Transaction Costs for Nonpoint Source Water Quality Trading Credits: Implications for the Chesapeake Bay Kurt Stephenson & Gwen DeBoe Department of Agricultural & Applied Economics Virginia Tech ACES 2016 Conference Jacksonville Florida December 2016

Rationale Nutrient trading programs often plagued with relatively few NPS trades Desire to see NPS trades increase, particularly for working agricultural lands 2 2

Objectives Identify sensitivity of transaction costs to different types of NPS crediting activities and monitoring regimes. To examine what degree can alternative designs lower transaction costs 3 3

Conceptual Framework: Transactions costs of Implementation Transaction Costs (1) Legislative Environment (2) Regulatory Design (3) Implementation Credit Creation Search for program participants Service provision Certification of service provision Credit registration & reporting (Market) Transactions Assessing the market Trading partner search & contracting Demonstrating eligibility to trade Trade Approvals Market support functions Monitoring & Enforcement Third party accreditation Monitoring Enforcement

Virginia Nutrient Trading (stormwater offsets) P Requirements via Land Use Restriction Offsite P requirements Permittee (Developer) Credit Providers Landowner Credits Compliance Conditions Enforcement Certification Verification Enforcement   Fee   Monitoring Enforcement   Registry   Regulatory Agency (VADEQ) Legend: Service flow Money flow Local Stormwater Program

Virginia Credit Projects Stormwater Nutrient Offsets Straightforward “Permanent Credits”: One time certification Performance criteria straight-forward (e.g. native 400 stems/ac) Remote verification 541 credits sold or retired as of July

What might future transaction costs look like? Severe data limitations (confidentiality, lack of experience, etc.) Method: Gather data from other water quality programs (Ohio (EPRI), Oregon (Willamette Partnership)) Consult with credit providers Use NRCS data on transactions costs of getting conservation on the ground 7 7

Analysis of transaction costs Which transactions costs did we focus on? Costs of “Credit Creation” (primarily credit provider) Costs of agency certification and verification monitoring Did not focus on: Market exchange costs Negotiation costs between credit provider & agency, permittee & agency Unique contracting issues 8 8

Transaction costs: “Credit Creation” Estimated transaction costs associated with executing NRCS conservation contracts Transactions costs of credit creation depend on the type of practice(s) used Simple project (e.g. ag. land conversion, cover crop) Moderate project (livestock exclusion fence + watering) Complex project (e.g. livestock waste management + prescribed grazing; enhanced nutrient management)

Ex-Post Monitoring Monitoring/Verification of credit generating activities Costs are a function of Type of Monitoring (on-site, remote, etc) Frequency of Monitoring Coverage Low cost – basically like the Virginia program now Medium cost – Willamette High cost - EPRI 10 10

Ex post Monitoring regimes Virginia DEQ (remote monitoring) Willamette Partnership (onsite, remote) EPRI (Ohio Basin) (annual on-site)

Transaction Costs Putting this all together, how might transaction costs change with project complexity and ex post monitoring regime? 12 12

Estimate Credit Creation Costs and Monitoring Costs for Multiple Types of Projects Simple Project Moderate Complex Complex Remote Verification Ex post monitoring Mixed Type Verification On-site Verification 13

Projects have different durations and thus different number of credit contract renewals Simple Project Moderate Complex Complex 30 yr 10 yr yearly 30 yr 10 yr yearly 30 yr 10 yr yearly Remote Verification Ex post monitoring Mixed Type Verification On-site Verification 14

Examples of Credit Generating Practices Simple Project Moderate Complex Complex 30 yr 10 yr yearly 30 yr 10 yr yearly 30 yr 10 yr yearly Remote Verification Ex post monitoring Mixed Type Verification Buffers Land Conversion Cover Crops Stream Fencing Enhanced N Mang Wetland restoration Animal Waste Facility On-site Verification 15

Estimating Transaction Costs To make equivalent across BMP type: Assume each BMP type generates credits for 30 yrs Calculate present value of credit creation and monitoring costs Normalize in reference to the low cost alternative (remote verification, permanent simple project) This slide is just a quick transition slide to frame the next part of the discussion about total TCs. 16 16

Examples of Credit Generating Practices Lowest transaction cost Simple Project Moderate Complex Complex 30 yr 10 yr yearly 30 yr 10 yr yearly 30 yr 10 yr yearly Remote Verification Ex post monitoring Mixed Type Verification Buffers Land Conversion Cover Crops Stream Fencing Enhanced N Mang Wetland restoration Animal Waste Facility On-site Verification Highest transaction cost 17

Relative Magnitude of Transaction Costs Relative to the Lowest Cost Alternative Simple Moderate Complexity Complex   30 yr 10 yr 3 yr Remote Verification 1.0 1.3 3.0 1.5 1.9 3.6 2.5 3.1 5.7 Mixed Verification 1.8 2.1 4.2 2.8 3.3 6.4 Onsite Verification 2.9 4.3 3.4 3.7 4.9 4.4 4.8 7.0 Assuming minimal cost to renew 3 or 10 year credit contract 18

Relative Magnitude of Transaction Costs Relative to the Lowest Cost Alternative Simple Moderate Complexity Complex   30 yr 10 yr 3 yr Remote Verification 1.0 2.1 6.6 1.5 3.2 9.6 2.5 5.0 14.8 Mixed Verification 1.3 2.3 7.3 1.8 3.4 10.3 2.8 5.2 15.5 Onsite Verification 2.9 3.9 7.9 10.9 4.4 6.8 16.1 Assuming full renew 3 or 10 year credit contracts 19 19

Transaction costs: What have we learned? TCs of creating credits from management and structural BMPs substantially higher than for credits from land conversions TC highly sensitive to frequency of credit renewals Verification protocols are important driver of transactions costs Based on best available evidence, the administrative costs of creating credits using management and structural BMPs will be significantly more costly on a per project basis than the activities involved in land conversions (the dominant credit generating practice in Virginia). It may be up to 2 to 3 time more costly to plan for working land BMPs than for land conversion an retirement. Furthermore, given dynamic and changing farm conditions and limited BMP lifespans, these costs are relatively frequent and recurring. However, while higher, transactions costs need to be compared to the relative value created in terms of reduction. In some situations, these costs might be quite modest relative to overall possible nutrient credit prices. The verification (compliance monitoring) protocols can be a significant driver of transactions costs, especially for credits generated from working agricultural lands. Several programs require annual site visits to verify the existence and performance of credit generating practices. The cost of providing annual “boots on the ground” verification is estimated at around $500 - $750 per visit per year. Significant reductions in transaction costs could be achieved through alternative verification processes. For instance, in our analysis monitoring costs were reduced 67% by allowing interim remote self-reporting of BMP status for 4 out of 5 years, and by 80% if all monitoring is undertaken remotely. Remote sensing technologies offer opportunities for dramatic reductions in verification costs. These results suggest an important cost/risk tradeoff between verification cost and compliance certainty for program designers to consider. Finally, our research indicates that there are both costs and benefits from using third parties in trading programs. This means it is not immediately clear whether the use of a third party in a particular instance will result in net program benefits. Use of third parties should be carefully considered on a case-by-case basis. 20 20

Contact: Kurt Stephenson: kurts@vt.edu For more information: G. DeBoe & K.Stephenson. 2016. “Transactions Costs of Expanding Nutrient Trading to Agricultural Working Lands: A Virginia Case Study” Ecological Economics 130:176-185 Acknowledgement: Funding provided by USDA, Office of Environmental Markets Contact: Kurt Stephenson: kurts@vt.edu