Decarbonisation opportunities to gain momentum in Latin America despite political ambiguity

Decarbonisation agendas, including those around carbon-offset regulation, have gained traction in Latin America over the past year – a trend that has only been reinforced by COP26.

Lagging behind

All Latin American countries have ratified the Paris Agreement. This means that multiple governments and civil societies have, in the past five years, developed efforts to promote decarbonisation policies. Even in Brazil – where President Jair Bolsonaro has adopted a rather dismissive rhetoric on climate change – there is an increasing prevalence of green narratives and proposals across the political spectrum and among corporate discussions. 

Despite that, the development of concrete policies around decarbonisation – and, particularly, around carbon-offset mechanisms – have remained timid in Latin America compared to developed nations. Overall, existing frameworks are still not mature nor aligned to international ambitions, while their adoption by the private sector remains limited. 

This is now set to change. As global momentum increases and continues to drive local trends, ongoing and future initiatives by both the public and the private sector will bring risks but also colourful opportunities for businesses across multiple sectors (including those whose carbon emissions are not necessarily high). 

Current situation

The two more common carbon-offset approaches globally are the emissions trading system (ETS) and carbon taxation. ETS involves the financial trading of pre-established emission endowment by companies to meet their emission targets. A carbon tax, on the other hand, imposes a price on carbon based on a predefined tax rate (without a cap for emissions). 

In Latin America, only Argentina, Chile, Colombia and Mexico have established systems for carbon taxation – with none of them using ETS to date (although its implementation is currently under consideration in Chile and Colombia). Which system(s) will be adopted in Brazil remains uncertain, with both ETS and carbon tax mechanisms being assessed by both Congress and the executive branch. 
For countries relying on carbon taxation, their specific tax rate plays a significant role in ensuring its efficiency. The higher the rate, the more incentives companies have to boost their decarbonisation policies. Data from 2020 indicates that Argentina, Chile, Colombia and Mexico have adopted what can be classified as low rates (below USD 6 per TCO2). For reference, European countries such as Sweden and Finland apply taxes at USD 119 per TCO2 and USD 68 per TCO2, respectively. This showcases the region’s still timid approach to the matter.

The scope of tax exemptions also plays an important role in the efficiency of carbon-offset mechanisms. In Argentina, the tax framework introduced in 2017 applies to liquid and solid fuels, but not to natural gas. This approach – based on the (often ad-hoc) introduction of exemptions for specific sectors – remains a regular feature of the regulatory environment across Latin America (with some notable exceptions, such as Chile), and will likely remain a barrier for the full alignment of incentives for decarbonisation in the region.

Summary map of carbon pricing initiatives in Latin America

Growing momentum

As in other regions, momentum for decarbonisation agendas has only intensified with the conversations around COP26 last year and, more recently, with energy transition demands on the back of the conflict in Ukraine. There has been a growing political consensus around the potential for these agendas to significantly attract foreign investment. In this context, Argentina and Uruguay have recently announced significant developments around green hydrogen projects. In Chile, Congress is currently discussing a climate change bill. This will set the country’s goal for carbon neutrality in 2050, establishing emission-reduction certificates that can be traded and used for compliance purposes. A tax reform approved in January 2021 has also provided Chile’s regulatory framework with positive changes. Tweaks to the carbon tax rules have implied the coverage of more businesses in the energy and industrial sectors. 

Mexico was one of the first nations in the region to introduce climate change legislation. The country has a sound regulatory framework for emissions reduction. However, co-ordination between federal government and private sector efforts to reduce emissions is lacking. In addition, President Andrés Manuel López Obrador (AMLO) has prioritised the fossil fuel sector and is seeking ways to roll back policies that favour renewables. This undermines the prospects for emission reductions. As a result, plans to cut emissions have been largely voluntary efforts by the private sector and subnational governments. 

Framing sustainability projects in a strong pro-job rhetoric will likely continue to be the main strategy for governments to push their decarbonisation agendas in Latin America. It will be a likely key topic in the 2022 elections in Brazil, where the opposition is set to explore Bolsonaro’s weakness on the environmental front. Uruguay – led by pro-business President Luis Lacalle Pou – will continue to rely on this approach to attract foreign investment as the country has one of the best ESG credentials in the region. 

Risks and challenges

This trend will likely benefit from the active and sustained support by multilaterals, reducing regulatory risks. The World Bank, in particular, has been directly involved in providing technical support for carbon pricing under the Partnership for Market Implementation (PMI) programme. This, however, has been limited to a few countries to date (namely Chile, Mexico and Colombia). After being selected for the first stage of the programme, Brazil has failed to advance to its next phases – likely due to its significant domestic co-ordination challenges on the back of Bolsonaro’s reduced political support for the agenda. The voluntary market for carbon offset in Brazil, however, has grown significantly in the past year, underlining the rising appetite by the private sector to lead on this front. 

The smooth advancement of decarbonisation agendas, including those specifically around carbon-offset mechanisms, will likely continue to suffer from occasional hiccups associated with ambiguous political priorities in the region. As many governments remain weak (both for their situation in Congress and their overall approval ratings) and economies vulnerable to external shocks, incumbents will continue to prioritise short-term measures, with green agendas occasionally taking the backseat. This is particularly the case of Brazil (at least throughout the remainder of Bolsonaro’s term, until December 2022), Argentina (where the official poverty rate remains around the 40% threshold) and Mexico (during the AMLO administration). In Colombia, where energy coverage remains insufficient, a persistent challenge is providing energy to rural areas – which poses a unique opportunity for investments in renewables. 

In terms of market incentives, the fact that many countries in the region – notably, Argentina, Ecuador and Mexico – still promote significant subsidies to fossil fuels means that relative prices for the development of renewables and carbon-offset mechanisms will continue to be hampered. In Brazil, a recent initiative by the government to cushion recent hikes to fuel prices has already impacted significantly relative prices in the sector. This will be an additional controversy posing economic-related risks for decarbonisation initiatives in the country in the short term. 

There is a consensus that long-term-oriented business plans help companies navigate macrotrends with reduced setbacks. This will be particularly the case for decarbonisation. Long-term strategies will help businesses anticipate economic costs, manage their carbon compensation requirements and minimise the social impacts of their operations. An active monitoring exercise will complement these measures with an informed notion of public sector plans – which are set to become increasingly impactful as climate change concerns gain traction among civil societies.