Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 57323-MX

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT FOR A PROPOSED LOAN

IN THE AMOUNT OF US$401 MILLION

TO

THE UNITED MEXICAN STATES

FOR A

LOW-CARBON DEVELOPMENT POLICY LOAN

October 25, 2010

Sustainable Development Department Brazil Country Management Unit Latin America and the Caribbean Region

This document is being made publicly available prior to Board consideration. This does not imply a presumed outcome. This document may be updated following Board consideration and the updated document will be made publicly available in accordance with the Bank’s policy on Access to Information.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS

(Exchange Rate as of October 15, 2010)

Currency Unit = Mexican Peso US$1.00 = MX$12.391

MX$1.00 = US$0.08

FISCAL YEAR

January 1 – December 31

WEIGHTS AND MEASURES

Metric System

ABBREVIATIONS AND ACRONYMS

ADF French Development Agency (Agence Française de Développement) BANSEFI BANXICO

National Savings and Financial Services Bank (Banco de Ahorro Nacional y Servicios Financieros S.N.C.) Bank of Mexico (Banco de México)

CAS Country Assistance Strategy CCE Management Coordination Council (Consejo de Coordinación

Empresarial) CDI National Indigenous People’s Commission (Comisión Nacional para el

Desarrollo de los Pueblos Indígenas) CDM Clean Development Mechanism CFAA Country Financial Accountability Assessment CFE Federal Electricity Commission (Comisión Federal de Electricidad) CICC Inter-Secretarial Commission on Climate Change (Comisión

Inter-secretarial de Cambio Climático) CNH National Hydrocarbons Commission (Comisión Nacional de

Hidrocarburos) CO2 Carbon dioxide CO2e Carbon dioxide equivalent CONABIO Nacional Commission for the Knowledge and Use of Biodiversity

(Comisión Nacional para el Conocimiento y Uso de la Biodiversidad) CONAFOR National Commission for Forestry CONANP National Council of Protected Natural Areas (Consejo Nacional de Áreas

Naturales Protegidas) CONAVI National Housing Commission (Comisión Nacional de Vivienda) CONUEE COP16

National Commission for the Efficient Use of Energy 16th Conference of the Parties (UNFCCC)

CPAR Country Procurement Assessment Report CPS Country Partnership Strategy CRE Energy Regulatory Commission (Comisión Reguladora de Energía) CTF Clean Technology Fund DPL Development Policy Loan ENACC National Climate Change Strategy (Estrategia Nacional de Cambio

Climático) EPA Environmental Protection Agency (U.S.) ESW Economic and Sector Work FCL Flexible Credit Line FCPF Forest Carbon Partnership Facility

FTA Free Trade Agreement GDP Gross Domestic Product GEF GGFR

Global Environment Facility Global Gas Flaring Reduction Initiative

GHG Greenhouse Gases GoM Government of Mexico GW Gigawatt IBRD International Bank for Reconstruction and Development IDB Inter-American Development Bank IDF Institutional Development Fund IMF International Monetary Fund IPP Independent Power Producer INE National Institute for Ecology (Instituto Nacional de Ecología) INFONAVIT National Workers Housing Fund (Instituto del Fondo Nacional de la

Vivienda para los Trabajadores) kWh Kilowatt-hour LDP Letter of Development Policy LFC Luz y Fuerza del Centro (Central Power and Light) LULUCF Land use, land-use change, and forestry MMCFD Million cubic feet per day mt Million tons MEDEC Mexico Low-Carbon Study (México: Estudio sobre la Disminución de

Emisiones de Carbono) MOU Memorandum of Understanding MRV Monitoring, Reporting, and Verification MTEF Medium-Term Expenditure Framework NAFTA North American Free Trade Agreement NAMA Nationally Appropriate Mitigation Action NDP OECD

National Development Plan Organization for Economic Co-operation and Development

PECC PEDHSCC

Special Program for Climate Change (Programa Especial de Cambio Climático) Sustainable Housing Program for Climate Change (Programa Específico Desarollo Habitacional Sustentable ante el Cambio Climático)

PEF Federal Expenditure Budget (Presupuesto de Egresos Federales) PEMEX Petroleos Mexicanos PER Public Expenditure Review PES Payment for Environmental Services PFM Public Financial Management PROCAMPO Programa de Apoyos Directos al Campo PROCYMAF Community Forest Development Program (Programa de Desarrollo

Forestal Comunitario) PRODEPLAN

Commercial Forest Plantation Program (Programa de Plantaciones Forestales Comerciales)

PROFEPA General Environment Protection Agency (Procuraduría General de Protección del Ambiente)

PROSENER National Energy Sector Program PROTRAM Federal Mass Transit Program PV Photo-voltaic (solar) RE Renewable energy REDD Reduced Emissions from Deforestation and Forest Degradation SAGARPA Ministry of Agriculture and Rural Development (Secretaría de

Agricultura, Ganadería, Desarrollo Rural, Pesca y Alimentación)

SCT Ministry of Communications and Transport (Secretaría de Comunicaciones y Transportes)

SDR Special Drawing Rights SE Ministry of Economy (Secretaría de Economía) SEDESOL Ministry of Social Development (Secretaría de Desarrollo Social) SEMARNAT Ministry of Environment and Natural Resources (Secretaria de Medio

Ambiente y Recursos Naturales) SENER Ministry of Energy (Secretaría de Energía) SFP Secretariat of Public Administration (Secretaría de la Función Pública) SHCP Ministry of Finance (Secretaría de Hacienda y Crédito Público) SHF Federal Mortgage Society (Sociedad Hipotecaria Federal) SICC Social Impacts of Climate Change TA Technical Assistance TESOFE National Treasury (Tesorería de la Federación) UMAS Management Units for Wildlife Conservation (Unidades de Manejo para

la Conservación de la Vida Silvestre UN United Nations UNFCCC United Nations Framework Convention on Climate Change UTTP Urban Transport Transformation Program

Vice President:

Country Director: Sector Director: Sector Manager:

Task Team Leader: Co-Task Team Leader:

Pamela Cox Gloria Grandolini Laura Tuck Philippe Benoit Todd Johnson Juan Miguel Cayo

MEXICO

LOW-CARBON DEVELOPMENT POLICY LOAN

TABLE OF CONTENTS

LOAN AND PROGRAM SUMMARY ............................................................................... i I. INTRODUCTION..................................................................................................... 1

II. COUNTRY CONTEXT............................................................................................ 4

RECENT ECONOMIC DEVELOPMENTS IN MEXICO ........................................ 4

MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ..................... 5

III. THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES ................................................................................................. 8

ENERGY: ISSUES AND GOVERNMENT PROGRAMS ....................................... 9

TRANSPORT: ISSUES AND GOVERNMENT PROGRAMS ..............................12

URBAN SECTOR: ISSUES AND GOVERNMENT PROGRAMS ........................13

FORESTRY AND LAND USE: ISSUES AND GOVERNMENT PROGRAMS ....14

PARTICIPATORY PROCESS AND CONSULTATIONS ......................................17

COGENERATION AND SMALL-SCALE RENEWABLE ENERGY ...................17

GAS FLARING REDUCTION .................................................................................18

FUEL EFFICIENCY IN VEHICLES AND TRANSPORT OPERATIONS ............18

ENERGY-EFFICIENT HOUSING DEVELOPMENT ............................................19

LAND USE AND FORESTRY .................................................................................19

IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM ............................20

LINK TO THE COUNTRY PARTNERSHIP STRATEGY .....................................20

COLLABORATION WITH THE IMF AND OTHER DONORS ............................20

RELATIONSHIP TO OTHER BANK OPERATIONS ............................................21

CROSS-SECTORAL OPERATIONS AND ANALYSES .......................................21

SECTOR SPECIFIC OPERATIONAL WORK AND ANALYTICAL STUDIES ...................................................................................................................24

LESSONS LEARNED...............................................................................................27

ANALYTICAL UNDERPINNINGS ........................................................................28

V. THE PROPOSED LOW-CARBON DPL ..............................................................30

OPERATION DESCRIPTION ..................................................................................30

POLICY AREAS .......................................................................................................32

ENERGY SECTOR OBJECTIVES ..........................................................................32

POLICY AREA 1 – COGENERATION AND SMALL-SCALE RENEWABLE ENERGY DEVELOPMENT .....................................................................................33

POLICY AREA 2 – GAS FLARING AND VENTING REDUCTION IN OIL AND GAS PRODUCTION .......................................................................................33

TRANSPORT SECTOR OBJECTIVES ...................................................................34

POLICY AREA 3 – FUEL EFFICIENCY IN VEHICLES AND TRANSPORT OPERATIONS ...........................................................................................................34

URBAN SECTOR OBJECTIVES .............................................................................35

POLICY AREA 4 – ENERGY EFFICIENT HOUSING DEVELOPMENT ...........36

FORESTRY AND LAND USE OBJECTIVES ........................................................36

POLICY AREA 5 – SUSTAINABLE FOREST MANAGEMENT .........................37

VI. OPERATION IMPLEMENTATION ....................................................................40

POVERTY AND SOCIAL IMPACTS ......................................................................40

ENVIRONMENTAL ASPECTS ...............................................................................42

IMPLEMENTATION, MONITORING AND EVALUATION ...............................43

FIDUCIARY ASPECTS ............................................................................................44

DISBURSEMENT AND AUDITING .......................................................................46

RISKS AND RISK MITIGATION ...........................................................................47

ANNEXES

ANNEX 1: LETTER OF DEVELOPMENT POLICY AND SUPPLEMENTAL LETTER WITH MATRIX ...................................................................................................50

ANNEX 2: POLICY MATRIX ............................................................................................62

ANNEX 3: FUND RELATIONS NOTE .............................................................................67

ANNEX 4: THE GOVERNMENT’S PUBLIC CONSULTATION PROCESS FOR LOW-CARBON DEVELOPMENT .....................................................................................70

ANNEX 5: ENGAGEMENT WITH MEXICO ON CLIMATE CHANGE ........................71

ANNEX 6: COUNTRY AT A GLANCE ............................................................................75

ANNEX 7: MAP SECTION ................................................................................................78

The Low-Carbon Development Policy Loan was prepared by an IBRD team consisting of Todd Johnson (Task Team Leader, LCSEG), Juan Miguel Cayo (co-Task Team Leader, LCSEG), Elisabeth Goller (LCSTR), Aiga Stokenberga (LCSSD), Janina Franco (LCSEG), Raquel Fernandez (LCSSD), Todd Crawford (LCSSD), Jozef Draaisma (LCSPE), Mariangeles Sabella (LEGLA), Viviana Maya (LEGLA), Alma Domenech (LCSEG), Luis Aviles (LCSEG), Laura Berman (LCSEG), Maria Castro-Munoz (LCSSO), Robert Ragland Davis (LCSAR), Ricardo Hernandez (LCSEN), John Nash (LCSSD), Xiomara Morel (LCSFM), Victor Ordonez (CTRFC), Diana Jimenez (LCC1C), and Gisela Campillo (LCC1C). The operation was undertaken under the guidance of Gloria Grandolini (Country Director, LCC1C), Philippe Benoit (Sector Manager, LCSEG), Laura Tuck (Sector Director, LCSSD), Gustavo Saltiel (Sector Leader, LCSSD), and Harold Bedoya (LCC1C). The Peer Reviewers were Michael Toman (Research Manager, DECEE), Sameer Shukla (Senior Energy Specialist, ECSS2), and Charles Feinstein (Sustainable Development Leader, EASNS). Additional reviewers for forestry and transport issues respectively were Benoit Bosquet, Werner Kornexl (ENVCF) and Andreas Kopp (TWITR).

i

LOAN AND PROGRAM SUMMARY

MEXICO

LOW-CARBON DEVELOPMENT POLICY LOAN

Borrower The United Mexican States

Implementing Agency Ministry of Finance and Public Credit

Financing Data US$401,002,507

Operation Type Development Policy Loan

Main Policy Areas Climate Change, Energy, Transport, Housing, Land Use, Forestry

Key Outcome Indicators

Energy: The number of new cogeneration permits issued by CRE increases from 59 (2009) to 70 (2012); the capacity of small-scale RE producers that are connected to the grid increases from 25MW (2009) to 35MW (2012); at least 1 large-scale Pemex project receives a new cogeneration permit; Pemex reduces total gas flaring for associated natural gas (excluding Cantarell) from 195 MMCFD (2009) to 145 MMCFD (2012), and for Cantarell, gas flaring is reduced from 504 MMCFD (2009) to 47 MMCFD (2012).

Transport: The energy efficiency and CO2 emission control standard for new light duty vehicles issued by SEMARNAT /SENER/SE is in force; the number of vehicles covered by transport operators’ action plans under the new Transporte Limpio program reaches 30,000, and the number of freight service users who adopt action plans reaches 50 companies.

Urban: The number of newly constructed housing units that qualify for CONAVI’s new energy efficient housing subsidy increases to 200,000; the number of new housing units that qualify for international carbon credits under the CDM programmatic methodology for sustainable housing (AMS-III.AE) reaches 100,000, and; the recipients of CONAVI’s housing subsidy that participate in the green mortgage (Hipoteca Verde) program reaches 140,000.

Land Use and Forestry: The number of permits for forest management increases from 4,000 permits in 2010 to 6,600 permits by June 2012 as a result of the regulatory reform, contributing to the PECC goal of incorporating 2.95 million hectares by 2012; a draft final national REDD+ strategy is published for consultation.

Program Development Objective(s) and Contribution to CPS

The objective of the proposed operation is to support sector-specific, high-priority policy and regulatory reforms that have been identified as critical to achieve Mexico’s climate change mitigation targets under the PECC for: (1) increasing renewable energy supply, promoting energy efficiency through cogeneration, reducing gas flaring and venting; (2) improving the efficiency of the vehicle fleet and road

ii

transport operations in Mexico; (3) strengthening the market for energy-efficient housing; and (4) mainstreaming climate change considerations into land-use and forestry activities.

The operation fits within the framework of the CPS by supporting the Government’s climate change strategy through a multi-sector DPL.

Risks and Risk Mitigation

A range of economic, political, institutional, environmental, and social risks were considered in preparing this operation. Overall, none of them is expected to have a significant impact on the sustainability of the supported government programs.

The selection of the policy areas contained in this DPL was based on extensive analytical work and consultations in Mexico over the past three years, most notably through the World Bank’s Mexico low-carbon study. The policy areas and actions for climate change mitigation included are expected to have large potential for reducing GHG emissions, have good financial and economic returns, and were judged by Mexican and international experts to be politically and institutionally feasible to implement (and most are already being implemented at some scale in Mexico today).

The macroeconomic risk that a continuing recession in the United States will negatively affect Mexico’s economic recovery is mitigated by sound and predictable macroeconomic and public debt management by Mexican authorities.

The risk of a contraction in the overall investment in low-carbon programs is mitigated by the Government’s passage of national legislation, the continuing commitment to the climate change program, and an investment plan supported by the Fund for the Energy Transition and the Sustainable Use of Energy. The regulatory reforms that have been included in this DPL increase the likelihood that low-carbon investments will take place by the inclusion of measures that reduce the transactions costs of new energy technologies, such as the interconnection and net-metering legislation for cogeneration and renewable energy.

The risk that the large parastatals in the energy sector (CFE and Pemex) will not have the financial authority or incentives to implement the reform measures and make investments in their sectors is mitigated by the legislative and organizational reform measures that have been passed in the past two years (oil and gas reform, renewable and energy efficiency laws). The risk that the Government will not have sufficient financing for low-carbon investments is also mitigated by the now dominant model of using independent power purchase (IPP) agreements with the private sector for financing infrastructure (such as RE capacity and cogeneration).

The risk that the fuel efficiency and emission control standard for new light duty vehicles will not be issued is mitigated by the fact that the current Administration has committed itself to issue fuel efficiency standards through two key policy documents; the PECC and the National Program for Sustainable Energy Use 2009-2012. The new standard is expected to be published for public consultation before or during the Conference of the Parties to the United Nation Framework

iii

Convention on Climate Change (COP16, UNFCCC) in Mexico in December 2010.

In the Forestry sector, there is broad consensus that the forest management licensing process is inhibiting sustainable forest management and SEMARNAT has consequently simplified and strengthened the process, and is facilitating the reforms with local training programs. Furthermore, as stipulated in Mexico’s Forestry and Rural Development Laws, the Government of Mexico has set in place national and state forest councils that also promote close coordination between agencies.

The risk of adverse social and poverty impacts associated with low-carbon policies is mitigated through the consultations that have accompanied the adoption of the Government’s national climate change program (ENACC, PECC), as well as the consultations for sector-specific programs.

To mitigate social risks related to the implementation of the reforms in the Forestry sector, the Government is undertaking a broad consultation program at the local level. In addition, the Bank is closely engaged with CONAFOR in the development of Mexico’s REDD+ National Strategy, and CONAFOR already has experience in conducting these types of analyses through Bank-funded projects like PROCYMAF and the Environmental Services Project.

Operation ID P121800

1

IBRD PROGRAM DOCUMENT FOR A PROPOSED LOW-CARBON DEVELOPMENT POLICY LOAN

TO MEXICO

I. INTRODUCTION

1. The Government of Mexico has requested a Low-Carbon Development Policy Loan (DPL) in the amount of US$401 million in order to recognize and support its on-going reform and implementation of policies and programs to respond to global climate change. The Government has asked that the DPL be presented to the IBRD Board of Executive Directors for approval before the end of calendar year 2010, consistent with the needs of its fiscal and debt management strategy. 2. Mexico has a strong record, both domestically and internationally, of credible commitment and concrete actions to address the challenges of global climate change. The creation of the Inter-secretarial Commission on Climate Change (CICC) in 2005 (a commission that includes major ministries and the President’s Office) was an early public signal of Mexico’s recognition of and intention to address the range of mounting threats to its sustainable development that arise from global climate change. As a dry and subtropical country lying between two oceans, these climate change impacts include an increase in average and extreme temperatures, a reduction in rainfall and changes in runoff patterns, and an increase in the intensity of tropical storms from both the Atlantic and the Pacific. 3. Since the inauguration of President Calderon on December 1, 2006, the need to address the challenges of global climate change has been a unifying, consistent, and increasingly high-profile theme of Mexican social and economic policy. The 2007-2012 Plan Nacional de Desarrollo (NDP or National Development Plan) was the first broad statement of the Calderon administration’s development priorities and, having been widely consulted with civil society, had environmental sustainability as one of its four pillars. Building on this emphasis, the CICC’s approval in May 2007 of the Estrategia Nacional de Cambio Climático (ENACC or National Climate Change Strategy) was the Government’s next important step in furthering its climate change agenda. Announced by President Calderon himself, ENACC placed climate change adaptation and mitigation at the core of Mexico’s national development policy, establishing the long-term agenda and setting medium- to long-term adaptation and mitigation goals. In August 2009, the Programa Especial de Cambio Climático (PECC or Special Climate Change Program) was published. It established the Government’s plan of action, including sectoral programs and targets for reducing greenhouse gas (GHG) emissions, the identification of the principal climate change risks and plans for adaptation, and cross-cutting policy initiatives. In parallel with ENACC and PECC, Mexico has progressively strengthened the legal and regulatory framework and public policies and programs so as to achieve its climate change adaptation and mitigation goals. 4. With the credibility gained from its strong domestic climate change agenda and its international commitments, Mexico has obtained an international reputation as a leader in the climate change field and become a chief advocate for an international climate change agreement. Mexico’s hosting of the 16th Conference of Parties (COP16) of the United Nations

2

Framework Convention on Climate Change (UNFCCC) in November-December 2010 in Cancun is but the latest example of its leadership. It is also noteworthy that, while not obligated under the UNFCCC or the Kyoto Protocol to adopt policies and measures to reduce its GHG emissions, Mexico has done precisely that. In January 2009, President Calderon reiterated the commitment made by Mexico at COP14 in Poland that the country intended to halve its GHG emissions by 2050 compared to 2002 levels. The PECC has mainstreamed climate change in the country’s economic and social development by establishing sector-specific reductions targets and adaptation measures. In addition, to date Mexico is the only UNFCCC non-Annex 1 country to have submitted its Third and Fourth National Communications and is already at work on its Fifth for submission by 2012. Recognizing Mexico’s leadership in terms of both its domestic policies and programs and its international commitments, Mexico is ranked 11th among all countries on the Climate Change Performance Index (CCPI) for 2010.1 5. The Bank’s support for Mexico’s climate change and sustainable development agenda has steadily expanded since the mid-1990s in line with the Government’s growing emphasis on mainstreaming social and environmental sustainability considerations in all of its national development plans and sector strategies. The FY2008-2013 Country Partnership Strategy (CPS), which the Board discussed in April 2008, was fully aligned with President Calderon’s priorities as enunciated in the NDP and, as such, featured support for environmental sustainability, including climate change mitigation and adaptation, as one of its pillars. The CPS Progress Report, which the Board discussed in March 2010, confirmed this focus as a key element in the partnership.

6. The Bank’s engagement in the field of climate change in Mexico currently comprises the full range of Bank instruments, including: (i) analytical work, technical advisory and convening services; (ii) policy dialogue; (iii) knowledge sharing; and (iv) financial services, including investment and policy-based lending as well as CTF concessional financing, GEF and other grants, and Carbon Finance. As shown in Figure 1, this engagement has progressed over the past years, with subsequent stages building on previous actions. In the initial stage, Bank support focused on technical advice (TA), analytical work and investments in clean technology and institutional frameworks in the urban, energy and transport sectors (financed in large part by the GEF and Carbon Finance), while DPLs recognized and supported the foundations of Mexico’s national climate change strategy. In the second stage, TA and analytical work focused more specifically on climate change issues as inputs to Mexico’s climate change program (PECC), sector investments in sustainable urban transport became mainstreamed, and DPLs recognized and supported institutional capacity building for energy and transport and key sector reforms such as national renewable energy and energy efficiency legislation. Current and future engagement by the Bank is intended to further the support to Mexico’s climate change program, including priority low-carbon development policies and programs, continuing to mainstream mitigation and adaptation to climate change in key

1 The Climate Change Performance Index compares the climate protection performance of the 57 countries that account for more than 90 percent of energy-related CO2 emissions. Four-fifths of the evaluation is based on objective indicators of emissions trend and level. The remainder is based on an assessment by more than 130 independent NGO experts of the respective country’s national and international climate policy. Emissions from land-use changes are not yet included in the index. Rankings 1-3 are not awarded; in 4-10 are: Brazil, Sweden, U.K., Germany, France, India, and Norway.

3

sectors as water, forestry, energy, agriculture and social programs, and providing assistance to states and municipalities to develop specific programs for climate change adaptation and mitigation.

Figure 1: World Bank Support for Climate Change in Mexico

7. The proposed low-carbon DPL consolidates the Bank’s support for Mexico’s climate change program by focusing on multi-sector regulatory reforms, standards, and institutional reforms that were outlined in previous operations as necessary for meeting Mexico’s near-term climate change goals. Drawing on the results of recent analytical work, principally the World Bank’s study on low-carbon development for Mexico,2 this program recognizes and supports priority climate change mitigation measures in key sectors of the Mexican economy – energy, transport, urban housing, and forestry. The measures that have been chosen are important for Mexico’s mitigation program, not only because they have large

2 Johnson, T., C. Alatorrre, Z. Romo, and F. Liu. (2010). Low-Carbon Development for Mexico (México: Estudio sobre la Disminución de Emisiones de Carbono, MEDEC). Washington, D.C.: The World Bank. This study is the first of several completed by the World Bank that were undertaken for the key developing and middle-income countries, including studies for Brazil, China, India, South Africa, and Indonesia. A number of other studies have been done on Mexico’s climate change mitigation potential (Galindo, Quadri, Mckinsey, Mario Molina), and the results of the analysis in terms of the priority areas and actions that can be taken are largely consistent with the results of the MEDEC study. Unlike some of the Mexican studies, the MEDEC report focused on the a cost-effectiveness analysis of some of the leading mitigation measures such that measures in different sector s could be directly compared in terms of their GHG emission reduction potential and their net economic cost.

Stages of Climate Change Engagement in Mexico

Initial Engagement:

The Foundations (2004-2007)

Strengthening of Climate Change

Policies (2008-2009)

Consolidation: Mainstreaming Adaptation and

Mitigation to CC in Sectors (2010- )

� Subnational Climate Change Plans � Cap and Trade Study � Social Impacts of Climate Change

Study � Water Sector Adaptation TAP � Environmental TAP

� Low-Carbon Development in Mexico (MEDEC) Study

� Energy Sector Technical Advisory Program � CTF Investment Program � Low Carbon, High Growth: Latin

American Responses to Climate Change

� Technical Assistance to the Housing Sector

� The Study on Residential Electricity Subsidies in Mexico

� Energy Efficiency Program � Forestry and Climate Change

Investment Loan (in preparation)

� Environmental DPLs I & II � Climate Change DPL

� Environmental Sustainability

DPL � Green Growth DPL

� Adaptation to CC in the Water Sector DPL

� � Sustainable Territorial Development

DPL (in preparation) � Forestry and Climate Change DPL (in

preparation)

Low-Carbon DPL

Adv

isor

y/

Con

veni

ng

Serv

ices

Inve

stm

ent

Ope

ratio

ns

D

PLs

� GEF Integrated Energy Services Project

� Sustainable Transport and Air Quality

� Environmental Services Project

� Urban Transport Transformation

Program (UTTP) � Mexico Massive Urban Transport

Federal Program

National Climate Change Strategy Third UNFCCC Communication

Special Program for Climate Change

(PECC)

Fourth Communication to the UNFCCC

Adapt/develop sector programs to meet PECC targets

Gov

ernm

ent

Act

ions

4

potential for reducing GHG emissions, but because they are cost-effective, implementable in the short-term, and are fundamental to fulfilling other sustainable development goals.

II. COUNTRY CONTEXT

RECENT ECONOMIC DEVELOPMENTS IN MEXICO 8. The Mexican economy is recovering from a brief but very deep recession. The collapse of external demand, particularly in durable consumer goods, in the last quarter of 2008 and the first half of 2009 led to an almost immediate and severe downturn in manufacturing industry and economic activity in Mexico. The ensuing loss of employment and income generation opportunities as well as the higher level of uncertainty and risk created by the global financial and economic crisis contributed to a fall in private consumption and investment further denting aggregate demand. A subsequent rebound in external demand as of the second half of 2009 is giving rise to an economic recovery, even though private consumption and investment are trailing behind and have not yet contributed significantly to the upturn of economic activity. Figure 2 provides a graphical presentation of the levels of economic activity and the main components of aggregate demand. As can be observed from Figure 2, by the 2nd quarter of 2010, the level of GDP was still slightly below its pre-crisis level. The same is the case for private consumption and investment, whereas the level of exports is just back to it pre-crisis level and public expenditure never dropped. 9. The sharp fall in aggregate demand of 2009 created a large output gap. The average annual growth of about 3.0 percent observed during the decade previous to the global crisis provides a reasonable indication of the country’s potential output growth at the time. The financial crisis may have led to a temporarily lower rate of potential output growth3 but, even if that is the case, the contraction of economic activity by 6.5 percent in 2009 created a large output gap. This implies that the economy may grow for a couple of years at a level moderately above its potential rate of growth absorbing excess capacity instead of creating undue inflation pressures.

10. The government proceeded with a gradual withdrawal of the fiscal stimulus as of 2010 to assure markets of fiscal sustainability. By maintaining public expenditure in 2009 at about the same level in real terms as the previous year despite a sharp public sector revenue decline, a fiscal stimulus of about 2.5 percent of GDP was generated last year.4 The stimulus was mainly financed by non-recurrent revenue that is not available in 2010. In 3 “The Global Crisis and Potential Growth in Mexico” in Mexico: Selected Issues, IMF Country Report 10/70 March 2010. 4 Mexico: 2010 Article IV Consultation, IMF Country Report 10/71 March 2010.

70

75

80

85

90

95

100

105

110

115

120

2008

:II

2008

:III

2008

:IV

2009

:I

2009

:II

2009

:III

2009

:IV

2010

:I

2010

:IIGDP Private Consumption

Private Investment Public Expenditure

Exports

Figure 2: Mexico GDP and Aggregate Demand (s.a. Q2-2008=100)

5

view of market concerns regarding fiscal sustainability, largely related to a rapidly falling volume of oil production, the authorities opted for initiating a program of fiscal consolidation by increasing taxes and containing public expenditures. To moderate the withdrawal of fiscal support and in line with Mexico’s fiscal responsibility law, the budget allowed for a deficit (excluding budgetary investments in the oil sector) of 0.7 percent of GDP in 2010, which is expected to decrease to 0.3 percent by 2011 and should return to a balanced budget by 2012.5

11. Monetary policy has been left unchanged after substantial easing in 2009. The increase in tax rates and public sector prices, that are part of the 2010 budget law, have been estimated to increase consumer price inflation by the end of 2010 to about 5.0 percent compared to 3.6 percent observed by the end of 2009. The monetary authorities have left the monetary policy intervention rate unchanged in view of the temporary nature of the price increases and the continued significant output gap that should contain inflation pressures.

12. The monetary authorities have expressed their intention to increase the level of international reserves to mitigate the impact of possible future financial shocks. A rules-based mechanism that allows market participants to sell foreign exchange to the Central Bank was reintroduced in February 2010 and should allow for a steeper increase of international reserves. Over the first nine months of the year, the mechanism contributed US$3.8 billion to an overall reserve accumulation of US$17.4 billion, with the difference consisting of net public sector foreign exchange receipts. In the meantime, the US$47 billion Flexible Credit Line, contracted with the IMF in April 2009 for the period of one year, was recently renewed for another year.

MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

13. After a sharp rebound of external demand over the past year, the Mexican economy is headed for a more moderate and balanced expansion of economic activity. Economic growth is expected to moderate in the second half of 2010 and continue to slow to about 3.8 percent in 2011. Strong external demand for Mexican manufactured goods is projected to persist due to the close integration of manufacturing industry with industrial production in the United States, though growth of exports will normalize compared with its sharp post-crisis rebound and as a result of a moderation of growth in the United States. More importantly, the expansion of economic activity will be more balanced with respect to the contribution of domestic and external demand to aggregate demand as GDP growth converges to the underlying growth of domestic demand (see table 1). 14. Domestic demand is recovering with a lag as it depends largely on a strengthening of the level and quality of employment. Household consumption in Mexico is closely related to developments in the labor markets, as labor income is the main source of disposable income. In this regard, the recovery mirrors the sequence of the economic downturn in which the collapse of external demand led to a decline in manufacturing industry followed by a loss in employment and eventually a weakening of private consumption. Similarly, the recovery of trade and industrial activity is leading to a rebound in employment which will be reflected in a strengthening of private consumption. The increasing level of employment has taken place 5 Investments in the oil sector, that are not included in this deficit target, amount to 2.0 percent of GDP annually (See paragraph 17).

6

largely in the form of lower-paid jobs, which has held back a more vigorous increase of private consumption yet.

Table 1: Mexico Macroeconomic Indicators 2008-2012 (average annual rate of growth)

Actual Projections 2008 2009 2010 2011 2012 GDP 1.5 -6.5 4.5 3.8 4.2 Consumption 1.7 -5.0 2.8 3.7 4.2 Investment 4.4 -10.1 3.3 6.1 6.1 Exports 0.5 -14.8 24.1 9.0 7.9 Imports 2.8 -18.2 23.0 9.5 8.7 Current account balance (as a % of GDP) -1.5 -0.6 -0.8 -1.2 -1.5 Source : Bank staff estimates based on SHCP and INEGI

15. Trade and current account deficits will increase as domestic demand starts to play a larger role in the economic recovery. The gradual recovery of domestic demand contributes to import growth catching up with and slightly surpassing export growth. The widening of the trade deficit is taking place from a low base after the trade balance narrowed substantially in 2009 (see table 2). The evolution of the trade deficit is currently the main driver of the current account of the Balance of Payments, as the net outflows from tourism and freight services together with the net interest payments and profit remittances are largely offset by the receipts from workers’ remittances. After a drop of almost 16 percent at the height of the crisis, workers’ remittances have stabilized at about US$21 billion annually. The current account deficit is projected to increase from US$5.7 billion in 2009 to US$16.6 billion by 2012, which remains moderate relative to the size of the economy and is mainly financed by Foreign Direct Investment inflows projected at about 2 percent of GDP or US$22 billion annually between 2010 and 2012.

Table 2: Mexico External Accounts 2008-2012 (Billion US$)

Actual Projections 2008 2009 2010 2011 2012 Exports 291.3 229.8 294.9 320.1 343.1 Imports 308.6 234.4 296.9 324.8 351.1 Workers' Remittances 25.6 21.2 21.5 23.1 25.2 Current Account -16.2 -5.7 -8.9 -13.1 -16.6 Portfolio Investment 2.4 7.7 12.3 11.2 10.6 FDI 24.3 14.0 20.4 22.5 23.3 International Reserves (Year-end) 95.1 99.9 118.7 129.3 139.7 Gross External Debt (Year-end) 201.5 192.6 209.5 223.8 239.2 Source : Bank staff estimates based on Banco de Mexico

7

16. Mexico’s medium-term growth outlook is reasonably encouraging. Progress in the economic reform agenda and higher levels of investment in public infrastructure over the past few years are likely to raise potential growth. Taking into account this impact, a recovery of domestic demand, and a moderation of U.S. growth to a range of 2.7-3.0 percent annually, the government has based its medium-term fiscal outlook on an annual economic growth of 4.2 percent for 2012-2016. 17. Over the next few years, 2010-2012, the public sector will be subject to a continued effort of fiscal consolidation. The budget proposal for 2011 presented to Congress contains an update of the fiscal consolidation program as adopted in the budget for 2010 (see table 3). Implementation of the program is on track with minor adjustments in terms of revenue and expenditure estimates as a result of a more rapid economic recovery, a slightly higher oil price and volume of production, and a stronger exchange rate. Budget deficit targets remain unchanged, i.e., a budget deficit in terms of the fiscal responsibility rule of 0.7 percent of GDP in 2010, 0.3 percent in 2011, and a return to budget balance by 2012. Investments in the oil sector, that are not included in this deficit target, amount to 2.0 percent of GDP annually. Tight public expenditure conditions, as reflected by a reduction in programmable6 budget expenditure by 5.7 percent in real terms in 2010 and 0.3 percent in 2011, are likely to prevail as proposals for a comprehensive, base broadening tax reform are unlikely to advance before the upcoming presidential elections (July 2012).

Table 3: Mexico Public Finance 2009-2012 (as a percent of GDP)

Actual Projections 2009 2010 2011 2012 Revenue 23.8 21.6 21.4 21.2 Oil 7.4 7.2 7.0 6.9 Tax 9.5 10.0 10.3 10.6 Other 6.9 4.4 4.1 3.7 Expenditure 26.1 24.3 23.7 23.2 Budget deficit 2.3 2.7 2.3 2.0 PSBR 2.5 3.2 2.7 2.5 Net public debt 36.9 36.8 36.6 36.3 Source : Bank staff estimates based on SHCP

18. The medium-term fiscal outlook projects a gradual reduction in the public debt-to-GDP ratio. The outlook is based on a return by 2012 to a balanced budget in terms of the Mexican Fiscal Responsibility Law. In addition, it assumes a gradual reduction of investments in the oil sector from 2.0 percent in 2012 to 1.6 percent in 2016 which will lead to a decrease of the Public Sector Borrowing Requirements (PSBR) from 3.2 percent of GDP in 2010 to 1.9 percent by 2016. These public sector deficit targets in conjunction with nominal output growth projections lead to a reduction of the net public debt from 36.8 percent of GDP in 2010 to 36.3 percent in 2012 and 33.9 percent by 2016.

6 Total expenditure excluding interest payments and tax revenue shared with sub-national governments.

8

19. The downward path in the public debt-to-GDP ratio is mainly susceptible to weaker economic growth. Some of the main macroeconomic variables that have an impact on Mexico’s public finances include economic growth, inflation, interest rates and the oil price. The impact of a variation in the average annual oil price by US$1 per barrel on oil revenue is estimated at 0.04 percent of GDP, whereas a variation by 100 basis points in the average annual nominal interest rate raises the interest cost of public debt by 0.12 percent of GDP. The institutional framework for the formulation of fiscal policies, including the balanced budget rule, provides for coping mechanisms, such as the use of revenue stabilization funds, and requires adjustments to public finances in the light of adverse developments to assure sustainable public finances. In this environment, only a lower nominal output growth could derail the projected downward path in the public debt-to-GDP ratio, as a 1 percentage point lower level of nominal GDP raises the public debt-to-GDP ratio by 0.4 percent. This implies that if, after the recovery, the economy falls back to the average annual rate of growth of 3 percent instead of the projected 4.2 percent, and absent further fiscal adjustments, the public debt-to-GDP ratio will fail to come down and stabilize at the higher level attained during the crisis. 20. The macroeconomic policy framework is deemed appropriate for the proposed Development Policy Loan. Fiscal and monetary policies continue to be well-managed in view of the challenges posed by the significant uncertainties about the strength and sustainability of the global recovery and the volatility in global financial markets. No major internal or external macroeconomic imbalances have been building up or are projected in the near future.

III. THE GOVERNMENT’S PROGRAM AND PARTICIPATORY PROCESSES 21. On May 25, 2007, President Felipe Calderón announced Mexico’s National Climate Change Strategy (Estrategia Nacional de Cambio Climático, or ENACC), which put climate change at the center of Mexico’s national development policy. The ENACC established an initial blueprint for the long-term climate change agenda for the country, together with medium- and long-term goals for adaptation and mitigation. The PECC, in turn, defines the specific policies and actions to be put in place over the subsequent three years (2009-2012), in particular, by identifying vulnerable sectors and priority actions for mitigating GHG emissions.7 Although the PECC does not prioritize actions according to their financial costs and benefits, such considerations are recognized by the Government as critical to the success of the country’s climate change program and this analysis of costs and benefits has been one of the key areas of support by the World Bank.

7 Annex 5 provides more detail on the government’s consultation process for designing the PECC.

9

Figure 3: Greenhouse Gas Emissions from Energy Production and Consumption

Source: MEDEC, 2010.

22. As reflected in the PECC, low-carbon development is an economy-wide undertaking by multiple sectors. Among the activities that are the largest sources of emissions in Mexico are energy production and consumption, transportation, urban services (such as emissions associated with buildings and municipal organic waste), deforestation, and agriculture (such as from livestock and fertilizers). While the Mexican Government has made considerable progress in the past five years in establishing a climate change program and has passed legislation in several key areas (such as for energy and transport), additional regulatory and administrative measures are essential for helping the Government meet its PECC goals. The MEDEC study, which has been endorsed by Mexico’s Inter-secretarial Commission on Climate Change (CICC), has identified a number of high-priority interventions for reducing the carbon intensity of development. While the majority of these measures have low net financial costs, a number of regulatory, administrative, and knowledge barriers have inhibited their development. 23. For the purposes of categorizing Mexico’s principal GHG emissions and mitigation efforts, the following discussion focuses on four key sectors: energy, transport, urban, and forestry and land-use. ENERGY: ISSUES AND GOVERNMENT PROGRAMS

24. Mexico ranks 13th in the world in total GHG emissions, and its CO2e emissions from energy consumption are greater than those of Brazil, making it the largest energy emitter in Latin America. About 60 percent of Mexico’s total GHG emissions are generated from fossil fuel-based energy production and consumption, including significant fugitive emissions (leakage, venting, flaring) from oil and gas production and transportation. In 2006, electric power, oil and gas production, and gas flaring and fugitive emissions accounted for about 46 percent of the country’s GHG emissions from fossil fuels (figure 3), with the electric power sector alone representing approximately 26 percent.8 8 In 2006, the share of emissions from fossil fuel production and consumption amounted to 34 percent for transport, 26 percent for electric power, 13 percent for manufacturing and construction, 11 percent for fugitive gas emissions, 9 percent for oil and gas production and transformation, and 8 percent for other sectors. INE

050

100150200250300350400450500

1990 2002 2006*

MtC

O2e

Other Sectors

Manufacturing & ConstructionTransport

Fugitive Emissions/Oil & Gas

Fossil Fuel Use/Oil & Gas

Power Generation

10

25. At present, as much as 76 percent of Mexico’s installed electric power capacity is based on fossil fuels – mostly natural gas, fuel oil, and coal – with only a small share contributed by hydropower (19 percent), nuclear (2.3 percent), geothermal, biomass, and wind. Nonetheless, recent studies have shown that the potential for renewable energy and energy efficiency in Mexico is large.9 For instance, with modest changes in policies and investment, wind power could increase its share in the generation mix from 1.4 percent in 2008 to 6 percent 2030, while the share of cogeneration could provide as much as 13 percent of new power capacity over the period, with a significant share (3,700 MW) produced in Pemex facilities. 26. High levels of gas flaring and venting – within the context of an overall decline in oil and gas production levels—at existing fields present an important opportunity to improve resource use by capturing and using the flared gas. The amount of gas that is currently flared and vented is significant and is approximately equal to Mexico’s total gas imports (which amounted to about one-quarter of Mexico’s total gas demand in 2008). Measures such as gas flaring and venting reduction and other efficiency improvements at Pemex can help offset the current losses from its largest field (Cantarell) and thus help to offset the drop in Mexico’s oil exports and, consequently, public revenues. As such, these measures are a high priority for both the country and the state oil company. At the same time, they are also crucial for reducing the significant amount of CO2e emissions that originate from the natural gas (mainly methane)10 that is either not effectively burned during flaring operations or is lost along the process of oil and gas production (i.e., as fugitive emissions in storage, compression, and transmission). These sources of CO2e represent a significant part of the GHG emissions from oil and gas production activities in Pemex, which in turn constitute a sizable share of Mexico’s overall emissions. 27. To reduce the energy sector’s contribution to Mexico’s GHG emissions, meet future electricity demand (projected to grow 4.8 percent a year between 2007 and 2016), and limit the growth of hydrocarbon imports, new reforms and investments are needed. Among the high priority measures for reducing GHG emissions in the energy sector are: the promotion of renewable energy technologies; tapping the unused cogeneration potential in industry, including at Pemex facilities; lowering the level of gas flaring and venting in upstream hydrocarbon production; and reforming energy pricing in the agricultural sector. 28. To address the climate change and sustainability agenda in the energy sector, the Mexican Congress adopted a comprehensive reform package in 2008:

(2006): Estudio de evaluación socioeconómica del proyecto integral de calidad de combustibles. Johnson, T., C. Alatorrre, Z. Romo, and F. Liu. (2010): México: Estudio sobre la Disminución de Emisiones de Carbono. Washington, D.C.: The World Bank. 9 The potential for renewable energy is estimated by comparing the net costs of each renewable energy technology with those of displaced fossil fuel-fired- capacity. Johnson, T., C. Alatorrre, Z. Romo, and F. Liu. (2010). México: Estudio sobre la Disminución de Emisiones de Carbono. Washington, D.C.: The World Bank. 10 The combined methane (CH4) emissions from Pemex fields are estimated at 36.1 MtCO2e, where uncombusted methane from flaring is the largest single source, accounting for 78 percent of total emissions. See: PEMEX/Methane to Markets (2010): “Methane Emissions in PEMEX: A Targeted Approach for Reducing Flaring and Greenhouse Gas Emissions.” February 12.

11

� The Energy Efficiency Law provides a legal framework for promoting more efficient energy use, complemented by the Program for the Sustainable Use of Energy11 and more specific regulations for implementing energy efficiency measures throughout the Mexican economy.

� The Law on Renewable Energy provides a broad legal, regulatory, and financial basis for implementing a national strategy to transition away from hydrocarbon-based electricity generation to a broader use of renewable energy sources. The Law and the accompanying regulations are intended to allow Mexico to achieve its goal of a 35-percent share of renewable energy in the national electricity mix by 2025.

� The Reform of the Hydrocarbon Sector Law aims to strengthen the governance structure of Pemex and increase the company’s flexibility in allocating expenditures and managing debt and procurement. To improve the efficiency of Mexico’s oil and gas production, the law establishes the National Hydrocarbons Commission (Comisión Nacional de Hidrocarburos, CNH) as the institution responsible for regulating the exploration and exploitation of oil and gas.

29. The reforms summarized above can contribute meaningfully to the implementation of the Government’s voluntary commitment to reduce GHG emissions to 50 percent below 2002 levels by 2050. Transitioning to a low-carbon growth path in the energy sector, specifically for cogeneration and renewable energy, faces a number of policy and institutional barriers, translating into increased transaction costs, in particular for small-scale private generators. While in many cases these technologies are competitive with conventional ones in terms of cost, their wider adoption is hindered by specific regulatory gaps, such as utility procurement rules that in practice exclude small-scale producers, and the current power generation planning methods that fail to account for the significant environmental co-benefits characteristic of low-carbon technologies. One of the reasons for the low penetration level of cleaner technologies in Mexico’s energy mix is the fact that the Constitution mandates least-cost procurement of electricity generation sources, with the Comisión Federal de Electricidad (CFE) employing a relatively strict interpretation of this mandate focusing on “first-cost” rather than “life-cycle cost.” Another reason is that CFE evaluates power production bids based on regulated and pre-specified prices of fossil fuels (such as natural gas) that are supplied to the independent power producers (IPPs) by CFE. This puts renewable energy at a distinct disadvantage since CFE and not the IPP is assuming the fuel price risk, which is one of the main advantages of renewable energy. 30. Achieving the objectives of a more diverse and carbon neutral electricity generation mix requires additional regulatory, policy, and institutional modifications. Specific obstacles to a low-carbon growth path in Mexico’s energy sector include: � High transaction costs for cogeneration and small RE projects, lack of transmission and

connection arrangements, lack of experience with small-scale RE contracts by CFE, payments to RE producers at a level that covers only the marginal (variable) cost, and unfavorable conditions and the lack of an integral strategy for the sale of surplus electricity produced by Pemex and other key industrial complexes.

11 Programa Nacional para el Aprovechamiento Sustentable de la Energía.

12

� Lack of an institutional and regulatory framework for the implementation and monitoring of activities aimed at reducing gas flaring and venting in Pemex’s upstream facilities.

TRANSPORT: ISSUES AND GOVERNMENT PROGRAMS

31. Transport is the largest and fastest-growing sector in Mexico in terms of GHG emissions and energy consumption, representing nearly 34 percent of total GHG emissions associated with energy production and consumption in 2006 (Figure 3) and about 18 percent of the country’s total GHG emissions. The amount of energy consumed by road transport in Mexico increased more than fourfold between 1973 and 2006, compared with an approximate doubling of energy use by industry and other sectors. Road transport accounts for about 90 percent of the transport sector’s energy consumption and emissions. 32. The large contribution of the transport sector to the country’s GHG emissions and other types of pollution is explained by many factors, including: (i) rapidly growing motorization rates, partially caused by the import of used vehicles from the U.S., the availability of relatively inexpensive new vehicles, and relatively low fuel prices; (ii) insufficient mass transit alternatives; (iii) the composition of the public transport fleet, favoring smaller-capacity vehicles and including a growing share of older vehicles; (iv) increased road congestion; (v) inadequate vehicle standards that impede improvements in fuel efficiency and reduction of airborne pollutants; (vi) lack of consistent and rigorous vehicle inspection schemes to enforce emission standards and restrict the use of inefficient and heavily polluting vehicles; (vii) inefficiencies in road freight transport operations; and (viii) the neglect of transport aspects in urban development plans. 33. The average fuel performance of new light-duty vehicles in Mexico is low. In 2008 it was about 12 km per liter compared to about 18 km per liter in Europe. An increase in the fuel performance of new cars from 12 km per liter to 20 km per liter would lead to savings of 50 grams of CO2 per km. The age of the vehicle fleet also has a marked impact on Mexico’s overall energy performance and GHG emissions, with 10-year-old vehicles consuming 30 percent more fuel than new ones and producing proportionally more GHG emissions. The high average fleet age (16.3 years) can be largely attributed to used vehicle imports from the U.S. 34. Long distance freight and passenger road transport accounts for about 20 percent of the transport sector’s CO2 emissions. A total fleet of 330,000 motor units and a similar number of trailers are operated by approximately 110,000 operators. In this fragmented sector, small one-person businesses (hombre-camion) are dominating. Many of them struggle to survive, not being able to modernize their equipment or innovate. 35. To lower the carbon footprint of development and tackle other problems related to excessive automobile use, such as high levels of congestion and air pollution, Mexico has chosen to follow a path of greater efficiency in transport use. This commitment was made at the highest level, through the PECC, specifically focusing on policies and programs in three broad areas: (i) improvement of public transport and support to modal shift mainly through a nationwide US$2.7 billion ongoing federal program to finance mass transit systems, which is complemented by aspects of urban planning and non-motorized transport; (ii) cleaner vehicles

13

and fuels and demand management, among others, through fuel efficiency standards, stricter vehicle emission standards, the regulation of vehicle inspection methods and characteristics for in-use vehicles at federal level, including provisions for imported vehicles,12 and vehicle scrapping; and (iii) greening and fuel efficiency improvements of long-distance passenger and freight transport, including through improvements to the inspection scheme operated by the Ministry of Communications and Transport (SCT) for heavy duty vehicles, heavy duty vehicle scrapping, a program to improve the fuel and environmental performance of heavy duty vehicles and measures favoring a shift to rail transport. These policies and programs are in line with the National Development Plan 2007-2012, and most are also envisaged in the National Program for the Sustainable Use of Energy, the Communication and Transport Sector Program 2007-2012 or State programs. URBAN SECTOR: ISSUES AND GOVERNMENT PROGRAMS 36. Mexico’s economic and population growth during the past decade has increased consumption levels and demand for goods and services, placing increasing pressure on cities through augmented energy end-use and solid waste generation patterns and, consequently, increased GHG emissions, impacts on health, ground water, soil, and air quality. 37. With the expected demographic and economic growth in the next two decades, managing residential electricity demand will be critical to mitigate GHG emissions. Currently, the residential sector accounts for 18 percent of total energy end-use in Mexico, with per capita residential electricity use at 320kW/year, about one-tenth of that consumed in the U.S.13 However, with a growth in average incomes, and increasing rates of electrical appliances and air conditioning, the expected rates of growth for residential electricity demand are enormous. 38. Housing plays a key role in increased energy demand and the potential generation of a large share of GHGs. According to the National Housing Commission (Comisión Nacional de Vivienda, CONAVI), Mexico currently has 24.8 million houses, with about 7 million new houses to be constructed over the next decade, to increase to a total of 45 million by 2030. CONAVI estimates that a poorly designed house in a warm climate has an additional consumption of 1,000 kWh a year. Air-conditioner saturation rates in Mexico were only about 20 percent in 2005, compared with about 95 percent in regions of the U.S. with similar cooling-degree days. A recent study projects that air-conditioner electricity use in Mexico could increase 10-fold by 2030, reach a value that is three times higher than total residential electricity use in 2005.14 In addition to air conditioning, other energy systems in residential 12 It should be noted that an important remaining issue on which relatively little progress has so far been made is the need for improved inspection and maintenance of in-use vehicles throughout Mexico. While emission standards for in-use vehicles established at federal level are rigorously enforced in Mexico City and the State of Mexico, vehicle emission control is the responsibility of States and Municipalities and there is often minimal enforcement in other States and in border areas. The State of Baja California has recently introduced a mandatory vehicle inspection scheme, which is especially important because of the large number of old and polluting vehicles crossing the border from the US. Other States are also in the process of improving their vehicle verification schemes. 13 Johnson, T., C. Alatorrre, Z. Romo, and F. Liu. (2010). México: Estudio sobre la Disminución de Emisiones de Carbono. Washington, D.C.: The World Bank. 14 M.A. McNeil, V. E. Letschert, et al. (2008). Global Potential of Energy Efficiency Standards and Labeling Programs, LBNL for METI.

14

housing can also be improved. There is considerable potential for improving lighting, since incandescent lamps still account for about 85 percent of residential light bulbs in Mexico. Given the large potential for improving energy efficiency in the residential sector, Mexico is preparing to launch a large-scale energy-efficient lighting and appliances program. 39. Mexico does not have a residential building energy-efficiency code, but recent programs by CONAVI to set energy efficiency and other sustainability criteria are a step in the right direction. Residential building codes have proven to be a highly effective means of reducing cooling loads (through thermal insulation and window improvements) in the U.S. state of California. The combination of codes for residential housing units and high-efficiency air conditioners can drastically reduce air-conditioning electricity consumption in new homes. 40. Low-carbon development in urban areas is fully contained in the PECC, specifically in the objective of promoting new, energy-efficient housing. Sustainable housing development is an important element of Mexico’s National Program for the Sustainable Use of Energy 2009-2012. Despite the Government’s commitment to achieving sustainable housing, reaching the specific objectives contained in the PECC and other programs will require additional regulatory reform (such as building codes) and financial support (such as green mortgages) to overcome upfront costs of energy efficient technologies and create the market for sustainable housing. The Government is encouraging the private sector to adopt sustainable energy criteria in housing construction by providing a subsidy to low-income households that provides the critical upfront capital to allow the purchase of housing. This multi-year process has allowed the private sector to modify their building practices and incorporate energy and water-efficient devices, whereas previously they would build low-cost housing but inadvertently pass the higher operation costs (such as utility bills) on to homeowners. FORESTRY AND LAND USE: ISSUES AND GOVERNMENT PROGRAMS

41. Land use, land-use change, and forestry (LULUCF) contributed about 14 percent of Mexico’s GHG emissions in 2006, with 10.5 percent of emissions due to deforestation associated with forest conversion to agriculture and pasture. The remaining 3.5 percent of GHG emissions in 2006 were due to degradation driven by factors such as over-logging, illegal logging, high grading (harvesting only the best trees), bad management, forest grazing, pests, fires, and other human activities.15 The Government and the PECC recognize that only by improving forestry management, including reducing the emissions from deforestation, can Mexico meet its climate mitigation goals. 42. Given the contribution of deforestation and degradation to the country’s greenhouse gas inventory, the Government of Mexico has recognized that interventions in the forestry sector constitute some of the most important GHG emission mitigation options in the short-and medium-term. The PECC contains the following four main objectives for the forestry sector: (i) mitigate emissions from the forestry sector and those originating from land use changes through programs for the sustainable protection, conservation, and management of forest ecosystems; (ii) increase the potential of forests as carbon sinks through reforestation 15 SEMARNAT (2006). Tercer Comunicado Nacional ante la CMNUCC. Mexico’s REDD+ Readiness Preparation Proposal. FCPF Participants Committee, October, 2009.

15

and afforestation activities; (iii) stabilize the forestry-agriculture frontier so as to reduce GHG emissions generated by the conversion of forest lands to agricultural uses; and (iv) decrease the incidence of forest fires due to forestry and agriculture-related activities. Within these objectives, one of the most important medium-term (PECC) goals is to incorporate 2.95 million hectares of land under sustainable forest management. Increasing the number of forestry management plans is in this regard one of the most important ways for Mexico to reduce emissions caused by deforestation and degradation (REDD). 43. Mexico has made great strides in achieving its forestry goals through the creation and implementation of key forestry-related programs and strategies. Among the most important programs are the Programa Estratégico Forestal para México 2025, whose objective is to promote and strengthen the sustainable development of natural resources in forest ecosystems through conservation, protection, restoration, promotion, and production activities, as well as to propose investment options in the forestry sector; and the Programa Sectorial de Medio Ambiente y Recursos Naturales 2007-2012, which aims to identify actions for the conservation of forest carbon stocks and the reduction of GHG emissions, and to promote knowledge generation to strengthen climate change policy formulation. Since 2007, the Federal Government, through CONAFOR, has implemented the ProÁrbol program for developing community forestry, promoting sustainable forest management, soil conservation, and reforestation. In addition, the Government of Mexico has also established the Programa de Plantaciones Forestales Comerciales or PRODEPLAN (1997), whose main objective is to develop productive activities through commercial forest plantations; and the Bank-supported Programa de Desarrollo Forestal Comunitario (PROCYMAF, 1998), which aims to strengthen community forestry schemes for sustainable forest management. 44. Consistent with the National Development Plan, Mexico has paid close attention to halting the advance of the agricultural frontier on forests and jungles. The Government of Mexico has established ecological projects related to land conservation, restoration, and reforestation through its farm-support program, Programa de Apoyos Directos al Campo (PROCAMPO). Since 1995, PROCAMPO Ecológico has allowed PROCAMPO-eligible land to be converted to ecologically friendly uses. However, this environmental component has been limited, due largely to structural and institutional impediments, and to the limited economic benefits that it offers. 45. While the above mentioned measures have represented important steps to foster the low-carbon development of the forest sector, limit the advance of the agricultural frontier on forest lands, and protect biodiversity, there are several additional areas that need to be addressed. Considering that the majority of GHG emissions within land use, land use change, and forestry are caused by deforestation and degradation, the Government of Mexico recognizes it must undertake regulatory, institutional, and policy reforms to promote sustainable forest management. 46. Mexico’s forests cover close to 30 percent of the country’s land territory (30.5 million hectares of temperate forest and 26.5 million hectares of tropical forest).16 An additional 58.5 million hectares, or 40 percent of the territory includes xerophytic vegetation (vegetation

16 García Trujillo, Zazilha (2006) Presentation made at the International Forum on Investment in Tropical Forests.

16

that requires little water) that is also under the responsibility of the National Forestry Commission (CONAFOR). The forestry sector contributes around 1.4 percent of GDP,17 and generates over 100,000 permanent jobs that pay an income 3 to 4 times higher than that of agricultural activities.18 Although an estimated 38 percent of Mexico’s total forested area has commercial potential (21.6 million hectares),19 only around 15 percent (8.5 million hectares) of the area is currently managed under approved sustainable management plans. 47. Sustainable forest management has been proven to generate significant environmental and social benefits. In the Mexican context, the natural protected areas (NPA) system covers nearly 10 percent of the forest area in the country and, for reasons of budget and ecosystem management, the inclusion of additional areas needs to be selective. Outside of the NPAs, abandonment has led to land degradation due to fires, plagues, illegal logging, and other land use changes. According to the OECD, sustainable forest management has proven to protect forest cover as effectively as NPAs (OECD, 1997), while providing livelihoods to over 12 million rural inhabitants in Mexico. The estimated emissions reductions from incorporation of new areas to sustainable forest management are estimated to total 15.7 mtCO2e by 2012. 48. SEMARNAT, CONAFOR, and forest producers agree that some of the most important challenges preventing the incorporation of forests under sustainable forms of management are the lack of streamlined procedures for permits, weak capacity, and inadequate information for planning, promotion, and enforcement. The simplification, elimination, and modification of administrative procedures represents an important step along several dimensions: (i) acting as an incentive for users to incorporate forest land under sustainable forms of management and preventing illegal land uses, (ii) harmonizing procedures and requirements and promoting transparency, (iii) enhancing inter-institutional coordination by creating a common language between government agencies involved in forest management activities, and (iv) contributing to a systematic way of gathering and processing information relevant to the forestry sector. This last dimension is particularly important, as the generation of relevant data on the forestry sector allows for the informed planning, promotion, and enforcement of sustainable forest management activities by SEMARNAT, CONAFOR, and PROFEPA, respectively. 49. Mexico is currently developing a comprehensive REDD+ strategy20 as a framework for existing and future interventions in the forestry sector. Progress has been made in this area, both on the institutional front and on defining and fulfilling the technical needs for the

17 Merino et al (2008) . The contribution of the forestry sector to GDP was 1.6 percent in 2000 and declined to 1.39 percent in 2005. 18 Torres Rojo, Juan Manuel (2004) Estudio de Tendencias y Perspectivas del Sector Forestal en América Latina al año 2020, Informe Nacional México, SEMARNAT/FAO 19 Merino et al (2008). 20 Mexico is a proponent of the REDD+ approach, which promotes the development of strategies and incentives for the reduction of emissions from deforestation and degradation (commonly referred to as REDD) and for the conservation and sustainable management of forests and for the enhancement of carbon stocks. While reducing global forest loss from deforestation and degradation results in a decrease in further emissions of carbon into the atmosphere, REDD+ recognizes that leaving growing forests intact also increases the removal of carbon already in the atmosphere, a process known as carbon sequestration. Additionally, REDD+ supports the idea that forestry initiatives could simultaneously address climate change and rural poverty, while conserving biodiversity and sustaining vital ecosystem services.

17

design of the strategy. Along these lines, the country has submitted a Readiness Preparation Proposal to the Forest Carbon Partnership Facility (FCPF)21 to receive grant support to work out its national reference scenarios for emissions from deforestation and forest degradation, design a national monitoring, reporting, and verification systems for REDD+, and put in place national REDD+ management arrangements. Mexico is also one of eight countries that will have pilot projects under the Forest Investment Program and has been welcomed as an observer to UN-REDD’s Policy Board. Through its involvement in these various spaces, by 2012 Mexico aims to have developed the instruments, mechanisms, schemes, and institutional arrangements that will allow for the formalization of its REDD+ strategy and its initial execution.

PARTICIPATORY PROCESS AND CONSULTATIONS

50. As part of the National Development Plan (PND) and the Special Program for Climate Change (PECC), the majority of the policies and programs included in this program benefitted from a long-standing consultation process carried out by the Government in this context. Additionally, Bank engagement in infrastructure and climate change projects requires regular consultations and the participation of key stakeholders. 51. The public consultations of the PECC were carried out from March 24 to June 18, 2009. Comments and suggestions were received from 97 persons and institutions and posted on the Environment Ministry’s web page (www.semarnat.gob.mx). Participants included: 25 Schools, Universities, and Research Centers; 23 Environmental and Non-Government Organizations (NGOs), 23 Consultants and Firms, 12 National and Sub-national Government Officials, and 2 Rural Producers Organizations. In parallel with the creation of the Inter-Secretarial Commission on Climate Change, the Government of Mexico invited the scientific community and civil society to form a Consultative Council to provide input to the PECC to ensure that strategies and sector programs are developed with due consultation for potentially affected parties.

Cogeneration and Small-Scale Renewable Energy 52. The three resolutions that promote increased cogeneration and renewable energy supply went through a series of technical and public consultations prior to being published in April 2010. On the technical side, input was solicited from both domestic and international experts on the interconnection, net-metering, and model contract proposals, prior to be being released for public consultation. In compliance with the Federal Law on Administrative Procedures (Ley Federal del Procedimiento Administrativo), the draft of every regulation must be pre-published in the respective institution’s website or in the Diario Oficial de la Federación to allow input and feedback from the general public. In the case of these energy regulations, the draft resolutions were made available prior to their release on both SENER’s and CRE’s website, and several workshops on renewable energy and energy efficiency were held to discuss the specific content and implications of the three resolutions. In particular, the RES/054/2010 (model contract for small-scale renewable or cogeneration) was pre-published in the Diario Oficial on April 8th, 2010 for a period of 53 days; the RES/066/2010 21 The FCPF, which is managed by the World Bank, was originally announced at CoP13 in Bali in December 2007; it became operational in June 2008.

18

(net-metering methodology) was pre-published in the Diario Oficial on April 16th for 5 days; and the RES/067/2010 (interconnection model contract) was pre-published in the Diario Oficial on April 28th, 2010 for 5 days. Gas Flaring Reduction 53. The Resolution to Reduce Gas Flaring and Technical Specifications was extensively discussed with Pemex through four working meetings with senior management, during which time the main agreements were reached, including thresholds for gas flaring, and the reporting protocol. In addition, consultations on the Technical Specifications of the resolution were held with international experts to verify their accuracy and technical feasibility, including the GGFR of the World Bank and the Energy Resources Conservation Board of Alberta (Canada). The draft Resolution on gas flaring was published on the CNH website. Fuel Efficiency in Vehicles and Transport Operations 54. The preparation of the energy efficiency standard for new vehicles takes place through an open and participatory process. It begins with the dissemination of basic information on the proposed standard in the National Standardization Program that is published in the Official Gazette. This signals the formal start of the standardization process, and is meant to serve as an instrument to plan, inform and coordinate the preparation of national standards. The responsible entities, in this case SEMARNAT, SENER, and SE, prepare the draft standard along with a regulatory impact analysis (manifestación de impacto regulatorio). The draft standard is published in its entirety for public consultation, and interested parties may provide comments to the National Consultative Standardization Committee during a 60-day-period. During this period the regulatory impact analysis is available for consultation with the Committee. The draft standard is revised based on the comments received. The modifications to the draft standard as well as the answers to the comments are published in the Official Gazette at least 15 days prior to the issuance and publication of the final standard. 55. Since 2008, SEMARNAT and STC have held regular meetings with all main transport associations representing the road transport sector. These meetings discussed measures for improving the Transporte Limpio Program under preparation. Additionally, SEMARNAT and STC took advantage of sectorial conferences and events to present the Program. In the beginning of 2010, a pilot of the Program was launched with approximately 15 firms to test the program and make revisions. Given the imminent launch of the Program, STC organized a meeting on September 6, 2010 with the four main transport associations which represent nearly all transport companies in the country. These associations are: Cámara Nacional del Autotransporte de Carga - CANACAR, Asociación Nacional de Transporte Privado - ANTP, Cámara Nacional del Autotransporte de Pasaje y Turismo – CANAPAT, and Confederación de Transportistas de la República Mexicana - CONATRAM.

19

Energy-Efficient Housing Development 56. The Sustainable Housing Program for Climate Change (PEDHSCC), including the newly established CDM methodology for sustainable housing22 and the sustainable criteria for the basic housing package,23 had an extensive consultation process in various phases, involving government, academia, private sector developers, and potential homebuyers. A government consultation process was established through the formation of a technical evaluation committee, consisting of the Ministry of Social Development (Secretaria de Desarrollo Social, SEDESOL), the National Housing Commission (Comision Nacional de la Vivienda, CONAVI), the National Workers Housing Fund (Instituto del Fondo Nacional de la Vivienda para los Trabajadores, INFONAVIT), and the Federal Mortgage Society (Sociedad Hipotecaria Federal, SHF). The committee’s goal was to determine the energy efficiency and sustainable housing criteria which would enable a new homeowner to receive CONAVI’s subsidy. A sustainable development committee was established by CONAVI to meet with academia, housing developers, and housing finance institutions (such as SHF and INFONAVIT) to discuss and get feedback on the PEDHSCC. The committee decreed that all housing developers must provide potential homebuyers information about CONAVI’s sustainable housing subsidy criteria and the green mortgage code. In addition, a public consultation was held in Mexico City on December 1, 2009 in which the PEDHSCC and the new housing CDM methodology were presented and queries answered. This event was announced in the local newspapers and on CONAVI’s website and included the participation of over one hundred people from the state, local, and national level from the urban development, housing and environment sectors, academia (public and private universities), private developers, the construction industry, the housing finance sector, and potential homebuyers. Land Use and Forestry 57. Given the importance of sustainable forest management for the forestry sector in Mexico as well as to the PECC goals, a consultation process has been established for the regulatory reforms in the forestry sector. Under the National Planning Law, indigenous peoples have been represented in the development of the forestry law through their involvement at the federal (National Council for Indigenous Peoples), municipal (Municipal Councils), and rural levels (Rural Development Councils). Related to forest management, Mexico has also recently created a REDD+ task force housed within CONAFOR and composed of representatives of governmental institutions (forestry and non-forestry), NGOs, forest organizations, academia, and financial institutions. The REDD+ task force has met regularly to define the national REDD+ preparation strategy, to discuss and agree upon the various components of the Readiness Preparation Plan Proposal (R-PP) submitted to the Forest Carbon Partnership Facility (FCPF), and to discuss and agree upon the national consultation strategy for REDD+. At the sub-national level, various REDD+ related meetings and stakeholder consultations were held in 2009, with the participation of various state-level or local-level stakeholder participation. Chiapas and Michoacán have formed working groups to help develop REDD+ at the state level, and to mainstream Sustainable Forest Management within their REDD+ strategies. Specific to the regulatory reforms for forest management,

22 UNFCCC methodology for energy efficiency and renewable energy measures in new housing (AMS-III.AE). 23 Características de Paquete Básico para Programa de Subsidios 2009.

20

mechanisms have been established by SEMARNAT to disseminate the changes. These efforts include four annual regional capacity-building workshops that will act as platforms for consultations with local communities.

IV. BANK SUPPORT TO THE GOVERNMENT’S PROGRAM

LINK TO THE COUNTRY PARTNERSHIP STRATEGY 58. A multi-sector DPL supporting the Government of Mexico’s Climate Change strategy, as proposed in this DPL, is envisioned in the existing Country Partnership Strategy for Mexico. Aligned with the Government of Mexico’s 2007- 2012 National Development Plan, the Mexico Country Partnership Strategy (CPS) for FY08-FY13, composed of the same four pillars24 as the National Development Plan (NDP), proposes a streamlined approach to lending, accompanied by an enhanced program of non-lending advisory services and technical assistance. Among other types of support, the CPS framework suggests that the implementation of the Government’s climate change strategy could be supported by a multi-sector DPL, addressing barriers to reducing emissions across a number of sectors in the context of the overarching objectives defined in the Government’s National Development Plan. 59. The individual policy areas that are recognized and supported by the Bank through this DPL and other assistance address multiple themes of the CPS. While environmental sustainability is the key objective of all of the policy areas, there are also strong linkages to the other themes as well. The reduction of poverty and inequality are directly promoted through the subsidies for the purchase of energy-efficient housing under the National Housing Commission (CONAVI), which are limited to lower-income groups in Mexico. The reforms in sustainable forest management will allow low-income communities in rural areas, many of them indigenous peoples, to make use of forested lands for their livelihood in exchange for sustainable stewardship. Competitiveness would be strengthened through the promotion of greater efficiency in the supply of energy (cogeneration), and in the improved efficiency of freight and passenger transport (Clean Transport Program). For all of the policy areas that are included in this DPL, institutional strengthening is an important objective and explicit component of programs. For example, the forest management reforms are accompanied by training of local communities in preparing and implementing sustainable forest management plans. COLLABORATION WITH THE IMF AND OTHER DONORS 60. The macroeconomic situation and prospects for Mexico are regularly discussed between the World Bank and the IMF. These consultations, held quarterly or more frequently, involve an exchange of documents and recent reports conducted by the respective teams, as well as a discussion of Mexico’s financial sector issues, given their relevance for IMF and World Bank engagement with the country. A Flexible Credit Line (FCL) for approximately 24 The four pillars are: (i) reduction of poverty and inequality, (ii) increasing competitiveness, (iii) strengthening institutions, and (iv) environmental sustainability.

21

US$47 billion was approved by the IMF in April 2009, whereby Mexico became the first country to qualify and request this new instrument, only available to countries with a solid financial system. At the same time, the U.S. Federal Reserve arranged a US$30 billion currency swap in response to the financial turmoil that occurred in spring of 2009. 61. Intended as a one-year arrangement, the IMF’s FCL is being used as a precaution by governments. For Mexico, the announcement of the FCL greatly reduced the volatility of the peso. This flexible instrument, recently renamed, can be used at any time within a one-year timeframe and the disbursements do not have to be staggered. This type of precautionary support, complementary to World Bank and Inter-American Development Bank (IDB) financing of the Mexican Government’s budget, has also served as a backstop on international reserves of the Central Bank, thus limiting the possibility of speculative capital outflows that could cause further damage to Mexico’s economic prospects. Meanwhile, Bank financing has provided counter-cyclical and long-term financing of government expenditure and has allowed the government to limit the crowding out of private sector access to local and international capital markets. 62. Through its joint preparation of the Clean Technology Fund Investment Plan, the World Bank and the Inter-American Development Bank have shared their respective experience in the identification of low-carbon development options in Mexico. During the preparation of the MEDEC study, which provides the analytical underpinning for this DPL, the World Bank and the IDB held numerous meetings and attended multiple workshops with Mexican counterparts, particularly on energy sector issues. While the Bank was preparing MEDEC, the IDB was supporting a parallel analysis on the economics of climate change that provided information to MEDEC, and vice versa. 63. In the preparation of this DPL, the World Bank has also coordinated with the French Development Agency (ADF), which has been an active player in the climate change area in Mexico. In February 2010, ADF approved a US$250 million program to support Mexico's climate change agenda through targeted technical assistance on sectoral and cross-cutting issues. Given their common interest in supporting environment programs in general, and low-carbon development in particular, the World Bank and ADF officials have met to discuss their respective assistance programs in the areas of renewable energy, energy efficiency, and forest management, including in the context of the preparation of this DPL. RELATIONSHIP TO OTHER BANK OPERATIONS CROSS-SECTORAL OPERATIONS AND ANALYSES

64. The current low-carbon program builds on a number of past operations by the World Bank in support of Mexico’s Climate Change policy and institutional development. The range of Bank activities is broad, and includes the areas of potential climate change impacts, as well as measures that can be taken to reduce emissions (mitigation) and contribute to overall sustainability goals. The Bank has worked in almost all sectors of Mexico’s economy that are

22

relevant to climate change through a range of advisory services, analytical work, investment projects, and DPLs.25 65. Through its analytic and advisory work, the Bank has contributed to the development of Mexico’s national climate change program, most significantly through the evaluation of impacts, adaptation measures, and mitigation strategies related to water, forests, energy, transport, and urban development. In all of these areas, the Bank has provided Mexico with the experiences from other countries, such as in the use of carbon markets and renewable energy policy, and in turn has helped to disseminate Mexico’s best practices internationally, such as in the areas of community forestry, bus rapid transit, and overall environment and climate change planning. The Bank has contributed to the financing of Mexico’s sustainable development and climate change agenda through the use of grants (GEF), concessional financing (CTF), carbon payments, and sector investment loans in the areas of clean energy, urban transport, waste management, and land-use and forestry, as well as through development policy loans.

66. Several DPLs have been requested by the Government of Mexico in recognition and support of their climate change program. These include the programmatic Environmental SALs, the Climate Change DPL and the Environmental Sustainability DPL (both approved in 2008), the Green Growth DPL (2009) and the DPL for Adaptation to Climate Change in the Water Sector (2010). These previous DPLs have recognized and supported: (i) Mexico’s overall climate strategy, including the adoption of the ENACC and the PECC programs, (ii) the establishment of key institutions in the energy and transport sectors, namely CONUEE and PROTRAM, (iii) the passage of key legislation in the energy sectors, namely the energy efficiency and renewable energy laws, and (iv) the establishment of an adaptation program in the water sector. 67. The programs and policies that are recognized and supported by this DPL cover sector-specific regulations, standards, and programs that have been determined as essential for meeting the PECC goals, and which have been assessed in the World Bank’s low-carbon study and other analytical work to have good financial and economic returns, and can be feasibly implemented in the near term. The interventions that are covered by the policy areas included in this program cover actions in four key sectors: energy, transport, urban housing, and forestry. Table 3 provides a list of the relevant interventions, along with the potential for GHG reductions that they represent in Mexico both for the long-term (to 2030) and on an annual basis. 68. The proposed DPL is anchored in the analytical work carried out jointly by the World Bank and a number of counterpart agencies in Mexico. Among these analytical works, most relevant to the design and preparation of this operation is the World Bank study on Low-Carbon Development in Mexico (MEDEC), prepared in consultation with representatives from the Ministry of Environment and Natural Resources, the National Institute of Ecology, the Ministry of Energy, the National Commission for Efficient Use of Energy, Pemex, and CFE. Evaluating 40 low-cost interventions across key emissions sectors in Mexico, the

25 The range of Bank assistance to Mexico in the climate change area is elaborated in more detail in Annex 5.

23

MEDEC develops a low-carbon scenario through 2030 assuming no major changes in technology. The interventions evaluated as part of the study were selected based on their potential for reducing GHG emissions, feasibility in the short or medium term, and low economic and financial costs. 69. The policy areas that were selected for inclusion in the Low-carbon DPL were identified in the PECC as being of high-priority for Mexico’s climate change mitigation agenda in the near term. While the PECC did not evaluate mitigation measures from a cost-benefit perspective, such an analysis was conducted as part of the MEDEC study. The criteria that were used to evaluate and select the policy areas included: (i) the size of carbon emissions reduction (table 4), (ii) the financial and economic returns of the measures without considering the global environmental benefits, and (iii) the feasibility of implementing the measures in Mexico in the short term, including the consideration of political and social acceptability. All of the policy areas included in this DPL ranked high in terms of the MEDEC criteria. Their overall potential for reducing carbon emissions is large, while their net cost of reducing carbon emissions is modest (figure 4).

Table 4: Low-Carbon Interventions Affected by the DPL Policy Areas

Sector Intervention

Total emissions reduction potential

2010-2030 (Mt CO2e)

Maximum annual

emissions reduction (Mt CO2e)

Energy Cogeneration in industry 61 6.5 Energy Bagasse cogeneration 59 6.0 Energy Cogeneration in Pemex 387 26.7

Energy Renewable Energy (RE)-Biogas* 55 5.4

Energy RE-Biomass electricity* 376 35.1 Energy RE-Small hydro* 86 8.8 Energy RE-Windpower* 240 23.0 Transport Fuel economy standards 195 20.1 Transport Road freight logistics** 157 13.8 Urban Housing

Residential Air Conditioning*** 42 2.6

Urban Housing Residential lighting*** 100 5.7 Urban Housing Solar water heating*** 169 18.9 Forestry Forest management 92 7.8 Forestry Reforestation &

restoration**** 169 22.4 TOTAL Direct 794 67.1 Total Partial 1394 135.7

* The portion of the renewable energy potential that meets the “small-scale” definition would be stimulated by the new CRE regulations. ** A portion of the road freight logistics potential would be stimulated by the Transporte Limpio Program. *** A portion of the residential energy efficiency potential would be captured by CONAVI’s sustainable housing program. **** A portion of the reforestation and restoration potential would be stimulated by the new forestry management reforms. Source: MEDEC.

24

Figure 4: Marginal Abatement Cost Curve for the Interventions Affected by the DPL

Source: MEDEC.

Sector Specific Operational Work and Analytical Studies 70. The current DPL is linked to a number of sector-specific engagements that reflect a long-standing and comprehensive policy dialogue and operational relationship between the Government of Mexico and the World Bank. 71. In the Energy sector, the World Bank currently supports a variety of interventions aimed at putting the sector on a low-carbon development path. Among others, these include studies on renewable resources (Mexico Renewable Energy Assistance Program, to be completed in 2011) and on the social and environmental standards needed to develop wind farms (Greening the Wind, forthcoming November 2010). They also include investments in the development of wind plants (through Venta II) and studies on the potential for mini-hydro development (through the Promoting Mini-Hydro Potential in Mexico technical assistance project). A large IBRD and CTF-financed operation, the Mexico Efficient Lighting and Appliances Project, to be presented to the Bank’s Board in parallel with this operation, supports Mexico’s end-use energy efficiency efforts by financing the replacement of appliances and incandescent lighting in residential and municipal buildings with more energy efficient technologies for both public and private consumers. Under the Mexico Integrated Energy Services Project, the World Bank is supporting rural electrification solutions in

Bus

sys

tem

opt

imiz

atio

n

Rai

lway

frei

ght

Bor

der v

ehic

le in

spec

tion

Urb

an d

ensi

fica

tion

Bus

rapi

d tr

ansi

tN

on-m

otor

ized

tran

spor

tRo

ad fr

eigh

t log

isti

cs

Coge

nera

tion

in P

EMEX

Stre

et li

ghti

ngRe

side

ntia

l lig

htin

gN

on-r

esid

enti

al li

ghti

ngCh

arco

al p

rodu

ctio

n

Indu

stri

al m

otor

sU

tilit

y ef

fici

ency

Zero

tilla

ge m

aize

Coge

nera

tion

in in

dust

ryI&

M in

21

citi

esSo

lar w

ater

hea

ting

Fore

st m

anag

emen

tFu

el e

cono

my

stan

dard

sN

on-r

esid

enti

al A

CR

esid

enti

al re

frig

erat

ion

Gas

leak

age

redu

ctio

nRe

side

ntia

l AC

Biom

ass e

lect

rici

ty

Impr

oved

coo

ksto

ves

Biog

asW

indp

ower

Baga

sse

coge

nera

tion

Sorg

hum

eth

anol

Palm

oil

biod

iese

lFu

elw

ood

co-f

irin

g (2

0%)

Aff

ores

tati

on

Refo

rest

atio

n &

rest

orat

ion

Smal

l hyd

roSu

garc

ane

etha

nol

Geo

ther

mal

Ref

iner

y ef

fici

ency

Wild

life

man

agem

ent

Envi

ronm

enta

l ser

vice

s

-100

-50

0

50

100

0 1,000 2,000 3,000 4,000 5,000

Net

ben

efit

s ←

→

Net

cos

ts[U

S$/t

CO2e

]

Cumulative mitigation 2009-2030 [MtCO2e]

25

isolated poor communities using small-scale renewable energy, mainly solar photo-voltaic (PV) units. 72. Through a Fee-based Analytical and Advisory Services project, to be completed in 2011, the Bank is supporting Pemex in improving its analytical and management tools to help evaluate the environmental and social externalities of the company’s operations, build performance indicators based on the valuation of environmental costs and benefits that can complement corporate benchmarking exercises to report more fully on the company's strategic goals, and analyze the strengths and weaknesses of Mexico's institutional framework to regulate the environmental impact of the oil industry. The Bank has undertaken a review of Mexico’s residential electricity subsidy system (World Bank, 2009)26 and has proposed a range of options that could both reduce the overall fiscal burden of the subsidies (estimated at some US$10 billion in 2006) and better target subsidies toward low-income consumers. 73. In the energy/agriculture sector, the Bank has been assisting Mexico to implement low-carbon measures related to energy use. Support to the adoption of environmentally sustainable agri-business practices is being provided through the Sustainable Rural Development Project by financing investments in environmentally sustainable and renewable energy technologies, including solar systems and biodigestors. The project also provides assistance for policy development to address issues related to climate change and the environmental impact of sub-projects and for institutional strengthening of SAGARPA. Lastly, the recently delivered Agriculture and Rural Development Public Expenditure Review (PER) provides a comprehensive overview of public expenditure in agricultural programs at the federal and state levels, assesses the impact of major programs on competitiveness and equity, and discusses key issues linked to Mexico’s sectoral strategy. Complementary to this Economic and Sector Work (ESW), an Economic Assessment of Policy Interventions in the Water Sector is currently being implemented, supporting the development of regional and macro analysis of policy interventions in Mexico’s water sector as they relate to water use in irrigation in the agricultural sector and its associated environmental externalities. 74. In the Transport sector, particularly urban transport, the proposed Low-Carbon Development DPL builds on and complements, among others, the outcomes of such Bank-supported projects as the Mexican Medium Size Cities Transport Program, which supported the strengthening of local institutional capacity as well as the federal urban transport decentralization process; the Introduction to Climate Friendly Measures in Transport, a GEF project that assisted the Government in developing policies and measures for stimulating a long-term modal shift toward cleaner and less carbon-intensive transport in the Mexico City Metropolitan Area; and the Mexico Mass Urban Transport Federal Technical Assistance Program, which helped in designing, creating and establishing a federal support program for mass transit. The DPL also links to the outcomes of the CTF and IBRD supported Urban Transport Transformation Program (UTTP) and the Global Environment Facility (GEF)-supported Sustainable Transport and Air Quality project, both aimed at placing Mexico’s urban transport on a low-carbon growth path. Lastly, the DPL complements the transport component of the Framework for Green Growth DPL.

26 Komives, K., T. Johnson, J. Halpern, J. Aburto, J. Scott (2009): Residential Electricity Subsidies in Mexico, Exploring Options for Reform and for Enhancing the Impact on the Poor. World Bank, Working Paper No. 160.

26

75. In the Urban development sector, the Bank supported Mexico through a project aimed at reducing solid waste methane emissions. In urban housing development, the ongoing Third Fee for Advisory Services to Sociedad Hipotecaria Federal project is assisting Mexico’s Ministry of Finance in analyzing options for improving the functioning of the housing finance markets in the medium term. Similarly, through the Private Housing Finance Markets Strengthening Project, approved in 2008, the Bank is helping strengthen the financial and technical capacity of Federal Mortgage Corporation (SHF) to develop and consolidate markets for housing finance and to expand access to lower income groups. 76. Relevant to the type of support the current DPL aims to provide to the Forestry and Land Use sector, two Community Forestry or PROCYMAF projects successfully assisted indigenous communities and forest owners to improve management and conservation of their forest resources and generate alternative sources of sustainable income. In conjunction with these projects, the GEF Indigenous and Community Biodiversity Conservation project built upon the technical assistance offered through the PROCYMAF in the states of Oaxaca, Michoacán, and Guerrero by initiating a parallel, demand-driven program for financing the creation of community biodiversity conservation areas and complementary biodiversity-friendly sustainable land use activities. Linking biodiversity conservation efforts in Mexico with other countries of the region, the Fostering Sustainable and Competitive Production Systems Consistent with Biodiversity Conservation project (P121111) that is currently under preparation with funding from the GEF, will focus on sustainable management and value chains development in the Mesoamerican Biological Corridor. Additionally, the ongoing Sacred Orchids of Chiapas: Cultural and Religious Values in Conservation Project is helping strengthen Mexico’s sub-regional Protected Areas system by establishing partnerships with landowners to secure a more effective long-term conservation in the country’s forest eco-regions. 77. The GEF Consolidation of Protected Areas System project addresses forest protection issues in national protected area systems, while the GEF-funded Environmental Services Project aims to enhance and protect biological diversity and preserve globally significant forest and mountain ecosystems through improving the targeting of the Payments for Hydrological Environmental Services Program, piloting a market-based system to contract environmental services, and establishing an endowment fund for biodiversity conservation to provide long-term financing for PES. The complementary IBRD-IDA funded portion of the project has the goal of substantially increasing the development of markets for environmental services in Mexico through sustainable financing mechanisms and efficient payment delivery mechanisms. 78. The Bank has provided assistance to the Government of the State of Michoacan to prepare a Climate Change Strategy led by the minister of environment (Secretaría de Urbanismo y Medio Ambiente). The Bank´s support to subnational climate change initiatives is one of the activities under the climate change MoU with SEMARNAT. The Bank´s assistance has been two-fold: (a) a participatory planning process has been initiated to promote awareness, identify issues, existing information and priorities, reaching out to civil society through a series of national and international workshops, and assisting in the preparation of proposals for donors funding; and (b) based on identified priorities and key studies, a risk management approach of the impacts of climate change for selected sectors is being prepared.

27

79. In the Social Development sector, the Bank currently supports a variety of interventions aimed at strengthening environmental sustainability principles within the Government’s social policy framework, as well as the social and equity dimensions of its environmental and climate change policy. A study on the Social Dimensions of Climate Change provides an impact analysis of disaster and climate risks on the poor, a municipal index of climate vulnerability, and an assessment of the effectiveness of current risk management programs. The Bank also has an MoU with the Ministry of Social Development (SEDESOL) to mainstream sustainability principles across its social programs and to pilot a more integrated approach to sustainable local development in the most marginalized municipalities. At the municipal level, the Bank also supports a climate change municipal development plan and a green fund in the municipality of Othon P. Blanco, Quintana Roo (with a Cities Alliance grant). These and other initiatives are part of an ongoing policy dialogue for a DPL on Sustainable Territorial Development and Adaptation to Climate Change (FY12) through which the Bank aims to strengthen pro-poor adaptation planning, climate risk management for the poor, and sustainable territorial development practices in urban and rural settings of Mexico. LESSONS LEARNED 80. The design of the proposed DPL draws on the lessons learned from the World Bank’s continued dialogue with Mexico on climate change issues, from the Bank’s investment lending and technical assistance portfolio for Mexico’s energy, transport, and land-use sectors, and, from Bank activities related to climate change in other middle-income countries. In particular, the design and scope of the current operation has been informed by lessons learned from a number of previous cross-sectoral DPLs and other operations in Mexico, including due to their strong links with related technical assistance packages and Memoranda of Understanding. The long-term engagement between the Bank and the Government on climate change has supported Mexico’s leadership in the climate change arena. As such, the proposed operation thus represents the logical next step in this relationship. 81. In particular, the DPLs and sector investment loans provide valuable lessons with respect to the need to ensure the anchoring of the proposed operation in the sector-level analytical work carried out both by the Bank and institutions in Mexico. In the case of the proposed DPL, a strong analytical basis across all the sectors it covers is provided by the MEDEC Study, carried out by the Bank in coordination and consultation with a number of environmental and sectoral institutions in Mexico, which, in turn, contributed to the analytical foundation of the Government’s Special Program for Climate Change (PECC). The DPL also builds on the sector-specific and institutional lessons learned and advances made as a result of the extensive analytical work done to prepare Mexico’s Clean Technology Fund Investment Plan, its Renewable Energy Assistance Program and Urban Transport Program. 82. The analytical foundation and guidance in terms of the need for a sound and well-developed monitoring program, consultation framework, and thorough assessment of possible adverse social and distributional effects has been provided by the Bank’s ongoing Advisory Program aimed at improving the operational and environmental performance of Pemex. In the Land-Use and Forestry sectors, similar lessons can be drawn from the preparation process for the country’s participation in the Forest Carbon Partnership Facility.

28

Overall, the proposed DPL relies on the analysis underlying the Government’s PECC, a key part of the National Development Plan, which was widely consulted in accordance with participatory processes established in Mexico’s Planning, Transparency and Access to Information legislation as well as other laws. 83. Based on a review of project Implementation Completion Reports and discussions with central government and line agencies, the Bank-supported climate change and above-mentioned sectoral activities highlight the importance of Strong Country Ownership in the selection of the Policy Areas included in the DPL. Country ownership is critical to success, particularly for high-profile and important policy reforms, such as those included in the proposed loan. The proposed project responds to Government’s request to support specific priority programs and areas that reflect the outcome of national policymaking processes. Namely, the current DPL is grounded in the Government’s exemplary program and activities in climate change, including a comprehensive National Climate Change Strategy and the related PECC, as well as Mexico’s three National Communications to the United Nations Convention for Climate Change (UNFCCC). The DPL also builds upon sustained and effective efforts to support climate-friendly energy, transport, urban development, and land-use management programs, based on an objective assessment of the long-term economic sustainability issues and inter-institutional coordination complexities. 84. Thus, the proposed operation builds upon the Government’s own framework for prioritizing low-carbon interventions across the sectors of the economy, acknowledging the need to focus on a select number of central actions, impacts, and results. Toward this aim, the monitoring indicators established for this operation are drawn directly from those the Government is using to assess the success of its interventions. The Government has repeatedly requested the Bank’s support on climate change mitigation and adaptation, environmental management, and sector-specific issues. The experience with developing and providing comprehensive analytic and advisory packages on those priority issues, through various MOUs, as a complement to policy lending, has served to ensure that the Bank’s engagement and support to Mexico is timely and strategic, and that policy development is predicated upon a sound and strategic analytic basis. 85. It is important for Mexico and other developing and middle-income countries to establish domestic climate policies and programs in the context of the international framework for climate change. Mexico’s PECC program is a prime example of a Nationally Appropriate Mitigation Strategy (NAMA), and Mexico and other developing and middle-income countries should be recognized for well-designed national climate change programs. Establishing standard methodologies and reporting protocols for national programs can facilitate access to the international carbon market, while the preparation of mitigation strategies (such as “low-carbon” analyses) can serve as the basis for international climate change funds (such as the CTF). ANALYTICAL UNDERPINNINGS 86. The preparation of this DPL has been informed by numerous analytical studies and a rich set of technical assistance activities covering the Energy, Transport, Urban, and Forestry sectors as well as Climate Change and environmental management issues more broadly. Among the analytical works that form the basis for this operation are:

29

� World Development Report 2010 – Development and Climate Change analyzes the

climate change impacts on economic development and finds that, in order to reduce vulnerability to climate change, societies will need to increase efforts to protect natural resources and pursue other cross-sectoral, “climate smart” practices.

� Low-carbon, High Growth: Latin American Responses to Climate Change explores how the region is exposed to climate change impacts and what it can do to avert its effects, both unilaterally and with the incentives of a global climate agreement.

� Low-Carbon Development for Mexico (México: Estudio sobre la Disminución de Emisiones de Carbono, MEDEC) -- prepared by the World Bank in consultation with representatives from key Mexican agencies, research institutes, and civil society, ,assessed Mexico’s potential for low-carbon growth and the macroeconomic and fiscal implications of a low-carbon development plan. The MEDEC study highlights opportunities for carbon emissions reductions from a range of sectors, including energy, transport, end-use energy efficiency, and forestry and land-use. Evaluating 40 low-cost interventions across the main emissions sectors in Mexico, MEDEC develops a low-carbon scenario through 2030. The interventions evaluated were selected based on their potential for reducing GHG emissions, feasibility in the short or medium term, and low economic and financial costs. The MEDEC study has provided the primary source of information for the policy and institutional measures included in this DPL.

� Clean Technology Fund (CTF) Investment Plan, a multi-year “business plan” agreed on by the Government of Mexico, the IBRD, the IDB and the IFC, provides support for the low-carbon objectives in Mexico’s Energy and Transport sectors contained in the 2007-2012 National Development Plan, the National Climate Change Strategy, and the PECC.

� Environmental Technical Advisory Program (TAP) with SEMARNAT aims to strengthen Mexico’s capacity to mainstream environmental and climate change consideration in key economic sectors and public policy by: (i) supporting SEMARNAT and the Instituto Nacional de Ecologìa (INE) in building capacity at the state level for developing sub-national climate change mitigation and adaptation plans and environmental mainstreaming; (ii) strengthening SEMARNAT’s capacity to mainstream environmental considerations in the agriculture, energy, and housing sectors; and (iii) supporting SEMARNAT in carrying out technical studies to assess climate change impacts and adaptation measures and identify GHG emissions mitigation measures.

� Memorandum of Understanding (MOU) with SENER aims to strengthen further Mexico’s capacity to implement its National Energy Strategy and covers the following areas of cooperation: (i) support for integrating the policy to promote the use of renewable energy in power generation, (ii) analysis of options for modifying the regulatory framework for energy efficiency, (iii) identification of best practices for reducing gas flaring and venting, (iv) support for designing programs to promote the use of efficient lighting and appliances, and (v) support for developing a National Energy Strategy.

� Study on Residential Electricity Subsidies in Mexico (January 2008) focuses on subsidy distribution across households according to income cohorts, sheds light on how the electricity pricing scheme could be modified, and suggests that there is room to reduce the magnitude of residential electricity subsidies while improving the targeting on low-income groups.

� Global Gas Flaring Reduction partnership. Mexico, represented by Pemex and SENER, joined the GGFR in April of 2010. The GGFR partnership is supporting national efforts to

30

increase Pemex’s operational efficiency program (2008-2012) and the National Energy Sector program (PROSENER), as these initiatives establish concrete goals on gas flaring and venting reduction and gas utilization. In May of 2010, GGFR finished a study to review the gas flaring reduction implementation program of the offshore region (RMNE), which found that the integrated Cantarell and Ku-Maloob-Zaab oil fields emitted some 15 mtCO2e in 2009.

� Mexico Renewable Energy Assistance Program (ESMAP). Since 2009, this program has helped provide SENER and other energy agencies with timely support for their renewable energy regulations. Analytical work and associated workshops have been held covering the development of guidelines for contracting renewable energy and energy efficiency projects, international experiences with solar PV, valuing externalities for thermal power projects, and economic valuation of renewable energy.

� Mexico Urban Transport Sector Technical Advisory Program (TAP) aims to help the Government of Mexico: (i) implement the Federal Mass Transit Program (PROTRAM) and the Urban Transport Transformation Program (UTTP); and (ii) strengthen the technical capacity of the team in charge of implementing these two programs.

� Road Freight Transport Industry in Low and Middle-Income Countries (June 2007), a World Bank study, includes a case study for Mexico that examines the regulatory structure and related barriers to the improvement of road freight transport.

� The Environmental Sustainability DPL (September 2008) included housing as a policy area and recognized CONAVI’s publication of voluntary cross–sector guidelines for incorporating environmentally sustainable practices into housing construction. This was the first effort by the GoM to incorporate energy efficiency into the housing-related government programs and was designed to be implemented on a voluntary basis.

� Technical Assistance to the Housing Sector (CONAVI) supported formulation of the Housing Construction Code. The new voluntary code is based on the methodology of the International Code Council and incorporates energy efficient criteria. It is intended to serve as a guide for government funded programs and to the municipal governments to update their local regulations.

V. THE PROPOSED LOW-CARBON DPL

OPERATION DESCRIPTION 87. This DPL recognizes and supports specific regulatory and institutional reforms for implementing important actions throughout Mexico’s economy – ranging from energy efficiency to forest management – that have been identified as having large climate change mitigation benefits, good financial and economic returns, and the ability to be implemented. Drawing on the results of recent analytical work, principally the Mexico low-carbon study,27

27 Johnson, T., C. Alatorrre, Z. Romo, and F. Liu. (2010). Low-Carbon Development for Mexico (México: Estudio sobre la Disminución de Emisiones de Carbono, MEDEC). Washington, D.C.: The World Bank. This low-carbon study for Mexico is the first of several completed by the World Bank that were undertaken for the key developing and middle-income countries, including studies for Brazil, China, India, South Africa, and Indonesia. A number of other studies have been done on Mexico’s climate change mitigation potential (Galindo, Quadri, Mckinsey, Mario Molina), and the results of the analysis in terms of the priority areas and actions that can be taken are largely consistent with the results of the MEDEC study. Unlike some of the Mexican studies, the MEDEC report focused on the a cost-effectiveness analysis of some of the leading mitigation measures such

31

this program recognizes and supports priority climate change mitigation measures in the energy, transport, urban housing, and forestry sectors. By undertaking these and other near-term priority actions in key sectors, Mexico will be able to put itself on a low-carbon development path and meet its national goals as established in the PECC (see figure 5).

Figure 5: Low-Carbon Scenario for Mexico

Source: MEDEC, 2010. 88. The Policy Development Objective (PDO) of the Development Policy Loan is to support sector-specific, high-priority policy and regulatory reforms that have been identified as critical to achieve Mexico’s climate change mitigation targets under the PECC for:

� Increasing renewable energy supply, promoting energy efficiency through cogeneration,

reduce gas flaring and venting, and piloting the reform of the rural agricultural electricity subsidy;

� Improving the efficiency of the vehicle fleet and road transport operations in Mexico; � Strengthening the market for energy-efficient housing; and � Mainstreaming climate change considerations into land-use and forestry activities. 89. In addition, the proposed operation will contribute to the efforts of the Mexico government to: (i) facilitate Mexico’s involvement in the international carbon market, and (ii) implement Nationally Appropriate Mitigation Actions (NAMAs), in particular the ones adopted in the PECC. 90. The policy areas that are included in the proposed DPL promote low-carbon development in Mexico are shown in Figure 6 and described in more detail below. that measures in different sector s could be directly compared in terms of their GHG emission reduction potential and their net economic cost.

0

200

400

600

800

1000

1200

2008 2030

Em

issi

ons

[MtC

O2e

/yea

r]

MEDEC emissions

Agriculture and forestry

+ 1137 Mt

+ 660 Mt

Oil and gas

Stationary energy end-use

Transport

Electricity

32

Figure 6: Low-Carbon Development Policy Loan for Mexico

POLICY AREAS Energy Sector Objectives 91. This DPL would provide support to the institutional and regulatory initiatives underway in Mexico, aimed at mainstreaming renewable energy supply, increasing cogeneration, reducing gas flaring and venting, and thus contribute to Mexico’s Climate Change and Low-Carbon Development agenda and help to diversify the energy matrix. Specifically, the operation recognizes and supports key regulatory changes in the electric power and oil and gas sectors that will allow the implementation of the Renewable Energy and Energy Efficiency Laws of 2008 and the related regulatory, policy, and institutional initiatives launched in 2009.28 92. To overcome the challenges identified previously, GoM is already implementing a number of specific sub-sectoral initiatives. These include a policy reform to allow for an increased use of cogeneration in industry (including petroleum and gas); new regulations that remove the restrictions for small-scale RE projects (<30MW) that allow them to sign electricity supply contracts with CFE; and new regulations from CNH that will reduce the amount of gas flaring and venting in Pemex.

28 Such as the secondary regulations for the Renewable Energy Law (Reglamento de la Ley para el Aprovechamiento de Energías Renovables y el Financiamiento de la Transición Energética), September 2, 2009.

• Reform of regulatory process for forest management

• Development of national REDD+ strategy

• Sustainable housing and carbon credits

• Green mortgage

• EE standards for new vehicles

• Voluntary Clean Transport Program

•Cogeneration and small-scale renewables

•Gas flaring reductionblesnn

Energy

• EE newnew

• VoTTraTra

Transport

••••••••••••••••••••••••• R fRefoproceprocemana

•• DDeveDeveREDD

ForestryHousing

Low-Carbon Development DPL for Mexico

33

POLICY AREA 1 – COGENERATION AND SMALL-SCALE RENEWABLE ENERGY DEVELOPMENT

93. Prior Action under this policy area is the adoption of a net-metering29 regulation, a wheeling tariff covering transmission and distribution charges, and a model interconnection contract for cogeneration and RE-based electricity generation.30 These rules provide new incentives for large- and small-scale cogeneration plants to produce electricity and sell it to the grid, at terms that are comparable to renewable energy. Notably, as a result of the new set of regulation, small-scale renewable energy producers are now allowed to sell the excess capacity they have to the grid, whereas previously only large-scale projects were allowed to do so. Of particular importance here are the predetermined contracting procedures for cogeneration and small-scale renewable energy suppliers to sell to the grid. At the end of the project (12-18 months), it is expected that the number of new cogeneration permits signed by CRE will increase from 59 (2009) to 70 (2012) and that the combined capacity of grid-connected small-scale photovoltaic-based electricity producers will increase from 25 MW (2009) to 35 MW (2012). It should be noted that while the new reforms will affect all small-scale renewable suppliers, solar PV, for which a baseline exists, will be used as a proxy for overall RE capacity. 94. One of the largest untapped sources of cogeneration potential in Mexico is in the oil and gas facilities of Pemex, which is estimated to be equivalent to about 6 percent of Mexico’s entire electric power capacity. The new rules are expected to make it easier for Pemex to sell electricity to the grid, and thus tap its huge cogeneration potential. By the end of the project, it is expected that at least one large-scale Pemex project will comply with the new cogeneration rules and, thus, be eligible for sale of electricity to the grid.

POLICY AREA 2 – GAS FLARING AND VENTING REDUCTION IN OIL AND GAS PRODUCTION

95. The Prior Action in this area is the publication by the CNH of the Resolution to Reduce Gas Flaring and Venting31 at Pemex and the associated Technical Specifications-guidelines for facilitating and monitoring progress in reducing gas flaring and venting. For the first time, a regulatory entity has instructed Pemex to reduce gas flaring and venting, setting a specific goal of gas flaring reductions in the Cantarell field (the largest)32 from 30 percent of the associated gas produced to a target of 2 percent by 2024, along with continuous reductions also in other fields. Complementing the issuance of the official resolution and specifications for gas flaring and venting reductions, a second Prior Action

29 Net-metering refers to the ability of electricity generators (usually small-scale), who also consume electricity from the grid, to be paid, or receive credit, for the excess amount of electricity they generate and provide to the grid. When their demands exceed the amount of electricity they generate at any point in time, they are net consumers, and when their production exceeds their consumption, they are net sellers. Net-metering is critical in allowing intermittent energy generators, such as small businesses and homeowners, to be able to afford to install and produce electricity, including from cogeneration and renewable energy equipment. 30 Resolution No. RES/054/2010, RES/066/2010 and RES/067/2010. The model contracts, published by CRE in April 2010, specify that auto-producers with capacity under 500 kW will be able to swap energy with the system with carry-over conditions, while those above 500 kW will be able to receive payments in exchange of the excess energy they provide to the grid. 31 Resolución CNH.06.001/09 32 The Resolution states that “specifically for the Cantarell field, the Commission will review the situation that keeps the projects executed for flaring and venting of gas for the purpose of establishing a specific work program with PEMEX which will end in 2012.”

34

under this policy area is the submission by Pemex itself of a number of Manifests to the CNH, outlining the process and timeline for reducing gas flaring and venting at Cantarell and other fields. While these Manifests are not binding instruments, since they can be unilaterally modified by Pemex, they represent the public commitment by Pemex to the goals outlined in the Resolution issued by CNH for gas flaring reduction, and are regarded as a major achievement in the process of oil industry reform. 96. As an outcome of the actions taken by CNH and Pemex outlined above, in the near term (12-18 months from project effectiveness), Pemex is expected to reduce total gas flaring for associated natural gas (excluding Cantarell) from 195 MMCFD (2009) to 145 MMCFD (2012). In the case of Cantarell, Pemex is expected to reduce gas flaring from 504 MMCFD (2009) to 47 MMCFD (2012).

Transport Sector Objectives 97. The objective of the program in the road transport sector is to recognize and support the Government’s creation of a regulatory framework and incentives for increased energy efficiency and lower vehicle emissions. While previous Bank operations have focused on the issues of urban mass transit, including aspects of urban planning and non-motorized transport, this operation focuses largely on the issues of vehicle efficiency and efficiency of interurban freight and passenger road transport operations. The main policy measures and interventions included in the operation include: (i) the establishment of a coherent set of standards for fuel efficiency and emissions in new vehicles; and (ii) the operation of a program to assist long-distance freight and passenger transport operators and freight transport service users to enhance their fuel and environmental performance.

POLICY AREA 3 – FUEL EFFICIENCY IN VEHICLES AND TRANSPORT OPERATIONS

98. In the absence of fuel efficiency standards for new vehicles, vehicle producers lack incentives to put more energy efficient and less polluting vehicles on the market. In addition, the long-distance freight and passenger transport industry in Mexico is inefficiently run, warranting improvements in sector management and fuel efficiency. 99. The Prior Action in this policy area consists of the initiation of a national fuel efficiency standard for new light duty vehicles as part of the 2010 National Standardization Program. A second Prior Action is the adoption by SEMARNAT and SCT of a Voluntary Clean Transport Program to help long-distance freight and passenger operators and freight transport service users to assess their fuel performance and to provide them with technical assistance to improve it. 100. By project end, it is expected that as a result of the first Prior Action the fuel efficiency standard for new light duty vehicles will be in force. This outcome is highly likely because the President committed himself through the PECC and the National Program for Sustainable Energy Use 2009 to 2012 to issue fuel efficiency and emission control standards for new vehicles. In addition, to set an example for broader action the National Commission for Energy Efficiency (CONUEE) has already issued energy efficiency guidelines for new vehicles, which are mandatory for the Mexican federal public administration.

35

101. The standard for light duty vehicles will be similar to the U.S. Corporate Average Fuel Efficiency (CAFE) standard, but it will also take CO2 emission reductions into account. Flexibility measures to reduce the cost of compliance, such as credits and debits if producers exceed or miss the target or banking, are under consideration. In the medium term, SEMARNAT/SENER/SE will also have issued a fuel efficiency standard for new heavy-duty vehicles and will thus have completed a comprehensive framework of vehicle energy efficiency standards. 102. The second Prior Action in this policy area consists of the adoption by SEMARNAT and SCT of a Voluntary Clean Transport Program to help long-distance freight and passenger operators and companies that use freight services assess their fuel performance and provide them with technical assistance to improve it. This program is based on the SmartWay Program that has been successfully operated by the U.S. Environment Protection Agency (EPA), and that has been replicated in a number of developing countries, including China. Participants in the Program receive a rating based on their fuel performance and have to prepare and implement a three-year action plan to improve it. Many of the measures proposed for freight transport operators are extremely cost-efficient and can be implemented almost immediately, such as proper inflation of tires, the use of low-friction lubricants, driver efficiency training, improved operating practices (such as reduced empty hauling), and speed reductions. The initial measures can easily and quickly be offset by fuel savings. Other measures, such as new equipment, will require more time to implement and can be implemented in later stages. Users of freight transport services in the program (such as consumer goods manufacturers) will have to select at least part of their suppliers among participants in the Program. They may also include in the action plan measures to improve their freight logistics. Participants’ performance will be reevaluated on a yearly basis and the rating will be updated. 103. By project end, it is expected that the number of vehicles covered by freight transport operators action plans to improve fuel performance will be at least 30,000 vehicles, and that at least 50 companies that use freight transport services will have an action plan. In the medium term, it is expected that the Program will be improved. It is also expected that the Program will be expanded to include a considerable part of the industry, with reductions of 0.9 million tons of CO2e by 2012 according to the PECC.

Urban Sector Objectives

104. The objective of the DPL in the urban sector is to assist the Government in meeting its short- and medium-term climate change goals through the promotion of energy-efficient housing. The DPL will build on past efforts, specifically supporting the PECC goals that address energy use in the housing sector. 105. Given the expected large expansion of the housing market in Mexico in the coming decades, it is crucial to ensure that new housing is as efficient as possible, including the key energy systems for lighting, water heating, and space conditioning. A key barrier to sustainable housing is the lack of financing to help overcome higher upfront costs of energy efficient technologies; this is particularly true for low-income housing. As a result, the policies included in the urban sector focus on the national housing programs for low-income

36

consumers established by the national housing commission (CONAVI), and the primary mortgage provider (INFONAVIT) that is responsible for about two-thirds of total mortgages in Mexico. An additional and complementary program for supporting the higher costs of energy-efficient housing is the use of the international carbon market. For this, it is necessary to establish clear methodologies and verification conditions to qualify for international carbon credits.

POLICY AREA 4 – ENERGY EFFICIENT HOUSING DEVELOPMENT

106. The Government of Mexico aims to integrate housing policies, programs and instruments that are able to reduce direct and indirect GHG emissions and at the same time take advantage of the international carbon market opportunities for the housing sector. To this end, CONAVI established the Sustainable Housing Program,33 which will help to create a market for energy efficient housing by: (i) defining the Technical Criteria for the Development of Sustainable Housing,34 with homeowners qualifying for a CONAVI subsidy under the program “Esta es Mi Casa” by purchasing a house that meets the criteria; (ii) implementing a nation-wide homogenous “green mortgage” (hipoteca verde),35 product, and (iii) allowing CONAVI subsidy recipients to be eligible for the green mortgage and thus receive better financing to overcome upfront costs of energy efficient technology. The sustainable housing program is the Prior Action for this policy area. 107. By the end of the project it is expected that residential building development will increasingly adopt the sustainable housing energy efficient criteria (energy and water use, and solid waste management), which are financed with the green mortgage and with CDM emission reduction certificates. In particular, it is expected that: (i) 200,000 newly constructed residential buildings incorporate CONAVI’s sustainable housing criteria and receive the subsidy; (ii) 100,000 newly constructed residential buildings are registered to receive carbon credits under the CDM programmatic methodology for sustainable housing; and (iii) CONAVI’s housing subsidies are mainstreamed with the “green mortgage” and that at least 140,000 subsidies are tied to the green mortgage.

Forestry and Land Use Objectives

108. In the forestry and land use sector, the DPL recognizes and supports the Government’s reforms to the regulatory framework for sustainable forest management, which will contribute to Mexico being able to meet the PECC target of incorporating 2.95 million hectares of forests under sustainable management.36 Within the context of such regulatory reforms, the 33 Programa Especifico para el Desarrollo Habitacional Sustentable ante el Cambio Climático, PEDHSSC, December 2009. 34 Características Paquete Básico para Programa de Subsidios, CONAVI, October 2009. 35 Hipoteca verde is a mortgage product developed by INFONAVIT in 2007 for the financing of eco-technologies (efficient in energy and water use, and in solid waste management) by providing an additional 20 percent of capital on the basis that the savings from the eco-technologies will provide a better cash-flow for mortgage repayment. 36 Mexican law makes a clear distinction between: (a) Sustainable Forest Management, which applies to native forest managed as a permanent forest and that is partially harvested without losing a percent of forest cover; (b) Commercial Plantations which are established in plots previously used for agriculture/livestock, or are simply deforested/degraded, where there is no forest cover; and (c) Reforestation and Restoration, which correspond to plantations with the exclusive purpose of recovering previously forested areas, with environmental objectives

37

operation will also build on Mexico’s efforts to formulate its national REDD+ strategy, a key pillar of which is sustainable forest management. POLICY AREA 5 – SUSTAINABLE FOREST MANAGEMENT 109. The PECC highlights the goal of incorporating 2.95 million hectares of forest under sustainable management by 2012. However, the lack of streamlined procedures for the approval of forest management initiatives by landowners acts as a barrier to be able to achieve this goal by promoting behaviors such as abandonment, which leads to uncontrolled plagues, fires, illegal logging and land use change to more readily available and competitive economic activities (urban growth, tourism, infrastructure, mining, agro-exports). Furthermore, given that sustainable forest management is a key instrument to reduce emissions from deforestation and land degradation, the lack of sufficient incentives to preserve forests and forestry-related activities would limit the potential positive environmental and social benefits that could be derived from the implementation of the country’s REDD+ strategy in the future. Along these lines, this policy area highlights the need for an adequate regulatory framework to promote sustainable forest management, which will in turn be embedded within the more comprehensive national REDD+ strategy currently being developed by the Government. 110. One of the main barriers preventing the incorporation of land under sustainable forest management is the process for reviewing and approving management plans and obtaining permits for forest management activities. To address this bottleneck, SEMARNAT, CONAFOR, and forest producers agree to the need to reform the regulatory and administrative processing of forest management plans and the issuance of associated permits. 111. One of the Prior Actions in this area is the publication by SEMARNAT of an agreement that eliminates requirements, simplifies administrative procedures, and presents standardized forms that must be completed to carry out forest management activities in the Diario Oficial de la Federación. It is expected that within 12-18 months from loan effectiveness, the administrative procedures governing forest management will have been simplified as a result of the publication of the aforementioned agreement, with 2.95 M ha of forest having been incorporated under simplified administrative procedures.37 Consistent with PECC goals, in the medium term, Mexico should see an increase in the number of hectares incorporated under forest management. 112. The second Prior Action under this policy area recognizes Mexico’s efforts in developing a REDD+ strategy to preserve the quantity and quality of its forests and in due course to access carbon markets. The prior action consists of the recent creation of a REDD+

and not subject to commercial harvesting. For purposes of this DPL, Sustainable Forest Management refers to all of the above and provides a framework for integrating the economic, environmental, and social aspects related to the use of forest resources. This conceptualization is consistent with Mexico’s Strategic Forestry Program for 2025 (Programa Estratégico Forestal 2025), which establishes that the objectives for sustainable forest management, plantations, and restoration include increasing the production and productivity of areas under forest management, improving the quality of the forest ecosystems, and reducing rural poverty. 37 The number of permits given out by SEMARNAT and the associated areas under sustainable forest management included as indicators in the policy matrix will depend on a variety of factors such as specific programs, public and private investment, other substitute or complementary investments, the dynamic of economic growth, and external and internal market prices.

38

Working Group (GT-REDD), a permanent sub-committee within the Inter-secretarial Commission on Climate Change, led jointly by CONAFOR and SEMARNAT. The GT-REDD38 will coordinate the design and implementation of the REDD+ strategy and contribute to the formulation of national REDD+ policies, including those related to the promotion of sustainable forest management. So far the GT-REDD has acted as a platform to improve institutional and policy harmonization among government agencies in REDD+ related areas and has successfully driven the submission of the country’s Readiness Preparation Proposal to the Forest Carbon Partnership Facility (FCPF), which was reviewed and assessed by the FCPF Participants Committee in March 2010 and clearance given for a Readiness preparation grant. By 2012, the Government aspires to have developed the instruments, mechanisms, schemes, and institutional arrangements that will allow for the publication by SEMARNAT of a final REDD+ strategy draft for public consultation.

38 The GT-REDD is composed of government agencies (federal ministries of Environment and Natural Resources; Agriculture, Livestock, Rural Development, Fisheries, and Food; Energy; Communications and Transport; Economy; Tourism; Social Development; Internal Affairs; Finance and Public Credit; Health; Foreign Affairs; and the Institute of Statistics, Geography and Information).

Box 1. Prior Actions for the Low-Carbon Development Policy Loan

The Government has implemented the following Prior Actions: Policy Area 1: Cogeneration and Small-Scale Renewable Energy Development

� CRE adopted and published interconnection and net-metering regulations, and model contracts for cogeneration and RE-based electricity.

Policy Area 2: Gas Flaring and Venting Reduction

� National Hydrocarbons Commission adopted the Resolution to Reduce Gas Flaring and Technical Specifications for reducing gas flaring at Pemex.

� As a result of the issuance of the CNH Resolution, Pemex adopted a series of gas-flaring and recovery goals (Manifiestos) and submitted them to CNH.

Policy Area 3: Fuel Efficiency in Vehicles and Transport Operations

� SEMARNAT initiated the process for the creation of a standard for carbon dioxide (“CO2”) emissions and energy efficiency for new light duty vehicles.

� SEMARNAT and SCT established a Voluntary Clean Transport (VCT) Program to assist private long-distance passenger and freight operators and freight transport service users to improve the fuel efficiency of their operations.

Policy Area 4: Energy Efficient Housing Development � CONAVI established a Sustainable Housing Program (Programa Especifico para el Desarrollo

Habitacional Sustentable ante el Cambio Climatico) to promoted energy efficient housing. Policy Area 5: Sustainable Forest Management

� SEMARNAT published an agreement in the Diario Oficial de la Federación that modifies the regulatory framework for forest management activities, including the simplification of administrative procedures for forest management.

� The Inter-Secretarial Commission for Climate Change within SEMARNAT created an internal Working Group to coordinate the development of a national REDD+ strategy.

39

Box 2. Good Practice Principles for Conditionality

Principle 1: Reinforce Ownership � In May 2007, President Calderón announced México’s National Climate Change Strategy (ENACC),

culminating a two-year process of preparation and public consultation. Adopted in August 2009, the PECC adopted medium- and long-term goals for climate change mitigation and adaptation and defined strategies for each sector. ENACC and PECC are at the heart of the environmental sustainability pillar of México’s National Development Plan (PND) for 2006-2012, which Congress approved, and are also central to Calderón’s vision for México in 2030.

� Energy consumption—including by the energy sector, as well as by transport and housing—is a major source of México’s GHG emissions. The Government’s strong commitment to reducing emissions from energy consumption is evidenced by the approval of laws for the Sustainable Use of Energy and Use of Renewable Energy and Finance of Energy Transition; the more recent secondary regulations related to renewable energy generation, energy efficiency, and transport efficiency; and the initiation of various sector-specific sustainable development financing mechanisms, including the Energy Transition Fund, the National Infrastructure Fund (FONADIN), and the Green Mortgages program.

� As a single-tranche operation, this DPL acknowledges and reinforces these important steps to develop and implement transport and energy sector policies necessary to achieve México’s climate change goals.

� As indicated in Section IV, the policies and actions recognized and supported by this operation are underpinned by a substantial body of analytical work and by an in-depth and on-going dialogue with the Government.

Principle 2: Agree up front with the government and other financial partners on a coordinated

accountability framework � The prior actions outlined in Box 1 and in the Operation Policy Matrix (Annex 2) have been agreed with

the Government. They are all key elements of the Government’s own strategy and programs to ensure that the energy, transport, urban development, and land-use and forestry sectors meet their intended contributions to México’s climate change mitigation goals as established under the PECC.

Principle 3: Customize the accountability framework and modalities of Bank support to country circumstances � The choice of a single-tranche DPL responds directly to the Government’s request for support for its debt

management strategy in light of the exigencies of the global economic downturn and tightening of credit. � As indicated under Principle 1, the policy areas included in this operation are all core aspects of the

Government’s program to strengthen the regulatory and institutional framework, financing mechanisms, and M&E systems pertaining to low-carbon transport, energy generation and use, and land use.

� As noted under Principle 2, all of the policies reflect the Government’s extensive internal deliberations and public consultations and are also underpinned by the Bank’s on-going dialogue with the Government and the substantial body of analytical work to which the Bank has contributed.

Principle 4: Choose only actions critical for achieving results as conditions for disbursement � The Bank has agreed with the Government that the eight prior actions are all steps that are critical to the

achievement of México’s climate change mitigation goals, related to the areas of renewable energy, energy efficiency (both supply-side and demand-side including housing), transport efficiency, and sustainable forest management.

Principle 5: Conduct transparent progress reviews conducive to predictable and performance-based

financial support � Reviews of progress will be conducted jointly by the Bank, SHCP and concerned line ministries and

other agencies, including SEMARNAT, SENER, SCT, and CONAFOR. The outcome indicators in the Operation Policy Matrix have been agreed with the Government and, together with the description of the Government’s emission reduction program in the Letter of Development Policy, will provide a transparent basis for monitoring progress in program implementation.

40

VI. OPERATION IMPLEMENTATION

POVERTY AND SOCIAL IMPACTS 113. In the Energy sector, the proposed programs are not expected to have significant negative poverty or social impacts on consumers or the population at large. By improving the efficiency of the energy sector, both for oil and gas and electric power, there are likely to be cost reductions in the provision of energy services and a positive effect on affordability. The renewable energy technologies (wind, hydro, geothermal) that are likely to be stimulated through the program’s reforms are not expected to raise supply costs, and some large-scale renewable energy technologies (such as wind) have recently been procured in Mexico at costs below conventional thermal plants (such as natural gas and coal). 114. The Transport sector programs and regulatory changes included in the operation are not likely to have significant adverse social or poverty effects, being concentrated primarily on vehicle and transport operation efficiency. The participation in the Clean Transport Program is voluntary for freight and passenger transport operators and freight transport service users. They decide on how far they wish to go in terms of efficiency improvements. Many of the measures to reduce fuel consumption are very cost-effective and the initial investment can be recovered in a couple of years; examples include automatic inflation of tires, low friction lubrication, energy efficient driving, vehicle maintenance, and changes in operating practices. As such, the introduction of these measures will have a positive impact on operators, who often struggle to survive in the competitive environment, since they help them to save fuel costs. 115. As far as fuel efficiency standards for new vehicles are concerned, no significant increases in vehicle prices are envisaged nor are these standards expected to negatively affect the mobility of low-income households and small businesses. Indeed, prices of new vehicles normally depend much more on the accessories and the dress level than on their efficiency. A recent market study of the Mexican car industry shows that 36 percent of all new cars are sold at a price higher than the price of the “top-runners” in terms of energy efficiency. Other studies to quantify vehicle price increases due to the standard showed that the average price of new vehicles in Mexico could go up by US$1,600 to 3,400, but this increase could be considerably lower if the Mexican Government implements a number of flexibility mechanisms currently under consideration, such as weighted corporative fuel performance averages, compensation among companies, and fuel-efficiency banking. These mechanisms reduce the cost for car companies to comply with the standard. The cost-benefit analysis for this measure carried out by SEMARNAT/INE showed net benefits of approximately $3,000 per vehicle over its life.39 Finally and most importantly, middle and high income households buy new cars in Mexico, while low income households generally drive used vehicles or use public transport. Thus, even if prices of new vehicles increase, this would unlikely affect the mobility of low income households.

39 The cost-benefit analysis considered an increase in the price of the vehicle due to technological changes, the rebound effect of increased driving, fuel savings, reduction in GHG emissions, and savings in fuel subsidies.

41

116. In the Urban sector, the sustainable housing program and its energy efficiency component is expected to have largely positive social effects. CONAVI’s housing subsidy program will help low- and middle- income urban dwellers afford a house and will also lower their utility bills. Under the sustainable housing program, households can receive a subsidy of around US$5,000, while the package of energy efficiency and other measures increases the costs of the house by approximately US$1,300. The package of “green” measures includes CFL lighting, solar water heating, water-efficient plumbing fixtures, and waste disposal. In addition, the energy efficiency investments are cost-effective and have a financial payback of several years, while the reduced electricity payments constitute a continuous benefit to dwellers. 117. Through the promotion of sustainable forest management at the community level, the Government programs included in the Forestry and Land Use sector will help ensure the incorporation of rural livelihoods and increase the organizational and technical capacity of communities or ejidos to make sound decisions with respect to the use of forest resources. The prior actions included within this DPL for the forestry sector are expected to have positive social and poverty effects. The promotion of sustainable forest management through the regulatory reforms and the integration of SFM within the context of a future national REDD+ strategy, are expected to improve the quality of life of people living in forestry regions through the sustainable use of forest resources and the ensuing protection of the environment. Vulnerable populations such as indigenous peoples and ejido communities, are expected to be positively affected, as they are disproportionably dependent on natural resources for their livelihoods, and lack the capacity to withstand environmental shocks that can result from the unsustainable use of forest resources. 118. Furthermore, the incorporation of land under sustainable forest management schemes, particularly as it relates to the legal use of timber and non-timber resources and payments for environmental services, is expected to promote increased opportunities for the development of income-generating activities and employment creation for forest dwellers, ejidatarios, and indigenous peoples living in forested areas. The Programa Estratégico Forestal para México 2025 highlights the role of SFM as a key instrument to overcome rural poverty along the aforementioned lines, projecting the creation of 180 thousand additional jobs in the forestry sector and a resulting increase in the contribution of the sector’s GDP from 1 to 4 percent from 2001 to 2025. 119. Additionally, positive social and economic benefits can be derived from SFM at the community level. Through projects like PROCYMAF targeting poor indigenous and non-indigenous people from communities and ejidos (comuneros and ejidatarios), Mexico has promoted local capacity and social cohesion through the conservation of forest resources. As an example, PROCYMAF has emphasized the creation of regional fora which have brought communities and state governments together to set priorities and discuss the allocation of investment resources, which has in turn promoted the development of the complementary infrastructure (roads, schools) that will help to make forest communities more viable.

42

ENVIRONMENTAL ASPECTS 120. The Government’s reforms supported by this DPL are likely to have significant positive effects on the environment, forests, and other natural resources. The policies and programs recognized and supported through this DPL are expected to facilitate more efficient use of energy in the supported sectors and, in turn, lower the associated GHG and local air pollutant emissions. 121. In the Energy sector, the policy reforms included in the program will contribute to providing access to efficient, renewable and clean energy, thereby reducing air pollution and mitigating its impacts on human health and associated costs related to treatments of respiratory diseases. The focus on increasing energy efficiency through cogeneration and reducing gas flaring at Pemex facilities, similarly, will help reduce the use of fuels that have negative local environmental and health externalities, and generate substantial energy and efficiency gains for Mexico’s state-owned energy companies. 122. In the Transport sector, the reforms and programs included in the operation will contribute to a more efficient and less polluting vehicle fleet, thus bringing Mexico on a path to greater energy self-sufficiency and reducing local air pollution and the related negative health impacts and costs. Likewise, the supported reforms and programs will contribute to a more efficient road transport sector, reducing the related externalities and improving the financial health of the operators. 123. In the Urban sector, the policy reforms included in the operation will contribute to reducing energy demand from the residential sector, in particular increasing energy demand buildings, lighting, and home appliances. The promotion of sustainable eco-technology improvements in residential buildings will further help reduce the use of fuels and, in turn, the associated emissions of GHG and local air pollutants. 124. In the Forestry and Land Use sector, the policy reforms included in this operation are expected to have only positive impacts on the environment, as they aim to generate global environmental benefits through sustainable forest management and the associated reduction of emissions generated by deforestation and land degradation (REDD+) and promotion of biodiversity conservation and protection. 125. There may be short-term negative environmental impacts associated with the policy reforms, such as through the construction of renewable energy facilities, cogeneration plants, or new energy-efficient housing. For these potential effects, Mexico will rely on its well-developed environmental impact assessment process to mitigate unwanted environmental impacts. 126. In its dialogue with the Government of Mexico, through numerous analytical studies and through the MOUs with SENER, SEMARNAT, and the Ministry of Finance, the Bank will continue to help the relevant agencies in developing a framework and, where necessary, the capacity to identify, assess, monitor and evaluate, and manage any social and environmental impacts that may result from the planned institutional and policy changes. Through the Energy Sector Management and Assistance Program (ESMAP), for instance, the

43

World Bank is supporting the Mexican Government in identifying mechanisms to address environmental and social issues when developing energy projects, including the expected sharing of costs and benefits. IMPLEMENTATION, MONITORING AND EVALUATION 127. A separate Project Implementation Unit (PIU) will not be created for this operation, but rather each governmental institution will be responsible for the policy areas or activity included in this program for monitoring and evaluation. Because of the focus on policy, regulatory and institutional development, the majority of the monitoring steps involve one-step evaluation of program achievements by the time of ICR (approx 18-24 months). The Ministry of Environment (SEMARNAT) will be responsible for the coordination among these agencies under this DPL. The sectoral Ministries and agencies responsible for the monitoring and evaluation of the different policy areas are: a. Policy Area 1: Cogeneration and Small-Scale Renewable Energy Development

CRE is the agency responsible for regulating and providing technical standards for the operation of the electricity sector. In particular, CRE will monitor the success of the new regulations for small-scale renewable producers and cogeneration, establishing baseline indicators for the cogeneration contracts, the number of small-scale renewable producers that connect into the grid, and will verify the existence of any contract between CFE and Pemex in order to purchase power.

b. Policy Area 2: Gas Flaring and Venting Reduction in Oil and Gas Production CNH is the agency created to regulate the upstream activities in hydrocarbons. CNH adopted the Resolution to Reduce Gas Flaring and Technical Specifications which intends to reduce gas flaring at Pemex, and is responsible for approving the Declarations (Manifiestos), which are not binding instruments since they can be unilaterally modified by Pemex, but which outline the gas recovery goals and gas flaring reduction work plan and timeline by Pemex. Accordingly, CNH will publish the timeline and goals derived from these commitments and establish a methodology for M&E of the Pemex compliance (including baseline and specific targets). CNH will have to publish the evaluation and the degree of compliance of the goals by Pemex in its different fields on a regular basis.

c. Policy Area 3: Fuel Efficiency in Vehicles and Transport Operations SEMARNAT leads the actions in fuel efficiency standards from an environmental point of view and SENER/CONUEE from an energy efficiency point of view. SEMARNAT will also co-issue the final standard. Accordingly, these entities are committed to publish a set of fuel efficiency standards for new light duty vehicles that is considered as one of the key outcomes of this DPL by the time of ICR (18-24 months).SEMARNAT will be the pivotal entity for the Voluntary Clean Transport (VCT) program that will assist private long-distance passenger and freight operators and freight transport service users to improve fuel efficiency of their operations. SEMARNAT will establish the baseline and the targets for this activity, while it will remain responsible for the monitoring and evaluation of the VCT program.

d. Policy Area 4: Energy Efficient Housing Development CONAVI is the entity responsible for the Sustainable Housing Program. Accordingly, it will establish the methodology and the M&E system for this program, in particular the monitoring of the three key indicators included in this DPL: (i) new housing units with

44

energy efficient housing criteria, (ii) qualification for international carbon credits under the CDM programmatic methodology for sustainable housing, (iii) joint participation in CONAVI’s housing subsidy and in the green mortgage (Hipoteca Verde) program.

e. Policy Area 5: Sustainable Forest Management SEMARNAT is the Ministry responsible for modifying the regulatory framework for forest management activities and the simplification of the relevant administrative procedures in this area. Accordingly, SEMARNAT will monitor the reduction in the processing time for management licenses, and quantify how many permits are issued and the total amount of land under sustainable management that is established. Additionally, SEMARNAT, through its REDD+ working group, is also responsible for coordinating the inter-institutional efforts involved in the design of the national REDD+ strategy in which policies to promote sustainable forest management will play a key role.

128. The implementation of the sector reforms and the regulatory framework embedded in this program is likely to require strong inter-institutional coordination capacity, horizontally as well as vertically. In response to this need, the World Bank has been engaged in the last years, through lending instruments and technical assistance programs in supporting the Government of Mexico in implementing its Urban Transport, Energy Efficiency and Renewable Energy programs, as well as strengthening its Housing Financial Markets and the Protected Areas System. A core element of the assistance is helping to build the capacity of the institutions involved and to strengthen the linkages of those institutions in their policy-setting, investment review and financing capacities. 129. The proposed monitoring framework for this operation includes 8 monitoring indicators and corresponding expected outcomes, which can be considered strategic milestones in assessing progress in implementation of the DPL. The Bank will monitor actions taken to achieve these outcomes and review progress in the implementation of the DPL, as well as subsequent government actions, through the closing of the loan. FIDUCIARY ASPECTS 130. As documented in the 2003 Country Financial Accountability Assessment (CFAA), the 2007 Country Procurement Assessment Report (CPAR), and other analytical work, the public financial management (PFM) systems at the federal level are adequate to support development policy lending in Mexico. As envisioned in the CPS, the Bank is collaborating with the Mexican Government at the central and sub-national level in strategic areas aimed at modernizing and reforming public finances, and increasing transparency. This has been supported by a number of knowledge services to the SHCP and Secretariat of Public Administration (SFP), through different Bank financing products. Likewise, the Bank has reviewed the PFM systems of the Mexican federal administration in the context of a series of different DPLs approved in the last fiscal year. 131. In the last decade, the Mexican Government has introduced a number of laws and policy reforms in public finances aimed at improving fiscal responsibility and transparency by modernizing the budget process and creating a more efficient and transparent fiscal framework in line with international good practices. The funding from this DPL will support

45

the Federal Expenditure Budget (Presupuesto de Egresos Federales, PEF) and, accordingly, will be subject to provisions of the annual PEF Law, the Federal Budget and Fiscal Responsibility Law, the Government Accounting Law, and the Manual of Budget Procedures, among others. This set of legal and regulatory arrangements, together with the country financial management operating systems, provides for sound budget formulation, execution and internal control arrangements for public expenditures. Other internal control aspects are ruled by the Federal Public Administration Internal Control Standards. 132. Although rules and procedures governing the budget, accounting and public expenditure laws are clear and comprehensive, and the budget monitoring and control systems work well, there remain areas within the public finances where further advances could be made. Developing a long-term focus for the budget, including performance results in the budget formulation process, and engaging the public sector to focus on results are key priorities. Currently the Mexican Government is working towards achieving the envisioned PFM reforms, including harmonized budget and financial accounting reporting, modernization of its treasury operations including full implementation of the Single Treasury Account, as well as designing an integrated financial management system at federal and state levels. With Bank support, progress has been made to move towards international standards in different areas of the country PFM systems. 133. The most recent World Bank Country Procurement Assessment Review (CPAR) of 2007, prepared jointly with the IDB, identified issues in the public procurement system including excessive regulatory complexity and the need for more effective governance and coordination. The current Government has the objective to align public procurement more closely with economic expenditure policy, aimed at producing value for money, ensuring transparency, economy and efficiency, while improving the overall quality of goods and services. To that end, recent amendments to the legal framework and operational reforms advanced in 2009 and 2010 have taken several important steps towards addressing the issues identified in the 2007 CPAR. These changes include legitimizing the use of framework agreements, a more comprehensive role for e-procurement (COMPRANET), addressing some of the bid-opening procedures, and an effort to streamline disputes by providing an out-of-court conciliation process managed by the Civil Service Ministry. Other significant reforms include greater recognition of the professionalization of the procurement function and the importance of best practice in terms of total cost of ownership and fair dealings. As envisioned in the CPS, the Bank is collaborating with the Mexican Government in strategic areas aimed at modernizing and reforming the PFM system, including its public procurement system. In particular, in the procurement arena, this support has been provided by a number of technical assistance and knowledge services to the Secretariat of Public Administration (SFP) and through different Bank financing products. 134. As for external oversight, the Federal Supreme Audit Institution conducts, on a regular basis, a number of performance, financial and compliance audits on Government federal programs. The annual public accounts are prepared and sent to Congress within four months of the end of each fiscal year. The external audit of these accounts is undertaken by the Auditor General’s office and submitted to the legislature fourteen months after the end of each fiscal year. Audit reports are comprehensive and there is a system in place to follow up on audit findings and recommendations. The results of audits by the Auditor General’s office are made public in the Annual Audit Report on the Federal Public Accounts.

46

DISBURSEMENT AND AUDITING 135. The flow of fund arrangements for this operation will be those customarily observed in DPLs for Mexico, as per long-standing agreements with the Government. The SHCP has informed the Bank that BANSEFI will be the financial agent of the Borrower with regard to this DPL.40 Under this arrangement, upon effectiveness and compliance with any withdrawal tranche release conditions the Bank would deposit the single tranche disbursement to a designated account of the Bank of Mexico (BANXICO) in US Dollars for subsequent credit by BANXICO to an account of the National Treasury (SHCP/Tesorería de la Federación, TESOFE) used for budgeted expenditures. Based on the review of the 2009 audit reports of the financial agent and the extensive experience between the Bank and BANSEFI regarding funds flow from bank-financed projects, there is no evidence that the banking control environment into which the DPL proceeds would flow is other than adequate. If requested by the Bank, the SHCP would provide the Bank with a written confirmation of the described transaction after funds are disbursed by the Bank. 136. Based on the assessment of the borrower’s current PFM and the conclusion that the fiduciary arrangements for this financing are adequate, the Bank will not require an audit of the designated account of the financial agent, and no additional fiduciary arrangements are considered necessary at this time.

40 The use of a financial agent and designated account is a standard procedure of the Government of Mexico for their control purposes and not an additional requirement by the Bank.

47

RISKS AND RISK MITIGATION The matrix below sets out a preliminary set of risks, and their mitigating measures, that will be discussed further with Government counterparts during project preparation.

Economic and Fiscal Risks Mitigation Measure

An important downside risk for Mexico’s macroeconomic outlook is the possibility of a sharp weakening in the economic recovery of the United States. Lower export growth endangers the incipient recovery of domestic demand as less job opportunities and labor income are generated in manufacturing industry and trade related services. Higher volatility and a deterioration of access to finance on international financial markets is another risk to Mexico’s economic and fiscal outlook. Concerns about the global economic recovery or the fiscal situation in a number of advanced economies may lead to renewed jitters on international financial markets and translate into less favorable conditions of access to finance for the public and private sectors. The exposure of public finance to lower oil prices or lower volumes of oil production remains high. Oil revenue still makes up a third of total public sector revenue. A severe weakening of the recovery, lower public sector revenue, or less favorable conditions of access to finance may reduce the ability and willingness of the public and private sectors to invest in low-carbon development.

Mexico maintains a record of sound and predictable macroeconomic management. This contributed to an adequate and timely policy response to the global crisis which has set the stage for a strong economic recovery. Commitment to the main elements of the fiscal and monetary policy framework–fiscal discipline, inflation targeting, and flexible exchange rate–remains strong. Sound public debt management has reduced vulnerability to financial shocks. Public debt policy favors local currency financing that reduces exposure to exchange rate volatility. Fiscal policy is conducted within the framework of a fiscal responsibility law that contains a balanced budget rule to ensure fiscal sustainability and mechanisms to limit the impact of oil price volatility on public spending. The latter includes an oil stabilization fund and a policy to leverage resources in the fund through the contracting of oil price hedges. The Government has confirmed that the programs and policy initiatives included in the DPL are given priority in its spending program. While the main available resources to finance Pemex’s projects come from the public budget, in terms of the implementation of Pemex´s plans to reduce gas flaring and venting, the CNH´s regulation established that it is possible to concur other resources (e.g., carbon finance). Gas flaring and venting reduction is also facilitated by Pemex membership in the Global Gas Flaring Reduction initiative, and will improve the company’s overall financial performance.

Political and Institutional Risks Mitigation Measure

The implementation of programs included in the proposed DPL will require significant multi-institutional collaboration. For example, close coordination among SENER, SEMARNAT, SAGARPA, public utilities, and sub-national institutions will be needed for mainstreaming electricity generation from RE sources. In the Forestry sector, the

The approval of the PECC entails a strong collaboration among federal government agencies as well as with sub-national institutions. Furthermore, in the Energy sector, the Bank is already engaged through several other instruments in supporting the Government in implementing its RE program, by assisting in the design of regulatory reforms and by helping to build the capacity of the institutions involved. In the Forestry sector, one of the prior actions itself, through the creation of the REDD+ Working Group, mitigate this risk by serving as a platform for cross-institutional collaboration. Furthermore, as stipulated in Mexico’s Forestry and Rural Development Laws, the

48

approval and implementation of sustainable forest management plans, as well as the design and execution of the REDD+ strategy, will require significant coordination between various government agencies including CONAFOR, SEMARNAT, PROFEPA, CONABIO, CONANP, CDI, INE, and SAGARPA.41

Government of Mexico has set in place national and state forest councils that also promote close coordination between agencies.

Political changes can potentially threaten the sustainability of program implementation.

Political developments, to the extent that they affect decision-making processes in the Congress, are not expected to have an impact on the programs supported by the DPL. For example, Mexico’s energy sector laws have already been approved, and the Ministry of Energy is fully committed to the implementation of the RE Law and its secondary regulations.

The two parastatals in the energy sector (Pemex and CFE) may be unable, institutionally, to implement the required policy changes, including through a lack of budgetary authority over the required investments, for example, cogeneration plants or equipment for capturing natural gas leakages.

CFE has increasingly been using IPP arrangements for the construction and operation of power plants, thus shifting the initial investment to the private sector. This reduces the risk of the federal government not approving investment financing for renewable energy or energy efficiency investments. Pemex can make use of IPPs for cogeneration investments as well, but so far has not taken advantage of this option. The extensive organizational reforms that have been taking place within Pemex under the Calderon Administration indicate that new financing mechanisms such as IPPs will be promoted in the oil and gas sector, especially where the investment does not involve the private entity from taking possession of the oil or gas resources.

Although the preparation of the emission control and fuel efficiency standard for new light duty vehicles is well advanced, resistance from the car industry could delay the adoption of a new standard.

The current Administration has committed itself to the issuance of fuel efficiency standards through two key policy documents; the PECC and the National Program for Sustainable Energy Use 2009-2012. The publication in April 2010 of compulsory energy efficiency guidelines for the federal public administration’s vehicle fleet signaled a first step. The details of the emission control and fuel efficiency standard for light duty vehicles have been studied and discussed for more than two years, and the standardization process was officially launched in September 2010. The standard is expected to be published for public consultation before or during the Conference of the Parties to the United Nation Framework Convention on Climate Change (COP16 UNFCCC) in Mexico in December 2010. There will certainly be negotiations with the car industry on the fuel efficiency targets, which may result in compromise, however, even slightly less ambitious targets will be important. There will also be an opportunity to further strengthen the new standards, which cover the period 2012-2016.

41 CONAFOR: Comisión Nacional Forestal manages a wide range of forestry programs including forest management, community forestry, payments for environmental services, inventories, pest management and others. PROFEPA: Procuraduría General de Protección del Ambiente acts as the enforcement branch of SEMARNAT. CONABIO: Comisión Nacional para el Conocimiento y Uso de la Biodiversidad that manages the intellectual resources related to forest and other types of biodiversity, supports scientific studies and public awareness on the theme, and maintains a national biodiversity database. CONANP: Consejo Nacional de Áreas Naturales Protegidas in charge of the country’s 23 million ha of protected areas and national parks. CDI: Comisión Nacional para el Desarrollo de los Pueblos Indígenas responsible for development issues with indigenous groups working jointly with CONAFOR in forestry issues. INE: Instituto Nacional de Ecología responsible for supporting the formulation of environmental and sustainable development policies through the generation, integration, and dissemination of scientific research.

49

Social and Environmental Mitigation Measure

Adverse social and poverty impacts associated with low-carbon policies.

The risk is mitigated through the consultations that have accompanied the adoption of the Government’s national climate change program (ENACC, PECC), as well as the consultations for sector-specific programs that have large associated climate mitigation benefits.

Reforms in the forestry sector could cause negative social impacts.

To mitigate social risks related to the implementation of the reforms in the Forestry sector, the Bank is closely engaged with CONAFOR in the development of Mexico’s REDD+ National Strategy, and CONAFOR already has experience in conducting social impact analyses through Bank-funded projects like PROCYMAF and the Environmental Services Project. Consultation and participatory mechanisms have also been set up through the creation of a REDD+ task force housed within CONAFOR, which receives feedback from ejidos and indigenous communities on the potential social impacts of forestry related policies and initiatives.

50

ANNEXES

ANNEX 1: LETTER OF DEVELOPMENT POLICY AND SUPPLEMENTAL LETTER WITH MATRIX

51

52

53

54

55

56

57

58

59

60

61

62

A

NN

EX

2: P

OL

ICY

MA

TR

IX

The

Polic

y D

evel

opm

ent O

bjec

tive

(PD

O) o

f the

Dev

elop

men

t Pol

icy

Loan

is to

sup

port

sect

or-s

peci

fic, h

igh-

prio

rity

polic

y an

d re

gula

tory

re

form

s th

at h

ave

been

ide

ntifi

ed a

s cr

itica

l to

ach

ieve

Mex

ico’

s cl

imat

e ch

ange

miti

gatio

n ta

rget

s un

der

the

PEC

C f

or:

(1)

Incr

easi

ng

rene

wab

le e

nerg

y su

pply

, pro

mot

ing

ener

gy e

ffic

ienc

y th

roug

h co

gene

ratio

n, re

duce

gas

flar

ing

and

vent

ing,

and

pilo

ting

the

refo

rm o

f the

ru

ral

agric

ultu

ral

elec

trici

ty s

ubsi

dy;

(2)

Impr

ovin

g th

e ef

ficie

ncy

of t

he v

ehic

le f

leet

and

roa

d tra

nspo

rt op

erat

ions

in

Mex

ico;

(3

) Stre

ngth

enin

g th

e m

arke

t for

ene

rgy-

effic

ient

hou

sing

; and

(4) M

ains

tream

ing

clim

ate

chan

ge c

onsi

dera

tions

into

land

-use

and

fore

stry

ac

tiviti

es.

The

Mat

rix b

elow

sum

mar

izes

the

prop

osed

Pri

or A

ctio

ns, O

utco

me

Indi

cato

rs, a

nd M

ediu

m-t

erm

Act

ions

in e

ach

Polic

y A

rea,

whe

re

Are

as 1

-3 a

re in

the

Ener

gy S

ecto

r, A

rea

4 in

the

Tran

spor

t Sec

tor,

Are

a 5

in th

e U

rban

Sec

tor,

and

Are

a 6

in th

e Fo

rest

ry a

nd L

and-

Use

Se

ctor

.

Obj

ectiv

e Is

sues

and

O

bsta

cles

Pr

ior

Act

ions

O

utco

mes

at I

CR

Dat

e M

ediu

m-te

rm A

ctio

ns

ENER

GY

Polic

y A

rea

1: C

ogen

erat

ion

and

Smal

l-Sca

le R

enew

able

Ene

rgy

Dev

elop

men

t In

crea

se th

e pr

oduc

tion

of

elec

trici

ty fr

om

coge

nera

tion

and

smal

l -sca

le

rene

wab

le

ener

gy (R

E)

supp

liers

Unf

avor

able

pric

ing

and

purc

hase

ag

reem

ents

dis

cour

age

the

prod

uctio

n an

d sa

le

to th

e gr

id o

f ele

ctric

ity

from

cog

ener

atio

n.

Hig

h tra

nsac

tions

cos

ts

for s

mal

l pro

duce

rs,

lack

of t

rans

mis

sion

an

d co

ntra

ctua

l ar

rang

emen

ts, a

nd

paym

ents

cov

erin

g on

ly

the

mar

gina

l pric

e

1. T

he B

orro

wer

, thr

ough

SEN

ER (t

hrou

gh C

RE)

, has

ta

ken

step

s to

stre

ngth

en th

e re

gula

tory

fram

ewor

k fo

r N

et-M

eter

ing

and

inte

rcon

nect

ion

for r

enew

able

en

ergy

-bas

ed e

lect

ricity

supp

liers

, as e

vide

nced

by:

(i)

Res

olut

ion

No.

RES

/054

/201

0 is

sued

by

CR

E an

d pu

blis

hed

in th

e B

orro

wer

’s O

ffic

ial G

azet

te (D

iari

o O

ficia

l de

la F

eder

ació

n) o

n A

pril

8, 2

010

issu

ing

the

mod

el c

ontra

ct fo

r the

inte

rcon

nect

ion

to th

e gr

id b

y m

ediu

m sc

ale

coge

nera

tion

and

rene

wab

le e

nerg

y -ba

sed

elec

trici

ty p

rodu

cers

and

subs

titut

ing

the

mod

el

cont

ract

for t

he in

terc

onne

ctio

n to

the

grid

by

smal

l sc

ale

sola

r ene

rgy

prod

ucer

s with

the

mod

el c

ontra

ct

for t

he in

terc

onne

ctio

n to

the

grid

by

smal

l sca

le

(i). C

RE

has i

ncre

ased

the

num

ber o

f new

co

gene

ratio

n pe

rmits

aw

arde

d fr

om 5

9 in

200

9 to

70

in 2

012.

(ii

). Th

ere

is a

n in

crea

se in

th

e co

mbi

ned

capa

city

of

grid

-con

nect

ed sm

all-s

cale

pr

oduc

ers f

rom

25

MW

ph

otov

olta

ic (2

009)

42 to

35

MW

pho

tovo

ltaic

in

2012

. (ii

i). A

t lea

st 1

larg

e-sc

ale

SEN

ER/C

RE/

CFE

im

prov

e th

e m

etho

dolo

gy

for d

efin

ing

effic

ient

co

gene

ratio

n an

d es

tabl

ish

a ce

rtify

ing

agen

t.

SEN

ER/C

RE/

CFE

ado

pt

an im

prov

ed

met

hodo

logy

for

inco

rpor

atin

g sm

all -s

cale

R

E pr

ojec

ts in

to th

e gr

id

whi

ch in

clud

es c

apac

ity

paym

ents

in o

rder

to

42

Sou

rce:

Nat

iona

l Sol

ar E

nerg

y A

ssoc

iatio

n

63

impe

de R

E pr

oduc

tion.

co

gene

ratio

n an

d re

new

able

ene

rgy-

base

d pr

oduc

ers;

(ii

) Res

olut

ion

No.

RES

/066

/201

0 is

sued

by

CR

E an

d pu

blis

hed

in th

e B

orro

wer

’s O

ffic

ial G

azet

te (D

iari

o O

ficia

l de

l a F

eder

ació

n) o

n A

pril

16, 2

010

setti

ng

forth

the

met

hodo

logy

for t

he d

eter

min

atio

n of

the

serv

ice

char

ges f

or th

e tra

nsm

issi

on o

f ele

ctric

ene

rgy

base

d on

rene

wab

le e

nerg

y or

eff

icie

nt c

ogen

erat

ion;

an

d (ii

i) R

esol

utio

n N

o. R

ES/0

67/2

010

issu

ed b

y C

RE

and

publ

ishe

d in

the

Bor

row

er’s

Off

icia

l Gaz

ette

(D

iari

o O

ficia

l de

la F

eder

ació

n) o

n A

pril

28, 2

010

issu

ing

the

mod

el c

ontra

ct fo

r the

inte

rcon

nect

ion

for

rene

wab

le e

nerg

y ge

nera

tion

or e

ffici

ent c

ogen

erat

ion

and

the

mod

el c

ontra

ct fo

r the

tran

smis

sion

serv

ice

of

elec

trici

ty fr

om re

new

able

and

effi

cien

t cog

ener

atio

n en

ergy

supp

liers

.

Pem

ex p

roje

ct c

ompl

ies

with

the

new

cog

ener

atio

n ru

les.

prov

ide

bette

r and

mor

e pr

edic

tabl

e pa

ymen

ts.

Obj

ectiv

e Is

sues

and

O

bsta

cles

Pr

ior

Act

ions

O

utco

mes

at I

CR

Dat

e M

ediu

m-te

rm A

ctio

ns

Polic

y A

rea

2: G

as F

lari

ng a

nd V

entin

g Re

duct

ion

in O

il an

d G

as P

rodu

ctio

n R

educ

e ga

s fla

ring

and

vent

ing

asso

ciat

ed w

ith

oil a

nd g

as

prod

uctio

n

An

inst

itutio

nal a

nd

regu

lato

ry fr

amew

ork

for r

educ

ing

gas f

larin

g an

d ve

ntin

g , a

nd

prov

idin

g in

cent

ives

for

Pem

ex to

com

ply

has

been

lack

ing.

2. T

he B

orro

wer

, thr

ough

SEN

ER (t

hrou

gh C

NH

) has

ta

ken

step

s to

gr

adua

lly

redu

ce

gas

flarin

g an

d ve

ntin

g,

as

evid

ence

d by

: (i)

R

esol

utio

n N

o. C

NH

.06.

001/

09 is

sued

by

CN

H a

nd p

ublis

hed

in

the

Bor

row

er’s

Off

icia

l Gaz

ette

(D

iari

o O

ficia

l de

la

Fede

raci

ón)

on

Dec

embe

r 4,

20

09,

setti

ng

forth

te

chni

cal

spec

ifica

tions

to

redu

ce g

as f

larin

g an

d ve

ntin

g in

th

e ex

plor

atio

n an

d ex

ploi

tatio

n of

hy

droc

arbo

ns;

and

(ii)

decl

arat

ions

(m

anifi

esto

s)

issu

ed b

y PE

MEX

(as

a r

esul

t of

the

iss

uanc

e of

R

esol

utio

n N

o. C

NH

.06.

001/

09)

and

sub

mitt

ed t

o C

NH

, and

pub

lishe

d on

CN

H’s

web

site

in J

uly,

201

0 (w

ww

.cnh

.gob

.mx )

, ou

tlini

ng,

inte

r al

ia,

PEM

EX’s

ga

s re

cove

ry g

oals

and

gas

fla

ring

redu

ctio

n w

ork

plan

and

tim

elin

e.

Pem

ex re

duce

s tot

al g

as

flarin

g fo

r ass

ocia

ted

natu

ral g

as (e

xclu

ding

C

anta

rel l)

from

195

M

MC

FD (2

009)

to

145

MM

CFD

(201

2).

In th

e ca

se o

f Can

tare

ll,

Pem

ex re

duce

s gas

flar

ing

from

504

MM

CFD

(200

9)

to 4

7 M

MC

FD (2

012)

.

Pem

ex re

duce

s nat

ural

ga

s fla

ring

and

vent

ing

for e

ach

field

that

pr

oduc

es a

ssoc

iate

d na

tura

l gas

, as e

stab

lishe

d in

ann

ual M

anifi

esto

s.

Can

tare

ll w

ill b

e in

corp

orat

ed in

the

calc

ulat

ion

of th

e na

tiona

l up

per l

imit

by 2

013.

St

artin

g in

201

3 th

ere

will

be

a u

niqu

e up

per l

imit

for t

he w

hole

sys

tem

.

64

Obj

ectiv

e Is

sues

and

O

bsta

cles

Pr

ior

Act

ions

O

utco

mes

at I

CR

Dat

e M

ediu

m-te

rm A

ctio

ns

TR

AN

SPO

RT

Polic

y A

rea

3: F

uel E

ffici

ency

in V

ehic

les a

nd T

rans

port

Ope

ratio

ns

Cre

ate

a re

gula

tory

fr

amew

ork

and

ince

ntiv

es t

o im

prov

e fu

el

effic

ienc

y of

ne

w v

ehic

les a

nd

road

tran

spor

t op

erat

ions

Insu

ffic

ient

ince

ntiv

es

for v

ehic

le p

rodu

cers

an

d im

porte

rs to

mar

ket

mor

e fu

el e

ffic

ient

ve

hicl

es

Insu

ffic

ient

aw

aren

ess,

ince

ntiv

es, a

nd

reso

urce

s for

pas

seng

er

and

frei

ght t

rans

port

com

pani

es to

max

imiz

e fu

el e

ffic

ienc

y

3. T

he B

orro

wer

, thr

ough

SEM

AR

NA

T an

d SC

T, h

as

take

n st

eps f

or th

e cr

eatio

n of

a re

gula

tory

fram

ewor

k an

d in

cent

ive

syst

em to

impr

ove

fuel

eff

icie

ncy

of

new

veh

icle

s and

road

tran

spor

t ope

ratio

ns, a

s ev

iden

ced

by: (

i) a

supp

lem

ent t

o th

e 20

10 N

atio

nal

Stan

dard

izat

ion

Prog

ram

, pub

lishe

d in

the

Bor

row

er’s

O

ffic

ial G

azet

te ( D

iari

o O

ficia

l de

la F

eder

ació

n) o

n Se

ptem

ber 1

3, 2

010,

initi

atin

g th

e pr

oces

s for

the

stan

dard

izat

ion

on c

arbo

n di

oxid

e (“

CO

2”) e

mis

sion

s co

ntro

l and

ene

rgy

effic

ienc

y fo

r new

ligh

t dut

y ve

hicl

es; a

nd (i

i) an

agr

eem

ent b

etw

een

SEM

AR

NA

T an

d SC

T ad

optin

g th

e V

olun

tary

Cle

an T

rans

port

Prog

ram

, sig

ned

on O

ctob

er 6

, 201

0 an

d pu

blis

hed

on

SEM

AR

NA

T’s w

ebsi

te in

Oct

ober

201

0 (w

ww

.sem

arna

t.gob

.mx)

.

(i) T

he e

nerg

y ef

ficie

ncy

and

CO

2 em

issi

on c

ontro

l st

anda

rd fo

r new

ligh

t dut

y ve

hicl

es is

sued

by

SEM

AR

NA

T/SE

NER

/SE

is in

forc

e.

(ii) T

he n

umbe

r of v

ehic

les

cove

red

by tr

ansp

ort

oper

ato r

s’ a

ctio

n pl

ans

unde

r the

new

Tra

nspo

rte

Lim

pio

prog

ram

reac

hes

30,0

00.

The

num

ber o

f fre

ight

se

rvic

e us

ers w

ho a

dopt

ac

tion

plan

s rea

ches

50

com

pani

es.

(i)SE

MA

RN

AT/

SEN

ER/

SE is

sue

an e

nerg

y ef

ficie

ncy

and

CO

2 em

issi

on c

ontro

l st

anda

rd

for n

ew h

eavy

dut

y ve

hicl

es a

nd to

geth

er w

ith

the

light

dut

y ve

hicl

e st

anda

rd a

nd th

e en

ergy

ef

ficie

ncy

guid

elin

es fo

r th

e fe

dera

l pub

lic

adm

inis

tratio

n fle

et

com

plet

e a

regu

lato

ry

fram

ewor

k fo

r fue

l ef

ficie

ncy

in v

ehic

les

(ii

) SEM

AR

NA

T an

d SC

T ex

pand

and

impr

ove

the

VC

T Pr

ogra

m, s

o as

to

reac

h th

e PE

CC

targ

et

of re

duci

ng 0

.9 m

illio

n to

ns o

f CO

2e b

y 20

12.

65

Obj

ectiv

e Is

sues

and

O

bsta

cles

Pr

ior

Act

ions

O

utco

mes

at I

CR

Dat

e M

ediu

m-te

rm A

ctio

ns

UR

BA

N

Polic

y A

rea

4: E

nerg

y E

ffici

ent H

ousi

ng D

evel

opm

ent

Prom

ote

ener

gy

effic

ienc

y in

new

ho

usin

g co

nstru

ctio

n

Nat

iona

l hou

sing

pr

ogra

ms d

o no

t ful

ly

cons

ider

ene

rgy

effic

ienc

y, a

nd th

ere

are

inad

equa

te

ince

ntiv

es fo

r bui

lder

s to

con

stru

ct a

nd b

uyer

s to

pur

chas

e m

ore

ener

gy-e

ffic

ient

hou

ses

4. T

he B

orro

wer

, thr

ough

CO

NA

VI,

has t

aken

step

s to

pro

mot

e lo

w-c

arbo

n ur

ban

deve

lopm

ent a

nd

inte

grat

e pr

ogra

ms a

nd in

stru

men

ts in

hou

sing

po

licie

s to

redu

ce d

irect

and

indi

rect

GH

G e

mis

sion

s,

as e

vide

nced

by

the

esta

blis

hmen

t of t

he S

usta

inab

le

Hou

sing

Pro

gram

dat

ed D

ecem

ber 1

, 200

9 an

d pu

blis

hed

on C

ON

AV

I’s w

ebsi

te o

n D

ecem

ber 1

, 20

09 (h

ttp://

ww

w.c

onav

i.org

.mx)

.

(i) T

he n

umbe

r of n

ewly

co

nstru

cted

hou

sing

uni

ts

that

qua

lify

for C

ON

AV

I’s

new

ene

rgy

effic

ient

ho

usin

g su

bsid

y in

crea

ses

to 2

00,0

00.

(ii) T

he n

umbe

r of n

ew

hous

ing

units

that

qua

lify

for i

nter

natio

nal c

arbo

n cr

edits

und

er th

e C

DM

pr

ogra

mm

atic

m

etho

dolo

gy fo

r su

stai

nabl

e ho

usin

g (A

MS-

III.A

E) re

ache

s 100

,000

. (i

ii) T

he re

cipi

ents

of

CO

NA

VI’

s hou

sing

su

bsid

y th

at p

artic

ipat

e in

th

e gr

een

mor

tgag

e (H

ipot

eca

Ver

de) p

rogr

am

reac

h 14

0,00

0.

By

2012

, CO

NA

VI

deve

lops

and

ado

pts a

gr

een

build

ing

code

that

is

ass

ocia

ted

to a

ratin

g pr

ogra

m

CO

NA

VI ‘

s sub

sidi

es

have

sust

aina

ble

tech

nica

l cr

iteria

and

fina

ncia

l too

ls

( Hip

otec

a Ve

rde)

66

Obj

ectiv

e Is

sues

and

O

bsta

cles

Pr

ior

Act

ions

O

utco

mes

at I

CR

Dat

e M

ediu

m-te

rm A

ctio

ns

FOR

EST

RY

AN

D L

AN

D-U

SE

Polic

y A

rea

5: S

usta

inab

le F

ores

t Man

agem

ent

Incr

ease

the

area

of

fore

sts u

nder

su

stai

nabl

e fo

rest

m

anag

emen

t to

reac

h na

tiona

l m

itiga

tion

goal

s fo

r the

fore

stry

se

ctor

Lack

of s

tream

lined

pr

oced

ures

to fa

cilit

ate

issu

ing

perm

its,

stre

ngth

en c

apac

ity,

and

impr

ove

info

rmat

ion

syst

ems f

or

plan

ning

, pro

mot

ion,

an

d en

forc

emen

t, as

w

ell a

s lac

k of

a

com

preh

ensi

ve

fram

ewor

k fo

r su

stai

nabl

e fo

rest

m

anag

emen

t em

bedd

ed

with

in a

larg

er n

atio

nal

RED

D+

stra

tegy

5(i).

The

Bor

row

er, t

hrou

gh S

EMA

RN

AT,

has

m

odifi

ed th

e na

tiona

l reg

ulat

ory

fram

ewor

k an

d si

mpl

ified

the

adm

inis

trativ

e pr

oced

ures

for

proc

essi

ng a

nd a

ppro

ving

fore

st m

anag

emen

t pla

ns,

and

issu

ing

asso

ciat

ed p

erm

its, a

s evi

denc

ed b

y a

decl

arat

ion

( Acu

erdo

) iss

ued

by S

EMA

RN

AT

and

publ

ishe

d in

the

Bor

row

er’s

Off

icia

l Gaz

ette

(Dia

rio

Ofic

ial d

e la

Fed

erac

ión)

on

June

29,

201

0.

(ii).

The

Bor

row

er, t

hrou

gh S

EMA

RN

AT,

with

the

supp

ort o

f the

Inte

r-se

cret

aria

l Com

mis

sion

on

Clim

ate

Cha

nge,

has

cre

ated

a w

orki

ng g

roup

on

redu

cing

em

issi

ons f

rom

def

ores

tatio

n an

d fo

rest

de

grad

atio

n (R

EDD

+) w

hich

is in

volv

ed in

the

deve

lopm

ent o

f, in

ter a

lia, a

stra

tegy

for r

educ

ing

emis

sion

s fro

m d

efor

esta

tion

and

fore

st d

egra

datio

n,

as e

vide

nced

by

the

min

utes

of t

he 2

009

seco

nd

mee

ting

of th

e In

ter -

secr

etar

ial C

omm

issi

on o

n C

limat

e C

hang

e da

ted

Dec

embe

r 2, 2

009,

the

min

utes

of

the

first

mee

ting

of th

e w

orki

ng g

roup

RED

D+,

da

ted

Mar

ch 2

2, 2

010,

the

min

utes

of t

he se

cond

m

eetin

g of

the

wor

king

gro

up R

EDD

+, d

ated

Ju

ne 1

6, 2

010

and

the

min

utes

of t

he e

xtra

ordi

nary

m

eetin

g of

the

wor

king

gro

up R

EDD

+, d

ated

July

12,

20

10.

(i) T

he n

umbe

r of p

erm

its

for f

ores

t man

agem

ent

incr

ease

s fro

m

4,00

0 pe

rmits

in 2

010

to

6,60

0 pe

rmits

by

June

20

12 a

s a re

sult

of th

e re

gula

tory

refo

rm,

cont

ribut

ing

to th

e PE

CC

go

al o

f inc

orpo

ratin

g 2.

95 m

illio

n he

ctar

es b

y 20

12.

(ii) F

inal

dra

ft of

the

natio

nal R

EDD

+ st

rate

gy

for p

ublic

con

sulta

tion,

in

clud

ing

polic

ies l

inke

d to

su

stai

nabl

e fo

rest

m

anag

emen

t, is

pub

lishe

d on

SEM

AR

NA

T’s

web

site

.

(i) R

efor

m o

f the

Gen

eral

Fo

rest

ry L

aw (L

ey

Gen

eral

de

Des

arro

llo

Fore

stal

)

(ii) A

pplic

atio

n of

the

fore

st se

ctor

’s n

atio

nal

info

rmat

ion

syst

em

( Sis

tem

a N

acio

nal d

e G

estió

n Fo

rest

al) t

o de

velo

p be

tter p

lann

ing

inst

rum

ents

for

sust

aina

ble

fore

st

man

agem

ent

(ii) T

he n

atio

nal R

EDD

+ st

rate

gy is

fully

con

sulte

d an

d ad

opte

d

67

ANNEX 3: FUND RELATIONS NOTE

68

69

70

ANNEX 4: THE GOVERNMENT’S PUBLIC CONSULTATION PROCESS FOR LOW-CARBON DEVELOPMENT

1. The design of the Mexico Low-Carbon Development Policy Loan was informed by a long-standing consultation process carried out by the Government in the context of the National Development Plan (PND), the Special Program for Climate Change (PECC), the Clean Technology Fund (CTF) Investment Plan, and, more recently, the preparation of the REDD+ National Strategy. In addition, the Bank’s extensive engagement with the Government on climate change, environment, and sector-specific activities include consultations and participation of key stakeholders. 2. As the Government’s main instrument for advancing the implementation of the National Strategy for Climate Change (ENACC), the PECC was developed under the standards of the General Planning Law which mandates a participatory process. The public consultation of the PECC was carried out from March 24 to June 18, 2009. Comments/suggestions from ninety seven persons/institutions were recorded in the Environmental Ministry’s web page (www.semarnat.gob.mx). Participants included: 25 Schools, Universities, and Research Centers; 23 Environmental and Non-Government Organizations (NGOs), 23 Consultants and Firms, 12 National and Sub-national Government Officials, and 2 Rural Producers Organizations. Along with the creation of the Inter-Secretarial Commission on Climate Change (Comisión Inter-secretarial de Cambio Climático – CICC), the Government of Mexico invited the scientific community and civil society to form a Consultative Council to ensure that strategies and sector programs are developed with due consultation with potentially affected parties. 3. Preparation of the CTF Investment Plan was carried out jointly by the Government of Mexico, the IBRD, the IDB, and the IFC and also included consultations with relevant UN agencies as well as representation from various countries engaged in Climate Change related activities in Mexico. This multi-year business plan identifies programs to be co-financed by the CTF jointly with the IBRD, IDB and IFC in the Urban Transport and Energy Sectors. 4. A Technical Assistance MOU on Environmental Sustainability and Climate Change is the framework for the Bank’s support to the Climate Change Program in Mexico. The monitoring and evaluation of implementation, support to sub-national initiatives, the public consultation design and the study on Social Impacts of CC are some of the relevant activities under the MOU. 5. In parallel to the Low-Carbon DPL, the Bank is also preparing a Study on the Social Impacts of Climate Change (SICC) in Mexico, based on all the Mexico-specific findings accumulated during the preparation of the climate change regional study, based on the combination of desk research and fieldwork that was carried out as part of the SICC report preparation. Preparation of this study has incorporated consultations with a series of communities, as well as the National Ecology Institute (INE); SEMARNAT; and Universities. 6. The Bank is also assisting the State of Michoacán in the design and implementation of a participatory planning process, based on a Strategic Environmental Assessment multisectoral type of approach, to define and implement an Environmental Sustainability and Climate Change Program.

71

ANNEX 5: ENGAGEMENT WITH MEXICO ON CLIMATE CHANGE 1. The World Bank has had an extensive engagement with Mexico on climate change issues, which has addressed potential impacts, adaptation measures, and the mitigation of emissions. The Bank has used a number of instruments, ranging from analytical work, technical assistance, project investments, and development policy lending (see figure 7). While some support has been directed at broad strategy and policy design, the majority of the Bank’s activities have taken place at the sectoral level. Among the sectors or themes that have been the focus of the Bank’s climate change work in Mexico have been energy, transport, forestry, agriculture, water, urban development, and environmental and social sustainability.

2. In the energy sector, a substantial amount of analytical work and technical assistance has been undertaken by the Bank on clean energy. In the renewable energy field, the Bank has been actively involved in the assessment of mini-hydro, solar PV for off-grid applications, large-scale wind, solar thermal electric, regulatory policy, valuing externalities, and renewable energy auctions. Other priority topics have been an analysis of residential electric subsidies in Mexico and options for reform, a study and workshop on international best practices for reducing gas flaring, and assessment of the potential benefits and reform measures necessary to improve energy efficiency. A Memorandum of Understanding with SENER was signed to strengthen Mexico’s capacity to implement its National Energy Strategy and an ongoing Renewable Energy Technical Assistance Program is providing support to the government for implementing the renewable energy law and its regulations.

3. On the transport side, analytical work and technical assistance has also been carried out on diverse topics such as road freight transport, mass urban transport, and climate friendly transport and air quality measures. The Mexico Urban Transport Sector Technical Advisory Program is one example of technical assistance which aims to help the Government of Mexico implement its Federal Mass Transit Program and the Urban Transport Transformation Program and also to strengthen the technical capacity of the team in charge of implementing these two programs. Similarly, the Road Freight Transport Industry in Low and Middle-Income Countries Study examined the regulatory structure and related barriers to the improvement of road freight transport in Mexico.

4. An Environmental Memorandum of Understanding with SEMARNAT was signed which aims to strengthen Mexico’s capacity to mainstream environmental and climate change consideration in key economic sectors and public policy. In the urban sector, a Housing Sector Technical Assistance Program has supported the formulation of the Housing Construction Code, which is intended to serve as a guide for government funded programs and for municipal governments to update their local regulations.

5. Broader climate change analytical work has also been conducted on social development and resilience to climate change, addressing key poverty and vulnerability issues associated with climate change, cap and trade systems, mainstreaming climate change into key development sectors, responses to climate change, and sub national climate change strategies, and low-carbon development. All of these studies have helped address key aspects of Mexico’s climate change program and have made the topic one of the key pillars of the Bank’s Country Partnership Strategy.

72

6. With regards to investment lending, the Bank has provided financing for a number of projects related to climate change. Through a combination grants (GEF), concessional loans (CTF), credits (carbon finance), and IBRD loans, the Bank has provided financial support to projects on energy efficiency, renewable energy, urban transport, solid waste management, community forestry, water services, and protected areas. Among the clean energy projects that the Bank has helped finance in Mexico are the Integrated Rural Energy Services project which supports small-scale off-grid energy services through the use of renewable energy technologies; the Large-scale Renewable Energy Development Project supporting grid-connected wind development in Oaxaca, and; the Efficient Lighting and Appliances project that expands Mexico’s energy efficiency programs in the residential sector. In the transport sector, the Bank has financed the Urban Transport Transformation Program through a combination of IBRD and CTF loans as well as a GEF grant that supports bus rapid transit, clean bus technologies, and capacity building for public transport. In urban sector, the Bank is helping strengthen the financial and technical capacity of Federal Mortgage Corporation to develop and consolidate markets for housing finance and to expand access to lower income groups through the Private Housing Finance Markets Strengthening Project. In addition, the GEF Consolidation of Protected Areas System project is addressing forest protection issues in national protected area systems and the Environmental Services Project aims to enhance and protect biological diversity and preserve globally significant forest and mountain ecosystems.

7. In light of Mexico’s international commitment to voluntarily reduce GHG emissions, the country was supportive of undertaking analyses of potential climate mitigation actions. The World Bank proposed undertaking a low-carbon study in Mexico in 2008 as one of several similar studies being done in key developing and middle-income countries, including Brazil, China, India, and South Africa. The Mexico low-carbon study developed a consistent cost-benefit methodology for evaluating promising mitigation interventions, covering all major sectors: electric power, oil and gas, transport, end-use energy efficiency, agriculture and forestry. By focusing on selected projects with good financial and economic returns, it was estimated that Mexico could maintain its emissions trajectory basically flat over the next two decades without reducing the rate of growth the economy. The results of the study, referred to as MEDEC for its acronym in Spanish, form the basis for the policy measures selected for the current Low-carbon DPL. It should be noted that all of the interventions are all key measures as part of Mexico’s domestic climate change program, PECC. 8. On the policy side, a series of development policy loans have been carried out, starting with the Climate Change DPL (April 2008), which aimed to assist the GOM to integrate climate change considerations into public policy. The Environmental DPL (October 2008) balanced the objective of socio-economic development with environmental protection and improvement by integrating environmental concerns in the sectoral policies and programs of key development sectors (tourism, energy, forestry, water, agriculture and housing).

9. Building upon the objectives of these prior DPLs, the Green Growth DPL (October 2009) sought to further develop the regulatory, monitoring and financial framework for a low emissions evolution of the transport and energy sectors; the two sectors responsible for the bulk of GHG in Mexico. Most recently, the Adaptation to Climate Change Water Sector DPL (June 2010) recognized and supported the government's efforts to strengthen the institutional

73

framework and monitoring capacity in integrated water resources management as well as mainstream adaptation to climate change in water programs. 10. The current Low-Carbon DPL builds on the previous analytic, investment lending, and policy development loans directed at climate change. It focuses on some of the most important policy areas for meeting Mexico’s climate change mitigation targets. Over the past three years, Mexico has developed a national climate change strategy and action plan, passed national legislation in key sectors, developed institutional capacity to promote sectoral programs, and put in place key regulatory reforms to achieve specific high-priority outcomes. The six policy areas covered by the Low-Carbon DPL covering energy efficiency (cogeneration), renewable energy, gas flaring reduction, efficient vehicles and transport operations, energy efficiency housing, and sustainable forestry have the ability to dramatically transform Mexico’s GHG emission profile.

74

Figure 7. World Bank Involvement in Climate Change in Mexico Low-Carbon

DPL (P121800)

Objective:

support sector-specific, high-priority policy and regulatory reforms that have been

identified as critical to achieve

Mexico’s climate change

mitigation targets

Broad

Regulatory and

Institutional Reform,

focusing on: � Cogeneration

and Renewable Energy

� Gas Flaring Reduction

� Sustainable Use of Electricity in Agriculture

� Fuel efficiency in vehicles and transport operations

� Energy efficient housing

� Sustainable Forest Management

� Reducing Emissions from Deforestation

TRANSPORT � ROAD FREIGHT TRANSPORT INDUSTRY IN LOW AND

MIDDLE-INCOME COUNTRIES � MEXICO MASS URBAN TRANSPORT FEDERAL PROGRAM

(P110474) � INTRODUCTION OF CLIMATE FRIENDLY MEASURES IN

TRANSPORT (P059161) � SUSTAINABLE TRANSPORT AND AIR QUALITY (P114012) � MX URBAN TRANSPORT SECTOR TECHNICAL ADVISORY

PROGRAM (UT-TAP)

ENERGY � SEMARNAT MoU (P112959) � SENER MoU (P114892) � STUDY on Residential Electricity

Subsidies � MX RENEWABLE ENERGY

ASSISTANCE PROGRAM (P117870) � PROMOTING MINI-HYDRO

DEVELOPMENT IN MEXICO � ADVISORY SERVICES TO PEMEX

(P116628)

ENVIRONMENT / CLIMATE CHANGE � CAP AND TRADE STUDY (MoU) � MEDEC (TA) � POLICY FRAMEWORK DEVELOPMENT AND MAINSTREAMING CLIMATE CHANGE IN KEY DEVELOPMENT

SECTORS (P121527) � LOW CARBON, HIGH GROWTH: LATIN AMERICAN RESPONSES TO CLIMATE CHANGE � MX MoU SUBNATIONAL CLIMATE CHANGE PLANS (P105849)

INVESTMENTS AND FINANCING

TRANSPORT � CTF PROGRAM

� URBAN TRANSPORT TRANSFORMATION PROGRAM (UTTP)

RENEWABLE ENERGY � LA VENTA II (P080104) and LA

VENTA III (P077717)

� HYBRID SOLAR THERMAL PROJECT (P066426)

� INTEGRATED ENERGY SERVICES (P095038)

ENERGY EFFICIENCY � MX LIGHTING AND APPLIANCES

EFFICIENCY - CTF (P106424)

ANALYSIS AND TECHNICAL ASSISTANCE

Sectoral analysis

and baselines

Emissions regulation and cross-

sectoral carbon plans

Financing, capacity and safeguards

for investments in energy, transport,

solid waste management

, and forestry and agriculture

development

SOLID WASTE MANAGEMENT � METHANE GAS CAPTURE AND

USE AT LANDFILL-DEMONSTRATION PROJECT (PID8127)

LAND USE AND FORESTRY � MX COMMUNITY FORESTRY, PROCYMAF I & II (P035751) � ENVIRONMENTAL SERVICES PROJECT (P087038) � FORESTS, CLIMATE CHANGE & COMMUNITIES (P101278) � CONSOLIDATION OF PROTECTED AREAS SYSTEM (P106103)

NATURAL RESOURCES � ECONOMIC ASSESSMENT OF POLICY INTERVENTIONS IN THE WATER SECTOR (P096999) � MX WATER SECTOR ADAPTATION TECHNICAL COOPERATION PROGRAM (P122166) � AGRICULTURE AND RURAL DEVELOPMENT PUBLIC EXPENDITURE REVIEW (PER)

SOCIAL DEVELOPMENT AND CLIMATE CHANGE RESILIENCE � MX SOCIAL IMPACTS OF CLIMATE CHANGE Study (P112024) � MoU SEDESOL SUSTAINABLE LOCAL DEVELOPMENT (P116549)

CLIMATE CHANGE DPL (P110849)

ENVIRONMENTAL DPL (P095510)

POLICY

Public Policy Framework

Sectoral Policy Framework

GREEN GROWTH DPL (P115608)

ADAPTATION TO CLIMATE CHANGE IN THE WATER

SECTOR DPL (P120134)

75

ANNEX 6: COUNTRY AT A GLANCE

76

77

Citlaltépetl (5,747 m) Citlaltépetl (5,747 m)

Si e r r a

Ma

dr e O

c c i d e n t a l

S ierra Madre del Sur

Si e

r r a M

ad

r e O

r i e nt a

l

CAMPECHECAMPECHE

CHIAPASCHIAPAS

TABASCOTABASCO

OAXACAOAXACA

GUERREROGUERRERO

COLIMACOLIMA

JALISCOJALISCO

NAYARITNAYARIT

ZACATECASZACATECAS

TAMAULIPASTAMAULIPAS

NUEVONUEVOLEONLEON

C O A H U I L AC O A H U I L A

C H I H U A H U AC H I H U A H U ASONORASONORA

D U R A N G OD U R A N G O

SAN LUISSAN LUISPOTOSIPOTOSI

MICHOACANMICHOACAN PUEBLAPUEBLA

VERACRUZVERACRUZ YUCATANYUCATAN

QUINTANAQUINTANAROOROO

S INA

LOA

S I NA

LOA

MazatlánMazatlán

TorreónTorreónMatamorosMatamoros

LaredoLaredo

OjinagaOjinaga

Los MochisLos Mochis

NavojoaNavojoa

NogalesNogalesSanSan

FelipeFelipe

LoretoLoreto

SonoitaSonoita

AguaAguaPrietaPrieta

GuaymasGuaymas

TehuantepecTehuantepec

FronteraFrontera

VillahermosaVillahermosa

TuxtlaTuxtlaGutierrezGutierrez

OaxacaOaxaca

ChilpancingoChilpancingo

ColimaColima

GuadalajaraGuadalajara

TepicTepic

DurangoDurango

SaltílloSaltíllo

ChihuahuaChihuahua

CuliacánCuliacán

HermosilloHermosillo

MexicaliMexicali

GuanajuatoGuanajuato

PachucaPachuca

AguascalientesAguascalientes

QuerétaroQuerétaro

MoreliaMoreliaTolucaToluca

CuernavacaCuernavaca PueblaPuebla

TlaxcalaTlaxcala

JalapaJalapa

San LuisSan LuisPotosíPotosí

CiudadCiudadVictóriaVictória

ZacatecasZacatecas

MonterreyMonterrey

MEXICOMEXICOCITYCITY

Yaqui

Rio Bravo

Fuerte

Salado

Lerma

Balsas

Conchos

BAJABAJACALIFORNIACALIFORNIA

BAJABAJACALIFORNIACALIFORNIA

SURSUR

MEXICOMEXICO

MORELOSMORELOS

DISTRITO FEDERALDISTRITO FEDERAL

HIDALGOHIDALGOGUANAJUATOGUANAJUATO

AGUASCALIENTESAGUASCALIENTES

TLAXCALATLAXCALA

QUERÉTAROQUERÉTARO

Usuummacinta Rio Grande

GUATEMALAGUATEMALATapachula

PuertoEscondido

Acapulco

Puerto Vallarta

Mazatlán

TorreónMatamoros

Laredo

Ojinaga

Los Mochis

Navojoa

Nogales

Ensanada

Tijuana

SanFelipe

SantaRosalia

Loreto

Cabo San Lucas

Sonoita

AguaPrieta

Ciudad Juárez

Guaymas

Veracruz

Tampico

Tehuantepec

Cozumel

Cancun

Frontera

Chetumal

Merida

Villahermosa

Campeche

TuxtlaGutierrez

Oaxaca

Chilpancingo

Colima

Guadalajara

Tepic

Durango

Saltíllo

Chihuahua

Culiacán

Hermosillo

Mexicali

La Paz

Guanajuato

Pachuca

Aguascalientes

Querétaro

MoreliaToluca

Cuernavaca Puebla

Tlaxcala

Jalapa

San LuisPotosí

CiudadVictória

Zacatecas

Monterrey

MEXICOCITY

CAMPECHE

CHIAPAS

TABASCO

OAXACA

GUERRERO

COLIMA

JALISCO

NAYARIT

ZACATECAS

TAMAULIPAS

NUEVOLEON

C O A H U I L A

C H I H U A H U A

BAJACALIFORNIA

BAJACALIFORNIA

SUR

SONORA

D U R A N G O

SAN LUISPOTOSI

MICHOACAN

MEXICO

MORELOS

DISTRITO FEDERAL

PUEBLA

HIDALGOVERACRUZ

GUANAJUATO

AGUASCALIENTES

TLAXCALA

YUCATAN

QUINTANAROO

S INA

LOA

QUERÉTARO

UNITED STATES OF AMERICA

GUATEMALA

BELIZE

HONDURAS

ELSALVADOR

Yaqui

Rio Grande

Rio Bravo

Fuerte

Salado

Lerma

Balsas

Usumacinta

Conchos

PACIFICOCEAN

Gulf of Mexico

Bay of Campeche

Gulf ofTehuantepec

Gulf of

Honduras

Gu

l f of C

al i f o

r ni a

To Los Angeles

To Gila Bend

To Albuquerque

To Alamogordo

To Midland

To San Antonio

To San Antonio

To Houston

To San Salvador

Si e r r a

Ma

dr e O

c c i d e n t a l

S ierra Madre del Sur

Si e

r r a M

ad

r e O

r i e nt a

l

Citlaltépetl (5,747 m)

115°W

30°N30°N

25°N

15°N

25°N

20°N

15°N

110°W

110°W

105°W 100°W 95°W 90°W

105°W 100°W 95°W

85°W

MEXICO

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

0 100 200

0 50 100 150 200 Miles

300 Kilometers IBRD 33447R

NO

VEM

BER 2008

MEXICOSELECTED CITIES AND TOWNS

STATE CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

STATE BOUNDARIES

INTERNATIONAL BOUNDARIES