Economic activity in the energy sector is often characterised by large-scale and long-term investments that can entail significant and sometimes existential risks, at the project and corporate level, when matters go awry. Energy disputes historically made up a large part of the diet of arbitrators and arbitration counsel. Indeed, such disputes2 made up 41 per cent of arbitrations for ICSID and 19 per cent for LCIA in 2018 and the equivalent figure was 19 per cent for the ICC in 2017.3
This chapter examines the sources and nature of energy sector disputes historically. It further identifies areas of the energy economy in which future disputes (both arbitration and more general litigation) are most likely to arise given likely general changes and specific commercial drivers in the sector. Finally, it considers the impact on the arbitration community and how that community might approach this future world.
ii Sources and nature of energy disputes
This section examines the basis for the ecosystem of energy disputes, first examining the industry characteristics that make it prone to frequent and substantial disputes.
i Sources of dispute
The time horizon, scale and complexity of many energy sector investments not only increases the probability of a dispute but also the quantum of damages when a dispute occurs. The willingness of parties to pursue and fight a claim may also increase as the balance of power shifts in the commercial relationship underpinning the typically long duration of such investments.
Long-term investments and contractual relationships
Energy sector investments typically have investment horizons lasting decades (most power plants or oil and gas concessions, for example). For that reason, investors need to take a view on future market developments and make contractual commitments to others that will last as long. The commercial bargain struck at the time of investment will be predicated on a set of assumptions about the future that investors should know will change over time. The original commercial bargain or premise, therefore, is at risk from significant unforeseen step changes in the project (e.g., a technical failure) or market circumstances (e.g., a significant change in price), and the accumulation of small changes over time which significantly impact the balance of power between the parties involved. Time, in this instance, is not a healer, but rather a motivator for disputes.
Scale of investment
The very large scale of investment and subsequent revenue streams which can characterise many energy sector projects mean that as issues arise, the impact (in terms of costs incurred or profits lost) can be significant. Recovery or compensation may be necessary for project or corporate survival, and the damages may be significant relative to the cost of pursuing an arbitration.
Many energy projects are complex. They typically have multiple technical and commercial interactions for inputs and outputs, with a major impact across the project if those interactions do not work as expected. This applies across the different subsectors. Drilling for oil and gas, transporting, cooling or re-gasifying LNG, gas, coal or nuclear power plants, and ever-larger wind turbines now increasingly located offshore, are just some examples.
Many of the world's oil and gas deposits have been in countries with volatile politics, uncertain legal environments, resource nationalism and corruption all of which can increase the likelihood of problems and therefore disputes. However, it is also increasingly true that even the countries that were not expected to suddenly change regulations or take actions against investors have done so – Spain and Italy are two examples where their governments have acted to change renewable energy investor rights in a way that has led to investment treaty claims.
ii Drivers affecting parties' propensity to dispute
To understand how these features of energy investment translate into disputes, particularly investor–state disputes, it is worth considering how the relative bargaining power of the parties to a project changes over time, which can encourage disputes, as well as factors that restrain the incentive to litigate.
Shifting balances of power
The 'obsolescing bargain model' traditionally has been a popular explanation of how power shifts from multinational companies and investors to host governments over the course of an investment, and served as a basis for interpreting terms of expropriation and changes of conditions applied by host governments. While academic opinion on the model differs, it remains true that the strength of bargaining power of the parties does vary over time. As the balance of power shifts between parties, as well as the environment where a project is based, there is a risk that parties will seek to challenge and renegotiate the original deal.
A number of factors, on their own or in combination, may come into play. For example:
- skills: the need for specialised skills that are not universally available (e.g., nuclear engineering, offshore drilling) can explain why a foreign investor is in a stronger bargaining position than a host government than would otherwise be the case. Many host nations, however, impose operating conditions that enforce requirements on training and use of local resources and labour that can erode the foreign investor's position. Many nations have also built local industrial capability (e.g., by strengthening skill bases within national oil companies), so this imbalance can vary over time;
- finance: if part of establishing an exploration and production business or power producing business relies upon associated finance, that puts the party able to obtain finance in a far better position. Once the investment is financed and executed, this factor provides much less leverage in discussions;
- physical: once there is a producing asset that is intrinsically fixed to a particular country, the ability to move it is difficult or impossible (at least economically), which gives greater bargaining power to those who can take control of the asset in country (usually the host government). In a similar way, floating plants, whether power, liquefaction or gasification, give greater bargaining strength to the owner or operator through the ability to literally take away the core of the asset even if that is not easy;
- contractual: the strength of the contracts between investors and host governments will help to determine their respective positions. However, this does not mean that parties will not breach contracts. Where the pricing set by a contract diverges too much from the marketplace more generally, there is a strong risk of a party wanting to, or being forced to, breach the contract. An example of this is that of long-term power purchase agreements: a number have been breached over the years when market conditions changed; and
- political: energy is always high up the political agenda, whether it is the cost to consumers and business, the environmental and human impact locally or the share of profits that is retained locally. The pressures on governments and on investors over time can vary, changing the balance of power.
iii Factors limiting the number of disputes
As the balance of power shifts between parties, a number of factors can dampen the incentives to proceed with a dispute, including:
- long-term mutual need relationships: in a long-term contractual relationship like a power purchase agreement or an upstream production agreement, both parties will often continue to depend on each other, irrespective of the outcome of any single dispute. For example, host nations may continue to need foreign oil investors to monetise hydrocarbon reserves, and foreign oil companies will continue to need access to those reserves;
- repeat relationships: where the same limited number of companies need to work together on several projects (as occurs in the upstream oil and gas industry), there can be less incentive to push disputes hard on one project while trying to maintain good relations in others; and
- cultural: there is an element within some of the parties investing in energy, for example (at least historically) those from China and the Middle East, of preferring to reach settlements rather than disputes being fully fought at hearings. This has meant fewer cases that might have gone to arbitration actually reach that stage.
iii Types of Dispute
Having considered the underlying sources and drivers for energy disputes, it is also worth looking at the types of dispute that have arisen. Some of the more common forms of dispute are summarised below.
i Investment treaty disputes
Historically, we have seen investment treaty disputes in Africa, Latin America, Russia and CIS, and South and South East Asia in relation to oil and gas projects and power plants. More recently, however, there has been a new wave of cases against European governments resulting from changes in pricing regimes and plant closures or the inability to build plants as a result of government actions.
There has been a spate of power sector investment treaty disputes in recent years resulting from changes to renewable power subsidies and tariffs. At the same time, disputes have been arising from the deterioration in the economics of conventional power plants, often where relationships with governments have soured.
ii Gas pricing disputes
Gas pricing disputes have been standard fare in European markets now for many years. Several of the factors above apply. Long-term supply contracts were necessary for producers to finance exploration and production as well as for customers to be able to rely upon sources of gas for heating, industrial use or generation. Future pricing is not known with any certainty, so price-review mechanisms afforded parties an opportunity to reopen pricing at set intervals. Deregulation of the European energy markets and post-financial decreases in energy demand put particular stress on these renegotiations and, given the value at stake, generated a decade of disputes involving most of Europe's long-term natural gas contracts.
iii Contract termination disputes
In the past 10 years, the oil industry has been buffeted by two dramatic and rapid declines in oil price. As investment plans changed and existing contracts in the sector became less profitable, there has been a stronger incentive to break them where possible. Parties have used defects that otherwise might have been ignored, notice or renewal clauses or other clauses to terminate contracts.
iv Shareholder disputes
Many energy projects have multiple shareholders with differing objectives and issues. This can give rise to a variety of disputes about how one party's actions have reduced value for another, or how shareholders are not complying with specific contractual terms in shareholders' agreements, joint operating agreements or similar, for example in not complying with a drawdown request.
v Royalties taxation and production sharing disputes
Even in more successful projects there can still be disputes around what is included or excluded in reaching numbers for royalties, establishing whether a minimum work programme has been achieved under a production sharing agreement or determining tax payable, to give just a few examples.
vi Construction disputes
Large construction projects such as power projects, LNG and pipelines also sometimes incur all the typical sorts of disputes around delay and failure to achieve specifications. What may exacerbate these disputes is the overlay of energy price and demand volatility, which can affect both the likelihood of disputes and the calculation of any sums due.
iv Future energy disputes
i Market trends driving future disputes
In 2017, the chair of BP told shareholders at its 2017 AGM 'In our 109-year history, it is unlikely that there has ever been as much change as there is now'. While the energy sector has always been dynamic, the speed of change has accelerated. Transformational change is occurring within the lifetime of individual investments, and this pace of change and radical transformation is likely to continue if climate change objectives are to be met.
In the early 1990s, few market observers would have predicted the pace of cost reduction in and adoption of renewable energy and storage technologies that has allowed energy companies to displace more traditional thermal generation in many countries. In terms of oil and gas, concern about finite supply and peak oil production in the 2000s has been displaced by discussion of peak oil demand as transport and heat are electrified, and of the existential threat to oil majors unless they transition away from hydrocarbons to renewable energies. Looking ahead, new areas could develop in relation to the use of hydrogen or methane hydrate ('fire ice').
The potential, therefore, for environmental policy, and technological and economic factors to drive dramatic and disruptive step changes continues to increase, and will continue to disrupt investments and commercial relationships.
At the same time, increasing resource nationalism and economic populism in the resource-rich economies of Asia, Africa and Latin America, combined with a lessening of the mutual need for parties to work together and the end of certain production sharing agreements, may open up disputes that previously would not have occurred, such as challenges by governments regarding remediation works by producers at the end of a contract. In addition, as national oil companies continue to grow in strength and can buy in experience to fill gaps from service providers or bring in a wider range of other national oil companies, they have less need for the traditional international oil companies, thus altering the balance of power between the two and meaning it is easier for countries to raise a dispute with international companies.
ii Climate reporting and related changes in accounting
There are changes underway that will affect the way that energy companies and those investing in such companies will need to report their accounts.
The Climate Disclosure Standards Board (CDSB) is an international consortium of business and environmental organisations attempting to align the corporate reporting model to equate natural capital with financial capital. The CDSB has been working with the Financial Stability Board's Task Force on Climate-Related Financial Disclosures to develop voluntary, consistent, climate-related financial risk disclosures for companies to provide information to investors, lenders, insurers and other stakeholders. These will include physical, liability and transition risks associated with climate change and what constitutes effective financial disclosures across industries. The EU Non-Financial Reporting Directive is also making reporting on certain environmental and human rights issues obligatory for a number of large companies in the first instance.
It is likely this kind of reporting will become mandatory or at least seen as best practice over time not only for the largest corporates but their supply chains. Companies may have to provide more information to shareholders on the risks of climate change, which might impact corporate values. Disputes may occur when material differences occur between reported and expected exposures to climate change risk or where risks are considered to have been either misrepresented or under-reported. One such example is the Peabody Energy, Corporation settlement with the New York Attorney General over claims that Peabody's public statements on risks posed to the company by climate change violated state laws prohibiting false and misleading conduct in connection with securities transactions.
These changes to accounting may also provide a vehicle for public interest groups to seek behavioural change through litigation, building on what is already being done (see below).
iii New forms of funding
Once a niche activity only for impecunious claimants, third-party funding is now a full-scale investment industry. Where there is a tenable claim against a respondent considered as a worthy target in terms of recoverable assets, there is likely to be money available to fund it. Increasingly there is also funding for respondents to defend claims, either on a one-off basis or on a portfolio basis. The key impacts of such funding are:
- potentially larger numbers of cases;
- greater analysis of likely quantum figures from the outset of a case. Like most investors, third-party funders are concerned about their likely returns before investing, and a key element is how much a damages claim is likely to be worth; and
- greater consideration of enforcement, where if insufficient recoverable assets are identifiable a case will not go forward.
Crowdfunding is also emerging as a means to pursue disputes. This source of funding has been used already by environmental organisations like Greenpeace to pursue claims. It can increase the number of claims, but sometimes with less focus on quantum (at least at the outset), as people believe in bringing such cases to change actions (most frequently environmental in this area), so the funding is less about recovering a specific amount quantum of compensation.
iv New forms of dispute
Arising out of these macro trends are a number of new types of litigation and regulatory disputes.
Human rights claims
Human rights arguments are increasingly forming the basis of some claims in the energy sector. The Hague International Business and Human Rights Arbitration Rules are currently being drafted in response. As Julianne Hughes-Jennett, head of business and human rights at Hogan Lovells, explained in a recent article:
Although we are still some way off from business and human rights disputes becoming a main feature of arbitration, the growing incidence of “human rights clauses” in commercial contracts is paving the way for contractual human rights disputes, some of which will necessarily be resolved by arbitration.4
Environmental-related claims and actions
Environmental claims are likely to arise in three ways:
- state actors or countries may seek to use environmental counterclaims in commercial disputes: for example, an ICSID tribunal in Burlington v. Ecuador awarded US$41 million against Burlington as part of an environmental counterclaim in an award on expropriation;
- claims between corporates in contractual relationships may arise for breach of environmental obligations (possibly leading to contract termination), which could well fall to be considered in arbitration clauses under a contract; and
- possibly largest of all in terms of impact are actions by individuals, pressure groups, non-governmental organisations (NGOs) or groups of businesses against major corporations in relation to alleged environmental damage.
There is a new breed of activism perhaps exemplified by ClientEarth. ClientEarth describes itself as: 'a charity that uses the power of the law to protect the planet and the people who live on it. We are lawyers and environmental experts who are fighting against climate change and to protect nature and the environment.' On its website, it states that 'The environment cannot be protected by environmental laws alone. At ClientEarth we are developing innovative legal strategies using company and financial laws to drive companies, investors and directors towards sustainable and environmentally sound modes of governance and decision-making.'
At the energy disputes session at London International Disputes Week, ClientEarth explained that there are now over 1,000 climate change cases globally, and that ClientEarth is not pursuing class actions, but is rather targeting companies, financial institutions, directors and professional advisers. While the cases to date have mostly focused on the large polluters, there are apparently also actions coming against large energy users, potentially drawing in financers, insurers and professional advisers.
Requirements for existing companies to change their operations are not only coming from third-party NGOs, however. Climate Action 100+ is an investor initiative with over 320 investors and more than US$33 trillion in assets. It is aimed at ensuring the world's largest corporate greenhouse gas emitters take necessary action on climate change.5 It was apparently engagement by this group that led Glencore to agree it will agree to align its business and investments with the climate goals of the Paris Agreement and not grow its coal business, for example. While not a direct cause of dispute, actions like this can force changes in existing and future operations, and those changes themselves then lead to arbitrations.
So how might this affect energy-related arbitration? The impact is potentially broad, but a few examples include the following:
- ClientEarth has written to insurance underwriters at Lloyds warning them of the risks of insuring a proposed new coal mine in Queensland, Australia. The Australian Conservation Foundation has also launched a legal challenge against water permits granted for the same mine, which, with financing secured, is approaching operation. If the mine does go forward, it is possible claims or environmentalist action, or both, will emerge against the developer, investors or insurers in some other context. If there are claims or actions against the developer, shareholders or joint venture partners could raise claims in the developer's other enterprises under joint-venture agreements or shareholders' agreements if their own interests are damaged as a result, and they can
find an arguable cause of action if the mine does not go forward, the unwinding of a number of existing agreements could create scope for related arbitrations;
- Greenpeace and ClientEarth have drafted a new German law obliging the rapid phase out of coal-fired generation.6 If this law were enacted, it is not hard to imagine further investment treaty claims concerning existing power plants. In addition, ongoing coal supply, transport, operation and maintenance, and management agreements need to be amended or terminated, leading to possible disputes that could be arbitrated; and
- in South Africa, JustShare and ClientEarth commissioned an opinion from pensions lawyer Rosemary Hunter, which indicated that 'a failure to consider material financial risks arising from climate change would likely amount to a breach of duty by the board of a pension fund', something that was then shared with 50 local pension schemes. Influence from such investors could force changes in both existing and new projects, which again could have knock-on effects in terms of arbitrations.
Use of national legislation in projects globally
Parties have begun to pursue international claims in relation to environmental or human rights obligations using national courts.
As an example, in the Lliuya v. RWE case in Germany, a Peruvian farmer (whose costs are crowdfunded) is suing RWE, a German energy company, on the grounds of nuisance for RWE's share of the damage caused to him as a result of the expansion and possible overflow of a glacier lake in Peru. The case has been running since 2015. An appellate court accepted it as a potentially legitimate claim in 2018, and the case continuing.
The ongoing Lungowe v. Vedanta case in the UK further demonstrates the risks to corporates with multinational operations from claims in national courts. Negligence claims have been brought by Zambian residents in relation to a Vedanta-owned company, Konkola Copper Mines, and breaches of Zambian environmental legislation. In this instance, the UK Supreme Court decided that a case against Vedanta as parent company in relation to potential damage can go forward on the basis that Vedanta itself owed a duty of care to the villagers, with control of the subsidiary management arrangements, a sustainability policy and training being taken into account. The case is continuing.
Finally, US courts have confirmed that a claim could be brought against the World Bank acting in a commercial capacity. For those of the International Finance Corporation, Inter-American Development Bank and other organisations that are based in the US but carry out what could (under this definition) be regarded as commercial activities, this could be significant. Combine this with the trend toward holding investors liable as well for environmental damage, and it could be particularly damaging. This is not directly arbitration in and of itself, but it may lead to a further push toward arbitration with investees and any other related parties in order to avoid the US court system as far as possible.
v Impact on arbitration
What will the changes in the environment mean in relation to arbitration, then? Most, if not all, of the traditional types of energy dispute will continue to occur, even if some of the routes – for example, intra-EU bilateral investment treaties, Energy Charter Treaty, and North American Free Trade Agreement (NAFTA)/US–Mexico–Canada Trade Agreement (the NAFTA replacement) claims – are less accessible. Overall, we do not consider there is a reason to assume that traditional disputes will decrease in number.
Only in investment treaty disputes have there been some doubts, but new ICSID claims were at an all-time high in 2018, despite the long-discussed potential impacts on EU-related cases coming out of the Achmea decision in 20177 and actions after that. Even regarding investment treaty disputes, the highly skilled legal teams that evaluate these disputes are likely to continue to find ways to bring such claims going forward, and future investments are more likely to build in protections via contractual mechanisms, investing via countries where there remains existing treaty protection, or both. For non-investment treaty cases, the ongoing dynamic nature of the sector will continue, and further changes in the sector and an increase in funding from third-party funders could help to drive more cases.
Energy companies and their counsel need to gear up for the likely increase in environmental and human rights claims that may be directly expressed through litigation. It is to be expected that this will feed through to associated arbitration between commercial partners and counterclaims by states in investor–state arbitrations. In arbitration, new cases may be seen where termination is imposed or damages claimed on the basis of a failure to comply with environmental and human rights-related clauses in contracts. Similarly, an uptick may be seen in claims between companies and investors, companies and insurers, and also companies and professional advisers on the basis that environmental, climate or human rights risks were under-accounted for or not fully disclosed.
An increase in climate, environment and human rights claims will bring related skills and experiences more firmly into the arbitration arena. It will force counsel and commercial advisers to maintain a perspective on how litigation in national courts may ripple through a company's global portfolio of investments or contract arrangements. This may require greater knowledge sharing and coordination across different geographies of firms with multinational clients as to legal risks in one jurisdiction that could then be applied to actions in another. It may also consolidate the trend for energy companies to establish teams and departments to manage portfolios of disputes and have a broader perspective on the litigation risks they face.
How to mitigate or avoid the potential current and future impact of national litigation and claims is another emerging area. This could involve analysis of the risks and benefits to groups of group-wide policies; imposing and providing training and oversight in relation to environmental and human rights issues; and considering what current activities could potentially lead to claims, and where. Such activities may also need to be part of a company's reporting going forward.
Changes in the reporting and claims landscape may also force energy companies to consider how they might restructure to minimise the risk that claims in one jurisdiction cascade through other commercial relationships or impact the shareholding: this could lead to wholesale restructuring to compartmentalise risk where possible.
The latter two may not lead to direct work for arbitration lawyers, but they will be areas to watch for resulting claims from, as well as end-of-contract and end-of-field life situations that similarly can be expected to drive new claims.
1 Colin Johnson is a vice-president at CRA International (UK) Limited.
2 Here defined as disputes in the oil and gas, mining and electricity sectors.
3 Latest available figures.
7 Achmea BV v. The Slovak Republic, UNCITRAL, PCA case No. 2008-13 (formerly Eureko BV v. The Slovak Republic).