The Exchange Meeting

1
The Exchange Meeting

• Glen Allen Cultural Arts Center
• November 14, 2006, 100 p.m.

2
Welcome Introductions
Mark Haley City of Hopewell
3
Todays Agenda

• Exchange Schedule Overview
• Draft Credit Exchange Policy
• Future River Basin Meetings
• General Permit Registration Statement QA

4
Exchange Schedule Overview

• Credit Exchange Policy (Nov. Dec.)
• Basin-Specific Workshops, Series 1 (Feb.)
• Basin Level Compliance Plans, Draft 1 (Feb.)
• Exchange Meeting (Mar.)
• Basin-Specific Workshops, Series 2 (Mar.)
• Basin-Level Compliance Plans, Draft 2 (Apr.)
• Exchange Meeting (Apr.)
• Basin-Level Compliance Plans, Draft Final (May)
• Basin-Level Compliance Plans, Final (July)

5
DRAFTCredit Exchange Policy
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Guiding Principles

• 1 Trading is voluntary
• 2 Benefits for all
• 3 Compliance first (safety first)
• 4 Never forget the CWA base case

7
General Approach

• Highly-structured, well-planned program
• Convenient and reliable trading mechanism
• Practical legal structure that promotes
  participation
• Fair and effective pricing methodology

8
Presentation Organization

• Credit Pricing Cash Flow (Harvey)
• Exchange Rules (Pomeroy)
• Comment Process (Haley)

9
DRAFT Credit Exchange PolicyProposed Credit
Pricing Cash Flow Overview
Glenn Harvey Prince William Co. Service Auth.
10
Key Credit Pricing Considerations

• Certainty issues
• Complexity issues
• Price level issues

11
Certainty Issues Findings

• Market-based program (trading) nested in a major
  regulatory program (CWA NPDES)
• Failure is not an option
• Guiding Principle 3 Compliance First
• Uncertainty is an obstacle to success, especially
  during startup phase (through 2015)
• Pricing approach needs to balance free market
  benefits with the need of participants to ensure
  VPDES permit compliance

12
Certainty Issues Proposal

• Establish prices for credits traded through The
  Exchange
• Set the price structure to facilitate long-term
  planning
• Consider including a price escalator

13
Complexity Issues Findings Proposal

• Findings
• Wide spread observed in both capital and OM cost
  data
• Difficult to normalize the data
• Desire to avoid policing the data
• Approach KISS

14
Credit Price Level Issues Basic Assumptions

• Majority of owners on path to construction due to
  short compliance schedules and need to ensure
  permit compliance
• Bad market conditions due to various reasons,
  including competing nutrient removal projects
• Mutual benefits to decreasing the of upgrades,
  especially during the early peak years

15
Credit Price Level Issues Range of Prices

• Relatively high prices would be expected to
• Enable sellers to recover more of their costs
• Encourage more initial upgrades, not fewer
• Relatively low prices would be expected to
• Enable sellers to recover some but not all costs
• Provide more incentive to defer construction past
  early peak years

16
Credit Price Level Proposal

• Establish a relatively low price as an
  incentive to attract buyers who will defer
  construction now
• Base price at a level high enough to cover
  minimal OM (e.g., chemical cost plus)
• Provide stable and predictable schedule of prices
  through first planning horizon (2015)
• Anticipate moving toward more market-based
  pricing beginning in 2015

17
Credit PriceNitrogen vs. Phosphorous Costs

• Nitrogen
• Capital intensive general requires big tanks
• Alkalinity and DO recovery
• Supplemental carbon required at/below BNR
• Small additional biosolids costs
• Phosphorous
• Relatively small capital cost for chemical feed
• Relatively higher capital cost for filters
• Much larger biosolids/sidestream costs
• More long-term OM than for nitrogen

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Credit PriceSummary of Costs
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Credit Price Proposal

• Nitrogen 2.00 / lb (2007)
• Phosphorous 4.00 / lb (2007)
• THE FINE PRINT
• These are Class A prices charged on a
  take-or-pay basis to promised buyers
• The price paid to promised sellers and prices
  paid by/to other parties vary as explained in the
  Credit Exchange Policy

20
Two-Tier System Proposal

• Class A credits
• Promised supply by sellers
• Promised demand by buyers
• These promises parallel the Compliance Plans
• Class B credits
• Extra credits generated beyond those promised in
  Compliance Plans
• Fixed, small percentage of income stream divided
  among Class B credit sellers

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Sources of Funds Proposal

• Sales to participating Class A promised buyers
  on a take-or-pay basis
• Price 4 P / 2 N
• Sales to Exchange participants to meet their
  unexpected requirements
• If available (prorate among members if short)
• Price 1.5 X Class A 6 P / 3 N
• Non-participants
• If available beyond Exchange participant needs
• Price 2 X Class A 8 P / 4 N

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Distribution of Funds Proposal

• All cash goes into The Bucket
• Class A sellers get lions share (90)
• Remaining 10 divided among Class B sellers
• Unless Class B price would exceed Class A price,
  then the excess amount would revert to the Class
  A sellers
• Exchange operating expenses

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Cash Flow The Bucket
Sources of Funds
Class A Buyer 4 P / 2 N
ExChange Buyer 6 P / 3 N Outside Buyer 8 P
/ 4 N

THE BUCKET
Disbursement of Funds
90
10
Class B Supply B Pool / Total B Credits
Class A Supply Pool A Pool / Total A Credits
Class B credit price gt Class A? Excess
reverts to Class A fund
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All Winners, No Losers

• All Exchange participants should win
• Benefits for firm Class A buy/sell commitments
• High level of certainty
• Best buy/sell prices
• Accurate planning yields best results
• Benefits of Class B system
• Modest financial benefit for sellers
• Safety net for all participants

25
DRAFT Credit Exchange PolicyExchange Rules
Chris Pomeroy AquaLaw
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Overview

• Implementation Documents
• Key Policy Considerations
• Participation Options Definitions
• Buying Selling Credits
• Credit Shortfall Avoidance Mitigation
• Timeframes
• Participation Changes

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Implementation DocumentsCompliance Plans

• Required by DEQ General Permit Regulation
• MUST contain any capital projects and
  implementation schedules needed to comply with
  individual and combined WLAs ASAP
• MAY rely on exchange of point source credits
• Due August 2007

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Implementation DocumentsCredit Exchange Policy

• Policy called for by Exchange Bylaws
• Establish internal operating rules and procedures
  for trading through The Exchange
• Develop together (by dischargers, for
  dischargers)
• Designed to provide certainty while maintaining
  owner flexibility

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Implementation DocumentsNutrient Credit
Services Agreement

• Participants have indicated a desire for
  certainty and ability to rely on trades and
  credits
• While the Compliance Plan establishes
  accountability relative to DEQ, this Agreement
  will establish accountability within the group
• A relatively simple agreement in that
  incorporates the Compliance Plans and Credit
  Exchange Policy, which will provide most of the
  substance
• Streamlined year-end trading documentation based
  on General Permit documents

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Implementation DocumentsProposal Summary

• Nutrient Credit Services Agreement
• Entered among Participants Exchange
• Based directly on the Compliance Plan Credit
  Exchange Policy below

• Compliance Plan
• One for each basin
• Covers all participants
• Developed together
• Approved by DEQ

• Credit Exchange Policy
• Sets trading procedures
• Developed together
• Issued by Exch Board

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Key Policy Considerations

• Encourage advance Seller commitments needed to
  ensure credit supply adequate for permit
  compliance (compliance first)
• Provide certainty for Class A credit Buyers and
  Sellers (e.g., quantity and and price of credits)
  
• Provide incentive to all dischargers to
  participate on some level and increase the
  strength of the Class B credit safety net

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Proposed Participation Options Definitions

• Seller Agrees in advance to supply a certain
  minimum of credits in a given year
• Buyer Agrees in advance to purchase a certain
  minimum of credits in a given year
• Neutral Makes no buy / sell commitments in
  advance, but is covered by Plan and as such has
  preferred rights over Non-Participants

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1. Buying/Selling Class A Credits

• Seller
• Agrees to supply a certain minimum of credits
  (Class A credits)
• Price depends on number of credits sold
• Exchange (Credit Aggregator)
• Agrees to purchase Sellers Class A credits
• Buyer
• Agrees to buy a certain minimum of Class A
  credits at the established price (e.g., 2/lb TN)
• This demand is anticipated and covered in the
  Exchange Compliance Plan

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2. Selling Class B Credits to The Exchange

• Class B credits are those credits beyond the
  advance Class A commitments
• Class B credits are discovered at year end
• When a Seller produces more credits than promised
  in advance
• When a Neutral produces any credits
• When Buyer has extra credits on hand at year end

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2. Selling Class B Credits to The Exchange
(cont.)

• Class B credits have some value
• Safety net for Participants
• Good P.R.
• Potential future source of Class A credits
• To secure these benefits for the group, The
  Exchange will run a Surplus Credit Market
  Clearing Program on an opt-in basis

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2. Selling Class B Credits to The Exchange
(cont.)

• Exchange promises to purchase all Class B credits
  _at_ equal price from Plan Participants who opt in
• Exchange announces 10 revenue set aside amount
  based on planned Class A credit transactions
• Participants must opt in to market clearing in
  advance
• Necessary to avoid gaming of system in a
  shortfall year (by definition the only year when
  Class B credits are likely to have any
  significant value to those who fund market
  clearing by means of the 10 set aside on Class A
  revenue)
• Class B credit price is unknown until
  reconciliation

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2. Selling Class B Credits to The Exchange
(cont.)

• Market Clearing Price 10 set aside / Class
  B credits
• Notwithstanding above formula, price for Class B
  credits is capped at Class A credit price
• Fairness to Class A credit exchange parties
• Class B credit exchange parties made no firm
  commitments, but Class A credit exchange parties
  did
• Class A credit exchange parties funded Class B
  credit purchases (10 set aside)
• If Class B credit price cap is triggered, refund
  remainder of 10 set aside to Class A Sellers
  based on of Class A credits produced

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Buying Surplus Credits from The Exchange

• Priority will be given to sales to Plan
  Participants
• The Exchange will consider sales to
  Non-Participants only after needs of all Plan
  Participants (Buyers, Sellers Neutrals) have
  been met
• Exchange will sell available surplus credits at a
  multiple of Class A credit price
• To maximize Exchange participation protection
  (safety net)
• To encourage good advance planning
• To discourage gaming of the take-and-pay Class A
  system
• Exchange will sell surplus credits at the
  following prices
• Plan Participants 1.5 x Class A credit price
• Non-Participants 2 x Class A credit price

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Credit Shortfall ManagementPotential Scenarios
Causes

• Potential Scenarios
• At year end, Seller failed to produce the of
  Class A credits promised in advance
• At year end, Buyer needs more credits than he
  requested in advance
• Potential Causes
• Late project construction
• Treatment problems
• Rapid unanticipated residential or industrial
  growth

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Credit Shortfall Management Proposal
Multi-Layered Defense Plan

• Group compliance
• Use available surplus to cover all Participants
• See above surplus price rules for cost
• Monitor performance monthly and adjust
• If non-compliance anticipated, adjust within
  group wherever reasonably possible
• Contingency Plan
• Compensation (e.g., 2 x Class A credit price)

41
Credit Shortfall Management Proposal
Multi-Layered Defense Plan

• If adjustment unsuccessful, DEQ approval of Plan
  revision (if appropriate)
• E.g., compliance schedule revision
• If Plan revision inappropriate/unsuccessful
• At-fault Sellers obtain credits from other
  sources to make up their shortfall at their
  expense and keep their commitments
• At-fault Buyers are in permit non-compliance
  unless they obtain credits from other sources

42
Credit Shortfall Management Proposal
Multi-Layered Defense Plan

• Sources of credits to remedy shortfall
• Participant Opt-Out Class B credits
• Non-Participant credits
• WQIF credits (assumed to be available if SWCB
  determines no credits available, this approach
  may be revisited)
• Assign responsibility to each party for its own
  shortfall and provide a process to remedy that
  shortfall
• Protect all group members who met their
  commitments
• Avoid situation where a one or a few members
  throws entire group into non-compliance

43
Credit Shortfall Management Proposal
Multi-Layered Defense Plan
44
Credit Shortfall Management Proposal Allocation
of Exchange Credits

• Assume multiple Participants miss Class A
  commitments (or neutrality) and there are not
  enough surplus credits to fully cover this
  shortfall
• First allocate credits available within The
  Exchange equally to all Participants,
• Then apply rules on previous slide

45
Timeframes The Trading Cycle

• 1 - Planning Year(s)
• Compliance Plans Plan Updates
• Decision to buy or sell Class A credits
  (including price)
• Decision to opt-in to year-end Class B credit
  market clearing
• 2 - Compliance Year
• 3 - Reconciliation Year
• To meet all pre-planned (Class A) credit
  exchanges
• To clear market of surplus (Class B) credits
• To sell surplus credits (if and when needed)

46
Timeframes Planning Windows

• Model Projections
• DEQ requests annually through 2015 and 5-year
  increments thereafter
• General Permit Compliance Plan
• Regulation requires through the first compliance
  year
• Plan is binding upon approval by DEQ
• Plan is subject to annual updates (and DEQ
  approval)
• Plan will meet regulatory requirement, but also
  include information through 2015 (information
  only)

47
Timeframes Planning Windows(cont.)

• Nutrient Exchange Services Agreement
• 5-year rolling commitment
• This term tracks withdrawal notice provision
  (below)

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Participation Change ProposalEntering Late
(After 2007)

• Original significant dischargers
• Had opportunity but did not participate
• Entry may or may not be disruptive to compliance
  and/or economics of the Plan
• Protect position and planning of original
  Participants, while making reasonable
  accommodations for admission of latecomers
• New / expanding facilities subject to offsets
• Decision depends on impact on the Compliance Plan

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Participation Change ProposalEntering Late
(cont.)
50
Participation Change ProposalWithdrawing

• Significant advance notice needed for disruptive
  withdrawal (5 years)
• Obligation continues through notice period

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Other Participation Changes

• Involuntary Removal for Cause
• Board retains discretion to remove for
  malfeasance, misfeasance, non-compliance or
  similar circumstances
• Provide a process of notice
• Transferring Membership
• Track automatic provision of General Permit

52
Year-End Reconciliation Process

• Determine of credits actually generated/needed
• All Buyers, Sellers and Neutrals
• Class A and B credits
• Buy/sell Class A credits
• Buy Class B credits (marketing clearing)
• Sell surplus to Participants for shortfalls (as
  needed)
• Consider sales to non-Participants
• Use reports/documentation similar or identical to
  that used by DEQ under General Permit

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DRAFT Credit Exchange PolicyComment Process
Mark Haley City of Hopewell
54
Exchange Bylaws

• The Board of Governors shall develop and
  implement, with advice of the Members, a Credit
  Exchange Policy for coordinating and facilitating
  the participation of the Members in the Exchange
  Program on fair and reasonable terms. - Article
  VII

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Exchange Bylaws (cont.)

• To obtain the advice of the Members and otherwise
  ensure an open process, the Board of Governors
  will use the procedures described in this Article
  VII. Article VII
• Release Proposed Policy
• Take Comment
• Issue Final
• Monitor Adjust

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Comment Process

• Nov. 9 Release draft Credit Exchange Policy
• Dec. 7 Comments due to Admin_at_TheExchangeAssociat
  ion.org
• Dec. 12 Board review

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Future River BasinWorkshops
Cy Jones CH2M HILL
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Basin-Specific Workshops

• Timeframe
• Mid/late-February following comment on Credit
  Exchange Policy and model enhancements
• Objective
• To discuss and adjust strawmen into DRAFT
  compliance plan scenarios live during workshop
  based on OWNER input

59
Basin-Specific WorkshopsNew Strawman Basin
Scenarios

• Include only those facilities where owner has has
  expressed interest in participating
• Incorporate
• Updated owner data (June -August survey)
• Additional owner comments/preferences submitted
  Dec. Jan.
• Include owner-specified upgrades in progress
• As needed identify for discussion purposes
  additional cost-effective projects

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Basin-Specific WorkshopsScenario Discussion
Revision

• Owner discussion
• Which projects are firmly underway
• Which additional projects are certain to happen
• Which owners may consider deferring or
  accelerating a project
• End with generally acceptable draft scenario for
  further development

61
General Permit Registration Statement QA
Allan Brockenbrough DEQ