics of a 

number of common pollutants are provided. Appendices A, B, and C contain this 

information. Stakeholders should also consider TMDLs, implementation plans, NPDES 

permit language, and other local assessments and requirements to evaluate specific 

sources or conditions in your watershed. 
Water Quality Trading Assessment Handbook.....................................................................

6 

STEP ONE: CREATE A WATERSHED DISCHARGE PROFILE 

The purpose of this step is to characterize the pollutant(s) of concern that are discharged 

in the watershed or defined trading area. You will use this information in later steps to 

evaluate suitability and, in the next chapter, the financial attractiveness of trading. During 

this step, it will be important to understand the type/form, location, and quantity of 

pollutants being discharged from point and non-point sources. 

One way to display this information is to use a simple chart, as in Figure 1.1. You will 

complete only certain columns during this step; in subsequent steps you will gather more 

information to fill in additional columns. In the example that follows, this same format is 

used to create a profile for the sources in a hypothetical watershed. 

Figure 1.1: Template for Creating a Watershed Discharge Profile 

Discharge 

Location

River Mile

As Addressed 

by TMDL

As 

Discharged

Discharge 

(e.g., seasonal, 

cyclical, etc.)

Obligation 

(Regulatory)

Baseline 

Load*

(lbs./day)

Current 

Load*

(lbs./day)

Target 

Load*

(lbs./day)

Total 

Reduction 

Needed*

(lbs./day)

Source #1

Source #2

Diversion #1

Return #1

Source #3

* The Baseline Load is the amount of discharge used to develop a TMDL. During TMDL development, a specific year or flow rate is typically 

chosen to characterize the discharge behavior of point and non-point sources. This information can be found in the TMDL. The Current Load is 

the amount of pollutant discharged as you analyze the watershed for trading viability. The Target Load is the amount of pollutant discharge 

allocated to each source in the TMDL. The Total Reduction Needed is the difference between the Current Load and the Target Load.

Name of 

Discharge 

Source, 

Diversion, 

Agricultural 

Drain, or 

Tributary

Form of Pollutant Timing Quantity

You can typically find information to complete the chart in the text of a TMDL, in the 

TMDL implementation plan, or from other sources in the local watershed. For example, 

information about quantities discharged by point sources is contained in TMDL analyses 

and in the relevant NPDES permits (permit numbers are often listed in the TMDL). The 

TMDL will typically describe quantities discharged during a selected baseline period (e.g., 

1995), current discharges (or “loads”), and the TMDL’s specified waste load allocation for 

each point source based on a calculation of what is required to meet desired instream 

concentrations and achieve water quality standards. Additional guidance is provided in 

the following chapter (Financial Attractiveness) about calculating quantities associated 

with projected future growth. For nonpoint sources, TMDLs generally do not provide data 

about each individual source, but estimate quantities from selected reaches, inflows, or 

tributaries. Additional information about cropping patterns and agricultural practices in 

each area will be needed to estimate current loads from individual sources. 

This profile offers a coarse initial screen for water quality trading viability. For example, if 

there are no major point sources in the watershed that are required to reduce pollutant 

loads, or if only a small number of widely dispersed sources discharge small quantities of 

the pollutant of concern, trading may not be viable. On the other hand, a watershed that 

includes a point source with large reduction obligations and many other closely clustered 
.....................................................................Water Quality Trading Assessment Handbook 

7 

sources of the same pollutant may present opportunities for water quality improvements 

and other environmental benefits at lower cost through trading. 

The questions below will help create a profile of pollutants being discharged into the 

watershed. It is important to gather as much of this information as possible because you 

will need it in later steps to evaluate suitability more specifically with regard to pollutant 

type/form, impact, time, and quantity. 

For each source of the selected pollutant in the watershed: 

 What is the geographic location of the discharge (by river mile)? 

 What form of the pollutant is discharged (and/or controlled) by the source? 

 What quantity of the pollutant does the source discharge? If possible, this should 

include current loads and allocated loads from the TMDL, along with any seasonal or 

other cyclic load variability considerations. 

Overview of Happy River Basin 

To demonstrate how you will use the information gathered to assess trading opportunities, a 

hypothetical watershed, the Happy River Basin, is presented below. 

A number of segments along the Happy River currently experience nuisance aquatic growth 

conditions. A TMDL for phosphorus has recently been completed for the main stem of the river, 

providing Waste Load Allocations for the permitted point sources and Load Allocations for the 

nonpoint sources and tributaries. The TMDL indicates that, to achieve water quality standards, the 

concentration of phosphorus in the water column must be at or below .07 milligrams per liter 

along the entire river with monitoring stations established for compliance purposes. Eight sources 

of phosphorus discharge in the basin. 

 Herb’s Farm, a family-owned farm growing a range of crops, is located on an irrigation 

district controlled return flow which enters the Happy River at RM (river mile) 570. 

 Pleasantville POTW (publicly owned treatment works), a municipal wastewater treatment 

plant owned and operated by the City of Pleasantville, is located at RM 567. 

 Acme Inc., a food processing facility, is located four miles up Nirvana Creek, a tributary to 

the Happy River. The creek currently meets water quality standards and is not subject to a 

TMDL; therefore, Acme has not received a Waste Load Allocation. However, the Happy 

River TMDL provides a Load Allocation requiring a reduction in the phosphorus loads 

entering Happy River from Nirvana Creek. The creek’s confluence with the Happy River is 

at RM 547. 

 Hopeville POTW, a municipal wastewater treatment plant, owned and operated by the City of 

Hopeville, is located at RM 546. 

 AAA Corp., a sugar mill owned and operated by a multinational corporation, is located three 

miles up Lucky Creek, a tributary to Happy River. AAA Corp. is required to meet a Waste 

Load Allocation provided in the Lucky Creek TMDL, which was finalized two years ago. 

Lucky Creek enters the Happy River at RM 544 and has been given an allocation at its 

confluence with the main stem. 
Water Quality Trading Assessment Handbook.....................................................................

8 

 Ortho Company is a chemical manufacturing plant and a major discharger of phosphorus 

located downstream of Hopeville at RM 541. 

 Easyville Dam, owned by Peaceful Power Company, is located downstream, at the end of 

Lake Content, a fifty-mile long reservoir, which is the pool behind Easyville Dam. The dam 

does not produce phosphorus. However, the power company has been given a load allocation 

under the TMDL to improve depressed levels of dissolved oxygen (DO) in the reservoir. The 

Dam sits at RM 490. 

 Laughing Larry’s Trout Farm, a privately owned aquaculture facility, is located at River Mile 

489, below the Easyville Dam. 

Figure 1.2: Schematic Map of Happy River Basin 
.....................................................................Water Quality Trading Assessment Handbook 

9 

Figure 1.3: Chart of Sources with Location, Pollutant Form, and Quantity Information 

Discharge 

Location Forn of Pollutant

River Mile

As Addressed by

TMDL

Baseline 

Load*

(lbs./day)

Current 

Load*

(lbs./day)

Target Load*

(lbs./day)

Total 

Reduction 

Needed

(lbs./day)

Drain A--Herb's Farm 570 Total Phosphorus 632 753 527 226

Pleasantville 567 Total Phosphorus 760 791 633 158

Acme Inc. (Nirvana Creek Confluence) 547 Total Phosphorus 492 547 410 137

Hopeville 546 Total Phosphorus 60 62 50 12

AAA Corp. (Lucky Creek Confluence) 544 Total Phosphorus 199 195 166 29

Ortho Company 541 Total Phosphorus 786 1645 655 990

Laughing Larry's Trout Farm 489 Total Phosphorus 185 250 154 96

Quantity

Name of Discharge Source, Diversion, 

Agricultural Drain, or Tributary

*Note: Nirvana Creek and Lucky Creek have received allocations at their confluene with Happy River. The Baseline, Current, and Target 

Loads displayed are for the actual point of discharge to the tributary and are derived from the discharges' environmental impact at the 

confluence with Happy River.

STEP TWO: IDENTIFY TYPE/FORM OF POLLUTANT DISCHARGED 

BY SOURCES 

The purpose of Step Two is to help evaluate whether sources are discharging the same 

type and/or form of pollutant. Type/Form is the first of the four factors that must be 

aligned among dischargers for trading to be viable. Sources must first determine that 

there is a common type of pollutant to be traded (e.g., phosphorus, sediments, or 

temperature). Types of pollutants may or may not be sufficiently correlated to allow 

trading. Even if sources are discharging the same type of pollutant, the form of pollutant 

as discharged may differ from source to source. Current practice requires that pollutant 

trading systems use an identified controllable pollutant common to all potential market 

participants. This establishes a “common currency” with which market participants can 

evaluate offers of behavior change from others. 

A. Determine if sources are discharging the same form of pollutant as 

regulated by the TMDL. 

Using the information developed in Step One, identify the form of pollutant addressed in 

the TMDL, and the form discharged by each identified source. In some cases, the formsuitability determination may be simple. If the TMDL has provided the majority of 

dischargers an allocation expressed as the same form of the pollutant (e.g., Total 

Phosphorus), then potential trading participants will have a solid match. For example, 

phosphorus loading is often regulated in TMDLs because excessive phosphorus 

concentrations encourage nuisance aquatic growth, reduce dissolved oxygen levels, and 

result in violations of water quality standards. In many cases, TMDLs provide load 

allocations for Total Phosphorus, rather than soluble or non-soluble forms because Total 

Phosphorus can be easily measured in monitoring samples. 

Although Total Phosphorus is the pollutant form being measured, most sources 

discharge a combination of phosphorus forms (e.g., soluble or non-soluble). However, 

certain pollutants, including phosphorus, may pose difficulties even if the TMDL assigns 

allocation of a single pollutant form to all dischargers. (See Appendix A for more 

information.) For example, if individual dischargers have load characteristics that vary 

widely (e.g., one primarily discharges soluble phosphorus while another primarily 

discharges non-soluble sediment attached phosphorus) then a trade between the two 
Water Quality Trading Assessment Handbook.....................................................................

10

may not be environmentally equivalent. As trading opportunities are considered in a 

watershed, it will be important to understand the actual forms of the pollutant being 

discharged by each source to assure that trades represent an equivalent impact on water 

quality. 

The following questions are intended to help assess whether the pollutant can be treated 

as a “tradable commodity” based on commonality of the form of the pollutant being 

discharged. 

 What is the form of pollutant addressed in the TMDL? For each pollutant, does the 

TMDL provide load allocations for more than one form? 

 Do sources discharge the same form of the pollutant? If not, what form is 

discharged? 

 What are the impacts of concern for this pollutant and do they vary by the different 

forms (if any) discharged? 

In answering these questions, if you find that, 1) the TMDL provides load allocations for a 

single pollutant form; and 2) sources in a watershed discharge and measure that same 

form—you are in a strong position to continue the trading analysis. If this is the case, 

proceed to Step Three, to evaluate the potential for establishing environmental 

equivalence. If this is not the case, use the next set of questions in Step Two (B) to 

consider whether you can establish translation ratios between different pollutant types or 

forms. 

B. Determine if there are opportunities to trade between different forms of 

the same pollutant, or between different types of pollutants. 

This section considers circumstances in which different forms or types of a pollutant 

might be involved in a water quality trade. For example, if the TMDL provides load 

allocations for different forms (e.g., chemical compounds) of the same pollutant, you 

would need to assess the potential for establishing a translation between them. In some 

instances, such a translation can make it possible to trade more than one form of 

pollutant by defining the ratio at which the two forms may be exchanged with an “equal” 

effect on water quality. Without a reliable, scientifically defensible translation basis, it 

may be impossible to trade different forms of a pollutant. 

In some cases, trading can even occur between two different types of pollutants if there is 

sufficient information to establish translation ratios that describe how they interrelate. For 

example, reductions in upstream nutrient levels can improve downstream dissolved 

oxygen levels or biochemical oxygen demand. The EPA Water Quality Trading Policy 

supports cross-pollutant trading for oxygen-related pollutants when translation ratios can 

be established. 

The following questions should be answered if you are considering trading more than one 

form of the same pollutant, or if you are considering trading two different types of 

pollutants. (This will also help you identify situations where a TMDL provides load 

allocations for a single form, but sources actually discharge very different forms that have 

different impacts on water quality.) Establishing translation ratios requires adequate 

data and analysis about how pollutants behave under specific watershed conditions. If it 

appears that the data or analysis cannot be developed, water quality trading opportunities 

will be limited. 
.....................................................................Water Quality Trading Assessment Handbook 

11 

 If different forms are being discharged, is there sufficient information to establish a 

translation basis between those different forms of the pollutant? 

 Is the pollutant measured/regulated directly or by using an indicator of its indirect 

effects on water quality? Has a basis for translating direct regulatory limits to indirect 

effects been established? 

 Is there a typical causal relationship between this pollutant and others? Has a 

specific translation relationship been established between two pollutants within this 

watershed? 

Type/Form: Exploring Potential Trading Opportunities Between 

Dischargers 

The hypothetical TMDL provides Total Phosphorus load allocations for all dischargers located on 

the main stem of the Happy River. Lucky Creek, where AAA Corp. discharges, has a phosphorus 

TMDL in place and AAA is subject to a WLA. Because these dischargers have allocations for the 

same form of phosphorus, and their loads have reasonably similar form characteristics, they will 

be sufficiently matched to proceed with further consideration of trading. 

The following examples of potential trades illustrate how pollutant form and type play a role in 

assessing the viability of trading in a watershed. 

Pleasantville POTW and Hopeville POTW. The discharges from the two POTWs located at 

Pleasantville and Hopeville contain a similar combination of both soluble and non-soluble 

attached forms of phosphorus. Because the discharges will be measured using the same form of 

phosphorus (Total Phosphorus) and the actual forms discharged are also very similar, trading 

opportunities between these two sources can exist. 

Herb’s Farm and Pleasantville POTW. Herb’s Farm is the only farm located on the irrigation 

district drain flowing into the Happy River at RM 570. Although the phosphorus entering the 

river through this agricultural drain is likely to be primarily the non-soluble sediment attached 

form, Total Phosphorus will be the form measured to monitor compliance with the TMDL load 

allocations. The discharge from the Pleasantville POTW, which contains a different combination 

of actual phosphorus forms than the Herb Farm drain, will also be measured and reported in units 

of Total Phosphorus. Although both dischargers will be measuring and reporting the same form 

of phosphorus, this trade might raise concerns because these sources are discharging different 

combinations of phosphorus forms. However, in practice, the trade is not likely to create localized 

impacts, and trading opportunities between these two sources can exist. 

Easyville Dam and Hopeville POTW. Easyville Dam has a load allocation for dissolved oxygen 

(DO), not for Total Phosphorus (TP). Phosphorus loading in the Happy River above the dam 

contributes to nuisance aquatic growth in the reservoir, which is the major cause of violations of 

water quality standards related to DO. Hopeville POTW has a waste load allocation for Total 

Phosphorus. The operators of the dam have expressed interest in substituting upriver TP 

reductions for more direct DO enhancement efforts in the reservoir (e.g., direct oxygenation) to 

meet its allocation. A clear causal relationship does exist between phosphorus loading and DO 

levels, and the TMDL modeling provides a basis for developing a translation ratio to support TP to 
Water Quality Trading Assessment Handbook.....................................................................

12

DO trading. If a reliable translation ratio can be established between the two types and the two 

sources, trading opportunities between these two sources can exist. In the absence of such a 

translation ratio, however, Easyville Dam would lack the basis for trading in the Happy Basin 

market. 

Figure 1.4, Chart of Sources with Type of Pollutant in TMDL, and Type of Pollutant actually 

discharged. 

Location

River Mile As Addressed by 

TMDL

As Discharged

(% Soluble/ % 

Non-Soluble)

Herb's Farm 570 Total Phosphorus 30/70

Pleasantville 567 Total Phosphorus 90/10

Acme Inc. (Nirvana Creek Confluence) 547 Total Phosphorus 100/0

Hopeville 546 Total Phosphorus 90/10

AAA Corp. (Lucky Creek Confluence) 544 Total Phosphorus 100/0

Ortho Company 541 Total Phosphorus 100/0

Laughing Larry's Trout Farm 489 Total Phosphorus 50/50

Name of Discharge Source, Diversion, 

Agricultural Drain, or Tributary

Form of Pollutant

STEP THREE: DETERMINE THE POTENTIAL ENVIRONMENTAL 

EQUIVALENCE OF DIFFERENT DISCHARGE POINTS

The purpose of Step Three is to evaluate the location of potentially tradable discharges 

and relevant receiving water conditions to determine whether the environmental impact is 

equivalent. Environmental impact is the second of the four factors that must be aligned 

for trading to be viable. Your Step One watershed discharge information will give you the 

location of the pollutant discharges. Participants must be able to establish that the trade 

would result in the same (or better) environmental improvement in the receiving water if 

pollutant loadings are reduced in the seller’s discharge rather than in the buyer’s. 

Two related factors influence environmental equivalence. First, the fate and transport 

characteristics of a pollutant (e.g., how it behaves in a river system) must be considered. 

Second, the unique conditions of the watershed must be evaluated. The pollutant’s 

concentration or presence and its effects on water quality may vary greatly as it moves 

from upstream to downstream. For example, a pound of phosphorus discharged into a 

river can “disappear” as it travels down a river through uptake by aquatic plants, settling 

out, and/or water diversion for agricultural or other uses. This can diminish the 

environmental value of a purchased pollutant reduction as it travels downstream. 

Purchasers therefore may be required to buy more total loading reduction from other 

sources than would have been required at their discharge point . Some trading systems 

use pollutant “equivalence ratios”, or similar mechanisms, to establish the necessary 

environmental equivalence relationships. In these systems, each source or trade 

transaction is assigned a ratio to account for the effects of inputs, withdrawals, and 
.....................................................................Water Quality Trading Assessment Handbook 

13 

diversions between the seller’s and buyer’s discharge points and all relevant compliance 

points. These ratios depend on pollutant parameter stability as well as the distance, river 

hydrology, and other relevant environmental conditions. 

In general, the greater the geographic distance between discharge points, the greater the 

chance of high volume pollutant uptake and settlement, and/or complex hydrology in the 

receiving waters between those points. Therefore, sources in close geographic proximity 

are more likely to be able to establish a straightforward environmental equivalence 

relationship. In some cases, the influence of diversions and tributaries may be too great 

to establish reliable impact relationships. 

Appendices A, B, and C of this Handbook provide information about the inherent 

characteristics of selected pollutants that is relevant to how they may behave in receiving 

waters. You will also need to collect information about relevant conditions in your specific 

watershed, such as the locations and volumes of major inflows and outflows. If necessary 

data or reliable models are lacking, or pollutant fate and transport characteristics are very 

complex, uncertain, or unknown, conditions for trading may not be favorable. 

How Ratios Are Used to Establish Environmental Equivalence

Most trading systems use equivalence ratios, or similar mechanisms, to adjust for the complex 

fate and transport characteristics of pollutants and variable watershed conditions. In these 

systems, each source or trade transaction is assigned a ratio to account for the effects of 

inputs, withdrawals, and other effects on the pollutant between the seller and buyer’s discharge 

points, and any other monitoring points, to assure the equivalent environmental impact from 

pollutants present in the water column. Ratios allow trading partners to adjust the amount of 

reductions to assure trades create environmentally equivalent outcomes at the point(s) of 

environmental concern. Ratios are often based on each source’s location along the river, 

tributary, or agricultural drain in relation to other market participants and/or designated instream 

compliance points. They can also be based on other site location factors that reflect the 

potential for further diversion and reuse of water below the point of discharge. Other site 

location factors for nonpoint sources include soil type and permeability, slope, vegetation, 

amount of rainfall, etc. Some demonstration programs use separate ratios to account for river 

location and other site location factors. Others use a composite ratio that accounts for all 

factors. 

The example of phosphorus helps illustrate why equivalence ratios are needed. A pound of 

phosphorus discharged upstream may not arrive as a pound of phosphorus at a given point

downstream. Some may be lost as the stream is diverted for agricultural use or for other water 

supply needs. Phosphorus can also drop out of the water column and be deposited as 

sediment, transmitted to groundwater through infiltration, or taken up by plants along the way. 

The ratio reflects the best estimate of the effect of a reduction that will be realized at the buyer’s 

discharge point, or other compliance points. For example, a 3:1 ratio indicates that for every 

three pounds of phosphorus released by a discharger, one pound will reach and have an 

environmental effect on water quality at the critical monitoring point. River location ratios are 

often calculated using modeling. Often, modeling (such as mass balance calculation) has 

already been used for TMDL development. 
Water Quality Trading Assessment Handbook.....................................................................

14

Answering the following questions will help you assess the potential environmental 

equivalence between discharges. Information to help answer these questions can be 

found in the Watershed Discharge Profile developed in Step One, in Appendices A, B, 

and C, and in relevant TMDLs. 

 Where are the discharges of the relevant pollutant? 

 Where are the major hydrologic inflows and outflows? 

 What are the general fate and transport characteristics of the pollutant? 

 How do river conditions, such as flow rate and temperature, affect the behavior and 

impact of the pollutants? 

 Is there a potential for localized impacts? Under what conditions? 

 What options need to be considered for establishing environmental impact 

equivalencies for different areas of the river? 

Water quality trading is one of several tools available to implement TMDLs. Trading 

requires understanding the effect of pollution reductions by sources at different points in 

the watershed. Trades that result in localized impacts and fail to meet water quality 

standards are not acceptable. It is possible to use predictive models to estimate the 

environmental equivalence of different discharges, but water quality monitoring will be an 

essential element in any trading program to ensure that water quality goals are achieved. 

Localized Impacts 

Some potential trades that could result in a general water quality improvement in a broad area 

may also result in acute, localized impacts. Trades that create “hot spots” -- localized areas 

with high levels of pollution within a watershed – should be avoided. The following factors 

should be considered. 

 Characteristics of the Pollutant-- 

› Each pollutant poses different risks to local water quality. 

 Watershed conditions-- 

› Areas that have no additional assimilative capacity for the relevant pollutant may 

show localized impacts if loads are increased. 

› Areas with low flows and/or a high capacity for retentiveness will be more likely to 

show localized impacts. 

› The presence of other pollutants will affect the potential for localized impacts. 

 Type of trade-- 

› Downstream trades (i.e., a source compensates a source downstream to 

overcontrol its discharge) have greater risks of localized impacts because if the 

buyer’s discharge exceeds its TMDL allocation, loads in the stream segment 

between the sources may be too high. 

› Upstream trades (i.e., a source compensates a source upstream to overcontrol its 

discharge) present lower risks because overcontrol by the upstream discharger 

will result in improvements to water quality beyond those specified in the TMDL in 

the segment between the sources. 

 Use of monitoring-- 

› Monitoring programs designed to support trading should identify potential 

localized impacts and provide for control regime modifications to mitigate impacts. 
.....................................................................Water Quality Trading Assessment Handbook 

15 

Environmental Equivalence: Exploring Potential Trading 

Opportunities Between Dischargers 

Information on the general fate and transport characteristics of phosphorus is provided in 

Appendix A. With that information in mind, you are ready to take a closer look at the specific 

conditions in the Happy River Basin watershed to assess the potential environmental equivalence 

and trading opportunities among dischargers. 

The following examples of potential trades illustrate how environmental equivalence can play a 

role in assessing the viability of trading. 

Herb’s Farm and Pleasantville POTW 

Herb’s Farm is the only identifiable source located on an agricultural drain that empties into the 

Happy River at RM 570. The Pleasantville POTW discharges nearby, only three miles 

downstream. Because of swift flowing water, no other intervening diversions or returns, and little 

plant life between the two sources, the equivalence ratio between the two dischargers is close to 

1:1. (Trades involving other sources will require calculation of separate ratios.) Because of the 

low equivalence ratio between Herb’s Farm and Pleasantville POTW, opportunities for water 

quality trading between these two dischargers can exist. 

Pleasantville POTW and Hopeville POTW 

The Hopeville POTW is located over 21 miles from the Pleasantville POTW. Between Hopeville 

and Pleasantville is one major agricultural diversion, which diverts 75 percent of the flow of the 

river. Because of the diversion and resulting slower river flow, as well as plant uptake and other 

factors, trades between Hopeville and Pleasantville will have a 5:1 ratio. 

There are two potential options for trading between the POTWs. One option is an “upstream 

trade,” in which Pleasantville overcontrols phosphorus reductions beyond its waste load allocation 

to create reduction credits. In this case, Hopeville would purchase reduction credits from 

Pleasantville. However, because of the 5:1 ratio, Hopeville would need to purchase five pounds of 

reductions at Pleasantville to achieve an equivalent reduction of one pound of phosphorus at its 

plant. (This may or may not be cost effective for Hopeville.) Pleasantville would then reduce its 

phosphorus discharges beyond its waste load allocation and water quality in the 21 mile segment 

would be improved beyond that specified by the TMDL. This trade should also result in improved 

water quality in the river segment below Hopeville. 

Another option is a “downstream trade,” in which Hopeville reduces its phosphorus discharge 

beyond its TMDL allocations and Pleasantville purchases reduction credits from Hopeville. In 

this example, Pleasantville would not meet its TMDL waste load allocation and this will result in 

no phosphorus reduction in the 21 mile segment between the two dischargers. However, water 

quality downstream of Hopeville would improve as a result of its overcontrol. A downstream 

trade such as this would satisfy the TMDL only if the water quality impairment occurs in the river 

segment below Hopeville and not between Pleasantville and Hopeville. It is possible that, 

Pleasantville’s TMDL waste load allocation was established to reduce its contributions to 

impairments below Hopeville. However, except in such unique circumstances, the elevated 

concentrations of phosphorous in the 21 mile segment between the sources is likely to cause 

unacceptable localized adverse impacts. 
Water Quality Trading Assessment Handbook.....................................................................

16

Laughing Larry’s Trout Farm and Hopeville POTW 

Laughing Larry’s Trout Farm is located downstream of Lake Content, the reservoir behind 

Easyville Dam. A reliable location ratio has not been established for the trout farm that would 

allow it to trade with any dischargers located upstream. The complexity of the river ecosystem 

increases significantly in this area of the Basin as water flows through the reservoir. The slower 

moving water promotes aquatic plant growth and higher retentiveness of phosphorus in this area. 

The fate and transport characteristics of phosphorus and the complexity of the watershed 

conditions make it difficult to predict how phosphorus reductions above the dam will affect water 

quality at locations below the dam. This high level of uncertainty will likely prevent development 

of a ratio allowing Laughing Larry’s to trade in the Happy River market area. 

STEP FOUR: DETERMINE THE POTENTIAL FOR ALIGNING THE 

TIMING OF LOAD REDUCTIONS AND REGULATORY TIMEFRAMES AMONG 

DISCHARGERS 

Timing is the third factor that must be in alignment for trading to be viable. In Step Two, 

you considered the variability among discharges in terms of the forms of a pollutant or 

types of pollutants. In Step Three, you considered the variability of geographic locations

in the watershed. In this step, you will consider how discharges from different sources 

vary across time and the implications of this variability for the viability of trading. Three 

timing dimensions must be considered. Alignment of all three is needed to match trading 

partners. 

Load variability: A discharger’s load is likely to vary from time to time. You will need to 

identify only major load variations that occur over the course of the year, not minor 

fluctuations in discharges. For example, some POTWs reduce discharges to zero by 

substituting land application during summer months. Some agricultural nonpoint sources 

have significant reductions of nutrient loadings during the winter months. One important 

consideration is whether the load allocations in the TMDL are seasonal or annual. 

Potential trading partners must meet TMDL timing requirements and also link up with 

other sources with similar discharge timing. Because of the effects of temperature and 

sunlight, for example, winter nutrient loadings have very different environmental impacts 

from summer loadings. 

Compliance determination variability: Because of the different considerations in 

establishing appropriate NPDES permit limits, as well as other factors such as the cost of 

monitoring, the temporal specifications for discharge monitoring and compliance 

determinations vary among dischargers (e.g., some have monthly limits, others have 

daily limits, and some have both). To be viable, a trade must be consistent with the time 

periods that are used to determine compliance with permit limitations or other regulatory 

requirements. For example, a point source with a permit that requires compliance with 

monthly average limitations will be able to trade only with a discharger who can 

demonstrate monthly reductions. 

Compliance deadline variability: For a viable trade, dischargers’ compliance deadlines 

must be reasonably aligned. For example, a potential purchaser may need to meet 

pollutant reduction requirements in 24 months. It may take twelve months to fund, install, 
.....................................................................Water Quality Trading Assessment Handbook 

17 

and fully implement the pollution control technology needed to meet those requirements. 

Such a potential purchaser cannot wait 18 months while a potential reduction provider 

verifies its own obligations, selects its mitigation option, and calculates any surplus 

reductions available for purchase. In some cases, potential market participants may 

have different compliance deadlines because they are located in nearby tributaries with 

different TMDL implementation schedules. 

Much of the information required to assess time dimension variability in Step Four will be 

found in the TMDL and NPDES permit language specific to each watershed and source. 

Appendices A, B, and C also include a discussion of the typical range of regulation for 

each pollutant. 

Answering the following questions will help determine the potential alignment of 

schedules in terms of seasonal requirements, metrics for pollutant limits, and deadlines 

for compliance. If participants are unable to align all three dimensions of time, trading 

may not be viable. It is not necessary for all sources in the watershed to align their 

compliance schedules; however, a sufficient number must be aligned to support one or 

more beneficial trades. 

 Permit and TMDL Compliance Periods- 

› Does the TMDL establish seasonal allocations or year-round reductions? 

› What units of time are used to define and monitor compliance with relevant 

permit limits? 

› What time period is used by non-permitted dischargers (e.g., nonpoint 

sources) to measure and, where applicable, report discharges? (Hourly, 

daily, weekly, annually?) 

› Do any sources have significant seasonal or other cyclical load variability? 

 TMDL Compliance Deadlines- 

› Has a TMDL implementation schedule been established? If so, do 

compliance schedules among major dischargers reasonably match up? 

› Are there other compliance deadlines (e.g., permit requirements based on 

national effluent guidelines) that must be considered? 

Timing: Exploring Trading Opportunities Between Dischargers 

Three types of timing issues present challenges to potential trading partners in the Happy River 

Basin. The following examples illustrate issues relating to (1) seasonal load variability, (2) 

compliance determination variability, and (3) compliance deadline variability. 

Herb’s Farm and Pleasantville POTW (load variability) 

Pleasantville POTW operates year-round, with some minor variation in the amount of phosphorus 

in its discharge. Herb’s Farm contributes to phosphorus loading in the river only during the 

growing season. In the winter, when farmland is frozen over, the farm contributes very little 

phosphorus. 
Water Quality Trading Assessment Handbook.....................................................................

18

If the TMDL required year-round load reductions to meet Pleasantville’s waste load allocations, 

Herb’s Farm would not be able to produce reductions for the entirety of the relevant time period. 

However, the Happy River phosphorus TMDL is typical of other phosphorus TMDLs and 

establishes only seasonal load allocations which are applicable between April and September. 

Therefore, opportunities for trading between these two dischargers can exist. 

Hopeville POTW and Pleasantville POTW (compliance determination variability) 

In this hypothetical, both POTWs are regulated by NPDES permits with limits expressed in 

similar temporal terms (e.g., monthly averages). These closely matched limits help support water 

quality trading opportunities between the POTWs. 

AAA Corp. (compliance deadline variability) 

AAA is located on Lucky Creek, a tributary to the Happy River. Lucky Creek has its own 

separate TMDL and implementation plan. AAA was given a waste load allocation under the 

Lucky Creek TMDL. The Lucky Creek and Happy River TMDL plans have different compliance 

deadlines, so there is a potential timing misalignment. If the TMDL for Lucky Creek had not yet 

been completed, AAA might not be able to participate in the trading market with Happy River 

dischargers. However, because the Lucky Creek TMDL has been completed, AAA currently has 

sufficient knowledge about its requirements. With this knowledge, they may be able to align the 

timing of their compliance efforts in order to participate. 

STEP FIVE: DETERMINE IF THE SUPPLY OF AND DEMAND FOR 

POLLUTION REDUCTION CREDITS IS REASONABLY ALIGNED WITHIN THE 

WATERSHED

The watershed discharge information developed in Step One should include quantities of 

the relevant pollutant discharged by the sources in the watershed. In this Step, that 

information will be analyzed to determine whether supply and demand are reasonably 

aligned. For trading to be viable, the quantity of reductions that can be supplied must 

meet or exceed the quantity of reductions needed to ensure compliance. 

Demand for reductions is driven by current and future loads (what dischargers are 

currently discharging or expect to discharge in the future), as compared to target loads 

(what the TMDL allows sources to discharge). For individual nonpoint sources, 

estimates of these quantities are not normally specified in the TMDL, and so will need to 

be calculated, using aggregated nonpoint discharge data from the TMDL along with other 

information, such as data developed by soil conservation districts. The TMDL will provide 

information about current and target loads from inflows and tributaries. Methodologies for 

calculating historical, current, and target loads for individual non-point sources along 

each inflow and tributary may differ from watershed to watershed and from state to state. 

These calculations may have a high degree of uncertainty, but can produce a valuable 

rough understanding of the supply and demand dynamics in the watershed. 

Supply is dictated by a discharger’s ability to “overcontrol,” or reduce its discharges below 

the target load specified by the TMDL. The volume of reductions achieved beyond TMDL 

obligations represents the stock of potential surplus reductions available for exchange 

with other parties. The increments, or range, of reductions demanded and supplied will 
.....................................................................Water Quality Trading Assessment Handbook 

19 

determine whether a match is possible. The quantity of reductions that may be supplied 

is determined by the efficacy of control techniques and management methods available 

to sources. These techniques and methods include altering industrial product production 

levels or land management practices, substituting inputs such as raw materials and 

agricultural chemicals, or investing in new technology. 

In the next chapter, the financial feasibility of various control options are examined as a 

factor in projecting supply and demand. At this stage, answering the following questions 

will help develop an initial understanding of the supply and demand dynamics in the 

watershed. If it appears that the supply of reductions can reasonably meet the demand, 

then trading may be a viable tool to address water quality problems. 

 For each relevant discharger, what are the quantities of current/future loads 

compared to target loads? 

 For each discharger, what is the capacity to provide reductions beyond applicable 

required TMDL load allocations (i.e., do they have the technical capacity to generate 

overcontrol)? 

Supply and Demand: Exploring Trading Opportunities Among 

Dischargers 

It is often difficult to project the balance of supply and demand for reductions. In the Happy Basin 

hypothetical, you have a general idea of the total amount of reductions needed by all sources to 

meet TMDL load allocations. In the next chapter on Financial Attractiveness, the Handbook will 

examine how differing costs of control options may make some sources likely buyers and others 

likely sellers. But even at this stage, some early supply and demand patterns begin to emerge. 

The following examples illustrate how supply and demand plays a role in assessing the viability of 

trading. 

Acme Inc. and Hopeville POTW (Supply and Demand in Balance) 

Hopeville has projected that it will need to reduce phosphorus discharges by 12 pounds per day to 

meet TMDL target allocations. (See Figure 1.5, Chart of Sources with total reductions needed by 

Happy River dischargers.) Hopeville may consider purchasing reduction credits from Acme Inc. 

rather than investing in control technology that is projected to produce considerably greater 

pollutant loadings reductions than it needs. To meet its load allocation, Acme also expects to 

install control technology with potential to overcontrol, thus generating potentially saleable 

reduction credits. Other dischargers in the Basin also have potential to generate a sufficient 

supply of reduction credits to meet Hopeville’s demand. 
Water Quality Trading Assessment Handbook.....................................................................

20

Ortho Company (Demand outstrips Potential Supply) 

Ortho Industries, located at River Mile 541, is a major discharger of phosphorus. To meet its 

TMDL waste load allocations, Ortho will need to reduce its discharges by about 990 lbs./day. 

Ortho is considering an on-site control option that will meet its allocation. It is also considering 

purchasing reductions from other dischargers in the Basin. For cost reasons, Ortho has decided to 

focus on a “one size fits all” control technology package. There is no available alternative that 

would allow for a blended strategy that includes the use of both a less effective, less costly 

technological treatment control option and purchased reductions from other dischargers. Ortho 

must choose trading or on-site control. As Ortho considers purchasing reductions from other 

dischargers, it will need to project whether the potential supply of reductions will meet its demand 

(i.e., enable it to comply fully with its waste load allocation). The calculated ratios needed to 

ensure environmental equivalence are likely to at least double the reduction needed, increasing 

Ortho’s demand to approximately 2000 lbs./day. Using Figure 1.5, Chart of Sources, you can 

calculate that it will be almost impossible for the remaining dischargers in the Basin to create a 

sufficient supply of reduction credits to meet Ortho’s demand. Even if all other sources reduced 

their phosphorus discharges to zero, the supply of reduction credits generated by such overcontrol 

would total only about 1900 lbs./day. Ortho can see that trading will not be an option for its 

compliance plan because the supply of reductions cannot meet its demand. 

STEP SIX: REVIEW THE RESULTS OF STEPS ONE THROUGH FIVE 

TO COMPLETE THE POLLUTANT SUITABILITY DETERMINATION

Before moving on to the next chapter, review the outcome of the suitability analysis in the 

five steps above. Pollutant suitability requires a high potential that all four suitability 

factors will be in alignment for at least two market participants. If any one of the five 

Pollutant Identification steps (i.e., watershed discharge profile, type/form, location, timing, 

and supply/demand) show low potential for alignment, the pollutant is probably not 

suitable for water quality trading in this watershed. Unless the pollutant has a medium to 

high potential for all four factors, further analysis to assess water quality trading of this 

pollutant in your watershed is probably not warranted. However, the user may wish to 

consider whether other pollutants discharged by sources in the watershed may have 

potential trading. 
.....................................................................Water Quality Trading Assessment Handbook 

21 

Figure 1.5, Complete Discharge Profile with all pertinent information 

Location

River Mile

As Addressed by 

TMDL

As 

Discharge

d

(Soluble/N

onSoluble)

Discharge (e.g., 

seasonal, cyclical, 

etc.)

Obligation 

(Regulatory)

Baseline 

Load*

(lbs./day)

Current 

Load*

(lbs./day)

Target 

Load*

(lbs./day)

Total 

Reduction 

Needed*

(lbs./day)

Herb's Farm 570 Total Phosphorus 30/70 Seasonal June-Sept. 632 753 527 226

Pleasantville 567 Total Phosphorus 90/10 Year-round June-Sept. 760 791 633 158

Acme Inc. (Nirvana Creek Confluence) 547 Total Phosphorus 100/0 Year-round June-Sept. 492 547 410 137

Hopeville 546 Total Phosphorus 90/10 Year-round June-Sept. 60 62 50 12

AAA Corp. (Lucky Creek Confluence) 544 Total Phosphorus 100 Year-round June-Sept. 199 195 166 29

Ortho Company 541 Total Phosphorus 100 Year-round June-Sept. 786 1645 655 990

Laughing Larry's Trout Farm 489 Total Phosphorus 50/50 Seasonal June-Sept. 185 250 154 96

Name of Discharge Source, Diversion, 

Agricultural Drain, or Tributary

Form of Pollutant Timing Quantity

Outcome of Six Step Suitability Analysis 

Of the seven Happy Basin sources identified at the beginning of the Six Step Suitability analysis, 

five appear to reasonably meet the four suitability factors; while two appear to be unlikely trading 

participants because they cannot match a key trading suitability factor with other sources. 

 Laughing Larry’s is located downstream of the Easyville Dam. Its location involves complex 

factors that prevent definition of a reliable relationship with other dischargers to ensure 

environmentally equivalent water quality improvements. (Trading Suitability Factor: 

Environmental Equivalence) 

 Ortho Company will require more pollution reductions than could possibly be generated from 

all the sources in the basin when likely trading ratios are factored in. Its demand far outstrips 

potential supply. (Trading Suitability Factor: Supply/Demand) 

In the next chapter, the remaining five sources will be further examined to assess if trading will be 

financially attractive for dischargers in the Happy River Basin. 
Water Quality Trading Assessment Handbook.....................................................................

22

Financial Attractiveness 

Purpose 

Financial attractiveness is the second major consideration in assessing water quality 

trading potential in your watershed. This chapter reviews the financial relationships 

affecting the viability of trading. The potential economic gains associated with trading 

are influenced by factors specific to the watershed as well as factors external to the 

watershed. Because the relevant financial relationships are often nuanced and dynamic, 

this section can offer only the foundation needed to begin examining current financial 

relationships in the watershed and their sensitivity to different assumptions. This chapter 

will help answer the following questions: 

 What makes water quality trading financially attractive? 

 How can I measure financial attractiveness? 

 Where can I find the data? 

 What could the analysis mean for my watershed? 

 What should I do next? 

After reading this chapter, considering the examples provided, and employing the tools or 

methodologies discussed, the watershed participant will be able to screen out unlikely 

trading scenarios and make an informed decision as to whether further pursuit of 

pollutant trading is warranted. Although this chapter discusses detailed calculations, a 

rigorous analysis will not typically lead to a definitive answer. However, the reader will be 

able to locate an individual trade’s position along a relative continuum of financial 

attractiveness, from “high” to “low”. This chapter will also help improve the reader’s 

ability to discuss water quality trading with other watershed participants by creating a 

common “language” to describe their needs and issues. In watersheds across the 

country, people are talking with one another and developing new, non-traditional ways to 

“trade” and solve their problems. Understanding the financial challenges potential trading 

partners face can help you identify such opportunities in your watershed. 

Approach 

This chapter reviews the primary drivers of financial attractiveness and describes the 

steps for conducting an analysis to assess those drivers in a specific situation. First, the 

Handbook suggests investigating a discharge source for which the necessary data are 

relatively accessible. The investigation includes building a basic model assessing the 

source’s current and future costs for controlling the relevant pollutant(s). With this basic 

understanding of the financial considerations for one source, the reader is encouraged to 

compile data for other sources in the watershed. Data collection strategies and data 

formatting are considered. Finally, this chapter details the factors that influence the 

strength of financial attractiveness and how to incorporate them into an analysis. 

Possible barriers to a viable trading market are discussed. Certain types of trades will 

present themselves as relatively straightforward, easy to execute, and financially 

beneficial to all parties. Other potential trades will be more difficult and may not result in 
.....................................................................Water Quality Trading Assessment Handbook 

23 

cost savings. For example, two point sources of phosphorus, located a quarter-mile 

apart, and facing large differences in their control costs likely will uncover a compelling 

case for trading. On the other hand, two sources at opposite ends of a complex 

watershed, attempting to control temperature, and sharing only moderately different 

control costs are unlikely to obtain any advantages from trading. The ability to 

differentiate scenarios systematically will help watershed participants use trading wisely 

as a tool to improve water quality at lower cost. Throughout this chapter, the Happy 

River Basin hypothetical will be used to illustrate the analytical process and some of the 

common barriers. 

The economic models, financial models, and analysis techniques provided in this chapter 

are, by design, very basic. They will help you screen your watershed for financial 

attractiveness at a very general level and provide you with the basic ability to gauge 

whether you have low, medium, or high financial opportunities. Pilot projects have 

indicated that conducting more precise and in-depth analysis will typically involve a 

substantially increased level of effort and will quickly move outside the realm of readily 

available data. The tools provided in this chapter have been well tested, do not require 

sophisticated economic modeling skills to implement, and are fully sufficient for basic 

screening purposes. More precise analysis will typically require in-depth interaction with 

individual discharge sources and may quite quickly encounter barriers related to 

proprietary business information. As a result, this more in-depth work will often be best 

conducted by individual sources in the context of specific trade negotiation activities. 

What Makes Water Quality Trading Financially Attractive? 

The financial attractiveness of pollution trading is created by differences in the pollution 

control costs faced by individual dischargers. These differences may make it possible to 

improve water quality at lower cost overall by allowing pollution dischargers facing high 

control costs to pay dischargers with lower cost control options to “overcontrol” their 

discharges. “Overcontrol” as used herein means reducing a pollutant discharge below 

the target load specified by the watershed’s market driver (typically a TMDL). The volume 

of reduced discharge below obligations represents the stock of potential surplus 

reductions available for exchange with other parties. Pollution overcontrol creates a 

“product” with buyers and sellers in a potentially competitive market that can encourage 

innovation and efficiency untapped by a conventional regulatory regime. 

To assess trading viability, a common measure is needed to assess the costs each 

discharger will face to comply with its requirements. Chapter One explained the need to 

identify a tradable commodity. Moving on to calculate the cost of producing the 

commodity in the form of surplus pollution reductions will show whether the relative cost 

efficiency of some dischargers’ control options can lead to economically efficient trades. 

Some pilot projects have used “incremental cost of control” as the common measure. 

Incremental cost of control is calculated as the average cost of control for the increment 

of reduction required for an individual source to achieve compliance. For example, if a 

discharger needs a 5 lbs./day reduction to comply but the only reasonably available 

technology costs $10 million and produces a 20 lbs./day reduction, then the incremental 

cost associated with the 5 lbs./day reduction is substantial relative to the average cost of 

reductions. Traditional average cost would divide costs by 20 lbs./day; incremental 

analysis divides the costs by 5 lbs./day and would be four times higher than average 

cost. As discussed earlier, incremental cost represents a good approximation of the 

upper-bound of a source’s willingness to pay others within their watershed to alter their 

discharging behavior. 
Water Quality Trading Assessment Handbook.....................................................................

24

STAGE 1: CALCULATING INCREMENTAL COST OF CONTROL FOR A 

SINGLE SOURCE

The first step to assess financial attractiveness is to calculate the incremental cost of 

control for each pollution source. You may have ready access to needed data for at least 

one source. (Gathering information from other sources is discussed later.) The following 

data are needed to calculate incremental cost of control: 

 The source’s current load; 

 The source’s TMDL (or equivalent) target load; 

 The source’s projected load on its required compliance date if no controls are 

implemented; 

 The source’s projected long-term future load (considering anticipated growth and 

other relevant factors); 

 Annualized cost of the control option(s) including capital investment and annual 

operating and maintenance (O&M) costs; and 

 Expected reductions achieved by the control option. 

Calculating the incremental cost then involves the following tasks. 

Task 1: Calculate Required Reductions 

A facility’s future discharge will be influenced by any changes in demand for the facility’s 

primary services or products (e.g., municipal sewage treatment, industrial production, or 

agricultural production). For a publicly owned wastewater treatment plant, discharge will 

likely vary as local population increases and/or the number and activity level of industrial 

users changes. Industrial sources may discharge more as production rises. An increase 

(or decrease) in discharge (and resulting reductions needed to maintain compliance) will 

affect needed reductions, incremental cost of control and, potentially, the financial 

attractiveness of trading in the watershed. 

The reductions needed to comply equal the discharger’s target pollutant waste load 

minus its current loads and any expected future loading increases. Both the projected 

load at the compliance date and the projected long-term future load should be calculated. 

Compliance dates and capital budgeting interact with changing demand to influence 

discharge control choices; therefore, multiple timeframes may require examination. The 

motivation for cost savings will materialize when a looming compliance date presents the 

possibility of enforcement and penalties if discharges are not reduced. Currently, NPDES 

permits implement TMDLs for point sources and typically give sources three to five years 

to control their discharge. This normally gives dischargers a window of opportunity to 

evaluate their options, select the best alternative, and implement it. In the Happy River 

Basin hypothetical, the NPDES permit holders have five years to comply. 

 

Water pollution control technology often represents a significant, fixed, long-term capital 

investment. If a discharge increases beyond the existing control technology’s ability to 

maintain compliance during its useful life, new investments may be required in the future. 

Sources therefore need to examine the implications of their available options over an 

extended period. 
.....................................................................Water Quality Trading Assessment Handbook 

25 

In the hypothetical, the sources project discharge volumes in five years for compliance 

requirements and in ten years for capital budgeting needs. Future discharge levels can 

be difficult to estimate. For the purposes of analysis, it may be best to create several 

scenarios with different levels of anticipated growth. Past pilot projects have used a 

system of “High,” “Moderate,” and “Low” growth trends. Current pollutant loadings may 

be estimated to increase at a constant rate over a specified period to estimate future 

loads and future required reductions. 

Hopeville’s Incremental Cost of Control

Projecting Hopeville’s Needed Reductions 

The Hopeville POTW currently discharges, on average, 4.1 million gallons of wastewater per day. 

Routine sampling results show that the Total Phosphorus (TP) concentration in the effluent is 2.99 

milligrams/liter. Converting gallons into liters and milligrams into pounds, the POTW’s current 

TP load is 62 lbs./day3. POTW managers believe their system could face demand increases 

between 1 percent and 8 percent, on average, over 10 years. Hopeville believes that a reasonable 

assumption is that moderate population and industrial growth will increase its TP load 3 percent 

annually over the next five years to 72 lbs./day. The TMDL assigns Hopeville a waste load 

allocation, or Target Load, of 50 lbs./day and this is an enforceable compliance requirement in its 

permit. The following table summarizes needed reductions at today’s current discharge, five years 

from now at the time permit compliance is required, and ten years in the future assuming 1 

percent, 3 percent, and 8 percent annual growth. 

As shown in the table, Hopeville needs to consider a wide range of potential reductions to meet its 

permit under the TMDL. At current discharge levels, the POTW needs to reduce TP discharge by 

12 lbs./day. Five years from now, when failing to comply has real economic consequences, 

Hopeville will need to have reduced its TP discharge by between 16 and 42 lbs./day, depending on 

demand for its services. Looking further into the future, Hopeville will need to generate between 

19 and 84 lbs./day of TP reductions to remain in compliance. For the purposes of examining 

financial attractiveness, you will focus on reductions needed in five years for compliance and 

assume that Hopeville will experience moderate growth. Therefore, the assumption is that 

Hopeville will be generating 72 lbs./day of TP and will have to reduce that discharge by 22 

lbs./day in five years. 

 

3

 1lb = 453592.37 milligrams and 1 gallon =3.785411784 liters 
Water Quality Trading Assessment Handbook.....................................................................

26

Figure 2.1, Hopeville’s POTW Load Projections 

Current

Discharge

Annual 

Growth TP Load

Target 

Load

Reduction 

Needed

62 0% 62 50 12

62 1.0% 66 50 16

62 3.0% 72 50 22

62 8.0% 92 50 42

62 1.0% 69 50 19

62 3.0% 83 50 33

62 8.0% 134 50 84

Current Baseline

5 years (Compliance Date)

10 years (Capital Budgeting)

Hopeville POTW Load Projections

(lbs./day)

Task 2: Examine Control Technology Options 

The next task is to examine available technologies’ ability to control the pollutant 

discharge and the associated costs. Multiple technologies and mitigation approaches 

may be available to each source to help address water quality impairments. The cost 

and efficacy of control options varies. Usually, more control equals greater cost. 

Moreover, current control technology often achieves reductions by removing pollutants in 

large increments. Some control technologies will, therefore, produce the needed 

reduction increment and a (significant) additional increment for little or no additional cost. 

As control needs increase past the technology’s ability to control pollution, the facility may 

need to invest in more control and/or take the next “technology step.” 

Hopeville’s Technology Options 

Hopeville’s wastewater treatment engineers have identified three technologies that could reduce 

phosphorus discharge from their POTW and offer a range of control. Advanced Primary 

Treatment (APT) is capable of removing 16 lbs./day. After an investment in APT, the next “step” 

is Biological Nutrient Removal which would remove an additional 24 lbs./day. Finally, additional 

aeration basins and secondary clarifiers would eliminate 55 lbs./day of additional total 

phosphorus. 

Task 3: Calculating Incremental Reductions Needed for Compliance 

When a technology step (or combination of steps) fails to generate, at a minimum, the 

total reduction needed, a source may be forced to consider investment in an additional 

technology step, even though this would produce more reductions than are needed. To 

evaluate its options, Hopeville generated the following table for its 5-year projection. 
.....................................................................Water Quality Trading Assessment Handbook 

27 

Figure 2.2, Hopeville’s POTW 5-Year Projection 

Annual

Growth

TP

Load

Target

Load

Total

Reduction

Needed

Reduction

Achieved

Cumulative

Reduction

Achieved

Incremental 

Reductions

Needed

for

Compliance

1.0% 66 50 16

 Step 1 16 16 0

 Step 2 22 38 N/A

 Step 3 30 68 N/A

Annual

Growth

TP

Load

Target

Load

Total

Reduction

Needed

Reduction

Achieved

Cumulative

Reduction

Achieved

Incremental 

Reductions

Needed

for

Compliance

3.0% 72 50 22

 Step 1 16 16 6

 Step 2 22 38 N/A

 Step 3 30 68 N/A

Annual

Growth

TP

Load

Target

Load

Total

Reduction

Needed

Reduction

Achieved

Cumulative

Reduction

Achieved

Incremental 

Reductions

Needed

for

Compliance

8.0% 92 50 42

 Step 1 16 16 26

 Step 2 22 38 4

 Step 3 30 68 N/A

High Growth

Low Growth

Moderate Growth

Hopeville POTW 5-Year Projection

(lbs./day)

Hopeville’s Incremental Reductions Needed for Compliance 

Under low growth assumptions, Hopeville faces a reduction need of 16 lbs./day. As the table 

demonstrates, APT generates 16 lbs./day of reductions, the exact volume of reductions required by 

the TMDL. If the POTW implemented this control technology, compliance would be reached and 

there would be no incremental reductions needed. However, under moderate growth estimates, the 

TMDL would require Hopeville to reduce its discharge by 22 lbs./day. The difference between 

the reductions achieved with APT (16 lbs./day) and the total reductions needed (22 lbs./day ) 

would equal 6 lbs./day. These represent the incremental reductions needed for compliance. 

Similarly, under high growth assumptions, implementing APT and Biological Nutrient Removal 

would generate 38 lbs./day of reductions, while Hopeville would be required to reduce its TP 

discharge by 42 lbs./day. Under these assumptions, the POTW would fall short of compliance and 

need 4 lbs./day of incremental reductions. 
Water Quality Trading Assessment Handbook.....................................................................

28

Task 4: Calculating Annualized Control Costs 

To estimate the anticipated annualized cost of each control option, you will need to total 

the annualized capital cost and the annual O&M cost. 

 Annualized capital cost is the total cost (including associated finance charges) 

incurred for installing a control option divided by the control option’s useful life. 

 Annual O&M cost should include but not be limited to monitoring, inspection, 

permitting fees, waste disposal charges, repair, replacement parts, and 

administration. 

The following worksheet describes the calculations4

: 

Cost of Installing Control Option (1)

Time Period of Financing (Expressed as years) (n)

Interest Rate for Financing (Expressed as a decimal) (i)

Annualization Factor* (2)

Annualized Capital Cost [Calculate (1)x(2)] (3)

Annual Cost of Operation & Maintenance** (4)

Total Annual Cost of Control [(3)+(4)]

** For recurring costs that occur less frequently than once a year, pro rate 

the cost over the relevant numbers of years (e.g., for pumps replaced once 

every three years, include one-third of the cost in each year).

* Appendix D contains the Annualization Factor for a range of interest rates 

and time periods

Calculation of Annualized Control Costs

The appropriate interest rate will depend on the facility’s ability to access financing. 

Public treatment works may have access to grants and revolving funds designated for 

water quality infrastructure improvements. Currently, the EPA and state funded Clean 

Water State Revolving Fund issues loans at rates between 0 percent and market rates, 

with approximately 2.5 percent being average. In some circumstances, certain private 

entities are also eligible for loans from these below market funds. Borrowers from the 

capital markets currently face interest rates of approximately 6 percent. 

 

4

 As previously mentioned, the models and tools in this chapter provide you with general screening capabilities. 

In certain cases, an investment made in control technologies may be phased in over several years. This 

potentially affects your annualized cost calculation. When analyzing a phased investment, the precision of your 

analysis will increase by appropriately modeling each phase of the project and summing the individual results in 

a logical manner. 
.....................................................................Water Quality Trading Assessment Handbook 

29 

Hopeville’s Annualized Control Costs 

Hopeville is analyzing its control costs based on installing APT. The equipment costs $332,468 to 

install (1) and will be financed through a municipal bond backed by Hopeville’s water and sewer 

fees over a 10-year period (n). Currently, similar bonds issued by comparable municipalities pay 

4.5 percent (i). The Annualization Factor for a 10 year financing period at 4.5 percent is .1264 (2); 

therefore the annualized Capital Cost equals ($332,468) multiplied by (0.1264) or $42,024 per 

year (3). The O&M costs for this option are estimated to total $14,008 (4) annually. Therefore it 

will “cost” the POTW $56,032 each year to control their discharge and maintain compliance by 

investing in APT. 

Task 5: Calculating Incremental Control Cost 

The final task is to divide annualized costs by the incremental reductions needed for 

compliance. This should be done for each relevant time period (e.g., 5 years and 10 

years) under each growth scenario. Hopeville analyzed its three options for the POTW 

and produced the following table for its five-year projection. 

Figure 2.3, Hopeville’s POTW 5-Year Projection Including Costs 

Control 

Option

Annual 

Growth TP Load

Target 

Load

Total 

Reduction 

Needed

Reduction 

Achieved

Cumulative 

Reduction 

Achieved

Incremental 

Reduction

Needed

for

Compliance

Control Increment

Capital/O&M 

Incurred 

Annualized

Incremental

Control

Cost

Average

Control

Cost

1.0% 66 50 16 16

 Step 1 16 16 0 $56,032 $9.59 $9.59

 Step 2 22 38 N/A $219,022 N/A $27.28

 Step 3 30 68 N/A $339,450 N/A $31.00

Control 

Option

Annual 

Growth TP Load

Target 

Load

Total 

Reduction 

Needed

Reduction 

Achieved

Cumulative 

Reduction 

Achieved

Incremental 

Reduction

Needed

for

Compliance

Control Increment

Capital/O&M 

Incurred 

Annualized

Incremental

Control

Cost

Average

Control

Cost

3.0% 72 50 22 22

 Step 1 16 16 6 $56,032 N/A $9.59

 Step 2 22 38 N/A $219,022 $100.01 $27.28

 Step 3 30 68 N/A $339,450 N/A $31.00

Control 

Option

Annual 

Growth TP Load

Target 

Load

Total 

Reduction 

Needed

Reduction 

Achieved

Cumulative 

Reduction 

Achieved

Incremental 

Reduction

Needed

for

Compliance

Control Increment

Capital/O&M 

Incurred 

Annualized

Incremental

Control

Cost

Average

Control

Cost

8.0% 92 50 42 42

 Step 1 16 16 26 $56,032 N/A $9.59

 Step 2 22 38 4 $219,022 N/A $27.28

 Step 3 30 68 N/A $339,450 $232.50 $31.00

Medium Growth

High Growth

Low Growth

Hopeville POTW 5 Year Projection

(lbs./day)
Water Quality Trading Assessment Handbook.....................................................................

30

Hopeville’s Incremental Control Cost 

As noted earlier, Hopeville’s “Step 1” control option generates the exact number of reductions 

needed for compliance under low growth assumptions. Therefore, the incremental control cost for 

Step 1 is equal to $56,032 (the annualized cost) divided by 16 lbs./day (the incremental reduction 

needed for compliance with no additional control) or $9.59/lb./day.5 If the city experiences 

medium growth over the next five years, Step 1 will fall 6 lbs./day short and force Hopeville to 

implement both Step 1 and Step 2. The incremental control cost for Step 2 is equal to $219,022 

(the annualized cost of Steps 1 and 2) divided by 6 lbs./day (the incremental reduction needed for 

compliance using Step 1 control) or $100.01/lb./day. However, Step 1 and Step 2 together would 

not produce compliance under a high growth scenario. Consequently, the incremental control cost 

would be $339,450 (the annualized cost of Steps 1, 2, and 3) divided by 4 lbs./day (the 

incremental reduction needed for compliance using Steps 1 and 2) or $232.50/lb./day. 

STAGE 2: EXAMINING THE WATERSHED

As already discussed, the goal of water quality trading is to take advantage of differences 

in incremental control costs among sources in a watershed by allowing facilities facing 

higher costs to compensate those who can produce reductions at lower cost, thereby 

producing the same (or more) environmental benefit with less overall cost to society. 

Analyzing incremental costs for all dischargers in a watershed may be seen as a 

premature segmentation of the market into high cost reduction producers (likely buyers) 

and low cost pollutant reducers (likely sellers). However, at this time, the main focus of 

analysis should be to characterize the size of the incremental control cost differences 

present in your watershed. The differences in incremental control costs may be 

consumed by other financial and market factors that are discussed in Stage 3. At this 

time, you are concerned only with identifying the range of differences present based on 

different growth assumptions. 

Compiling Information from Other Sources 

The potential advantages of trading may motivate a variety of actors, both public and 

private, to investigate trading opportunities in the watershed. Analyzing trading potential 

therefore may involve compiling information from many sources, including family farms, 

POTWs, and publicly traded corporations. These potential market participants, while 

under pressure from the same market driver (e.g., the need to meet a TMDL allocation), 

may have different motivations for discussing water quality trading. In addition, 

incentives to share information with outsiders, like regulators or environmental groups, 

may vary. Engendering trust and being creative may help in acquiring needed data. (For 

example, Appendix E is a sample data sheet distributed to pollutant sources participating 

in a pilot project. This information was then compiled into spreadsheets used for a 

market assessment.) 

 

5

 Most pilot projects have chosen to denominate their costs in dollars/pound/day. Accordingly, the table divides 

the annualized control cost by 16 lbs. and 365 days. $56,032/16 lbs./365=$9.59. 
.....................................................................Water Quality Trading Assessment Handbook 

31 

Public Point Sources 

Ability to gather the needed control cost information for POTWs or other public point 

source dischargers is likely enhanced by public disclosure and information laws. Citizens 

are often entitled to obtain a wealth of information including planning documents and 

discharge data from individual industrial dischargers to the public system. Often, public 

facilities have required planning cycles for projecting future demands for service and 

preparing to cost-effectively manage community infrastructure needs. In addition, 

working directly with the POTW to obtain the pertinent information may help develop 

relationships beneficial to future trading efforts. 

Private Point and Non-point Sources 

Soliciting information from private sources is more challenging. Creating a water quality 

trading market is an unconventional approach to improving water quality which explicitly 

depends on the potential benefits of trading in a given watershed. In conventional 

markets, cooperation evolves during the exchange of goods and services when buyers 

indicate their willingness to pay and sellers exhibit their willingness to accept. 

Consequently, in a traditional market, information sharing is usually limited to negotiating 

a specific transaction. Analyzing the financial attractiveness of water quality trading 

requires sharing information prior to negotiating trades. The desired information includes 

potential reduction costs, which could give competitors clues about a facility’s future 

strategic plans. Wide dissemination of this information could reduce competitive 

advantages currently enjoyed by the local facility. In addition, detailed information on 

cost, market supply, and market demand for pollutant reductions may allow other market 

participants to capture larger shares of trade benefits. Therefore, both the information 

required to develop the watershed trading financial analysis and the results of that 

analysis may be perceived as potentially leading to financial losses. 

Private entities may be understandably reluctant to provide information considered 

business sensitive. It is even possible that some entities may attempt to secure 

bargaining power by providing inaccurate cost information. This could allow them to buy 

reductions at a price lower than their willingness to pay or selling reductions at prices 

higher than their actual willingness to accept. Although these incentives may muddy the 

financial analysis, private sources are unlikely to game themselves out of participating in 

a water quality trading market. 

Sources for Non-Point Source Cost/Pollutant Reduction Information 

In many cases, non-point sources have access to information resources pertinent to their 

likely costs. If they are unwilling or unable to share the information, non-point cost and 

pollutant reduction information will likely have to be pieced together from a variety of 

sources. Some trading pilot projects, like Tar-Pamlico in North Carolina, have completed 

studies and published them on the Internet. Other information sources include the U.S. 

Department of Agriculture’s Natural Resource Conservation Service, Agricultural 

Research Service, and agricultural extension programs at colleges and universities. 

Putting the Information Together 

As more dischargers are included in an analysis, complexity increases. The key to 

organizing the information is to ensure an “apples to apples” comparison. As discussed 

in the previous chapter, annual and seasonal TMDL allocations are often implemented 

through NPDES permit limits with daily, weekly, or monthly compliance metrics. In the 

hypothetical, as in many pilot phosphorus trading projects, the pollutant is measured in 
Water Quality Trading Assessment Handbook.....................................................................

32

pounds per day. Although translating between any two metrics is possible, you should 

verify that the analysis employs a common numerator and denominator for all sources. 

The format used below to analyze incremental cost of control in the hypothetical has 

been used in pilot trading programs. It is always wise, however, to tailor the format for the 

analysis according to the needs and skills of watershed participants. 

A Financial Snapshot of the Happy River Watershed

Combining the Needed Data 

Hopeville and its fellow sources exchanged the needed information and produced the following 

spreadsheet, cataloging each source’s incremental control cost in five years under a moderate 

growth scenario. Sources are listed from upriver to downriver and all possible technology steps 

for each source are listed. 

Figure 2.4, Happy River Watershed Combined Analysis 

Facility

Annual 

Growth

TP

Load

Target 

Load

Total 

Reduction 

Needed

Reduction 

Achieved

Total

Reduction 

Achieved

Incremental 

Reduction

Needed

for

Compliance

Control 

Increment

Capital/O&M 

Incurred 

Annualized

Incremental 

Control Cost

Average

Control

Cost

Potential

Surplus 

Reductions 

Available to 

Market

Pleasantville 3.0% 917 633 284

 Step 1 662 662 N/A 2,074,237 $ $20.01 $8.58 378

 Step 2 107 769 N/A 5,222,364 $ N/A $133.72 485

Herb's Farm 3.0% 873 527 346

Step 1 91 91 255 49,823 $ N/A $1.50 None

Step 2 623 714 N/A 464,444 $ $4.99 $2.04 368

Acme Inc. 5.0% 698 410 288 506 506 N/A 6,308,251 $ $60.01 $34.16 218

Hopeville 3.0% 72 50 22

 Step 1 16 16 6 56,032 $ N/A $9.59 None

 Step 2 24 40 N/A 219,022 $ $100.01 $27.28 18

 Step 3 55 95 N/A 339,450 $ N/A $31.00 73

AAA Corp. 7.0% 274 166 108 163 163 N/A 590,906 $ $14.99 $9.93 55

Medium Growth

5 Year Projection

(lbs./day)

STAGE 3: ANALYZING THE RESULTS

Task 1: Identifying Potentially Viable Trades 

The format used to compile incremental control cost information for the hypothetical 

watershed allows watershed participants to analyze a one-to-one pollution reduction 

purchasing relationship. The next step is to identify potentially viable trades. As 

demonstrated in the 5-Year Medium Growth Projection, the incremental control costs 

($/lb), in descending order, are: 
.....................................................................Water Quality Trading Assessment Handbook 

33 

 Hopeville $100.01; 

 Acme $60.01; 

 Pleasantville $20.01; 

 AAA Corp. $14.99; and 

 Herb’s Farm $4.99. 

Because trading allows facilities facing higher reduction costs to compensate those with 

lower reduction costs, sources theoretically would consider trading with any source below 

them on the list. Using this simple assumption, the following nine possible transactions 

appear to be financially attractive: 

 Hopeville compensates Acme Inc. to overcontrol; 

 Hopeville compensates Pleasantville to overcontrol; 

 Hopeville compensates AAA Corp. to overcontrol; 

 Hopeville compensates Herb’s Farm to overcontrol; 

 Acme compensates Pleasantville to overcontrol; 

 Acme compensates AAA Corp. to overcontrol; 

 Acme compensates Herb’s Farm to overcontrol; 

 Pleasantville compensates AAA Corp. to overcontrol; 

 Pleasantville compensates Herb’s Farm to overcontrol; and 

 AAA Corp. compensates Herb’s Farm to overcontrol. 

Task 2: Detailed Analysis 

Although the Preliminary Analysis may identify potential trades, assessing financial 

attractiveness on this basis alone requires making several assumptions. (The previous 

chapter discussed how unlikely some of these assumptions may be.) For example, one 

would have to assume that: 

 The effectiveness of the control technology selected is not variable; 

 Reductions in all locations in the watershed are environmentally equivalent; 

 Transaction costs are zero; 

 Reductions are certain to occur; and 

 The timing of all reductions will coincide with compliance mandates. 

The financial attractiveness of a trade is subject to deterioration as these and other 

complicating factors are included in the analysis. Pilot project experience indicates that 

an organized analysis is needed to add the relevant additional considerations as an 

overlay to the preliminary analysis. These additional considerations (discounts, ratios, 

transaction costs, and risk) are best investigated in ascending order of complexity. As 

each consideration is added to the analysis, the stakeholder can decide whether further 

effort to create a trading market is warranted. If the incremental cost differences become 

very small, thereby substantially reducing financial attractiveness, watershed participants 
Water Quality Trading Assessment Handbook.....................................................................

34

may decide that trading is not viable. If a reasonable level of financial attractiveness 

remains, additional factors can be considered. 

Uncertainty Discount Adjusted Incremental Control Cost 

Two types of pollutant reductions have been identified in pilot projects and the literature—

measured reductions and calculated reductions. Certain control technologies result in 

easily measured water quality improvements; ongoing monitoring effectively quantifies 

the actual reductions achieved. In some cases, however, measuring a control option’s 

impact on pollutant loading is either infeasible or very costly. Reductions for these 

control options are often estimated based on scientific modeling for the watershed. 

Loading reductions from Best Management Practices (BMPs) used by non-point sources 

are most likely to be calculated. 

BMPs perform differently based on a variety of site specific factors that may not be 

included in the model, introducing the chance for variable and unpredictable results. In 

pilot projects, the relatively variable and unpredictable performance of BMPs has been 

handled by discounting the associated estimated reductions available for trade. The 

uncertainty discount ensures that estimate errors in the BMP reduction equation (derived 

from the model) will not jeopardize the environmental equivalence between different 

types of pollutant reduction methods. The size of the discount will likely be driven by 

local conditions with input from stakeholders. To measure the uncertainty discount’s 

effect on the financial attractiveness of individual trades, you will need to recalculate the 

source’s incremental cost of control using the discounted reductions. 

Analyzing the Happy River Watershed

Pleasantville and Herb’s Farm 

Herb’s Farm can use its Step 1 and 2 control options -- sediment ponds and constructed wetlands – 

to control discharges from its fields and trade the overcontrol to Pleasantville. Research shows 

that, on average, these options could reduce phosphorus loadings from the farm by 623 lbs./day. 

At an annualized cost (based on the length of the growing season when the farm can generate 

reductions) of $464,444 the incremental control cost for Step 1 is $4.99/lb./day6. However, 

reductions by Herb’s Farm are likely to vary based on its unique (and sometimes unknown) 

characteristics. It would be too costly to measure the actual phosphorus reduction achieved on a 

daily basis. Potentially, stakeholders could ask that an uncertainty discount factor be applied to 

the projected reductions achieved. A 50 percent discount would mean, in effect, that the farm 

must produce 2 lbs. of projected reductions for every 1 lb. it wishes to trade. Consequently, from 

Pleasantville’s perspective, the total cost of achieving its needed increment of control through 

trading will increase because it will need to purchase more credits to achieve an environmentally 

equivalent reduction. The price per pound of reduction increases from $4.99 to $9.98, modestly 

eroding the financial attractiveness of a trade between Herb’s Farm and Pleasantville. 

 

6

 The cost per pound per day is based on the same incremental costs analysis performed for Hopeville. As per 

Figure 2.4, Herb’s Farm Step 1 reduces discharge by 91 lbs. The farm would need an additional increment of 

255 lbs. to comply with the TMDL. As such, to calculate the incremental control cost, the annualized cost for 

Steps 1 and 2 ($464,444) must be divided into 255 lbs. 
.....................................................................Water Quality Trading Assessment Handbook 

35 

Environmental Equivalence Ratios 

The water quality impact of a pollutant discharge varies depending on its location in the 

watershed. As discussed in the previous chapter on Pollutant Suitability, a discharge’s 

impact depends on the pollutant’s fate and transport as well as hydrologic conditions in 

the watershed. Environmental equivalence ratios must sometimes be established to 

ensure that the overall pollutant load does not impair beneficial uses of the river at 

specific monitoring points. But ratios can be distributed within a market to find the least 

cost pathway to achieving the load goal. 

Pilot projects have used different environmental equivalence ratio methodologies ranging 

from the simple to highly complex. Some have used a simple fixed ratio (i.e., 2-1) for all 

trades. Others have created an index system based on a mass balance model that 

accounts for inputs, withdrawals, and groundwater infiltration. In these systems, a 

compliance point downstream is used to index the fate and transport of the pollutant from 

upstream sources. Dividing Source A’s index by Source B’s index determines the ratio of 

reductions Source A would have to buy from Source B. 

Because these ratios can compare environmental equivalence only between two 

sources, it is difficult to present a comprehensive analysis of their effects on the financial 

attractiveness of trading for the whole watershed in a single spreadsheet. Watersheds 

with a large number of sources can be extremely complex. Ten potential trading sources 

would involve 54 trade permutations, many of which are not likely to prove viable. The 

goal of your analysis should be to identify “Alpha Trades,” those with potentially 

significant financial gains, and, therefore, strong financial attractiveness even after 

environmental equivalence ratios are introduced. As suggested by the previous chapter, 

Alpha Trades are not likely to involve sources separated by significant distances or 

sources with significant water diversions in the stream segment separating them. 

Alpha Trades that may merit analysis in the Happy River Watershed are: 

 Hopeville compensates Pleasantville to overcontrol; 

 Hopeville compensates Herb’s Farm to overcontrol; 

 Pleasantville compensates Herb’s Farm to overcontrol; and 

 Acme Inc. compensates Pleasantville to overcontrol. 

Environmental equivalence ratios can have a profound effect on financial attractiveness. 

As the ratio between buyer and seller increases, the volume of purchased reductions to 

maintain compliance increases, driving the cost per unit of purchased reduction higher. 

Conversely, as the ratio between buyer and seller gets smaller, cost per unit of 

purchased reduction falls. The following hypotheticals illustrate various key nuances of 

this relationship. 

Hopeville, Pleasantville, and Herb’s Farm 

Hopeville faces incremental control costs of $100/lb. Pleasantville is able to control for $20/lb. 

creating an incremental control cost difference of $80/lb. Financial attractiveness appears high 

assuming the reductions have an equivalent effect on water quality. However, as a mass balance 

model indicates, the long distance between the two sources and an intervening river diversion 

between create an environmental equivalence ratio of 5.0. Therefore, Hopeville must purchase 5 
Water Quality Trading Assessment Handbook.....................................................................

36

lbs. of reductions from Pleasantville for every 1 lb. of its own required reduction. The cost to 

Hopeville of a one pound reduction purchased from Pleasantville increases from $20 to $100, 

completely eroding any potential gains from the trade. 

In contrast, Herb’s Farm is able to overcontrol for $5/lb., creating an incremental control cost 

difference between Hopeville and the farm of $95/lb. The river diversion creates an 

environmental equivalence ratio of 3.0 between the POTW and the farm. Therefore, Hopeville 

must purchase 3 lbs. of reductions from Herb’s Farm for every 1 lb. of its own required reduction. 

In this case, the unit cost to Hopeville of a one pound reduction purchased from the farm increases 

from $5 to $15. The difference between Hopeville’s cost of controlling one pound of phosphorus 

or purchasing the environmental equivalent from the farm is ($100 minus $15) $85. This appears 

to be a highly attractive potential trade. 

Pleasantville’s close downstream proximity to Herb’s Farm means that almost every pound of 

phosphorus the farm can remove from the river achieves more environmental benefits than if 

Pleasantville made the pollutant reductions itself. Mass balance modeling shows that Pleasantville 

needs to purchase only six-tenths (0.6) of a pound of overcontrol for every pound of reduction it 

needs. The cost to Pleasantville per pound of equivalent reduction purchased from the farm would 

be $3 rather than $5. 

Acme and Pleasantville 

Environmental equivalence ratios in downstream trades can reverse the relationship between 

higher and lower incremental control cost sources. Acme’s index to the compliance point at the 

confluence of its tributary and the mainstem is (0.9). The large diversion downstream of 

Pleasantville means only a portion of the discharge from its facilities remain in the mainstem of 

the river at the compliance point. Pleasantville has received an index of (0.25). In this case, 

Pleasantville would need to buy a little over a quarter of a pound (0.25/.9=.2777) of reductions 

from Acme for every one pound of required reductions at its facility to lower the watershed’s 

Total Phosphorus at the compliance point. This means the unit cost to Pleasantville of a one 

pound reduction purchased from Acme is approximately $16.66/lb. $3.34 less than the $20/lb. 

Step 1 would achieve at Pleasantville’s own facility. Therefore, in this case, the lower cost 

producer of reductions may find it beneficial to purchase reductions from a higher cost source. 

Transaction Costs 

Transaction costs influence the financial attractiveness of a trade. Transaction costs 

represent all the resources needed to affect the trade, including information gathering, 

negotiation, execution, and monitoring. For a trade to be developed, at least one party 

must expend resources (usually time and effort) assessing the potential viability of the 

trade and communicating findings to the other party. To achieve the necessary “meeting 

of the minds,” discussions with the other party and additional key stakeholders (i.e., 

regulatory agencies and local interest groups) must be undertaken. These negotiations 

may involve staff time, travel expenses, and legal fees. Costs are later incurred in 

monitoring compliance with trade agreements and maintaining communications with 

stakeholders. 

It may be helpful to consider transaction costs in your financial attractiveness analysis. 

Transaction costs are highly variable, depending on such factors as the volume of 

trading, the infrastructure needed to facilitate trading, and the number and types of 

participants involved. Regulatory agencies may have significant influence on the relevant 

variables, and are therefore key controllers of transaction costs. Trading system 
.....................................................................Water Quality Trading Assessment Handbook 

37 

designers must be attentive to the transaction costs they design into each trading 

arrangement. Failure to adequately take account of financial realities by controlling 

transaction costs can diminish or even eliminate the potential benefits of trading. 

Several common tools can be used to estimate transaction costs. For example, Full 

Time Equivalents (FTEs) can be used to represent the salary and personnel overhead 

expenses of employees typically performing functions related to the trading market. In 

addition to assessing and negotiating a trade, employees will need to meet monitoring 

and reporting obligations related to the trade. New equipment needed for effluent and 

instream monitoring and data management may be needed and/or fees for laboratory 

analysis may be incurred. All these transaction costs of trading, along with the 

annualized capital and O&M cost for each control technology step, increase incremental 

control cost. To the extent that you are able to include these in your annualized costs, 

the precision of your in incremental control costs estimates will increase. 

Risk 

Risk is the final factor to consider in assessing the financial attractiveness of a trade. The 

first consideration is that efforts to create a trading system may or may not result in an 

approved trade. As already discussed, designing a water quality trade can be difficult 

and highly complex. The costs involved can be substantial. During initial design and 

negotiation, watershed participants are likely to reassess the chances of success 

continuously and will discount the value of a potential trade accordingly. For a trade to 

be viable, potential participants must believe that the financial benefits of the trade will be 

large enough to justify bearing the market risk. The timeliness and predictability of the 

decision processes prior to the first trade are therefore key leverage points to mitigate 

market risk and facilitate trading. 

The other dimension of risk is trade risk. In a water quality trading market, one party 

must rely on other party(s) to fulfill its obligations. Agreed upon terms of a trade may or 

may not be performed by the parties. If agreed upon reductions are not achieved and 

NPDES permit requirements are thereby violated, the purchaser of those reductions may 

face legal enforcement and monetary penalties. In the context of water quality trading, 

trade risk represents the expected cost of non-compliance and the perceived probability 

that such non-compliance will occur. Currently no entity provides third-party insurance 

policies for water quality trading. Because they must self-insure, watershed participants 

will value trade risk subjectively and mitigate for it by discounting the price paid for 

available reductions. 

The subjective valuation of trade risk limits your ability to estimate the trade risk 

markdowns watershed participants are likely to demand when negotiating a trade. At this 

point in your analysis, it may prove beneficial to discuss trade risk and the associated 

discounts with other watershed participants. Risk markdowns may be considerable in 

light of the large noncompliance penalties authorized by the Clean Water Act and the 

uncertainties surrounding trade risk. 

As you begin to examine risk and transaction costs, you may wish to review the likely 

incremental cost differences between parties after uncertainty discounts and location 

ratios are considered. If a substantial difference remains, it is likely that risk and 

transaction costs will erode only a portion of the remaining financial attractiveness of a 

trade. If uncertainty discounts and location ratios have already significantly eroded the 

difference in incremental control costs, the remaining financial attractiveness may well be 

entirely consumed by transaction costs, market risk, and the buyer’s trade risk 

markdown. 
Water Quality Trading Assessment Handbook.....................................................................

38

Implications of Transaction Costs, Risk, and Market Design 

Transaction costs and risk can be mitigated to some extent through thoughtful market 

design. Chapter 4 more fully describes the building blocks and key functions of a market 

and offers specific advice on how to tailor a market to its watershed’s unique 

characteristics. Many stakeholders may be involved, each with different needs. A highly 

constructive stakeholder will focus on designing a market that meets, at a minimum, two 

goals: 1) reduced risk and 2) lower transaction costs. Transaction costs are largely 

associated with collecting and communicating information and obtaining agreements and 

regulatory approvals. To the extent that trading arrangements are transparent and 

frictionless, costs and risks associated with communication and understanding can be 

reduced. Similarly, transparency and the free flow of information create stable 

expectations and outcomes for market participants. With fewer lurking “unknowns”, 

participants will feel less vulnerable in the marketplace and their required risk discount 

may shrink. 

Other Important Factors 

As you can see, the financial attractiveness of water quality trading may be highly 

nuanced by the considerations already addressed. Other factors may arise in your 

watershed based on its unique characteristics. The following are just two examples of 

watershed-specific considerations. 

Market Size 

Because pollution control technologies often produce reductions in large blocks, the 

water quality trading marketplace may be “lumpy”. Depending on how much reduction a 

potential buyer needs relative to what technology can deliver, this can limit or enhance 

financial attractiveness. If a discharger needs one pound per day of reductions to 

comply, but the only available control technology is very expensive and will produce 

reductions well in excess of one pound per day, then that discharger’s willingness to pay 

another party for that one pound of reduction could be very strong. On the other hand, if 

the same discharger needs 200 lbs./day, they will only be willing to purchase reductions if 

the entire 200 lb. reduction is reliably available. If that 200 lb. reduction is available only 

from diffuse sources with small individual surplus reductions, the associated transaction 

costs and risks may be so significant that trading is not viable. 

Missing the Market 

The ratio of fixed to variable costs associated with control options, combined with the 

timing of reduction demand and supply, will affect the financial attractiveness of a trade. 

If the discharger’s control option involves relatively high fixed costs, the incremental costs 

of control will differ dramatically before and after investment in that control option. Before 

investment, a potential reduction purchaser will calculate the incremental cost of control 

as the combination of the amortized fixed and the annual variable costs of control. Once 

the discharger invests in high fixed-cost controls, those fixed costs are “sunk” and he will 

calculate the incremental cost of control based only on his annual variable costs. As a 

result, any trades that were financially attractive before the investment, will have a greatly 

diminished incremental cost differential after the investment and may actually represent a 

negative financial return. 

It is especially important to consider the fixed/variable cost profile in cases where supply 

will lag behind demand. In such situations, the potential reduction purchaser will need to 
.....................................................................Water Quality Trading Assessment Handbook 

39 

comply (i.e., meet demand) by creating its own reductions, at least initially. If this 

discharger needs a high fixed cost control strategy to create these reductions, the 

financial attractiveness of any potential future trade will be altered, probably diminished. 

In effect, the parties will have missed the market unless potential reduction suppliers 

have low incremental control costs that can compete with the discharger’s lowered 

incremental control costs after its large fixed cost investment. In some cases, a 

discharger can use a high variable cost control strategy to create the reductions needed 

initially without incurring large fixed costs. In such cases, the discharger may still find it 

financially attractive to purchase reductions from another party in order to avoid 

continued implementation of its short-term, variable-cost control strategy (or in order to 

create additional margins for growth). 

Alternative Scenarios 

In light of the various factors influencing financial attractiveness and market participation, 

a watershed participant would be wise to assess market resiliency under alternative 

assumptions. This is especially important relative to the two factors that are likely to 

exhibit variability due to quantification difficulties and/or subjectivity—transaction costs 

and perceived risk. Spreadsheet programs allow for easy scenario playing, including: 

removing individual participants from the market; changing environmental equivalence 

ratios; or projecting alternative TMDL reduction requirements. Examining alternative 

scenarios may reveal, for example, that a large source unable to garner all reductions it 

needs from other watershed participants may decide to invest in controls and thereby 

eliminate almost all of the demand in the watershed, rendering trading unlikely or 

impossible due to insignificant remaining demand. You may discover other factors that 

could erode control cost differences beyond the level at which trading remains financially 

attractive. Identifying the most sensitive factors in your watershed will help you build a 

more robust understanding of trading viability in your watershed as well as highlight 

specific relationships to keep in mind as you move forward and design your market. 
Water Quality Trading Assessment Handbook.....................................................................

40

Market Infrastructure 

Purpose 

The first two chapters of this Handbook addressed the viability of trading based on 

pollutant suitability, watershed and discharger characteristics, and the financial 

attractiveness of likely trades. This chapter considers the infrastructure required to 

enable trading. This chapter will help answer the following questions: 

 What functions must a water quality trading market perform? 

 Why is each function important to the success of water quality trading? 

 What mechanisms have been used to perform these functions in demonstration 

trading projects? 

 What are the considerations in selecting appropriate mechanisms and integrating 

them into a market? 

After reading this chapter, considering the examples provided, and reflecting on what you 

have learned in the previous chapters, you will better understand the watershed’s unique 

market infrastructure needs, market mechanisms best suited for the watershed, and the 

commitment that may be needed to create a market. This Handbook does not provide a 

specific blueprint for creating a market, but does highlight challenges you will face and 

identify ways to benefit from lessons learned in other watersheds. With this information 

you will be better able to decide whether trading is viable and tailor a market to your 

watershed’s unique needs. 

Approach 

All viable markets, whether trading water pollutant reductions or widgets, must efficiently 

create benefits for its participants. “Markets” are social constructs facilitating interactions 

among parties interested in exchanging goods or services. Research indicates that 

successful markets evolve to reduce costs associated with: 

 identifying others willing to purchase or supply goods or services; 

 comparing the goods or services offered by other parties; 

 negotiating the terms of an exchange of goods and services; and 

 enforcing the terms of the exchange. 

A market is more likely to be successful if it has rules, procedures, and norms allowing 

parties to participate at a cost acceptable to everyone involved. Viable water quality 

trading (WQT) markets are no different from conventional markets in this regard. 

However, WQT markets are unconventional in the sense that they exchange goods 

(pollutant loading reductions) that are created primarily by (i.e., have value because of) 

regulations and administrative procedures. As such, WQT markets may require different 

and/or additional infrastructure to ensure environmental equivalence and practical 

enforceability, while providing the opportunity for cost savings. 
.....................................................................Water Quality Trading Assessment Handbook 

41 

This chapter of the Handbook will introduce you to the primary functions of a viable WQT 

market. These functions are to ensure that, along with satisfying the efficiency criteria for 

conventional markets, WQT markets provide for environmental equivalence and practical 

enforceability. 

Market development and transaction costs, as well as risks associated with various 

uncertainties, play an ongoing role in encouraging or suppressing market activity. These 

considerations, which collectively represent the degree of “friction” individual transactions 

face in the marketplace, should remain central to all infrastructure design decisions. 

Failure to manage market friction effectively will substantially constrain and may entirely 

stifle otherwise environmentally equivalent and financially attractive trades. 

As discussed in the previous chapter, potential WQT market participants may be 

challenged by a variety of market development costs, including those associated with 

analyzing the viability of trading in the watershed, developing and selecting options for 

market infrastructure, convening interested parties to discuss trading perspectives and 

options, and creating the infrastructure. Market development uncertainty – the risk that 

a market may not emerge – compounds these challenges. 

In addition to market development costs, transaction costs include information 

gathering, trade execution, and compliance monitoring efforts undertaken while trading is 

underway. These transaction costs will be driven largely by the procedures, trade 

execution methods, and tracking infrastructure established by the market for the 

watershed. Transaction uncertainty due, for example, to an unclear basis or timeframe for regulatory approvals will compound these costs. A market that needs trade-bytrade regulatory approval, for example, will be relatively costly and uncertain. There will 

be a constant risk that any particular trade will not materialize or will not receive 

regulatory approval in time to satisfy a source’s capital budgeting and/or compliance 

deadline constraints. 

High market development costs/uncertainty combined with high transaction 

costs/uncertainty produce substantial overall market friction. High market friction will limit 

activity to only very, very financially attractive trades. The market’s infrastructure will 

contribute to or reduce this friction. Therefore, the infrastructure designer’s goal is to 

create the smoothest transaction path consistent with regulatory requirements and water 

quality improvement goals. 

WQT markets are intended to provide for improved water quality at a lower societal cost. 

In most situations, market drivers are primarily concerned with attaining environmental 

goals and allow trading only as one option to further that effort. Federal, state, and local 

laws and the need for stakeholder involvement may require complex infrastructure 

mechanisms (monitoring regimens, auditing practices, public participation opportunities, 

etc.) that increase costs and may restrict and/or complicate market infrastructure design. 

For purposes of this analysis, you may think of these considerations as “regulatory 

friction”. When designing a WQT market you need to look for ways to minimize both 

market friction and regulatory friction. 

This chapter of the Handbook suggests ways to manage market and regulatory 

imperatives to encourage efficiency and increase the likelihood that trading will occur. To 

this end, three WQT models will be discussed based on how each model performs 

particular functions. Building on the information and analysis you were asked to develop 

in the previous chapters, this additional information will help you design an appropriate 

market infrastructure to perform the essential functions in your watershed. No particular 

approach is prescribed, but this chapter offers options and criteria to evaluate them. 
Water Quality Trading Assessment Handbook.....................................................................

42

Considerations: Market Sizing 

This section is intended to help you find ways to substantially reduce market and 

regulatory friction by appropriately sizing your market infrastructure to your watershed’s 

unique trading characteristics. The first two chapters of this Handbook, Pollutant 

Suitability and Financial Attractiveness, help you develop a solid understanding of where 

your watershed might be positioned along the water quality trading spectrum. At one end 

of the spectrum is a watershed with a single viable trade between two point sources who 

will experience modest financial benefits and are expected to sustain the trading 

relationship for the foreseeable future. At the other end of the spectrum is a watershed 

with an unknown number of viable trades among both point and non-point sources. 

These trades would be for limited durations and require frequent negotiations and 

approval, while potentially saving millions of dollars. For the watershed with only one 

viable trade, a market infrastructure consisting of a web-based trading platform linked to 

state agency databases would be unnecessary and so expensive that, if it were required, 

it would likely make the trade unattractive. On the other hand, if participants in the large, 

dynamic market were required to continually revise their NPDES permits to reflect every 

new trading arrangement, the costs and uncertainty in the market would diminish or 

eliminate the value of trading to many if not all of them. The following information and 

examples illustrate ways to tailor your “overhead” costs to the potential size of the market 

in your watershed. 

What Is Driving the Market? 

All markets evolve to help fulfill the demands of consumers. Consumers provide 

producers an opportunity to earn a profit for altering their behavior and attending to the 

market’s constantly changing demands for goods and services. Until a consumer 

decides they “need” a soda, and is willing to pay someone to produce it, there is no 

market for sodas. 

Total Maximum Daily Loads (TMDLs) are the leading market drivers for WQT markets 

today because they typically create the “need” to alter behavior by reducing pollutant 

loadings discharged to waterways. TMDLs and similar frameworks are sometimes 

described as “budgets” for the introduction of pollutants into watersheds. Scientific 

studies estimate the volume of discharge a specific watershed, or segment of the 

watershed, can assimilate without exceeding the water quality standards enacted to 

protect the watershed’s designated beneficial use(s). This “pollutant budget” is then 

allocated across point sources and non-point sources located in the watershed, as well 

as a federal mandated “margin of safety.” The allocation of discharge limits forces 

sources in the watershed to analyze current practices to see if they need to alter their 

discharging behavior and the associated options and costs to do so. 

Although the EPA Water Quality Trading Policy indicates, “[A]ll water quality trading 

should occur within a watershed or a defined area for which a TMDL has been 

approved,” the EPA’s 1996 Draft Framework for Watershed-Based Trading also 

acknowledges trading may be possible in equivalent analytical and management 

frameworks like the Lakewide Area Management Plans (LaMPs) and Remedial Action 

Plans (RAPs) found in the Great Lakes. The Water Quality Trading Policy also supports 

“pre-TMDL trading in impaired waters to achieve progress towards or the attainment of 
.....................................................................Water Quality Trading Assessment Handbook 

43 

water quality standards,” as well as “pre-TMDL trading that achieves a direct 

environmental benefit relevant to the conditions or causes of impairment to achieve 

progress towards restoring designated uses where reducing pollutant loads alone is not 

sufficient or as cost-effective.” This chapter assumes that your watershed has a TMDL, 

or similar framework, driving your interest in creating a WQT market. 

What Are the Essential Functions of a Water Quality 

Trading Market? 

Based on a review of the academic literature and the water quality trading projects 

conducted to date, a WQT market has at least eight essential functions. Various 

mechanisms can perform these functions. Market mechanisms are limited only by 

participants’ creativity, the regulatory environment, and the characteristics of the 

watershed. In some cases, specific mechanisms may perform more than one function, 

potentially increasing market efficiency. 

The eight essential functions are: 

1. Defining marketable reductions; 

2. Communicating among buyers and sellers; 

3. Ensuring environmental equivalence of trades; 

4. Defining and executing the trading process; 

5. Tracking trades; 

6. Assuring compliance with relevant federal Clean Water Act and state and local 

requirements; 

7. Managing risk among parties to trades; and 

8. Providing information to the public and other stakeholders. 

The following discussions review briefly why these functions may be necessary for 

conventional markets and why they are essential for WQT. How well a mechanism may 

perform its function is discussed in light of market and regulatory friction. 

1. DEFINING MARKETABLE REDUCTIONS

Conventional Market Function—In conventional markets, a “marketable” product or 

service is anything that one individual is willing to compensate another individual to 

produce. The marketability of a product or service may be influenced by personal need, 

taste, and economic conditions. For example, a person may need shelter, may prefer to 

live in a townhouse, and may find it financially advantageous to pay someone to build the 

house rather than foregoing salaried employment to build it alone. A product may be 

marketable to one person but not another. For example, some people need shelter, 

prefer to live in treehouses, and have the skills and time to build it themselves. Such a 

person might not be open to purchasing a townhouse. 

Marketable Products in WQT Markets—TMDLs are intended to set a budget for local 

pollutant discharges that ensures water quality standards, including designated uses, are 

attained in a watershed. Discharge “overcontrol” is the marketable product and is 

produced when the reduction of pollutant loadings goes beyond a discharger’s regulatory 

obligation. A WQT market must do two things to create a marketable product. First, the 

market must identify the relevant pollutant control obligations. Overcontrol cannot exist 
Water Quality Trading Assessment Handbook.....................................................................

44

until a regulatory framework sets the baseline obligations. Second, the market must 

transform overcontrol into a marketable product by allowing that behavior to acquire 

value. Value is acquired when a regulatory framework allows one source to offset its 

discharge reduction obligations with overcontrol by other sources. As described in the 

Financial Attractiveness chapter of this Handbook, the value of overcontrol is highly 

dependent upon differences in incremental control costs. Minor differences will create 

little, if any, value even if the regulatory framework allows offsets. 

2. COMMUNICATING AMONG BUYERS AND SELLERS

Conventional Market Function—All conventional markets are first and foremost 

communication systems. They provide participants with information on product 

availability, variety, quality, quantity, and price. This information is used to: 

 Identify parties willing to produce or consume goods; 

 Compare the merits of similar offers; and 

 Negotiate mutually beneficial terms of exchange. 

Without a means to acquire the needed information, potential market participants would 

be unable to benefit from each other’s ability and willingness to produce goods and 

services. 

 

Communication’s Unique Role in WQT Markets—A WQT market gives dischargers 

who face pollutant control costs a forum for communicating with other sources to identify 

environmentally equivalent discharge reductions potentially executable at a lower cost. 

Because pollutant suitability and financial attractiveness are specific to the pollutant’s 

chemical properties, the watershed’s physical characteristics, and the relevant economic 

conditions, WQT markets must facilitate sharing information regarding a relatively 

complex product—a certain type/form of pollution reduction, at a specific time and place, 

for a predetermined duration, in a particular quantity, for a certain cost.

A good WQT market allows parties to learn what quantity of discharge reductions are 

being offered and demanded, when they can/will be delivered, their duration, their likely 

impact on water quality at the point of purchase/sale and all relevant compliance points, 

and how much they will potentially cost to acquire. A WQT market is more likely to 

succeed if it allows participants to efficiently survey the details of all potential offers to buy 

or sell overcontrol and identify those most beneficial to their unique needs. It is less 

likely to succeed if it fails to disseminate the pertinent information and/or requires 

participants to expend an inordinate amount of time, energy, and money to do so. 

3. ENSURING ENVIRONMENTAL EQUIVALENCE

Conventional Market Function – Some market mechanisms allow consumers to 

compare the characteristics and quality of products targeting similar needs. For example, 

over the counter drug packaging must inform consumers of the drug’s chemical 

contents—including the relative volume of active ingredients. This allows consumers to 

compare the likely effectiveness of various painkillers and cold remedies so they can 

select the product that best meets their needs.

Equivalence in WQT Markets—As mentioned earlier, trading requires that the impact of 

the purchased pollutant reduction is (at least) environmentally equivalent to the required 
.....................................................................Water Quality Trading Assessment Handbook 

45 

reduction. Market participants and other stakeholders must be able to evaluate the 

environmental equivalence of reducing pollutants at the points of purchase and sale. For 

example, hydrologic conditions in the stream between the two trading points must be 

evaluated because they can have a profound impact on environmental equivalence.

Demonstration WQT projects have used various mechanisms to perform the essential 

market function of facilitating environmental equivalence assessments. One important 

consideration is the higher cost of developing an accurate model versus setting ratios 

based on a rule of thumb (i.e., 3 to 1). Although establishing ratios based on accurate 

modeling and a wealth of ambient data may be the most scientifically precise approach, 

your WQT program may not be viable unless less costly approaches can be found. The 

potential participants may be willing to make a tradeoff in such a case. For example, a 

rule of thumb ratio that is less expensive to develop can be set artificially high to ensure 

equivalence with a margin of safety, even though this might drive up the cost per unit of 

needed reductions. A good equivalence mechanism will keep the total cost of a specific 

trade (i.e., costs to develop the ratio and the cost of needed equivalent reductions) to a 

minimum. A poor mechanism will fail to control total costs. 

4. DEFINING AND EXECUTING THE TRADING PROCESS

Conventional Market Function— Each conventional market has its own unique trading 

process. The types of trading processes depend on the types of products and 

participants involved. For example, in a simple retail exchange at the local convenience 

store, a customer chooses a loaf of bread based on personal taste and posted prices, 

pays the proprietor at the cash register, and leaves the store free to eat the bread or feed 

it to the pigeons. A more complex trading process occurs when a party seeks to 

purchase goods and services for construction of a new skyscraper. This process may 

involve a request for proposals, bidding by several interested firms, financing the project, 

selecting a general contractor, purchasing materials, subcontracting special elements of 

the work, overseeing and inspecting physical construction, and agreeing on the level of 

completion. Friction in conventional markets can be minimized if participants have a solid 

understanding of the steps involved in a transaction, the order in which they need to be 

completed, and each step’s likely cost.

The Trade Process in WQT Markets—EPA’s Water Quality Trading Policy supports 

trading under different conditions (i.e., both within the context of a TMDL and prior to its 

approval.) The policy does not prescribe specific processes that each market must 

employ to complete a trade. Each WQT market may develop its own trading process.

The “Trading Process” includes the steps all parties must take to complete a proposed 

trading transaction that ensures full CWA practical enforceability and fully supports TMDL 

requirements. These steps could include, but are not limited to: 

 Negotiating a transaction; 

 Accounting for environmental equivalence; 

 Completing and conveying appropriate paperwork; 

 Reviewing and approving trades; 

 Installing control technologies or adopting pollutant management methods; 

 Monitoring and verifying reductions; 

 Reporting to appropriate regulatory agencies and other stakeholders; 
Water Quality Trading Assessment Handbook.....................................................................

46

 Auditing reported information against regulatory obligations; and 

 Taking enforcement actions, if necessary. 

A good trading process covers these steps in the appropriate order while minimizing 

uncertainty and costs associated with the trading transaction. A poor mechanism is 

incomplete and adds to uncertainty and costs associated with the transaction so that 

trading is potentially suppressed. This can happen if the steps don’t generate enough 

momentum towards trade completion. For example, if the process requires control 

technology installation and monitoring to confirm reductions prior to allowing sale of such 

reductions, dischargers may be reluctant to commit scarce resources to overcontrol. In 

addition, redundancies in the process (i.e., steps that are revisited without adding 

sufficient value) add to transaction costs and will erode the value of trading. 

Some states considering trading and those with demonstration projects underway, have 

developed “State Trading Documents” to describe the process the state will use to 

formally recognize water quality trades. These documents usually do not prescribe 

exacting protocols for individual trades, but provide general guidelines while maintaining 

the state’s ability to control water quality administration. Great care should be taken to 

review your state’s document (if it has one) and design the market within its guidelines. 

5. TRACKING TRADES

Conventional Market Function—Most conventional markets track transactions. How 

much information is gathered, who stores it, and its future use depend on the types of 

transactions and the purposes for tracking. For example, when an individual purchases a 

loaf of bread at the local convenience store, the store may track the amount paid, when 

the transaction was completed, and what was purchased. This information may be saved 

by the register or transmitted to a large database for all transactions completed in the 

region. The information may be used to justify keeping that store open until 2 a.m., to 

document sales tax collection, or to manage inventory. The customer receives a receipt 

that can help reconcile their budget, obtain reimbursement from housemates, or enable a 

return of damaged goods.

Why Trades Need to be Tracked in WQT Markets—Tracking trades in a WQT market 

is necessary to ensure that trades are not double counted (i.e., one source does not sell 

the same reductions to more than one buyer) and to provide an easy audit trail for 

compliance assurance purposes. The two crucial pieces of information a water quality 

trade tracking mechanism must include are volume of reduction and chain of custody. In 

this context, chain of custody refers to the possession of the right to use the pollutant 

reduction for regulatory compliance purposes. Keeping track of this information helps 

ensure that the goal of the TMDL, improved water quality, is being advanced and that 

practical enforceability is maintained. In addition, this information makes the creation and 

ownership of individual reductions clear and traceable in the context of determining if 

sources are complying with NPDES or other relevant permits.

A good trade tracking mechanism minimizes market and regulatory friction by keeping 

transaction costs for chain of custody low, while providing regulators with easy and 

prompt access to appropriate levels of transaction detail. Transaction costs can be kept 

low by setting clear and consistent expectations for what information is required and 

limiting the administrative burden on trading partners. Sizing the tracking system to the 

market will help limit transaction costs. When regulators can access trade information 

efficiently, they are less likely to intervene on particular trades or in the market system. A 
.....................................................................Water Quality Trading Assessment Handbook 

47 

poor trade tracking mechanism will drive up the cost of administering individual trades to 

the point where it erodes the value of trading. It may require trading partners or 

regulatory agencies to perform non- value-added administrative tasks (i.e., completing 

unnecessary paperwork, reconstructing market activity from inconsistent transaction 

statements). 

6. ASSURING COMPLIANCE WITH CLEAN WATER ACT AND STATE/

LOCAL REQUIREMENTS

Conventional Market Function—In some conventional markets, buyers and sellers 

have regulatory obligations to entities outside the transaction. These obligations derive 

from a variety of public policy goals including protecting the parties directly involved in the 

trade and/or those with an indirect interest in the transaction’s outcome. For example, 

the Securities and Exchange Commission requires publicly traded companies to conduct 

third-party audits of financial statements and report specific information annually to the 

public. This reduces the opportunity to commit fraud and lowers investors’ market risk. 

Regulatory Obligations in WQT Markets—WQT processes must involve various 

watershed participants, including important non-discharging stakeholders like regulatory 

agencies. According to the EPA Water Quality Trading Policy, trading programs must be 

developed in the context of regulatory and enforcement mechanisms, which 

predominantly rely on discharge permits. Thus, the market, federal, state and local 

regulations, and the agencies responsible for their enforcement are closely connected. 

EPA’s Water Quality Trading Policy, says that “mechanisms for determining and ensuring 

compliance are essential for all trades and trading programs . . . States and tribes should 

establish clear, enforceable mechanisms consistent with NPDES regulations that ensure 

legal accountability for the generation of (reductions) that are traded.” EPA’s 1996 Draft 

Framework for Watershed-Based Trading suggests a market must meet conditions, 

standards, and procedures for ensuring that agencies maintain their ability to enforce the 

intent of a specific regulation. The appropriate regulatory agency(s) therefore will need a 

process to authorize, evaluate, permit, verify, and audit trading programs or even 

individual trades. Demonstration projects have performed this function in a variety of 

ways. 

A good regulatory compliance assurance mechanism minimizes the regulatory friction, 

transaction costs, and transaction uncertainty associated with any potential trade by 

achieving consistent approval decisions—in both outcome and timing—based on the data 

needed to ensure environmental equivalence, prevent degradation, and preclude 

localized impacts. A poor mechanism increases regulatory friction, transaction costs, and 

transaction uncertainty by sending incorrect signals to the market regarding what is 

expected of participants and then inconsistently processing the provided information. 

7. MANAGING TRANSACTION RISK AMONG PARTIES TO A TRADE

Conventional Market Function—During the exchange of goods or services, a chance 

always exists that the specific terms or the intent of a negotiated deal will not be fulfilled. 

Conventional markets allow parties to identify this transaction risk, assign the burden of 

the risk to the appropriate party, and provide the opportunity for recourse if it is needed. 

Escrow deposits and performance bonds are examples of such risk mitigation 

mechanisms.
Water Quality Trading Assessment Handbook.....................................................................

48

Managing Transaction Risk in WQT Markets—WQT markets involve three facets of 

transaction risk: 

 The risk that regulators will find that the discharge reductions negotiated under the 

agreement do not conform to market rules; 

 The risk that the specific discharge reductions negotiated under the agreement (for a 

certain type/form, at a specific time, for a predetermined duration, in a particular 

quantity) will not be produced; and 

 The risk that reductions will fail to have the required impact on water quality. 

The chapter on Financial Attractiveness explained the detrimental effects transaction risk 

can have on trading. Insufficiently managed risk will induce participants to steeply 

discount the price they are willing to pay for discharge overcontrol. This erodes the 

financial benefits associated with trading and can potentially suppress market activity. 

Risk management transaction costs (identifying and assigning risk) increase when 

remedies for nonperformance of discharge reduction obligations are less certain and the 

number of parties involved in enforcement issues (regulators, lawyers) increase and/or 

they become adversarial. 

A good transaction risk management mechanism identifies and assigns the three risks 

associated with WQT to specific parties, and sets reasonable expectations about how 

failure to fulfill terms of the agreement will be handled, including the size of the remedy. 

As always, good mechanisms minimize transaction costs. A poor mechanism will create 

high transaction costs and fail to account for all three transaction risks, assign the risk to 

an inappropriate party, and/or create ambiguity over how a transaction “gone bad” will be 

handled. 

8. PROVIDING INFORMATION TO THE PUBLIC AND OTHER 

STAKEHOLDERS

Conventional Market Function—Some conventional markets recognize that 

commercial activity can directly or indirectly affect parties other than the traders. For 

example, the Securities and Exchange Commission requires corporate managers to 

notify the public when they decide to purchase or sell stock in the companies they 

manage. Public dissemination of this information provides investors and securities 

regulators with information relevant to investment decisions and public policy. 

Public Information in WQT Markets—The CWA and other federal, state, and local 

water quality regulations require provision of opportunities for public participation, 

including public notice and opportunity for comment. WQT markets, given this regulatory 

framework, must therefore perform this essential function. WQT viability often depends 

on the public participation process to generate understanding and trust among watershed 

participants. Failure to do so could influence stakeholders to challenge the market 

system or specific trades, potentially introducing uncertainty and eroding the value of 

trading.

Although EPA’s Water Quality Trading Policy supports, “public participation at the earliest 

stages and throughout the development of water quality trading programs to strengthen 

program effectiveness and credibility,” informing the public about on-going operations 

and trades may be even more important. Easy and timely public access to transaction 

information may increase market efficiency. Improving water quality takes sustained 
.....................................................................Water Quality Trading Assessment Handbook 

49 

effort. An uninformed public may lose interest in a trading program, threatening its longterm viability. Informed watershed participants are more likely to discover and/or support 

new forms of trading. Some trading markets have produced trading opportunities that do 

not conform to the market design’s original vision of trading, but do provide real water 

quality and economic benefits. Such opportunities evolve as watershed participants learn 

more about each other’s needs, and the needs of the watershed’s ecosystem. 

A good public information mechanism is transparent, easy to engage, and available to all 

interested parties while controlling transaction costs. The EPA Water Quality Trading 

Policy encourages electronic publication of information on: 

 Boundaries of the watershed and trading areas; 

 Discharge sources involved; 

 Volume(s) of reductions generated and sold; and 

 Price(s) paid for reductions. 

Additional information may be important to participants in your watershed. The value of 

satisfying all interests should be weighed against the cost of collecting, managing, and 

distributing data. A poor public information mechanism will be resource intensive for both 

the information distributors and its consumers. This leads to higher transaction costs and 

can have serious regulatory friction consequences. As watershed participants work 

harder to get information, their level of trust may diminish, thereby threatening the 

market’s stability. 

Current Market Models 

The remaining market infrastructure discussion focuses on three market models that are 

in various stages of implementation in the United States. Each of these market models 

responds to the unique needs of its watershed and market participants while handling the 

essential WQT market functions discussed above. Each market model is discussed in 

terms of the basic premise underlying the market, important mechanisms used to support 

the system, and how the model performs certain WQT market functions. These models 

illustrate significantly different approaches. After reviewing them, you will have a better 

understanding of approaches potentially suitable for your watershed. 

A PRIVATE, NON-PROFIT CO-OPERATIVE FACILITATING PREAPPROVED, DYNAMIC TRADING

In 1998, the Lower Boise River Water Quality Trading Pilot Project undertook design of a 

WQT system for approximately 64 miles of river from Lucky Peak Dam to the mouth of 

the Boise River. Market participants agreed they could make trading more robust, 

flexible, and cost-effective by focusing on minimizing regulatory friction. Participants 

identified seven design principles they felt were crucial to a viable market in their 

watershed, including the following: 
Water Quality Trading Assessment Handbook.....................................................................

50

 Avoid trade-by-trade changes to the TMDL; 

 Avoid trade-by-trade changes to NPDES permits; and 

 Minimize trade-by-trade agency review and approval. 

To support these three design principles, watershed participants and regulatory 

stakeholders worked together to design clear guidelines and requirements for trades that 

would preclude the need for trade-by-trade review of most transactions. Public notice, 

review, comment, and agency approval of these trading guidelines and requirements 

were pivotal to this approach and created a model for dynamic trading. The key element 

of the Lower Boise market that allows market participants to trade in this fashion is the 

pre-approval of trade transactions through the issuance of a single new or modified 

NPDES permit enabling trading.7

The Idaho Clean Water Cooperative, a private, nonprofit association of various 

watershed participants, is charged with the day-to-day management of trading in the 

Lower Boise River. The Co-op will rely on language in the TMDL, language in NPDES 

permits, and a State Trading Document establishing the ground rules for creating and 

verifying trade transactions to facilitate trading. The Co-op will be responsible for helping 

connect buyers and sellers, developing and maintaining a trade tracking database, and 

preparing monthly watershed-wide trade summaries. The Cooperative will provide an 

important link among trading parties, the environmental agencies ensuring Clean Water 

Act compliance, and the public. By maintaining the trade tracking database and regularly 

disseminating transaction details, the association will also ensure that timely information 

about trades is available to the public and the environmental agencies. As a nongovernmental organization, the Cooperative will be dedicated to supporting the trading 

system as requested and agreed to by its members. 

Water Quality Market Functions in the Lower Boise River 

Defining marketable reductions—The Lower Boise market uses a common definition of 

overcontrol (control below a source’s TMDL defined allocation) to classify the reductions 

that sources may sell. To enable non-point source market participation, market 

stakeholders (including state and federal regulators as well as agricultural and technical 

assistance agencies) created a list of Best Management Practices and construction 

management, monitoring, and verification protocols that pre-qualify resulting reductions 

for sale. The BMP List provides the basis for the straight-forward verification of the nonpoint source generated reductions. This was done to eliminate the need for an 

intermediary in any transaction and create the opportunity for direct participation of nonpoint sources in dynamic trading. Non-point sources that can demonstrate they follow 

the appropriate protocols have reductions automatically recognized as valid and fungible. 

Communicating among buyers and sellers—Although the Co-op is charged with 

connecting buyers and sellers, the mechanisms used to fulfill that role are currently 

undefined. As the market manager, to which all sources must report certain information if 

they choose to trade, the Co-op is uniquely situated to act as a “broker”. This may entail 

providing an electronic or physical bulletin board of bids and offers for reductions or may 

evolve into a more formal matchmaking role where the Co-op introduces sources with 

reduction needs to dischargers capable of addressing them. Both methods can help 

 

7

 As of the publication of this document, trading in the Lower Boise market has not been initiated. Several steps 

and mechanisms have been created to enable trading, including the creation of the Idaho Clean Water Cooperative, reporting forms, model NPDES permit language, model TMDL language, and the State Trading 

Document. 
.....................................................................Water Quality Trading Assessment Handbook 

51 

participants identify trades that may meet their needs. The costs of communication in the 

Lower Boise will be borne by both the Co-op and market participants. 

Ensuring environmental equivalence—One significant barrier to dynamic, preapproved trading is the potential for adverse environment impact resulting from individual 

trades. To lower the total cost of developing a ratio and the needed equivalent 

reductions, the Lower Boise market will rely on the water quality model developed for 

formulating the TMDL. This model provided each major discharger with an individual 

index, allowing a source to relate their discharge’s effect on water quality to discharges 

by other sources. Use of an existing model keeps development costs to a minimum. In 

addition, this model ensures that trading ratios used are consistent with the TMDL. 

Relative to ratios based on a rule of thumb set artificially high to ensure equivalence, this 

minimizes the number of reductions a source must purchase. 

Assuring compliance with the Clean Water Act—The Lower Boise market supports 

consistent approval decisions—in both timing (immediate) and outcome (if protocols are 

followed). This limits friction in the market through use of specific mechanisms to marry 

the pre-approval process to compliance assurance. 

 

In this market, the pertinent TMDLs will contain base phosphorus waste load allocations 

(WLAs) for point sources and a provision for trade-dependent WLA variability. Sources 

will then receive a new or modified permit incorporating their WLA as a limit and, if 

desired, a provision enabling a trade-dependent variable limit. As explained below, the 

enabling provision will allow monthly changes to either the sources’ discharge limits (the 

amount of discharge both sources are allowed to put into the river) or the recognized 

discharge volume (the amount of discharge counted against the limit) based on trading 

arrangements. 

In all point-source to point-source trades, the enabling provision automatically adjusts the 

buyer’s NPDES discharge limit up and the seller’s NPDES discharge limit down, based 

on the volume of reductions traded and their environmental equivalence ratio. If a source 

exceeds its adjusted discharge limit during a reporting period, it is in violation of the CWA 

and potentially subject to regulatory enforcement. 

In non-point source to point source trades, the enabling provision gives the point source a 

“credit” that can be applied against the point source’s NPDES permit limit during that 

reporting period. The credit is based on the volume of environmentally equivalent 

reductions that have been traded from the non-point source(s) to the point source. A 

point source violates the CWA if its actual discharge, adjusted for all reduction credits 

acquired through trading during that period, exceeds its discharge limit. In this market, 

EPA or the Idaho Department of Environmental Quality (DEQ) may invalidate credits 

established by the non-point source reductions if they fail to meet BMP protocols and 

retain full authority to enforce the corresponding point source’s effluent limit without 

crediting its discharge volume. 

Point sources involved in a trade will use modified Discharge Monitoring Reports (DMRs)

to report to the EPA. Along with the modified DMR, each source will submit an individual 

Monthly Trade Report created by the Co-op. DMRs and Trade Reports include actual 

discharge, point source trades lowering or increasing their discharge limit, and non-point 

source credits reducing their recognized discharge volume. The EPA uses this 

information to assure CWA compliance. 

Defining and executing the trading process—The Lower Boise stakeholders 

developed a trading framework clearly defining the roles and responsibilities of all parties 
Water Quality Trading Assessment Handbook.....................................................................

52

involved in a transaction (the buyer, the seller, the Co-op, and the regulatory agencies) 

and the steps needed to “complete” a transaction. Two steps common to water quality 

trades are handled automatically by certain mechanisms: 1) accounting for environmental 

equivalence; and 2) reviewing and approving trades. 

The framework allows market participants to negotiate trades on their own and provides 

clear guidelines for paperwork submission, control technology or process installation, and 

reporting protocols. Reduction monitoring and/or verification is generally assigned to 

point sources, while the Co-op, Idaho DEQ, and EPA work together to audit trades and 

assure regulatory compliance. EPA is responsible for regulatory enforcement actions. 

Without trade-by-trade regulatory review, transactions could fail to maintain or improve 

water quality. To prevent the need for trade-by-trade review without increasing 

transaction costs or transaction uncertainty, the Lower Boise market uses three market 

mechanisms to eliminate the potential adverse environmental effects of individual trades. 

The use of known, published ratios lowers transaction costs because this eliminates the 

need for potentially time and resource intensive discussion with regulators over individual 

trades. The pre-qualified BMP list provides participants a clear understanding of what 

reductions will be recognized, minimizing transaction uncertainty. To preclude localized 

impacts, modified NPDES permits will include caps limiting the downstream trading 

capacity of individual sources. This will ensure that individual trades do not produce 

discharges in excess of the local assimilative capacity of the river segment between 

trading sources. 

How the Idaho Clean Water Co-operative tracks trades—In the Lower Boise, the 

tracking system was designed to establish chain of custody, maintain accountability, and 

provide the public with a means of readily tracking all reductions bought and sold. Key 

elements of the trade tracking system are 1) a record keeping and reporting protocol, and 

2) a trade tracking database. The system strives to minimize transaction costs by setting 

clear and reasonable expectations for reporting. Regulatory friction is managed by 

providing reasonably direct communication channels between participants, the Co-op, 

and the regulatory agencies. 

Trading parties are required to gather documentation and retain specific information 

pertaining to trades and then report selected information to the Co-op using standardized 

forms. For each point-source to point-source trade, a Trade Notification Form is required 

to officially register the trade, transfer reductions from seller to buyer, and trigger the 

enabling NPDES permit provision(s) to adjust allowable discharge limits. For trades 

involving non-point sources, both a Trade Notification Form and a Reduction Credit 

Certificate must be submitted by the point source to certify the non-point source reduction 

and generate a credit against the point source’s discharge volume. The Co-op will 

maintain a trade tracking database as well as individual trade and account information 

and produce a Monthly Trade Report for each source. 

Managing risk among Lower Boise market participants—The Lower Boise market 

manages the three risks associated with WQT through its trading framework and private 

contracts. The market mitigates the risk that specific transactions will not be recognized 

by regulatory authorities by including in the market driver (applicable TMDLs and 

implementation plans), as well as the regulatory mechanism (NPDES permits), and the 

state trading document, the explicit requirements for defining marketable reductions and 

their proper conveyance to other sources. This information is publicly available, so 

buyers and sellers of reductions jointly assume the risk that the paperwork documenting 

their transaction is proper and filed with the required entities.
.....................................................................Water Quality Trading Assessment Handbook 

53 

A defining feature of the Lower Boise market is how it manages the risk that an agreed 

upon reduction will not be achieved. Water quality regulatory agencies in the Lower 

Boise have limited or no authority over non-point sources’ discharge behavior. Although 

non-point sources are issued “load allocations” by the TMDL, they are not issued NPDES 

(or state equivalent) permits that create CWA regulatory liability. Non-point sources 

involved in creating the market wanted to maintain their independence from CWA 

regulatory liability and still be allowed to participate in the market. Faced with supporting 

point source trading while maintaining regulatory independence for non-point sources, 

market designers decided that CWA liability would reside with NPDES permit holders, 

while the liability for failing to produce purchased credits would be handled, particularly in 

the case of non-point source trades, through private contracts. 

In the Lower Boise WQT market, trading parties agree on the specific terms of a trade by 

entering into a private contract that identifies the trading parties, reduction measures to 

be undertaken, reduction amounts to be achieved, effective date, responsibilities of each 

party, price and payment provisions, and remedies for failure to deliver reductions. 

Although private contracts cannot shift regulatory liability from one source to another, 

they can assign the financial liability of regulatory non-compliance to the seller of pollution 

reductions. Subject to applicable contract law, the parties to the trade can decide 

between them who will pay for damages in the event reductions are not delivered and the 

purchasing source is consequently found to be violating its NPDES permit. 

As in all markets, the water quality science is still imperfect and there is some risk that 

the TMDL analysis was mistaken. The TMDL’s waste load allocations, along with 

associated trading may not be strict enough to achieve water quality standards, including 

protection of the watershed’s desired beneficial use. The TMDL allocations may 

ultimately be ratcheted down by regulators if water quality improvement is insufficient. 

Sources committing to discharge reduction strategies—whether through trading, control, 

or a combination of the two—could find themselves looking for additional reductions after 

making capital expenditures and/or purchasing/selling reductions. Private contracts help 

manage this risk in two ways. First, the duration of individual trades is up to the parties. 

This allows participants to manage uncertainty about future load allocations by choosing 

the length of time they are willing to commit to a certain strategy. Private contracts can 

also provide for a party to cancel its contractual obligations in the event that the trade 

does not ensure compliance with future, more stringent TMDL allocations. 

Private contracts in the Lower Boise allow parties to the trade to decide how great they 

believe the risks are and who will bear them. Writing the contract may require legal 

assistance, which may be relatively expensive for some non-point sources. It is 

important to remember that the contract terms used to manage risk will be based on the 

buyer’s and seller’s perceived risk. High perceived risk may result in large price 

discounts and erode the financial attractiveness of trading. 

Providing information to the public and facilitating their participation—The public 

participation mechanism in the Lower Boise relies on transparency in the Co-op’s 

activities and in the issuance of relevant NPDES permits. This is extremely important 

because pre-approved, dynamic trading in the Lower Boise requires market designers to 

generate and maintain trust from non-discharging stakeholders and also satisfy CWA 

public notice and comment procedures. 

A point source wanting to trade remains subject to the standard NPDES permitting 

process. The usual CWA public notice and comment procedures will give stakeholders 

the opportunity to learn about and participate in the consideration of issues surrounding 

market participation by a specific source. Where appropriate, the new or revised NPDES 
Water Quality Trading Assessment Handbook.....................................................................

54

permits will then include language supporting trading. As already noted, trade enabling 

permit provisions will include: the authorization to trade; the adjustment of the discharge 

limit or discharge volume; trading caps to prevent localized impacts; and trading 

procedural requirements. Once a trade enabling permit has been issued, the source’s 

discharge limits and/or discharge volume may be adjusted without further administrative 

process for each qualifying trade, thereby minimizing transaction costs and uncertainty. 

The permit will be renewed according to the standard permit cycle schedule (e.g., once 

every five years). 

The Co-op will be responsible for making transaction information accessible to the public. 

The marginal cost of providing the information—whether on demand or published at 

regular intervals—will be minimal, as the trade tracking database already manages the 

information likely to be requested. In the Lower Boise, non-discharging stakeholders 

have an open forum to question and influence the permitted discharge limits and then 

easy access to information keeping them informed of actual discharge behavior. 

A PUBLIC AUTHORITY BANKING AND MANAGING PHOSPHORUS 

CREDITS

In 1985 Cherry Creek Basin Water Quality Master Plan was created to manage 

development’s environmental impact on the Cherry Creek Reservoir in Colorado. In the 

basin, point source and non-point source nutrient discharges cause eutrophication 

problems that preclude attainment of the reservoir’s designated uses. Rapid economic 

development in the area was forecasted to strain the ability of local Publicly Owned 

Treatment Works’ (POTWs) to serve the burgeoning population without further degrading 

water quality in Cherry Creek Reservoir. As dischargers of predominantly soluble 

phosphorus, which is readily available biologically and promotes rapid algal growth, 

seven utility districts operating POTWs were challenged to limit their phosphorus 

contribution to the Cherry Creek reservoir. A Total Maximum Annual Load (TMAL) for 

phosphorus discharged into the reservoir was set at 14,270 pounds. The wastewater 

facilities received a total allocation of 2,310 pounds per year. 

Two counties, four cities, and the seven utility districts reached an intergovernmental 

agreement chartering a state empowered government entity, the Cherry Creek Basin 

Water Quality Authority (the Authority), to develop and administer a water quality trading 

program facilitating continued economic growth while minimizing adverse impact on 

water quality in the basin. Although a pilot trading program has been in place for several 

years, few trades have been completed. Recently, an effort has been made to elicit more 

market activity. The Authority has been charged with designing a market in which 

POTWs and other point source dischargers would be able to purchase “credits” included 

in the POTWs’ 2,310 pound phosphorus allocation while funding new phosphorus 

reduction projects. These credits may increase an individual point source’s TMAL 

allocation and allow it to expand its services to new developments, which would 

otherwise cause the POTW to exceed its Waste Load Allocation. The trading market 

requires POTWs to fund phosphorus removal projects in exchange for an allocation of 

additional phosphorus discharge. 

In the Cherry Creek market, the Authority functions as a “Water Quality Bank” by owning 

and allocating purchasable phosphorus credits associated with four non-point source 

phosphorus control projects built by the Authority in the 1990’s with taxes levied by the 

Authority on watershed residents. These projects have reduced the net amount of 

phosphorus discharged, creating additional loading capacity in the reservoir. The credits 

from these projects have been placed in the “Phosphorus Bank” from which POTWs may 
.....................................................................Water Quality Trading Assessment Handbook 

55 

draw credits to meet their regulatory obligations. A total of 216 annual pounds of 

phosphorus credits were allocated to the Phosphorus Bank by the TMAL. 

The control technologies used in the non-point source projects include retention/detention 

ponds, constructed wetlands, and shoreline stabilization above and beyond required 

BMPs, leading to phosphorus discharge overcontrol. The Authority has total control over 

these “Sale Credits” and decides who may purchase them. Funds raised from the sale of 

Sale Credits will be used by the Authority to fund additional projects that will further 

improve water quality. 

The Authority also manages an additional 216 pounds of phosphorus credit allowances

that give POTWs the right to purchase reductions from non-Authority phosphorus 

reduction projects and receive an increased WLA. The TMAL allocated the allowances to 

a “Reserve Pool.” POTWs wanting to increase their phosphorus allocation may construct 

projects and/or compensate third-party landowners, local governments, or other POTWs 

to do so for them. 8 “Transfer Credits” tied to these reductions enable the Authority to 

transfer a portion of the Reserve Pool phosphorus allocation to POTWs. A phosphorus 

reduction project will be evaluated by the Authority before a specific agreement is 

reached to use Transfer Credits. An approved project’s reductions are registered with 

the Authority and create “Transfer Credits.” A POTW may seek additional phosphorus 

discharge capacity by compensating the owner of the Transfer Credits for their use. The 

total number of credit allowances third-party projects may generate for redistribution to 

the POTWs is currently capped at 216 pounds annually. 

Important Market Functions in the Cherry Creek Basin 

Defining marketable reductions—Marketable reductions in the Cherry Creek market 

are defined as reductions accruing from the implementation of control technologies in 

excess of those expected from the Mandatory Best Management Practices identified in 

the Cherry Creek Reservoir Control Regulations. Mandatory BMPs include temporary 

measures implemented to mitigate construction runoff (i.e., filter fences, re-vegetation, 

and hay bales) and/or permanent water quality improvements required by drainage 

criteria and land use regulations for all new development (i.e., detention ponds, swales, 

and constructed wetlands).9

The Reserve Pool marketable reductions, as defined in the draft guidelines, evolve from 

one of six different types of projects. 

 Additions to Existing Development—Phosphorus removals from BMPs not 

completed during land development prior to January 1, 2000 are eligible for trading. 

 Expanded or Retrofitted BMP Removals—Phosphorus removals from BMPs that 

are added to land development undertaken prior to January 1, 2000 that result in 

additional reductions are eligible for trading. 

 Projects Beyond Required BMPs—Phosphorus removals from BMPs that result in 

reductions in excess of the removals from required BMPs are eligible for trading. 

 Cooperative Authority Projects—Phosphorus removals from Authority and third 

party co-development projects are eligible for trading. Credits placed in the Reserve 

Pool will be limited to the proportion constructed or funded by the third party. 

 

8

 A more detailed description of these projects is provided below. 9 Phosphorus Credit Trading in the Cherry Creek Basin: An Innovative Approach to Achieving Water Quality 

Benefits. Water Environment Research Foundation. Project 97-IRM-5A. 2000. 
Water Quality Trading Assessment Handbook.....................................................................

56

 Engineered Authority Projects—Phosphorus removals from any non-point source 

project for which the Authority completes preliminary engineering and design and 

which the Authority agrees to third party construction of that project are eligible for 

trading. 

 Water Supply Operations—Phosphorus removals beyond the incidental reductions 

from regular, normal operations are eligible for trading. 

Not every pound of phosphorus overcontrol from a project may be associated with credit 

allowances in the Reserve Pool. A project specific “Trade Ratio” is applied to calculate 

the volume of phosphorus reduction that results in credit allowances recognized by the 

Authority and the regulatory agencies. 

Defining and executing the trading process— Similar to other trading programs, the 

Cherry Creek Authority and various stakeholders have developed a trading framework 

clearly defining the roles and responsibilities of all parties (the buyer, the seller, and the 

Authority) in reviewing reduction projects and trades and administering the allocations of 

credits. Program evaluations have identified four steps that support these efforts in the 

Cherry Creek basin.10 The fifth step described below provides for regulatory review and 

transforms the trade into a regulatory obligation. 

 Project Evaluation and Approval—Authority constructed phosphorus reduction 

projects have already been evaluated and their credits placed in the Phosphorus 

Bank. Interested parties may nominate other projects for consideration by the 

Authority. The technical specifications of the project, the estimated reductions, 

reliability of the project operations, comments from Colorado’s Water Quality Control 

Division (WQCD), consistency with the Master Plan, trading guidelines, and control 

regulations, and the effect on water quality are all considered by the Authority. Other 

stakeholders may contribute input at a public meeting. The Authority’s Board of 

Directors votes to recognize the validity of the reductions.

 Credit Calculation—After voting to include reductions in the Reserve Pool, the 

Authority’s Board of Directors determines the volume of credit allowances that will be 

associated with the project based on projected reductions and a project specific 

trading ratio.

 Credit Allocation—Point sources looking to exceed their permitted discharge limits 

may apply to acquire phosphorus credits from the Phosphorus Bank or credit 

allowances from the Reserve Pool. Trades are reviewed based on the buyer’s 

history of regulatory compliance and operating abilities, as well as the trade’s 

conformance to the Master Plan and control regulations. Potential Sale Credit 

applicants are also reviewed based on their “need” as defined by the Authority. A 

Technical Advisory Team (TAC) reviews all trades and makes recommendations to 

the Authority Board of Directors. The Board then approves or disapproves each 

specific trade.

 Trade Review—After a transaction is completed, the Authority retains the right and 

obligation to review reduction performance and periodically adjust the number of 

credits or credit allowances awarded to point sources based on actual reduction 

performance. 

 NPDES Permitting—Prior to discharging phosphorus in excess of its existing 

NPDES permit, the credit or credit allowance purchaser must be issued a new or 

modified permit. 

 

10 Ibid. 
.....................................................................Water Quality Trading Assessment Handbook 

57 

The trading guidelines used in the Cherry Creek market provide all participants with a 

clear understanding of what’s expected of market participants. Transaction costs are 

likely to be relatively known prior to initiating a trade, as the information needed and the 

process used to evaluate a trade are well defined. Market participants are also likely to 

understand the transaction costs associated with the permitting process. 

Ensuring environmental equivalence—The focus of water quality trading in this market 

is to maintain the designated uses of the Cherry Creek Reservoir, not to improve water 

quality within specific stretches of rivers or tributaries. Environmental equivalence is 

therefore confined to the effect each sources’ individual discharge has on the 

concentration of phosphorus in the reservoir. 

Each Reserve Pool transaction receives a trade ratio, which translates phosphorus 

reductions into credit allowances, set between a minimum of 2-to-1 and a maximum of 3-

to-1. The trade ratio varies based on the relative load of soluble and non-soluble 

phosphorus between the two parties and/or the attenuation of discharged phosphorus as 

it moves through the watershed. For example, the ratio may be increased when the 

credit allowance buyer is closer to the reservoir than the credit producer. This adjustment 

is based on site-specific monitoring data, empirical modeling, and/or best available 

scientific evidence to account for environmental equivalence. Institutional and scientific 

uncertainty factors help ensure the ratios reflect actual benefits to the reservoir. 

Communicating between buyers and sellers—Use of this market model influences the 

transaction costs associated with trading partner identification, product comparison, and 

deal negotiation and their effect on market efficiency. All available credits or credit 

allowances are held or managed by the Authority. Buyers do not have to contact several 

potential trading partners to find a mutually beneficial deal. This market model can 

inherently limit interactions between certain buyers and sellers. The Authority explicitly 

identifies and then selects trading partners allowed into part of the market by placing 

reductions from specific projects into the Phosphorus Bank and allowing certain buyers, 

based on Authority defined “need,” to apply for the right to buy the Sale Credits. For the 

Reserve Pool, the Authority only approves or disapproves the transfer of credit 

allowances for individual transactions. The Authority has limited justifications for stopping 

a transaction. As such, market participation in this segment of the market is not limited. 

The Authority manages product comparison for Phosphorus Bank reductions by 

quantifying their volume, applying a project specific trade ratio, and establishing the price 

of credits. For these reductions, the authority sets the terms of the trade based on 

authority funded costs of building, operating, and monitoring current and future 

phosphorus reduction projects, as well as the costs of establishing and administering the 

trading market. The Authority also manages product comparison for Reserve Pool trades 

by quantifying available credit allowances based on the trade ratio. However, the 

Authority does not price these allowances; price is negotiated by the parties to the trade. 

Tracking Trades—The Authority is in a unique position to track trading activity because 

it plays an active role in all transactions. In addition, trades are considered to last in 

perpetuity, limiting the number of actual transactions that will take place during any given 

period. The trading activity to date has imposed minimal tracking burdens on the 

Authority. It is anticipated that the Authority will develop a trade tracking system as 

trading activity increases. Most likely, a spreadsheet managed by the Authority will be 

used to ensure that reductions and their associated credits or credit allowances are 

traded to other sources only once. Trades approved by the Authority are documented in 

Appendix A of the Cherry Creek Water Quality Authority Trading Program Guidelines. 
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58

Compliance assurance with regulations in the Cherry Creek Basin—Although the 

Authority administers the transfer of credits and credit allowances in the Cherry Creek 

water quality market, transactions do not automatically alter a source’s obligations to 

federal, state, or local water quality regulations. In this watershed, Colorado’s Water 

Quality Control Division (WQCD) is responsible for administering NPDES permits. The 

WQCD does not acknowledge Sale or Transferred Credits as immediately off-setting the 

sampled, actual phosphorus discharge counting against the source’s NPDES permit limit. 

As stated in the Trading Guidelines, “It shall be the sole responsibility of the (credit buyer) 

to obtain any approvals or modifications to their discharge permits necessary to allow 

increased or modified phosphorus discharges.” Therefore, a source wishing to use 10 

pounds of Sale or Transfer Credits must go through the normal permit modification 

process to increase their discharge by 10 pounds. Sources purchasing credits must work 

with the WQCD to amend their NPDES permit limits, prior to discharging excess 

phosphorus. Monitoring and reporting protocols for the POTWs are set out in their 

individual NPDES permits and follow the standard reporting mechanisms used for 

NPDES permitting. 

Managing risk among parties trading in the Cherry Creek Market—As is common 

with most water quality banks, Phosphorus Bank credits are made up of credits from 

various projects co-mingled together. A quantity of credits sold out of the Phosphorus 

Bank likely includes reductions from several projects that have different risks associated 

with them. The Cherry Creek market model both actively and passively manages the risk 

that reductions do not conform to market rules, the risk that specific reductions fail to 

materialize, and the risk that reductions fail to have the required impact on the designated 

uses of the watershed for these transactions. The risk management mechanisms are 

largely a result of the banking model and the trading guidelines developed by 

stakeholders specifically for Cherry Creek.

In this market, the Authority is delegated the responsibility of evaluating and allocating 

credits and credit allowances by the regulatory and administrative agencies responsible 

for watershed oversight. The Cherry Creek Authority, a water quality bank operated as a 

quasi-government entity, plays an active role in defining marketable reductions. For both 

Phosphorus Bank and Reserve Pool transactions, the Authority, per its charter, is only 

allowed to allocate credits or credit allowances if reductions conform to market rules. 

Therefore, the Cherry Creek Authority manages the buyer’s risk of purchasing nonmarketable reductions by acting as a credit and credit allowance certifier. 

The Authority’s certification role also helps manage the risk that the credits or credit 

allowances purchased by the buyer are not connected to actual overcontrol. The 

rigorous reduction certification during project approval coupled with the trade ratio 

creates leeway between the desired environmental benefit and the reductions outlined in 

the transaction agreement. In addition, if phosphorus reduction projects begin to perform 

poorly, the Authority may revoke or adjust the number of credit or credit allowances 

downward. For Phosphorus Bank credits, if re-evaluation results in lowering the 

reductions achieved (and therefore the credits), the Authority relies on surplus credits in 

the trading pool that have not been allocated and sold to other sources to make up the 

difference. If there are insufficient surplus credits in the Phosphorus Bank, the Authority 

notifies all Phosphorus Bank credit holders that their credits have been reduced on a prorata basis for three years. If additional credits become available from the Phosphorus 

Bank during those three years, credits will be restored. After three years, the credit 

reductions are permanent. 
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59 

Transaction risk management for Reserve Pool transactions, where the credit allowances 

are merely “warehoused” by the Authority until a private deal is struck, is not as actively 

managed by the Authority. The Authority also certifies these credit allowances. 

However, Reserve Pool credit allowance purchasers, who have negotiated with a specific 

reductions producer for specific reductions, cannot be awarded surplus Reserve Pool 

credit allowances if reductions fail to materialize. They must negotiate another trade and 

pay for additional allowances. 

Finally, the market manages the risk that new development and use of reductions fail to 

protect the designated uses of the waterbody. The TMAL driving the Cherry Creek 

market has a periodic review schedule, during which the TMAL allocations may be 

modified, up or down. Allocations may be adjusted to reflect the volume of phosphorus 

being discharged into the reservoir or existing water quality. Therefore, the TMAL 

allocation process manages the risk that reductions will fail to maintain designated uses 

by ratcheting up and down the volume of phosphorus permitted into Cherry Creek 

Reservoir by changing the allocation among POTWs and by adjusting the volume of 

credits and credit allowances available for use. 

Providing information to the public and other stakeholders—The on-going public 

participation mechanism in Cherry Creek relies on standard public notice and comment 

procedures commonly used for NPDES permits. In the Cherry Creek market, nondischarging stakeholders have several opportunities to play an active role in trading 

activity, including open forums to question and influence project evaluation, credit and 

credit allowance allocation, and permit modification. For project evaluation and 

allocation, the Authority is required to issue a public notice of its intent to review specific 

proposals and listen to stakeholders attending that hearing. A similar procedure is used 

during permit modification. These steps are necessary to create transparency and 

engender trust in the trading system. 

The Authority is responsible for making transaction information accessible to the public. 

The marginal cost of providing the information—whether on demand or published at 

regular intervals—will likely be minimal as the Authority already possesses or generates 

all the pertinent information. Trades approved by the Authority are documented in 

Appendix A of the Cherry Creek Water Quality Authority Trading Program Guidelines. 

A NITROGEN CREDIT EXCHANGE

In 1990, Connecticut, the State of New York, and the federal EPA adopted a 

Comprehensive Conservation and Management Plan (CCMP) for the Long Island Sound 

National Estuary Program, known as the Long Island Sound Study (LISS). The CCMP 

calls for the reduction of nitrogen to increase dissolved oxygen in Long Island Sound and 

mitigate hypoxia damaging the Sound’s ecosystem. The CCMP was designed to reduce 

the total enriched nitrogen load coming from point and non-point sources by 58.5 percent 

between 2000 and 2015. A TMDL, approved in April 2001, includes Waste Load 

Allocations for point sources and Load Allocations for non-point sources in the 

watershed. Connecticut chose to develop a trading program for the sources within its 

borders to lower the cost of implementing the CCMP and the TMDL. 

The main mechanism facilitating trading in Connecticut is a “General Watershed Permit.” 

Connecticut’s program uses both its general state authority and its EPA delegated 

NPDES permitting authority to issue a single General Permit for the nitrogen dischargers 

it regulates in the watershed. The General Permit covers the nitrogen discharges of all 

point sources willing to trade on a voluntary basis through a single permit. POTWs can 
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60

have opt out of the General Permit and receive a traditional permit and implementation 

schedule. However, all POTWs have chosen to take advantage of trading under the 

General Permit. The General Permit sets a ceiling for annual, permitted, nitrogen 

discharges at 2000 levels, and reduces the total nitrogen discharges allowed in each year 

between 2000 and 2015 on a percentage basis. Individual point sources under the 

permit (called sub-dischargers) are required to lower their proportional share of the 

annual percentage reduction based on their normalized discharge in 2000. 

Market designers faced two challenges. The Connecticut market area is predominantly 

urban, with very few opportunities for low-cost nonpoint source controls. To achieve the 

58.5 percent nitrogen reduction from all identifiable sources, Connecticut’s 79 POTWs 

located within the watershed were tasked with lowering their nitrogen discharge by 

64percent from 2000 baseline levels. The second challenge involved several factors, 

including the proximity of certain dischargers in western Connecticut compared to their 

eastern counterparts, Connecticut’s previous efforts to fund nutrient removal projects 

near Long Island Sound, and the economic disparity between communities in western 

and eastern Connecticut. The communities in western Connecticut are generally more 

affluent and able to absorb the cost of implementing new control technology. They also 

had been the focus of pre-trading nitrogen removal grants. Eastern Connecticut 

communities are relatively less affluent. Market designers felt that the water quality 

trading market models used in other pilot projects might lead to inequities across the 

regulated communities, as affluent western communities would likely be able to generate 

environmentally equivalent reductions by relying on previous control technology 

investments and their larger tax bases. Under some market models, the generally poorer 

eastern communities would then have to pay for available western reductions. 

The trading program that evolved from this effort is best described as a “Nitrogen Credit 

Exchange.” Sources discharging less than their annual limit receive “credits” for 

overcontrol. CTDEP is obligated by state law to purchase all nitrogen credits from these 

sources. Facilities that exceed their limit are considered out of compliance. These 

sources are allowed to purchase nitrogen credits from DEP to meet compliance 

obligations. DEP is obligated by state law to sell the credits it purchases from 

overcontollers to facilities that fail to comply. 

Important Market Functions of the Connecticut Nitrogen Credit Exchange 

Defining marketable reductions—Marketable reductions in Connecticut’s Nitrogen 

Credit Exchange are defined as reductions in excess of a point source’s Waste Load 

Allocation. As described in the February 2003 General Permit for Nitrogen Discharges 

and Nitrogen Credit Exchange Program publication, by March 31 of each year, the 

Nitrogen Credit Exchange Program (NCEP) and the Connecticut Department of 

Environmental Protection (CTDEP) compile the calendar year monitoring data for each 

individual source. The average nitrogen discharge for each month is calculated and the 

end-of-pipe surplus or deficit is reported as a yearly average. Marketable reductions 

emerge if the actual, sampled yearly average is less than the WLA for that year. A 

“Nitrogen Equivalency Factor,” based on a source’s contribution of nitrogen to Long 

Island Sound, is then applied to calculate the number of credits that the Nitrogen Credit 

Exchange (NCE) buys from that source. Appendix 1 of the General Permit provides a 

schedule of each sub-discharger’s individual Annual Discharge Limit for Total Nitrogen as 

well as a Nitrogen Equivalency Factor. 

Defining and executing the trading process—Unlike the other two models discussed 

in this section, Connecticut’s trading process is stipulated in state law. Public Act No. 01-
.....................................................................Water Quality Trading Assessment Handbook 

61 

180 describes the processes used to transfer marketable reductions from POTWs 

achieving overcontrol to POTWs out of compliance with their NPDES permit. 

Trading in this market is executed through a multi-step process completed on an annual 

basis. The first step is the setting of the annual discharge limits in the General Permit. 

These limits, set by the Nitrogen Credit Exchange Board, are based on a 2000 baseline 

for each POTW, reduction goals ensuring compliance with the TMDL by 2015, and the 

projected nitrogen reductions to be achieved by control projects likely to be operating 

during the year. The annual limits require each POTW to attain an equal percentage 

reduction from its 2000 baseline. 

POTWs unable to meet their new limits may elect to build nitrogen control projects. 

Funding for projects is available on a competitive basis through the Connecticut Clean 

Water Fund. Funding consists of a 30 percent grant with the balance loaned at 2 percent 

interest. Alternatively, POTWs may choose to find alternative revenue sources. 

Regardless of their approach to meet their annual regulatory obligations, POTWs monitor 

and report their discharge throughout the ensuing year pursuant to language in the 

General Permit. 

At the end of the year, the Nitrogen Credit Exchange Board (NCEB), in conjunction with 

the CTDEP, analyzes the discharge for individual dischargers for compliance with the 

annual WLA. This analysis includes the calculation of credits produced by dischargers 

able to overcontrol and the number of credits needed by POTWs failing to meet their 

WLA. Credits are generated if the actual, sampled yearly average nitrogen discharge of 

a particular POTW is less than its WLA for that year. The Equivalency Factor translates 

the overcontrol into credits automatically purchased by the NCEP. Conversely, if the 

actual, sampled yearly average is more than the WLA for that year, the POTW needs to 

purchase credits. The Equivalency Factor translates the difference between actual, 

sampled discharge and the WLA into the number of credits that the POTW must buy from 

the NCE. 

The NCEB then calculates the price of credits for both buyers and sellers. The dollar 

value of credits is determined annually, based on the average capital and operating costs 

of all nitrogen removal projects operating during that year and the total reductions 

achieved by those projects during that year. This is the uniform price (per pound) buyers 

are charged to reach permit compliance or sellers credited for their overcontrol. Those 

POTWs exceeding compliance with their annual WLA receive a check for their credits. 

Those POTWs out of compliance receive a bill for the total cost of all credits that would 

bring them into compliance with the General Permit. 

Ensuring environmental equivalence—The focus of water quality trading in this market 

is to attain the designated uses of the Long Island Sound, not to improve water quality 

within specific watersheds or basins that drain into the Sound. Environmental 

equivalence is therefore confined to the effect each sources’ individual discharge has on 

the concentration of nitrogen in the Sound itself. 

As part of the LISS, a peer-reviewed water quality model was developed to delineate the 

impact nitrogen discharges in the large area covered by the TMDL has on oxygen 

concentrations in Long Island Sound. This broke the area affected by the TMDL into six 

different zones closely aligned with the major watersheds or basins and relates their 

nitrogen to oxygen impacts. Some zones were further broken down into tiers. Further 

modeling was done to relate nitrogen discharges within each of the identified zones or 

tiers. The final step used to calculate environmental equivalence involved multiplying the 
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62

two factors together to create an Equivalency Factor that relates the impact of all 

individual discharges across the market to one another. 

Communicating between buyers and sellers—The Connecticut water quality trading 

model does not promote contact between individual dischargers. The NCEP manages 

the transaction costs that would otherwise be associated with trading partner 

identification, product comparison, and deal negotiation because redistribution of the cost 

of nitrogen control is handled exclusively by the NCEP as it carries out its statutory 

responsibilities. As previously discussed, the NCEP gathers information from regulated 

dischargers, rewards POTWs for overcontrolling, and charges others for failing to comply 

with their permit. This results in redistributing the cost of overcontrolling nitrogen 

between the two groups. 

NCEP administrators of the program need three sets of information to facilitate trading in 

this market—discharge volumes, nitrogen reductions achieved by control projects, and 

the cost of those control projects. Actual, sampled discharge volumes are collected by 

CTDEP as part of its General Permit administration responsibilities. 

The NCEP relies on funds from the purchase and sales of nitrogen credits for 

administration of the NCEP. Currently, the NCEP is staffed by 2.5 FTEs assigned to 

several programs throughout the CTDEP. 

Tracking Trades—In the Connecticut market, trade tracking consists of analyzing 

discharge, overcontrol, and cost redistribution. In this program, trading is an annual 

process. By March 31 of each year, the NCEP notifies each individual facility regarding 

their credit balance. After the credit checks and bills are paid or redeemed, the books are 

“closed” for that year and the process begins again. The additional burden of trade 

tracking (on top of the year-end analysis) borne by the NCEP entails collecting payments 

from dischargers buying credits to reach compliance. 

Assuring compliance with regulations in the Connecticut Market—Trading in the 

Connecticut market takes place within the framework of the General Permit, which 

regulates the annual discharge of nitrogen into Long Island Sound. The aggregated 

General Permit discharge is set each year to ensure steady progress towards full 

implementation of the TMDL in 2015, as well as providing a buffer in case total reductions 

achieved fall below those anticipated in the annual allocation. Each individual discharger 

is issued a WLA incorporating the annual reduction of the aggregated General Permit 

and their baseline discharge in 2000. 

Trading in this market is performed based on actual, sampled discharge performance. 

Monitoring and reporting protocols for point source discharge are set out in the General 

Permit and follow the standard reporting mechanisms used for NPDES permitting. 

Sampling frequency and procedures are based on the volume treated by the POTW on a 

daily basis. The collected chemical analysis samples are entered into a Nitrogen 

Analysis Report (NAR) and Monthly Operating Report (MOR) and submitted to the 

CTDEP. In addition, each POTW calculates a monthly mass loading of total nitrogen and 

submits it to the CTDEP in a Discharge Monitoring Report (DMR). Each POTW is also 

responsible for retaining a copy of all reports submitted to CTDEP as well as the data 

used to generate those reports for at least five years. 

POTWs failing to reach compliance must purchase credits from the NCEP by July 31st of 

each year for their previous year’s discharge. Failure to purchase credits by this date 

results in non-compliance and opens the POTW to enforcement actions by the CTDEP. 
.....................................................................Water Quality Trading Assessment Handbook 

63 

Managing risk among parties participating in the Nitrogen Credit Exchange 

Program—In the Connecticut market, credits are based on the level of nitrogen 

discharged during the year and the WLA. Implicitly, they can only be generated by the 

sources subject to the General Permit, which are all POTWs. The authorizing legislation 

(Public Act No. 01-180), the General Permit, and CTDEP publications, clearly describe 

the process used to create the annual permitted limit, calculate discharge, and the 

analysis used to compute the surplus or deficit of credits for compliance purposes. 

Nitrogen credits are only available from the NCEP, making the program the de-facto 

certifier of the credits and eliminating the risk of purchasing non-marketable reductions. 

The Connecticut Nitrogen Exchange Program executes trading at the end of the year, 

when actual discharge volumes and overcontrol are known. The NCEP is obligated by 

state law to sell all the credits needed by all sources to meet their regulatory obligation 

under the General Permit. This statutory requirement eliminates the risk to individual 

dischargers that specific credits will fail to materialize, regardless of the actual supply that 

year. 

There are two risks created by this market model because of its reliance on cash 

management and load allocations lower than TMDL implementation requirements to 

maintain active participation from the POTWs . First is the risk that during the year the 

POTWs, in aggregate, will create more credits than are needed to offset the POTWs that 

fail to meet their regulatory obligations. As the NCEP is obligated by law to purchase all 

credits and unable to sell them to other sources, the NCEP annually runs the risk of 

subsidizing the surplus overcontrol. For example in 2002, the NCEP purchased 

$2,757,323 worth of credits from 39 dischargers. The program sold $1,317,233 worth of 

credits. The $1,440,110 deficit was paid for by NCEP funds. 

The second risk is that during the year the POTWs, in aggregate, may fail to create 

enough credits for other POTWs to maintain compliance. In years when the demand for 

credits is larger than the supply, the NCEP receives a net infusion of cash because all 

sources must purchase credits to meet compliance and the NCEP must sell them, 

regardless of their actual availability. This infusion of cash is designed to pay off any 

deficits from previous years when there is a credit surplus. Purchasing credits from the 

NCEP relieves the POTW from regulatory consequences under the General Permit. The 

annual allocations are low enough to maintain compliance with the TMDL 

implementation. In addition, allocations may be adjusted in light of the previous year’s 

deficit or surplus and the projected control to be completed during the year. This helps 

manage the annual deficits and surpluses, both control and dollars, while encouraging 

additional nitrogen projects.

Finally, the market manages the risk that reductions generated and traded in the market 

do not achieve the designated uses of the waterbody by providing for periodic review of 

both TMDL allocations and the General Permit allocations. These are adjusted to reflect 

actual progress towards the designated use. The TMDL driving the Connecticut market 

includes a periodic review schedule, during which the TMDL allocations may be modified, 

up or down. A change in the TMDL allocation could force a modification of the annual 

allocations of the General Permit. Therefore, the TMDL and General Permit allocation 

process manages the risk that reductions will fail to achieve designated uses by 

ratcheting up and down the volume of nitrogen allowed to enter Long Island Sound.

Providing information to the public and other stakeholders—The on-going public 

participation mechanism in Connecticut relies on traditional public notice and comment 

procedures commonly used for NPDES permits. The NCEP is operated within the 

framework of the General Permit, providing the opportunity for public comment for the 
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64

permit when it was issued and when it is renewed. Public comment is only allowed on 

the aggregated General Permit and not allowed for the WLAs for individual subdischargers regulated. 

In addition, the NCEP annually produces a publication listing the price of nitrogen credits 

as calculated by the NCEB. Included with the report is a LIS Total Nitrogen Credit 

Exchange Final Balance detailing the dollar value of the credits bought by the NCEP from 

POTWs discharging less than their WLA as well as the dollar value of credits to be 

purchased by facilities exceeding their WLA. 
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65 

Stakeholder Readiness 

Purpose 

The first three chapters of this Handbook suggested how to assess your watershed’s 

potential to create a viable water quality trading market based on pollutant suitability, 

watershed and discharger characteristics, the financial attractiveness of likely trades, and 

an understanding of the infrastructure required to enable trading. As you pursue further 

consideration of trading opportunities, you will need to reach out to other potential 

participants and stakeholders to begin exploring water quality trading opportunities in the 

watershed. This chapter will help answer the following questions: 

 Which other participants will be needed to create a viable water quality trading 

market in your watershed? 

 Do key participants have a reasonable level of interest in considering water quality 

trading as a potential mitigation option? 

After completing this section and reflecting on the lessons in the first three chapters of 

this Handbook, you should have a better understanding of how to engage other 

stakeholders in the watershed to discuss water quality trading opportunities. The previous 

chapter on market infrastructure, may have helped you begin to identify parties to include 

in discussions about water quality trading in your watershed. Because each situation will 

present unique challenges, this chapter does not prescribe a specific path for you to 

follow, but does offer tools to assist you in identifying and engaging the necessary 

players. 

Approach 

This chapter recognizes that water quality trading requires the participation of certain 

parties. In addition to dischargers, there are many other critical players that must be 

engaged in development of a viable water quality trading system. Each watershed will 

have a unique set of potential participants. This chapter suggests a two step approach 

for engaging stakeholders. The first step involves identifying essential participants by 

using tools such as a checklist of potential participants, a description of their roles, and a 

series of questions that can help evaluate how the conditions in your watershed will 

influence your priority list of participants. The second step is designed to improve your 

understanding of the interests of priority participants so that you will be better prepared to 

recruit them. It includes a review of key benefits of trading that can help you begin 

discussions. It also suggests several likely stakeholder needs and interests and offers 

tips for responding to them. Finally, this section gives with three examples of how trading 

programs have provided for stakeholder participation. 

IDENTIFYING AND PRIORITIZING POTENTIAL PARTICIPANTS

A wide range of parties may have an interest in participating in discussions about water 

quality trading in your watershed. To begin the process of identifying key parties, you 

should focus on the water quality problem that is being addressed. Looking at potential 
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66

solutions to the problem will help you identify those parties whose behavior needs to 

change. The first Chapters have prepared you for this phase by increasing your 

understanding of the suitability of the pollutant, the conditions in the watershed, the 

control cost differentials among dischargers, and the market infrastructure needs. In 

identifying parties that need to work together to consider the viability of trading, each 

category of participants can be important for different reasons. 

Dischargers in the watershed. Dischargers include municipal and industrial point 

sources, and nonpoint sources located in relevant urban and rural areas. You should 

focus especially on any dischargers that need to achieve substantial reductions and may 

be capable of overcontrolling their discharges. Dischargers make up the pool of potential 

trading partners. As discussed in Chapter 2, it will be important to engage dischargers to 

gather information to evaluate financial attractiveness. It will also be important to build an 

understanding of the water quality challenges individual dischargers face to help identify 

those that will be essential parties to viable water quality trades. For example, at an early 

decision point in the Lower Boise River discussions, the group recognized that a viable 

program could not be developed without the involvement of nonpoint sources from the 

agricultural community. Other watersheds may need the participation of a major point 

source facing imminent and more stringent permit limitations. 

Federal, tribal, state, and local government. The participation of federal, tribal, state, 

and local regulatory agencies in the watershed will be essential to assess whether and 

how trading might fit within current regulatory requirements. EPA has federal oversight 

responsibilities under the Clean Water Act (CWA) and also implements the NPDES 

program in some states (e.g., Idaho and Alaska). Most states and some tribes have 

delegated CWA authorities. Participation of NPDES permitting and TMDL development 

authorities will be needed to interpret CWA requirements, formulate new rules where 

possible and necessary, and, perhaps, to provide technical and scientific expertise. 

Depending on the market’s design, it is also likely that these agencies will need to 

approve elements of the trading program. Other governmental agencies may need to be 

involved because of their responsibilities for protecting fish and wildlife, regulating water 

supply, managing irrigation projects, land management, or other activities affecting the 

watershed. These agencies may also be able to provide valuable technical assistance. 

Tribal governments may be interested for a variety of reasons, including potential impacts 

on businesses they operate and their treaty rights to harvest fish and shellfish in the 

watershed. 

In addition to local government agencies that operate treatment plants which are NPDES 

permitted point source dischargers, other agencies may operate water or power utilities 

that impact water quality in the watershed. Other government agencies may need to be 

involved because their activities contribute to nonpoint source runoff or storm water 

discharges related to transportation, construction, or urban drainage systems. 

Local businesses. Some local businesses will have a direct interest in water quality 

trading because they are dischargers. Certain businesses may utilize public water 

treatment facilities. As indirect dischargers, these businesses may face rate increases 

resulting from investment in control technologies and will have an interest in trading. 

Affected businesses may include significant industrial water users, land owners, canal 

companies, developers, recreation and tourism interests in the watershed, commercial 

fishermen, and others. 

Interest groups. Groups or associations representing affected businesses and local 

governments will have an interest in discussions about trading in the watershed. 

Examples of these groups include Farm Bureau chapters, water users associations, and 
.....................................................................Water Quality Trading Assessment Handbook 

67 

associations of local county officials or wastewater treatment authorities. Of critical 

importance are active citizen environmental groups in the watershed. Many 

environmental groups are watching trading efforts carefully to ensure that all CWArelated substantive and procedural requirements are met and that TMDL water quality 

objectives are fully supported by proposed water quality trades. Many environmental 

group members are very knowledgeable about watershed conditions and challenges. In 

addition, some watersheds have councils or watershed management organizations with 

various planning and implementation responsibilities. It is important to include these 

groups in market design. 

College and university resources. Local colleges and universities may be good 

sources of information and technical assistance to support trading development efforts. 

As you consider which participants should be included, the first step is to identify the 

range of potential participants. The checklist provided below will assist you in this effort. 
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68

 

Although all of these groups will have an interest in water quality trading, not all of them 

necessarily need to be included in a stakeholder dialog about trading in the watershed. 

To assess the importance of each potential participant, it may be helpful to ask the 

following questions. 

 Which dischargers will need to change their behavior and achieve substantial 

reductions that will contribute to solving the water quality problem being addressed? 

 Which dischargers are capable of changing their behavior? 

 Which dischargers appear capable of overcontrolling their discharge? 

 Which regulatory agencies must be involved to assure regulatory compliance? 

 What is the type of technical assistance needed and where will I find it? 

 Which interest groups were involved in the development of the TMDL? 

 What key information or expertise will be needed to pursue trading opportunities that 

can be provided by interest groups? 

 Which groups can bring expertise and key information to the effort? Based on the 

identification of key dischargers, which groups support or represent these groups? 

 Which interest groups have the ability to withhold support and delay or prevent the 

success of a new trading program? 

 Which groups have an interest, but may not have an ability to affect success? 

Based on the answers to these questions, you should be able to create a prioritized list of 

essential participants. 

RECRUITING ESSENTIAL PARTICIPANTS

Before attempting to engage essential participants, you should begin by assessing their 

interests in water quality trading. Try to view the issues from their perspective. Try to put 

yourself in their “shoes.” Why would water quality trading be attractive to them? Why 

might it appear to threaten their current situation? What information will they need to 

encourage their participation? As with any new program, participants are likely to need 

more information about the potential benefits of trading and raise questions about 

potential risks. 

BENEFITS OF WATER QUALITY TRADING

In discussing water quality trading opportunities with potential participants, it may be 

helpful to keep in mind the following benefits. 

Water quality trading can result in significant cost savings. Water quality trading is a 

business-like way to solve water quality problems by focusing on cost-effective, local 

solutions. Typically, a party facing relatively high pollutant reduction costs compensates 

Checklist of Potential Participants

 Dischargers in the watershed 

› Individual Point Sources (including wastewater and storm water dischargers) 

 Municipal 

 Industrial (Direct and Indirect) 

› Individual Nonpoint Sources 

 Urban entities 

 Farmland owners/operators 

 Canal companies 

 Irrigation districts 

 Forest land managers 

 Range land managers 

 Federal agencies 

› The Regional U.S. EPA Office 

› U.S. Department of Agriculture 

 Natural Resource Conservation Service (NRCS) 

 Resource Conservation and Development Councils 

 Soil and Water Conservation Districts 

› U.S. Bureau of Reclamation (USBR) (related to irrigation activity) 

› U.S. Fish and Wildlife Service 

› National Marine Fisheries Service 

 State/Tribal Government 

› Department of Environmental Conservation (DEC, DEQ, etc.) 

› Department of Fish and Game 

› Department of Water Resources 

› Court-appointed water master 

› Tribal Councils 

 Local Government 

› Municipal utilities 

 Water supply 

 Power 

› Cities 

› Counties 

 Local Businesses 

o Significant industrial users (dischargers to POTW treatment systems) 

o Developers 

o Power companies 

 Interest Groups 

o Associations 

 Water users 

 Local business (e.g., Farm Bureau) 

 Local government 

o Environmental Groups 

o Watershed groups 

 Colleges and Universities (and other water quality research facilities in the area) 
.....................................................................Water Quality Trading Assessment Handbook 

69 

another party to achieve an equivalent, though less costly, pollutant reduction. Cost 

savings for a municipality could result in lower sewage treatment bills to citizens. For an 

industry, trading may translate into lower operating costs and/or more capital available for 

productive investment enabling a stronger competitive position and more economic 

opportunity in the community. For some sources, trading may be a source of revenue. In 

the right circumstances, trading markets can help participants achieve needed water 

quality improvements at the lowest possible cost to society. 

Water quality trading provides flexibility to dischargers in meeting pollutant load 

reductions. Trading opens up new options for meeting TMDL load allocations. Although 

water quality trading cannot compensate for common technology based standards, 

trading can be used to access the water quality improvements that are created by other 

discharger’s adoption of different technologies, expanding options for meeting TMDL 

obligations. In addition to possible cost reduction benefits, trading provides opportunities 

for creating new value to businesses and consumers through the use of creative ideas for 

improving water quality in the watershed. 

Water quality trading is voluntary. Successful trades will occur only if both parties 

perceive they will gain benefits from the trade. Some dischargers, especially nonpoint 

dischargers, are more likely to come to the table to discuss reductions in a voluntary 

context. Voluntary approaches may lead to more effective and immediate water quality 

improvements. Because most trading systems are designed to fit within existing 

regulatory frameworks, trading typically will not create new regulatory control obligations. 

Water quality trading provides incentives for overcontrol beyond current limits. 

For point sources, trading provides financial incentives for installing pollution control 

technology beyond TMDL waste load allocations because increments of pollution 

reduction beyond TMDL allocations can be sold to other dischargers. Nonpoint sources 

can be compensated for installation of best management practices that result in pollution 

reductions beyond meeting their load allocations. Trading provides additional incentives 

to create reductions where the incentives and disincentives (such as enforceable 

requirements for nonpoint source management) are relatively weak or nonexistent. These 

additional incentives can accelerate the rate of water quality improvements in many 

areas. 

Water quality trading places a greater emphasis on measuring water quality 

outcomes and will provide additional data about the watershed. Trading will provide 

additional information, through monitoring and specific nonpoint source screening criteria, 

regarding water quality in and the dynamics of the watershed. This information will 

provide a better understanding of watershed conditions and increase awareness of the 

progress of water quality improvements. 

Water quality trading can result in other ancillary environmental benefits. Trading 

provides incentives to use control options such as wetland restoration, floodplain 

protection, or other management practices that both improve water quality and provide 

additional fish and wildlife habitat. 

LIKELY PARTICIPANT NEEDS AND INTERESTS RELATING TO WATER 

QUALITY TRADING

Even if participants understand the benefits of trading, they will have legitimate needs 

and concerns that must be addressed. The following list of likely needs and interests 

also includes some suggestions for responding to them. 
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70

Lack of a Market Driver. Dischargers are likely to be interested in exploring alternative 

pollution reduction options only if they are facing an imminent change to their regulatory 

requirements. 

Response: In the watersheds being evaluated for trading viability, the market 

driver is the TMDL (or similar framework). The TMDL provides waste load 

allocations for point sources and load allocations for nonpoint sources 

dischargers that generally require new pollutant discharge reductions. The 

allocations will result in new permit limits for point source dischargers and goals 

for nonpoint sources. Watersheds with new TMDL’s generally have a sufficient 

incentive to explore trading as a possible cost–effective pollution control option. 

Monitoring of nonpoint discharges will be costly, technically challenging, and will 

lead to increased regulation. Some nonpoint dischargers may be concerned that 

trading will require on-site monitoring to measure pollution reductions. Monitoring may be 

perceived as intrusive, costly, unreliable, and a precursor to additional regulatory 

requirements. 

Response: Effective monitoring of nonpoint source discharges for trading 

purposes is designed to determine the value of the pollution reduction credits 

being generated. These credits, when established through monitoring, become a 

valuable commodity that can be sold to willing buyers. Those who participate in 

the discussions about trading in the watershed can help shape a monitoring 

program that meets their needs. Depending on the market infrastructure 

developed, the cost burden associated with monitoring can be assigned to an 

appropriate party. 

It is better to wait for regulators to enforce TMDL requirements than to proactively 

expend resources designing a new, untested compliance strategy. Participation in 

discussions about trading in the watershed could represent a significant investment in 

time and resources. Unless participants see the potential benefits, they will be reluctant 

to commit the resources and prefer to see greater emphasis on meeting TMDL load 

allocations employing traditional approaches. 

Response: Trading discussions among dischargers and regulators provides 

new opportunities for meeting the TMDL requirements for improved water quality 

that incorporates the concerns of local participants. Potential participants should 

also be made aware of the key benefits of trading suggested above, especially 

the opportunity trading provides for more effective and immediate water quality 

improvements. 

If trading results in more efficient pollution reduction, it could provide incentives 

for additional development in the watershed. Participants often bring different 

perspectives about the broad goals of water quality trading. Some groups may only 

support trading if they believe it will achieve early reductions and improve water quality 

beyond the requirements of the TMDL. They may not support the flexibility of trading if 

they believe it will lead to growth and development in the watershed. 

Response: It will be important to come to an early understanding about the 

goals of water quality trading in the watershed. For example, is the goal for 

trading to produce more cost-effective TMDL implementation or do stakeholders 

expect trading to produce environmental improvements beyond those required by 

the TMDL? In general, the focus has been on cost-effectiveness, while 
.....................................................................Water Quality Trading Assessment Handbook 

71 

producing some ancillary benefits. There is no CWA requirement or EPA 

guidance that requires trading programs to achieve environmental outcomes in 

excess of TMDL requirements. However, there are water quality benefits from 

more active engagement by nonpoint sources that leads to more immediate 

improvements, additional habitat improvements, and increased instream flows, 

rather than simply end-of-the-pipe traditional controls. 

Trading reduces the degree of certainty in meeting water pollution reduction 

targets. Some groups are concerned that trading does not include enough safeguards 

to ensure that it will produce real reductions in the amount of pollutants entering the 

watershed. They perceive that trading could sacrifice almost guaranteed, enforceable 

reductions from point sources in return for uncertain, unenforceable nonpoint source 

reductions elsewhere. 

Response: Trading systems can be designed to use monitoring, specific 

nonpoint source screening criteria, and other mechanisms to assure that only 

verified reductions can be traded. They also use discounting factors to account 

for the uncertainty of nonpoint management practices. Conservative river ratios 

are also used to predict the amount of pollution that will reach downstream 

compliance points. 

Trading can create “hotspots,” or localized areas with high levels of pollution 

within a watershed. Concerns are often raised that a trading program may improve the 

watershed’s overall water quality, but may leave certain areas with highly degraded water 

quality. 

Response: Trading programs can be designed to avoid unacceptable localized 

impacts by considering the characteristics of the pollutant, the watershed 

conditions, the location of potential trading partners, the type of trades, the scope 

of the trading area, and the use of effective monitoring programs in the design of 

trading programs. Programs should consider specific mechanisms related to the 

direction of trades (e.g., upstream versus downstream) and the use of caps and 

ratios to avoid localized impacts. EPA’s Water Quality Trading Policy supports 

trades only in the same watershed or the boundary established by a TMDL. This 

policy helps ensure that water quality standards are maintained or achieved 

throughout the trading area and contiguous waters. 

Trading provides less opportunity for public participation in pollution reduction 

activities. There is rising public interest in watershed related activities. Citizen groups 

are interested in becoming involved in decisions that affect local watersheds. These 

groups will be concerned about whether trading will change conventional public 

participation opportunities such as public notice and comment for NPDES permit 

modifications. Representatives of these groups will want to be engaged in discussions 

about the design and implementation of trading programs. Groups will be particularly 

sensitive to issues relating to monitoring and enforcement. 

Response: Participating in the early stages of a trading program development 

provides a more meaningful opportunity for public involvement than responding 

to an already developed proposal. Concerns about enforcement and monitoring 

can be raised during program design. All public participation requirements 

applicable during implementation must also be satisfied by the market according 

to EPA guidance. However, it may be harder to influence the specifics of a 

market approach once the details have been established. Early participation will 
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72

help all parties understand the information and assumptions used in the market’s 

development 

STAKEHOLDER PARTICIPATION IN MARKET INFRASTRUCTURE

Each of the three trading programs described in the Market Infrastructure chapter 

provided for stakeholder involvement during the development stage. This section briefly 

describes the range of stakeholder participants, the function and authority of the 

stakeholder group and any other key opportunities for stakeholder involvement that were 

provided during program development in two of those markets. 

Lower Boise River Effluent Trading Demonstration Project 

As described in the market characterization, participants in the Lower Boise River project 

worked together to develop a trading program framework. The project was launched with 

a state workshop to educate all attendees about the trading concept and to direct 

participation in the Lower Boise. Participants included wide representation from federal, 

state, and local agencies with water quality responsibilities, agriculture, municipalities, 

industry, and the environmental community. Participants included: the Idaho Water 

Users Association; the Idaho Farm Bureau; Pioneer Irrigation District; the Payette River 

Water Master; the Canyon Soil Conservation District; the Idaho Soil Conservation 

Commission; the Natural Resources Conservation Service; Idaho Rivers United; the Ada 

County Highway District; the Association of Idaho Cities; the Cities of Boise, Meridian, 

Nampa, and Middleton; the U.S. Bureau of Reclamation; the Southwest Idaho Resource 

Conservation and Development Council; Micron; Simplot; American Wetlands; Idaho 

Power Company; Idaho Division of Environmental Quality; US EPA; and the Boise State 

University Environmental Finance Center. 

Participants were supported by a contractor providing neutral facilitation, process 

support, and various forms of analysis. Process support from neutral parties was 

important for recruiting participation and managing the program development process to 

allow EPA and Idaho DEQ to be involved as project participants. 

As the participants worked together to pursue the development of a trading system, they 

recognized that state and federal regulatory agencies would maintain their existing 

authorities, but the group would develop and provide recommendations for their 

consideration that would likely carry significant weight. The participants were divided 

into three main teams: 1) the Framework Team, charged with developing the 

mechanisms, rules, and procedures for dynamic trading in the watershed; 2) the Point 

Source-Point Source Model Trade Team, responsible for developing a model trade 

between two point sources; and 3) the Point Source-Nonpoint Source Model Trade 

Team, tasked with developing a model trade between a point source and a nonpoint 

source. Smaller workgroups were also formed to work through specific parts of the 

trading system. These workgroups also provided an opportunity for stakeholder groups 

to identify and resolve issues specifically related to their interests and needs. These 

included the Agriculture Workgroup, the Ratios Workgroup, the Trading Framework 

Workgroup, the Indirect Dischargers Workgroup, and the Association Workgroup. 

Stakeholder participation was supported by a state-run small grants program, facilitating 

production of materials for the workgroups. Idaho DEQ is also preparing for public 

comment a state water quality trading guidance, model permit language for point source 

to point source trading, and the BMP list for the Lower Boise project. 
.....................................................................Water Quality Trading Assessment Handbook 

73 

Connecticut’s Nitrogen Credit Exchange Program 

As described in the Market Infrastructure section, a nitrogen trading program was 

established in Connecticut as a means for attaining the nitrogen reduction requirements 

outlined in the TMDL waste load allocations. Connecticut’s program does not include 

nonpoint sources of nitrogen discharge and is limited to the 79 municipal wastewater 

treatment plants in the region. Because of this limitation to point sources, the range of 

interested stakeholders was generally more restricted than other trading projects that 

included rural and urban nonpoint sources. 

Public involvement in the program has been provided through a traditional administrative 

process of public workshops and hearings, through the legislative process required 

during the passage of implementing legislation, and through ongoing monthly meetings of 

the Nitrogen Credit Advisory Board. In addition, a number of individual meetings were 

held with affected sources, cities and towns, and other interested parties. 

Administrative Process 

Prior to the development of the trading program, a series of six informational public 

workshops were held in the region on the Waste Load Allocations proposed in the 

nitrogen TMDL for Long Island Sound. Nitrogen trading was one of the options 

discussed at the workshops for meeting the TMDL load allocations. These workshops 

were attended by affected point sources, local communities, and local and national 

environmental groups. 

Another series of public workshops were held by the Connecticut Department of 

Environmental Protection to increase public understanding of the General Permit for 

Nitrogen Discharges and the Nitrogen Credit Exchange Program. Invitations and public 

notices were issued for these workshops and they were attended by point sources and 

other interested parties. 

Following the informational meetings, a two day formal public hearing was held to receive 

comments on the General Permit for Nitrogen. The agency formally responded to these 

comments and made several changes to the General Permit. 

Legislative Process 

Several components of the program required enabling state legislation for 

implementation. Legislation was introduced in the Connecticut General Assembly to 

implement the Nitrogen Credit Exchange Program. Opportunity for stakeholder groups 

and the general public to comment on the program were provided through the normal 

legislative process, which included hearings in relevant legislative committees. As a 

result of the legislative process, a number of changes were made to the proposed 

program. 

Nitrogen Credit Advisory Board 

The legislation established a Nitrogen Credit Advisory Board to assist and advise the 

Commissioner of Environmental Protection in administering the program. In addition to 

three representatives of state agencies, the board includes nine public members. The 

legislation requires that public members reflect a range of interests and experience and is 

well balanced with regard to buyers and sellers of credits, large and small municipalities, 

and representatives from different geographic regions of the state. In addition, members 
Water Quality Trading Assessment Handbook.....................................................................

74

with experience in wastewater treatment, environmental law, or finance will be included. 

The Board has been conducting monthly meetings that are open to the public. 
.....................................................................Water Quality Trading Assessment Handbook 

75 

Glossary 

Best Management Practice (BMP): A method that has been determined to be the most 

effective, practical means of preventing or reducing pollution from non-point sources. 

Designated Uses: Those water uses identified in state water quality standards that must 

be achieved and maintained as required under the Clean Water Act. Uses can include 

cold water fisheries, public water supply, irrigation, and others. 

Discharge Monitoring Report (DMR): The EPA uniform national form, including any 

subsequent additions, revisions, or modifications for the reporting of self-monitoring 

results by permitees. DMRs must be used by approved stated as well as by EPA. 

Discharge: Flow of surface water in a stream or canal or the outflow of groundwater 

from a flowing artesian well, ditch, or spring. Can also apply to discharge of liquid from a 

facility or to chemical emissions into the air through designated venting mechanisms. 

Downstream Trade: A water quality trade in which one source compensates another 

source downstream of its position within the watershed for producing an environmentally 

equivalent pollutant reduction impact at all pertinent compliance points within the 

watershed. 

Effluent: Wastewater, treated or untreated, that flows out of a treatment plant, sewer, or 

industrial outfall. 

Incremental cost: The average cost of control for the increment of reduction required 

for an individual source to meet compliance. For example, if a discharger needs a 5 

lbs./day reduction to comply with requirements but that drives a $10 million technology 

investment that actually reduces 20 lbs./day, then the incremental cost associated with 

the 5 lbs./day is substantial relative to the average cost of reductions. Traditional 

average cost would divide costs by 20 lbs./day; incremental analysis divides the costs by 

5 lbs./day and would be four times higher than average cost. 

Indirect Discharge: A non-domestic discharge introducing pollutants to a publicly 

owned treatment works. 

Load Allocation: The portion of a receiving water’s loading capability that is attributed to 

either one of its existing or future non-point sources of pollution or to natural background 

sources. Load allocations are best estimates of the loading which can range from 

reasonable accurate to gross allotments, depending on the availability of data and 

appropriate techniques for predicting loading. 

National Pollutant Discharge Elimination System (NPDES): The national program for 

issuing, modifying, revoking and reissuing, terminating, monitoring, and enforcing permits 

and imposing and enforcing pretreatment requirements under Sections 307, 402, 318, 

and 405 of the Clean Water Act. 

Non-point source: Diffuse pollution sources (i.e., without a single point of origin or not 

introduced into a receiving stream from a specific outlet). The pollutants are generally 

carried off the land by stormwater. Common nonpoint sources are agriculture, forestry, 

urban mining, construction, dams, channels, land disposal, saltwater intrusion, and city 

streets. 
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76

Overcontrol: Taking steps to reduce pollutant discharge below the waste load allocation 

for individual point sources or the load allocation for nonpoint sources. 

Point source: Any discernible confined and discrete conveyance, including, but not 

limited to, any pipe, ditch, channel, tunnel, conduit, well, discrete fissure, container, rolling 

stock, concentrated animal feeding operation, landfill leachate collection system, vessel, 

or other floating craft from which pollutants are or may be discharged. 

Total Maximum Daily Load (TMDL): The sum of the individual waste load allocations 

(WLAs) for point sources and load allocations (LAs) for nonpoint sources and natural 

background. TMDLs can be expressed in terms of mass per time, toxicity, or other 

appropriate measure that relates to a state’s water quality standard. 

Upstream Trade: A water quality trade in which one source compensates another 

source upstream of its position within the watershed for producing an environmentally 

equivalent pollutant reduction impact at all pertinent compliance points within the 

watershed. 
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77 

Appendix A 

Water Quality Trading Suitability Profile for Phosphorus 

TRADING SUITABILITY OVERVIEW 

The EPA Water Quality Trading Policy supports nutrient (e.g., total phosphorus and total 

nitrogen) trading. Sources of phosphorus include background sources such as natural 

springs, point sources such as municipal sewage treatment plants and food processors, 

and non-point sources such as irrigated agriculture. Water quality trading pilot projects 

across the country have demonstrated that phosphorus from these and other sources 

can be successfully traded. These projects have found that phosphorus discharges and 

in-stream concentrations can be readily measured at key points within a watershed, and 

that the pollutant is relatively stable as it travels through river systems. As a result, 

phosphorus dischargers will have a reasonable ability to establish environmental 

equivalence relationships between themselves or between a discharger and a 

compliance point. 

TMDLs address phosphorus and nitrogen to control a number of water quality problems 

including aquatic plant growth, low dissolved oxygen, and high pH. To establish 

equivalence appropriately, trading parties will need to understand how their load 

connects to the specific problem. Phosphorus and nitrogen are nutrients which are often 

associated with eutrophication in fresh waters. Excessive phosphorus contributes to 

exceeding the narrative water quality criteria established by many states relating to 

nuisance aquatic plant growth, deleterious materials, floating, suspended, or submerged 

matter, oxygen-demanding materials, or other similar standards. Excessive phosphorus 

concentrations have both direct and indirect effects on water quality. Direct effects 

include nuisance algae and periphyton growth. Indirect effects include low dissolved 

oxygen, increased methylmercury production, elevated pH, cyanotoxins from blue-green 

algae production, trihalomethane production in drinking water systems, and maintenance 

issues associated with domestic water supplies. 

Most TMDLs recognize the correlation between phosphorus concentrations and these 

water quality concerns. Excess nutrient loading causes excess algal growth within the 

water column, which in turn affects levels of dissolved oxygen and pH in aquatic systems. 

This correlation between phosphorus concentrations and other water quality concerns 

can be seen in the Draft Snake River- Hell’s Canyon TMDL recently developed by the 

states of Idaho and Oregon. In this TMDL, concentration levels are established for both 

Chlorophyll a and Total Phosphorus to ensure that nutrient concentrations do not result in 

excessive algae or other aquatic growth, which may impede the attainment of water 

quality standards for dissolved oxygen and pH. 

KEY TRADING POINTS

A. Phosphorus Pollutant Form(s) 

Total Phosphorus TMDLs —Most TMDLs establish load allocations for Total Phosphorus, 

although levels of both Total Phosphorus and Ortho-phosphorus are often monitored. 

Total Phosphorus is, however, comprised of two forms: 
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78

 Soluble—also known as Dissolved Ortho-phosphate or Ortho-phosphorus—includes 

highly soluble, oxidized phosphorus. Because of its solubility, ortho-phosphorus is 

commonly more available for biological uptake and leads more rapidly to algal growth 

than non-soluble phosphorus. 

 Non-Soluble—also known as Sediment-Bound or Particulate-Bound phosphorus—is 

mineral phosphorus incorporated in sediment and is not as likely to promote rapid 

algal growth, but has the potential to become available to plants over time. 

The concentration of total phosphorus is calculated based on the sum of the soluble and 

non-soluble phosphorus. Due to phosphorus cycling in a waterbody (conversion between 

forms) TMDLs usually consider Total Phosphorus concentrations. Total Phosphorus then 

represents the phosphorus that is currently available for growth as well as that which has 

the potential to become available over time. 

Sources covered by a Total Phosphorus TMDL will be measuring discharges and 

reductions using a common metric. Use of this common metric for measuring phosphorus 

reductions in a TMDL should provide a high potential for matching phosphorus 

discharges from various sources in the watershed. It will be important, however, to 

understand the actual forms of phosphorus being discharged because some trades may 

not represent an equivalent impact on water quality. For example, if individual 

dischargers have substantially divergent load characteristics (e.g., one primarily 

discharges soluble phosphorus while another primarily discharges non-soluble 

phosphorus) then a trade between the two may not be environmentally equivalent. If a 

high percentage of the total phosphorus is present as soluble ortho-phosphate, it is more 

likely that rapid algal growth will occur than if the majority of the total phosphorus is 

mineral phosphorus incorporated in sediment. Adjustments, using a trade ratio or other 

means of establishing and equivalence relationship, may be needed to account for such 

differences. 

Other Phosphorus-Related TMDLs—To the extent that a TMDL establishes load 

allocations in terms of individual phosphorus forms, challenges to trading may exist. If a 

TMDL provides load allocations for different forms, participants in the watershed will be 

limited to trading within two, smaller, more constrained markets for each form. 

Alternatively, a reliable translation ratio may be generated to create broader trading 

opportunities. 

There may be circumstances where some dischargers receive phosphorus allocations 

while others receive dissolved oxygen allocations. There is a known and wellcharacterized link between phosphorus concentrations and dissolved oxygen problems. 

This relationship provides an opportunity to establish a specific translation ratio between 

Total Phosphorus and Dissolved Oxygen, potentially enabling additional trading 

opportunities. For example, under the Draft Snake River-Hells Canyon TMDL, Idaho 

Power Company was given a load allocation for DO, while municipal, industrial, and 

agricultural sources have received Total Phosphorus allocations. Idaho DEQ is exploring 

the development of a total phosphorus/dissolved oxygen (TP/DO) translation ratio, which 

would enable Idaho Power to become a potential purchaser of TP surplus reductions 

from other sources. 

B. Impact 

Adjusting for Fate, Transport, and Watershed Considerations—In general, phosphorus 

fate and transport are sufficiently well understood, and the models used to develop 
.....................................................................Water Quality Trading Assessment Handbook 

79 

phosphorus TMDLs are reasonably well suited, to support the development of 

environmental equivalence relationships among potential phosphorus trading parties. 

The phosphorus “retentiveness” of a water body describes the rates that nutrients are 

used relative to their rate of downstream transport. As ratios are set for trading 

opportunities, the factors that contribute to retentiveness should be considered. Areas of 

high retentiveness are usually associated with low flows, impoundments, dense aquatic 

plant beds, and heavy sedimentation. Trades that involve phosphorus loading through 

these areas will likely require high ratios (e.g., 3:1) to achieve environmental equivalence 

between dischargers. In areas with swift flowing water and low biological activity, 

phosphorus is transported downstream faster than it is used by the biota, resulting in low 

levels of retentiveness and minimal aquatic growth. In areas of low retentiveness, where 

phosphorus is transported rapidly through the system, low ratios (e.g., 1.1/1) will likely 

emerge. 

Other factors, including substrate stability and light contribute to plant growth and factor 

into a segment’s “retentiveness.” Sedimentation is another condition that can affect how 

phosphorus will move through and be utilized in a system. Phosphorus is often found in 

sediments and will persist longer in them. As a result, the presence of these factors 

should be an explicit consideration in setting environmental equivalence ratios. 

Examining Local Considerations—In a downstream trade, the upstream source will not 

meet its allocation under the TMDL because it is purchasing reductions from another 

source downstream. Discharges from the upstream source will not be reduced, and 

water quality will not be improved in the segment between the two sources. Overcontrol 

by the downstream source will result in improved water quality further downstream. 

These types of trades will only avoid unacceptable localized impacts if the segment 

between the two sources has not reached its assimilative capacity. 

Additionally, a trade, irrespective of its direction (up or downstream), involving sources 

discharging substantially different phosphorus forms may be vulnerable to creating 

localized impacts. In particular, a trade that involves offsetting a primarily soluble 

phosphorus discharge with a sediment-attached discharge will leave a greater quantity of 

readily available phosphorus in the water body than otherwise would have been the case. 

This readily available phosphorus has the potential, as discussed earlier, to contribute to 

short-term, local nuisance aquatic growth problems. 

C. Timing 

The key time element to consider when examining phosphorus trading is the seasonal 

load variability among dischargers. Agricultural non-point sources usually discharge 

during the growing season only, i.e., between April and October. Point sources generally 

discharge all year round. The relative importance of this difference plays out in the 

context of how TMDL phosphorus allocations are set. Many TMDLs provide seasonal 

phosphorus load allocations that apply only during those months of the growing season. 

The potential for excessive algal growth occurs predominately in the summer when 

sufficient light and temperature conditions support plant growth. Under these 

circumstances, both point and non-point sources will likely receive a seasonal allocation, 

and their ability to match reduction needs with the timing of phosphorus reduction credits 

will overlap and readily support trading. However, allocations to lakes or other large 

water bodies may be annual because of the relationship in these water bodies between 

annual phosphorus loadings and eutrophication. In such cases, sources receiving yearround allocations may be restricted from trading with sources that produce seasonal 

loads. 
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D. Quantity 

Typically, phosphorus TMDLs establish WLAs and LAs in terms of concentration or mass 

based reductions. For the most part, these allocations provide a straight forward means 

to establish over control for purposes of identifying marketable reductions. For example, 

a POTW with a permit limit established at 700 lbs./day that currently discharges 600 

lbs./day, will have 100 lbs./day of marketable reductions. However, for some non-point 

sources, estimates may need to be utilized to establish the level of phosphorus 

reductions. This will likely be needed when sampling a discharge is complex, infeasible, 

and/or not cost effective. Pilot projects have used estimation methods based on the type 

and degree of BMP implementation to establish phosphorus reductions. Such estimates 

should be based on the type and extent of BMP implementation and local conditions. 

While less precise, if conservative assumptions are utilized, the degree of control which 

can be achieved with various BMPs can be estimated and utilized for trading purposes. 

Thus, in either case, reasonably well established methods exist for understanding the 

degree of over control achieved by phosphorus sources and enabling trading parties to 

clearly verify the existence of marketable reductions. 
.....................................................................Water Quality Trading Assessment Handbook 

81 

Appendix B 

Water Quality Trading Suitability Profile for Temperature 

TRADING SUITABILITY OVERVIEW 

Unlike nutrient trading, which has been piloted in a number of areas around the country, 

there is very little experience trading water temperature. The EPA Water Quality Trading 

Policy does recognize that trading of pollutants other than nutrients and sediments has 

the potential to improve water quality and achieve ancillary environmental benefits if 

trades and trading programs are properly designed. Issues related to determining the 

tradable commodity and establishing environmental equivalence are currently being 

considered in a few watersheds in EPA Region 10. These efforts, as well as discussions 

within Region 10, indicate that temperature impacts, fate, and transport are sufficiently 

well understood to support at least some level of trading among sources of elevated 

temperature sources. The current expectation is that environmental equivalence can be 

established through direct sampling and through the models used in TMDL development. 

Temperature standards have been established to protect beneficial uses such as cold 

water biota, salmonid spawning and rearing, and anadromous fish passage. TMDLs in 

Region 10 address water temperature primarily to protect cold water fish (salmonids) as 

the most sensitive beneficial uses. As of 1996, water temperature was addressed in 240 

TMDLs in Region 10 (38 by Idaho, 141 by Oregon, and 61 by Washington). Water 

temperature is also an important consideration in Region 10 because a number of 

salmonid species listed as threatened or endangered under the Endangered Species Act 

(ESA) inhabit these waters and require improved water quality to support survival and 

recovery. 

In Region 10, water temperature has direct and indirect impacts on native salmonids, bull 

trout, and other species listed under the ESA. Water temperature affects all life stages of 

these fish. It directly affects spawning, rearing, feeding, growth, and overall survivability. 

The incidence and intensity of some diseases are directly related to increased water 

temperatures. Indirect effects include changing food availability, increasing competition 

for feeding and rearing habitat, and enhancing the habitat for predatory fishes. Increased 

water temperature also indirectly affects water quality by increasing the toxicity of many 

chemicals, such as un-ionized ammonia. High water temperatures reduce DO 

concentrations by increasing plant respiration rates and decreasing the solubility of 

oxygen in water. 

Sources of elevated temperature increases usually include both natural loading (from 

high air temperatures and solar radiation) and anthropogenic loading (from point source 

discharges and nonpoint sources such as devegetation of riparian areas, agricultural and 

stormwater drains, and tributary inflows). Non-point sources contribute to solar radiation 

heat loading by removing near stream vegetation and decreasing stream surface shade. 

In urban areas, impervious surfaces reduce the cooling effect of natural infiltration of 

surface runoff and increase the temperature of stormwater inflows. The Pacific 

Northwest State and Tribal Water Quality Temperature Standards11 identified the four 

largest sources of increased temperature in the Pacific Northwest to be 1) removal of 

 

11 Pacific Northwest State and Tribal Water Quality Temperature Standards (US EPA, April 2003, 901-B-03-

002) 
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82

streamside vegetation, 2) channel straightening or diking, 3) water withdrawals, and 4) 

dams and impoundments. 

KEY TRADING POINTS

A. Temperature Pollutant Form(s) 

Temperature TMDL allocations are designed to limit human-caused water temperature 

increases and to meet the applicable water quality standards. The standards are usually 

expressed as specific limitations on surface water temperatures, as expressed in 

degrees. For example, temperature load capacity in the Snake River-Hell’s Canyon 

TMDL is defined (through Oregon state standards) as no measurable increase over 

natural background levels. The quantitative value used by Oregon Department of 

Environmental Quality as “no measurable increase” is 0.25°F (0.14° C). 

Most TMDLs provide temperature waste load allocations to point sources in degrees 

Centigrade, (°C), degrees Fahrenheit (°F), or as heat per unit time, such as BTU’s or 

Kilocalories per day. In effect, allocations establish what volume of discharge at a given 

temperature may enter a water body over a given period of time. 

For non-point sources, temperature load allocations are often expressed as “no 

anthropogenic increase” or no loading by human sources. For ease of implementation 

these are also expressed in terms of percent of stream area shade required, providing 

site-specific targets for land managers. In temperature impaired reaches, non-point 

sources often meet this target by allowing stream banks to revegetate naturally until it 

attains “system potential,” or the near stream vegetation condition that would naturally 

grow and reproduce on a site, given elevation, soil properties, plant biology, and 

hydrologic processes. 

 

Although point and non-point sources tend to receive different forms of temperature 

allocations, models have been developed to convert the effect of increased stream shade 

into degrees cooling. Oregon DEQ uses several different models during TMDL 

development. The “Heat Source” model uses multiple data sources related to 

temperature, vegetation, and hydrology to accurately predict stream temperature at 100-

foot distances. Other models are used to simulate stream temperatures for various 

hypothetical riparian restoration strategies. These models provide a basis for converting 

between point and non-point source temperature reductions for purposes of trading 

allocations. 

B. Impact 

Adjusting for Fate, Transport, and Watershed Conditions—In general, temperature fate 

and transport are sufficiently well understood, and the models to develop temperature 

TMDLs are reasonably well suited, to support the development of environmental 

equivalence relationships among potential temperature trading parties. Moreover, EPA 

Region 10 temperature guidance currently supports the establishment of a mixing zone 

for temperature discharges. If a similar provision is included in the state’s water quality 

standards and utilized in the development of the WLAs in the TMDL, this provides for 

some mixing between the discharge water and receiving stream. If the receiving water is 

sufficiently cool as a result of upstream overcontrol, additional mixing may be allowed 

provided that the temperature standard is met at the edge of the mixing zone. 
.....................................................................Water Quality Trading Assessment Handbook 

83 

However, water temperature fluctuates in response to natural conditions, such as 

ambient air temperature, solar heating, and flows. Thus, the temperature effects of 

control options can dissipate quickly as water bodies rapidly reach a new water 

temperature equilibrium with the atmospheric and hydrologic conditions. As a result, 

although models and sampling can be used to predict and track the impacts of water 

temperature reductions at locations in a watershed, major water temperature effects are 

not likely to be seen at distant locations. For trading purposes, this suggests that 

potential trading parties will likely need to reside in relatively close proximity to each other 

for an environmentally equivalent trade to emerge. 

A second aspect of assessing the environmental equivalence of temperature reductions 

relates to the potential importance of cold water refugia in streams which provide 

salmonid habitat. Although temperature load allocations are designed to meet the 

numeric criteria of applicable water quality standards, narrative standards also often 

address the need to protect ecologically sensitive cold-water refugia. Thus, it will be 

important to identify how sources of temperature impacts are connected to these refugia. 

If these connections can be modeled to determine how overcontrol options can benefit 

refugia, then trading opportunities that provide targeted temperature improvements to 

refugia can be explored. In this context, and as discussed under the Quantity section 

below, certain locations of temperature reductions will be of higher quality (more valuable 

to protection of the desired beneficial use) and therefore more desirable. To the extent a 

trading system can recognize this value and help to steer reductions to these areas it can 

substantially support the TMDL goals. 

Examining Local Considerations—Certain forms of temperature trades hold the potential 

to create localized impacts. In some areas, high water temperatures can have harmful or 

even lethal impacts on fish populations. In other areas, fish may be able to avoid the 

hotspots with little effect on the species. The creation of a mixing zone under NPDES 

permits will provide some flexibility in this context, although the expectation is that even if 

standards are met at the zone’s edge, there will be elevated temperature impacts at and 

in close proximity to the discharge point. Any established threshold temperature level will 

be site and conditions specific, and watershed participants should expect that the 

presence of cold water refugia will almost certainly require limitations on the degree to 

which a source could exceed their temperature allocation and mitigate through trading. 

In general, caps on purchasing activity placed in NPDES permits will be a primary means 

to control for local temperature impacts. 

C. Timing 

Exceedances of temperature-related water quality standards are more likely to occur in 

the summer months. As a result, temperature TMDLs have focused allocations 

seasonally, with required temperature reductions applying at the typically hottest times of 

the year. In response, many waste load allocations provide (or are expected to provide) 

different allocations for various times of the year, with more stringent limits during 

summer months and salmonid spawning or other life cycle periods that are critical to fish 

survival. In general, this seasonal approach supports opportunities for point sources and 

non-point sources to consider temperature trading options. Irrespective of the 

temperature allocation cycle, non-point source temperature reduction efforts in the form 

of shade are seasonally dependent, as greater cooling effects are provided from the 

shade during this period. Most nonpoint source temperature allocations are not 

seasonal—thus encouraging the vegetation to be in place year-round and indirectly 

support channel stability and other key channel characteristics. Under a seasonal 

temperature TMDL, point sources’ need for reductions or willingness to overcontrol will 
Water Quality Trading Assessment Handbook.....................................................................

84

coincide with the non-point sources ability to influence stream temperature, thus 

establishing a strong match for trading from a timing standpoint. 

D. Quantity 

Based on the nature of temperature allocations and related control options, both point 

and non-point sources of temperature impacts have the ability to over control their 

“discharge” and create temperature credits. For point sources, overcontrol would take 

the form of lowering discharge temperature below that required in a TMDL. In instances 

where the point source is a significant contributor to elevated in-stream temperatures 

(e.g., the discharger’s flow is greater than the in-stream flow with a temperature 50 

percent higher), the impact of over control will likely be discernable for some distance. 

This situation would readily support upstream trading with other point or non-point 

sources. In EPA Region 10, however, most point sources of heat are relatively small and 

have limited thermal loads. As a result, it is anticipated that their over control would 

quickly be offset by more dominant in-stream and riparian conditions. Trading 

opportunities, as a consequence, would be constrained to other sources in very close 

proximity to the source of over control. 

In order to attain most non-point source allocations in temperature TMDLs, land along 

streams would need to achieve site potential shade. Natural re-vegetation varies with 

species, climate, and local conditions, requiring between 20 and 80 years to achieve site 

potential shade. If there are no state or local measures in place requiring landowners to 

actively plant and restore riparian areas, non-point sources can over control by 

influencing stream area shade in three ways: 1) earlier shade creation through tree 

planting; 2) more effective shade creation through selection of planted vegetation with a 

denser canopy; and 3) increasing the total shaded area of the stream. 

In Region 10, tree planting programs that substantially advance the creation of shade as 

compared to natural re-vegetation have emerged as strong candidates for creating over 

control. Current thinking indicates that generating temperature benefits sooner than 

would be present under either natural or required stream bank re-vegetation can be used, 

at least temporarily, as reduction credits available for trading. The value of these credits 

may be quite high, as they are potentially available for at least five and possibly up to 

fifteen years, allowing other sources to delay what might otherwise be very substantial 

capital expenditures to reduce discharge temperatures. 

Other means of non-point source over control are more theoretical at this time. Although 

it remains an untested concept, certain trees that create a denser and/or higher canopy 

than natural vegetation may produce greater shading and thus reduce the warming 

effects of sun light. Under such an approach, tree planting would not only produce 

temperature benefits earlier than natural re-vegetation, it would create a more consistent 

and/or greater area of shade than described in the TMDL. If utilized, tree selection 

should take into consideration a diversity of species and the ability of the re-vegetated 

community to sustain other functions of the riparian area. 

Additionally, in instances where TMDLs do not require site potential shade throughout a 

watershed, expanding the area of stream bank vegetation beyond TMDL allocations 

could represent over control. However, Region 10 temperature TMDL experience to date 

indicates that a typical TMDL approach will be to require natural re-vegetation throughout 

the TMDL area, substantially reducing the opportunity for this option. 

Both point and non-point sources may have two additional options for creating 

temperature reduction credits for either their own use or for sale to others. First, 
.....................................................................Water Quality Trading Assessment Handbook 

85 

modifications to channel complexity that return streams to more natural width-to-depth 

ratios may result in temperature reductions. Moreover, reestablishing tree-covered 

islands in mid stream is another channel modification that can create additional shading 

effects to reduce water temperature. 

Second, water volume and flow are critical factors affecting water temperature. Creative 

solutions to water temperature problems often involve changes in flow regimes. Water 

temperature improvement measures relating to flow include changes in location of 

discharges, increases in irrigation efficiencies, and water right purchases or leases. It is 

likely that any such changes in flow regimes that result in improved temperature 

conditions can be easily accounted for with models used in the development of the 

TMDL. 

Irrespective of the means by which non-point sources achieve over control, these actions 

hold the potential to be more attractive than point source temperature reductions from an 

overall watershed health standpoint. Non-point source over control options that 

accelerate the return of vegetation in riparian areas provides important benefits to water 

quality and fish and wildlife habitat. Increased vegetation along stream banks helps to 

maintain temperature improvements from other sources. Increased vegetation in riparian 

areas support other water quality objectives by reducing erosion, sediments, and 

providing natural filtration of water entering the stream. Vegetated stream banks improve 

the health of riparian areas, which provide important habitat for many types of wildlife and 

aquatic species. As a result, a trade in which a point source opts to pay for non-point 

source over control may prove highly desirable from an overall watershed health 

perspective.
Water Quality Trading Assessment Handbook.....................................................................

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Appendix C 

Water Quality Trading Suitability Profile for Sediments

TRADING SUITABILITY OVERVIEW 

The EPA Water Quality Trading Policy specifically supports sediment trading. Sources of 

sediments include both natural and anthropogenic sources. Soil erosion from surface 

water flow is the largest natural source of sediments. Erosion from high flow events, 

such as flash floods or snow melt can result in greater sediment deposition in a single 

large event than occurs all year from average flows. Nonpoint sources of sediment 

include agricultural sources such as plowing and flood and furrow irrigation, forestry 

sources, such as logging and stream bank disturbance, and urban/suburban sources 

including construction, stormwater runoff, and irrigation. Point sources generally contain 

sediment discharge limits in their NPDES permits but are usually not major contributors 

to sediment concentrations. 

Region 10 has had limited experience considering sediment trading opportunities. 

However, other areas of the country have had more experience with sediment trading, 

with pilot projects involving sediments conducted in the Delaware River, PA, the Truckee 

River, NV, and the Lower Smith River, VA. 

Water quality standards are developed to protect the most sensitive beneficial use and 

have generally been established for sediments to protect designated uses associated 

with aquatic life. They are often based on both a numeric standard related to turbidity 

(e.g., 50 NTU’s above background), and a narrative standard that protects beneficial 

uses. Narrative standards are translated into a wide range of numeric criteria depending 

on the conditions in the watershed, the fish species present, and the interpretation of the 

agencies and stakeholders in the area. 

TMDLs address sediments to meet water quality standards and control a number of 

water quality problems. To establish appropriate environmental equivalence, trading 

parties will need to understand how their sediment loads connect to the specific problem. 

High concentrations of sediment can have both direct and indirect effects on water 

quality. Excessive amounts of sediment can directly impact aquatic life and fisheries. 

Excessive sediment deposition can choke spawning gravels, impair fish food sources, 

and reduce habitat complexity in stream channels. Excessive suspended sediments can 

make it more difficult for fish to find prey and at high levels can cause direct physical 

harm, such as scale erosion, sight impairment, and gill clogging. Stream scour can lead 

to destruction of habitat structure. Sediments can cause taste and odor problems for 

drinking water, block water supply intakes, foul treatment systems, and fill reservoirs. 

High levels of sediment can impair swimming and boating by altering channel form, 

creating hazards due to reductions in water clarity, and adversely affecting aesthetics. 

Indirect effects associated with sediment include low dissolved oxygen levels due to the 

decomposition of organic sediment materials, and water column enrichment by attached 

pollutant loads, such as nutrients, or legacy application of DDT or mercury-based seed 

treatments. Elevated stream bank erosion rates also lead to wider channels which can 

contribute to increased temperatures. Sediment targets and monitored trends often 

function as indicators of reductions in transport and delivery of these attached pollutants. 
.....................................................................Water Quality Trading Assessment Handbook 

87 

Sedimentation is also an important consideration in Region 10 because a number of 

species listed as threatened or endangered under the Endangered Species Act (ESA) 

inhabit impaired waters in the region and require cold, clear, well oxygenated water to 

support spawning, survival, and recovery. 

KEY TRADING POINTS

A. Sediment Pollutant Form(s) 

Sediment TMDLs—Sediment is discharged by sources in a wide range of particle sizes 

and weights. TMDLs generally provide separate load allocations for sediments based on 

two different particles sizes. 

 Suspended or “water column” sediments are particles that are small and light enough 

to remain suspended in the water column, generally less than 1 mm. Sources also 

discharge two different types of these suspended sediments. Nonpoint sources 

discharge geological particles, which are derived from rock and soil. Point sources, 

such as wastewater treatment plants, usually discharge biological particles as part of 

the treated wastewater. These different forms of suspended sediments may have 

different impacts on water quality. As discussed below, TMDLs often establish 

different load allocation forms for point and nonpoint sources to control water column 

sediments. 

 Bedload sediments are larger particles that are too heavy to be suspended in the 

water column. They are generally discharged by nonpoint sources and are 

transported by sliding, rolling, or bouncing along the bed of the stream. Bedload 

sediments consist of particles greater than 1 mm in diameter and can range in size 

from sand and gravel to small pebbles or large boulders. TMDLs often establish 

mass-based load allocations for bedload sediments such as pounds per day or 

tons/square mile/year of sediment loading, or use a percentage of fines deposited in 

stream bottoms. 

 

TMDLs often establish different load allocation forms for point and nonpoint sources. 

Waste load allocations for point sources often use concentration-based limits, such as an 

average weekly limit of 45 mg/L of Total Suspended Solids (TSS). Load allocations for 

nonpoint sources are often expressed in mass-based allocations, such as tons/square 

miles/year of sediment loading. Point source dischargers with similar sediment discharge 

forms and waste load allocation metrics may have trading opportunities. For example, 

two POTWs from neighboring jurisdictions in Virginia have entered into a cooperative 

agreement whereby one POTW has agreed to a reduction in its permit limit for 

discharging total dissolved solids so the other can have an increased limit. The 

allocations are both expressed in terms of kg/day of total dissolved solids. The two 

plants discharge into the same stream segment and the Virginia DEQ has determined 

that the agreement would not result in a decrease in water quality. However, point 

sources will also need to be aware of the form of sediment being discharged. A point 

source discharging a biological form of sediment can have different water quality impacts 

than a source discharging a geological form. 

B. Impact 

Adjusting for Fate and Transport Characteristics and Watershed Considerations—As 

dischargers consider trading opportunities, it will be important to understand the specific 

water quality impacts of each potential trading partner. Sediment load reductions by 
Water Quality Trading Assessment Handbook.....................................................................

88

sources may be measured directly by sampling, with the models used to develop 

sediment TMDLs, or using surrogate measures, such as percentage of fines in stream 

bottoms. Other site specific watershed conditions, such as velocity, slope, channel 

conditions, and type of sediment, are important considerations for understanding water 

quality impacts and matching potential trading partners. 

For suspended sediments, models are available to determine the impacts of reductions. 

However, depending on the watershed conditions, and the water quality problem that is 

being addressed, geological and biological forms of suspended sediments may have 

different impacts. It is likely that trading between similar forms (e.g., geological to 

geological, and biological to biological) will support water quality improvements. But 

trading between different forms of suspended sediments will be dependent on the water 

quality impacts that each reduction is intended to address. For example, if a source’s 

reduction in geological suspended sediments is intended primarily to reduce levels of 

attached phosphorus, then a trade with a source discharging a biological form of 

suspended sediments will not meet the water quality improvement needs of the 

watershed. However, if suspended sediment reductions are intended primarily to reduce 

turbidity, then a trade between two different forms may be supported. 

While bedload sediment reductions may also be easily modeled, the impacts of bedload 

sediments are generally experienced relatively close to the source of discharge as the 

heavier particles are transported very slowly along the river bottom. Thus, opportunities 

for trading bedload are likely to be limited to geographically smaller market areas. 

Because suspended sediments and bedload sediments will have different impacts on 

water quality, it is unlikely that there will be direct opportunities for trading between these 

two different forms of sediment. 

Watershed flow patterns are also likely to define market areas for trading. Sediment 

movement in a stream varies as a function of flow. Suspended sediments discharged into 

high flow areas will travel longer distances and may define a large market area. The 

boundaries of markets may be defined by lower flows areas. The areas usually occur in 

the lower sections of watersheds where flows decrease and the lighter, smaller 

suspended sediments fall out. Upper sections of watersheds with higher flows often 

transport more bedload sediment. Impoundments create significant barriers that restrict 

sediment transport and create areas of sediment deposition. These distinct areas, based 

on flow patterns, are likely to delineate defined trading market areas, with trading limited 

to within each defined area. 

Examining Local Considerations—Because watershed conditions relating to velocity, 

slope, and channel conditions will directly affect the impact of sediment reductions, each 

trade will have to be assessed to determine the potential for localized impacts. As with 

other pollutants, downstream trades will only avoid unacceptable localized impacts if the 

segment between the two sources has not reached its assimilative capacity. Additionally, 

a trade, irrespective of its direction (up or downstream), involving sources discharging 

substantially different sediment forms may be vulnerable to creating localized impacts. 

For example, a trade that involves offsetting a biological form of suspended sediment 

discharge with a geological form of suspended sediment discharge will leave a greater 

quantity of biological sediments in the water column. This form of sediment may have a 

greater impact on dissolved oxygen levels and may lead to unacceptable dissolved 

oxygen-related water quality problems. 
.....................................................................Water Quality Trading Assessment Handbook 

89 

C. Timing 

Although sediment delivery to streams from nonpoint sources is an inherently seasonal 

phenomenon, sediment allocations are generally applied year round. Allocations are 

expressed as an average amount of sediment per year. To account for variability 

between years (i.e., years with high snow melt or other extreme weather events will have 

higher sediment delivery) some TMDL load allocations are expressed as ten year rolling 

averages. Because sediment load allocations are generally applied on an average basis 

year round, participants will be likely to align reductions between potential buyers and 

sellers. 

D. Quantity 

There are a number of ways that sources can apply control options to reduce sediment 

loads. These controls can be sampled and/or modeled to determine the amount of 

sediment reduction beyond TMDL allocations. 

Point sources can apply technological control options that result in a measurable change 

in sediment concentration and associated loads. Permit limits for point sources are 

usually based on a technology-based limit which may be lower than required to meet the 

TMDL target. Under the Clean Water Act, point sources are required to comply with their 

technology-based limits, irrespective of watershed conditions or their opportunities to 

trade. Under such circumstances, there is no incentive for such sources to become 

purchasers of sediment reductions. However, in circumstances where the technologybased limit is higher than the water quality standards, incentives for trading may exist. 

In many watersheds experiencing sediment related water quality problems, point sources 

are often only minor contributors to excessive sediment loads. Therefore, they may have 

a limited capacity to overcontrol in a meaningful way to improve water quality. As 

discussed above, point sources also discharge a different form of suspended sediment. 

Point sources may be limited to trading with other sources discharging similar forms. 

Nonpoint sources have the ability to overcontrol using more aggressive controls than 

required to meet load allocations, using controls that cover broader areas, or using 

controls that target more valuable areas for sediment reduction. 

Nonpoint sources can overcontrol using Best Management Practices (BMPs). 

Aggressive BMPs, such as conversion to drip irrigation on agricultural lands have the 

ability to reduce sediment loads below TMDL allocations. BMPs can also be applied to 

cover broader areas than specified in a TMDL. 

Another potential overcontrol option is for sources to select higher value areas to apply 

nonpoint BMPs, thus achieving higher reductions in the waterbody of concern. 

Marketable reductions may be generated by applying control options that focus on areas 

with highly erodible soils, or areas that have a direct impact on the beneficial use, such 

as salmonid spawning areas, and may create a greater improvement in water quality than 

specified under the TMDL allocation. 

BMPs can be modeled to project the reduction in sediment loading. However, models 

used in TMDL development usually provide only very coarse estimates of sediment 

loading. Because of the limitations of models in projecting sediment reductions, TMDLs 

often use surrogate measures that provide a more direct connection to the beneficial use 

that is being protected. Measures such as the depth of sediment fines in riffle pools are 

used in addition to the numeric targets to assess sediment reductions. These methods 
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90

should allow nonpoint sources to calculate the amount of reductions beyond TMDL load 

allocations. 
.....................................................................Water Quality Trading Assessment Handbook 

91 

Appendix D 

Capital Cost Annualization Factors 

Year 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00%

1 1.005 1.01 1.015 1.02 1.025 1.03 1.035 1.04

2 0.5038 0.5075 0.5113 0.515 0.5188 0.5226 0.5264 0.5302

3 0.3367 0.34 0.3434 0.3468 0.3501 0.3535 0.3569 0.3603

4 0.2531 0.2563 0.2594 0.2626 0.2658 0.269 0.2723 0.2755

5 0.203 0.206 0.2091 0.2122 0.2152 0.2184 0.2215 0.2246

6 0.1696 0.1725 0.1755 0.1785 0.1815 0.1846 0.1877 0.1908

7 0.1457 0.1486 0.1516 0.1545 0.1575 0.1605 0.1635 0.1666

8 0.1278 0.1307 0.1336 0.1365 0.1395 0.1425 0.1455 0.1485

9 0.1139 0.1167 0.1196 0.1225 0.1255 0.1284 0.1314 0.1345

10 0.1028 0.1056 0.1084 0.1113 0.1143 0.1172 0.1202 0.1233

11 0.0937 0.0965 0.0993 0.1022 0.1051 0.1081 0.1111 0.1141

12 0.0861 0.0888 0.0917 0.0946 0.0975 0.1005 0.1035 0.1066

13 0.0796 0.0824 0.0852 0.0881 0.091 0.094 0.0971 0.1001

14 0.0741 0.0769 0.0797 0.0826 0.0855 0.0885 0.0916 0.0947

15 0.0694 0.0721 0.0749 0.0778 0.0808 0.0838 0.0868 0.0899

16 0.0652 0.0679 0.0708 0.0737 0.0766 0.0796 0.0827 0.0858

17 0.0615 0.0643 0.0671 0.07 0.0729 0.076 0.079 0.0822

18 0.0582 0.061 0.0638 0.0667 0.0697 0.0727 0.0758 0.079

19 0.0553 0.0581 0.0609 0.0638 0.0668 0.0698 0.0729 0.0761

20 0.0527 0.0554 0.0582 0.0612 0.0641 0.0672 0.0704 0.0736

Year 4.50% 5.00% 5.50% 6.00% 6.50% 7.00% 7.50% 8.00%

1 1.045 1.05 1.055 1.06 1.065 1.07 1.075 1.08

2 0.534 0.5378 0.5416 0.5454 0.5493 0.5531 0.5569 0.5608

3 0.3638 0.3672 0.3707 0.3741 0.3776 0.3811 0.3845 0.388

4 0.2787 0.282 0.2853 0.2886 0.2919 0.2952 0.2986 0.3019

5 0.2278 0.231 0.2342 0.2374 0.2406 0.2439 0.2472 0.2505

6 0.1939 0.197 0.2002 0.2034 0.2066 0.2098 0.213 0.2163

7 0.1697 0.1728 0.176 0.1791 0.1823 0.1856 0.1888 0.1921

8 0.1516 0.1547 0.1579 0.161 0.1642 0.1675 0.1707 0.174

9 0.1376 0.1407 0.1438 0.147 0.1502 0.1535 0.1568 0.1601

10 0.1264 0.1295 0.1327 0.1359 0.1391 0.1424 0.1457 0.149

11 0.1172 0.1204 0.1236 0.1268 0.1301 0.1334 0.1367 0.1401

12 0.1097 0.1128 0.116 0.1193 0.1226 0.1259 0.1293 0.1327

13 0.1033 0.1065 0.1097 0.113 0.1163 0.1197 0.1231 0.1265

14 0.0978 0.101 0.1043 0.1076 0.1109 0.1143 0.1178 0.1213

15 0.0931 0.0963 0.0996 0.103 0.1064 0.1098 0.1133 0.1168

16 0.089 0.0923 0.0956 0.099 0.1024 0.1059 0.1094 0.113

17 0.0854 0.0887 0.092 0.0954 0.0989 0.1024 0.106 0.1096

18 0.0822 0.0855 0.0889 0.0924 0.0959 0.0994 0.103 0.1067

19 0.0794 0.0827 0.0862 0.0896 0.0932 0.0968 0.1004 0.1041

20 0.0769 0.0802 0.0837 0.0872 0.0908 0.0944 0.0981 0.1019

Interest Rate

Interest Rate
Water Quality Trading Assessment Handbook.....................................................................

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Year 8.50% 9.00% 9.50% 10.00% 10.50% 11.00% 11.50% 12.00%

1 1.085 1.09 1.095 1.1 1.105 1.11 1.115 1.12

2 0.5646 0.5685 0.5723 0.5762 0.5801 0.5839 0.5878 0.5917

3 0.3915 0.3951 0.3986 0.4021 0.4057 0.4092 0.4128 0.4163

4 0.3053 0.3087 0.3121 0.3155 0.3189 0.3223 0.3258 0.3292

5 0.2538 0.2571 0.2604 0.2638 0.2672 0.2706 0.274 0.2774

6 0.2196 0.2229 0.2263 0.2296 0.233 0.2364 0.2398 0.2432

7 0.1954 0.1987 0.202 0.2054 0.2088 0.2122 0.2157 0.2191

8 0.1773 0.1807 0.184 0.1874 0.1909 0.1943 0.1978 0.2013

9 0.1634 0.1668 0.1702 0.1736 0.1771 0.1806 0.1841 0.1877

10 0.1524 0.1558 0.1593 0.1627 0.1663 0.1698 0.1734 0.177

11 0.1435 0.1469 0.1504 0.154 0.1575 0.1611 0.1648 0.1684

12 0.1362 0.1397 0.1432 0.1468 0.1504 0.154 0.1577 0.1614

13 0.13 0.1336 0.1372 0.1408 0.1444 0.1482 0.1519 0.1557

14 0.1248 0.1284 0.1321 0.1357 0.1395 0.1432 0.147 0.1509

15 0.1204 0.1241 0.1277 0.1315 0.1352 0.1391 0.1429 0.1468

16 0.1166 0.1203 0.124 0.1278 0.1316 0.1355 0.1394 0.1434

17 0.1133 0.117 0.1208 0.1247 0.1285 0.1325 0.1364 0.1405

18 0.1104 0.1142 0.118 0.1219 0.1259 0.1298 0.1339 0.1379

19 0.1079 0.1117 0.1156 0.1195 0.1235 0.1276 0.1316 0.1358

20 0.1057 0.1095 0.1135 0.1175 0.1215 0.1256 0.1297 0.1339

Interest Rate
.....................................................................Water Quality Trading Assessment Handbook 

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Appendix E 

Participant Pollutant Management Options 

Characterization 

1. Background Information 

a. Model Trade Participant Organization Name: 

b. Organization Representative Contact Information: 

i. Name: 

ii. Address: 

iii. Phone Number: 

iv. E-mail: 

2. Phosphorus Load Source(s) for Consideration: 

a. Source A: (provide name of load source e.g., Trout Growers, Inc at Bhule) 

b. Source B: 

c. Source C: 

3. Individual Source Characterization (Source A) 

a. Source Description: 

b. Source Location (river mile): 

c. Source Discharge Location (river mile): 

d. Source Phosphorus Type(s): 

e. Source Baseline Discharge Quantity (from TMDL): 

f. Source TMDL Target Load (from TMDL): 

g. Source Current Load (by type if possible): 

h. Source Expected Future Load (annual growth/decline rate and time horizon): 

i. Seasonal or Other Cyclic Load Considerations: 

4. Source Phosphorus Control Option(s): 

a. Option A: 

b. Option B: 

c. Option C: 

5. Source Phosphorus Control Option Description (Option A): 

a. Description: (include technology/management practice, ability to scale/size to 

specific control levels, seasonal variability of control, and design, construction, 

shakedown periods along with overall lifespan) 

b. Currently in Place: (yes or no, and provide date of completion and expected 

lifespan) 

c. Capital Cost: 

d. Annual O&M Cost: 

e. Phosphorus Control Achieved/Expected (in lbs. Phosphorus/day): 
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