Developing Recommendations for AIIocating Emissions Rights for a Mexican Emissions Trading System

This study has developed an allocation tool in order to support policy makers with the allocation of allowances under the Mexican ETS cap during the pilot phase to participating installations in different sectors of the economy. The allocation scenarios were primarily based upon the grandparenting approach to allocation (i.e. allowances allocated based on historic emissions of the installations). The distribution of allowances to installations based upon grandparenting may be based upon different priorities (i.e. such as protecting firms from carbon leakage) and this is reflected in the allocation scenarios (i.e. in several scenarios the historic emissions of the sectors at risk of carbon leakage were fully covered by free allowances). However, the allocation of free allowances based upon grandparenting distorts the price signal and may undermine the cost effectiveness of the abatement realised.

A stronger price signal may be achieved via the free allocation of allowances based upon a benchmarking approach (i.e. allowances allocated based upon a benchmark factor applied to activity rates at the installation level). In an additional scenario, the impact of applying such an approach at the installation level revealed that there would be both ‘winners’ and ‘losers’ with installations receiving more or less allowances than their historic emissions based upon their benchmark performance. Politically this may be especially challenging for installations with relatively large absolute emissions that receive fewer allowances than their historic emissions and additional support may need to be provided to assist installations to transition to less carbon intensive forms of production. Eventually, if the volume of allowances auctioned increased over time, the revenues raised could be used to directly support industries in order to decarbonise by capitalising existing national funds in Mexico i.e. Fondo para el Cambio Climático. Consignment auctions are one way to explore auctioning already in the pilot phase while maintaining a high share of free allocation.

At the outset of other ETSs, the allocation of allowances based upon grandparenting has often been adopted to overcome initial data limitations and to reduce the need for participants to trade immediately with one another. However, over time different forms of allocation (i.e. auctioning, benchmarking and output based forms of allocation) are introduced that requires additional data in order to implement. The collection of activity data, especially in terms of production, will be important if alternative forms of allocation to grandparenting are to be introduced after the pilot phase. By following a more differentiated approach to allocation by sector, the carbon leakage concerns of industry can initially be addressed via grandparenting. However, in the longer term, a stronger price signal will encourage the energy transformation required for the country to fulfil its NDC and subsequent updates.