The effects of a linked carbon emissions trading scheme for Latin America

The number of carbon pricing mechanisms implemented in developing countries is increasing. Even though there is regional fragmentation in terms of climate change strategies in Latin America, market-based initiatives are taking shape also in this region. Post-2020, combining these efforts towards carbon integration via an Emissions Trading Scheme (ETS) could be an option for Latin America to adhere to more cohesive and ambitious climate policy actions. Given the lack of quantitative studies, this paper aims to provide preliminary evidence on the appropriateness of this mitigation policy, highlighting potential environmental and economic outcomes in Latin America, as well as identifying trade patterns and the effects of revenue recycling for the region. Using a dynamic-recursive computable equilibrium model, a hypothetical Latin American ETS regulates only carbon emissions from the electricity generation and energy-intensive sectors. Regional carbon-integration among developing countries in this way demonstrates that it is possible to curb emissions at minimum cost. The distributional effect of linking shows a financial flow from Brazil and Mexico to the rest of Latin America, comprising a wider abatement effort within a shared carbon price. There are opportunities from revenue-recycling, which plays an important role in alleviating the additional costs from the policy. The advantage of this approach is to culminate in broad participation where competitiveness concerns may be addressed along with transformations of the energy system. However, to effectively address climate change, additional sectors should be considered for inclusion in the proposed ETS, in line with the region’s energy and economic profiles.Key policy insights A regional carbon policy based on emissions trading in Latin America would expand opportunities for mitigation at lower cost.Brazil and Mexico would import allowances more cost-effectively from the rest of Latin America in the linked scenario.Further energy substitution towards low-carbon sources would be achieved with revenue recycling.A linked ETS system should include land use and forestry-related emissions.