Whether G20 countries embrace responsible climate policy is of critical importance, since together they account for roughly 80 percent of global greenhouse gas emissions and 80 percent of global GDP. German Chancellor Angela Merkel has announced responsible climate policy as a goal of this year’s G20 Summit in July. In the lead up to the Summit, WRI researchers will take a close look at G20 countries’ progress toward meeting their targets under the Paris Agreement through our G20 Climate Progress blog series.

Mexico has been a leader amongst developing countries addressing climate change, showing willingness and determination to decouple carbon emissions and economic growth. The country aims to reduce its emissions 22 percent below 2000 levels by 2030; 50 percent by 2050.

The country is using carbon pricing as a key policy instrument, presented as a carbon tax in its Nationally Determined Contribution (NDC) under the Paris Agreement and as emissions-permit trading in its Mid-Century Strategy (MCS). Because carbon pricing is also under discussion in many other countries, including China, Singapore and Kazakhstan (though currently in a hiatus), a close look at how Mexico is implementing its carbon pricing may highlight useful lessons for others moving towards a similar system.

Here are three steps the Mexican government has taken to establish more comprehensive carbon pricing:

The Mexican Congress passed a tax on carbon from fossil fuel use, charging $3.50 per ton of emissions. Natural gas was zero-rated initially as a relatively "clean" fossil fuel and in order to boost political acceptance of the tax. The carbon tax is expected to reduce annual carbon emissions by 1.6 million tons of greenhouse gas emissions and generate almost $1 billion in revenue annually. Under the General Climate Change Law, Mexico launched MÉXICO2, a voluntary exchange that provides carbon credits to companies that develop environmentally friendly projects in the country. These credits can be used to offset costs from the carbon tax. The Mexican Stock Exchange (BVM) operates the program, making it one of only seven stock exchanges in the world to offer environmental markets. In November 2016 at COP22, Mexico launched the Carbon Market Exercise, or Ejercicio de Mercado de Carbono (EMC), an initiative jointly managed by MÉXICO2 (Plataforma Mexicana de Carbono) and the BMV Group in cooperation with the Secretariat for the Environment and Natural Resources (SEMARNAT). The exercise is a carbon market simulation (no real emissions will be traded) to help companies get familiar with the way carbon trading works. At the same time, it will provide useful information to the government for defining the rules of a real carbon market, which the country plans to draft by the end of 2017 and implement in 2018. About 50 companies are currently participating, having just completed phase 0 at the end of March 2017, and are now transitioning toward Phase 1, where the first trading auctions will take place. Participating firms represent 13 sectors of the Mexican economy, including two of the largest emitters, the state-owned electricity (CFE) and oil (PEMEX) companies.

The Key to Hitting Mexico's Emissions Target

Recent WRI analysis shows that expanding Mexico's modest carbon price to an economy-wide carbon tax could be a key to achieving the country's emissions-reduction targets. By setting a carbon price of $15 per ton of emissions, the study found that Mexico could see 12 percent of the emissions reductions needed to meet the objectives of its NDC.

A strong carbon price will induce the electricity sector to shift away from high-carbon fuels and, to a more gradual extent, the transportation sector to shift toward cost-effective alternative fuels and vehicles. It may also provide enough incentives to reduce emissions in other economic sectors by shifting investments to more cost-effective, low-carbon alternatives.

The analysis recommends that crucial government agencies—such as the Secretariats for the Environment and Natural Resources, Energy, and Finance and Public Credit—increase support for an effective carbon tax. In particular, the study recommends removing the political and social barriers and uncertainty about economic impacts of the tax in different sectors. The current carbon market exercise may help.

Moving Forward

If the Carbon Market Exercise is effective, it will help the government draft clear rules for the actual carbon market planned for next year, which is expected to cover up to 40 percent of Mexico's greenhouse gas emissions. That first-of-its-kind market in Latin America, if successful, will be an example for the rest of the region, sending positive signals and potentially aligning with or even linking to efforts in the United States (California) and Canada (Quebec and Ontario).

EDITOR'S NOTE: 4/14/17: A previous version of this blog post stated that the Mexican Congress exempted natural gas from a carbon tax. We have since amended the post to indicate that the Congress gave natural gas a zero-rating initially.