Climate change and sustainability disputes: Energy sector perspectives
Global | Publication | July 2021
- What are climate change & sustainability disputes?
- Climate change disputes trends in the energy sector
- Cases brought to either mandate or change climate-related policy or conduct
- Cases brought to seek financial redress for damages associated with the effects of climate change
- Contractual disputes relating to transition, adaptation or mitigation activities
- Contracts affected by climate change and sustainability issues
- Investor-state disputes
- State-state disputes
- Avoiding a climate litigation disaster
For companies operating in the energy sector, climate change and the energy transition manifest as a complex myriad of legal, financial and reputational risk. The number of climate-related cases commenced to date is well over 1,800 and that number continues to rise. Most cases fall beneath the radar (low key skirmishes over statutory permissions or breaches) but in recent years a number of high stakes claims have been fought very publicly before the highest courts and regularly in the courts of public opinion. Regardless of success, such claims inspire imitative cases all over the globe. Put plainly, climate change and sustainability disputes risk is now part of corporate reality.
What are climate change & sustainability disputes?
There is no single common definition of what constitutes a climate change dispute. One helpful description was offered in the recent ICC Commission Report ‘Resolving Climate Change Related Disputes through Arbitration and ADR’ (ICC Taskforce Report) which took a broad view of such disputes as including “any dispute arising out of or in relation to the effect of climate change and climate change policy, the United Nations Framework Convention on Climate Change (“UNFCCC”) and the Paris Agreement”. By contrast, UNEP defines climate litigation as “cases that relate specifically to climate change mitigation, adaptation, or the science of climate change.” This latter definition is helpful in that it expressly captures disputes arising out of the rapid and deep transitions currently underway in the energy sector and all other industries. This is critical. As noted in a recent IEA Report, “[a]chieving Net Zero emissions [for the global energy sector] by 2050 will require nothing short of the complete transformation of the global energy system.” Such change will present significant opportunities but there will also be related risks including risks of disputes.
We adopt these approaches, save to add ‘sustainability’ to our definition. This is in recognition of the fact that these disputes often encompass other distinct issues which traditionally would not be viewed as climate change related but fall within the larger sustainability sphere. For example, human rights and other fundamental rights traditionally have been viewed as a distinct category. But commentators tracking climate change dispute trends have for years been predicting (accurately) that there will be an increase in claims that are essentially climate change related disputes albeit formulated as fundamental rights arguments. This trend will increase in coming years, not least because such arguments have already seen some success around the globe. Other examples are biodiversity and land degradation issues which are impacted by climate change as well as many other factors. As such, in practice the term “climate change” on its own is often unhelpfully narrow, outside niche academic enquiry.
Admittedly even our definition is incomplete – ‘sustainability’ notoriously suffers from being subjective and lacking in clearly defined parameters. But rather than getting wrapped up in linguistics niceties and wrestling with a strict definition, it is easiest to follow the approach famously taken by U.S. Supreme Court Justice Potter Stewart to describe his threshold test for obscenity in that “you know it when you see it”.
To this end, we offers a number examples to bring to life the variety of climate change and sustainability related disputes faced by the energy sector.
Climate change disputes trends in the energy sector
The range of climate-related disputes brought to date is vast – it is a global phenomenon, where legal issues traverse multiple fields of law and various causes of action, and involve a wide range of claimants and defendants from multiple sectors. The oil and gas sector has been a primary target of litigants, however, climate change and sustainability disputes risk are no longer just an oil and gas issue – claims have been brought against a variety of energy related companies (in particular involving renewable energy projects, but a variety of other examples are given below). Claims are also being brought against many other industries.
The risk profile is not only complex but in a state of flux. This is partly due to innovative claims being brought by claimants as they seek to get around the legal hurdles frequently faced by such claims (standing, justiciability, causation, to name a few). It is also due to the ongoing evolution of the energy sector as well as the evolution of climate related regulation, on the national and international stage, as states grapple with how to address climate change and who should shoulder the fiscal burden.
It can be useful to roughly divide climate change and sustainability disputes by certain practical identifying features. For example, it can be helpful to use the following categories (again somewhat similar to the approach taken by the ICC Taskforce) when talking about such disputes:
- cases brought to either mandate or change climate-related policy or conduct (including regulatory action);
- cases brought to seek financial redress for damages associated with the effects of climate change (so-called “climate change damages litigation”);
- contractual disputes arising out of the energy transition and other industries transitions;
- contractual disputes resulting from climate-related weather events;
- related disputes between foreign investors and host states; and
- related disputes between states, and between other transnational actors.
Claims falling within categories 1 and 2 tend to be brought before domestic courts. Categories 3 and 4, contractual disputes, are brought before both domestic courts or in international arbitration. Disputes between investors and states, if contractual, can also be brought before domestic courts or in international arbitration, but if treaty-based they tend to be international arbitration. Likewise, disputes between states and between states and other international actors.
Cases brought to either mandate or change climate-related policy or conduct
The first category includes cases pursued by NGOs, pressure groups (often crowd-funded), and even governmental authorities against governments or corporations to enforce existing climate policies or accelerate policy change or behaviour. The Urgenda case is a notable example. The Urgenda Foundation successfully sued the Netherlands and obtained a court order compelling the government to implement more stringent climate change policies. Urgenda spawned numerous copycat proceedings across the globe, with mixed rates of success. Notably, this case also set the foundation for a claim in the Netherlands against an oil and gas corporation on similar grounds, which has thus far succeeded at the District court level (though reportedly the company will be appealing the decision). That case is a landmark decision in that the Dutch court ordered the company to reduce its global greenhouse gas emissions (including phases 1 through 3) drastically in a very short period of time.
Also in this category are claims focussed on regulatory compliance, corporate governance and consumer protection, brought either by regulatory authorities or aggrieved shareholders primarily in relation to the disclosure and mitigation of climate related risk or the veracity of climate change and sustainability commitments. There have been regulatory investigations of energy companies over disclosure and mitigation of material climate related risk. As more corporations commit to emission reduction targets and other sustainability measures, there is increasing regulatory scrutiny of the veracity of corporate statements and their potential to mislead consumers and shareholders.
For these types of dispute (at least for the time being), national courts will continue to be the fora of choice, and arbitration will play a more limited role. Many of these claims will be based on statute or constitutional or administrative law challenges rather than contractual disputes, and some may well be brought by national regulatory authorities under their mandates. More fundamentally, as arbitration is a contractual process, public interest groups often will not have legal standing to pursue arbitration. Likewise, there can be problems with arbitrability of such disputes.
In addition, a big part of the attractiveness of litigation for claimants in such disputes is the public nature of proceedings – public relations and reputational pressure is brought to bear on defendants, and claimants also seek to raise the profile of, and galvanise public support for, what is often a political or public interest cause. Pressure groups readily admit that publicity is often a significant win, even if the case is lost on its legal merits. In contrast, arbitration has an inherently private nature. Of course, not all arbitrations are confidential (though many are), but almost all arbitrations are private – in that only parties can participate in proceedings, access pleadings and evidence, attend hearings, and see the final awards. To the extent that awards or arbitration related judgments are published, these are often anonymized.
Cases brought to seek financial redress for damages associated with the effects of climate change
In the second category are claims against corporates where the main purpose is to seek damages for direct or indirect effects of climate change on the claimant’s property or investments (often in conjunction with other relief). A number of such claims have been brought by individuals and pressure groups (again often crowd funded). A significant proportion of these have been brought against energy companies.
One example is Lliuya v RWE AG. In that case, Germany’s largest electricity producer, RWE, is being sued by Saúl Luciano Lliuya, a Peruvian farmer, for a financial contribution towards costs of putting in place flood protections in his village in Peru. This claim is notable for its fact profile – Lliuya is suing RWE before the German courts for emissions released in Germany which Lliuya alleges contributed to climate change and ultimately the melting of a Peruvian glacial lake above his village thereby necessitating the flood defences. It shows the truly global nature of climate change disputes risk. The case survived an initial challenge, with the court of appeal finding that a polluter can be liable for impacts of climate change in principle. The case is ongoing.
Such claims are not limited to individuals or pressure groups but are also being brought by sub-national governmental authorities. For example, the various high profile lawsuits commenced by US cities and communities against carbon majors, before both federal and state US courts.
Arguably also within this category are claims by foreign investors against states, which seek to apportion liability for the impact of climate-related state conduct (e.g. change in policy or law) on their investments. Those types of disputes are addressed further below.
Contractual disputes relating to transition, adaptation or mitigation activities
The IPCC Special Report on the impacts of global warming of 1.5°C predicted the need for “rapid, far-reaching and unprecedented changes in all aspects of society”, which includes in particular “rapid and far-reaching transitions in land, energy, industry, buildings, transport and cities”. Transitions in these key sectors, individually and collectively, will impact every private, commercial and public endeavour. One hundred years ago, transitions in energy, industry and transport led to fundamental societal change. The advent of the automobile, for example, enabled speedier and safer travel over larger distances, transformed industry and trade, and reshaped our cities as well as our private lives. Modern transitions to limit and adapt to the changing climate (not least, the energy transition) call for an equally radical reorganisation of the way our societies, cities, industries and lives are configured and run. The difference is that these transitions are occurring at a pace that has never been attempted nor achieved in the history of humanity.
It is trite to say that significant financial investment will be required to fund these transitions. According to a recent report by the IEA, to reach net zero emissions by 2050, the cost of annual clean energy investment worldwide will need to more than triple by 2030 to approximately USD $4 trillion. It also requires massive deployment of all available clean energy technologies (such as renewables, electric vehicles, and energy efficient building retrofits) and huge investment in research and development for new technologies between now and 2030. That is just the cost of the energy transition – the transitions occurring in other major industries will also require significant levels of investment. In addition, according to the 2020 UNEP Adaptation Gap Report, the costs of adaptation (i.e. measures to reduce countries’ and communities’ vulnerability to climate change by increasing their ability to absorb or withstand the impacts) are estimated at USD $70 billion annually in developing countries. This figure is expected to reach USD $140-300 billion in 2030 and USD $280-500 billion in 2050.
This presents enormous opportunities for industry and businesses. It will, however, also result in an increased risk of disputes. This is in part due to a simple increase in the number of transactions, a percentage of which will invariably result in some form of dispute. In addition, there is also an increased risk of disputes given the particular characteristics of these transactions. Many investments and projects will be peppered with novel aspects, such as new innovations (technologies, products or processes), new infrastructure and systems, new collaborations (including between non-traditional partners such as energy and technology companies), new suppliers and manufacturers, new markets and customers, and new competitors. These are also occurring in the context of a rapidly changing regulatory environment as new regulatory regimes are introduced or old regimes adapted to be fit for purpose. As is the case with clean energy technology, project partners will find themselves navigating a heavily regulated industry, perhaps for the first time. Last, but certainly not least, the pace at which these transitions are occurring will have a significant impact on the risk profile – mistakes are bound to happen in the course of rapid, large scale disruption.
A few examples of disputes relating to transition, adaptation or mitigation activities are given below.
A significant number of reported cases to date, both in litigation and arbitration, have involved renewable energy facilities (from wind farms to biogas installations). According to a recent 2019 SCC Report on ‘Green Technology Disputes in Stockholm’ (SCC Report), typical issues include whether the facility satisfied the contractual standards, for example production of the agreed amount of power, or preventing environmental risks.
Construction issues always prove fertile ground for disputes, with usual disputes relating to quality, liability for additional costs, work and delay (including liquidated damages claims). A high profile example is that of the disputes brought in the wake of a disaster during the construction of the multibillion Hidroituango hydroelectric dam in Colombia which collapsed causing a major flood. A Colombian public utility is seeking USD $1.6 billion from a Spanish insurer following the collapse, and another billion dollar dispute with the consortiums behind the project has also been referred to arbitration. A less extreme example, cited in the SCC Report, is a dispute concerning construction of a biogas facility in which it was alleged that the work performed suffered errors so significant that the facility could not be used. There are many other examples of construction disputes related to renewable energy or resilience and adaptation projects or infrastructure being referred to arbitration.
In addition to these common issues, recent upheavals at both global and regional levels have led in some instances to companies struggling to find financing for projects which has led to delays at best, termination of contracts at worst, and ultimately legal proceedings.
There will also be disputes related to financing, whether that be financing of climate change or sustainability-related projects, failure to meet technical specifications to achieve green or sustainability-linked financing, or the appropriate use of sustainable finance or climate-related funding.
Similarly, disputes will arise under carbon credits or emissions trading schemes. As an example, a Danish engineering company won a USD $150 million SCC award against two Russian state-owned entities in an arbitration arising from a contract to undertake works to reduce carbon emissions at gas pipelines. Under that contract, the engineering company was to receive carbon credits for its work which it could trade on international markets under the Kyoto Protocol. However, the Russian entities failed to get the project registered by a certain time. In response, the claimant sought to enforce a contractual mechanism to claw back its investment and an agreed rate of return. In turn, the defendants (unsuccessfully) alleged in the arbitration that the contract was procured by corruption and related criminal complaints in Russia were also instigated.
Supply and delivery disputes are also commonplace, involving performance, delivery, quality and quantity related to climate change or sustainability-related contacts.
Commodities are a particularly important area to watch – on the one hand fluctuations in commodity prices will impact climate change and sustainability-related contracts, and on the other hand, commodity prices and contracts (whether related or unrelated to climate change and transition activities) will be impacted by the effects of climate change and the transitions. For example, commodities may be harder to source or transport due to more extreme weather conditions, and there will be fluctuations in demand and pricing for example due to technological advances, or changes in policy, law or consumer sentiment, and in some instances certain commodities may no longer commercially viable as a result.
Given the fluctuations to commodity prices that have been seen in recent years, and the further anticipated fluctuations in global markets, price review disputes, as well as disputes over performance and termination, with some connection to climate change and sustainability are predicted to rise. Gas price review arbitrations of course spring immediately to mind when thinking about price review disputes, and these cases offer real insight to what could come given most were driven largely by external events such as changes to markets and economic crises, and as a group they resulted in some of the highest-value disputes in the world. But to offer another example, a dispute between a German manufacturer and supplier and a Taiwanese photovoltaic (PV) company related to performance of a long-term supply agreement for silicon wafers (an essential component of cells used to generate solar electricity) was referred to arbitration after the PV company refused to continue to perform the contract following a rapid plunge in the cost of silicon and wafers.
The SCC Report also cited contract-based arbitrations involving unpaid delivery of wind energy converters, claims for payment for consultancy services in connection with share issuance for an organic food producer, and disputes arising from distribution agreements (such as where breach of an exclusive distribution agreement in respect of bioenergy products was alleged). Other commercial disputes such as under licencing, joint venture and partnership agreements related to climate change and sustainability projects should also be expected.
As governments invest in new projects and infrastructure related to the energy and other industries’ transitions or to mitigate the effects of climate change, it is inevitable that contractual disputes involving states and state owned entities will arise. As an example, a German renewables company successfully pursued ad hoc arbitration against the African state of Lesotho after the state refused to perform on a contract to purchase solar energy equipment. Subsequent court proceedings to enforce the €50 million award have also been pursued in the US, UK, South Africa and Mauritius. Nigeria is also reportedly facing an ICC claim worth USD $400 million after allegedly breaching a settlement intended to resolve a prior arbitration over the construction and operation of a major hydropower project. The underlying dispute involved allegations that the main contractor had been excluded from the project. Similarly, a dispute has been reported to have arisen in relation to a wind energy complex in a remote area of the Dominican Republic. The claimant company alleged that it had completed a comprehensive, multi-year study of the wind patterns in the contracted area, leased the property for the complex and obtained all the required licences – only for the state-owned energy company to refuse to formalise a power purchase agreement (PPA) and awarded the PPAs to other companies.
Disputes involving infrastructure arrangements are also likely to increase given that in many instances infrastructure for transition-related projects may be limited or need to be introduced specifically for these projects. As an example, a dispute under a partnership agreement to build a wind farm was referred to arbitration after the claimant alleged that, because the grid connection was no longer available for the wind farm, an event of default under the agreement had occurred and it therefore had the right to transfer its shares in the project back to the respondent. In a similar vein, a Chinese-owned entity has reportedly threatened a Pakistani state entity with arbitration over a USD $2.2 billion electricity transmission project that is part of China’s Belt and Road Initiative over alleged delays in commissioning work which also involved counter-allegations over the impact on the local grid.
Contracts affected by climate change and sustainability issues
The effects of climate change are already impacting commercial enterprises. A quick review of reports by insurance companies shows significant increases in losses due to extreme weather-related events – the increasingly frequency and severity of which many attribute to climate change. These impacts are predicted to further worsen in the coming years. Its worth noting that the effects could go beyond the physical; they could also be transitional (such as loss of an existing market or new competitors), or legal or regulatory (such as inability to renew permits or greater restrictions on doing business that impact profitability).
There is a myriad of ways that weather-related issues might negatively affect contracts and result in commercial disputes. Obvious examples are claims of force majeure, frustration or termination due to the impact of weather-related events. Disputes relating to insurance arrangements will also arise. The recent COVID-19 pandemic offered insight into the potential scale of global disruption that climate change could have, and highlighted in particular the vulnerability of supply chains.
More broadly, however, changes in policy, technology and physical risks could prompt a reassessment of the value of a large range of assets as costs and opportunities become apparent, leading to contractual defaults or distressed or stranded assets.
In addition, where new risks manifest, parties will invariably seek to mitigate and allocate such risks as between them contractually. Unsurprisingly, many contracts now include obligations to comply with and/or warrant compliance with environmental, human rights or sustainability obligations, and commitments to put in place back-to back arrangements with counterparties further down the line. Disputes over these provisions will invariably arise.
By way of example, a number of disputes have arisen out of the recent severe storms in Texas in early 2021 which caused widespread power blackouts across Texas, shut down oil and gas wells, froze pipelines, and led to the price of natural gas skyrocketing. Other countries that are reliant on natural gas imports from the US were also impacted, including Mexico which also suffered widespread blackouts. Reportedly, a US investment bank commenced international arbitration against Mexico’s state electric utility to recover USD $400 million in debt that allegedly arose under a gas purchase agreement as a result in massive surges in the daily price rate as compared to the monthly rate. The utility has refused to pay the increase which it said was caused by an unforeseen event (as well as now alleging other discrepancies in the deal).
Disputes have also been referred to arbitration and litigation in relation to important infrastructure such as ports and railway lines which suffered devastating damage from flooding, after which the impacted transport companies and the state were unable to agree who should be liable for the costs of repairs and whether the flooding constituted an event of force majeure.
As noted above, significant investment will be needed to fund global climate goals, of which only a small proportion will be met by states. The gap will be filled by private investment, including foreign direct investment (FDI). Reports are already showing a significant rise in FDI in low carbon initiatives and climate financing. With any increase in new FDI, there will be an increase in disputes between investors and host states.
Disputes will also likely arise in the context of pre-existing investments. Over the last ten years, legal, regulatory, and other changes in response to environmental issues have been implemented at an unprecedented rate, at national and international levels. These will increase as states introduce measures to meet the Paris Agreement commitments and seek to allocate the financial costs of dealing with climate change. Changes to the investment environment often also lead to disputes between investors and host states. Bilateral or multilateral treaties (BITs or MITs) offer foreign investors a further layer of protection against host state conduct. In particular, they generally afford investors the direct right to bring proceedings against host states, usually in investor-state arbitration (ISDS).
A prime example is the significant number of claims (40 at last count) brought against Spain under the Energy Charter Treaty (ECT) following reforms to Spain’s renewable energy policies. We are also now seeing a small number of claims brought in relation to decisions by states to phase out fossil fuels (in particular coal). Claims related to climate change and sustainability issues in investor-state arbitration are certain to increase.
One well-touted state-state dispute, in the environmental context, is the Indus Waters Kishenganga arbitration (Pakistan v India, PCA 2011-01) commenced under the Indus Waters Treaty. There is obvious scope for similar disputes in respect of climate-related matters.
There are two key climate treaties – the Paris Agreement, aimed at enabling states to combat climate change and adapt to its effects, and its parent framework, the UN Framework Convention on Climate Change (UNFCCC). These mark a significant leap forward in global climate change policy. Currently, however, there is a lacuna in respect of enforcement. The Paris Agreement contains optional provisions for state-state arbitration, to be conducted in accordance with yet-to-be agreed arbitral procedure. It also incorporates the dispute settlement provisions of the UNFCCC (with minor necessary alterations). But to date the majority of state parties have chosen not to opt-in to these procedures. The difficulty is that there is little impetus (and significant disincentive) for states to open themselves up to claims from other states, particularly given the potentially catastrophic impact of climate change which some states already claim threatens their very existence. It will likely take substantial public and political pressure, at international and national levels, before the majority of states agree some form of dispute resolution provisions for climate-related disputes. In parts of the globe, the trend towards nationalism and hostility towards international treaties (and international arbitration as a process) may make this difficult to achieve any time soon.
Avoiding a climate litigation disaster
Climate change is leading to new economic realities and legal frameworks to which all state and corporate entities must adapt. Climate change and sustainability disputes are the new corporate reality, particularly for the energy sector. There is no cause for alarm – no transaction is without risk. However, parties are well advised to consider dispute resolution mitigation and resolution strategies at the outset of every transaction. Other important mechanisms include conducting climate change and sustainability disputes risk audits of the company’s global and regional operations, and establishing protocols for dealing with disputes immediately as they arise. If done well, these can save significant time, costs, reputation and preserve relationships with counterparties. The latter is a critical point in climate change and sustainability contractual disputes given many such contracts will be long-term arrangements involving significant levels of investment both at the outset and ongoing. Considering disputes risk at the outset of such transactions is the best way to avoid a climate change disputes disaster.