Decarbonization efforts in the global south are crucial for addressing climate change and promoting sustainable development. Central to these efforts are carbon pricing mechanisms. In Latin America and the Caribbean, where the impacts of climate change are particularly acute, the adoption and implementation of effective carbon pricing mechanisms are essential for achieving climate goals and fostering resilience. In this OpEd, we explore carbon pricing mechanisms and their state of adoption in the region.
What are Carbon Pricing Mechanisms intended for?
Carbon pricing mechanisms are designed to internalize the external costs associated with greenhouse gas (GHG) emissions by assigning a monetary value to carbon dioxide (CO2) emissions. These mechanisms capture the costs borne by society due to climate change impacts, such as damage to crops, healthcare expenses from extreme weather events, and property loss from flooding and sea level rise. By imposing a price on carbon emissions, carbon pricing mechanisms aim to shift the financial responsibility for these damages back to the emitters who are accountable for them. The primary purpose of carbon pricing is to provide an economic incentive for emitters to reduce their emissions. In Latin America, they typically target the transportation, electricity generation, agriculture, and buildings sectors.
The revenue generated via carbon pricing mechanisms—around US$940M in 2023—can be used to support targeted initiatives aimed at addressing energy access and affordability, strengthening social safety nets, and advancing other socioeconomic priorities. This can enable a just transition to a low-carbon economy while promoting broader societal well-being.
How can Carbon be Priced?
Expanding the reduction of GHG emissions and reducing mitigation costs are essential for the decarbonization of economies. Given the magnitude and urgency of the climate challenge, a comprehensive array of carbon pricing strategies is necessary, in conjunction with complementary policies and regulations. Below is a synopsis of various carbon pricing mechanisms:
Emission Trading Systems (ETS): This system enables emitters to trade emission units to meet their emission targets. To fulfill their obligations at minimal expense, regulated entities can either adopt internal abatement measures or procure emission units in the carbon market, based on the relative costs. By generating demand and supply for emission units, an ETS establishes a market price for GHG emissions. There are two main ETS systems:
Cap-and-trade systems set an absolute limit on emissions within the ETS and distribute emission allowances, often through auctions or free allocation, equal to the established cap. For example, the European Union uses the ETS cap and trade system.
Baseline-and-credit systems define baseline emission levels for individual regulated entities and issue credits to those entities that reduce emissions below this threshold. These credits can then be traded with entities surpassing their baseline emission levels. India and China have implemented these schemes.
Carbon Taxes: These directly establish a carbon price by stipulating an explicit tax rate on GHG emissions or, more commonly, on the carbon content of fossil fuels, typically denoted as a price per tonne of CO2 equivalent. Unlike an ETS, a carbon tax does not predetermine the emission reduction outcome but does fix the carbon price. As shown in the figure below, Mexico, Chile, Argentina, and Colombia use this system.
Carbon Credits: These represent GHG emission reductions from project- or program-based activities, which can be traded domestically or internationally. Crediting Mechanisms issue carbon credits based on specific accounting protocols and maintain their own registries. These credits serve compliance under international agreements, domestic policies, or corporate sustainability objectives related to GHG mitigation. Australia uses this type of system via the Australian Carbon Credit Scheme.
Results-Based Climate Finance (RBCF): This financing approach disburses payments following the achievement and verification of predefined outputs or outcomes associated with climate change management, such as verified emission reductions. Many RBCF initiatives seek to procure certified GHG emission reductions while simultaneously addressing poverty alleviation, enhancing access to clean energy, and delivering health and community benefits. This mechanism is often used by the World Bank and other development financing institutions.
How can it be measured?
A good measure of carbon pricing is Effective Carbon Rates (ECR)—as defined by the Organisation for Economic Co-operation and Development (OECD), which defines effective carbon rates as the price on carbon emissions resulting from explicit carbon pricing instruments, such as carbon taxes and ETS, as well as implicit carbon prices embedded in energy taxes and other policies affecting the use of fossil fuels.
The OECD ECR database presents carbon prices arising from carbon taxes, ETSs, and fuel excise taxes and their mapping to the GHG emissions they cover for each country by sector and fuel. Net ECR accounts for fossil fuel subsidies (as a negative adder).
Overview of Carbon Pricing in Latin America and the Caribbean
Generally, Latin American and Caribbean countries have low effective carbon rates compared to OECD countries. As of 2023, only four countries have implemented explicit carbon pricing systems: Chile, Argentina, Colombia, and Mexico. As provided by the OECD database, Chile enforces a specific carbon tax of EUR 1.40 per tCO2e for power generation while excluding the transport and building sectors. It is the highest in the region. Meanwhile, Argentina, Colombia, and Mexico primarily impose explicit carbon taxes in the transport and agriculture sectors, with average rates of EUR 0.73, EUR 0.79, and EUR 1.16, respectively, across their entire national emissions.
Other countries, such as Costa Rica, Dominican Republic, Uruguay, Panama, Guatemala, Peru, Paraguay, Brazil, and Ecuador have adopted fuel excise taxes (typically in the form of point of sale fuel taxes for fuels such as gasoline or petrol). As a result, (on road) transportation is the sector that is most targeted by carbon pricing initiatives.
Although considered by many countries (including Brazil and Chile), and piloted in Mexico, ETS are not yet deployed in the region.
As seen below, Costa Rica, Jamaica, and Mexico are the three countries in the region with the highest net effective carbon rates—all driven by high fuel excise taxes. Note that the majority of the countries in the region have ECRs lower than the average OECD ECR.
Source: OECD
Carbon Tax: Individual Country Overview
Chile: As of 2021, carbon pricing measures in Chile primarily comprise carbon taxes, accounting for 33.2% of GHG emissions in CO2e. Additionally, a positive Net ECR applies to 55.8% of GHG emissions, a figure unchanged since 2018. Fuel excise taxes cover 22.6% of emissions in 2021, while fossil fuel subsidies offset 1.3% of emissions. In June 2022, Chile passed its "Framework Law on Climate Change," establishing a carbon neutrality goal by 2050 and outlining national, regional, and local climate policies to achieve it. These policies include Chileʼs Nationally Determined Contributions (NDC), Long-Term Climate Strategy, Climate Change Financial Strategy, and sectoral mitigation and adaptation plans. The specific design of the emissions limits system remains undetermined and could be realized either as an ETS or a tradable performance standard. Furthermore, in August 2022, the government released its 2022-2026 Energy Agenda, which outlines plans for developing a pilot ETS project in the energy sector. This initiative aims to assess the effectiveness of the instrument in reducing emissions and facilitating a just transition in a cost-effective manner.
Mexico: Since 2021, Mexico's explicit carbon pricing framework comprises carbon taxes, addressing 42.4% of GHG emissions in CO2e—a rise from 40.6% in 2018. Additionally, fuel excise taxes accounted for 22.7% of emissions in 2021, compared to 22.1% in 2018. A characteristic feature of Mexico is that it applies carbon taxes at the subnational level: Zacatecas, Tamaulipas, Querétaro, Yucatán, and the State of Mexico maintain the application of the tax in force. The average price is 262 MXN (US$14.62).
Colombia: In 2021, carbon taxes covered 19.4% of GHG emissions—up from 11.9% in 2018. Fuel excise taxes cover 17.9% of emissions, but fossil fuel subsidies also cover 16.7% of emissions. Colombia’s CO2 emissions from energy use make up about 44% of its GHG emissions. Colombia priced about 50% of its carbon emissions from energy use and about 2% were priced at an ECR above EUR 60 per tonne of CO2, which is often considered as a midpoint estimate for carbon costs in 2020 needed to be on track to reach the goal of the Paris Agreement and decarbonise by mid-century economically.
Argentina: The Argentine government introduced a carbon tax (known as "impuesto al dióxido de carbono") on January 1, 2018, applicable to most liquid fuels, thereby replacing previous fuel taxes. This tax also extends to certain solid products, such as mineral coal and petroleum coke. For fuel oil, mineral coal, and petroleum coke, the tax rate has been gradually phased in. It commenced operation in January 2019 at 10% of the full tax rate and is set to incrementally increase by 10% annually, reaching 100% by 2028. All revenue generated on solid product taxes is allocated in accordance with the Federal Revenue Distribution System for fuel oil, mineral coal, and petroleum coke. As for other products, revenue is distributed among various beneficiaries, including the social security system, the Transport Infrastructure Trust, the National Housing Fund (FONAVI), and the provinces, among others. In 2021, carbon taxes accounted for 15.8% of GHG emissions. Additionally, fuel excise taxes covered 38% of emissions, while fossil fuel subsidies covered 29.9% of emissions.
For more information on country-specific carbon pricing mechanisms, visit this World Bank dashboard.
What could be done next?
Implementing effective carbon pricing mechanisms in Latin America and the Caribbean requires a multifaceted approach that addresses various challenges and leverages opportunities specific to the region. Here are some strategies for enabling better carbon pricing mechanisms in the short, medium, and long term.
Short Term:
Policy Alignment: Coordinate with regional governments to align existing policies and regulations with carbon pricing objectives. This may involve integrating carbon pricing mechanisms into broader climate change strategies or updating existing environmental regulations. This includes, for example, the progressive halt of fossil fuel subsidies (this being an opportunity in Ecuador, for example).
Capacity Building: Provide technical assistance and capacity-building programs to governments, businesses, and civil society organizations to enhance their understanding of carbon pricing mechanisms and their implementation.
Stakeholder Engagement: Foster dialogue and collaboration among key stakeholders, including government agencies, businesses, academia, and civil society, to build consensus and support for carbon pricing initiatives.
Pilot Projects: Launch pilot carbon pricing projects in select industries or regions to demonstrate the feasibility and benefits of such mechanisms. This can help generate momentum and build confidence among stakeholders. This is currently performed in Mexico for the ETS.
International Collaboration: Collaborate with international organizations, such as the World Bank, Inter-American Development Bank, and United Nations agencies, to access funding, expertise, and best practices for carbon pricing implementation.
Medium Term:
Legislative Support: Advocate for the enactment of carbon pricing legislation or the integration of carbon pricing mechanisms into existing climate change laws. This can provide a more stable regulatory framework and ensure long-term commitment to carbon pricing.
Market Development: Develop and strengthen carbon markets or trading platforms to facilitate the buying and selling of carbon credits. This can create additional incentives for emission reductions and promote cost-effective mitigation strategies.
Sectoral Approaches: Implement sector-specific carbon pricing mechanisms tailored to the unique characteristics and challenges of key industries, such as energy, transportation, and agriculture. As seen above, current carbon pricing initiatives are mainly based around the transportation sector. Optimizing initiatives for industrial and agriculture sectors could be equally beneficial, depending on the emission profiles of each country.
Carbon Tax Reform: Introduce or reform carbon taxes to reflect the true cost of carbon emissions and incentivize emission reductions. This may involve gradually increasing carbon tax rates over time to align with climate targets.
Monitoring and Enforcement: Enhance monitoring, reporting, and verification mechanisms to ensure compliance with carbon pricing regulations and prevent fraud or abuse.
Long Term:
Integration with Sustainable Development Goals: Integrate carbon pricing objectives into broader sustainable development frameworks, such as the United Nations Sustainable Development Goals (SDGs), to promote synergies between climate action and other development priorities.
Innovation and Technology Deployment: Invest in research, development, and deployment of low-carbon technologies and innovation to facilitate the transition to a more sustainable and low-carbon economy.
Just Transition: Develop policies and programs to ensure a just transition for workers and communities affected by the shift to a low-carbon economy, including retraining and job creation in emerging green industries.
Carbon Neutrality Targets: Set ambitious long-term targets for achieving carbon neutrality or net-zero emissions, and use carbon pricing mechanisms as a central tool to drive progress towards these goals. Some countries in the region still do not have long term decarbonization objectives (including Venezuela and Bolivia as of 2023).
Regional Collaboration: Strengthen regional cooperation and collaboration on carbon pricing initiatives, including harmonizing carbon pricing policies across countries and sharing best practices and lessons learned.
By pursuing these strategies in the short, medium, and long term, Latin America and the Caribbean can enhance the effectiveness of carbon pricing mechanisms and contribute to global efforts to mitigate climate change.
In conclusion, the adoption and implementation of carbon pricing mechanisms represent a vital step towards successful and inclusive decarbonization. By internalizing the external costs of GHG emissions, carbon pricing mechanisms can incentivize emission reductions, drive innovation, and promote sustainable development. However, realizing the full potential of carbon pricing requires concerted efforts at the national, regional, and international levels. Through policy alignment, capacity building, stakeholder engagement, and long-term planning, Latin America and the Caribbean can harness the power of carbon pricing to mitigate climate change, promote economic prosperity, and build a more resilient future for all.
Comments