ecosystem service markets & associated performance...

draft v3 – 03-15-10REPORT: FHWA workshop Jan. 10, 2010

Ecosystem Service Markets & Associated Performance Measuresat the Transportation Research Board 89th Annual Conference

January 10, 2010, 1:30-5:00 p.m.Hilton Washington Hotel 1919 Connecticut Ave., NW, Washington, D.C.

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Table of Contents

3 Executive Summary

4 Workshop Format and General Information

5 Workshop Attendees

6 Summaries of Presentations

6 Dan Nees, The Chesapeake Fund8 Joe Whitworth, The Freshwater Trust12 Allan Brockenbrough, Virginia Department of Environmental Quality15 Paul Sutton, University of Denver18 James Mandel, Advanced Conservation Strategies

21 Panel Discussion/Q&A Session

24 Next Steps/Follow-up Questions and Comments

# Appendix: Speaker Presentations

# Joe Whitworth, The Freshwater Trust# Allan Brockenbrough, Virginia Department of Environmental Quality# Paul Sutton, University of Denver# James Mandel, Advanced Conservation Strategies

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Executive Summary

The “Ecosystem Service Markets and Associated Performance Measures” workshop, held January 10, 2010 during the 89th Transportation Research Board Conference, served to shine a spotlight on the emerging concept of ecosystem service markets through current examples and proposed approaches.

Dan Nees of The Chesapeake Fund introduced the topic and explained the biggest hurdle to overcome is the complexity. Nees believes public policy can foster efficient and expedient markets that allocate risk appropriately.

Joe Whitworth of The FreshWater Trust presented his organization’s innovative approach to helping speed water conservation projects in Oregon. StreamBank, a software platform, drastically cuts project completion time by simplifying the permitting process. The accounting principals applied calculated first generation ecosystem service credits for water quality and salmon habitat.

Virginia’s Nutrient Trading Program was showcased as an example of a successful, public sector cap and trade system by Allan Brockenbrough. Dischargers of nitrogen and phosphorus along the state’s tributary system operate under a single permit to limit the damage to the Chesapeake Bay Watershed.

Paul Sutton, a geography professor at the University of Denver, highlighted a study he co-authored on evaluating the monetary worth of coastal wetlands protection from hurricane damage. A complex database and mathematical analysis proves the high value of wetlands and the importance of location, and could be a model for evaluating other ecosystem services.

Advanced Conservation Strategies’ James Mandel offered alternative ideas for developing markets by focusing on outcomes and performance. Using hypothetical examples of endangered species, Mandel demonstrated how bonds and derivatives can be used to shift the risk to the marketplace and align incentives of all involved parties.

A question and answer session allowed for speakers and three additional panelists, representing federal regulatory agencies, to address audience comments on the challenges surrounding developing markets. The panel also expanded on how ecosystem service markets can be used in transportation projects to the benefit of the agencies, the locality, and the environment.

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Workshop Format

Sponsors: Ecology and Transportation Committee; Geographic Information Science and Applications Committee; and Environmental Analysis in Transportation Committee

Presiding: Stephen Earsom, U.S. Department of Transportation, Federal Highway

Administration Joseph A. Burns, U.S. Department of Agriculture, Forest Service

Program Description: Payments for ecosystem services concepts and tools are developing rapidly. While mitigation for wetland, stream, and endangered species impacts has progressed to include banks and credits, payments for other ecosystem services are now being proposed, piloted, or implemented that may have implications for how transportation agencies do business. Nascent programs in areas such as water quality trading, multi-species banking, and carbon offsets each have potential for linking buyers for credits with willing sellers. Foreseen benefits include: 1) reduced compliance costs by increasing the supply of providers; 2) better tools for linking buyers and sellers resulting in lower transaction costs; 3) upfront acceptance of market standards and performance measures by regulatory agencies, yielding faster permitting; and 4) larger-scale, better prioritized mitigation that yields demonstrably improved ecosystems. Realizing these benefits will require straightforward, accurate systems to measure and track performance, and potentially will result in revision of existing policies, regulations, and/or legislation. While appropriate valuation of the full suite of ecosystem services will remain controversial for the foreseeable future, participants in this workshop gained a better understanding of what ecosystem service components have existing or developing markets, what the major impediments are to a market-based approach, and how industry leaders are developing tools to resolve these impediments.

Speakers: Dan Nees, The Chesapeake Fund Joe Whitworth, The Freshwater Trust Allan Brockenbrough, Virginia Department of Environmental Quality Paul Sutton, University of Denver James Mandel, Advanced Conservation Strategies

Additional Panelists: Palmer Hough, U.S. Environmental Protection Agency Deblyn Mead, U.S. Fish and Wildlife Services Jennifer Moyer, U.S. Army Corps of Engineers

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Workshop Attendees

[insert attendee list here]

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Speaker Summary – Dan Nees, The Chesapeake Fund

Introduction to Ecosystem Service Markets

Ecosystems and the services they provide to us are very important, even fiscally. They have value. Their value is what leads the discussion on service markets. But, how do we translate that value into action?

Why do we care about ecosystem markets? The way we protect ecosystems now is not effective; we are not efficient, not expedient and we haven’t managed risk. As a result our ecosystems are disappearing at an alarming rate. In fact, all the major ecosystems around the world are in peril.

Effective markets are efficient, expedient and they allocate risk. These are three critical components.

1. Efficiency – a key attribute of an effective market. We can get things done cost-effectively using markets unlike any other method. Examples will be presented in the workshop today.

2. Expediency – things can be accomplished faster in a marketplace environment. We are failing miserably to save the Chesapeake Bay. We have made no progress to restore it because the management process is too slow. Markets make decisions faster, so a market is a better model. Markets also create incentives for changing behaviors if designed correctly.

3. Risk allocations – markets are complex and confusing, and there is no compulsion to act. There must be an “owner” of the risk.

Why don’t we have markets now? Currently, very few environmental markets are functioning. Carbon markets are only one example to date, along with some water quality trading systems. Why are there not more? Often, they are just not appropriate. And people do not trust them because markets are challenging to understand.

The complexity of markets scares people away. A theory called blocked exchange essentially says there are certain things we handle in society because we don’t trust the marketplace. The environment is one example; we don’t trust it to the market. People don’t care how much it costs, they just want it to get done. This is a major hurdle to overcome in developing service markets for ecosystems.

Expectations are also skewed; people get disappointed. Some mistakenly believe markets may funnel money into other areas of need, such as agriculture or urban storm water management. That is not what markets are designed to do, however. So, when

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abrockenbrough, 03/01/10,

Although I agree with your premise that markets can provide expediency, I disagree that we have made no progress in cleaning up the Bay. There have been some substantial load reductions. The main problems are that we didn't even have water quality standards reflective of what a healthy Bay would look like until 2005 and that a substantial portion of the loads come from non-regulated sources.


this doesn’t happen as expected, people assume the market is failing and their interest drops off.

There is no such thing as a free market, an unregulated market. The complexity makes it really hard to put these things together in way we can trust and understand.

There must also be accountability and transparency; and a compulsion for action. This is something else that makes people uncomfortable. You have to assign property rights. Property rights ensure someone will be compelled to go into a market and demand something. For transportation, this means you are required to protect these systems, to undo or mitigate any damage you’ve caused. If there is not a requirement, there is no reason for a market, no demand for protecting the environment and ecosystem services.

It takes laws, agencies, lawsuits – all these things – to make an environmental market work. Regulation is the answer, but people don’t want to hear that; they are afraid of that.

In environmental markets, we are always talking about trading systems. We know in economics, tax-based market systems are more efficient than cap and trade systems. However, people don’t like taxes. So they don’t really want those types. But cap and trade systems are really tax systems; we just call them something different.

To make environmental markets work we must require people to act. It is painful and difficult, but that’s when a market works really well. We don’t have many effective markets, because we don’t require people to act. In Virginia and Maryland, markets are developing only because it is being required.

For example, water quality – there are no standards for nitrogen and phosphorus, except for in the Chesapeake Bay Watershed. We have 40-45 water quality trading programs around the country, but they are all benign because there is no regulation for water quality standards.

Conclusion: If you start with the assumptions that ecosystem services are important, then you realize some action must occur. A public policy system can be developed to be efficient and expedient, and that’s what it will take to make a market.

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Speaker Summary – Joe Whitworth, The Freshwater Trust

The StreamBank Platform & Ecosystem Services: Creating Qualified Project Supply at Scale

The Freshwater Trust has been around for 25 years. We’re the ones who drew attention to the issue of wild salmon in the Pacific Northwest, and we’ve been valuing water longer than anyone else. We restore freshwater ecosystems – in stream and near stream work. We were the nation’s first water trust. We purchase excess water from farms and irrigators and put it into trust for the benefit of the streams.

I’m here to talk about our natural, but unintended, progression toward ecosystem service markets.

If you are a conservationist, mitigation is a four-letter word. It blocks us from achieving the sort of ecosystem resilience that we need.

In 2006, we realized that we could never recover freshwater health or listed species on any timeline, for any dollar figure. But we are now heading into the next iteration of conservationism. We’ve had a procedural-based past, and an outcome-based future, and we are now between value sets. We are suffering from “procedure fidelity disorder.”

We had focused historically on just getting projects done and monitoring those over time. However, we now have a platform – StreamBank – that stitches together both voluntary restoration and mitigation restoration.

If you care about water, private landowners own it, particularly west of Kansas, so relationships with landowners are a must. Farmers and ranchers are running a million dollar operation on a $5,000 margin. We cannot expect them to be experts on statutes and bureaucratic processes. In order to do right by the streams and rivers running through their land, they must work with local coordinators, most likely through a local conservation district or watershed council.

Right now the system for freshwater restoration is completely broken. Willing landowners and local coordinators employed to help them, spend a third of their time chasing a grant and filling out a permit application that takes too long and, with new technology, has become completely unnecessary. The process is too complex. To fix the problem, we built a software platform that embeds agency design and monitoring requirements into the screen-flow, creating what is essentially “turbo tax” for restoration.

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In the U.S., we spend billions on freshwater health and restoration every year, but we are failing; this is not a money question, however. We have a huge amount of people working on the issue in both the private and public sectors, but this is not a people problem. We have been trending down on water quality since the 1980s and we are not on track to recover any listed species. When there are only 16 ways to fix a river, this is not a science question. The issue is with the system itself.

For example, it required three and half years of steady work to get permits and funding to fix one mile of stream that only took two weeks of on-the-ground work to complete. In Oregon, the EPA says 80,000 of the 115,000 stream miles fail to fully support aquatic life. Moving at the rate of repairing one mile every three years means we’ll never achieve freshwater health.

We are a staff of 25 – scientists, lawyers, grant writers. We have great relationships with agencies and funders, but it still took us that long to fix one mile of stream. There are 80,000 stream miles in Oregon that need to be restored, but only about 500 projects are completed annually. The system has to change.

The current system is inefficient and the steps to stream restoration are highly repetitive; yet there are no economies of scale. In developing this new software platform, we identified 16 project types and we learned that with most agencies restoration is a retrofit on an originally extractive mission. The platform allows you to cut across the silos, which we all know can impede progress.

Public dollars, philanthropy and private funds all have to be matched and tracked. The StreamBank platform operates as a funnel and translator, getting everything together so permits can be secured and the project can commence quickly. When developing the platform, it was the end user, the landowner, that held the focus of the design and function.

Landowners and coordinators have tested the software by running 25 projects through the platform; on average, 70 percent has been cut from project completion time. This is a significant gain in efficiency and the only way to achieve acceleration. Information that would have taken months for the landowner or project coordinator to compile is now available instantly on the front end of the project.

The design criteria are very important. We synthesized all the design criteria from all the various agencies involved and it automatically populates as needed as you move through the question sequence of the platform. We can perform to whatever specs are required. We generally exceeded everyone’s requirements.

In general, post-project monitoring is horrendous across the board in relation to freshwater conservation efforts. We really don’t know how much good we may have

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done, despite the huge investment. And that’s not acceptable anymore. We must focus on outcomes going forward.

We created an electronic permitting platform, so you only have to fill out basic information one time and information is moved forward in an automated way. Permits are completed fully and accurately, within sideboards.

I believe in the long run we need to deregulate the permitting for restoration projects while ensuring project quality. To do that, we need to establish the quality control up front through the standardized set of questions required of all project types to ensure we are getting the ecological performance that we want on the back end. In Oregon, we passed legislation that allows exceptions for certain restoration projects from permitting. We are in discussion with USACE to expand this throughout the region over the coming years.

Monitoring is funded and focused on outcomes. It also creates a valuable database.

Prioritization: not all projects are created equal. We can score projects against the best available studies that delineate priority project types that lead to total maximum daily load (TMDL) implementation plans or special recovery. What used to take months, now takes hours.

This year in Oregon, with EPA and foundation funds, we calculated first generation ecosystem service credits for water quality and salmon habitat through the “Counting on the Environment” process. Those credits probably won’t be traded, but the accounting methodologies we developed are a starting point for ecosystem service markets.

What kind of ecological uplift do you get? How do you account for that? These are very complicated concepts that we as conservationists wrestle with. We cannot wrestle with it forever, however. If we want to achieve freshwater health, we must figure out the accounting and move it forward by operationalizing it. Do not kill the good in the name of the perfect. We must be okay with a little bit of breakage. Things will improve over time. We need to understand the accounting principals, so that when the highway department wants 40,000 qualified credits we can pull them off the shelf. We cannot continue to do business as usual. From the standpoint of ecological health and ecological wealth, we need to get this to work now.

In the Columbia Basin, we are making progress and continuing to build out the pieces. This can be a model for other regions, such as the Chesapeake Bay. Right now we are focused on voluntary restoration, but over time, this monitoring rigor has implications for ecosystem market development.

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An example would be the dead zone in the Gulf of Mexico. The U.S. Geological Survey says that if we engage riparian reforestation and strategic wetland placement of less than two percent of the landmass of the Missouri/Mississippi/Ohio complex, we can knock down the dead zone by 80 percent. In an ecosystem service market world, a $5 tree can do a lot. Businesses could then get credits for the investment in restoring the dead zone. This argument is going to gain more traction than any other with the business players in this scenario. The creators of the non-point runoff could invest in the measures that would rectify it in a market or voluntary restoration setting with the right tools

StreamBank can take a project and guide it through to the ecosystem credit mark. How those credits are held over time depends on who’s managing the portfolio. But of note here is that you can track what dollars go where for what ecosystem function.

Ecospeculators can bring dollars to the market. Developers, foundations, conservation groups. Some investments, however, can be managed as public trust resources and the derived values can be recycled and reinvested in more restoration work over time.

Follow-up Questions

Q: I’m intrigued by idea of telling people they must monitor something they don’t currently monitor. I see monitoring as the basis for determining if you have achieved success, then as the basis for the credit system. A: Monitoring is crucial to any restoration work, but particularly in a credit system. How do you get people to do it? We pay people to do it. We leverage the public investment with private investment; $20 per hour can get it done. The software creates a digital dossier of monitoring over time. The platform reduces enforcement down to a contract action: perform or remit. Reminding people of deadlines is a basic component.

Q: How long can we depend on foundation money as a large supporter? A: Foundation money is not a big player right now; they are still focused on policy and advocacy. Grant cycles are the standard. Program related investment is a new tool; long-term, low interest, non-secured loans that can bring new velocity to restoration capital. If you don’t pay it back, they will write it off as a grant, but you damage the relationship. We’ve been building this with private funds to keep momentum. If we are successful, then we not only can drive accelerated river fixes, we have an investment opportunity for others.

Q: Should foundations phase out and government phase in more? A: Ultimately it will be a mixed funding source. If government funds more, we need to radically shift how that money is distributed. Right now grant cycles are a barrier to action.

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Speaker Summary – Allan Brockenbrough, Virginia Department of Environmental Quality

Nutrient Trading in the Chesapeake Bay Watershed of Virginia

We are 25 years into the effort to clean up the Chesapeake Bay, which is impaired from too much nitrogen, phosphorus, and sediment. It has been a very slow process. In the first 20 years, there was lots of modeling, goal setting, and deadlines, which were constantly missed, extended, and redefined. In 2003, EPA issued guidance on water quality standards for the Chesapeake Bay. Until this regulatory driver was in place, there was really not much progress. By 2005, Maryland and Virginia had water quality standards in place. At that time Virginia established tributary strategies for each of its five sub-basins.

On the point source side, we had 125 significant discharges in the Virginia side of the bay watershed. We set load caps and told the dischargers they had until the end of 2010 to meet those limits. The dischargers got together and proposed a nutrient trading program modeled after existing programs in North Carolina and Connecticut.

Nutrient Trading Regulation – General Assembly passed this program in 2005. This program allows several things to happen: meet the 2010 deadline as quickly and cost effectively as possible; accommodate the growth and economic development; and provide a way to establish incentives. The jury is still out on the achievement of the last of these goals.

First and foremost, this program is a point source compliance program. We know had we issued individual permits, the sheer volume, cost and time required for permitting would detrimental to any success. By combining the dischargers into one permit and allowing them to trade, we can reach our goals much quicker and more cost-effectively.

We have 164 current registrants; we are expecting 180 total registrants in the program.

This permit has calendar year load limits for nitrogen and phosphorous; it is a conventional cap and trade type system, allowing for aggregate registrations. Point source to non-point source trading is reserved for future growth for new and expanding facilities.

What is the difference between a credit and an offset? In Virginia, if you are under your waste load allocation for the year, you are generating a credit that can be sold. When we use the term “offsets,” we are talking about the need to provide allocation to offset an increased load. New dischargers have arrived with offsets in hand.

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There are three ways to comply with your waste load allocations: 1) discharge less; 2) acquire credits from others; or 3) pay for/buy credits from the Water Quality Improvement Fund (WQIF). So the WQIF must have credits to sell. To sell credits, we need a bank with available credits in each of our five basins, but we do not have that in place at this point.

To offset new and expanded facilities, allocations must be acquired: 1) from permitted facilities in the same tributary; 2) by purchase from the WQIF; 3) from NPS load allocations through the use of best management practices (BMPs); or 4) other DEQ-approved methods.

How does a locality grow under nutrient caps? It can 1) upgrade to more advanced treatment; 2) purchase additional point source allocations; or 3) use non-point source offsets. At the time we developed this program, we thought there would be a significant offset demand, but due to the economy, that has not yet been the case.

Our department developed a guidance manual in January 2008 on how the BMP credits would be developed and marketed. It was not easy bringing the agriculture community to the table on this because they see us solely in the regulatory role. We established baseline BMP requirements, then enhancements to generate credits. It takes a tremendous amount of land to generate credits; there is a 2:1 trading ratio.

In August 2008, our first non-profit source nutrient bank was approved; but there was very limited demand. The banker had demand for storm water treatment, however, from big box retail developers. In March 2009, legislation was passed to allow for use in storm water control, too.

What is the future? The market for storm water offsets is going to completely overwhelm the point source offset market. Guidance for the development of offsets from urban storm water BMPs has not yet been developed, however.

How does a locality grow? Reclamation and reuse was not envisioned when the legislation was originated, but we have adopted regulations in the last two years for reclamation and reuse. The state of Florida is an example of reusing sewage/storm water for irrigation purposes; 600 million gallons of sewage reused per day in Florida, while Virginia uses only 2-3 million gallons. There is opportunity in reclamation and reuse, especially for the more rural areas to grow.

Other options for growth are being proposed, too, including aquaculture and algae production.

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Follow-up Question

Q: How do you do the monitoring? For both point source and non-point source?A: Point source is a self-reporting system. We have inspections to confirm reports. If non-point source ever takes off, it will be self-reporting too.

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Speaker Summary – Paul Sutton, University of Denver

Coastal Wetlands and Storm Protection: A Spatially Explicit Estimate of Ecosystem Service Value

Imagine building a highway where there is already in place a successful ecosystem providing ecosystem services such as protection of human built infrastructure from storms. Building a highway here is likely to actually increase the amount of ecosystem services that are being provided by these lands. Should we offer the builder of the highway subsidies for increasing the value of ecosystem services in this location? The value of many ecosystem services is spatially and temporally complex and variable. Valuation of these ecosystem services is a very complicated problem that may not lend itself to marketization.

My presentation is a case study on placing a dollar value on the storm protection services provided by coastal wetlands. This study involved a lot of people and a lot of data. This study demonstrates pretty clearly that ecosystem services have significant dollar value (in this case – storm protection services provided by coastal wetlands).

Ecosystem services are associated with market failures because ecosystems are in many cases public goods in and of themselves, are affected by both positive and negative externalities, and have problems associated with unclear property rights definitions.

Perhaps marketizing ecosystems is not a good idea. Should we use marketization to insure the provision of efficient quantities of public schools, prisons, or the military? Should we use markets to sustain the fish and wildlife service or the Coast Guard? The costs associated with enforcement of regulations and the monitoring of ecosystem health need to be contrasted with the potential benefits of creating markets for ecosystem services.

Coastal wetlands reduce the damage of hurricanes on coastal communities. What is the dollar value of the reduced damage? This study demonstrates coastal wetlands have a significantly large dollar value from mitigating damage from hurricanes, not factoring in the other services they provide.

To conduct this study, we needed lots and lots of data on hurricanes since 1980: storms characteristics (name, death toll, year, etc.), shapefiles of hurricanes (categories, temperatures, wind speeds, etc.), population and GDP in storm swaths, and land cover for information on wetlands in swaths.

The study was clear that the wetlands have value in mitigating damage from hurricanes, but location is important. For example, the ecosystem service of prevention of soil erosion provided by vegetation around a community water supply vs. prevention of soil

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erosion in a forest in Siberia could be expected to be valued differently. Spatial context clearly matters in terms of the valuation of ecosystem services.

The study showed that wetlands have an estimated value of $33,000 per hectacre (100x100 sq meters). Coastal wetlands in the United States were estimated to currently provide $23 billion in storm protection services annually.

A question was raised about the total annual value of storm protection services exceeding the average annual damage from hurricanes (average annual damage being estimated at $4.3 billion per year): How can storm protection services from wetlands be worth that much? The authors and reviewers questioned this. To answer this, think of body armor for soldiers. If six guys in a battalion die, there could have been six times that number killed if they had not been wearing body armor. The body armor can save more lives than are actually lost.

The study’s authors were able to make maps that were spatially explicit related to two spatial scales: states and pixels. One of the amazing capabilities GIS analysis allows for (in many cases) is the ability to actually drill the results of your analysis down to the pixel level.

Conclusion: Coastal wetlands provide storm protection as an ecosystem service worth billions per year in the U.S.; the per hectare value varies spatially based on spatial context associated with presence of infrastructure, hurricane frequency, and existing wetlands.

We may be wasting our time trying to establish ecosystem service markets. We may spend more time counting the beans than cooking them. The science is already there; we just need appropriate environmental experts/advocates in positions of authority within the government. The environment needs experts/professionals/advocates whose judgment is respected and who have the intellectual and fiscal authority to protect the environment. The economy has experts like Ben Bernanke and Hank Paulsen who have the respect and authority to print hundreds of billions of dollars to ‘save the economy’. The environment needs advocates with similar authority and power. Otherwise we will continue down the road that we have been on for the last four decades. And there is consensus in this room that our environmental policy path has not been a particularly good one.

Follow-up Questions

Q: I believe there is a publicized study on the tsunami a few years ago that shows a direct correlation on death and destruction of wetlands. Do you ever consider the lives saved? A: The study would work to study lives saved, but I’ve been told it is too empirical and not to pursue it. I’m increasingly interested in the rhetorical power of these studies. We

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are failing to convince people the issues are as serious as they are. Is creating markets for ecosystem services a delaying tactic that we cannot afford?

Q: Why are the insurance companies not more involved in this stuff? Hurricanes are obvious, but what about other issues that keep people healthy, and save lives? A: They know it and believe it. They are interested. They just don’t know how to invest in it.

Q: Could it not be a win-win for them? A: (Whitworth) It could be. We are zero for 27 in recovering a fish off the endangered species list in the Northwest. Water quality – almost half in the U.S. fail to support aquatic life. Enforcement is a joke. Mandates are yawning out in the future and climate change is accelerating. Marketizing is maybe not the best deal, but it is better than doing nothing. We are very worried about calculating it correctly, but at some point we must start investing at a whole new scale. First generation credits may be sloppy, but they will get better in time. Environmentalists and academics want to get it so right, but Rome is burning and we need a fire plan. A: (Sutton) The insurance companies do believe in the global warming. Academics developed the ideas of ecosystem services and their valuation. However, using ecosystem service valuation as a vehicle to marketize public goods such as ecosystem services is not what all academics intended. Just as the economy has respected experts (e.g., folks like Ben Bernanke, and Hank Paulsen who are granted the authority to print and spend billions of dollars to ‘save the economy’); the environment needs well-respected scientists who have similar authority to use their judgment and fiscal authority to ‘save the environment.’

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Speaker Summary – James Mandel, Advanced Conservation Strategies

A Performance Bond Approach to Endangered Species Conservation

Credits are useful, but tedious because they must be documented at every step of the process. I’m proposing an alternative approach to look at the final performance of an ecosystem or a species. The idea of performance bonds or derivatives 1) shifts the risk to the natural owner of the risk, the person who can provide the low-cost conservation outcome, and also 2) aligns incentives between stakeholders and the owner of the outcome.

The Endangered Species Act has been successful, but costly and contentious with high transaction costs. Listing is a very slow process plagued by litigation, leading to inadequate outcomes and delays. The government owns the risk, but often is not the “natural” owner of the risk.

An assumption we’ve made is that early conservation for a species will be cheaper and more effective than last minute conservation.

Is there a way to shift the risk to the marketplace, so that the natural owners of that risk could act early and prevent the need to list a species?

For most species, there is zero value. Once the ESA kicks in, however, there is almost infinite value. How do we get from a step function like this to a smooth, cost function? There are unpredictable events that can be enormously expensive (high risk) and the incentives are misaligned.

We are talking about species in these examples, but you should think about these points in relation to an ecosystem.

In market theory, who is the natural owner of the risk?

Examples: A) Catastrophe bonds and hurricanes in Florida. Insurance companies issue catastrophe bonds. Investors buy extra risk in hopes of a high return. If a hurricane hits, the bond holders forfeit investment and that money becomes available to the insurance company.

B) Weather derivatives from a business that depends on the weather (farm, water park, etc.). The business hedges against that risk by selling a bond whose payout is inversely correlated to bad weather. Your business is going to make up lost money from the insurance you sold into the market.

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A good example of a weather derivative is famine in Ethiopia is directly linked to rainfall. The World Food Program owns that risk, as well as the people of Ethiopia. If famine hits, you have a food crisis and a health crisis, both expensive. If rainfall levels indicate famine is likely, the World Food Program can sell a weather derivative. If the rainfall fails to hit a certain level, the investors lose their money and the program gets its money early to prepare for the likely food crisis. There is no litigation, and the risk was passed on to someone willing to take it on.

C) Employee stock options help explain how to align incentives. A company and its employees often differ in incentives or motivation. But if a company pays in the form of ownership via stock options, it can help ensure that employees have the best interest of the business in mind. The employees share in the good fortunes of the company and the bad fortunes. Risk has not been reduced, but incentives have been aligned.

So how can you incorporate aligned incentives and risk mitigation into a market for endangered species?

Two hypothetical examples:

1. Woodpeckers – a declining species scenario. The Department of Transportation (DOT) knows it will have costs if it runs into harming the species during the course of its building project. They want to deal with the risk early and in a way that is financially feasible. DOT sells performance bonds or derivatives that are tied directly to the viability of the species. If the species does well over the period of the contract, the bonds will pay out at a substantially higher rate to the investors. If the species does bad, the investors lose money, and the DOT then uses that money to enact conservation efforts. DOT is shifting its risk into the marketplace, and the capital is available early. Once you own the risk of endangering a species, you’re going to protect your investment by acting early to prevent damage. You’re not going to have to worry about documenting the process, you’re just going to act. At the end of the contract, what is scrutinized is success or failure.

2. Desert Tortoises – a species “swap” scenario. Solar providers in the southwest will impact the tortoises. The only costs are regulatory costs. Regulators will have different incentives than the solar providers. In order to give a price to the tortoise, the government or a private party would enter into a financial arrangement where the solar company could pay a fixed rate for a certain number of tortoises that need to stay viable on that property. Then the government or private party would pay back a floating rate based on the number of tortoises in any given year, ensuring an ongoing relationship. Now the solar company’s incentive is to make sure the number of tortoises stays high so it can

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maximize the investment and to make sure the payout exceeds any lost revenue not gained by adhering to a conservative business strategy. This approach encourages innovation. One party is getting insurance, the other is getting a market incentive for stewardship. This is potentially more cost effective than a worst-case scenario. The worst-case scenario can be used to set your trigger points. Again, the focus in on outcomes rather than process.

The spectrum of pricing for biodiversity bonds is broad and depends on the risk and your approach.

The devil is in the details. You are only monitoring outcomes, not steps, but you must have a good structure for your contract.

Follow-up Questions

Q: As you were talking, some things came to mind: 1) maybe the government pays people to host endangered species on their land, and we reward people for doing a good job; and 2) also the Defenders of Wildlife sends emails when the wolves are doing bad, so why not have organizations like that issue the derivatives for this type of risk?A: These are good examples. I do think conservation is moving in this direction because you have a step function where something is worth nothing, then worth an infinite amount. That’s not sustainable. You must come up with a way to price at intermediate amounts. Having a market incentive out there helps people understand the worth and simplifies the transaction.

Q: This is a new approach, but there is an issue not talked about. There is no technology to support the recovery of a species. A: (Nees) This is not about recovery of a species, but rather about preventing listing. This is a brilliant option. But my concern is in the fact that in the Chesapeake Bay, we are already impaired or endangered, if it were a species. A: (Mandel) In a case where the risk is already born out, you would align incentives, but it may be cost prohibitive. A: (Whitworth) We talk about correcting trajectories through restoration; we know how to improve functionality. The pace and scale has to radically alter if we are serious about meeting the mandate of the ESA. The entire point of the ESA is not to list species, but to engage in activities that will benefit a species with protection.

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Panel Discussion/Q&A Session

Questions Addressed by Speakers and Additional Panelists:

Q: What is the solution?Sutton: I think we can get bogged down in the complexity of it. If we had a trillion dollars, I think we could spend it on family planning and make a bigger difference to the environment. We’ve not done the right thing for a while even though we’ve known there was a huge problem.

Q: Can you illustrate the savings through studies? Such as, if you had spent X in New Orleans, then you would have saved X when Katrina hit?Sutton: Yes, those types of studies could be done.

Q: To the extent that each geographic area and the resulting impacts are different, for example along a river, how do you parse out that investment benefit?Nees: We do not know all the solutions to restore the bay, but we do know how we screwed it up, so we can go back and fix those problems. That is at least some sort of solution. We cannot use a lack of understanding about the ecologies to prevent us from putting a value around it. We need adaptive management, which requires money and investing.

Q: Transportation agencies do not always have the authority over land use choices and management, so it is exciting to have that issue pushed back. How do you align transportation mitigation with the private investments? Whitworth: All problems are solved with scale. Project by project myopia will not get us anywhere. The monitoring required by marketizing will end that. We need to move from a procedure based past to an outcome based future. Invest X at the headstream and make Z instead of investing X at the small spot downstream and only make Y.

Earsom: What do the panelists think about scaling up?Hough: New regulations in 2008 show that we have moved away from our traditional preference for assuming mitigation projects must be at the impact site. We’ve gotten away from that and now emphasize an entire watershed approach. Moyer: There is a trust factor that needs to be built among the government, the NGOS and the public; until we get to that trust point, there will be angst. Mead: On a small scale, we are using banking and asking for investment where we will get the most uplift. We need to think about how we do business and what needs to change to operate on a larger scale. Pilots based on landscape conservation cooperatives are being developed and are an example of how we are working collectively with other agencies and organizations to get the science down and apply it to developing markets for habitat and species. It is hard to develop a large market, however, because everything is so small scale and localized right now.

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Mandel: As ecologists, we don’t need to understand how everything works, but rather focus on rewarding good behavior and punishing bad behavior. Outcomes will be easier to achieve.

Earsom: I’m an investor who wants to buy a performance bond, but I want data. Who develops it?Mandel: The investor will have to determine the value and measure the risk. The initial issuer will sell at a discount, and then the investment could be resold by someone who understands the risk better. Over time, the process and investors will become more sophisticated.Audience Comment: I would suggest this is already going on and is quite an active market. There will be a mitigation/conservation banking conference in the spring in Austin, Texas. We are talking today about ecosystem needs and tools that foster improvement. We’ve not talked too much about the biologic metrics and how we are going to pay. There is no question that we are going to pay, one way or the other.

Q: Agriculture doesn’t have as much regulation as other industries, but they could be a significant driver in this area. How do we deal with those not regulated?Brockenbrough: Provide them a financial incentive. Nees: It is called the farm bill. Markets will never clear appropriately when the supplier of the credit is unregulated and the demander of the credit is. Without the legal risk, they are not on the hook. This is really a controversial statement, but you must regulate all the players. There is a bill pending to reauthorize the legislation allowing the Chesapeake Bay program to exist, but with more teeth to it this time. That’s going to mean more regulation.

Q: What can be done about the agriculture industry because they are not regulated? People are not going to do something they don’t have to do. There are so many factors at play and there is always still going to be the risk. Whitworth: All things being equal, farmers will do what is best to protect their land. Agriculture desperately wants to wear the white hat. How can we help them to do that? If we can figure that out, we’ll generate some real momentum.

Earsom: I have ideas about how each of these programs can relate to transportation. How do you, our speakers and panelists, think this will or will work in a transportation context? Sutton: I think moving into markets is more problematic and hopeful. It seems big and complicated to me. But I’m cynical and suspect. Whitworth: Advanced mitigation can create efficiencies for transportation. We need qualified supply that gives greater ecological uplift. Brockenbrough: I can tell you that point to non-point source is much more complicated. Storm water mitigation for highways could be something to explore. Nees: Performance and outcome based is best.

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Mandel: Focus on the outcomes; move away from trying to correct every problem and the top-down approach. Hough: It seems to me that if you want this idea to flourish, you need regulatory drivers, such as the Water Act and the ESA. If you want other markets to flourish, there needs to be a reason for someone to buy them, otherwise it is just heavy rhetoric. Regulators need good tools to know when to stack sales and credit.Mead: Markets are a necessary part of the solution here, and we need to keep working to expand market incentives. We have a heavy interest in supply – landowners willing to supply credits – but not for demand (buyers of credits). Where regulation is lacking, how do we create voluntary markets for habitat and species? Moyer: I think markets have some extreme benefits. Our state of ecological health in the U.S. is not very good, and we are paralyzed in fear of doing something that might make it worse. Sometimes “no” needs to be the answer. We need trust and direct conversations; we need collaboration.

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Next Steps/Follow-up Questions and Comments

[speakers and panelists to contribute answers/comments during draft review]

What are the major scientific, regulatory, cultural, and other barriers to the acceptance of the programs and ideas?Answers/comments here

Do the programs and ideas incorporate performance measures or standards to ensure continued delivery of ecosystem services? Answers/comments here

How can ESM benefit other community livability/transportation planning and project delivery priorities such as archaeology/historic preservation, environmental justice, or asset management?Answers/comments here

What geospatial data or application would advance the development of ecosystem services and markets?Answers/comments here

What geospatial data or application would optimize integration of transportation planning priorities in a manner that enhances livability?Answers/comments here

What steps need to be taken by the following to help the development of ESM: Congress, resource agencies, action agencies, non-governmental organizations, private sector, other?Answers/comments here

What steps can be taken by these entities (apart from Congress), without changes in laws and regulations, to foster development of ESM?Answers/comments here

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Appendix: Speaker Presentations

[Insert ppt documents into final pdf file]

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ecosystem service markets & associated performance...

Documents