October 9, 2019

By  David Gray, non-executive director, AAG Investment Management

The Clean Water Act (‘Act’) has been much in the news recently. More specifically, attention has been on the 2015 Clean Water Rules (the ‘2015 Rules’), and their impact on the definition of ‘Waters of the U.S.’, which were revoked on September 12, 2019. Characterized as ‘overreach’ by critics and the cause of litigation since they were issued, the 2015 Rules were the subject of a March 2017 executive order instructing the EPA to review them for conflicts with the Trump administration’s regulatory reform agenda. A ‘redefinition’ of the rules is expected near the end of the year; broadly, a much narrower version with a more limited description of ‘Waters of the U.S.’ is expected. The question is: how should ag industry stakeholders think about this? Since the 2015 Rules were issued it has been something of a knee-jerk reaction to say that farmers were opposed to them. No doubt this is true; the question is whether replacing/relaxing them is helpful to farmers and investors. 

In some respects, the revocation of the 2015 Rules changed nothing in substance: the EPA had formally suspended them in January 2018, and indicated that new regulations would be issued later that year; this did not happen. Equally, the 2015 Rules were only in effect in about half of the states – their implementation had been held up in court proceedings in the rest. So limbo has endured for a while and will do so at least until the new regulation is actually published. These new rules themselves will provoke challenges; some states have already announced planned litigation related to them – whatever they are. Not only is the Clean Water Act involved, some issues could also arise under other statutes, notably the Endangered Species Act. It is likely that these disputes will still be unresolved by the time the 2020 election campaign hits full swing. 

Water and water quality have particular relevance for agri investors. Agriculture is the largest source of pollution for rivers and streams, the second largest for wetlands, and the third largest for lakes. The potential liability is therefore material. As with other areas of regulatory policy, including ongoing debates about vehicle emissions and increased limits on methane emissions from oil and gas drilling, the Trump administration’s roll-back of Obama-era rules has consistently raised fear in environmental and other circles. In the case of water, more lax regulation is seen as increasing risks of higher levels of groundwater pollution, increased run-off of toxic chemicals from farms and industrial facilities, and more aggressive development that will jeopardize water safety with negative effects on human health, wildlife habitats, and local communities. 

While industry has, in some cases, welcomed the Trump changes, this is not universally true. Notably, some car manufacturers are pushing back against the full scope of proposed changes to emissions rules, called CAFE; the administration has even threatened some form of antitrust investigation of those manufacturers in response. Audio of oil and gas industry executives ravaging the administration’s policies has also surfaced. It is easy to understand their ambivalence: supply chains, product consistency, cost, public relations, liability concerns, and a host of other reasons are manifest. My purpose here is to ask a more targeted question for agriculture investors and managers: how will, or should, this impact sustainability policies that are now central to stakeholders across the sector? 

CONTEXTUALIZING THE DISCUSSION 

Some aspects of the Act’s scope have not been in doubt. There is universal acceptance that they cover ‘navigable waters’ of the U.S. – lakes, major rivers, and so on. The two main purposes of the 2015 Rules were (1) to ensure that Clean Water Act programs were more precisely defined; and (2) to avoid confusion and cost associated with the implementation of the Act. Hence the 2015 Rules sought to simplify planning and permitting by specifying the actions the EPA would take and what processes companies/applicants would have to undergo. The EPA and Army Corps of Engineers had determined that this approach would produce a ratio of 2:1 in terms of benefits and costs. 

Principal elements of the rule defined with more specificity the tributaries and adjacent waterways under Federal jurisdiction and carried over existing exclusions of the Clean Water Act, essentially seeking to codify the ‘significant nexus’ test that had been defined by Supreme Court cases as delineating waters that fell under the Clean Water Act regime. Tributaries or upstream water with physical features of flowing water (a river bed, high water mark or a bank, for example) were now covered by the Act. It also included headwaters with these characteristics that had significant connections to downstream waters. The 2015 Rules extended to adjacent waters such as wetlands, ponds, lakes, and so on which are home to aquatic wildlife and other ecosystems. They extended the definition of ‘Waters of the U.S.’ to include smaller bodies of water and wetlands that drain into other smaller bodies such as tributaries, on the principle that clean water upstream meant clean water downstream. This was a much broader construct than had applied previously; it raised the possibility of new and more stringent permitting requirements related to land use, including fertilizer and pesticides – in effect a fear that the federal government was telling people what they could do with their land. 

It has become axiomatic to anyone following the news on either side of the Atlantic these days that certainty is highly valued by business. Water regulations have long failed this test. The Obama administration hoped the 2015 Rules would have represented a welcome development, especially because much of the previous decade had seen much confusion and uncertainty in this area. Numerous attempts had been made between 2002 and 2010 to pass new legislation, the Clean Water Restoration Act, and failed. Early attempts in the George W. Bush administration to cap the total number of acres of isolated wetland subject to Federal oversight had been rejected and replaced by case-by-case reviews. 

Like many previous initiatives, the 2015 Rules failed to satisfy a large swath of constituencies. No doubt aided and abetted by the partisan polarities in the U.S. body politic, among other factors, they were widely resisted, and a number of court cases were filed to delay their implementation. They were seen, broadly, as threatening landowner rights and violating states’ rights. In addition, concerns were expressed that the definition of ‘tributaries’ could or would be extended to include drainage ditches and channels, which are widely needed on irrigated farms. During the 2016 election campaign the 2015 Rules were singled out as a target by Donald Trump, who vowed to replace them. 

IMPACT CONSIDERATIONS 

For agriculture investors and asset managers this uncertainty has potentially very negative ramifications. Sustainability is a crucial component of every fund-raise which touches the sector, and in the farming universe it is twinned with ‘regenerative agriculture’ as an essential operating guideline to be implemented across portfolios. The favorable impact of these best practices on operations, crops and even profitability is now widely recognized. 

Adherence to the 17 UN Sustainable Development Goals (SDG) has become axiomatic. Two of these specifically relate to water: SDG number 6 (clean water and sanitation), and number 14 (life below water). In specifying the targets for each SDG, 6.6 is to ‘protect and restore water-related ecosystems, including mountains, forests, wetlands, rivers, aquifers and lakes’ by 2020 (emphasis added), and 14.1 is to ‘prevent and reduce marine pollution of all kinds, in particular from land-based activities, including … nutrient pollution’ by 2025. ‘Nutrient pollution’ is the process by which nutrients, mainly nitrogen and phosphorous, are added to water in such large quantities that they stimulate excessive algae growth. A major user of fertilizers containing these elements is, of course, agriculture. 

So the challenge becomes clearer. Farmers object with reason to uncertainty around regulation, investors are liability-conscious but are also being held to higher standards by capital allocators. Consumers exert more and more pressure on growers and processors. Government policy is evolving but is expected to result in considerable relaxation of the 2015 Rules and likely the elimination of protections around smaller bodies of water and wetlands. The administration looks out of sync with the international consensus that links these issues to broader questions of health, well-being, and safety. Access to markets and, eventually, pricing of many crops and other agricultural products will be subject to greater disclosure related to on-farm behaviors and practices. Withdrawal by the U.S. from international agreements like TPP will necessitate renegotiation of trading relationships; a major test here will also come as and when Brexit leads to promised new trade talks between the UK and the U.S. 

So, the benefit of rule reversals may be less than advocates of ‘lighter’ regulation anticipate, and reactions to lower thresholds could be the basis of new tension between what the (revised) rules allow and what industry stakeholders – landowners, growers, processors, consumers, lenders, and investors – will tolerate. The value of any apparent relief from the 2015 Rules will likely be illusory. With the ongoing consolidation of land ownership and the increased institutional exposure in the sector, the sensitivity to risk of farm-level actions that create risk downstream can be expected to intensify. Consumer choices and increased awareness of provenance and traceability of food will also have an impact on upstream choices. Higher standards of land and animal husbandry will be a common denominator. 

Wishing for a return to past, lower standards sounds appealing as a way to mitigate cost and ‘increase control’. The government may be saying less about how land should be used and farmed but there will be other, louder voices. The first of these will be the (almost certain) return to stricter standards when the current administration becomes the previous one. There could be more: not only access to markets but also maximizing value of any farm will be variables whose importance only grows in the eyes of institutional capital providers. Higher water or other environmental standards could create real financial liability, too, by necessitating remediation or changes in farming practices. The extent of any required clean-up can be expected to have potentially meaningful valuation consequences – and could even impact the ability to sell a farm. Costs of any required remediation will have to be borne by the owner/seller and could be ruinous.

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