The research and analysis undertaken for the previous work packages demonstrates the potential benefits of instigating a PES scheme in the Milford Haven and Cleddau Catchments. After suggesting two possible options in WP4 this section outlines the structure of a Reverse Auction scheme that we believe the evidence shows is likely to deliver the best chance of successfully reducing nutrient loading in the waterbodies.
The main benefit of a reverse auction in the Pembrokeshire context is that the market is driven by those who provide the funds and is therefore not dependent on the numbers or scale of buyers. As indicated previously the size and number of buyers has always appeared to represent a potential barrier to successful PES schemes in Pembrokeshire. Though there are disadvantages (namely the source of the funding) the ability to run a scheme without any buyers in the traditional sense outweighs the other concerns.
Though Work Package 4 provided some detail about reverse auctions the following section provides a greater level of detail of how such an auction might work in Pembrokeshire. Whilst some very specific suggestions have been detailed below it will be up to any pilot / live scheme to identify which would work most effectively in the context of the Milford Haven and Cleddau catchments.
A reverse auction is where the roles of buyer and sellers are reversed – the bidder is the seller and not the buyer. It is a relatively simple process which at its most basic is characterised by organisations interested in a specific outcome contributing funds to an auction process where the winning bid generally provides the greatest value for money not the highest price as is typical in a normal auction. Most bids are different and reflect the variation of sellers that exist, each bid is weighted by the sellers themselves depending on the service the seller is proposing or the measures they are agreeing to put in place. Many reverse auctions occur online, and tend to be either open or sealed bids with one or more bidding rounds.
A reverse auction has the advantage of utilising competition between those seeking the contracts in order to reach an economically efficient outcome. Consequently, those farmers who find it the cheapest to undertake pollution activities are more likely to be successful in the auction process. This however, can dissuade potential participants as profit margins can easily be reduced when sellers are forced to lower prices to compete with other sellers. The reduction in costs and hence increase in value for money is often cited as an advantage of the scheme yet it must also be recognised that it can be seen as a disadvantage to achieving meaningful reductions in nutrient loading if sellers cannot identify how they would reduce costs or increase profitability via such a scheme.
The key to a reverse auction is that it requires Sellers to determine their own price for implementing the land management measures (which may include reducing yields, reducing stock numbers, increasing unproductive land etc.) which will be different for each farmer. By having to decide how much they are willing to accept in a competitive setting (because other landholders are also bidding), the landholders must consider seriously the relative values of the land in both its current and future managed states.
There may also be additional advantages, both in terms of value for money and environmental benefits, if groups of Sellers are encouraged to bid together. Benefits are compounded when delivered at a landscape scale, rather than at an individual farm scale and these joint bids should be encouraged wherever possible, especially if the benefits could be delivered at a sub-catchment scale. Joint bids also allow parties to apportion risks through negotiation, though the process of joint bidding would need to be carefully managed by the Broker and RAG.
Figure 15 below illustrates a potential reverse auction structure whilst Figure 2 shows the process in more detail.
Figure 15: Potential Structure of a Reverse Auction
The figure above shows a simplified method for how a reverse auction could operate, however in practice such a scheme would be more complex. Each stage of such a scheme has been outlined in Figure 16 and below.
Figure 14: Reverse Auction Flow Diagram
All organisations with an interest in reducing nutrient loading should identify the level of funding they can contribute. This should then be combined to provide the overall scheme budget for the first auction.
As has been mentioned elsewhere the need for an independent broker is clear, however, the role of such a body needs to be defined in the context of this scheme. It is recommended that this role is defined by the RAG group with external assistance if needed
As no single organisation, capable of operating as a broker, has been identified during this work it is proposed that all interested parties should submit an application to be considered for the role. This should detail their expertise in undertaking such a role including but not limited to: knowledge of the catchment; knowledge of buyers and sellers, ability to negotiate complex deals, a track record of stakeholder engagement; experience of managing large amounts of capital; experience of managing legal agreements; and ability to remain impartial.
It is recommended that the applications for the role of broker are assessed by the RAG with expert financial and legal assistance when required.
Though this work has recommended the structure and way such a scheme would work it is recommended that the Broker and RAG work through the suggested process and amend wherever necessary. This will then ensure that the final structure is the one most likely to deliver success
Once the level of funding and the broker have been identified it will be necessary to develop the administrative tools that will allow the scheme to function. It is recommended that this is undertaken by the Broker, with external assistance where required, with the RAG providing an oversight function. All material should be made available to stakeholders as early as possible to gather feedback and improve if necessary
This should be undertaken by all stakeholders however it is suggested that the majority of this work is undertaken by the Broker. Any and all techniques should be used to increase knowledge and understanding of the scheme amongst stakeholders (including the general public) to provide the greatest number of buyers and sellers possible. A related but distinct element of this work will be for the RAG group (and others where required) to promote the scheme within their own organisations. This will help for a number of reasons not least the fact that it might increase the scheme budget if other business areas can see the potential benefits to their objectives (i.e. multiple benefits over and above reducing nutrient loading).
During all stages of the process outlined above, it is recommended that the Broker collates a list of sellers. This should help identify the level of interest in the scheme (and allow for changes in approach to be made if there is little appetite) as well as the likely level of load reduction that might be achievable.
Whilst one of the benefits of a reverse auction is a reduction in the level of engagement with sellers which reduces scheme costs it is suggested that in the context of the Milford Haven and Cleddau catchments a greater level of engagement would be beneficial. The Frist Milk scheme has demonstrated the value of one to one visits and due to the loading problem it is likely that a skilled broker would be able to deliver greater reductions through using more land management measures than would be likely via the farmer alone. It would not be necessary to visit every single Seller however it is recommended that this option is provided where necessary, at least for the first auction.
At a pre-determined date the bidding process would be opened and all interested Sellers would be responsible for developing and submitting their bids. It is suggested that once the bidding process is live the Broker is barred from providing any further assistance to Sellers other than general administrative issues. Based on other similar schemes it is recommended that the process includes more than one bidding round whereby the Broker can provide feedback on individual bids and provide an opportunity for the Seller to amend their submission. This ensures the process is as fair as possible but also can help to increase the value for money as bids are re-worked, generally with lower costs or more measures included, in the expectation of receiving the funding.
The Broker would be responsible for evaluating all bids and recommending successful bidders to the RAG. The RAG would not have a role in confirming the successful bidders but would be required to evaluate the bidding process and confirm that it had been transparent and fair and undertaken along the previously accepted methodology.
All successful bidders would be required to sign legally binding contracts before receiving their funds. This would include the conditions of delivery especially the dates by which the management options needed to be in place. Once all contracts are signed the Broker would be responsible for transferring funds probably on a yearly cycle (though this is something that would need to be agreed during the development of the scheme).
Over the period of their agreement the successful bidder would be required to deliver at least all the measures they included in their bid. It would be their responsibility to maintain relevant records and evidence as well as informing the Broker of any problems. If Sellers looked to drop out from the scheme it would be the responsibility of the Broker to fill that capacity with other Sellers in order to deliver the continual decline in loading that is required.
As mentioned previously in this report the success of this scheme will be predicated on robust monitoring programmes being set up (and funded) from the outset. Once monitoring programme will need to be undertaken by the Broker and should involve the auditing of all successful Sellers to ensure that the measures they are being paid to deliver are in place. The scheme should include the ability to sanction any Sellers who are not delivering as agreed
As mentioned previously the reverse auction is a relatively simple process consisting of a defined budget being allocated to sellers via a competitive bidding process in which sellers would enter bids for funding a range of N reduction activities.
Sellers would construct their bids by identifying, from the 100 or so measures provided by ADAS what activities they would be willing to deliver for N reduction on their farm, before proposing the size of grant that they would require in order to deliver this work. It is suggested that the broker works closely with the sellers at this point to ensure the bids are focussed and likely to provide the benefits being sought.
The list of eligible options would be made available to farmers via a number of sources (website, handouts and events, post). and they would need to complete an order to submit a bid. It is recommended that the application process is on-line and sellers would be supported by the Broker.
In order to assist with the administration and scheme management it is suggested that the application process is undertaken through a secure bidding facility on a custom web portal. Other similar schemes such as the Fowey PES scheme successfully used such a system and noted that in particular bids submitted via the portal could be pre-checked by the software for completeness and errors ensuring only valid bids were entered by participants. In addition, bids submitted electronically could be processed automatically, reducing the need for administrator time in handling paper bids received through the post.
Whilst online applications have some obvious benefits it would not be fair to make this the only way to apply as this would discriminate against sellers who did not have the internet. The same form would be available to all sellers irrespective of whether they were completing it electronically or by hand and the timing of the auction would prevent discrimination against postal submissions to ensure the auction remained transparent and fair.
As was identified in WP4 one of the main issues with a reverse auction is the need for a fixed pot of money to fund the auction(s). It is difficult to identify how large each ‘pot’ for an auction would be but in the context of this scheme it is likely that it would need to be well over £100,000 and probably closer to £1,000,000. This level of funding requirement tends to place the burden of providing funding onto larger public sector bodies or significant private sector developments.
However, it is also worth noting that the funding does not need to originate with one organisation, and it is often better when multiple funders are involved. Currently there is no clear idea of what organisations might be willing to provide money though Welsh Government, Dwr Cymru Welsh Water, Pembrokeshire County Council, the National Park and NRW naturally all appear to be the main contenders. The appetite for this has not yet been adequately identified and needs to be checked during any subsequent stages of the scheme’s development.
The potential for wider stakeholders to act as funders should not be ignored and money originating in the private sector would help to reduce the reliance on the shrinking pot of public sector funds. The ability to draw in other funders will ultimately rest on whether the additional benefits of the scheme can be adequately communicated. If they can, and the cost would be lower than alternative activities, then it would clearly make financial sense for the wider stakeholder to contribute to this scheme.
As outlined in the previous section the role of the broker is crucial in a PES system. In the context of Pembrokeshire the broker would be expected to manage the auction mechanism; issue a call for bids; provide information about the procedure and rules associated with the auction; assist landholders to develop their individual management plans; provide information on costs to encourage realistic and feasible bids; manage the bid evaluation process; administration; and monitoring and enforcing the delivery of the land based measures.
The specific details of how the broker would function cannot be identified at this stage however one of the main requirements would be the ability to hold funds and manage contractual obligations for a maximum of 10 years. This is would be a major undertaking for an organisation and the EEP / RAG would need to be satisfied that any organisation putting itself forward for this role could satisfy these criteria as a minimum.
To be eligible for inclusion in the scheme it is suggested that sellers must agree to certain conditions, similar to the ones listed below. These have been amended from the current Glastir Rules Booklet.
In addition, it is likely to be necessary to provide information on land that is not eligible including:
Bids would be evaluated by the broker(s) on the basis of value-for-money, with bids offering higher value-for-money being considered for funding before bids offering lower value-for-money.
A bid’s value-for-money would probably be calculated using a formula that takes account of the number of measures proposed (and consequently the likely N reduction), the type and quantity of capital works, and the farm’s location in the catchment, although this latter one may not be included in the final proposals.
To be considered eligible for funding, bids must exceed a pre-set minimum value-for-money threshold (which will take into account maintaining profitability). Farmers would be able to improve the value-for-money of their bid by agreeing to deliver certain measures for less than the projected cost (i.e. they do not apply for 100% of the projected funding requirement if they think the measure can be delivered more cheaply).
All bids would be ordered according to their value for-money and bids would be accepted for funding up until the point at which the money runs out or the value-for-money threshold is reached. If the latter is reached before the former, unsuccessful sellers would be given an opportunity to re-evaluate and re-submit their bids to try and secure some of this underspend.
The RAG will retain oversight of the whole process and ensure that the broker delivers a transparent and fair scheme. The RAG will not however, be visible in the auction process and will not have any input into the day to day management of the scheme.
If the scheme is successful and expands beyond a traditional reverse auction there will also be a role for the RAG to provide the permitting and planning permission drivers to bring additional buyers into the scheme. This will be an important consideration if the scheme intends to move from a majority publicly funded scheme to a majority privately funded scheme.
 Day, B., Couldrick, L. (2013) Payment for Ecosystem Services Pilot Project: The Fowey River Improvement Auction (Defra London)
As detailed in Work Package 4 one of the main weaknesses of a reverse auction is the need for a funding pot. Typically in similar schemes this is either public or quasi-public (e.g. water company) money, and for a scheme looking to develop a market based solution a reliance on public funding would be a potential weakness. However, this weakness was considered to be less of a threat to implementing a scheme than a lack of buyers is to a more traditional ‘nutrient trading’ approach within Pembrokeshire.
As a result, further research was undertaken on a third option of a hybrid scheme, where the best elements from nutrient trading and reverse auctions are combined. It is envisaged that in Pembrokeshire this would see an element of the funding pot being provided by public funds (as with a reverse auction) but as and when other buyers (most likely to be industry or developers) require permits or planning permission they would be required to provide funds / buy credits which could then be auctioned off.
Over time, if sufficient alternative buyers were available the burden of financing the periodic auctions could move from the public to the private sectors. This would not preclude organisations such as Welsh Government or Dwr Cymru Welsh Water retaining an interest and providing funding to increase the scheme budget if required but it ensures a more equitable split of funding.
A flow diagram for a possible hybrid scheme structure is outlined below. It is similar to the standard reverse auction shown in 24.2 with the exception of the front end. In this scheme whenever a permit or planning application is submitted the submitting body would be informed of the cost of offsetting their impact and they would pay these funds to the Broker. Once the funds have been paid this removes any liability from the Buyer for reducing nutrient levels. The broker would hold the funds until a sufficiently large budget was available to hold an auction.
As detailed above, any other organisation could supplement the budget provided by the Buyer by providing additional funds. These would be secured by Sellers in the same way, irrespective of source, and it would be the role of the Broker to ensure that the measures being put in place delivered sufficient savings to reduce nutrient loading in the rivers.
Figure 17: Possible Hybrid Scheme Flow Diagram