Grist | 17 January 2023
The secretive legal weapon that fossil fuel interests use against climate-conscious countries
by Lois Parshley
For over a decade, debate has raged over the Keystone XL pipeline project, which aimed to transport Canadian tar sands to the Gulf of Mexico. After approving the project’s initial stages, the Obama administration rejected a permit allowing the pipeline to cross the national border in 2015.
However, the energy company backing the project didn’t take no for an answer: TransCanada soon sued the U.S. for $15 billion dollars — the future expected profits it claimed the pipeline would have earned, in addition to the $3.1 billion it had already invested in the project. The company was able to do so because the North American Free Trade Agreement, the treaty known as NAFTA that the U.S. signed with Canada and Mexico in 1994, included a clause about something called an investor-state dispute settlement, or ISDS — a closed-door legal process that’s an often overlooked, but increasingly urgent, hurdle to addressing climate change. ISDS mechanisms are included in many other bilateral and international trade agreements, allowing a country to be sued by investors from other member countries if it takes any subsequent actions that adversely affect those investments.
The threat of this liability has hung over the pipeline conflict ever since: When President Trump signed an executive order in 2017 reversing course and allowing Keystone XL to move forward, TransCanada announced that it would suspend its ISDS case against the U.S. for 30 days — exactly the deadline for the decision on their new permit application. In March of that year, the new permit was approved, and TransCanada dropped its ISDS claim.
Corporations’ ability to threaten this kind of financial liability is creating growing problems for countries looking to tackle climate change and restrict fossil fuel extraction, says Kyla Tienhaara, the Canada Research Chair in Economy and Environment at Queen’s University in Ontario. It’s far from the only recent example: Take Italy, which banned oil drilling within 12 nautical miles of its coast only to be sued by the UK-based oil company Rockhopper, which had hoped to develop a near-shore oilfield at Ombrina Mare, off the coast of Abruzzo. This summer, an international tribunal authorized to adjudicate investor-state disputes ordered the Italian government to compensate the firm $210 million pounds.
Tienhaara and her colleagues recently published a study in the peer-reviewed academic journal Science finding that global efforts to limit new oil and gas developments could generate as much as $340 billion in legal claims from fossil fuel investors seeking to recoup their losses. (To put this in perspective, the Green Climate Fund, an international mechanism established to help developing countries adapt to climate change, has a portfolio valued at $11.3 billion.) Already, fossil fuel industries represent a large and growing number of the plaintiffs in these kinds of disputes: In 2020, around 20 percent of ISDS cases were brought by oil and gas companies.
These settlements are decided in a private legal process. Unlike public judicial systems, these tribunals are typically run by three arbitrators chosen jointly by the disputing parties. These people tend to be repeatedly selected from a small group of experts in corporate law, and at times they act as lawyers for an investor in one case and arbitrators deciding the case in another, though the cases may be similar or even simultaneous — a practice known as “double hatting.”
Because ISDS systems are written into thousands of different treaties, each with different wording, there’s also no system of precedence. Just because arbitrators decide something in one case doesn’t mean that logic has to be applied to another. Proceedings can be kept confidential, and there is no way to appeal a tribunal’s decision.
Tieenhaara argues that the specter of being sued for making decisions that inhibit the profits of companies and investors has a chilling effect on countries’ efforts to reduce greenhouse gas emissions. New Zealand, for example, recently said that it could not join the Beyond Oil and Gas Alliance, an international consortium of governments working to phase out fossil fuels, because doing so “would have run afoul of investor-state settlements.” Countries in the developing world are even less able to afford the fiscal risk of being on the hook for lost profits.
As of 2017, the average amount awarded in an ISDS case was $504 million. Recently, however, there have been some exorbitant outliers, like a 2019 case in which Pakistan was ordered to pay $5.9 billion to the Australian Tethyan Copper Company for lost future profits after the country denied its lease. (The company had only invested about $150 million in the project to date.) The decision, which came down just one week after the International Monetary Fund approved a loan of almost exactly the $6 billion Pakistan was about to lose, represented the equivalent of 40 percent of the country’s cash reserves in foreign currency.
The annual United Nations conference COP27 concluded in November with a broad agreement that wealthy, developed countries have a financial obligation to support poorer countries that have contributed relatively little to causing climate change as they adapt to its consequences. Yet those latter countries also bear the majority of the financial risk stemming from potential ISDS claims. Tienhaara recently worked on an analysis, published in the peer-reviewed journal Climate Policy in December, which found that the developing world faces enormous liabilities if it cancels potential fossil fuel projects. Mozambique, for instance, which has substantial offshore gas reserves, currently has an ISDS risk of $29 billion — nearly twice its annual national income.
“The system is unbalanced toward investors,” said Lea Di Salvatore, a legal researcher at the Columbia Center on Sustainable Investment, affiliated with Columbia University. Di Salvatore recently analyzed 29 of Mozambique’s gas, coal, and oil projects and found the majority are protected by ISDS clauses. “Are we really expecting Mozambique to take action against TotalEnergies or ExxonMobil, who have all the political and economic power?” Tienhaara added that many other African countries are in a similarly precarious position, forced to choose between climate action and expensive payouts.
There are at least 2,500 investment treaties globally, many written with decades-old policy priorities in mind. Supporters of these international agreements suggest that they provide legal stability that can spur investors to commit to useful projects that might not otherwise find funding — including those critical to renewable energy development. But the Columbia Center on Sustainable Development argued in a December report that investment treaties “are neither effective nor decisive in attracting investment in renewables to developing countries.”
Instead, the authors recommend governments focus on establishing internal regulatory frameworks and strengthening domestic judicial systems to protect investors. Tienhaara believes that states should go further by taking steps to terminate existing treaties and developing binding rules to limit the amount of compensation that can be awarded to investors.
The Energy Charter Treaty, or ECT, which has been ratified by over 50 primarily European countries, is the international agreement that’s the largest hurdle to enacting policies to combat climate change. Signed in 1993, it explicitly aims to protect the energy investments of its members. Historically, many investor-state disputes resulted in rulings favoring companies based in rich countries. But thanks to the ECT, European countries have recently found themselves on the receiving end of ISDS claims more frequently.
This year, many appeared to reach a breaking point. Poland announced this fall that it would withdraw from the ECT; Spain, France, Germany, the Netherlands, and Slovenia followed. In late November, the Council of the European Union failed to reach an agreement on modifications to the treaty to bring it into alignment with Paris Agreement climate targets that came into force in 2016. Instead, the European Parliament called for a coordinated European Union departure from the treaty altogether.
Yet these countries may still be on the hook for claims under the ECT for another 20 years. That’s because the treaty, like many agreements with ISDS provisions, includes a “sunset clause” that extends its protections long after a state’s withdrawal. The United States is facing just such an issue currently: Though NAFTA expired in 2020, it included a sunset clause allowing investors to file disputes for three additional years. When the Biden administration canceled the permit for the Keystone XL pipeline once again in 2021, the company behind the pipeline brought back its ISDS claim. A tribunal to settle the matter was recently appointed, and the process is ongoing even as the pipe system the project would have extended gushes tens of thousands of barrels of oil into a creek in Kansas.
Advocates like Tienhaara say the recent signs of movement away from agreements like the ECT are promising, but many ISDS cases stem from countless other bilateral treaties, which likely need to be addressed individually.
Ultimately, Tienhaara argues that investor certainty should not be prioritized above climate action. “Climate change is a global problem,” she said. “We need to care about everyone, everywhere — and have policies that aren’t just about defending our own interests.”
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