Background

Mexico has the second largest economy in Latin America and was the twelfth largest oil producer in the world in 2016.[1] Oil and natural gas dominate its energy portfolio, accounting for 51% and 32% respectively of total energy supply. Almost 80% of the population lives in urban areas, which has pushed up greenhouse gas emissions from transport (many residents use private cars) and contributed to poor air quality. The cost of environmental degradation and natural resource depletion was estimated at 5.7% of GDP in 2015, which, while a drop from 7% of GDP in 2010, is still higher than economic growth, hence constituting “negative” growth if environmental factors were considered.[2] Water resource management is a challenge (15% of water abstraction is from unsustainable sources), as is deforestation and land use change. In the north and northwest part of the country, tropical and subtropical forests are cleared to make room for livestock and agriculture and deforestation has also caused erosion and soil destruction. Also, Mexico’s coastline is threatened by petroleum extraction in the Gulf of Mexico, which has damaged marine ecosystems.

Overall Fiscal Profile

Mexico has generally enjoyed low inflation (2.8% in 2016), though consumer prices spiked at 6.7% in early 2017 following fuel price hikes and currency depreciation, and macroeconomic stability as its real annual GDP growth rate exceeded expectations, coming in at 2.3% in the first half of 2017.  The government has committed to maintain its program of fiscal consolidation, keeping budget deficits at 2.5% of GDP and reducing public debt. The export sector has benefited from three years of relative peso depreciation and bolstered industrial production in the United States. Investment has remained flat for the past two years, with moderated public investment holding it back.

A Fiscal Responsibility Law has provided the overall framework for fiscal policy in Mexico since 2006. It was amended in 2011 to require the government to commit to limit the growth in public spending and keep within a target for the Public Sector Borrowing Requirement (PSBR) in order to keep public debt manageable. In October 2013, Congress approved a tax reform to boost tax revenues by 2% of GDP by 2018. Moreover, Petróleos Mexicanos’ (PEMEX, the state-owned petroleum company) hydrocarbon contracts have seen changes to its tax structure and measures were introduced to strengthen  the collection of sub-national taxes and enhance transparency in intra-governmental revenue sharing.[3] These commitments to a sound macroeconomic and fiscal stance have resulted in the country’s sovereign credit rating being upgraded from negative to stable.

The state will finance recovery and reconstruction efforts following two earthquakes in September 2017, primarily from reserves and a US$ 150 million payout from a World Bank-supported IBRD/FONDEN 2017 catastrophe bond, issued as part of the country’s disaster risk management strategy.[4]

Policy and Legislative Framework for a Green Economy

Environmental sustainability was one of the five pillars of the 2007-2012 National Development Plan and was also integrated into the current National Development Plan (2013-2018). The plans discuss the importance of economic growth and job creation while protecting Mexico’s natural heritage and fostering inclusive green growth, including fighting climate change and preserving biodiversity, while also emphasising more traditional growth indicators such as wealth, competitiveness, and employment.

In 2008, the Law for the Development of Renewable Energy and Energy Transition Financing (LAFAERTE) was passed, and was subsequently amended in January 2012. The Law provides the legislative framework for developing renewable energy and established an Energy Sustainability Fund to facilitate financing of green energy. The Law also sets a ceiling for fossil fuel generation in the overall power mix, limiting it to 65% by 2024; 60% by 2035 and 50% by 2050. The Energy Transition Law (LTE) was then passed in 2015, which also sets clear targets for the next decade.

In 2012, the Mexican Senate voted the Climate Change Law (LGCC – Ley General de Cambio Climático) into effect, committing the country to a 30% reduction of GHG emissions by 2020 and a 50% reduction by 2050 based on a 2000 baseline. Among other things, the LGCC explicitly encourages the deployment of economic tools for achieving national climate policy objectives at both the federal (Federation) and sub-federal (States and Federal District) levels. The LGCC also supports the establishment of a voluntary emissions trading scheme in order to promote cost-effective carbon emission reduction and reporting systems (see below).

In addition, a Special Climate Change Program (PECC) was published in 2014 to set a course for Mexico’s continued economic development without significantly increasing GHG emissions. It builds on the National Climate Change Strategy, published in 2013, and is the Mexican government’s blueprint for mitigating and adapting to climate change. Its overarching goal is to reduce emissions by 50% by 2050 from 2000 levels and  includes a number of mitigation actions to be carried out by different government departments, such as increasing the use of rail for freight transport. Four categories of action are identified: 1) energy production; 2) energy use; 3) agriculture, forestry and other land use; and 4) waste. The PECC is scheduled to end in 2018, and to date there has been no announcement regarding its renewal.

Mexico has also established a National Strategy on Sustainable Consumption and Production and the use of Economic and Environmental Accounts. In 2012, the Sustainable Development Centre, a public-private non-profit, was established and is supporting the development of policies to promote green economy and climate change action.

Fiscal Measures for a Green Economy

Mexico has implemented a variety of fiscal incentives and reforms to support the green economy transition, particularly by weaning itself off fossil fuels. An Energy Sustainability Fund was established in 2008 and is capitalized by a proportion of annual national oil and gas sales and it is used to support research, development and deployment in four areas: 1) energy efficiency, 2) renewable energy, 3) clean technology use, and 4) diversification of primary sources of energy. Since 2005, the Income Tax Law allows for fiscal incentives to investors in machinery and equipment used for renewable energy generation. Investors can benefit from a deduction of up to 100% of their total investment in the first year, provided that the generation plant remains operational for at least five years.

In 2009, a new fiscal policy was imposed on the exploration and production activities of PEMEX, which included a decrease in the special duty by 30%. While as recently as 2009, 40% of government revenue came from taxes and direct payments from PEMEX, the company’s contributions to government revenue have dropped to below 20%.[5] This follows a tax restructuring of PEMEX, which simplified and reduced its burden after the company reported a net loss of US$ 30.3 billion (with a tax and duty burden of US$ 22.9 billion) in 2015.[6] Declining oil prices have likewise played an important role, with the relative share of fiscal revenues from oil dropping by more than 50% in 2015.[7]

Looking at fuels, the Excise Tax on Products and Services provides a compensation mechanism to support volatility in diesel and gas. In addition, retail prices were elevated by 1% to mitigate increases in prices. To complement these efforts, financial support and credits have been allocated to renewable and transport projects, as well as to transportation modernization. In order to reach its renewable energy generation goals, Mexico has introduced a Clean Energy Certificate (CEC) scheme, an obligation on retail suppliers and large consumers, which will be sellable by qualified generators and tradable when the CEC market is launched in 2018 (see CFE unbundling below).[12]

Carbon Pricing Efforts

In 2013, the Federal Government proposed a tax on fossil fuels based on their carbon content at US$ 5.70 per ton of CO2. This proposal was well received, though the price was ultimately set at US$ 3.50 per ton of CO2, with a straightforward administration whereby taxes are paid at the production or import stage, which can be credited except at the final sale (similar to a VAT).[8] Focused on liquid transportation fuels and coal, the tax initially did not apply to natural gas, which was emphasized as a cleaner fuel. The tax is forecast to cut emissions by 1.6 million tons annually while generating US$ 1 billion in revenue.[9]

To offset some of these new costs, Mexico launched a voluntary exchange on the Mexican Stock Exchange that provided companies undertaking qualified projects with carbon credits. In December 2017, a new regulation set the rules for the use of emission reduction credits for compliance under the Mexico carbon tax. As a means to pay liabilities under the carbon tax, the regulation allows the use of Certified Emission Reductions (CERs) originating from Clean Development Mechanism (CDM) projects in Mexico as well as CERs that are also eligible for compliance in the EU ETS [16].

Taking this approach one step further, a national carbon market simulation was run between 2017 and 2018. The simulation brought together more than 100 Mexican companies from numerous economic sectors representing two thirds of Mexico’s greenhouse gas emissions. In 2017, the Mexican Lower Chamber of Congress approved amendments to the General Law on Climate Change, establishing the mandate to design and launch an ETS in Mexico. The ETS would operate in a pilot phase for 36 months and is planned to formally start from 2022 onwards [17]. It could possibly be joined with other North American allowance markets, such as those in California and Québec (with whom Mexico has signed MoUs on collaboration).

Fossil Fuel Subsidy Reform

Mexico is a producer of oil and government revenues have historically been highly dependent on oil exports. However, oil output has fallen significantly over the past decade, which has been partially offset by increasing energy imports, causing some fiscal strain. Further, the country has historically subsidized fuel use, with the government investing more into subsidizing gasoline consumption than its main poverty reduction program, Oportunidades, in 2012, and with most of the benefits going to high-income households.[10] While fuel subsidies have been mostly eliminated through incremental price adjustments, significant subsidies remain in the electricity sector, mainly to wealthy households and agricultural producers, amounting to 0.6% of public spending in 2015.[11]

The significant government spending on fossil fuel subsidies and transportation has placed a burden on the fiscal budget. Mexico had, until recently, a nationalized oil industry, and PEMEX, the national oil company, remains at the core of exploitation, operation and other activities pertaining to Mexican oil and gas. However, following declining production and poor performance by PEMEX (incl. management challenges, debt burdens, outdated technologies, and other), the government embraced reform through constitutional changes in 2013, which became codified into 10 new and 12 modified laws in 2014.[12, 13]

The energy reform law was passed, which in additional to introducing a carbon tax (see above) strove to promote investment in the energy sector by opening the sector up to participation from the private sector in exploration, extraction and power generation. This entailed a shift, as the sector had been under state control for approximately 75 years. To stimulate private activity, the Secretary of Energy can grant licences to private companies (both local and foreign) for refining, processing, transportation, and storage activities. The objectives of the reform are to privatize the market – though special rights are granted to PEMEX, for example it will have priority for entitlements to extract oil and gas on specific conditions – though joint ventures could be introduced to improve technology adoption.

The new law is expected to induce 1% of additional GDP growth and create 1.8 million jobs by 2018, with a 2% additional GDP growth and 1.5 million jobs by 2025. Further, the reforms addressed the pricing regime of transport fuels, slowly removing subsidies and allowing domestic prices of to track international prices. A band of 3% band in 2016 was followed by a 20% cap in 2017, with government intervention removed by 2018.

The reforms also addressed the state-owned electric utility, Comisión Federal de Electricidad (CFE), unbundling it into generation, transmission, and distribution subsidiaries. Opening up the market to private players to compete at the wholesale and retail levels is forecast to mobilize US$ 10 billion per year as well as decrease prices through efficiency gains, both critical to address increasing demand, forecast to climb 85% by 2040. [7] As previously mentioned, current subsidy (estimated net subsidies ot the sector were US$ 3.8 billion in 2015) beneficiaries are primarily higher-income households, with the top three deciles receiving 40% of the benefits, and 25% of those paying the lowest tariff are part of the top income decile.[11] In the agricultural sector, the subsidies encourage over-pumping of water and therefore the over-drawing of aquifers. Given the gravity of the situation, the prospect of electricity subsidy reform has the attention of policymakers, particularly following the successful implementation of reform efforts on transport fuels.

One key to effective reform, however, is high-quality data. To that end, Mexico has joined the G20 voluntary peer review of inefficient fossil fuel subsidies, a process initiated in 2013 with a view to reducing wasteful consumption. To date the United States and China have completed their reviews, and Mexico and Germany are next in line,[14,15] with their peer review reports launched in November 2017.

Bibliography:

1 – U.S. Energy Information Administration (n.d.), Total Petroleum and Other Liquids Production 2016, https://www.eia.gov/beta/international/

2 – The Economics of Ecosystems & Biodiversity (n.d.), Biodiversity of Mexico, http://www.teebweb.org/teeb-mexico/biodiversity/

3 – World Bank (2017), Mexico Overview, http://www.worldbank.org/en/country/mexico/overview

4 – Artemis (2017), Mexico confirms $150m cat bond payout for quake, 11 October 2017, http://www.artemis.bm/blog/2017/10/11/mexico-confirms-150m-cat-bond-payout-for-quake/

5 – Garcia (2017), Mexico’s Pemex posts profit for third straight quarter, CNBC, 27 July 2017, https://www.cnbc.com/2017/07/27/reuters-america-update-2-mexicos-pemex-posts-profit-for-third-straight-quarter.html

6 – Vietor R.H.K and H. Sheldahl-Thomason (2017), Mexico’s Energy Reform, HBS 717-027, https://sites.hks.harvard.edu/hepg/Papers/2017/Mexican%20Energy%20Reform%20Draft%201.23.pdf

7 – IEA (2016), Mexico Energy Outlook, International Energy Agency, https://www.iea.org/publications/freepublications/publication/MexicoEnergyOutlook.pdf

8 – Muñoz Piña, C. (2015), Fossil Fuel Subsidy Reform in Mexico, APEC Presentation, December 2015, https://www.ewg.apec.org/documents/Session_2_Munoz.pdf

9 – Carl, J. and D. Fedor (2016), Tracking global carbon revenues: A survey of carbon taxes versus cap-and-trade in the real world, Energy Policy 96: 50-77, https://doi.org/10.1016/j.enpol.2016.05.023

10 – Ramírez Mata, J. (2016), Rethinking Energy Subsidies in Mexico, Cornell Policy Review, http://www.cornellpolicyreview.com/rethinking-energy-subsidies-in-mexico/

11 – OECD/IEA (2016), Fossil Fuel Subsidy Reform in Indonesia and Mexico, https://www.iea.org/publications/freepublications/publication/PartnerCountrySeriesFossil_Fuel_Subsidy_Reform_Mexico_Indonesia_2016_WEB.pdf

12 – IEA (2017), Energy Policies beyond IEA Countries: Mexico 2017, International Energy Agency, https://www.iea.org/publications/freepublications/publication/EnergyPoliciesBeyondIEACountriesMexico2017.pdf

13 – Dominguez Ordonez, C. (2015), G20 subsidies to oil, gas and coal production: Mexico, https://www.odi.org/sites/odi.org.uk/files/odi-assets/publications-opinion-files/9967.pdf

14 – G20 (2017), Hamburg Annual Progress Report on G20 Development Commitments, http://www.g20.utoronto.ca/2017/2017-g20-hamburg-annual-progress-report-en.pdf

15 – G20 (2017), Mexico’s efforts to phase out and rationalise its fossil fuel subsidies: A report on the G20 peer-review of inefficient fossil-fuel subsidies that encourage wasteful consumption in Mexico, https://www.oecd.org/site/tadffss/Mexico-Peer-Review.pdf

16 – World Bank (2018). State and Trends of Carbon Pricing 2018. https://openknowledge.worldbank.org/bitstream/handle/10986/29687/9781464812927.pdf?sequence=5&isAllowed=y

17 – ICAP (2018). International Carbon Action Partnership. https://icapcarbonaction.com/en/?option=com_etsmap&task=export&format=pdf&layout=list&systems[]=59