Environmental, social & governance (ESG) standards have gained increasing attention in recent years as investors, corporations, and policymakers seek to address the urgent challenges of climate change, social inequality and ethical business practices. The energy industry (and in particular oil and gas) has faced considerable scrutiny owing to its impact on the environment and society.
Governments, banks and institutional investors play a crucial role in financing oil and gas projects, including exploration, production and infrastructure development. As ESG concerns have gained prominence, many of these investors have adopted more stringent criteria to take into account ESG factors in their investment decisions.
Growing calls to action to limit financing into the oil and gas sector
As concerns about climate change mount, there has been growing pressure on governments and financial institutions to limit or regulate investment in the oil and gas industry resulting in significant policy shifts and legal disputes.
One notable example concerned Royal Dutch Shell. In May 2019, the Dutch environmental organisation Friends of the Earth Netherlands filed a lawsuit seeking to compel Shell to reduce carbon emissions. This case built on the headway already made in the Netherlands by the Urgenda case, in which the Dutch Supreme Court (upholding the previous decisions in Urgenda) found that the Dutch government had obligations to urgently and significantly reduce emissions in line with its human rights obligations. The plaintiffs argued that Shell's emissions reduction targets were insufficient to meet the goals of the Paris Agreement and demanded that the company reduce its carbon emissions to meet those targets. Shell was ordered to reduce its emissions by 45 percent (relative to 2019) by 2030. While the ultimate outcome of the case is still to be determined by an ongoing appeal, it exemplifies the ways in which activists may employ legal avenues to hold companies accountable for their impact on the environment and push for more robust ESG policies.
In a similar call to action to address ESG obligations, 2021 saw institutional investors take unprecedented steps in the boardrooms. At ExxonMobil, three sitting board members were voted out and replaced by three fund-elected replacements to act as better proponents for the investor’s corporate ESG initiatives. This move made clear the willingness of large institutional investors to cause upsets in the boardrooms to more closely control where their invested funds were utilised, particularly with regards to ESG and climate change action.
Most recently on April 24, 2023 the US Supreme Court refused to hear five appeals brought by major oil companies who are defending climate-related claims in litigation in various state courts. This closes the door on further Federal challenges and will see the oil and gas industry facing a variety of climate-related claims under varying, evolving and unpredictable standards across the 50 States.
The implications for the oil and gas industry
In response to increased pressure from investors, banks, governments, and civil society, many countries have implemented or proposed policies aimed at limiting investment in fossil fuels. Tighter policies have emerged, setting more ambitious targets for reducing greenhouse gas emissions and introducing new regulations to limit oil and gas project financing. This in turn has contributed to decreases in stock price or higher financing costs imposed by the remaining sources of funding in the market. This may soon be reflected in other major jurisdictions.
Even where not mandated by government, investors have implemented their own, voluntary, ESG investment criteria that are often far more restrictive than that adopted in legislation. This is not necessarily driven by anticipated decreased yields in the medium to long term from the oil and gas sector, but rather by perceived obligations to invest away from fossil fuels, which drive investment into greener and more ESG-conscious revenue streams.
This self-propelled movement from investors has a direct impact on the oil and gas industry beyond simply choking investment. As companies face increased pressure to comply with stringent ESG standards and policies, disputes are bound to arise over issues such as emissions reductions, environmental impact assessments, social responsibility and corporate governance. Companies may also face challenges in meeting their existing contractual obligations with partners, customers, and suppliers due to changes in policy and investment limitations.
Recommended adoption of arbitration as the preferred dispute resolution mechanism
The stricter management of investments will have a direct impact on the oil and gas industry and will create new challenges and opportunities for dispute resolution. This is particularly true of arbitration. While not all disputes can be diverted from national courts, where possible, it is highly recommended for the oil and gas industry to do so.
The ICC Arbitration and ADR Commission Report on Resolving Climate Change Related Disputes through Arbitration and ADR recommends arbitration as the preferred method of dispute resolution. It does so for a number of key reasons, including the advantage of a neutral forum for the determination of the dispute (which frequently involves sovereign states) and because arbitration benefits from near-worldwide recognition and enforcement of arbitral awards under the New York Convention. In addition, arbitration allows for greater flexibility in regards to the control that parties have over tribunal selection, admissible experts, process and disclosure. Importantly, parties also maintain control over the confidentiality of the dispute.
The IBA Report Achieving Justice and Human Rights in an Era of Climate Disruption advocates strongly for ESG disputes, particularly those involving sovereign states as parties, to be resolved by way of arbitration. The IBA report cites the various arbitral institutions and forums available to parties, including the Permanent Court of Arbitration (PCA), the ICC and the LCIA. While most of the leading arbitral institutions are adopting specialised rules and expertise to specifically cater to and accommodate ESG disputes, the PCA has a set of Rules drafted specifically with environmental disputes in mind. The PCA also offers model arbitration clauses for inclusion into agreements.
Arbitration is ideal for resolving disputes relating to ESG issues for the reasons set out above, particularly for investors who are concerned with the increasing impact that political pressure may have on the ability to have disputes resolved fairly and with due process. Loan agreements, joint operating agreements, and PPP ventures with host governments would all benefit from being subjected to arbitration rather than litigated in national courts during a period where political and public opinion considerations would otherwise be highly prejudicial.