With a Potential $340 Billion Price Tag, Investor-State Disputes Threaten the Global Green Energy Transition

By Rachel Thrasher

The latest report from the UN International Panel on Climate Change has made clear that this decade is make-or-break for climate action and mitigating the worst-case scenarios of a warming earth. Crucial to keeping warming below the 1.5C threshold by 2100, countries must focus on phasing out both demand and supply for fossil fuels. The International Energy Agency (IEA) has laid out a roadmap toward that goal – urging countries to deny new fossil fuel investments after December 31, 2021. To reach that goal, 60 percent of oil and gas and 90 percent of coal must stay in the ground. 

However, states will also have to halt some projects already underway and demands for compensation from asset holders are likely to follow. Private investors can sue states directly for breach of agreements through a controversial process known as an investor-state dispute settlement (ISDS), which has been recognized as a “significant departure” from what is typically available under international law. Treaty breaches include alleged discrimination against the foreign investor, undermining the investor’s “legitimate expectations” of regulatory stability or introducing a measure that is “disproportionate” to the otherwise legitimate policy objective. Already, countries have been sued for environmental regulations, public health measures and efforts to maintain economic stability. Among investors, the fossil fuel sector has been the most litigious, accounting for 20 percent of the total investor-state disputes so far and winning almost three-quarters of them. 

A new study published in Science by a team of researchers at the Boston University Global Development Policy Center, Colorado State University and Queen’s University in Canada estimates the costs of possible legal claims from oil and gas investors in response to government actions to limit fossil fuels. They find legal claims could reach $340 billion, a substantial amount that would divert critical public finance from essential mitigation and adaptation efforts to the pockets of fossil fuel industry investors. This sum would exceed the total global public climate finance provided from 2019-2020, which was $321 billion.

Calculating the legal and financial risks

International investment agreements (IIAs) number in the thousands and act as political risk insurance for foreign investors in every sector. Initially promoted to increase much needed foreign investment in developing countries, firms are protected from certain kinds of state conduct but have no direct obligations under these treaties.

As a result of the legal standards that vigorously protect foreign investors in every sector, the global ubiquity of these agreements and the specific litigiousness of the fossil fuel sector, countries with large shares of fossil fuel assets owned by foreign investors are faced with substantial financial and legal risks if they phase out fossil fuels.

The Science study quantifies risk under two scenarios. The first imagines countries worldwide follow the IEA’s Net Zero Emissions Roadmap and agree to cease all new fossil fuel investment in their territory as of December 31, 2021. All projects which do not have a final investment decision by the investor (i.e., they have not yet fully and finally committed to the project), would be terminated. Prior to this decision, investors usually will have acquired various exploration licenses and concessions, sinking substantial funds into the initial stage. The second scenario envisions countries taking more aggressive action and canceling all fossil fuel projects that are not yet producing oil or gas. This includes all projects included in scenario one, as well as projects with a final investment decision but that have not yet entered the production phase.

Relying on Rystad Energy’s UCube database, the study captures lists and characteristics of all oil and gas assets worldwide, including the location of the asset, the company headquarters, estimates of production and net present value for each investment. By overlapping that information with the United Nations Conference on Trade and Development (UNCTAD)’s mapping of IIAs, the study is able to show which assets could give rise to an ISDS claim under one of the more than 1,800 treaties with an ISDS option. In order to consider the unpredictable prices of oil and gas, the study calculated the net present value for each asset based on four different prices of oil: $50, $75, $100 and a variable prediction included in the UCube database. 

The high cost of fossil fuel phase-outs

Under the first scenario, more than 10,000 fossil fuel assets worldwide are covered by IIAs with ISDS. The value of those investments ranges from $60-$234 billion. For countries like Mozambique, Guyana and Venezuela, this amounts to massive exposure to legal and financial risk, ranging between $5-31 billion. Scenario two exacerbates that outcome, introducing $32-$106 billion of additional risk exposure. 

The most problematic treaty is the Energy Charter Treaty, a European-centric investment treaty covering only energy sectors. Given its plurilateral membership, it contributes almost 20 percent of the total ISDS risk for countries, which amounts to between $3-16 billion. A proposed expansion of the treaty members would increase the potential price tag to $12-45 billion.

How ISDS makes climate change policy unaffordable

The global cost for transitioning all economies to renewable energy and reducing the world’s reliance on fossil fuels to zero is already an expensive task. As noted, the higher end of the liability estimate ($340 billion) exceeds global public climate finance from 2019-2020, which was $321 billion. The $340 billion estimate is also conservative, in that it does not count additional risks from phasing out coal investments and de-commissioning midstream oil and gas infrastructure. 

To reduce or eliminate these risks, policymakers must understand the extent of their exposure and act accordingly. Some have already begun this process, as member states of the Organization for Economic Cooperation and Development (OECD), for example, are exploring possible solutions. 

The study proposes three possible approaches to this problem. First, countries should terminate their treaties – even unilaterally – to avoid ISDS cases. South Africa and others have done so without substantial impact on foreign investment flows. Second, countries may bilaterally negotiate the removal of ISDS, assuming all parties agree to do so. As more countries understand the risks of ISDS for climate action, there may be more willingness to engage both treaty termination and renegotiation. Finally, there is a possibility for countries to simply withdraw consent to ISDS for any cases involving fossil fuel investments. This final effort may give rise to inter-state disputes, but should effectively protect states from direct investor claims. 

During the most important decade for climate action, the international community simply cannot afford to divert critical funds from essential mitigation and adaptation efforts to compensation for fossil fuel companies. 

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