Contracting Nitrogen Abatement in the Baltic Proper Watershed Under the Risk of Climate Change

Within the EU, it is agreed that watershed-based management of water quality problems is likelyto be more economically efficient compared to existing institutional arrangements. Watershedauthorities, assigned under the European Water Framework Directive, do however lack financialresources for policy implementation. EU funding for agri-environmental measures is mainlychanneled through CAP via national governments to the farmers. In this paper, a mechanism forallocating international funds to watershed authorities is investigated assuming that there is a riskof moral hazard on behalf of the regional authority. The assumed purpose of the funding is toreduce nitrogen loads to the Baltic Proper, and the implications of uncertainty about the risk ofclimate change are investigated. Results shows that the risk premium associated with the presenceof moral hazard can be high if there is a high likelihood of climate change and marginal damageis increasing rapidly in loads.