On 1 October 2019 the Mexican Ministry of Environment and Natural Resources (SEMARNAT) published final regulations for the pilot phase of the national ETS, the first in Latin America. The pilot will last three years beginning 1 January 2020 and ending 31 December 2022.
 
The pilot is designed to pose no economic impact on regulated entities, which means that there will be no monetary sanctions for non-compliance. However, it will help test system design and identify the need for adjustments after 2022; allow participants to familiarize themselves with emissions trading and develop essential capacities; and generate an indicative value for emission allowances and offsets for the operational phase beginning 2023.
 
The cap will be published by 1 December 2019 along with allowance allocations at the facility level. These elements will be prepared using the historical emissions reported in the National Emissions Registry (RENE) and will align with the Nationally Determined Contribution (NDC) sectoral mitigation targets established in the General Law of Climate Change. The final version of the regulations is very similar to the draft regulations released on 25 May 2019 for public consultation.   
 
Scope

The pilot will cover the energy and industry sectors. Energy encompasses electricity generation as well as fossil-fuel extraction and production. Industry includes, among others, automobiles, cement, chemicals, glass, steel, metallurgi1cal, mining, and petrochemicals, as well as the pulp and paper subsector. Only direct CO2 emissions will be regulated by the pilot, and participation is limited to entities with annual emissions greater than 100,000 tCO2. The pilot is expected to cover around 300 entities, corresponding to approximately 45% of national emissions.  

Reserves

Three reserves will be filled with allowances additional to the cap.

  • Auctions: Each year, a volume equivalent to 5% of the cap will be set aside for an auctions reserve.
  • New entrants reserve: Each year, a volume equivalent to 10% of the cap will be set aside for new entrants as well as increases in production among existing regulated entities.
  • General reserve: In addition, each year a volume equivalent to 5% of the cap will be set aside in a separate reserve that which may be used for ex-post adjustment allocation for entities with higher emissions relative to their baselines.

Allocation

The pilot will use free allocation with the following specifications.

  • Total volume: The total volume available for free allocation will correspond to the cap, plus the new entrants reserve, minus the reserve for auctions and the general reserve.
  • Initial free allocation: Entities will receive free allowances corresponding to the emissions in the year (between 2016 and 2019) in which they first crossed the 100k tCO2
  • Ex-post adjustment: An adjustment allocation will be carried out for those participants whose verified emissions in that year are higher than the free allocation received. The regulations do not specify how adjustments will be made in the event demand for additional allowances exceeds reserves.

Auctions

Starting from the second year of the pilot and depending on market behavior, SEMARNAT may auction allowances from the auctions reserve.

Policy interactions

Some of the covered entities are also subject to obligations under Mexico’s clean energy certificates (CELs) system. The draft regulations acknowledge the indirect relationship between the systems but explicitly rule out the use of CELs as compliance instruments during the pilot phase.

Flexibility instruments

Two types of flexibility instruments are foreseen, both of which generate offsets eligible for use under the pilot. Participants will be able to meet up to 10% of their compliance obligations with offsets.

  • Offsets: SEMARNAT will establish a domestic program for the generation of credits that can be surrendered for compliance in the national ETS. Eligible mitigation projects or activities are domestic projects that have been validated and verified under internationally or domestically recognized protocols (as yet unspecified). Emission reductions related to all GHGs will be eligible, though the pilot ETS regulates only CO2.
  • Early action: For those projects or mitigation activities operating under recognized protocols that received offsets before the pilot comes into force, SEMARNAT may issue offsets if a certificate of cancellation is presented. These projects will be allowed to continue generating offsets during the pilot phase.

Banking

If participants are in compliance with their surrender obligations, then the remaining allowances may be banked for use in subsequent compliance periods within the pilot phase. Allowances issued in the pilot phase will only be valid in that phase, although SEMARNAT is tasked to also assess the viability of allowing a share of pilot allowances to be banked into the national ETS.

Monitoring and compliance

Entities will be required to annually report and verify their emissions in accordance with the regulation, annually surrendering a corresponding number of allowances. Monitoring under the pilot does not replace obligations under the broader mandatory reporting system RENE, which requires reporting on greenhouse gases other than CO2. In case of non-compliance, entities lose the opportunity to bank across pilot years. Moreover, non-compliant entities will receive fewer allowances during the operative phase of the national ETS (two fewer allowances for each non-delivered allowance during the pilot phase).

Review and transition into the national ETS

SEMARNAT will annually review the pilot, publishing reports on topics such as price behavior and emissions reductions achieved. An evaluation of the pilot phase, possibly involving consultations with civil society and academia, will also be conducted to determine if adjustments to the ETS design are necessary before the start of the operational phase of the program. Regulations for the operational phase of the Mexican ETS are to be published in 2022, during which a transition from the pilot into the national ETS will take place.