Mexico's carbon tax faces headwinds from energy revamp

MEXICO CITY Mon Oct 7, 2013 1:53pm EDT

MEXICO CITY Oct 7 (Reuters) - Mexico's plan to become the first major oil-producing emerging economy to introduce a carbon tax has a problem: It clashes head-on with the government's ambitions to lower the cost of electricity and boost energy output.

Aiming to raise up to $2 billion, the carbon tax is part of a fiscal reform floated by President Enrique Pena Nieto just as he pushes an energy plan to encourage billions of dollars of investment in Mexico's flagging oil and gas industry.

Presented within one month of each other, Pena Nieto's energy and fiscal bills seek to lower the huge tax burden shouldered by state oil and gas company Pemex, which is also Mexico's biggest producer of carbon emissions.

The carbon tax would affect Pemex's production and its imports of refined products and natural gas, as well as industrial end-users of fossil fuels. Passing on the cost is likely to reach Mexicans in the form of higher prices.

"I think the government should find an alternative," said Jorge Villalobos, a tax expert in Mexico's lower house of Congress for the opposition conservative National Action Party. "It's obvious that our competitiveness would take a hit."

Even officials in the ruling coalition of the Institutional Revolutionary Party and the Green Party say privately the tax is unlikely to survive as it is and might be cut back when Congress starts to discuss the fiscal reform this week.

After Pemex and national electricity utility CFE, heavy industry and the transportation sector are the biggest consumers of fossil fuels in Latin America's second biggest economy.

Backers of the so-called "green tax" say it will encourage investment in renewables, creating a more favorable regime for companies tapping Mexico's abundant clean energy potential.

"The tax will indirectly make renewable energy, especially wind power, more competitive relative to traditional fossil fuel sources," said Adrian Escofet, director of Zapoteca de Energia, a company building a 70 megawatt wind park in southern Mexico.

More than 30 countries have adopted a carbon tax, and the CCE business lobby projects new revenues from the proposed carbon taxes in Mexico at about 26.6 billion pesos ($2 billion), while the government puts the figure at around $1.67 billion.

If it generated $2 billion, the tax would be equivalent to 0.17 percent of Mexico's gross domestic product last year. That compares with about 0.05 percent of GDP for Britain's carbon tax and 0.70 percent of GDP for the comparable Swedish measure.

Mexico's proposed levy would be based on the carbon dioxide (CO2) content in 10 fossil fuels that power the country's economy, which is more dependent than most on oil. The dirtier the fuel, the higher the carbon tax.

In 2012, $69 billion in taxes levied on Pemex funded more than a third of total federal government spending.

CROSS PURPOSES

Pena Nieto campaigned for office last year pledging to cut the cost of electricity, but the tax is unlikely to help.

Peak power costs for industrial users have risen 7.4 percent over the past year, according to CFE data, and would rise another four percent as a result of the new taxes, according to an estimate from the Mexico's main business lobby, CCE.

In the electricity sector, the government's energy reform would update the constitution to allow private sector competition and investment in power generation. But the fiscal reform would apply the highest carbon tax on fuel oil, which accounts for about 16 percent of current power generation.

"There's a sort of schizophrenia here from the government," said Rafael Ch, an economist at think tank CIDAC.

Another contradictory aspect to the carbon tax is that Mexico still spends more to subsidize car drivers and power consumers than the new levy is forecast to raise.

After factoring in existing taxes levied on fuels, Mexico's subsidy for gasoline is worth around $3.5 billion net annually, even though the government is cutting it back sharply.

Miriam Grunstein, an energy specialist with the CIDE research institute, said it made no sense for the government to levy carbon taxes and to control prices at the same time. Plus the gas market was taking a serious hit, she added.

"It would make sense in the United States where you have an incredible oversupply of fuels, but in Mexico you have a scarcity of natural gas," said Grunstein.

About half of Mexico's electricity is currently generated from natural gas, which will account for about 10 percent of total expected carbon tax revenues, according to Jose Ramon Ardavin, head of private sector research for business lobby CCE.

Even before Congress has started to debate the fiscal plan, major industries are talking down the tax.

"No other developing country has successfully implemented taxes on CO2 emissions and there's no reason for Mexico to jump out front," said C.P. Abel Ayala, finance chief for the mining arm of top steelmaker Altos Hornos de Mexico.

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