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While there are growing calls from the
scientific community that fossil fuel investment should be halted
to avoid a climate catastrophe, lawyers and researchers warn
governments could face large legal claims for cutting ties with
high-carbon energy sources.
In a recent study published by
Science, a team of researchers at Boston University, Colorado State
University, and Queen's University in Canada estimated countries
might be liable for up to $340 billion in compensation for
terminating proposed oil and natural gas projects that have yet to
begin production.
The analysis focused on potential claims from investors via the
investor-state dispute settlement (ISDS) procedure, a type of
international arbitration mechanism that allows an investor to take
legal action against a foreign government for alleged violation of
trade and investment agreements.
"Countries could be liable under investment treaties for
billions of dollars in damages if they phase out fossil fuels in
line with climate science," lead author Kyla Tienhaara, an
assistant professor at Queen's, said in a statement.
The researchers assumed the net present value, which weighs
future cash flows against the initial investment, as the maximum
claim amount, and took into consideration into 1,828 investment
treaties liable to ISDS claims.
Based on their findings, 97 national governments could face
legal claims totaling about $234 billion for cancelling upstream
projects that have yet to reach a final investment decision but
received at least an exploration permit. Of that figure, $114
billion is linked to crude production, $90 billion to gas, $21
billion to condensate, and $8 billion to natural gas liquids.
If states are to terminate all projects that are under
development but have yet to start production, investors could claim
another $106 billion in compensation, including $52 billion related
to gas projects and $42 billion to crude.
"Foreign investors may have a legal claim for compensation if
countries cancel treaty-protected fossil fuel projects," the
researchers wrote. "If the lawsuit is successful, countries face
substantial financial losses and may pull out of climate
commitments to avoid additional ISDS claims from other
investors."
Recent reports suggest France
and New Zealand have taken a less aggressive stance in countering
climate change due to potential ISDS claims, prompting worries
among climate scientists.
Earlier this year, the Intergovernmental Panel on Climate Change
publicly acknowledged that countries
might refrain from phasing out fossil fuels due to a "regulatory
chill" arising from international investment agreements.
More climate-related claims
The Science study cited earlier findings by the International
Institute for Sustainable Development (IISD) thinktank, which
suggested oil and gas firms enjoyed decent success in
treaty-related arbitration.
In a research report published in
January, IISD identified 231 ISDS cases linked to fossil fuel
investments, or nearly 20% of the total. About 92% of the fossil
fuel cases are related to oil and gas projects.
Of the 169 concluded fossil fuel cases, 32% were decided in
favor of investors while 31% were settled. The average amount
awarded in fossil fuel cases was more than $600 million.
There have been a limited number of fossil fuel cases directly
related to climate policies. Among them, the most high-profile are
TC Energy's $15 billion claim against the
US government's cancellation of the Keystone XL pipeline project,
based on the North American Free Trade Agreement, and RWE's and
Uniper's claims via the Energy Charter
Treaty against the Netherlands for coal phaseout.
Still, some believe that governments will face more claims from
fossil fuel investors in the coming years as they start to fulfill
their decarbonization commitments under the UN Framework Convention
on Climate Change.
"It is very likely that climate-related investor state disputes
will increase … New and newly negotiated treaties are not updated
at the pace of commercial change and scientific understanding,"
said Pamela McDonald, partner at law firm Pinsent Masons, adding
that changes in domestic environmental regulations could affect
foreign investors and lead to more ISDS cases.
Anja Ipp, co-founder of thinktank Climate Change Council, also
suggested there will be more claims from fossil fuel investors as
countries pass new laws and regulations to phase out fossil fuels.
"It will be extremely interesting to see how the arbitral tribunals
analyze and decide these cases," she told Net-Zero Business
Daily by S&P Global Commodity Insights.
A dilemma for governments
Countries generally sign investment treaties to promote
international trade and foreign investment, but critics suggest
national governments could face additional legal risks as a
result.
Earlier this year, the Organisation for Economic Co-operation
and Development launched a public consultation on how to
align investment treaties with climate goals.
Some in the legal and investment communities suggest that
governments can seek to modify existing treaties with additional
clauses to meet the Paris Agreement's goals, and formulate new
treaties that focus on climate action.
"Governments must find a balance between protecting investors
from abuse of regulatory powers, while at the same time securing
the possibility to genuinely legislate in the area of environmental
protection," McDonald told Net-Zero Business Daily.
To discourage further claims and pursue more climate action, Ipp
said governments should first try to win some outstanding
climate-related ISDS cases on existing treaty terms.
"The best way for states to mitigate their legal risks may be to
fight these cases. Rather than giving in to investor threats,
states should consider defending their right to regulate in the
public interest," Ipp said.
Lea Di Salvatore, a law researcher at the University of
Nottingham who wrote the IISD report, said countries can also
terminate or withdraw from any investment agreements that could
obstruct their decarbonization efforts.
Boston University's Rachel Thrasher, a researcher who also
participated in the Science study, advocated an even more outright
"abolitionist approach," and said: "Investment treaties number in
the thousands and act as political risk insurance for foreign
investors from government measures, even if those measures are in
the public interest. The benefits to governments are few, as these
treaties do not live up to their purported benefit of facilitating
investment and may act as a 'chill' on needed climate action."
A new Energy Charter Treaty?
The Science and IISD studies both highlighted the Energy Charter
Treaty as potentially the greatest contributor to climate-related
claims, with 17% of all fossil fuel arbitration cases based on the
treaty.
Launched in 1994, the Energy Charter Treaty allows investors to
seek compensation from state governments for policy measures that
could lower expected profits. It was signed by more than 50
countries, of which EU states account for nearly half.
The EU has been seeking to revise the treaty in
recent years in a bid to phase out the protection for fossil
fuel investors within 20 years. But signatories need to unanimously
agree to any change, and some—like Japan—have vocally
opposed the EU proposal.
If no conclusion is reached on the proposed reform in June, EU
states could begin to withdraw from the treaty. In mid-May, Member
of European Parliament Pascal Canfin tweeted: "The negotiation
around the reviews of the Energy Charter Treaty have so far proven
not to deliver meaningful changes up to the climate crisis … We
call for a coordinated exit of all EU countries from it."
As the treaty has a clause letting investors sue a state for 20
years after the state's withdrawal, some analysts suggest EU states
should team up and agree among themselves that they will not allow
EU-based investors to sue them in the sunset period. In a parallel
development, the Court of Justice of the EU
has already ruled against intra-EU arbitrations based on the Energy
Charter Treaty.
But the EU's withdrawal may not necessarily aid a low-carbon
transition. In February 2021, S&P Global Market
Intelligence reported renewables developers lodged twice as
many claims under the treaty as fossil fuel backers and secured
double the amount of damages.
McDonald stressed that the investment treaties are not
inherently incompatible with deep decarbonization. "Attracting
foreign investors will be a key component of countries'
decarbonization plans … states need to modernize treaties at the
point of negotiation or re-negotiation to expressly deal with
environmental considerations," she said.
While agreeing that cross-border investment in renewable energy
will be required to meet climate goals in the coming years, Ipp
said there is no evidence suggesting investment treaties are
necessary for those investments to happen.
"The problem with investment treaties generally is that they are
difficult to revise once signed. In my opinion, there are probably
better ways to offer investors protections and incentives," Ipp
added.
Paul de Clerck, economic justice coordinator at Friends of the
Earth Europe, suggested renewables investors can turn to local
courts for protection. As a mechanism, the Energy Charter Treaty is
too "flawed" because it covers fossil fuel projects and doesn't
protect domestic renewables investors, he added.
Posted 31 May 2022 by Max Tingyao Lin, Principal Journalist, Climate and Sustainability
This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.
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