Edmond Grieger
Von Wobeser y Sierra
Expert Contributor

Carbon Offset Markets, Climate Action: Where Does Mexico Stand?

By Edmond Grieger | Mon, 08/01/2022 - 12:11

Climate action is urgently required by all countries, companies and individuals to reduce greenhouse gas (GHG) emissions in developing and developed economies to mitigate the adverse effects of the climate change crisis. Worldwide, we have regulated and voluntary carbon credit markets that boost the development of green and sustainable projects to reduce GHG emissions, promote a greener energy transition, restore and protect ecosystems and empower local communities.

A regulated or mandatory carbon credit market consists of a mechanism wherein governments and obligated companies participate to offset their GHG emissions. The countries that have joined regulated mechanisms are those that have committed to the GHG emission limits established in the Framework of the United Nations Convention on Climate Change (UNFCCC), initially under the Kyoto Protocol and, subsequently, the Paris Agreement.

On the other hand, voluntary carbon credit mechanisms operate with the participation of companies and individuals in general through a voluntary process to reduce their carbon footprint. This mechanism can operate in parallel to mandatory markets or even where there is none.

Both mechanisms must pass strict scrutiny and verification processes by national governmental entities or international third-party agencies.

In September 2016, Mexico ratified the Paris Agreement, thus committing to reducing its GHG emissions by 22 percent by 2030 compared to its baseline. The Mexican government is primarily responsible for achieving this goal. However, meeting the goal is not possible without the active participation of the government, companies, local communities, and individuals, since we are all responsible to collaborate, commit and do our best efforts to reduce our GHG emissions.

To achieve the goal, in Mexico we have seen the implementation of a multipronged approach that required the participation of different sectors to be a successful integral strategy. This approach is made up mainly of (i) the holding of public bids for the development of solar, wind and geothermal energy generation projects, (ii) the issuance by the Energy Regulatory Commission of clean energy certificates that certify the production of a certain amount of electricity from clean energy, (iii) the creation of a special federal tax on fossil fuels for carbon content[1] and several local environmental impact and emissions taxes; (iv) reforms to the General Law on Climate Change and Energy Transition Law, which, among others, obliges the Mexican government to create an Emissions Trading System (ETS) and continue supporting the development of clean energy projects; and (v) the support and implementation of voluntary carbon offsets with the participation of multiple private stakeholders, mainly through standard verification processes like Verra or Gold Standard.

An ETS is a mechanism for reducing GHG emissions that works in accordance with the “cap and trade” principle[2]. That is, the government imposes a limit on GHG emissions in certain sectors of the economy. Limits will decrease over time so that, consequently, GHG emissions are reduced. Companies must have permits for each ton of GHG emissions that they release into the atmosphere. If companies do not have enough permits to cover their emissions, they must reduce them or buy permits from other companies, which in turn must reduce their emissions according to the number of permits or rights sold.

Prior to the ratification of the Paris Agreement in 2016, Mexico already had various mechanisms in place to reduce GHG emissions, such as the tax on fossil fuels for carbon content, approved by Congress in 2013 and applied since January 2014[3]. However, the argument behind the mandate to create an ETS is that this system offers the possibility of “promoting the reduction of emissions with the lowest possible cost, in a measurable, reportable and verifiable way, without undermining the competitiveness of the participating sectors in the international markets”[4].

In other words, although in recent times it has become a trend to be a “sustainable”[5] company, the reality is that companies are looking for real and measurable incentives to put aside the use of fossil fuels, which in most cases is much cheaper than using green fuels. The implementation of an ETS is one of the Mexican government's solutions to achieve the goals of the Paris Agreement by forcing and incentivizing companies in Mexico to use green fuels or to modify their operations to reduce their GHG emissions. However, in parallel we have seen an important uptick in the participation of several key players of the Mexican business sector that are developing important carbon capture projects and registering them through voluntary carbon credit mechanisms, such as Verra or the Gold Standard.

[1] Ley del Impuesto Especial sobre Producción y Servicios (Special Federal Tax for Production and Services); article 2, subsection H.

[2] Environmental Defense Fund, “How cap and trade works”, accessed July 27, 2021, available at: https://www.edf.org/climate/how-cap-and-trade-works

[3] Article 2, Section I, subsection H, Special Tax on Production and Services Law, available at: http://www.diputados.gob.mx/LeyesBiblio/pdf/78_241220.pdf

[4] Ministry of the Environment and Natural Resources, " Programa de prueba del sistema de comercio de emisiones ", accesed on July 27, 2021, available at: https://www.gob.mx/semarnat/acciones-y-programas/programa -test-of-emissions-trading-system-179414

[5] The generally accepted definition of “sustainable business” refers to one that has practices that meet the needs of the present without compromising the ability of future generations to meet their own needs. United Nations, Brundtland Report, accessed July 27, 2021, available at: https://sustainabledevelopment.un.org/content/documents/5987our-common-future.pdf

Currently, the ETS is in a test stage[1] where the only participants are facilities that carry out activities in the energy and industry sectors and whose annual emissions are equal to or greater than 100,000 tons of direct carbon dioxide emissions. It is worth noting that the SCE test program has been significantly delayed as the Ministry of the Environment and Natural Resources is still in the process of assigning emission rights[2].

At the moment, the SCE test program does not impose fines or payment obligations for emission rights, as its purpose is for market participants to know how the SCE works. However, since the SCE to be implemented in Mexico is based on international models[3], it is expected that sanctions and fines will be established for GHG emissions higher than those authorized.

The criticisms of the Mexican ETS include the supposed impact that the obligation to reduce emissions will have on the Mexican market and economy. But these types of systems have been successfully implemented around the world since 2005, when the European Union implemented the first ETS[4].

The implementation of the ETS in Mexico should be seen as an area of opportunity for companies in the energy sector and the different industrial sectors, since the Paris Agreement has caused a large majority of national and international investors to incorporate environmental aspects in the risk valuations that they engage to evaluate future investments in a company. This, for the investor, brings the advantage of knowing the company's environmental policy and the possibility of investing in a sustainable company that is effectively implementing a measurable mechanism for reducing its carbon footprint. For companies, it translates into an alternative that will allow them to comply with the applicable regulations with measurable environmental standards that allow the sustainable[5] development of their business in search of attracting more and better investments and clients[6].

Combating climate change by the business sector also has consequences on the ability of companies to attract new talent. Companies with high emissions have found it more difficult to attract new talent. By participating in the regulated ETS or voluntary carbon credit markets, companies guarantee compliance with legislation, reduce emissions, empower local communities, restore and protect ecosystems, eliminate risks of fines and penalties, promote good environmental practices and acquire an unrivaled reputation in the market.

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[1] Official Federal Gazette, accessed on July 27, 2021, available at: https://dof.gob.mx/nota_detalle.php?codigo=5573934&fecha=01/10/2019

[2] Ministry of the Environment and Natural Resources, "Aviso sobre la asignación de los derechos de emisiones y del Sistema de Seguimiento", accessed on July 27, 2020, available at: https://www.gob.mx/cms/uploads/attachment/file/606638/Aviso-Sistema-de-Seguimiento.pdf

[3] Official Federal Gazette, accessed on July 27, 2021, available at: https://dof.gob.mx/nota_detalle.php?codigo=5573934&fecha=01/10/2019

[4] European Commission, “EU Emissions Trading System”, accessed July 27, 2021, available at: https://ec.europa.eu/clima/policies/ets_en

[5] United Nations General Assembly. "Sustainable development", available at: https://www.un.org/es/ga/president/65/issues/sustdev.shtml.

[6] NACG Board Talk, “Climate Change is an Enterprise Risk Multiplier”, accessed August 3, 2021, available at: https://blog.nacdonline.org/posts/climate-change-risk-multiplier