Marine Pollution Bulletin 47 (2003) 169–174

www.elsevier.com/locate/marpolbul

Effluent trading for water quality management: concept

and application to the Chesapeake Bay watershed
Eiichiro Nishizawa *

Faculty of Economics, Hosei University, Aihara 4342, Machida, Tokyo 194-0298, Japan
Accepted 15 October 2002

Abstract

This paper examines the present and potential role of effluent trading in water quality management. In particular, it focuses upon
the case of the Chesapeake Bay on the east coast of the US, where the implementation of a trading system has been discussed and
undertaken. Potential benefits of effluent trading include advantages such as the following: (1) With appropriate monitoring and
enforcement, the total pollutant loadings can be kept at or below the prespecified level. (2) New and expanding dischargers can be
accommodated, as long as they purchase credits. (3) Abatement costs of pollutants can be reduced. (4) Flexible regulations in-
corporating trading can reduce the incentive for industries to relocate to areas with less stringent water quality regulation. (5)
Broader environmental goals can be addressed, such as wildlife habitat provision and endangered species protection. (6) Preliminary
studies with a view to trading-system implementation encourage discussion and dialogue among stakeholders, and positively foster
concerted, holistic solutions for maintenance of water bodies.

2003 Elsevier Science Ltd. All rights reserved.

Keywords: Pollution control; Policies; Nutrients; Chesapeake Bay

1. Introduction United States Environmental Protection Agency (EPA)

This paper examines effluent trading and argues that
it could be a promising and efficient policy tool for water
quality control in enclosed coastal seas.
In attempts to control the water quality of a given
body of water, the concepts of integrated coastal zone
management and watershed management are of crucial
significance. Obviously, water pollutants spring from
numerous discharge sources, such as (among others)
wastewater treatment plants, factories, agricultural
activities and stormwater. Accordingly, the goal of
integrated coastal zone management and watershed
management is the implementation of comprehensive
measures that cover all of the discharge sources (both
present and potential). The system known as effluent
trading (one of the chief themes of this paper) can
contribute immeasurably to efficient integrated coastal
zone management and watershed management. The
*
Fax: +81-42-783-2611.
E-mail address: nishizaw@mt.tama.hosei.ac.jp (E. Nishizawa).
0025-326X/03/$ - see front matter
2003 Elsevier Science Ltd. All rights reserved.
doi:10.1016/S0025-326X(02)00408-3
recommends the watershed-based effluent trading sys-
tem (US EPA, 1996b), and some watershed areas in the
US have already implemented it.
Under the name of emissions trading, the principle of
this policy instrument was first applied to the field of air
pollution prevention. Emissions trading programs for
sulfur dioxide (SO2 ) and nitrogen oxides (NOx ) are al-
ready firmly established in the US (US EPA, 2001).
With the aim of preventing global warming, an inter-
national carbon dioxide (CO2 ) emissions trading pro-
gram will be implemented when the Kyoto Protocol
comes into effect.
In Section 2, this paper attempts to explain how the
effluent trading program mechanism functions, while
Section 3 discusses the potential benefits of effluent
trading. Section 4 offers an overview of existing pro-
grams already implemented, as well as others now in the
planning stage. The current status of the effluent trading
program in the Chesapeake Bay watershed is depicted
in Section 5. In a concrete form, Section 6 examines
and outlines the conditions for successful trading pro-
grams.
170 E. Nishizawa / Marine Pollution Bulletin 47 (2003) 169–174
2. The mechanism of effluent trading
2.1. What is effluent trading?
In succinct terms, ‘‘effluent trading’’ is a system al-
lowing for the transfer of pollutant discharge permits
among present or potential dischargers of water pollu-
tants. Restated in different words, ‘‘. . . a source that can
. . . cost-effectively achieve greater pollutant reduction
than is otherwise required would be able to sell or barter
the credits for its excess reduction to another source . . .’’
(US EPA, 1996a). In short, through establishing a
market for discharge permits, an effluent trading pro-
gram can contribute to a decrease in total abatement
cost.
Through analysis of what dischargers buy and sell,
effluent trading programs can be classified into two
distinct types: respectively, the ‘‘cap and allowance’’
system and the ‘‘baseline and credit’’ system. In the
former of these, the term ‘‘allowance’’ refers to the
amount of pollutants that a given source may discharge
over a set period of time. If a source discharges fewer
pollutants than are allotted in its allowance, it can sell
the unused amount of the allowance. On the other hand,
as long as a source purchases the necessary allowance, it
may increase its discharge of pollutants.
Under the other category, the baseline and credit
system, the permissible baseline of discharge level is set
by the government: this might be at or below the current
discharge level. When a source maintains the baseline
and reduces its amount of discharge, the result is called
‘‘credit’’, which is the equivalent of the baseline minus
the actual discharge level; this credit amounts to a per-
mit, which, if unused, can then be sold. However, a
source cannot sell credits, if the allowable discharge level
exceeds its current discharge level. It obtains credits only
if and when it reduces pollutant discharge. Therefore,
the baseline and credit system will not lead to an in-
crease in the total discharge level. The US EPA rec-
ommends the baseline-and-credit form of pollutant
allocation trading, and most of the programs currently
in operation are of this type.
2.2. Factors and elements of trading
When the development of a trading program is under
discussion, there are several elements and factors to be
considered.
2.2.1. Pollutants
What substances are regarded as serious pollutants,
and what kinds of pollutants can dischargers trade?
Where trading programs are implemented or in the
planning stage, eutrophication remains a major prob-
lem. Toxic substances also contribute to water degra-
dation. The US EPA supports the trading of credits for
nitrogen, phosphorus, and biological oxygen demand
(BOD), but takes a negative attitude towards the credit
trading of toxic substances, for these could cause or
aggravate local and regional water quality problems.
2.2.2. Geographic scope
Can a discharger be allowed to purchase credits from
a source several hundred kilometers away? In the US,
where several watershed-based programs are already
active or in the process of development, the size of the
concerned areas varies greatly from watershed to wa-
tershed. In the guidelines for the program in the Ches-
apeake Bay area, the compilers have described the
resulting dilemmas thus: ‘‘In order to maximize program
participation, a larger geographic scope is useful. On the
other hand, the farther the trading partners are from
each other, the more difficult it is to ensure that local
water quality goals are met (Chesapeake Bay Program,
2001)’’.
2.2.3. Eligibility
Can individuals or organizations receiving subsidies
for installing pollution-control equipment sell credit? Is
it permissible for farms with very high discharge levels
to take part in point–nonpoint source trading? Obvi-
ously, this factor is fraught with potential difficulties.
Ideally, eligibility should be determined individually,
with questions of efficiency and fairness of program
administration receiving due attention.
2.2.4. Trading ratio
This can be effectively employed to account for un-
certain cases, as typified by the following hypothetical
example. A farm might adopt a best management prac-
tice, 1 which is expected to reduce nitrogen discharge by
10 kg per year. Suppose, then, that due to difficulties in
monitoring and lack of clearly calculable control effi-
ciency, the government allows the farm to sell credit for
only half of the reduced nitrogen: namely, 5 kg per year.
In this case, the trading ratio would amount to 2:1. If
the farmÕs best management practice actually succeeds in
reducing nitrogen by 10 kg, the trade of this credit
would clearly result in net nitrogen reduction.
2.3. Types of trading
Point sources are exemplified by wastewater treat-
ment plants and factories, while nonpoint sources in-
clude agriculture and storm water. In regard to
discharge sources, the effluent trading system offers
several types of potential credit-trade possibilities, such
as the following:
1
Best management practices are farming and animal husbandry
methods that guarantee optimum output and minimize adverse
environmental effects (Lilly, 1991).
 E. Nishizawa / Marine Pollution Bulletin 47 (2003) 169–174
Fig. 1. Concept of point–nonpoint source trading.
• Point–point source trading––trading among point
sources.
• Point–nonpoint source trading––trading between
point source and nonpoint source (Fig. 1).
• Nonpoint–nonpoint source trading––trading among
nonpoint sources.
In the US as well as in many other countries, there
are, apart from limited areas, no specific regulations
controlling nonpoint sources. When viewed in relation
to point sources, the marginal reduction cost for non-
point sources is generally seen to be less expensive. Most
major point sources have already implemented some
sort of abatement technology; if they are obliged to
make further reductions, they may require a more
sophisticated––and more costly––approach. Under the
point–nonpoint source trading scheme, instead of un-
dertaking further pollutant-discharge reduction solely
by themselves, point sources could then give money to
nonpoint sources for installing best management prac-
tices, such as planting trees around farmland or along
rivers and lakeshores to trap nutrients, and help make
more efficient use of fertilizers, which would also reduce
fertilizer application. This scheme is expected to yield
substantial and growing cost savings.
3. Potential benefits of effluent trading
What, then, are the potential benefits of effluent
trading?
(1) With appropriate monitoring and enforcement, total
pollutant loadings can be kept at or below a pre-
specified level, because the government sets the total
allowable discharge level. Under the effluent charge,
it is not easy to estimate the level of charge that will
ensure total maximum pollutant loadings.
(2) New and expanding dischargers can be allowed, as
long as they purchase credits. In order to maintain
total loadings, the effluent charge must be raised
under the charge system, alternatively, under the
command-and-control program, more stringent reg-
ulation will become obligatory.
(3) As economists have convincingly argued, the total
abatement cost of pollutants can be reduced.
(4) Flexible regulations in regard to trading can lessen
the incentive for industry to remove to areas where
171
the control of water quality is less strict. If a factory
moves out of an area due to tightened effluent stan-
dards, but simply continues its operations as before,
the total pollutant loadings into the water body
would increase at the new site of the factory. In ad-
dition, the relocation of the industry might also re-
sult in drastic influences upon the local economy.
(5) Broader environmental goals can be addressed. For
example, through point–nonpoint source trading,
the adoption of best management practices could
simultaneously serve two or more purposes: trees
planted around farmland could also function as a
wildlife habitat.
In essence and effect, effluent trading exemplifies a
holistic approach. Surveys with a view to trading sys-
tem implementation encourage discussion and dialogue
among the prospective stakeholders, and also foster
concerted, holistic solutions for the water body. In
practice, point–nonpoint source trading could encom-
pass all discharge sources. Its basic idea is as follows:
with consideration of abatement costs in each and every
concerned sector, it becomes easier to determine which
sectors could reduce pollutants with the least possible
outlay.
4. Experiences of the US
In many US watershed areas, effluent trading pro-
grams are implemented or are under consideration. In a
study published in 1999, Sessions and Leifman listed 37
instances. Of these, they describe 11 cases in which trades
were under way or had already been effected: 5 of these
had had specific trading mechanisms approved and were
nearing implementation, while 6 cases had completed the
development and program approval process, with no
specific trading activities yet identified. A further 12 in-
stances were in various stages on the way to program
approval, such as preliminary study, discussion, plan-
ning and/or development. Among these instances, how-
ever, one was exclusively a study, while two further
endeavors were inactive or had been discontinued.
In the western state of Colorado, three watersheds
(Dillon Reservoir, Cherry Creek Reservoir, and Chat-
field Reservoir) have instituted trading programs with
the intent of controlling phosphorus (see Table 1). In the
Tar–Pamlico River watershed, in the state of North
172 E. Nishizawa / Marine Pollution Bulletin 47 (2003) 169–174

Table 1
Major effluent programs in the US
Watershed/area State Since Typesa Pollutants Trading ratio Description
Fox River Wisconsin 1981 P–P BOD 1:1 Two trades occurred
Grassland area California 1998 P–P Selenium 1:1 Eight trades occured
Dillon Reservoir Colorado 1984 P–NP, NP–NP Phosphorus 2:1 One P–NP trade, three NP–NP
(P) trades occurred
Cherry Creek Colorado 1997 P–NP, P–P P 1.3:1–3:1 A wastewater treatment plant
Reservoir got credits
Chatfield Reservoir Colorado 1993 P–NP P 2:1 One trade occured
Tar–Pamlico River North 1991 P–NP Nitrogen (N) Crop 3:1 Phase 1: $56 per kg, Phase 2:
Carolina $29 per kg
P (Phase 1 Animal 2:1 Point sources earned credits of
only) 23 t/year, 10 years long
Kalamazoo River Michigan 1997 P–NP P 2:1 Demonstration project, yet to
trade
Fox–Wolf Basin, Wisconsin 1997 P–NP, P–P P Pilot project
Red Ceder River,
Rock River
Minnesota River Minnesota 1997 P–NP BOD vs. P, P At least 2:1 Permits to Malting company
and sugar cooperative plant
Sudbury River, Massachusetts 1998 P–NP P, temperature 2:1–3:1 Permits to office complex and
Hoosic River calcium carbonate plant
a
P–P: point–point source trading; P–NP: point–nonpoint source trading; NP–NP: nonpoint–nonpoint source trading.

Carolina on the east coast, nitrogen is the target of the
trading program. The north central state of Michigan
is developing a watershed-based trading program at a
statewide level. As for enclosed coastal sea areas, Con-
necticut plans to implement its program for nitrogen
control in the Long Island Sound in the near future.
5. A specific example: nutrient trading in the Chesapeake
Bay
5.1. Efforts to reduce nutrients in the Chesapeake Bay
The Chesapeake Bay, centrally located on the east
coast of the US, is the largest estuary complex in North
America. Since World War II, economic development
and population growth have been seriously affecting the
bay and adjacent regions. Due to the gravity of the
situation, the US Congress directed the EPA to con-
duct research on the condition of the bay environment.
The resulting study came to the conclusion that the
major problems included eutrophication, decrease in
submerged aquatic vegetation, pollution through toxic
substances, and overfishing. In 1983, Pennsylvania,
Maryland, Virginia, the District of Columbia and the
EPA signed the Chesapeake Bay Agreement, in which
they pledged to cooperate in the restoration of the bay
ecosystem. This multi-state, regional partnership for
improving the present and future health of the bay is
known as the Chesapeake Bay Program (1999).
The Chesapeake Bay Agreement in 1987 set a target
for control of nutrients: nitrogen and phosphorus. By
2000, nutrient loadings to the bay ought to have been
reduced by 40% from their 1985 level. In 1992, the
Agreement was revised to arrange for the reduction
strategies on 10 major tributaries. As matters turned
out, however, it was unfortunately impossible to meet
the desired goal by the year 2000.
In spite of this setback, the Chesapeake Bay Program
continued to search for innovative and creative mea-
sures. In 2000, a new agreement was ratified; this re-
confirmed the targets: a 40% reduction of problem
factors and the removal of the bay from the EPA list of
impaired water bodies by 2010. If these goals are not
achieved by the deadline date, a more stringent water
quality management system known as ‘‘total maximum
daily loads’’ will then come into effect.
5.2. Nutrient Trading Fundamental Principles and Guide-
lines
The document known as the ‘‘Nutrient Trading
Fundamental Principles and Guidelines’’ was developed
by the Chesapeake Bay Program through stakeholder
negotiation and discussion at public meetings. This
charter provides, in effect, a framework and a basic idea
or philosophy that allows each state to establish trading
programs for tributaries within its jurisdiction. Imple-
mentation of trading programs is not mandatory, but
voluntary for individual participating states.
Some examples of the pertinent trading guidelines in
the charter are given below:
• Pollutants and geographic scope: Within the water-
shed area of any given major tributary, credits for
total nitrogen and total phosphorus can be traded.
The overall Chesapeake Bay watershed consists of 10
major tributaries.
 E. Nishizawa / Marine Pollution Bulletin 47 (2003) 169–174
• Eligibility: If sources receive state or federal funds,
they may not buy or sell credits. Farms must follow
a state-certified nutrient management plan.
• Types of trading: Until the 40% cut-back goal is
achieved, only ‘‘like sources trading’’, will be allowed:
in other words, point–point and nonpoint–nonpoint
source trading, but no combinations of the two.
However, once the goal has been reached, point–
nonpoint source trading will be permitted, and can
prove useful in sustaining the target level.
5.3. Trading program activities in individual states
In Maryland, an analysis of the trading market con-
ducted by the Water Environment Research Foundation
was slated for completion in 2001. Pennsylvania has
already declared that it will soon open a pilot project to
demonstrate the operation of a trading program. The
Virginia Water Quality Improvement Act of 1998 in-
corporates a clause requiring that the concept of trading
be explored as a means of nutrient management
(Wiedeman, 2001).
6. Conditions for success
In actuality, credit-trading transactions in the cur-
rently functioning programs are not so frequent. An
investigation of the reasons behind the sporadic trading
of credits by dischargers could thus be very useful, for it
would help reveal and facilitate suitable conditions for a
successful program.
(1) The wider the gap in abatement costs among dis-
chargers, the stronger the incentive to trade––thus,
the greater becomes the amount of cost savings gen-
erated by trading. In some watershed areas, high
estimates on point source expenses for further re-
duction of pollutant discharge provided an effective
means of leverage for the implementation of a trad-
ing program. Naturally, the reverse is also true. On
the Tar–Pamlico River, for example, wastewater
treatment plants fulfilled the reduction in nutrient
discharge with far less expense than had been pro-
jected; accordingly, this decreased the incentive to
trade (Hall and Howett, 1995).
(2) There should be enough discharge sources within a
network to support the credit market and allow
it to work effectively. For example, along the Fox
River, there are only 10 paper mills and four waste-
water treatment plants where the point–point source
trading program can function. Therefore, an in-
crease in the number of potential participants in
the program might encourage credit trading. For
this reason, involving nonpoint sources could help
activate the market (Apogee Research Inc., 1992).
173
(3) Restrictions on trading, such as stringent eligibility
criteria, inhibit trading activity. Since, however,
some of these restrictions are set with the purpose
of maintaining water quality, or in order to ensure
net reduction, this can be interpreted as a kind of
trade-off relationship.
(4) The lower transaction and administrative costs can
be kept, the better for all prospects of trading activ-
ity. Transaction outlay includes the costs of finding
trading partners and negotiating trades, while ad-
ministrative budgets must cover the costs of check-
ing each trade, in addition to monitoring and
enforcement expenses. If a trading program effec-
tively incorporates existing institutions, such as soil
conservation districts and agricultural cost-sharing
programs, the costs can be significantly lowered, as
has already been the case with the Tar–Pamlico
River and the Kalamazoo River in Michigan (Hall
and Howett, 1995; Michigan Department of Envi-
ronmental Quality, 1998).
(5) Intensive data compilation, as well as the collection
of information on water quality, discharge sources,
and abatement cost, would also play a valuable role
in clarifying the effectiveness of the trading program.
(6) Public involvement and stakeholder participation
are keys to reaching an overall consensus that trad-
ing programs make good sense. The Chesapeake
Bay Program spent 18 months in a negotiation pro-
cess to develop principles and guidelines for nutrient
trading; for its part, the Bay Program Office held 12
public workshops to explain and discuss the draft of
the texts introducing these basic principles and
guidelines.
7. Some remarks in conclusion
Although current effluent trading programs in the US
have yet to realize the sizable cost savings for which they
can ultimately be of use, studies and examinations of the
trading program system have already contributed to the
establishment both of partnership in all concerned sec-
tors of US watersheds and of a comprehensive frame-
work for further development. For these reasons, the
major significance of the trading programs to date may
be found in this proof that they can (and, in several
cases, do) provide an effective tool for integrated coastal
zone management.
Acknowledgements
Grateful acknowledgements are due to Professor Ann
Herring and Mary Spaid for invaluable editorial aid in
the preparation of this manuscript.
174 E. Nishizawa / Marine Pollution Bulletin 47 (2003) 169–174
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