Reducing emissions in the Mexican power sector: Economic and political feasibility analysis of policy mechanisms

A comparative assessment of market-based climate policy instruments –carbon tax vs. ETS– for emission reduction in the Mexican electricity sector is presented. Model-based scenarios of different tax and cap levels were simulated on an existing Balmorel partial equilibrium model populated with data from the Mexican electricity system. The simulation results served to compare the performance of both instruments according to economic criteria. The analysis was further developed with the empirical evidence obtained from international experiences with both instruments, allowing to conclude on the first-best normative instrument based on an economic approach. The assessment was complemented with a political feasibility perspective, through the development of an on-line survey and in-depth interviews with representatives of the relevant stakeholder groups within the country. The first-best instrument was not favoured by the stakeholders, but the study allowed to hint a second-best alternative with a better probability of being fully implemented. The results of this project are useful to guide the necessary debate surrounding the selection of the most appropriate carbon-pricing mechanism for emissions reduction in the country, in particular in the electricity sector. A wide-coverage carbon tax with no exemptions and with revenue-recycling mechanisms, gradually increasing to 15 USD/tCO2 would be the first-best instrument from the economic perspective. However, when complementing the analysis with the political feasibility perspective, the most appropriate instrument for emissions reduction in the Mexican electricity sector is an emissions trading system with the cap set as the conditional target of the INDCs, with auctioned allowance allocation and an auctioning floor-price, set at a similar but lower value than the equivalent carbon tax. Such an instrument is in line with the priorities of the stakeholder groups and would generate a stable price signal, allowing for the earmarking of carbon revenue, and would avoid exempting natural gas from carbon pricing.