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Understanding restoration and transaction costs in a payment for ecosystem service water quality market in Oregon, USA

Comprendre les coûts de restauration et d'opération engendrés par un programme de paiements pour les services écosystémiques dans la cadre d'un marché de qualité de l'eau en Oregon, États-Unis
Kathleen Guillozet

Résumés

En Orégon (États-Unis), la température de l'eau de nombreux ruisseaux et rivières est réglementée dans le cadre de certains contextes par l’approche de paiements pour services écosystémiques (PSE). Grâce à cette approche, les entités de régulation visées par la réglementation sont en mesure de compenser leurs déversements qui font dépasser la température de l'eau au-dessus des valeurs admissibles en payant pour la restauration de la forêt riveraine et les avantages de refroidissement qu’apporte son ombre. Ainsi elles peuvent faire valoir leur conformité réglementaire. Les activités obligatoires de surveillance et de rapport de la qualité de l'eau menées par les entités qui font des rejets de sources ponctuelles fournissent la base sur laquelle un service écosystémique (l'ombre de la forêt riveraine) est quantifié (en kilocalories/mi) et vendu (par crédit thermique). La station de traitement des eaux usées de la ville de Medford, dans le sud de l'Orégon (États-Unis) est la première entité de régulation de l'eau à adopter une approche PSE pour sa conformité réglementaire. Grâce à l'analyse des transactions vérifiées et de nombreux autres documents publics, les coûts moyens de transaction associés à ce programme sont estimés à 85 pourcent des coûts totaux.

Malgré une littérature croissante sur les coûts de transaction dans les programmes de PSE, il y a peu de consensus ou de conseils sur ce qui est un pourcentage raisonnable des coûts totaux pour les programmes de PSE connus comme « efficaces ». Les régulateurs, les titulaires de permis et le public peuvent utiliser cette information pour examiner comment structurer les permis, quels types de coûts de transaction sont plus ou moins importants, et comment tirer parti des investissements pour les plus grands avantages sociaux, écologiques et économiques.

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Introduction

1A variety of PES programs have emerged in recent years, perhaps most notably those involving carbon sequestration that are linked to the Reducing Emissions from Deforestation and Forest Degradation (REDD) program. These programs have generated considerable debate in scientific and policy circles, particularly around issues of power, benefit distributions, and land and resource rights (Corbera and Schroeder, 2011). These debates have largely been driven by project-specific studies (Beymer-Farris and Bassett, 2012 ; Stickler et al., 2009), with an emphasis on examining the equity, efficiency and efficacy of outcomes (Martin et al., 2014). With other types of PES programs, such as wetland mitigation banking, are observed to have significant transaction costs associated with the actual creation of wetland and from government oversight (Bonds and Pompe 2003, Hook and Shadle 2013)

2The high transaction costs associated with many payment for ecosystem service (PES) programs have raised questions concerning whether or not using a PES approach to natural resource management and ecological restoration makes sense from an efficiency perspective. Transaction costs include all costs associated with PES program implementation, barring expenses incurred in the actual production of the ecosystem service itself (Jindal and Kerr, 2007). Types of transaction costs include those associated with design, communications, negotiation, project approval, monitoring, verification, enforcement, certification, and insurance (Milne, 2002). While there is general agreement that transaction costs in PES programs are often significant, there is no consensus surrounding what is reasonable in the context of overall program expenditures. For example, one study, reported by Jindal and Kerr (2007), found that transaction costs associated with carbon sequestration projects ranged from 6 to 45 % of total costs and another, which focused on USA-based carbon sequestration projects, found that transaction costs are generally less than 25 % of total implementation costs (Galik et al,. 2012). Research on programs similar to the one described in this paper indicates that nonprofits are important market intermediaries and that these markets may not always present a strong business case (Bennett et al., 2014). There is some indication that government-led PES programs may have lower transaction costs per unit area, they often have poorer monitoring and less targeted outcomes than user-led programs (Corbera et al., 2009). PES program cost efficiency is closely related to the transaction costs and therefore implementers often seek to minimize these costs, but at the same time PES programs are thought to be more effective under targeted delivery and management (Mayrand and Paquin, 2004). The protocols used to structure programs have a significant effect on transaction costs (Foley et al. 2009), but total transaction costs depend upon specific project context, including which types of activities are included and how they are undertaken (Galik et al., 2012).

3Much of the research on PES efficiency, efficacy and equity has occurred with respect to carbon sequestration programs. While Galik et al. note that the “largely proprietary nature of project finances and a shortage of targeted literature on the subject” may limit scientists’ and policymakers’ understanding of transaction costs (2012, p. 129), even less attention has been paid to the differences in transaction costs between PES programs. While findings from carbon sequestration projects may be transferable at least in part to programs that focus on other ecosystem services, such as those for biodiversity, landscape amenities, and watersheds, there are likely some inherent differences that will have implications for ecosystem service-specific transaction costs. This paper has three objectives : 1) to describe a nascent PES program in water quality in Oregon, USA, and estimate its probable early transaction costs, and 2) identify characteristics that make water quality programs different from carbon offset programs and 3) describe pros and cons of program design alternatives that might address high transaction costs associated with water quality markets.

4In a recent review, Osborne et al. (2014) identify what they see as three flawed assumptions associated with carbon sequestration projects implemented through REDD : 1) that projects are highly cost-effective, 2) that impacts will be large and 3) that projects can achieve market efficiency and sustainable co-benefits. In their analysis, Osborne and colleagues note that transaction costs actually make projects quite expensive rather than cost-effective, that REDD+ does not in fact address drivers of degradation and so impacts in fact are minimal, and that market concerns often trump sustainability concerns. While this paper does not attempt to evaluate these three assumptions in the context of Oregon’s water quality trades, it underscores the need for increased attention to the actual outcomes of PES programs.

Background

Oregon’s Water Quality Trading Program

5There is significant momentum building around the development of PES programs in locations including Oregon, where they are described as having potential to incentivize “the type of high-quality restoration that rivers need” (TFT, 2013, p. 2) and that might not otherwise take place. Entities involved in moving PES programs forward in Oregon, including the Willamette Partnership and the Oregon Sustainability Board, cite existing temperature trading projects as examples of successful PES programs, referencing them as supporting evidence in grant proposals and state legislation that advocate for further PES programming and standard development (Willamette Partnership, 2013 ; Byler et al., 2010). The Environmental Protection Agency’s (EPA) Water Quality Trading Policy supports trading as an innovative, flexible, and cost effective mechanism with “potential to achieve water quality and environmental benefits greater than would otherwise be achieved under more traditional regulatory approaches” (EPA, 2003, p. 1).

6Water quality trading is an alternative mechanism through which a small number of entities whose Total Maximum Daily Load (TMDL) requirements are either currently out of compliance (or will likely become out of compliance in the near future) can meet their regulatory obligations. In the case of water, TMDLs reflect maximum levels of designated pollutants or conditions that may be discharged into waterways without violating minimum health requirements of people and wildlife. Agreements to meet water quality standards through riparian tree planting are negotiated between regulated entities and the Oregon’s Department of Environmental Quality (DEQ), which represents the EPA’s National Pollutant Discharge Elimination System (NPDES) program at the state level. Third party actors are increasingly stepping in to subcontract the work of riparian shade establishment and to incorporate water quality trades into the language of ecosystem service markets.

  • 1 The term restoration is used loosely, and in reference to a prescribed approach to riparian reveget (...)

7In Oregon, water temperature is a regulated condition that is being addressed in some contexts through a PES approach, termed ‘shade trades’ in this paper. Restoration activities associated with shade trades occur within riparian zones, spaces that have suffered disproportionately high levels of conversion and degradation in the USA over the past century (Nilsson et al., 2007 ; Patten, 2006). Stream temperatures in Oregon are particularly important given the presence of salmonids listed as threatened or endangered under the Endangered Species Act and their sensitivity to elevated water temperatures (Carter, 2005). Mandatory water quality monitoring and reporting activities associated with certain types of regulated point source discharges provide the basis upon which an ecosystem service (riparian shade) is quantified (in kilocalories, or solar radiation blocked) and sold (per thermal credit). Rather than actively cooling water, shade trades operate on the principle that shade prevents additional solar warming of water in streams (Bowler et al., 2012). Regulated entities that discharge warmer than allowable water into streams are increasingly willing and able to pay for riparian restoration1 to achieve regulatory compliance.

PES versus Command and Control

8PES have their conceptual roots as alternatives to top-down regulation, the spirit of which is captured in the following quote : “PES schemes aim at creating positive attitudes and stimulating proactive behavior towards the development and utilisation [sic] of nature-based solutions, which means a considerable shift from the application of classic ‘command-and-control approaches’ that aim at discouraging certain environmentally harmful behaviours [sic]” (Grieber, 2011, p. 206). In practice, PES schemes rarely align with all of the idealized criteria that define them (Table 1), and can sometimes be more accurately characterized as the “carrot that makes the stick of regulations more palatable” (Engel et al., 2008, p. 669). ‘PES-like’ (Wunder et al., 2008) initiatives bolster environmental services but are driven by command and control regulation rather than the free market. As such, they may carry an additional “burden of proof” that has not been formally recognized in PES typologies. While idealized PES schemes must reflect an improvement over the status quo, regulatory-driven PES schemes must provide measurable benefits that are equivalent to or an improvement upon regulatory obligations. This burden of proof takes the form of transaction costs that are expended in the design and administration of the trading program, and include activities such as : site analysis and modeling ; management of landowner outreach and contract negotiations ; liaising with regulators, consulting engineers, and the permit holder ; quantification of the benefits of habitat restoration ; application for credits and third party verification ; and review and submission of permits and reports (TFT, 2014).

9Table 1 contrasts the basic characteristics that describe free market-based, or idealized PES schemes and command and control regulatory schemes. Key distinctions include the voluntary nature of PES engagement, its reliance on market mechanisms to function efficiently, its potential for additionality, and its tendency to incentivize environmentally beneficial practices among resource managers. In contrast, command and control measures are typically involuntary, are described as having little potential to produce benefits that extend beyond regulations and tend towards restrictive measures.

Table 1. Characteristics of Idealized PES schemes and Command and Control Regulations

Characteristic

Supply and demand : PES Programs

Command and Control : Environmental Regulation

Premise

Beneficial services provided by the environment are identified ; economic incentives that promote the sustainable delivery of that service are created

Environmentally harmful activities are identified ; regulations that force entities to comply with the imposed conditions or standards are developed and enforced

Basis of engagement

Voluntarism and negotiation

Imposition of specific conditions or standards

Potential for additionality

Moderate to high, as it promotes conservation activities which go beyond the pre-existing, mandatory environmental standards

Limited, as it does not necessarily promote conservation activities that go beyond the environmental regulations

Outcome

Market mechanisms incentivize exchange of ecosystem services between providers and beneficiaries

Costs of compliance and sanctions deter such activity in the future

Compliance Assessment

Input-based

Output-based

Type of sanction

Withholding of payments ; removal from program

Financial penalty ; cease and desist order

Actors involved

Property rights holders ; rights recognized

Regulated actors ; rights generally restricted

Source : modified from Grieber et al. 2011

10Compliance assessment is recognized as a weak link in PES implementation (Ferraro and Pattanayak, 2006). A Compliance Status Review of USDA agri-environmental incentive programs cited numerous problems with enforcement, including : inappropriate “selection of the sample for review, a lack of consistency and clarity in the guidance provided to local offices, data handling and analysis, failure to cite producers for significant deficiencies, and inadequate justification for waivers and penalties” (Claassen et al. 2008, p. 748). Since PES programs are touted as an innovative, efficient and cost effective means to address funding gaps in biodiversity conservation (Pirard and Lapeyre, 2012), an examination of the linkages between compliance and ecological outcomes can shed light on whether or not programs are meeting their stated aims. Regulatory-driven PES programs are designed in part to address these weaknesses so that monies that might be directed towards construction of a cooling tower or other hard-infrastructure solution can instead be directed towards “green infrastructure” development.

Methods

11This paper uses document analysis conducted from 2013-2015to describe water quality trading programs in Oregon, with emphasis on regulatory requirements, current trades and their verification requirements. These include NPDES Permits and permit fact sheets, legal documents including complaints and court rulings, white papers, program guidance documents, monthly and annual compliance reports, verification statements, monitoring protocols and project plans, Medford- The Freshwater Trust thermal credit contract documents and letters written by the EPA, Northwest Environmental Advocates (NWEA) and The Freshwater Trust. Additionally, I conducted telephone and e-mail-based communications with regulators, project implementers and other stakeholders to answer questions pertaining to functional aspects of trades that arose through document analysis. For example, I made calls to the City of Medford to verify project billing rates and to obtain copies of reports and contract amendments. This study did not obtain information about living individuals, and as such, no human research was undertaken and no Human Subjects Institutional Review was required..

12All documents reviewed are either freely available on the internet, or are considered public records, pursuant to the Oregon Department of Justice (2013). Project-specific data, including project plans, verification reports, monitoring reports and photos are available on Markit public registry https://mer.markit.com/​br-reg/​public/​index.jsp ?name =the %20freshwater %20trust&entity =project&entity_domain =Markit,GoldStandard. The review of compliance criteria involved transcription of permit and total maximum daily load (TMDL) agreement language and basic coding to facilitate comparative analysis (Glaser and Strauss, 1967). This process was relatively simple but nonetheless necessary because permits do not follow a uniform template, use varied language and present information in different ways.

Medford’s water quality PES program

13Medford is a city in southern Oregon with a population of over 77 thousand people, located about 27 miles north of the California border. As part of the Rogue Basin, which is known for whitewater rafting and fishing, Medford was facing likely future exceedance of its regulatory limits owing to population growth and increased wastewater production. In late 2011, after negotiating with DEQ to allow water quality trading as part of its permit, the City of Medford contracted a Portland-based NGO, The Freshwater Trust, to provide 300 million thermal credit offsets over the course of 20 years in accordance with its compliance schedule. These credits are produced through planting of native riparian trees and shrubs on degraded private lands. In the Medford case, the implementer pays private rural landowners land rental payments in exchange for the rights to access and plant designated riparian areas and to sell credits generated through these activities.

14Command and control approaches to water quality regulation were enabled in the United States as a result of a series of national laws enacted in the late 1960’s and 1970’s, including the 1968 Wild and Scenic Rivers Act, the 1969 National Environmental Protection Act (NEPA), the 1972 Federal Water Pollution Control Act (renamed Clean Water Act (CWA) in 1977), and the 1973 Endangered Species Act (ESA) (Lave et al., 2010). The Oregon Department of Environmental Quality (DEQ) is designated by the Environmental Protection Agency (EPA) as the state water pollution control agency responsible for issuing wastewater discharge permits that keep discharges of waste material within allowable limits and conditions. NPDES permits are required under the CWA for all point-source discharges into surface waters. National water quality trading programs include current or planned programs for the following regulated parameters : ammonia, biological oxygen demand, dissolved oxygen, mercury, nitrogen, phosphorus, sediment, selenium, and temperature (DEQ, 2013).

15Utilities such as the Medford wastewater treatment facilities are the typical subjects of point-source discharge regulations because of their need to return treated wastewater back to surface water systems (usually rivers) regulated by the Clean Water Act. Specific temperature limits in Oregon are set in large part based upon biological requirements of salmon (Boyd and Sturdevant 1997). Treated wastewater is often too warm to meet temperature standards, thus triggering the need for mechanisms to offset effects of discharges or to directly cool water in advance of its discharge into waterways.

16Oregon’s water quality trades reflect a unique PES approach that is difficult to place on an engagement spectrum from involuntary to voluntary (Table 2). This is because while it is a form of trading, which is typically considered voluntary, these trades are prescribed and governed by specific regulatory permits, an involuntary engagement type. As such, these water quality trades may be considered a hybrid that does not neatly fit While utilities and other regulated actors must meet their permit obligations or face heavy fines and other penalties, they do not need to meet those obligations though a trading approach. Shade trades arose as an alternative or supplement to other mechanisms including flow augmentation, mechanical cooling system installation, hyporheic injection (see Lancaster et al. 2005 for more information on hyporheic injection), or natural treatment system construction such as wetlands and infiltration ponds. Temperature trades in their current form use market language, and adopt a hybrid approach that involves utility-specific permit negotiations and long term contract arrangements rather than “turn-key” projects in which purchasers buy pre-built credits on demand.

Table 2. Selected State-Driven Approaches to Environmental Service Protection in the USA, 1972-Present

Engagement

Approach

Example

Involuntary

Voluntary

Regulation

Clean Water Act Section 404 (1972)

Conservation Compliance

Swampbuster (1985)

Land Retirement

Conservation Reserve Program (1996)

Cost Sharing

Environmental Quality Improvement Program (1990)

Incentive Payments

Water Quality Improvement Program (1996)

Environmental Quality Improvement Program (1990)

Trading/Banking/Bonding

Mitigation banking (1995)

Source : Modified from Heimlich and Claassen 1998, Claassen et al. 2008

17Utilities currently engaged in riparian planting to meet regulatory obligations either generate credits in-house, or subcontract different components of riparian revegetation planning, implementation, and monitoring to third party entities. A range of characteristics influence the potential of a given site to generate shade and associated temperature benefits. These relate to characteristics of the specific riparian, stream, and other physical factors such as existing vegetation stream, stream width, site aspect, slope, elevation, and proximity to the river.

18A wastewater utility, Clean Water Services District, located in Hillsboro, Oregon, was the first entity to engage in riparian shade establishment for permit compliance, and pioneered many of the methods and approaches used by other entities. The City of Medford’s Regional Wastewater Reclamation Facility’s program constitutes the first and only true “trade” in that it involves purchase of thermal credits from a third party entity (The Freshwater Trust). Each permit is the outcome of significant investments in time and resources amongst regulators, regulated entities and third party actors. As an emerging compliance option, permits reflect lessons learned and changing perspectives, and are generally considered works in progress.

19DEQ’s Internal Management Directive on Water Quality Trading states that “[m]echanisms for determining and ensuring compliance are essential for all trades and trading programs and include a combination of record keeping, monitoring, and reporting requirements” (DEQ, 2012, p. 7). In addition to the requirement that utilities possess a thermal credit generation plan, most permits require the submission of thermal credits calculations. All projects are held to projected, rather than actual, thermal credit reductions through provision of “effective shade”. Effective shade describes the “reduction in the amount of open sky solar radiation during a specified time period” (King County, 2005, p. 5). The DEQ Water Quality Trading Internal Management Directive (DEQ, 2012) provides a calculation for deriving effective shade from potential future forests. This calculation in its simplest form is :

20Available Credits = (Stream Surface Area) x (Increase in Effective Shade) x

21(Daily Insolation Rate) / Trading Ratio

22Permittees may elect to use one of the versions of DEQ’s excel-based Shade-a-lator model (DEQ, 2014), which uses parameters that affect kilocalorie offset generation including distance from the stream, stream width, aspect, and the calculated difference between existing or baseline conditions and expected future conditions (effective shade). Inputs that describe plant community heights and densities at maturity are generated from pre-defined plant community types that are selected from by the user. Vegetation categories are fairly general, and use set combinations of heights and canopy closure ( %) which generate different amounts of shade credits per unit area restored. Upon plant installation, and following verification of compliance, all potential shade credits are released to the entity that produced them at a 2 :1 ratio. In other words, for every two kilocalories offset by a planting project, the permitee may claim credit for one. The ratio is intended to account for the time lag between credit generation (credits are granted at planting) and shade provision, which will occur in the future as plants grow.

Results

Restoration and transaction costs

23Four years into the program, verified and pending projects have met over half of the 20 year compliance target, with revegetation completed on one side of 5.83 km of stream length and restoration extending over 11.22 hectares (Table 3). Total payments to The Freshwater Trust are equivalent to over 3.6 million dollars, at an average cost of $ 322,026 per ha ($ 130,375 per acre). These payments are intended cover all required restoration and transaction costs incurred by the contractor associated with supporting a functioning market, but do not include costs incurred by the City of Medford, by DEQ and other regulator entities involved in supporting water quality markets, or from other funders, including the United States Department of Agriculture or the Oregon Watershed Enhancement Board, which have both provided grant funds to support water quality market development for the City of Medford.

Table 3. Verified Projects with Area Affected (revegetated) and Costs 2011-2015

Site name (RM =river mile)

Date verified

Verified credits (#)

Area re-vegetated (ha)

Stream length (km)

Payment to TFT from Medford ($)

Percent of total credits required

Set up fees paid to TFT ($)

Total payment to TFT from Medford ($)

Per hectare cost ($)

Rogue RM 128

12-Dec

12,547,106

0.45

0.19

158,219

4.2

8,365

166,584

370,187

Rogue RM 128

13-Jun

21,989,706

0.92

0.31

277,290

7.3

14,660

291,950

317,337

Applegate RM 28.5

13-Dec

20,904,800

1.9

0.9

477,466

7

13,937

491,403

258,633

Applegate RM 30

14-Feb

28,460,963

0.97

0.5

650,048

9.5

18,974

669,022

689,714

Rogue RM 29.5

14-Feb

11,786,050

1.05

0.48

269,193

3.9

7,857

277,050

263,858

Little Butte RM 8.5

14-Jun

10,706,267

1.1

0.93

244,531

3.6

7,138

251,669

228,790

Rogue RM 95

15-Feb

33,884,329

2.4

1.23

773,918

11.3

22,000

795,918

331,633

Applegate RM 3

15-Feb

28,350,918

2.43

1.29

647,535

9.5

22,000

669,535

275,529

Totals / Weighted Average*

230,865,385

11.22

5.83

3,498,201

56.2

114,931

3,613,132

322,026*

Sources : Markit 2015, City of Medford-TFT 2014, City of Medford-TFT 2011

24In order to estimate the percentage of costs in the City of Medford-The Freshwater Trust PES program that are attributable to restoration costs, I used the estimated restoration costs provided to DEQ by the City of Medford and the Freshwater Trust in their Thermal Credit Trading Program Proposal (2011). At $ 44,840 per hectare, these costs are in line with those reported by other programs upon which the Medford approach was modeled, including Clean Water Services, which estimated restoration costs at $ 35,190 per hectare (Michie 2012). Land rental payments were estimated at $ 741/ha/year ($ 300/acre), which represents the high end of the $ 494-741 landowner payment range (Bienkowski, 2015). Among the eight projects included in this analysis, transaction costs calculated from these estimates ranged from 80-93 % of total project costs, with a weighted average of 85 % (Table 4).

Table 4. Estimated Restoration and Transaction Costs, City of Medford, 2011-2015

Site Name

Restoration cost @ $ 44,840/ha ($)

Total payment received ($)

Transaction costs ( % of total payments received)

Landowner payment @ $ 741/ha*20 years ($)

Landowner payments ( % of total payments received)

Rogue RM 128

20,178

166,584

88

6,669

4.0

Rogue RM 128

41,253

291,950

86

13,634

4.7

Applegate RM 28.5

85,196

491,403

83

28,158

5.7

Applegate RM 30

43,495

669,022

93

14,375

2.1

Rogue RM 29.5

47,082

277,050

83

15,561

5.6

Little Butte RM 8.5

49,324

251,669

80

16,302

6.5

Rogue RM 95

107,616

795,918

86

35,568

4.5

Applegate RM 3

108,961

669,535

84

36,013

5.4

Totals / Weighted Average*

503,105

3,613,132

85*

166,280

5*

Notes : Landowner payment rates range between $ 494-$ 741 per hectare per year (Bienkowski 2015). The higher rate of $ 741 per hectare was used in the above calculations. Restoration costs are based on the estimated cost for restoration provided to DEQ by the Medford Regional Water Reclamation Facility (2011) of $ 44,840 per hectare, assuming that the restored riparian buffers average 15.24 meters in width.

Sources : Markit 2015, City of Medford-TFT 2014, City of Medford-TFT 2011

Thermal credit rates

  • 2 Reporting data from Clean Water Services District Annual Temperature Management Plans and Credit Tr (...)

25As specified in their initial contract, the City of Medford agreed to pay The Freshwater Trust a variable rate per credit generated upon verification of planting (Medford-TFT, 2011). This rate varied based upon the average amount of kilocalories offset per mile restored, ranging between $ 0.03685 per credit on low credit-generating sites to $ 0.01261 per credit on high generating sites (Table 5). This variable rate increased was intended to incentivize revegetation work on smaller tributaries, which deliver greater overall temperature benefits than work on large streams or rivers (NWEA, 2014). The first revegetation project verified generated extremely high offsets – in excess of 200 million units per 1.6 km – a 16-fold increase over the uplift estimates used in the City’s program proposal (Medford RWRF, 2011) and an over 22-fold increase over the average credits generated per mile by Clean Water Services from 2004-2012.2

Table 5. Kilocalorie Offsets and Payment Ranges, 2011-2014.

Kilocalories per mile per day offset range (in millions)

Original payment rate, December 2011-May 2014 ($)

Renegotiated payment rate, May 2014- onward ($)

Change from original to renegotiated rates ( %)

5 to 10

0.03685

0.02286

-38

10 to 15

0.02286

0.02286

0

15 to 20

0.01810

0.02286

+26

20 to 25

0.01546

0.02286

+48

25 to 30

0.01377

0.02286

+66

30 and above

0.01261

0.02286

+81

Sources : TFT 2013 and TFT 2014

26Over the course of the next two years, five more projects were verified (Table 3) and paid for (personal communication, City of Medford staff, 9 September 2014), in addition to two projects verified in February 2015. Together, these projects yielded 56.2 percent of all credits required over the City’s 20 year compliance schedule, and a total of 5.83 km of verified restoration, an area equivalent to just one-seventh of previous projections made by the implementer, verifier, and the utility.

27In May of 2014, The Freshwater Trust renegotiated its payment arrangement with the City of Medford so that The Freshwater Trust would earn one rate, $ 0.02284 for all credits. This rate applied to all projects verified from December 2013 forward, and translated into an 81 % payment increase for the projects verified through June of 2014. In other words, The Freshwater Trust received $ 1,641,238 in payment for credits that would have formerly earned $ 906,130, with no additional services or verified restoration rendered in association with these credits. Over the life of the compliance period this could be equivalent to an additional 2.7 million dollar payment, or a 71 % increase in what the City of Medford had been formerly obligated to pay prior to the contract renegotiation.

Discussion and Conclusion

28There is no consensus on what percentage of total program costs should take the form of transaction costs, and even less information is available on what those ratios should look like for water quality trades such as the program described in this paper. However, examining actual transaction/restoration costs and restoration outcomes associated with trading programs can help inform discussions on trading program design and implementation.

29The payment renegotiation described in the preceding section led to higher than anticipated transaction costs, or inefficient contract arrangements from the perspective of the City of Medford and its ratepayers. Initial program planning documents and DEQ communications highlight program benefits including an estimated 64 kilometers of restored stream length (Medford RWRF, 2011 ; Nomura, 2014). The City of Medford’s first actual credit purchase took place in December 2012 and the most recent one occurred in February 2015. Both the total estimated cost and the estimated restoration outcomes have been revised downwards from original plans (TFT, 2014), but not in a linear fashion. While final cost estimates are 19 % lower than anticipated, actual restoration outcomes are, as of May 2016, 83 % smaller than planned.

30Scholars have noted “diseconomies of scale” (McAfee, 2012) associated with pro-poor PES programs that target smallholders because they often bear increased transaction costs associated with negotiating, monitoring and reporting outcomes (Bosselmann and Lund 2013). These costs tend to increase when program sites are non-contiguous and fragmented (Jindal and Kerr, 2007). Where social dimensions such as equity and engagement are goals, these increased transaction costs may be considered worthwhile. Landowner engagement and diversification of revenue sources for rural landowners is cited as a benefit of Medford’s water quality trading program (Bierman, 2015), but landowners payments associated with the Medford program account for a maximum of 2.1 to 6.5 % of program expenditures, and do not explain the high transaction costs associated with the Medford Program.

31While the program is lauded as a success by its implementing contractor, The Freshwater Trust, whose Executive Director Joe Whitworth has explained how “[s]ome in the environmental community are like ‘hey what are you doing here ? You’re doing tradeoffs and the environment will get shortchanged’,” he said. “But we can quantify” (Bienkowski, 2015). From a regulator perspective, there may be emerging concerns that trades are not being implemented as intended, as illustrated in internal DEQ e-mail correspondence obtained by an environmental organization through the Freedom of Information Act :

[H]ow do we value trades such that the resulting restoration projects take place in a manner/location that will maximize environmental gain ?...I saw slides from the Freshwater Trust showing restoration projects on the south side of the stream only. Once I saw those pictures, I understood the criticism I have heard of FWT that “they are only in it for the money”. If doing planting projects on only one side of the stream and only in those areas with maximum southern exposure was the best way to maximize biodiversity, that is how Mother Nature would do it. She does not do it that way. We need to make sure we don’t either. Temperature is a surrogate for ecosystem conditions, and if we focus too narrowly on the number (like FWT is doing), we miss the point, kind of like installing a chiller misses the point” (Sonia Biorn-Hansen [state regulator], 30 October 2014, email communication among state regulators).

32There are a number of program design, permitting and contracting elements that likely contribute to the high transaction costs seen in the Medford case. The bullets that follow identify some of these elements and propose solutions :

  • Thermal credits are sold to permittees at the time of planting, rather than when trees are mature. In order to assure the regulator that projects are on track, the contractor and regulator have agreed to labor-intensive practices such as weekly site visits and monthly reporting requirements. Selected project reporting elements are reviewed by a third party verifier, the Willamette Partnership, at additional expense to the contractor. An alternative approach that focused more on outcomes rather than labor-intensive reporting might lower these costs. For example, clear compliance standards and timelines, along with clearly enumerated sanctions for non-compliance would allow contractors and permittees to focus more on outcomes than on expensive, arduous reporting requirements.

  • Payments from the City of Medford to the implementing contractor are tied to thermal credits as opposed to hectares restored. This has meant that the contractor has made significant investments in mapping and modeling expertise to determine the location of high-credit generating sites. An approach that used an integrated Watershed Management Plan to guide restoration would reduce the need to intensively select high credit generating sites and would likely increase ancillary ecosystem benefits as well.

33Other program design and contracting elements might logically lead to lower transaction costs, but do not appear to do so. For example :

  • The City of Medford’s contract with The Freshwater Trust increases the economic burden on The Freshwater Trust as larger areas are restored and as more landowners are engaged. This is because more landowners and more restoration both increase landowner negotiation, restoration, monitoring and reporting costs, without providing any additional benefits to the Freshwater Trust. The contract provisions provide the same payment to The Freshwater Trust for restoring 10 stream kilometers and engaging 50 landowners to generate 15 million credits as it would to restore 0.1 kilometers and engage one landowner to generate 15 million credits. While one might expect the latter scenario to have significantly lower transaction costs, this is not the case under current contracting arrangements. There are numerous ways to modify the so that credit generation and payment are not the sole basis upon which payments are made.

34Exceptionally high transaction costs may not be inherent to water quality trades, but they are a defining characteristic of the Medford trades. Understanding contracting dynamics may help regulators, permittees and the public design PES programs that meet their goals and objectives. As currently structured, pricing arrangements stipulated in the City of Medford’s Thermal Credit contract may further reinforce high transaction costs because payments are not tied to actual acres restored but solely to thermal credits. The incentive to work on lower credit generating sites was removed in the 2014 contract amendment. As such, pricing arrangements also fail to pass on the savings and potential supplementary restoration investments that could otherwise occur.

35Water quality trades present a novel notion of cost efficiency, since costs are compared to avoided expenses of constructing artificial chillers or other hard infrastructure rather than in comparison to known restoration and associated transaction costs. One of the primary selling points of water quality trades is the significant cost savings they bring to utilities in meeting their regulatory obligations. In the Medford case, the City’s consulting engineer estimated that “[s]hading is more cost effective by a factor of three than chillers” (ORACWA, 2012, p. 8). This sentiment is shared by regulators ; the EPA overview on water quality trading describes it as a program that “allow[s] facilities facing higher pollution control costs to meet their regulatory obligations by purchasing environmentally equivalent (or superior) pollution reductions from another source at lower cost, thus achieving the same water quality improvement at lower overall cost.” Ultimately, citizen ratepayers fund many of the current and potential future shade trades and have an interest in ensuring that their money is allocated efficiently and effectively. More studies that highlight core information requirements for planning and monitoring and document proven approaches to restoration with attention to costs may help actors modify PES programs to meet their needs and interests. Outcomes from the Medford case affirm Osborne et al.’s (2014) skepticism concerning 1) whether programs are cost-effective (in the Medford case transaction costs add 85 % to restoration costs), 2) will have large impacts (actual restoration has been a small fraction of planned impacts) or 3) can achieve market efficiency and sustainable co-benefits (see 1 and 2).

36The information presented in this paper allow for a forward-looking analysis of potential implications of regulatory-driven PES programs on ecological and economic outcomes. This enables scholars and policymakers to draw “critical insights on the politics of design, such as whose interests prevail in PES design, and to inform debates about ES definition, pricing, additionality, conditionality and transaction costs” (Corbera et al., 2009, p. 758).

37There are a number of unknowns with respect to emerging water quality markets. Early cases provide a testing ground for regulators, permittees and contractors to refine approaches and expectations. An ecosystem service approach is inherently holistic and yet Oregon’s shade trade compliance mechanisms emphasize a single parameter : temperature. PES markets require an appropriate level of simplicity in order to function, and to date temperature has provided that simplicity. The actual costs associated with revegetation, reporting, and bearing the risk associated with Clean Water Act compliance are not well vetted and can vary widely. However, as currently written, contracts provide significant incentives for entities to maximize credit generation without attention to ecological criteria in site selection for revegetation.

38While it is too early to draw strong conclusions about the future direction of shade trades in Oregon, this is an opportune time to provide additional information and analyses on shade trades to inform potential policy reform and shape future permit and contract language. The translation of ecosystem services and processes into marketable services is an inherently social and political endeavor and in most cases will require significant revision in order to increase the functionality of these markets for the mutual benefit of credit buyers, sellers, and nature.

39This work highlights the need for future integrated socio-ecological research and policy consideration on how to 1) identify desired social, ecological and economic outcomes of trading programs and 2) how to structure water quality trading permits and contracts so that they meet desired outcomes. Novel aspects of water quality trades in comparison to carbon sequestration PES programs may help further inform theoretical and practical debates in PES implementation.

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Notes

1 The term restoration is used loosely, and in reference to a prescribed approach to riparian revegetation used in water quality trades that focuses on the reestablishment of particular riparian plant communities, typically on one side of a waterway. It is not intended to imply “a return to a pre-disturbance physical state as socially and technologically practical as possible” (Burchsted, D., 2006. What is River Restoration? Presentation at the Annual Meeting of the Geological Society of America, Philadelphia).

2 Reporting data from Clean Water Services District Annual Temperature Management Plans and Credit Trading Activities indicate that the District implemented riparian plantings on just over 40 stream miles from 2004-2012, yielding an average uplift of 8,898,976 thermal credits per mile.

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Kathleen Guillozet, « Understanding restoration and transaction costs in a payment for ecosystem service water quality market in Oregon, USA », VertigO - la revue électronique en sciences de l'environnement [En ligne], Hors-série 25 | août 2016, mis en ligne le 26 août 2016, consulté le 22 novembre 2017. URL : http://vertigo.revues.org/17473 ; DOI : 10.4000/vertigo.17473

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Kathleen Guillozet

Social Scientist, Ecologist, and Project Manager, Third Stream Research and Consulting, Courriel : k.guillozet@gmail.com

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