Shadow courts for fossil fuels want a green makeover

American Prospect | 15 December 2021

Shadow courts for fossil fuels want a green makeover

by Lee Harris

Wild bears, lynx, and wolves still roam the mountains of Abruzzo, a heavily forested and ecologically rich region of central Italy that also hosts rare orchids and endangered vipers. Fishermen along the shore use traditional trabocchi nets to fish for anchovies and sea bream in the shallow waters of the central Adriatic.

When residents of Abruzzo noticed a drilling platform for the Ombrina Mare oil field being installed less than six miles off the coast, public campaigns drew tens of thousands of protesters to oppose the extraction. In 2015, the Italian parliament ruled that companies could no longer drill so close to the shoreline.

Two years later, Rockhopper Exploration, a U.K.-based company that had purchased a license to explore for oil in the area, sued the Italian government over that ban. Although the company said it had invested some $29 million in the project, according to an attorney representing Italy, it sued for $275 million in damages, citing the loss of expected future profits.

The pending case was brought in a Washington, D.C.-based international court under the Energy Charter Treaty (ECT), a trade agreement with an arbitration clause that lets investors demand repayment for expected future profits if a new law shuts down energy infrastructure.

Rockhopper is not alone. Ascent Resources, another U.K.-based oil company, announced a €120 million arbitration suit under the ECT earlier this year over Slovenia’s decision to require extra studies on the environmental impact of proposed fracking. German companies RWE and Uniper are using the treaty to sue the Netherlands over its plan to phase out coal by 2030.

Climate advocates worry the ECT could deter countries from retiring some €344.6 billion worth of fossil fuel infrastructure in Europe, the U.K., and Switzerland, which includes oil and gas fields, pipelines, and power plants.

Yamina Saheb, a former employee of the secretariat that administers the ECT, quit her job in 2018 to raise the alarm about how it could undermine carbon-cutting goals. Since then, the secretariat has moved to rebrand the treaty as climate-friendly.

Once the secretariat could no longer deny that the current treaty threatens countries’ climate goals, Saheb told the Prospect, “they developed a strategy to say that the treaty is needed for the energy transition.”

Investor-state dispute settlement (ISDS) provisions like the one in the ECT allow foreign firms to sue over changes in law that violate treaty obligations and crimp their profits. Under the terms of ISDS, the companies can bypass litigation in the country hosting their investments, and instead seek a decision from sympathetic and discreet arbitrators in, say, London or the Hague.

The ECT allows companies to rely on existing tribunals or set up ad hoc courts. As of this month, the secretariat counts some 145 cases brought under the treaty, but that’s likely a significant underestimate, since investors aren’t required to notify it of a dispute.

For decades, similar extrajudicial tribunal frameworks were written into thousands of bilateral trade agreements. They became so commonplace that tapping ISDS figured into investment strategies: Bet on companies well placed to make an ISDS claim, and win payouts from taxpayers in the host country.

During the Trump administration, trade adviser Robert Lighthizer mostly struck these super-courts from USMCA, the updated agreement between the U.S., Canada, and Mexico. Activists hoped the change would put an end to similar clauses. The European Union has also moved to eliminate external dispute resolution mechanisms and force companies to bring complaints through national courts.

The ECT’s dispute settlement process remains, however, and activists argue that it could shift the financial risk of investment in soon-to-be-stranded fossil fuel assets onto taxpayers.

“You can actually get compensation for future, highly hypothetical profits. This could make it a lot more expensive for countries to phase out fossil fuels,” Cornelia Maarfield, a trade expert at Climate Action Network Europe, told the Prospect.

INSTEAD OF BEING WOUND DOWN, the ECT is currently being “modernized.” Urban Rusnák, the ECT’s secretary general since 2012, has spent several years working to expand the membership and revise the terms of the treaty, which was originally signed in 1994 to reassure Western investors looking to enter the oil and gas market in former Soviet countries.

Rusnák argues that the Treaty’s ISDS mechanisms are more relevant than ever, since they could become “an indispensable tool for securing private investment necessary for successful global low-carbon transition.” Modernizing the treaty, he has written, could make it so attractive that “membership would spread on all continents and would become quasi-universal.”

Public criticism—and a rising stack of expensive lawsuits—has made some members wary. Spain, France, and several others now want to exit the ECT altogether, according to leaked reports. But while you can check out of the treaty, it’s hard to leave. Italy formally withdrew from the ECT in 2014, but Rockhopper is suing it under a 20-year sunset clause.

Other members, like Japan and Azerbaijan, have shot down reform efforts. The biggest push for expansion comes from the secretariat itself, where an industry advisory panel represents energy companies like Shell and BP.

A new secretary general takes over for Rusnák in January, and is tasked with unifying these factions. The ECT is under pressure to reach an agreement by next summer. Guy Lentz, the incoming secretary, is a former sales and marketing manager for Shell who has spent the past two decades as an energy and trade diplomat for Luxembourg. He is reportedly hopeful that six months after taking office, he will have brokered a green-ish compromise to salvage the embattled treaty.

“He thinks that renewable energy requires the kind of ISDS protection that the ECT provides,” said Paul de Clerck, a climate campaigner with Friends of the Earth International, an environmental advocacy group involved in discussions with the incoming secretary.

In an interview, the outgoing secretary general argued to the Prospect that renewable-energy investments won’t be made at scale without a tribunal system to bypass national courts.

“If there is not enough resources in the country on its own, there is not enough capital in the international financial institutions, and there is not enough for the whole energy transition, the countries have to turn to private capital as well,” Rusnák said. As an investor, he said, “you expect that your investment will be successful, that you will develop your investment, you will make money, and you will be able to repatriate the benefit back.”

That’s the emerging narrative championed by John Kerry, the U.S. climate envoy who argues that public finance won’t be enough to fund the energy transition, and so rich countries should sweeten investment opportunities in emerging markets.

Climate activists are skeptical that a retooled ECT would spur clean investment. They say the ECT would be more likely to crowd out clean energy by keeping old carbon infrastructure alive.

Even if the treaty were reworked, the availability of ISDS isn’t necessarily an asset for developing markets seeking renewable investors, Maarfield said. That’s partly because clean-energy developers are typically smaller companies than oil and gas multinationals, making them more reluctant to take on the expense and political risk of private arbitration.

Rusnák cites the treaty’s success in catalyzing investment in oil and gas around the Caspian Sea after the fall of the Soviet Union as evidence that it can lend credibility to an investment climate seen as unpredictable. He said countries in the Global South that the secretariat has approached—the ECT set aside €445,500 in its 2021 budget for “consolidation, expansion and outreach”—are interested in similar investments.

“Countries in sub-Saharan Africa, some of them are so-called New Frontiers. They are expecting new development in fossil fuels. But some of them are indeed very much interested to get renewable investments,” Rusnák said. “The treaty is technologically neutral. This is the main message. It’s up to the countries how you use it.”

BUT ISDS IS A SKEWED MECHANISM. Oil and gas majors shielded under the treaty are typically based in richer member states, seeking to make foreign investments in countries that lack capital.

While ECT dispute resolution has often involved refereeing between developed countries like the U.K. and Italy, ISDS clauses like the one in ECT have also been invoked to undercut the energy sovereignty of poorer states like Colombia, where in 2017, mining companies Glencore and Anglo American sued the government over a ban on operations in an open-pit coal mine. During a drought, mine operators had diverted a river in order to mine the riverbed, severely limiting locals’ access to water.

“With developing countries, what actually happens is, we only gain access to their lands. It does not go in both directions,” Saheb said.

ISDS-protected energy deals are not only tilted to favor investors, Saheb added; they also overwhelmingly underwrite fossil fuel extraction, rather than renewables. She thinks the ECT will only deepen that status quo.

Rusnák retorts that the treaty is fuel-neutral, so countries that decide to join could decide that, after joining, they will only accept deals for investments in renewable energy. But although the ECT’s protection only applies to new investments, de Clerck fears that it could also be retroactively applied to existing carbon infrastructure, such as pipelines and refineries, when that infrastructure is repaired or expanded.

Even a greenwashed treaty—updated with a veneer of climate-friendliness—could be years from ratification. In the meantime, observers say the treaty may already deter governments from retiring polluting infrastructure.

Governments are eager to avoid investor claims, since being sued can impact a state’s credit rating and divert future foreign investment. Toby Landau, an arbitrator who has worked on ECT cases, told the London School of Economics that the opacity of the terms makes states even more careful to avoid upsetting investors.

“There are states who are now seeking advice from counsel in advance of promulgating particular policies, in order to know whether or not there is a risk of an investor-state claim,” Landau said. “They cannot know what are the limits of their so-called regulatory space.”