Countries that block fossil fuel projects as part of their green transition plans could face retaliatory legal action from investors, with potential claims totalling more than US$300bn, researchers have found.
Following warnings from the International Energy Agency that an immediate halt to all new fossil fuel projects is required to reach net-zero carbon emissions by 2050, governments are increasingly putting an end to energy-related projects already underway, such as oil or gas pipelines and coal-fired power plants.
However, this could result in huge liabilities to investors. A paper published by academics last week says foreign backers of such projects may be able to bring legal claims under international agreements, notably the North American Free Trade Agreement (Nafta) and the Energy Charter Treaty (ECT).
The paper estimates that under such agreements, countries could be liable to pay out up to US$340bn in damages – greater than the total level of public climate finance pledged globally in 2020 – resulting in a “chilling effect” on climate action.
Those funds “are needed for green energy transitions”, says Kyla Tienhaara, an assistant professor at the school of environmental studies at Queen’s University, Canada and an author of the report.
“The international community cannot afford to have such a substantial amount of public finance diverted from essential mitigation and adaptation efforts to the pockets of fossil fuel investors,” she says.
The paper gives several examples of legal action currently underway. Four pending cases are being brought under Nafta, a trade agreement between the US, Canada and Mexico in effect between 1994 and 2020.
Two relate to the Canada-US Keystone XL oil pipeline, and are being brought against the US by TC Energy and the Alberta Petroleum Marketing Commission. Another is brought against the Canadian government by Lone Pine Resources following the introduction of restrictions on gas fracking.
Several additional pending cases are brought under the ECT, an agreement in effect since 1998 that includes more than 80 countries as members and observers.
These include a claim from Rockhopper over Italy’s introduction of restrictions on offshore oil and gas exploration, and two from Uniper and RWE seeking compensation for the Netherlands’ phase-out of coal power.
The paper says the claims ultimately arise from the role of international treaties in protecting foreign investors from state action, which has historically been touted as a means of increasing investment from overseas.
Claims worth billions
The scale of the potential payouts identified by the paper are the result of tens of thousands of cases where upstream oil and gas projects could face cancellation, but where initial approvals – such as exploration permits – have already been granted.
Claims are brought before an ad-hoc tribunal, which typically requires governments to pay compensation to the investor if their actions are deemed to have breached investment treaties.
Increasingly, tribunals “use projections of an investment’s expected future income across its entire life cycle as the basis of compensation”, it explains.
The paper says the five countries facing the greatest potential losses if such claims arise are Mozambique, Guyana, Venezuela, Russia and the UK, with an estimated combined exposure of up to US$103bn. For the UK alone, damages could total between US$3bn and US$14bn, it says.
Whether countries could face claims from banks involved in providing financing for individual projects or to energy companies would generally depend on the terms of the treaty and nature of their investment, explains Rachel Thrasher, a researcher at Boston University’s Global Development Policy Center and co-author of the paper.
To ascertain whether a foreign investor can make a claim, most treaties use an asset-based definition, Thrasher says. This can cover moveable and immoveable property, equity, contract claims and intellectual property.
“Sometimes they include loans in the short list, but other times they don’t,” she tells GTR. “Some newer treaties have a footnote stating that ‘some forms of debt, such as bonds, debentures, and long-term notes, are more likely to have the characteristics of an investment, while other forms of debt are less likely to have such characteristics’.”
If a foreign bank finances a pipeline that stalls due to government policy, they may be able to claim if the facility had the characteristics of an investment, providing that language was used in the relevant international treaty.
The paper suggests that governments put an immediate halt to oil and gas exploration, which would limit the number of future projects that could later result in compensation claims.
They should also consider terminating bilateral investment treaties, pointing out that South Africa did so without suffering a drop in foreign investment.
Alternatively, states can remove relevant clauses from treaties – a step taken by the US in its recent trade agreement with Canada and Mexico, which replaced Nafta – or impose a ban on investor-state dispute claims arising from the fossil fuels industry.
Otherwise, the paper warns that treaties “increase the power of the fossil fuel industry to resist the implementation of policy measures that are crucial for the global green energy transition”.