1. 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

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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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)

10. 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

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

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

13. 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

14. 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 yr yearly
Remote Verification
Ex post monitoring
Mixed Type Verification
On-site Verification 14

15. Examples of Credit Generating Practices
Simple Project
Moderate Complex
Complex
30 yr 10 yr yearly
30 yr 10 yr yearly
30 yr 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

16. 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

17. 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 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

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
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

19. 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

20. 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

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