Mexico releases new draft regulations for pilot ETS

On 25 May 2019 the Ministry of Environment and Natural Resources (SEMARNAT) of Mexico released new draft regulations for public comment on the pilot phase of the national emissions trading system (ETS). The process originally began in October 2018 but was suspended to allow the incoming presidency to conduct new consultations.

According to the draft regulation, the purpose of the pilot is to help achieve Mexico’s climate targets in a cost-effective way; test the design of the system and allow for adjustments; allow participants to familiarize themselves with emissions trading and develop capacities; and generate a value for emission allowances and offsets. The pilot is scheduled to last 36 months, from 1 January 2020 to 31 December 2022.

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

Information on the cap and on allowance allocation for the pilot phase will be released before the start of the pilot. They will be based on historical emissions and sectorial goals, in line with the country’s Nationally Determined Contribution (NDC).

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: Each year, a volume equivalent to 10% of the cap will be set aside in a new entrants reserve, which may also be used for increases in production.
• General reserve: In addition, each year a volume equivalent to five percent of the cap will be set aside in a separate reserve to allow for adjustments.

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 minus 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 100ktCO₂ threshold.
• 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.

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

Some of the covered entities are subject also to the 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.

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 ten percent 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 SEMARNAT will issue credits that can be used for compliance under the pilot.
• 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 duration of the pilot.

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 for that period, although SEMARNAT is tasked to also assess the viability of allowing a share of pilot allowances to be banked into the national ETS.

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 is without prejudice to companies’ obligations under the broader mandatory reporting system and National Emissions Registry (RENE), which requires them to also report 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).

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.