Evolving Law and Policy for Freshwater Ecosystem Service Markets

William & Mary Environmental Law and Policy Review William & Mary Environmental Law and Policy Review

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36 (2011-2012)

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Deepwater Horizon: The Future of Offshore

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Article 6

December 2011

Evolving Law and Policy for Freshwater Ecosystem Service Evolving Law and Policy for Freshwater Ecosystem Service

Markets Markets

Martin W. Doyle

Todd BenDor

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EVOLVING LAW AND POLICY FOR FRESHWATER

ECOSYSTEM SERVICE MARKETS

MARTIN W. DOYLE

& TODD BENDOR

**†

INTRODUCTION

Humans have altered freshwater ecosystems worldwide.

With the

dramatic increase in irrigation, water storage projects, and land utilization

through the twentieth century, the scale of environmental conversion has

grown to influence fundamental biophysical processes including fundamen-

tal changes to the water cycle, cycling of elements (e.g., carbon, nitrogen,

and phosphorus), species composition, and climate.

These transforma-

tions have raised questions about the possibility of conserving and possibly

restoring damaged freshwater ecosystems.

While environmental conser-

vation and restoration efforts have historically focused on recovering im-

portant organisms (flora and fauna), recent scientific and policy endeavors

have centered on sustaining the services produced by ecosystems and their

components.

One way of accomplishing this is through the creation and

use of ecosystem service markets.

Duke University, Nicholas School of the Environment.

Department of City and Regional Planning, University of North Carolina, Chapel Hill.

†

Acknowledgments: We would like to thank Kathleen D. Oppenheimer for feedback and

assistance in editing this article. Funding for this work was provided by the UNC Institute

for the Environment and both Doyle and BenDor were visiting fellows at the Property

and Environment Research Center (PERC) while working on this project. This Article

represents an overview of our past and ongoing work on markets for freshwater services,

portions of which have been examined elsewhere, but which we here draw new conclusions

about current state and future possibilities.

See MILLENNIUM ECOSYSTEM ASSESSMENT, ECOSYSTEMS AND HUMAN WELL-BEING:

SYNTHESIS 26 (2005), available at http://www.millenniumassessment.org/documents

/document.356.aspx.pdf [hereinafter MEA] (stating that the “ecosystems and biomes that

have been most significantly altered globally by human activity include marine and fresh-

water ecosystems . . .”). See generally H

EINZ CTR. FOR SCI., ECON. AND THE ENV’T, THE STATE

OF THE NATION’S ECOSYSTEMS 133–54 (2002) [hereinafter HEINZ] (examining the state of

fresh water ecosystems).

Peter M. Vitousek et al., Human Domination of Earth’s Ecosystems, 277 SCIENCE 494,

494–99 (1997), available at http://www.sciencemag.org/content/277/5325/494.full.

Margaret Palmer et al., Ecology for a Crowded Planet, 304 SCIENCE 1251, 1251–52 (2004).

See Elizabeth M. Strange et al., Sustaining Ecosystem Services in Human-Dominated

Watersheds: Biohydrology and Ecosystem Processes in the South Platte River Basin, 24

153

154 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

Ecosystems are often defined as the complex of (1) organisms

appearing together in a given area and (2) their associated abiotic envi-

ronment, which interact through energy fluxes in order to construct biotic

structures and material cycles.

The study of ecosystems is somewhat dis-

tinct from that of the field of ecology in that ecosystem ecologists generally

study material or energy fluxes, while other ecologists commonly focus on

the behavior or patterns of particular organisms or groups of organisms.

Additionally, ecosystem ecologists generally consider ecosystems to be land-

scape features (physical features in the natural environment) that have

the ability to produce various functions.

Here, ecosystem functions are the

ability of a particular ecosystem (i.e., area) to change the flux or storage

of material or energy through time.

These functions include photosyn-

thesis (carbon sequestration), nutrient uptake or retention, metabolism,

or any other process characterized by the entirety of the ecosystem feature

(physical expression of ecosystem) rather than the process of any particular

individual organism or species.

“Ecosystem services” are derived from the beneficial outcomes of

ecosystem functions. These services provide the benefits that produce

ecological value.

For example, streams and wetlands naturally function

as retainers of nitrogen;

in watersheds in which there are nitrogen-

driven water quality problems (e.g., hypoxia of estuaries),

nitrogen re-

tention would be considered a valuable ecosystem service. The Millennium

ENVTL. MGMT. 39, 50 (1999) (acknowledging that “there is increasing concern that sub-

stantial changes will be required to ensure sustainability of essential ecosystem services”).

See HEINZ, supra note 1, at 16 n.7.

TIMOTHY F.H. ALLEN & THOMAS W. HOEKSTRA, TOWARD A UNIFIED ECOLOGY 90–92 (1993).

See, e.g., Wolfgang Haber, Landscape Ecology as a Bridge from Ecosystems to Human

Ecology, 19 ECOLOGICAL RESEARCH 99, 104–05 (2004); Monica G. Turner, Landscape

Ecology: The Effect of Pattern on Process, 20 ANNUAL REVIEW OF ECOLOGY AND SYSTEMATICS

171, 173 (1989).

Turner, supra note 7, at 173.

Rudolf S. de Groot et al., A Typology for the Classification, Description, and Valuation

of Ecosystem Functions, Goods and Services, 41 ECOLOGICAL ECON. 393, 394–95 (2002),

available at http://www.afordablefutures.net/uploads/3/5/8/5/3585210/degroot_et_al.pdf.

See Gretchen C. Daily et al., Ecosystem Services: Benefits Supplied to Human Societies

by Natural Ecosystems, 2 ISSUES IN ECOLOGY 1, 1 (1997); Dennis M. King & Luke W.

Herbert, The Fungibility of Wetlands, NAT’L WETLANDS NEWSL., Sept. 1997, at 10–13

[hereinafter King & Herbert].

See Mats Jansson et al., Wetlands and Lakes as Nitrogen Traps, 23 AMBIO 320, 320

(1994).

ECOLOGICAL SOCIETY OF AMERICA, HYPOXIA, available at http://www.esa.org/education

/edupdfs/hypoxia.pdf.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 155

Ecosystem Assessment (“MEA”)

groups ecosystem services into four

categories: provisioning services (e.g., providing food and water); regulat-

ing services (e.g., disease regulation); cultural services (e.g., recreation

opportunities); and supporting services (e.g., services necessary for the

production of other service types).

The lists of potential ecosystem ser-

vices appear to increase with time, and Ruhl et al.’s The Law and Policy

of Ecosystem Services

provides a useful review and synthesis.

Markets for these services are as difficult to define as functions and

services themselves.

Perhaps the most reasonable definition is given by

Robertson, who defines ecosystem service markets as those markets that

trade commodities based on ecological assessment criteria, such as wet-

lands, rather than units of weight or volume, as is the case for the acid

rain program.

However, the clarity of this definition begins to break

down as ecosystem service markets begin to interact, as in the case when

there are both wetland and water quality markets. As we will discuss in

Part III.C infra, there are instances in which markets attempt to trade in

weight or volume units whose values are estimated using ecological assess-

ment criteria (we describe this using the example of point-source to non-

point-source water quality trading).

Given these complicating factors,

it is imperative in any discussion of ecosystem markets to understand a

range of different resource markets and trading structures. Substantial

differences in commodity units and methods of assessment introduce prob-

lems that confront researchers and practitioners who study and implement

different types of markets.

See MEA, supra note 1.

Id. at vi.

See generally J.B. RUHL ET AL., THE LAW AND POLICY OF ECOSYSTEM SERVICES (2007).

See Pac. Nw. Research Station, Counting All That Matters: Recognizing the Value of

Ecosystem Services, 16 S

CIENCE UPDATE 1, 1–4 (2008), available at http://www.fs.fed.us/pnw

/pubs/science-update-16.pdf (describing the infancy of the concept of ecosystem services).

Morgan M. Robertson, Emerging Markets in Ecosystem Services: Trends in a Decade of

Entrepreneurial Wetland Banking, 4 FRONTIERS IN ECOLOGY AND THE ENV’T 297, 297

(2006) [hereinafter Robertson 2006].

See generally CYNDI KAROLY, N.C. DIV. OF COASTAL MGMT., NC WETLAND ASSESSMENT

METHOD (NCWAM) (2009), available at http://www.nccoastaltraining.net/uploads/Documents

/DWQ%20NCWAM%20PPT.pdf (providing an overview of the North Carolina Wetlands

Assessment Method); PAUL ADAMUS, HYDROGEOMORPHIC (HGM) ASSESSMENT GUIDEBOOK

FOR TIDAL WETLANDS OF THE OREGON COAST—PART 1: RAPID ASSESSMENT METHOD (2006),

available at http://www.oregon.gov/DSL/WETLAND/docs/tidal_HGM_pt1.pdf?ga=t (provid-

ing overview of the Oregon Rapid Assessment Method).

Morgan M. Robertson, Discovering Price in All the Wrong Places: Commodity Definition

156 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

There is rapidly growing interest and advocacy for using market

forces for regulating environmental quality, and this is perhaps most visibly

shown by the formation of the USDA Office of Ecosystem Services and

Markets.

This enthusiasm needs to be more critically informed by care-

fully examining markets that have existed, and evolved, over the past few

decades. Wetlands and streams comprise the oldest ecosystem markets,

and continue to be the most active at the national scale.

Ecosystem ser-

vice markets for wetlands and streams thus form one of the few empirical

bases for understanding the policies, guidelines, and operations of eco-

system service markets.

Nearly ten years ago, several studies began to explore the implica-

tions of different market structures as a means of protecting wetlands

and streams and enhancing ecosystem services.

In the intervening

decade, a number of analyses have collected data on the actual geo-

graphic,

economic,

and social

operation of these markets, in addition

to an emerging body of scientific work conducted at these sites.

This

and Price Under Neoliberal Environmental Policy, 39 ANTIPODE 500, 506–07 (2007)

[hereinafter Robertson 2007].

See generally U.S. DEP’T OF AGRIC., OFFICE OF ENVTL. MKTS., http://www.fs.fed.us

/ecosystemservices/OEM/ (last visited Nov. 7, 2011).

See BECCA MADSEN ET AL., STATE OF BIODIVERSITY MARKETS REPORT: OFFSET AND

COMPENSATION PROGRAMS WORLDWIDE vii, 8–9, 11–14 (2010), available at http://www

.ecosystemmarketplace.com/documents/acrobat/sbdmr.pdf.

See GRETCHEN C. DAILY & KATHERINE ELLISON, THE NEW ECONOMY OF NATURE: THE

QUEST TO MAKE CONSERVATION PROFITABLE 16 (2002); Gretchen C. Daily et al., The Value

of Nature and the Nature of Value, 289 S

CIENCE 395, 395 (2000); James Salzman & J.B.

Ruhl, Currencies and the Commodification of Environmental Law, 53 S

TAN. L. REV. 607,

607–09 (2000).

See Todd K. BenDor et al., Landscape Characteristics of a Stream and Wetland

Mitigation Banking Program, 19 E

COLOGICAL APPLICATIONS 2078, 2089 (2009), available

at http://dx.doi.org/10.1890/08-1803.1; P. Womble & M. Doyle, Setting Geographic Service

Areas for Compensatory Mitigation Banking, N

AT’L WETLANDS NEWSL., Sept./Oct. 2010,

at 18.

See generally Robertson 2006, supra note 17; Morgan M. Robertson, Discovering Price

in All the Wrong Places: Commodity Definition and Price Under Neoliberal Environmental

Policy, 39 A

NTIPODE 500, 500–26 (2007) [hereinafter Robertson 2007].

See Todd K. BenDor & Martin Doyle, Planning for Ecosystem Service Markets, 76 J. OF

THE

AM. PLANNING ASS’N 59, 60–61, 69–70 (2010); Salzman & Ruhl, supra note 22, at

612–13 (noting that there is “universal accord over the contributions of clean water and

flood control to social welfare . . .”).

See special issue of the journal ECOLOGICAL APPLICATIONS focusing on stream and river

restoration quality; many sites were mitigation (i.e., ecosystem service market) sites.

Evaluating River Restoration, 21 E

COLOGICAL APPLICATIONS 1925–2015 (2011).

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 157

paper seeks to explore these operational issues in markets for freshwater

ecosystems, which unlike many proposed, and still theoretical, markets

(e.g., markets for carbon, impervious surface,

and trees

) are operational

at a wide scale.

In discussing wetlands and streams, we will focus our discussion

and examples on markets in North Carolina, since they have been active

for over a decade and have been the focus of several recent studies as well

as recent federal and state regulation revisions.

Although the experience

of designing and implementing these markets meant successfully navigat-

ing certain policy and scientific problems, many others have been exposed

and are still in need of further study and remedy.

In addition to fresh-

water ecosystem markets, we also look at habitat conservation banking,

an emerging market that presents a new set of opportunities and chal-

lenges which will likely interact with these existing markets in the future.

We will describe the policies that created these markets, including those

crafted at the federal, state, and local level. We will also present a series of

summary statistics that provide a sense of scale of these markets. Finally,

we use these examples to point toward some of the potential limitations or

problems of these markets that merit considerable thought and research

attention as comparable markets proliferate.

See CLAIRE WELTY ET AL., FINAL REPORT: USING AN “IMPERVIOUS PERMIT” ALLOWANCE

SYSTEM TO REDUCE IMPERVIOUS SURFACE COVERAGE FOR ENVIRONMENTAL SUSTAINABILITY

(2005), available at http://cfpub.epa.gov/ncer_abstracts/index.cfm/fuseaction/display.abstract

Detail/abstract/7148/report/F (last visited Nov. 7, 2011).

See generally INT’L SOC’Y OF ARBORICULTURE, GUIDELINES FOR DEVELOPING AND

EVALUATING TREE ORDINANCES (2001), http://www.isa-arbor.com/education/resources/educ

_TreeOrdinanceGuidelines.pdf (search “mitigation”) (discussing how “tree ordinance develop-

ment can be integrated with an overall community tree program”).

See BenDor & Doyle, supra note 25 (“present[ing] a case study of the unique institu-

tional structure that oversees and regulates land development, highway construction, and

environmental restoration in North Carolina”); E

COSYSTEM ENHANCEMENT PROGRAM (EEP),

2003 MEMORANDUM OF AGREEMENT, available at http://www.nceep.net/images/Final

%20MOA.pdf [hereinafter EEP MOA] (establishing the EEP and “the procedures for pro-

viding compensatory mitigation through the [North Carolina Department of Environment

and Natural Resources] Ecosystem Enhancement Program (EEP) to offset impacts to waters

and wetlands due to activities authorized by Clean Water Act permits”).

See Dan Kane, EBX is Paid Twice for Wetlands Work, RALEIGH NEWS & OBSERVER,

Dec. 8, 2009, at A1 (explaining the “double-dipping” controversy of taxpayers apparently

paying twice for environmental clean-up in North Carolina).

See J.B. Ruhl et al., A Practical Guide to Habitat Conservation Banking Law and Policy,

NATURAL RES. & ENV’T 26, 26–27 (2005), available at http://www.law.fsu.edu/faculty

/profiles/ruhl/2005-HabitatBanking20NRESummer.pdf [hereinafter A Practical Guide to

Habitat Conservation Banking Law and Policy].

158 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

I. E

COSYSTEM SERVICE MARKETS: DESCRIPTION AND REGULATION

A. The Origin of Wetland Markets

Ecosystem service markets are almost all in some way based on,

or similar to, wetland markets.

Wetland regulation in the United States

is rooted in the U.S. Federal Water Pollution Control Act of 1972,

and the

Clean Water Act amendments of 1977,

which provide for the protection of

“waters of the United States” under the Interstate Commerce Clause of the

U.S. Constitution.

Congress designated the Army Corps of Engineers

(“Corps”) to administer § 404 for waters of the United States with oversight

from the U.S. Environmental Protection Agency (“EPA”).

Through judicial

interpretation, “waters of the United States” includes wetlands.

Most

development activities that affect waters of the United States fall under

§ 404 of the Clean Water Act, and thus require a permit from the Corps.

As part of the 404 program, the permittee must mitigate wetland damage,

a process through which they (a) avoid all possible impacts, (b) minimize

unavoidable impacts, and (c) provide compensatory mitigation of unavoid-

able impacts, i.e., create, restore, or preserve wetlands such that there is

no net loss of cumulative wetland ecosystem function.

In the early years of this regulation (until the mid-1990s), com-

pensatory mitigation was usually performed on-site by the permittee (also

often called the “developer” or “impactor”), resulting in the creation or

restoration of numerous, small mitigation sites with limited ecological

See Deborah L. Mead, History and Theory: The Origin and Evolution of Conservation

Banking, in CONSERVATION AND BIODIVERSITY BANKING 9, 9–11 (N. Carroll et al. eds., 2008).

Federal Water Pollution Control Act of 1972, Pub. L. No. 92-500, 86 Stat. 816 (1972),

codified as 33 U.S.C. §§ 1251–1263, 1265, 1281–1292, 1311–1326, 1328, 1341–1345, 1361–

1376 (2006).

Clean Water Act of 1977, Pub. L. No. 95-217, 91 Stat. 1566 (1977), codified as 33 U.S.C.

§§ 1281a, 1294–1297 (2006).

U.S. CONST. art. I, § 8.

33 U.S.C. § 1344 (2006); Palmer Hough & Morgan M. Robertson, Mitigation under

Section 404 of the Clean Water Act: Where it Comes From, What it Means, 17 WETLANDS

ECOLOGY & MGMT. 15, 15–16 (2007), available at http://www.springerlink.com/content

/ag615v755494325v/fulltext.pdf (describing how the Corps came to regulate wetlands

and streams).

Donn M. Downing et al., Navigating Through Clean Water Act Jurisdiction: A Legal

Review, 23 WETLANDS, 475, 476, 484 (2003).

33 U.S.C. § 1344 (2006).

See Hough & Robertson, supra note 36, at 15–16 (explaining the “history of three forms

of [wetland] mitigation: avoidance, minimization, and compensation”).

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 159

value in comparison to existing reference, less disturbed wetlands.

During

this period, regulations also began promoting off-site compensatory miti-

gation by permittees.

Although this was thought to promote better miti-

gation, the ecological values of these compensation sites were also often

extremely low, and the permittee, often a private land developer or a

state department of transportation, did not want to be in the business of

ecological restoration.

In response to slow § 404 permitting and high permittee-responsible

mitigation costs throughout the early 1990s, entrepreneurs and regulators

proposed creating large, consolidated areas of constructed wetlands, known

as “mitigation banks,” as pre-impact or advance mitigation.

In conjunction

with entrepreneurial mitigation bankers, developers, and EPA staff, Corps

districts developed the regulatory guidance necessary to define, create, and

maintain markets for mitigation of wetlands by overseeing the banks and

the trades that occurred.

Wetland mitigation banking allows private, third-party companies

to speculatively restore wetlands, which can then be sold as credits to de-

velopers who do not wish to perform their own compensatory mitigation

(Figure 1).

In order for a mitigation bank to be created, and credits from

that bank sold, the mitigation banker must have the site approved by an

Interagency Review Team (“IRT”) which is made up of personnel from the

Corps, EPA, and other local or federal natural resource agencies (e.g., U.S.

National Marine Fisheries Service, U.S. Fish and Wildlife Service, and

state departments of environmental conservation).

R. Eugene Turner et al., Count it By Acre or Function: Mitigation Adds Up to Net Loss

of Wetlands, 23 N

AT’L WETLANDS NEWSL., Nov./Dec. 2001, at 5, 6, 14.

NAT’L RESEARCH COUNCIL, COMPENSATING FOR WETLAND LOSSES UNDER THE CLEAN

WATER ACT 67–69 (2001) [hereinafter NRC] (explaining that mitigation banks “provide

off-site mitigation” for permittees “who anticipate having a number of future permit appli-

cations or by third parties who develop wetland credits for sale to permittees needing to

provide compensatory mitigation”).

Todd BenDor & Martin Doyle, Markets for Freshwater Ecosystem Services, in WATER

MARKETS (D. Gardner & R. Simmons ed., forthcoming), available at http://www.perc.org

/files/Doyle%20BenDor%20fresh%20water%20markets.pdf [hereinafter Markets].

See Robertson 2006, supra note 17, at 297–98.

See Federal Guidance for the Establishment, Use and Operation of Mitigation Banks,

60 Fed. Reg. 58,605–58,614 (Nov. 28, 1995) [hereinafter Corps 1995].

Id. at 58,605.

Compensatory Mitigation for Losses of Aquatic Resources: Final Rule, 73 Fed. Reg.

19,594–19,705 (2008), 33 C.F.R. § 332 (2008) [hereinafter 2008 Compensatory Mitigation

Rule].

160 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

Figure 1. Relationships between agencies, impactors (devel-

opers), and mitigation bankers in the originally conceived

structure of compensatory mitigation banking.

Note that

once impactors have purchased compensatory mitigation

credits, the liability for mitigation site failure is transferred

from the impactor to the mitigation bank.

A key requirement of mitigation banking is that wetlands should

be restored in advance of impacts.

In less-developed regions of the United

States, however, mitigation bankers are unlikely to speculatively invest in

banks because it is doubtful that there will eventually be sufficient demand

for the created credits.

Such markets are known as “thin” markets.

This

lack of economic incentive to invest in mitigation banks has a feedback

2008 Compensatory Mitigation Rule, supra note 46.

2008 Compensatory Mitigation Rule, supra note 46, at § 332.3.

Corps 1995, supra note 44, at pt. B; 23 C.F.R. § 777.2 (2008).

See Salzman & Ruhl, supra note 22, at 666–67 (“[D]evelopers want to develop wetlands

where land is dear (urban) and wetland banks want to locate where land is cheap (rural).”).

Id. at 645–46.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 161

to development activities, as development activities become hindered or

slowed by the lack of available mitigation banks in a region, since devel-

opers cannot easily obtain a § 404 permit.

Such lack of available advance

credits created the impetus for in-lieu fee (“ILF”) programs.

ILF programs are run by government or non-profit entities that

collect fees from developers (in lieu of actual compensation) and then con-

solidate these fees over time to build the necessary capital to restore wet-

lands.

Similar to mitigation banks, the obligation and associated liability

for providing compensatory mitigation under ILF programs is transferred

from the developer to the third-party mitigator.

The primary difference

between ILF programs and mitigation banks is the time at which mitiga-

tion occurs relative to impacts; in banking, restoration is performed prior

to impacts, while ILF programs allow mitigation to be performed years

after impacts are permitted.

To summarize, compensatory mitigation of wetlands can now take

place through three mechanisms: permittee-responsible mitigation, pur-

chase of credits from a mitigation bank, or purchase of credits through

an ILF. These and other rules for wetlands-related regulation under com-

pensatory mitigation were most recently summarized and formalized by

the Corps and EPA in 2008 through the published new regulations gov-

erning compensatory mitigation, Compensatory Mitigation for Losses of

Aquatic Resources.

B. Emerging Markets for Streams

How, when, and which wetlands merit being considered waters of

the United States (and thus subject to federal jurisdiction via the Corps)

remains highly contested between land developers and regulatory agencies,

and there has been a string of mixed Supreme Court decisions addressing

See David Sunding & David Zilberman, The Economics of Environmental Regulation

by Licensing: An Assessment of Recent Changes to the Wetland Permitting Process, 42 NAT.

RESOURCES J. 59, 73–76 (2002).

ENVTL. LAW INST., THE STATUS AND CHARACTER OF IN-LIEU FEE MITIGATION IN THE

UNITED STATES (2006) [hereinafter ELI 2006].

Id. at 1–3; Jessica Wilkinson, In-lieu Fee Mitigation: Coming into Compliance with the

New Compensatory Mitigation Rule, 17 WETLANDS ECOLOGY & MGMT. 53, 67 (2009), avail-

able at http://www.springerlink.com/content/y5538766x2551382/fulltext.pdf.

See 2008 Compensatory Mitigation Rule, supra note 46, at 19,594.

See ELI 2006, supra note 53, at 1–6.

2008 Compensatory Mitigation Rule, supra note 46, at 19,594–19,596.

162 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

this issue over the past twenty years.

The recent Rapanos v. Carabell

case

again raised the question of which waters in the United States

should be considered under the regulatory authority of the Corps, and

the Corps in part answered this question through the 2008 Compensatory

Mitigation Rule

discussed in Part I.A supra. In contrast to wetlands,

streams, and rivers are more easily justified as “waters of the United

States” that can be regulated by federal power over interstate commerce.

Although § 404 of the Clean Water Act is known generally as a “wetlands

rule,” streams and rivers also fall under its jurisdiction, specifically as a

category of a “difficult to replace” type of wetland.

In the past, impacts to

streams were often either considered by the Corps to be impractical to com-

pensate, or compensation was performed using wetlands credits.

Trading

stream impacts for wetland credits is called “out of kind” compensation,

since the resources traded are not of the same kind.

More recently, the Corps has begun requiring in-kind compensation

for streams, thus increasing the market for stream ecosystems and stream

banking separate from wetland banking.

Additionally, because streams

are a “difficult to replace resource,” stream impacts must be compensated

by stream restoration.

This policy has created a demand for stream resto-

ration credits, and in response, entrepreneurs have created stream miti-

gation banks similar to those for wetlands.

Stream mitigation banking

has adapted the wetland mitigation banking model to riverine systems,

and while only recently becoming nationwide, stream markets have sur-

passed wetlands markets in the number of trades in some states, as in

the case of North Carolina described in Part II infra.

See Downing, supra note 37 (examining the history of “navigable waters” as defined by

the courts).

See Rapanos v. United States, 547 U.S. 715, 716–17 (2006).

2008 Compensatory Mitigation Rule, supra note 46, at 19,595.

See Rapanos, 547 U.S. at 716–17.

2008 Compensatory Mitigation Rule, supra note 46, at 19,594–19,596.

See ENVTL. LAW INST., BANKS AND FEES: THE STATUS OF OFF-SITE WETLAND MITIGATION

IN THE UNITED STATES 7–10 (2002) [hereinafter ELI 2002].

See id. at 18.

2008 Compensatory Mitigation Rule, supra note 46, at 19,618 (explaining that

“compensation for difficult to replace resources . . . should be provided through in-kind

rehabilitation”); 33 C.F.R. § 323.3(b)(4).

See id.

Rebecca Lave et al., Why you Should Pay Attention to Stream Mitigation Banking, 26

ECOLOGICAL RESTORATION 287, 287–89 (2008).

Id. (explaining that “[s]tream mitigation banking is rapidly becoming a major driver of

the stream restoration industry”).

See also id. at 287.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 163

C. Water Quality Services

The Clean Water Act provides for trading of credits for nitrogen

(“N”) and phosphorus (“P”),

both of which are leading sources of pollu-

tion in the United States, particularly in the Mississippi River basin and

Gulf of Mexico,

as well as in many Atlantic river basins, including the

Chesapeake Bay, and the Albemarle-Pamlico sound of North Carolina.

Under the Clean Water Act, “point source” (“PS”) is distinguished from

“non-point source” (“NPS”) pollution: PS pollution is federally regulated

under the National Pollution Discharge Elimination System (“NPDES”),

which is focused on discrete pollution emitters (e.g., wastewater treatment

facilities), and sets discharge limits and technology standards for point

sources.

In contrast, NPS is regulated under total maximum daily load

(“TMDL”) requirements, which focus on ambient water quality in water-

sheds.

Nationally, NPS pollution, particularly from agricultural sources,

comprises seventy-six percent of Nitrogen and fifty-six percent of Phos-

phorus reaching waterways.

Although the EPA is responsible for NPDES

regulation, administration of the NPDES is typically delegated to state

agencies.

Some states regulating NPDES have allowed water pollution

trading districts to form, specifically allowing the emergence of both point

source–to–point source (“PS-PS”) trading and point source–to–non-point

source (“PS-NPS”) trading programs.

See 33 U.S.C. § 1267 (2006).

Richard B. Alexander, Effect of Stream Channel Size on the Delivery of Nitrogen to the

Gulf of Mexico, 403 NATURE 758, 758–61 (2000) [hereinafter Alexander] (discussing the

impacts of excessive nitrogen); see also EPA,

WATER: NUTRIENTS: GULF OF MEXICO, avail-

able at http://water.epa.gov/scitech/swguidance/standards/criteria/nutrients/gulfofmexico

.cfm (discussing increase of phosphorus and nitrogen in the Mississippi River and Gulf

of Mexico).

See Water Quality Issues: Nitrogen and Phosphorus Pollution, CHESAPEAKE BAY

FOUND., http://www.cbf.org/page.aspx?pid=913 (last visited Nov. 7, 2011); U.S. DEPT. OF

THE INTERIOR, U.S. GEOLOGICAL SURVEY, WATER QUALITY IN THE ALBEMARLE-PAMLICO

DRAINAGE BASIN: NORTH CAROLINA AND VIRGINIA 1992–1995, available at http://pubs.usgs

.gov/circ/circ1157/circ1157.pdf.

See 33 U.S.C. § 1342(f) (2006).

See id. § 1342(k).

See id. § 1313.

RUHL ET AL., supra note 15, at 228.

See generally U.S. State Information, EPA, http://cfpub.epa.gov/npdes/stateinfo.cfm (last

visited Nov. 7, 2011) (explaining how the NPDES permit program is delegated to the states

by region).

See Richard T. Woodward & Ronald A. Kaiser, Market Structures for US Water Quality

Trading, 24 REV. OF AGRIC. ECON. 366, 373 (2003).

164 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

Under the same theory driving atmospheric emissions trading

programs,

PS-PS trades should allow PS polluters to come into compli-

ance more efficiently than if each polluter were required to come into com-

pliance individually.

Moreover, because NPS can usually make reductions

in their pollution for relatively little cost (low marginal nutrient abatement

costs) compared to PS, PS-NPS trades should have even greater potential

than PS-PS trades to achieve regulatory compliance at reduced costs.

While these markets have great potential for regulatory and economic

purposes, within the thirty-seven nutrient trading districts created, only

eight have conducted any trades, and only thirteen trades (one PS-NPS

trade) had occurred as of 2007.

Water quality trading does not initially appear to qualify as an

ecosystem market since the commodity being traded is a chemical mea-

sured in pounds of N or P rather than an ecosystem service measured in

ecological assessment metrics.

In the case of PS-NPS trading, NPS loads

are not measured directly, as they are for PS or in air quality markets.

Rather, NPS pollution reductions arise through land use changes, spe-

cifically by landowners adopting best management practices (“BMPs”)

(e.g., riparian buffers and detention basins).

Just as wetland area or

stream length serve as surrogate estimates of wetland or stream ecosys-

tem function, so land use change through BMPs is used as a surrogate

estimate of water quality change.

Environmental management agencies

must develop ecological assessment techniques that provide conversion

factors linking land use, soil type, and other variables with their impacts

on water quality and nutrient (or other pollutant) loading. As a result, we

can consider NPS water quality trading programs to be operating ecosys-

tem service markets under the same definition used to articulate wetland

and stream markets.

James Boyd et al., Trading Cases, 217 ENVTL. SCI. & TECH. 216(A), 217 (2003).

See Woodward & Kaiser, supra note 78, at 373.

See Zoe Hamstead & Todd K. BenDor, Nutrient Trading for Enhanced Water Quality:

A Case Study of North Carolina’s Neuse River Compliance Association, 28 E

NV’T AND

PLANNING 1 (2010).

RUHL ET AL., supra note 15, at 229.

See Robertson 2006, supra note 17, at 297.

See generally NPDES, EPA, http://cfpub.epa.gov/npdes/index.cfm (last visited Nov. 7,

2011) (explaining NPDES permits with respect to point sources).

Robertson 2007, supra note 24, at 506–07.

See id. at 501, 507.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 165

D. Habitat Conservation Banking

Habitat conservation banking is a recent development in ecosystem

service markets.

Conservation banking occurs when habitat for a rec-

ognized (listed) threatened or endangered species is impacted and offset

with habitat preservation, enhancement, restoration, or creation at a dif-

ferent location.

Conservation banking is a similar concept to wetland

and stream banking, whereby compensation is performed in one location

to offset similar impacts at multiple locations.

The advantage of conser-

vation banking is that the conservation bank sites are often large, contig-

uous, and sited more strategically (to protect habitat) than impact sites.

Like wetland banking, this can produce economies of scale leading to higher

quality restoration and ecological benefits not seen in small, fragmented

conservation areas.

Conservation banking was first introduced in California by the U.S.

Fish and Wildlife Service (“FWS”) to distinguish banks developed specifi-

cally for federally listed endangered species from banks specifically desig-

nated for wetland mitigation.

Unlike stream and wetland mitigation,

which now is subject to very specific federal regulation, conservation bank-

ing remains regulated by an FWS guidance document.

Although this guid-

ance is comparable to early wetland/stream banking guidance documents,

the stated goal of conservation banking is to conserve species, which can

only be achieved through restoration or enhancement of the habitat needs

of that specific species.

Thus, while habitat conservation banks operate

almost identically to wetland or stream mitigation banks, their evaluation

(by a review team similar to the Mitigation Bank Review Team (“MBRT”))

See A Practical Guide to Habitat Conservation Banking Law and Policy, supra note 31,

at 26–27 (explaining agencies’ belief that conservation banking is beneficial for species

as well).

See id. at 26.

See id. at 26–29.

Mead, supra note 32, at 17.

See Mark W. Schwartz, Choosing the Appropriate Scale of Reserves for Conservation,

20 A

NN. REV. OF ECOLOGY AND SYSTEMATICS 83, 99–100; see also Todd K. BenDor & N.

Brozovic, Determinants of Spatial and Temporal Patterns in Compensatory Wetland

Mitigation Banking, 40 ENVTL. MGMT. 349, 361.

A Practical Guide to Habitat Conservation Banking Law and Policy, supra note 31, at 28.

See Memorandum from the U.S. Dep’t of the Interior, Guidance for The Establishment,

Use and Operation of Conservation Banks (May 2, 2003), available at http://www.usace

.army.mil/CECW/Documents/cecwo/reg/conserv_bank_guide.pdf.

See A Practical Guide to Habitat Conservation Banking Law and Policy, supra note 31.

166 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

is held to species-specific criteria, rather than general criteria used to

evaluate wetlands and streams.

Fisheries mitigation banks are perhaps the most relevant conser-

vation banks in the context of fresh water markets,

although very few

trades have occurred.

In two cases in California, over 100 acres were

restored to create the habitat specifically needed for a federally listed en-

dangered species.

This area included tidal marsh habitat primarily ac-

quired as habitat for delta smelt, as well as Sacramento River floodplain

habitat for several fish species, including Chinook salmon.

In contrast

to markets for wetlands, streams, and water quality, fisheries banks have

exhibited little market activity (trades) or research interest to date, but

we expect change as more regions experiment with implementing habitat

conservation banks.

100

E. Some Regulatory Issues: Monitoring, Service Areas, and In-lieu

Fee Programs

There are several issues with current ecosystem market regulation

that require elaboration, particularly given the impacts that regulations

can have on promoting successful ecological and economic outcomes.

101

First, regulations governing all of the markets that we have described

put very little emphasis on monitoring the ecological service actually being

traded.

102

In wetlands mitigation, a range of services are considered to

be preserved, enhanced, and restored, including flood attenuation, nutri-

ent retention, and wildlife habitat.

103

The only success criteria (denoting

a mitigation project as “successful”) measured in most Corps districts, how-

ever, relate to hydrology (water table elevation), soil type, and vegetation

See id. at 30.

See generally Tom Cannon & Howard Brown, Fish Banking, in CONSERVATION AND

BIODIVERSITY BANKING 159, 159–70 (N. Carroll et al. eds., 2008) (discussing the history

and potential future application of fish banks).

See id. at 163.

Id. at 159–60.

See id.

100

Id. at 163–64.

101

See Sunding & Zilberman, supra note 52, at 60–61 (analyzing the potential to reform

the most often issued wetland permit, National Wetland Permit 26).

102

In the case of stream mitigation in North Carolina, biological monitoring data from in-

stream communities are not required for any work, although they may be required on a case-

by-case basis.

U.S. ARMY CORPS OF ENGINEERS–WILMINGTON DIST., STREAM MITIGATION

GUIDELINES (2003). To our knowledge, no monitoring of in-stream biological communities

has been required for mitigation permits to date.

103

See Salzman & Ruhl, supra note 22, at 612, 635.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 167

type/survival.

104

While these are ecological components of wetlands, it is un-

clear whether these components are sufficient proxies to capture the range

of ecosystem services that regulations seek to protect under the auspices of

the Clean Water Act.

105

Furthermore, while the 2008 federal mitigation reg-

ulation requires the establishment of more explicit standards defining eco-

logical success criteria,

106

it does not explicitly define the range and type of

ecological functions and services that act as proxies for mitigation “success,”

leaving these to be determined by individual District Engineers.

107

In the case of streams in many states, only physical characteristics

of stream channel shape—width, slope, and riparian vegetation—are mea-

sured or restored under compensatory mitigation.

108

Although restoring

ecological functions (e.g., species recovery, nutrient retention) is the stated

purpose of compensatory stream mitigation, specific ecological aspects (e.g.,

community composition of fish or macroinvertebrates, nutrient retention)

are rarely monitored as a requirement for approval of the bank to sell its

credits.

109

Evaluating the success of compensatory mitigation programs

is difficult because of this disconnect between the purpose of mitigation

(functional replacement) and the reality, as it is far from clear what is

being achieved when just the physical habitat is being changed.

110

Recently published scientific literature is in fact casting doubts

on whether stream restoration can deliver demonstrable changes.

111

Com-

monly assumed hydrological benefits of restoration, such as sediment

retention or flood attenuation, have been shown to be more difficult to

either restore or measure than previously thought.

112

Biological changes

104

See NRC, supra note 41, at 35.

105

See Salzman & Ruhl, supra note 22, at 626 (explaining potential complications asso-

ciated with wetland mitigation).

106

2008 Compensatory Mitigation Rule, supra note 46, at § 332.5.

107

See 2008 Compensatory Mitigation Rule, supra note 46, at § 332.4(c).

108

See U.S. ARMY CORPS OF ENGINEERS–WILMINGTON DISTRICT, supra note 102, at 24–25.

109

In a review of several state regulations and Corps of Engineer Districts, we have found

a consistent pattern of requiring monitoring of physical variables (e.g., channel width, depth)

and riparian vegetation, but no in-channel biological data. For examples see U.S. ARMY

CORPS OF ENGINEERS–MOBILE DIST., COMPENSATORY STREAM MITIGATION STANDARD

OPERATION PROCEDURES AND GUIDELINES 31, 34 (Draft Edition, 2009); U.S. CORPS OF

ENGINEERS, STATE OF MISSOURI STREAM MITIGATION METHOD 11 (2007).

110

See infra notes 111–18 and accompanying text.

111

For limited effects of restoration on sediment loads see F. Douglas Shields, Do We

Know Enough About Controlling Sediment to Mitigate Damage to Stream Ecosystems?,

35 ECOLOGICAL ENG’G 1727, 1732 (2009). For limited effects of restoration on flood atten-

uation see Joel Sholtes & Martin Doyle, Effect of Channel Restoration on Flood Wave

Attenuation, 137 J.

OF HYDRAULIC ENG’G 196 (2011).

112

See Shields, supra note 111, at 1730–32.

168 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

are also proving difficult to demonstrate, as based on case studies or sys-

tematic reviews of many studies of fish and aquatic insect communities.

113

There is ongoing scientific debate about the potential benefits of stream

restoration for nutrient retention, with some studies showing its efficacy,

and others its limitations.

114

One limiting factor that has too often been

ignored is that background water quality may be so poor as to be both

toxic to aquatic organisms

115

and saturating of any nutrient retention

effects;

116

that is, in-stream water restoration may be moot given back

113

For fish studies, Phil Roni and his colleagues conducted a systematic meta-analysis

of published literature. See Phil Roni et al., Global Review of the Physical and Biological

Effectiveness of Stream Habitat Rehabilitation Techniques, 28 N.

AM. J. OF FISHERIES

MGMT. 856 (2008) (noting that definitive conclusions on many techniques of stream re-

habilitation are difficult to make due to a lack of biological information); Ian A. Tattam

et al., Scale Pattern Analysis of Selected Scale Characteristics and the First Annulus for

Distinguishing Wild and Hatchery Steelhead in the Hood River, Oregon, 23 N.

AM. J. OF

FISHERIES MGMT. 856 (2003); see also Ashley H. Moerke & Gary A. Lamberti, Responses in

Fish Community Structure to Restoration of Two Indiana Streams, 23 N. AM. J. OF FISHERIES

MGMT. 748 (2003); J.L. Pretty et al., River Rehabilitation and Fish Populations: Assessing

the Benefit of Instream Structures, 40 J. OF APPLIED ECOLOGY 251 (2003).

While a similar meta-analysis for insects is not available, case studies cast doubt

on stream restoration effectiveness. See S.S.C. Harrison et al., The Effect of Instream

Rehabilitation on Macroinvertebrates in Lowland Rivers, 41 J.

OF APPLIED ECOLOGY 1140

(2004); David J. Price & Wesley J. Birge, Effectiveness of Stream Restoration Following

Highway Reconstruction Projects on Two Freshwater Streams in Kentucky, 25 ECOLOGICAL

ENG’G 73 (2005).

114

There are two main studies that show that stream restoration increases nutrient

retention. See Sujay S. Kaushal et al., Effects of Stream Restoration on Denitrification in

an Urbanizing Watershed, 18 ECOLOGICAL APPLICATIONS 789 (2008); Paul A. Bukaveckas,

Effects of Channel Restoration on Water Velocity, Transient Storage, and Nutrient Uptake

in a Channelized Stream, 41 E

NVTL. SCI. AND TECH. 1570 (2007).

However, both have been interpreted incorrectly. For the Kaushal study, the effect

of restoration was measured on riparian zone denitrification, not in-stream processes. For

Bukaveckas, it is important to note that temperature in the stream increased dramati-

cally in the restored stream; thus denitrification increases are confounded by this effect,

not necessarily the in-stream restoration work. For studies showing the limitation of stream

restoration for nutrient retention see Todd V. Royer et al., Timing of Riverine Export of

Nitrate and Phosphorus from Agricultural Watersheds in Illinois: Implications for Reduc-

ing Nutrient Loading to the Mississippi River, 40 E

NVTL. SCI. AND TECH. 4126, (2006);

Elizabeth B. Suddoth et al., Testing the Field of Dreams Hypothesis: Functional Responses

to Urbanization and Restoration in Stream Ecosystems, 21 E

COLOGICAL APPLICATIONS

1972 (2011).

115

See Julio A. Camargo & Alvaro Alonso, Ecological and Toxicological Effects of Inorganic

Nitrogen Pollution in Aquatic Ecosystems: A Global Assessment, 32 ENV’T INT’L 831

(2006); Julio A. Camargo et al., Nitrate Toxicity to Aquatic Animals: A Review with New

Data for Freshwater Invertebrates, 58 C

HEMOSPHERE 1255 (2005).

116

See Stevan R. Earl et al., Nitrogen Saturation in Stream Ecosystems, 87 ECOLOGY 3140

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 169

ground conditions. In response to criticisms of stream restoration, there

is often an argument that restoration projects need more time, although

historical studies have shown long-term ineffectiveness as well.

117

Based

on these mixed results, scientists are suggesting that stream restoration

has limited effects on biological processes in comparison with the effects

of the broader watershed land use conditions, and thus site location rather

than project-specific design elements may be most important, although this

is an ongoing arena of active research.

118

The second issue pertains to geographic “service areas,”

119

which

is a key consideration in the economic and ecological success of an overall

ecosystem market.

120

When wetlands or streams are destroyed, regulators

prefer the mitigation to be as close as possible to the impact, and if possible,

within the same watershed. The reasoning for this was articulated in the

first federal guidance on wetland mitigation, where regulators argued that

wetlands mitigated near impacts were more likely to provide similar eco-

system services.

121

The area that any single mitigation bank can serve is

therefore limited to the same watershed (“service area”) as the impacts for

which it provides compensation.

However, the scale of these “watershed” service areas remains dif-

ficult to define explicitly, and the 2008 Compensatory Mitigation Rule has

been intentionally vague on this critical issue, essentially leaving it to each

Corps’ District Engineer to establish and enforce the scale they consider

most appropriate.

122

If a service area is too large, then many impacts can

(2006) (discussing nitrogen saturation within streams, stemming from increased ter-

restrial use).

117

Douglas M. Thompson, Did the Pre-1980 Use of In-Stream Structures Improve Streams?

A Reanalysis of Historical Data, 16 ECOLOGICAL APPLICATIONS 784 (2006) (noting “growing

concerns about the long-term stability and environmental impact of instream structures”).

118

Christopher J. Walsh et al., Riverine Invertebrate Assemblages Are Degraded More

by Catchment Urbanization Than by Riparian Deforestation, 52 FRESHWATER BIOLOGY

574 (2007). But cf. W.M. Lewis & D.P. Morris, Toxicity of Nitrite to Fish: A Review, 115

TRANSACTIONS OF THE AM. FISHERIES SOCIETY 183 (1986); Aaron A. Moore & Margaret A.

Palmer, Invertebrate Biodiversity in Agricultural and Headwater Streams: Implications

for Conservation and Management, 15 ECOLOGICAL APPLICATIONS 1169 (2005).

119

Womble & Doyle, supra note 23; 2008 Compensatory Mitigation Rule, supra note 46,

at § 332.2.

120

See Robert Bonnie & David S. Wilcove, Ecological Considerations, in CONSERVATION

AND BIODIVERSITY BANKING 53, 53–67 (N. Carroll, et al. eds., 2008).

121

EPA & CORPS OF ENGINEERS, MEMORANDUM OF AGREEMENT BETWEEN THE EPA AND

THE DEPARTMENT OF ARMY CONCERNING THE DETERMINATION OF MITIGATION UNDER THE

CLEAN WATER ACT SECTION 404(B)(1) GUIDELINES (1990), available at http://water.epa.gov

/lawsregs/guidance/wetlands/mitigate.cfm.

122

See 2008 Compensatory Mitigation Rule, supra note 46, at § 332.3(c)(4).

170 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

be concentrated in one geographic area, while all of the mitigation can be

geographically distant, leading to impact hot spots and localized net loss.

123

If service areas are too narrowly constrained, then there is potentially in-

sufficient demand in any one area to justify taking on the economic risk

of a speculative mitigation bank, i.e., a bank residing in a thin market.

124

Corps districts have not been consistent in defining the scale of

service areas, following on the devolution of responsibility in the Corps to

the District Engineer with whom authority resides for individual permit

decisions.

125

The most common geographic service area used by Corps dis-

tricts is an eight-digit Hydrologic Unit Class (“HUC”); in a survey of com-

pensatory mitigation policies in 2010, twenty-five of thirty-eight Corps

districts used HUC-8 as their geographic service area size.

126

Other Corps

districts define geographic service areas as agglomerations of eight-digit

watersheds, and still others allow trades across entire states.

127

Still in

others, service areas are set as twenty or forty mile radii from the miti-

gation bank, within which impacts can be compensated.

128

Other Corps

districts also included secondary service areas in which permittees could

purchase credits if no mitigation were available within the primary ser-

vice area.

129

In many areas, where local regulations augment the Corps’

authority, these service areas are further constrained by political bound-

aries such as counties.

130

Issues involving service area size differ across types of ecosystem

service markets: the goal of wetland and stream banking or water quality

trading programs such as PS-NPS programs is to sustain the quality of

local or receiving water bodies, and thus setting the geographic service

area at the watershed scale makes intuitive and regulatory sense.

131

How-

ever, there may be cases where local mitigation is not ideal, and distant

mitigation is actually desired. For instance, the goal of conservation banks

is to preserve viable species populations.

132

Moreover, one of the foremost

123

See Todd K. BenDor et al., Assessing the Socioeconomic Impacts of Wetland Mitigation

in the Chicago Region, 73 J. OF THE AM. PLAN. ASS’N 263, 276 (2007) [hereinafter Assessing

the Socioeconomic Impacts].

124

See Salzman & Ruhl, supra note 22, at 663, 666–67.

125

A significant number of provisions in the 2008 Federal Rule give the District Engineer

significant control over program implementation. See 33 C.F.R. §§ 325, 332 (2008).

126

Womble & Doyle, supra note 23, at 19.

127

Wilkinson, supra note 54, at 65.

128

Womble & Doyle, supra note 23, at 19.

129

Id.

130

See Robertson 2006, supra note 17, at 299 (highlighting restrictions in Illinois counties).

131

See NRC, supra note 41, 140–49.

132

See Mead, supra note 32, at 9.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 171

causes of habitat loss is urban and suburban development.

133

Thus, it may

be entirely defensible or even preferable to allow the loss of habitat in a

rapidly developing region in exchange for mitigation in a distant region, if

the distant region is the best source of quality, long-term conservation land

or genetic conservation resources.

134

That is, there are likely opportunities

in which giving up spatial proximity is justified in order to provide the most

ecologically beneficial restoration sites.

135

Arguably, the inadequate success

to date

136

of most ecosystem restoration suggests that there should be a bal-

ance between sites that are close but have limited restoration potential,

and sites that are further away that have greater restoration potential.

A third issue regards in-lieu fee programs.

137

For traditional miti-

gation trading to occur, offsets (in the case of wetlands and streams, this

implies mitigation banks) must be at least partly established before new

impacts are permitted.

138

“Advance” mitigation involves speculation on the

part of bankers who have limited information on the future of impacts in

a region or may have limited confidence in the stability of regulations that

govern banking.

139

This uncertainty acts as a barrier to entry for bankers

into the mitigation credit market, causing situations in which insufficient

credits are available in an area to compensate for new impacts.

140

ILF pro-

grams allow for potential impactors to pay a fee in lieu of actual mitigation,

essentially providing an ecological IOU program. It is questionable whether

ILF programs are ever appropriate, as they undermine both the economic

and ecological original intent of mitigation banking. Ecologically, banks are

meant to be established prior to impacts, thus reducing the time delay be-

tween impacts and an operational ecosystem.

141

When using an ILF, there

is an inherent time delay between impacts and establishment of a compen-

sating ecosystem function, thus undermining an important component of

ecologically responsible mitigation.

142

133

See EPA, WETLANDS: REPORT ON THE ENVIRONMENT DATABASE (March 10, 2011), avail-

able at http://cfpub.epa.gov/eroe/index.cfm?fuseaction=list.listBySubTopic&ch=47&s=202.

134

See Paul Armsworth et al., Land Market Feedbacks Can Undermine Biodiversity

Conservation, 103 PROCEEDINGS OF THE NAT’L ACAD. OF SCI. 5403, 5405–07 (2006).

135

See BenDor et al., supra note 23, at 18, 20.

136

See NRC, supra note 41, at 121–22.

137

Wilkinson, supra note 54, at 53 (analyzing potential improvements needed to ensure

the effectiveness of in-lieu fee programs).

138

See 2008 Compensatory Mitigation Rule, supra note 46.

139

See generally BenDor & Brozovic, supra note 91 (discussing factors, including regulation,

affecting distribution of banking sites).

140

See Robertson 2006, supra note 17, at 299–300.

141

Corps 1995, supra note 44, at 58,605.

142

Todd K. BenDor, A Dynamic Analysis of the Wetland Mitigation Process and its Effects

on No Net Loss Policy, 89 LANDSCAPE AND URBAN PLAN. 17, 18 (2009).

172 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

Economically, ILF programs produce even more potential problems.

ILF programs accept fees from developers at a rate that is assumed will be

adequate to purchase and restore sites in the future and then assume all

responsibility and liability for providing those mitigation credits.

143

ILF

programs could charge fees far in excess of restoration costs, thus holding

development projects hostage.

144

As discussed in the North Carolina case

below,

145

however, this is often not the case. ILF programs can (and often

do) in fact charge insufficient fees to offset increasing property and resto-

ration costs, which can quickly escalate beyond expectations.

146

Moreover,

ILF programs can potentially underprice private mitigation banks operat-

ing in the same areas by undercutting the market price for compensation—

by collecting fees that are lower than those needed to actually build the

project.

147

Because ILF programs are typically operated by public agen-

cies or non-profit groups, undercharging for ILF credits acts to subsidize

aquatic resource impacts from new public and private development by

charging impactors less than the full costs of compensation.

148

That is,

ILF programs can place public investments in direct competition with

private enterprise.

149

II. CHARACTERISTICS OF THE NORTH CAROLINA STREAM AND

WETLANDS MARKET

A. Policy Structure in North Carolina

In order to illustrate the operation of ecosystem service markets, we

will look more closely at a case study of the evolution of markets in North

Carolina, particularly focusing on policy structure and extent of market

activity. Stream and wetland mitigation banking in North Carolina is reg-

ulated by the North Carolina Department of Environment and Natural

Resources (“NCDENR”) and the Wilmington District of the Corps.

150

One

143

ELI 2002, supra note 63, at 104, 107.

144

See id. at 107 (noting the DuPage County, Illinois program charged $175,000 per acre

in an area where mitigation banks charged around $50,000 per acre).

145

See infra Part II.B.

146

ELI 2002, supra note 63, at 107 (explaining that Pennsylvania ILF program does not

account for land value when determining the fee rate).

147

David T. Urban & John H. Ryan, A Lieu-Lieu Policy with Serious Shortcomings (Article 1),

21:4 N

AT’L WETLANDS NEWSL., July/Aug., 1999, at 5, 9–10.

148

See id.

149

See id.

150

See generally N.C. GEN. ASSEMBLY, PROGRAM EVALUATION DIV., DEP’T OF ENV’T AND

NAT. RES. WETLAND MITIGATION CREDIT DETERMINATIONS, SPECIAL REPORT (April 29,

2010), available at http://www.ncga.state.nc.us/PED/Reports/documents/Wetlands/Wetland

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 173

of the key characteristics of North Carolina land use and environmental

management has been the rapid spatial growth of several urban areas in

North Carolina.

151

This rapid suburbanization, combined with the physi-

ography of the Eastern half of the state (topographically flat, humid, large

wetlands throughout), has led to significant impacts on streams and wet-

lands.

152

Frequent impacts requiring permits have led to extensive demand

for wetlands and stream compensatory mitigation credits.

153

In North Carolina, the largest impactor of aquatic resources is the

North Carolina Department of Transportation (“NCDOT”).

154

During the

mid-1990s, NCDOT began to experience project delays due to insufficient

mitigation credits produced by private bankers.

155

In response to this, the

state developed the Wetland Restoration Program in 1996, re-designated

as the Ecosystem Enhancement Program (“EEP”) in 2003. The EEP is a

state-administered wetlands and stream mitigation program that operates

as both an ILF program and mitigation bank (the history and documen-

tation establishing the policies and practices of the EEP are summarized

in the D

YE REPORT).

156

The EEP was intended to use projected NCDOT

construction projects as a platform from which to proactively develop miti-

gation credits well ahead of time in the needed geographic areas (similar to

a mitigation bank).

157

In 1998, the Corps allowed EEP-generated mitigation

credits to also be purchased by private developers, effectively opening up

the market to a new type of credit consumer for which the EEP was allowed

to provide compensation (under an ILF program).

158

Thus, within North

Carolina, the market for stream and wetland mitigation credits is (theo-

retically) made up of trades between private developers and commercial

banks, trades between the NCDOT and EEP, and trades between private

developers and the EEP (Figure 2). Moreover, while the EEP designs and

builds some of its “own” projects (through independent contractors), a major

source of wetland and streams credits is attained through reselling credits

_Presentation.pdf; U.S. ARMY CORPS OF ENGINEERS–WILMINGTON DISTRICT, http://www

.saw.usace.army.mil/ (last visited Nov. 7, 2011).

151

See REID EWING ET AL., MEASURING SPRAWL AND ITS IMPACTS 1 (2002).

152

See State Wetland Program Evaluation: Phase I, ENVTL. LAW INST., available at http://

www.elistore.org/reports_detail.asp?ID=11079&topic=Wetlands (last visited Nov. 7, 2011).

153

DYE MGMT. GROUP, STUDY OF THE MERGER OF ECOSYSTEM ENHANCEMENT PROGRAM

AND CLEAN WATER MANAGEMENT TRUST FUND, FINAL REPORT TO THE NORTH CAROLINA

GENERAL ASSEMBLY, RALEIGH, NC, at ES-1, 14–15 (2007) [hereinafter DYE REPORT].

154

BenDor & Doyle, supra note 25, at 67.

155

DYE REPORT, supra note 153, at ES-1, 2–3.

156

Id. at 20–29.

157

Id. at 53.

158

Id. at 20–22.

174 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

from “full delivery” sites—sites purchased, designed, and built by private

mitigation bank firms.

159

Thus, private mitigation banks can sell credits

to private developers, or they can develop sites specifically in response to

requests from the EEP.

Figure 2. Relationships between agencies, impactors, and

mitigation bankers in North Carolina in the presence of the

Ecosystem Enhancement Program. Prior to SL 2009-337,

private impactors could also pay a fee to the EEP in lieu of

purchasing mitigation credits from a bank.

160

159

See generally N.C. ECOSYSTEM ENHANCEMENT PROGRAM, http://portal.ncdenr.org/web

/eep (last visited Nov. 7, 2011).

160

See EEP MOA, supra note 29, at 6–10.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 175

B. North Carolina Ecosystem Markets: Economics and Geography

The North Carolina EEP reveals some of the weaknesses inherent

in ILF programs. Templeton et al. conducted an economic study of EEP

projects for 2006 and 2007 and showed that while the EEP collected fees

of $232 per linear foot of stream mitigation, the inflation-adjusted expense

for all projects was $242 per linear foot.

161

Moreover, this expense exceeded

any inflation-adjusted mitigation fee that EEP charged in previous fiscal

years.

162

And Templeton et al. estimate that this is a conservative cost esti-

mate as the projects are likely to still require more costs due to monitoring

requirements.

163

Given that the data set analyzed consisted of greater than

191,000 linear feet of stream, the EEP may have undercharged developers

by more than $1.9 million.

164

Again, because the EEP is an ILF program,

the EEP remained responsible for providing these credits even though they

did not collect adequate fees (prices are set by the North Carolina General

Assembly).

165

Presumably, the state of North Carolina provides the nec-

essary funds to fill the gap between costs and fees collected, i.e., the state

essentially provided more than $1.9 million in subsidies for environmental

degradation by land developers through the EEP.

166

In addition to these economic analyses, BenDor et al. recently com-

pleted an analysis of the North Carolina stream and wetland markets and

demonstrated how ecosystem markets affect the locations of ecosystem

services throughout the landscape.

167

Between 1998 and 2007, there were

715 transactions (trades) between 496 impact sites and 161 EEP compensa-

tion sites, with 369 involving regulated wetlands and 346 involving streams

(48%).

168

Mitigation sites were spread across the state, while impact sites

were concentrated in rapidly developing urban areas (Figure 3). By specifi-

cally linking the geospatial coordinates of Corps-licensed impacts with the

161

SCOTT R. TEMPLETON ET AL., ESTIMATION AND ANALYSIS OF EXPENSES DURING DESIGN-

ID-BUILD PROJECTS FOR STREAM MITIGATION IN NORTH CAROLINA, CLEMSON UNIV. DEP’T

OF APPLIED ECON. AND STATISTICS RESEARCH REPORT RR08-01, 18–21 (2008) [hereinafter

TEMPLETON].

162

Id. at 18.

163

Id. at 19.

164

Id. at 27–28.

165

EEP Schedule of Fees, N.C. ECOSYSTEM ENHANCEMENT PROGRAM, http://portal.ncdenr

.org/web/eep/fee-schedules (last visited Nov. 7, 2011).

166

See TEMPLETON, supra note 161, at 18–21.

167

See Assessing the Socioeconomic Impacts, supra note 123, at 265–66.

168

Todd K. BenDor & Audrey Stewart, Land Use Planning and Social Equity in North

Carolina’s Compensatory Wetland and Stream Mitigation Programs, 47 ENVTL. MGMT.

239, 243 (2011).

176 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

coordinates of EEP mitigation sites, BenDor and Stewart showed that miti-

gation transactions traded wetlands an average distance of 46.9 km be-

tween impact sites and mitigation (Figure 3).

169

Also, impact sites drained,

on average, 144 km

compared to 43 km

at mitigation sites, meaning that

mitigation sites were located in streams that were, on average, smaller

than streams in impacted sites.

170

Figure 3. EEP compensatory mitigation transactions in

North Carolina.

171

Each arrow maps compensatory mitiga-

tion transactions, originating at a stream or wetland impact

site and terminating at the compensatory mitigation site.

BenDor et al. also showed that mitigation performed under the

EEP led to virtually no net loss of streams or wetlands at the eight-digit

watershed scale, the broadest goal of wetlands and stream regulation.

172

However, there were several ecologically relevant effects: (1) defragmen-

tation, (2) movement upstream in the watersheds, and (3) loss of place-

specific functions. The first effect was a spatial defragmentation of streams

and wetlands, as numerous small impacts were mitigated at fewer, large

sites.

173

While there are economies of scale for compensatory mitigation

169

See id. at 239 (averaging the distances between “impact and mitigation sites for streams

(43.53 km) and wetlands (50.3 km)”).

170

Markets, supra note 42.

171

See BenDor & Stewart, supra note 168, at 244.

172

Todd K. BenDor et al., Landscape Characteristics of a Stream and Wetland Mitigation

Banking Program, U

NIV. OF N.C., at 17 http://www.unc.edu/~jsholtes/NCWRRI2008

_Presentation.pdf (last visited Nov. 7, 2011).

173

Bendor & Stewart, supra note 168, at 241.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 177

that drive the desire for large restoration sites,

174

whether there are eco-

logical advantages of single large sites over several small sites is not at

all clear.

175

Second, there was a preference to restore streams and wetlands

further upstream in the watershed rather than the impacts for which they

were compensating.

176

While this is not surprising, as smaller upstream

sites are easier and cheaper to restore than large downstream sites, there

will be ecological communities and functions that are both gained and lost

through such market-induced pressures for upstream migration of restora-

tion sites.

177

Third, there are place-specific functions that can be lost when

impacts are mitigated at restoration sites across the landscape. For in-

stance, when urban wetlands are destroyed and compensated by restoration

in remote rural areas, there is less potential benefit for retaining storm-

water runoff.

178

Thus, there are location-specific benefits that may be par-

ticularly problematic to compensate under mitigation banking programs.

C. North Carolina PS-PS and PS-NPS Market Characteristics

The Division of Water Quality (“DWQ”) within the NCDENR is

responsible for administering water quality programs and regulations in

North Carolina.

179

Also within NCDENR, the Environmental Management

Commission (“EMC”) creates water quality regulation within the Neuse

River basin.

180

This 6192 square mile basin (Figure 4) contains a large por-

tion of the state’s population in the headwaters (Raleigh-Durham metro-

politan area; a significant source of PS pollution), while agricultural areas

dominate the lower watershed (corn and swine; significant sources of

NPS pollution).

181

In 1998, the Neuse River basin adopted rules requiring

174

See BenDor & Brozovic, supra note 91, at 361.

175

See Schwartz, supra note 91 (explaining that conservation objectives have also been

met by small reserves).

176

See Assessing the Socioeconomic Impacts, supra note 123, at 263.

177

See Robin L. Vannote et al., The River Continuum Concept, 37 CAN. J. OF FISHERIES

& AQUATIC SCI. 130 (1980) (discussing the interrelationship between upstream and down-

stream communities).

178

See King & Herbert, supra note 10, at 12; Todd K. BenDor et al., The Social Impacts

of Wetland Mitigation Policies in the United States, 22 J. OF PLAN. LITERATURE 341, 342,

350 (2008).

179

About Division of Water Quality, N.C. DEP’T OF NATURAL RES., http://portal.ncdenr.org

/web/wq/home/about (last visited Nov. 7, 2011).

180

Neuse Nutrient Sensitive Waters Strategy, N.C. DIV. OF WATER QUALITY, http://h2o.enr

.state.nc.us/nps/neuse.htm (last visited Nov. 7, 2011).

181

General Information on the Neuse River Basin, NEUSE RIVER EDUC. TEAM, N.C. STATE

UNIV., http://www.neuse.ncsu.edu/geninfo.htm (last visited Nov. 7, 2011).

178 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

a reduction in N (nitrogen) at the estuary to seventy percent of the

1991–1995 annual average by 2001.

182

Under the rules, PS dischargers

who exceed their nitrogen discharge allocations are required to purchase

offsets from other PS emitters.

183

The rules created an option for waste-

water dischargers to meet their N reduction goals collectively by forming

an association in which no individual members are fined as long as the

group as a whole is in compliance.

184

Figure 4. Neuse River Compliance Association Map. NRCA

members are wastewater treatment plant operators who, as

a group, must comply with nitrogen reduction targets.

185

Twenty-three wastewater dischargers formed the Neuse River

Compliance Association (“NRCA”) and the association was granted a basin-

wide NPDES permit.

186

The permit allowed the association an N limit

182

See Hamstead & BenDor, supra note 81, at 6.

183

Neuse Nutrient Sensitive Waters Strategy, supra note 180, at Rule 0.0234 & 0.0240,

http://h2o.enr.state.nc.us/nps/neuse.htm (last visited Nov. 7, 2011).

184

Neuse Nutrient Sensitive Waters Strategy, supra note 180, Rule .0234, at pt. 9, http://

h2o.enr.state.nc.us/nps/2b-0234.pdf.

185

See Hamstead & BenDor, supra note 81, at 2.

186

NEUSE RIVER COMPLIANCE ASS’N, FACT SHEET—NPDES PERMIT NO. NCC000001, avail-

able at http://www.water.rutgers.edu/Projects/trading/00001nrcafactsheet_finalpermit.pdf.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 179

equivalent to the sum of the individual limits.

187

By 2006, the NRCA had

reduced total N reaching the estuary by sixty-seven percent, far surpass-

ing their requirements.

188

However, to date there have been no permanent

trades and only three temporary trades among members of the NRCA (i.e.,

year to year trades, or leases).

189

Regulators have also been concerned about the potential creation of

N pollution hot spots because the Neuse rules only require N reductions in

the river’s estuary (see Figure 4); there is no regulation of in-stream water

quality.

190

Over time, rapidly growing urban areas will need to purchase

greater N allotments from the agricultural areas downstream, where popu-

lation is not increasing as quickly.

191

Upstream N loading from urban areas,

combined with a lack of in-stream water quality regulation, will likely pro-

duce a water quality hot spot in the more upstream reaches of the Neuse

River. While some of this nitrogen will be retained or removed from the

water by natural biogeochemical processes as it is transported downstream,

the levels of nitrogen that can be reached within these rivers can be quite

large, with potentially toxic or biogeochemically saturating effects.

192

In addition to the NRCA, which is a PS-PS market, North Carolina

also allows PS-NPS trading.

193

It is in this case that nitrogen trading be-

comes an ecosystem service market as we defined earlier.

194

While the

units of trade in the PS-NPS market are in pounds of nitrogen, NPS re-

ductions are based on a land use classification that converts acres to pounds

of nitrogen retained per year.

195

Specifically, buffer strips are constructed

187

See id. at 1–2.

188

NEUSE RIVER COMPLIANCE ASS’N, 2006 ANNUAL REPORT (2007).

189

Id.

190

See Neuse River Basinwide Water Quality Plan (1998), N.C. DIV. OF WATER QUALITY,

http://h2o.enr.state.nc.us/basinwide/Neuse/neuse_wq_management_plan.htm (last visited

Nov. 7, 2011).

191

See Emily S. Bernhardt et al., Understanding, Managing, and Minimizing Urban Impacts

on Surface Water Nitrogen Loading, 1134 ANNALS OF THE N.Y. ACAD. OF SCI. 61 (noting that

few cities have addressed infrastructure issues to ensure proper nitrogen disposal).

192

See Julio A. Camargo & Alvaro Alonso, Ecological and Toxicological Effects of Inorganic

Nitrogen Pollution in Aquatic Ecosystems: A Global Assessment, 32 ENVTL. INT’L 831 (2006)

(noting the consequences of increased nitrogen within rivers).

193

Water Quality Trading Program, RUTGERS WATER RES. PROGRAM, http://www.water

.rutgers.edu/Projects/trading/WQTrading.htm (last visited Nov. 7, 2011).

194

See Robertson 2006, supra note 17, at 297 (explaining ecosystem service markets).

195

RTI INT’L, A STUDY OF THE COSTS ASSOCIATED WITH PROVIDING NUTRIENT CONTROLS

THAT ARE

ADEQUATE TO OFFSET POINT SOURCE AND NONPOINT SOURCE DISCHARGES OF

NITROGEN AND OTHER NUTRIENTS, FINAL REPORT (2007), available at http://www.nceep

.net/pages/Final_RTI_Report_Nutrient_Offset_June_2007.pdf.

180 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

on riparian lands,

196

and the area of buffer strips is converted into pounds

of nitrogen using a conversion factor.

197

These nitrogen credits can be sold

to a PS emitter as an offset.

198

In North Carolina, to our knowledge, the

first trade between private entities for PS-NPS occurred in 2008.

199

Thus,

the state of the market remains unclear. Regardless, it is worth noting that

the PS-NPS market mixes a traditional environmental market, based on

pounds or volume, with a market based on complex ecological assessment

techniques (ecosystem service markets).

200

III. ISSUES ON THE HORIZON

A. Science: Do Offsets from Compensatory Mitigation Work?

The critical question underlying all ecosystem service markets is

whether or not they work. That is, are restored ecosystems comparable

to predevelopment ecosystems? To date, there have been very few stud-

ies that have documented actual ecological success of stream restoration

projects,

201

and the value and efficacy of wetland restoration continues

to be questionable.

202

Emerging policies are placing greater emphasis on documenting

real ecological change rather than relying on indicators or surrogate vari-

ables, as has been the standard approach in the past.

203

For instance, in

North Carolina, the Division of Water Quality in 2008 released its guid-

ance for stream restoration via dam removal, which required substantial

documentation of recovery of actual ecological functions (e.g., species and

water quality), as opposed to recovery of simple channel geometry, in order

to receive approval for the site from the MBRT as a compensation site.

204

Presumably, more rigorous standards for data collection and monitoring

196

Lewis L. Osborne & David A. Kovacic, Riparian Vegetated Buffer Strips in Water Quality

Restoration and Stream Management, 29 F

RESHWATER BIOLOGY 243, 245 (1993).

197

RTI INT’L, supra note 195, at 1–4.

198

N.C. ADMIN. CODE § 15A NCAC 2B.0240(a) (2006).

199

Personal Communication, Adam Riggsbee, Riverbank Ecosystems, Austin, Tex.

(Sep. 7, 2010).

200

Markets, supra note 42.

201

See Emily S. Bernhardt et al., Synthesizing U.S. River Restoration Efforts, 308 SCIENCE

636, 637 (2005).

202

See NRC, supra note 41, at 3.

203

See id. at 7.

204

U.S. ARMY CORPS OF ENGINEERS & EPA, DETERMINING APPROPRIATE COMPENSATORY

MITIGATION CREDIT FOR DAM REMOVAL PROJECTS IN NORTH CAROLINA 3–5 (2008), avail-

able at http://www.nceep.net/pages/Comp%20_Mitig%20_Credit_Dam_Removal_Proj%20

_NC_21308.pdf.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 181

will increase the care with which project sites are designed and, more im-

portantly, selected.

205

Regardless of the specific monitoring required, we

expect that there will be greater emphasis on regulatory requirements for

empirically-based evaluation of restoration projects in the future, thereby

broadening the information available to guide future programs.

206

Indeed,

the 2008 federal compensatory mitigation rule places much greater em-

phasis on documenting ecological effects of restoration as a part of future

compensatory mitigation practices.

207

B. Policy: Geographic Service Areas and ILF Programs

One of the key considerations for any ecosystem service market is

the size of the geographic service area that can be served by a mitigation

bank.

208

There has been great inconsistency in the application of service

areas to ecosystem markets, be they wetland, stream, or conservation

banks.

209

For streams and wetlands, the 2008 compensatory mitigation

rule, while establishing a “watershed approach,” leaves the scale of the

market unspecified, and thus up to the interpretation and discretion of the

local District Engineer.

210

Determining a bank’s service area has critically

important implications for the financial viability of individual banks, as

well as an ecosystem service market in general.

211

ILF programs represent another major policy hurdle for the private

sector in future ecosystem markets. State regulators, departments of trans-

portation, and many private developers have argued that ILF programs

are vitally necessary to prevent development restrictions,

212

and for provid-

ing compensation in geographic areas that do not generate sufficient im-

pacts (demand) necessary for a private banker to establish a bank.

213

ILF

programs suffer from substantial problems, however, potentially leading

to insufficient and unsuccessful restoration, as well as the real potential

205

See id. at 16–17.

206

NRC, supra note 41, at 8–9.

207

2008 Compensatory Mitigation Rule, supra note 46, at § 332.5, § 332.6.

208

See supra Part I.E.

209

See generally Womble & Doyle, supra note 23, at 2078, 88–90 (analyzing spatial relation-

ships in stream and wetland impact and compensation sites).

210

See 2008 Compensatory Mitigation Rule, supra note 46, at § 332.3(c)(2).

211

See LEONARD SHABMAN, ET. AL, ENVTL. LAW INST., APPLYING LESSONS LEARNED FROM

WETLAND MITIGATION BANKING TO WATER QUALITY TRADING, 21 (2005), available at http://

www.eli.org/pdf/wqtforum/LanSiemStedShab05.pdf (noting that the ELI has identified

service area as a critical factor in determining the success of mitigation banks).

212

See id. at preamble.

213

Jack T. Chowning, In-Lieu-Fee Programs Belong Among Mitigation Options, 21 NAT’L

WETLANDS NEWSL., July/Aug., 1999, at 8–9 (1999).

182 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

for creating artificially low or high prices.

214

These factors combine to

create a system in which negative resource impacts from land development

can be essentially subsidized through the provision of artificially under-

priced restoration sites, as shown by the Templeton et al. study for North

Carolina.

215

Moreover, many of these ILF restoration sites are completed

after impacts, in contrast to their private mitigation bank counterparts,

which are required to be (at least partly) completed and certified prior to

impacts.

216

Thus, the advantages of ILF programs are, arguably, primarily

for developers.

We may now be seeing a distinct shift away from ILF programs,

at least in North Carolina. Perhaps the most damning political action in

North Carolina against ILF programs came after the 2008 state legislature

hearings on the EEP.

217

During these hearings, an unusual coalition of

environmental groups, private restoration industry, and home builders all

lobbied against the state’s ILF program.

218

The result was the unanimous

passage of Public Law 2008-152 (amended as Session Law 2009-337),

219

“An act to promote compensatory mitigation by private mitigation banks.”

220

This bill stipulates that non-NCDOT impactors must use credits from pri-

vate mitigation banks if those credits are available in the impacted area,

and that payment to the EEP ILF Program is only acceptable if no miti-

gation bank credits are available.

221

A critically important aspect of this

outcome is that private mitigation banks will no longer have to compete

with the EEP in providing wetland or stream credits if the mitigation

banks have credits available.

222

Unfortunately, the North Carolina mitigation bank act does not

address the fact that many areas in the state have no private mitigation

bank.

223

Increasing the geographic service area of banks (Figure 5) is one

214

See TEMPLETON, supra note 161.

215

See generally id. (discussing North Carolina’s Ecosystem Enhancement Program for

financing mitigation projects).

216

See Corps 1995, supra note 44.

217

Ecosystem Enhancement Program: Hearings on N.C. GEN. STAT. § 143-214.11 Before the

General Assembly of North Carolina, Sess. L. 2008-152, SB 1885 (2007).

218

Id.

219

See Ecosystem Enhancement Program: Compensatory Mitigation, Pub. L. No. 2008-152,

N.C. Sess. Law No. 2009-337.

220

Id.; N.C. GEN. STAT. § 143-214.11 (2009).

221

See N.C. GEN. STAT. § 143-214.11 (2009).

222

See id.

223

See Mitigation Banks in North Carolina, N.C. DIV. OF WATER QUALITY, http://portal

.ncdenr.org/web/wq/swp/ws/401/certsandpermits/mitigation (last visited Nov. 7, 2011)

(providing a list of all mitigation banks in North Carolina).

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 183

way to provide compensatory mitigation to these areas without relying

on ILF programs. Increasing the service area would provide much greater

incentive for private bankers to develop their own sites, which would pro-

vide proactive restoration rather than reactive restoration, as is the case

in ILF programs. In addition, larger service areas would encourage large

restoration projects, as greater certainty in demand would likely lead

to greater willingness to invest in larger restoration projects to take ad-

vantage of economies of scale.

224

Although we lack empirical evidence, our

ecological understanding of other systems and processes (e.g., island bio-

geography theory),

225

leads us to suspect that large restoration sites are

ecologically superior to small ones. Finally, rather than having a discrete

banking area, regulators could leverage trading ratios based on the dis-

tance away from impacts.

226

Banks that were far away from the impacts,

or in a different watershed (“low spatial quality” in Figure 5), would be

given higher ratios than those that were close.

227

Large mitigation banks

would still be desirable to develop since the banker could be ensured that

there would be some demand somewhere in the market for their credits.

In sum, current regulations have sought to avoid the proximity

problem by implementing mitigation methods (such as ILF programs)

that allow mitigation to occur after impacts. Sacrificing the benefits of

advance timing of mitigation is presumably made up by the advantages of

geographic proximity. In North Carolina, the stated focus of the EEP has

centered on ensuring proximity of mitigation to impact sites, while eco-

logical success criteria receive reduced emphasis, and current guidelines

facilitate post-impact mitigation (“low temporal quality” in Figure 5) rather

than advance mitigation. This approach represents a systemic problem

with in-lieu fee programs around the United States,

228

and has been jus-

tified by the argument that spatial proximity between impacts and miti-

gation sites is of paramount concern, i.e., spatial quality is preferred over

temporal quality (Figure 5).

229

This reflects recommendations that stream

224

See TEMPLETON, supra note 161, at 19–20 (providing analysis of economies of scale in

stream restoration projects).

225

Schwartz, supra note 91, at 90–91.

226

See BenDor & Brozovic, supra note 91, at 361–62.

227

Markets, supra note 42.

228

See ELI 2006, supra note 53, at 45–46 (discussing remedial action provisions and

contingency funds).

229

See Philip Womble & Martin Doyle, Army Corps Needs to Examine Rationale for

Mitigation Territories, E

COSYSTEM MARKETPLACE, (March 18, 2011), http://www.ecosystem

marketplace.com/pages/dynamic/article.page.php?page_id=8136&section=news_articles

&eod=1.

184 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

and wetland restoration consider “landscape position” and take a “water-

shed approach” as recommended by the NRC.

230

However, the NRC review

of compensatory mitigation of wetlands throughout the United States also

noted that compensatory mitigation should preferably be established prior

to permitted impacts.

231

Determining the extent to which spatial proximity,

timing, and mitigation project size affect project quality is a critical ques-

tion that will only be answered through case studies and landscape-scale

analysis of mitigation programs (Figure 5).

Figure 5. Conceptual model of tradeoffs in compensatory

mitigation programs among spatial proximity, timing, and

quality of restoration.

232

C. Technical Limitations to Establishing Property Rights

Property rights are central to environmental trading as they spec-

ify who must pay whom to modify actions relating to the environment.

These rights also develop in response to changes in economic values, which

230

See NRC, supra note 41, at 4–5.

231

Id. at 61.

232

BenDor et al., supra note 23.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 185

stem from the development of new technology and the emergence of new

markets.

233

Establishing property rights for ecosystem services is particu-

larly difficult because these services are based on ecological assessment

criteria rather than direct measurements of weight or volume (even though

these assessment criteria are then often used to convert into weight or

volume units).

234

Establishing property rights for ecosystem services re-

quires sufficiently precise and accurate measurement of the quantity and

quality of the service.

In sulfur dioxide (“SO

”) emissions markets, actual SO

is measured

at the smokestack.

235

That is, the quantity of measurement is mass, and the

quality of measurement is precise to the unit being traded (tons of SO

236

In this manner, it is like trading many other commodities for which the

unit of trade is precisely known and the quality of the commodity is mea-

sured directly (e.g., gasoline, corn, hogs, and nickel).

237

In contrast to air

quality markets, ecosystem service markets are plagued with uncertainty.

For over two decades, the intent of wetland trading regulation has

been to ensure no net loss of the bundle of wetland ecosystem functions and

services in an area.

238

Because of the difficulty in measuring the loss or res-

toration of functions at individual wetland sites, particularly small sites,

measures of wetland spatial extent (area) were deemed to be reasonable

surrogates for function.

239

This enshrined the use of size as the primary

mechanism for seeking no net loss in wetland mitigation.

240

Subsequent eco-

system service markets, such as streams and endangered species habitat,

have adopted similar approaches that establish functional no net loss as a

goal, but implement the regulation through size measures (e.g., length for

streams, species habitat area).

241

Thus, the currency used to commodify

streams, wetlands, and habitat in ecosystem service markets is typically

related to size, rather than ecologically derived functional characteristics.

233

Harold Demsetz, Toward a Theory of Property Rights, 57 AM. ECON. REV. 347, 350 (1967).

234

Robertson 2006, supra note 17, at 297–98.

235

Paul L. Joskow et al., The Market for Sulfur Dioxide Emissions, 80 AM. ECON. REV.

669, 670 (1998).

236

See id. at 670–71.

237

See id.

238

CONSERVATION FOUND., PROTECTING AMERICA’S WETLANDS: AN ACTION AGENDA, THE

FINAL REPORT OF THE NATIONAL WETLANDS POLICY FORUM 18 (1988).

239

See J.C. WARD ET AL., MONITORING CHANGES IN WETLAND EXTENT: AN ENVIRONMENTAL

PERFORMANCE INDICATOR FOR WETLANDS 2 (1999) (identifying categories used to monitor

wetlands).

240

Markets, supra note 42.

241

See generally Salzman & Ruhl, supra note 22 (discussing environmental trading

“currencies”).

186 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

Area can be measured precisely and quickly (some Corps require-

ments now require compensatory mitigation for impacts over 0.1 acres),

242

but accurately or precisely quantifying measures of ecosystem quality is far

more difficult. In a stream or wetland market, critical questions remain

unanswered as to what specific functions must be present to determine

that the specific site is a “certifiable” ecosystem from which credits can

be drawn. In the case of PS-NPS trading, some land area (e.g., riparian

buffer) is converted from acres into pounds of nitrogen.

243

A crucial yet

unresolved issue is whether the farmer’s actions installing a buffer strip

actually produce a measurable reduction in nitrogen loads downstream, or

whether the conversion of land itself is sufficient to generate water quality

credits.

244

How should water quality improvements be verified? Changes in

the ecological quality of traded ecosystems changes how regulators choose

to monitor actions and enforce precise property rights.

245

While monitoring

specific ecological functions has received increasing recognition in new

regulations,

246

it remains an ongoing area of study for researchers.

247

D. Economic Issues: Unbundling, Unstacking, and Double-Dipping

One of the critical issues, or opportunities, in the function of eco-

system markets is the potential for “credit stacking”—selling separate ser-

vices furnished by the same ecosystem in separate markets.

248

For instance,

100 acres of a wetland bank are first sold as wetland mitigation units, and

then sold again as water quality credits, endangered species credits, or

even carbon credits. Credit stacking has also been called “unbundling,”

242

See U.S. ARMY CORPS OF ENGINEERS, CHICAGO DISTRICT, REGIONAL PERMIT PROGRAM

13 (2007), available at http://www.lrc.usace.army.mil/co-r/rppbrief.htm.

243

See RTI INT’L, supra note 195, at 8–11.

244

See Richard C. Schultz, Effectiveness of a Constructed Buffer Strip in Capturing Nitrogen

in the Midwestern Agricultural Landscape, U.S. GEOLOGIC SURVEY http://water.usgs.gov

/wrri/96grants/ncr15ia.htm (last updated March 23, 2005) (proposing to study the effective-

ness of buffer strips capturing nitrogen in an agricultural setting).

245

See generally CARY COGLIANESE & JENNIFER NASH, LEVERAGING THE PRIVATE SECTOR:

ANAGEMENT-BASED STRATEGIES FOR IMPROVING ENVIRONMENTAL PERFORMANCE (2004),

available at http://www.hks.harvard.edu/m-rcbg/research/rpp/reports/RPPREPORT6.pdf

(discussing management-based private/public strategies).

246

See 2008 Compensatory Mitigation Rule, supra note 46, at § 332.5.

247

See NRC, supra note 41 (“[E]valuat[ing] both the ecological performance of mitigation

projects and the institutions under which mitigation projects are conducted.”).

248

See generally WORLD RES. INST., WRI FACT SHEET: STACKING PAYMENTS FOR ECOSYSTEM

SERVICES 1 (2009) [hereinafter WRI].

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 187

or “double-dipping,”

249

although there are several distinctions between these

three concepts. Ecosystem service unbundling involves treating ecosystems

as a set of discrete services that are fully distinct and segregable from

one another.

250

Credit stacking is the act of selling two or more ecosystem

services present on a single property as separate unbundled commodities,

compensating for different permitted impacts.

251

Double-dipping is simi-

lar to stacking, except that credits are understood to “double up” natural

resource benefits.

252

The distinction between stacking and double-dipping is an arena

of very unclear and unspecified policy. Fox argues that part of the dis-

tinction pertains to the additional activities that are necessary to gain the

additional credits.

253

For example, if 200 acres of riparian buffer are estab-

lished specifically to sell as endangered species habitat credits, but are then

sold additionally into a market for NPS water quality credits, then Fox

argues that the banker would be guilty of double-dipping, because the

water quality credits were established separately on the same land with

no additional land management activities.

254

To circumvent double-dipping,

Fox argues that the natural resource value accounting must be careful

and precise; it must clearly separate the riparian buffer needed for water

quality provision and that needed for salamander habitat provision, there-

by allowing these two areas to be sold separately.

255

This approach relies

on the concept of “additionality,” the idea that the ecosystem services pro-

vided by an ecological restoration project are over and above the benefits

that would have been present without the project.

256

However, the current

precision and accuracy of ecosystem service accounting is exceedingly low,

thereby causing potential barriers to establishing such closely coexisting

249

See Jessica Fox, Getting Two for One: Opportunities and Challenges in Credit Stacking,

in CONSERVATION AND BIODIVERSITY BANKING 171, 172 (N. Carroll et al. eds., 2008); J.B.

Ruhl, Mitigation: Stacking and Bundling and Bears, Oh My!, 32 N

AT’L WETLANDS NEWSL.,

Jan./Feb. 2010, at 24.

250

For a discussion of unbundling, see John P. Hoehn, et al., Untying a Lancastrian Bundle:

Valuing Ecosystems and Ecosystem Services for Wetland Mitigation, 68 J. OF ENVTL. MGMT.

263, 263 (2003).

251

WRI, supra note 248, at 1–2.

252

See Fox, supra note 249, at 172.

253

See id. at 177 (describing “additionality” as “the approach that credits are awarded only

for those land management activities that occur above and beyond previous commitments”).

254

See id. at 174–176 (explaining the difference between double-dipping and stacking).

255

See id. at 172–77.

256

See id. at 177; Joyotee Smith & Sara J. Scherr, Capturing the Value of Forest Carbon

for Local Livelihoods, 31 WORLD DEV. 2143, 2150 (2003).

188 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

ecosystem service markets.

257

If regulators decide that double-dipping is

undesirable, then they would need to somehow limit certification of new

bank credits (for new markets) to those that are generated by additional

land improvements that would not have otherwise been achieved without

proactive measures.

258

There are additional ecological and regulatory arguments against

credit stacking. Robertson and Mikota have argued that ecosystem functions

do not stack and unstack like Lego blocks, but rather are interrelated and

intertwined.

259

One example involves nitrogen trading, where the only path-

way to permanent removal of nitrogen from water involves denitrification,

the conversion of nitrate (“NO

”) into gaseous nitrogen (“N

”).

260

However,

the biogeochemical process of denitrification is limited by the availability

of carbon,

261

thus inextricably linking carbon to nitrogen markets. Simi-

larly, even at the most simple biochemical level, carbon, nitrogen, and

phosphorus are intertwined through basic stoichiometry, making sepa-

rate water quality markets for these different nutrients scientifically non-

sensical.

262

Moving into more complex ecological interactions, such as

the species interactions and food webs that are inherent to conservation

banks,

263

will undoubtedly be substantially more complex. In the end, un-

bundling ecosystems as a concept is problematic to justify scientifically.

From a regulatory standpoint, it is clear that it is difficult to “un-

stack” ecosystem services derived from ecological restoration projects.

264

There are multiple agencies that regulate ecosystem features and ecosys-

tem service markets: the Corps regulates streams and wetlands via the

Clean Water Act, while the U.S. Fish and Wildlife Service regulates con-

servation habitat banks through the Endangered Species Act;

265

state

257

E.g., U.S. GOV’T ACCOUNTABILITY OFFICE, CORPS OF ENGINEERS DOES NOT HAVE

AN EFFECTIVE OVERSIGHT APPROACH TO ENSURE THAT COMPENSATORY MITIGATION IS

OCCURRING: REPORT TO THE RANKING DEMOCRATIC MEMBER, COMMITTEE ON TRANSPOR-

TATION AND INFRASTRUCTURE, HOUSE OF REPRESENTATIVES (2005).

258

See Fox, supra note 249, at 172.

259

See Morgan M. Robertson & Michael Mikota, Water Quality Trading and Wetland

Mitigation Banking: Different Problems, Different Paths?, 29 NAT’L WETLANDS NEWSL.,

Mar./Apr. 2007, at 14.

260

See Robert C. Starr & Robert W. Gillham, Denitrification and Organic Carbon

Availability in Two Aquifers, 31 GROUND WATER 934, 934–935 (1993).

261

See id. at 935.

262

See Wyatt Cross et al., Ecological Stoichiometry in Freshwater Benthic Systems: Recent

Progress and Perspectives, 50 FRESHWATER BIOLOGY 1895, 1896 (2005).

263

Kevin S. McCann, The Stability-Diversity Debate, 405 NATURE 228, 230 (2000).

264

See Robertson & Mikota, supra note 259, at 14.

265

See Mead, supra note 32, at 10, 14.

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 189

agencies oversee water quality trading programs, and private organi-

zations oversee the currently voluntary carbon market.

266

Thus, credit

stacking poses a substantial administrative hurdle for any banker who

wishes to engage multiple agencies simultaneously. At the most basic

level, unbundling or stacking credits makes unclear what actually changes

hands when credits are sold.

267

When a wetland or stream credit is sold for compensatory mitiga-

tion, the banker has (1) inevitably sold a permanent easement to that prop-

erty, ensuring that the physical property will stay in its wetland/stream

natural condition; and (2) performed certain management actions that will

ensure the viability of the wetland or stream into the future.

268

However,

the transaction has occurred to fulfill the legal requirements of § 404(b)

of the Clean Water Act.

269

In the case of unstacking that same property into

water quality credits or endangered species credits, or even carbon credits,

the sale of these credits would be to fulfill a completely separate regulatory

requirement, such as the Endangered Species Act.

270

Quite simply, the

legal status for stacking, unbundling, and double-dipping is unclear.

The policy way forward is unclear, or at least not set. At one

extreme, policymakers may acknowledge the functional integration of

ecosystems, perhaps by recognizing “ecological condition” as a single inte-

grating ecological function.

271

Alternatively, policymakers may want to

embrace the unbundling approach through acknowledging that ecosystems

provide a wide range of services, and thus formulate regulations based

on precise valuations of these component services via separate markets

for each service.

272

E. Markets: Unintended Consequences

Additional issues emerge in ecosystem service markets from the

nonintuitive interactions between ecosystem and market processes. To

date, we have insufficient data from which to derive empirical observations

about landscape scale ecosystem market behavior,

273

but there are a few

modeling studies which provide some additional insight.

266

See Fox, supra note 249, at 178.

267

See Robertson 2007, supra note 24, at 506–07.

268

2008 Compensatory Mitigation Rule, supra note 46, at § 332.7(a).

269

33 U.S.C. § 1344(b) (2006).

270

See 16 U.S.C. § 1531 et seq. (2006).

271

See Robertson & Mikota, supra note 259, at 14.

272

See id.

273

See Martin W. Doyle & Andrew J. Yates, Stream Ecosystem Service Markets Under No-

Net-Loss Regulation, 69 ECOLOGICAL ECON. 820, 820 (2009).

190 WM. & MARY ENVTL. L. & POL’Y REV. [Vol. 36:153

In the case of streams, Doyle and Yates linked an economic model

of free-entry equilibria with a simple ecological model in order to examine

the interactions of stream markets and ecological processes in programs

aimed at preventing resource net losses.

274

Their modeling showed that

when implementing a no-net-loss program, a regulator must not only ac-

count for the ecological differences between restored and natural ecosys-

tems, but also consider the effect of market entry on the number and size

of restoration projects.

275

They showed that in a system with little to no res-

toration scale economies, the number of entrants into an ecosystem service

market will be greater than the number that maximizes welfare.

276

The

effect of this excess entry on restored ecosystems is to encourage the resto-

ration of smaller sites rather than larger sites, which are generally con-

sidered less ecologically desirable than larger sites.

277

Thus, considerations

of joint processes are crucial when designing and evaluating such programs.

A similar conclusion was reached for a different type of ecosystem market

by Armsworth et al. who examined conservation banks within a system

that included real estate property market dynamics.

278

They showed that

interaction between the local market for land and conservation purchases

could actually lead to a decrease in overall biodiversity.

279

Conservation

purchases can affect land prices and potentially displace development to-

ward biologically valuable areas or accelerate the pace of development.

280

While limited in number, emerging studies that link ecological

processes and characteristics with economic models suggest that these

coupled ecological-economic systems can produce unintended, or at least

nonintuitive, consequences.

281

A critical need at this point in time is to

more fully explore these types of coupled systems.

ONCLUSION

Within freshwater ecosystems, ecosystem service markets now

span wetlands, streams, non-point source water quality, and habitat

274

Id. at 820–27.

275

See id. at 822.

276

See id. at 823.

277

See id. at 824.

278

Paul R. Armsworth et al., Land Market Feedbacks Can Undermine Biodiversity

Conservation, 103 PROCEEDINGS OF THE NAT’L ACAD. OF SCI. 5403, 5403 (2006).

279

See id. at 5406–07.

280

See id.

281

See Stephen Polasky, Why Conservation Planning Needs Socioeconomic Data, 105

PROCEEDINGS OF THE NAT’L ACAD. OF SCI. 6505, 6505–06 (2008).

2011] FRESHWATER ECOSYSTEM SERVICE MARKETS 191

conservation.

282

Most importantly, the regulatory framework for these

markets is very unstable, with major policy changes being the norm rather

than the exception.

283

Moreover, under the auspices of compensatory

mitigation, the science and economics of ecological restoration is also in

its infancy.

284

There are state and federal policies that can, if structured incor-

rectly, undermine many of the original intents of compensatory mitigation

programs (e.g., in-lieu fee programs).

285

There are other policies that can

make private provision of compensatory mitigation difficult (e.g., small

geographic service areas).

286

Resolving these tensions between the policies

developed for specific problems that emerge locally and the initial goals

of broad, federal environmental policy will inevitably remain an ongoing

problem inherent to this type of adaptive management. So long as scien-

tific monitoring can play a role in evaluating the programmatic success

for maintaining and restoring the integrity of the nation’s waters, then

we expect that ecosystem service markets can play an important role in

freshwater ecological restoration.

282

See Doyle & Yates, supra note 273, at 820.

283

See BenDor & Brozovic, supra note 91, at 355; Robertson 2006, supra note 17, at

299–302.

284

See Doyle & Yates, supra note 273, at 820.

285

See ELI 2006, supra note 53, at 1–5.

286

See Womble & Doyle, supra note 23, at 18 (explaining that “[s]ervice areas effectively

determine the market size with important implications”).