Stranded Fossil Fuel Assets in International Investment Law: Socialising Losses by “Politicising” Commercial Risk?

Paolo Mazzotti (Max-Planck-Institute for Comparative Public Law and International Law)


The energy transition is set to cause unprecedented socio-economic disruption. The economic literature is resorting increasingly often to the notion of “stranded fossil fuel assets” (SFFAs) to describe those assets at all levels of the fossil value chain which, due to the move away from fossil energy sources currently underway in mankind's attempt to mitigate climate change, will be deprived of economic value before the end of the economic cycle hypothesised at the moment of the investment decision. Fossil fuel assets will be stranded because of the interplay between two main drivers. “Policy-driven” stranding occurs when a command-and-control policy prohibits the continued operation of the asset. “Market-driven” stranding, on the other hand, results from the decline in profitability of the operation of the asset caused by the economic dynamics of the energy transition (chiefly, but not exclusively, the increased competitiveness of renewable energy sources deriving from the drop in their operation costs).
International investment law (IIL) offers a way for “brown” companies to recoup the value of their SFFAs, enabling them to demand compensation from governments. Recent practice evidences, indeed, that policy-driven stranding is already being challenged before investment arbitral tribunals. On the other hand, market-driven SFFAs are, in principle, less amenable to compensation, since here the loss in value of the investments derives from the materialisation of commercial risk (as opposed to the “political risk” which IIL is institutionally designed to counter). The present paper addresses the question of whether and how IIL can be strategically used by brown companies to recover the value of market-driven SFFAs, socialising the losses of the energy transition by framing as political risk what an economic analysis shows to actually amount to commercial risk.
In fact, a review of past arbitral practice shows that companies have already sought to make such a strategic use of IIL, thereby “politicising” commercial risk. Such “politicisation” occurred through the identification of what this paper labels as a “sovereign hook”: that is, a governmental measure which intervened in the economy, thereby offering the affected companies a possibility to maintain that the destruction of value of their assets was caused by that measure itself. Under such circumstances, a closer analysis of the facts shows that such destruction was, however, entirely attributable to market dynamics. The paper undertakes to map such past attempts, trying to foresee along which lines market-driven SFFAs are likely to be brought to the attention of investment tribunals in the future. These include:
1) Challenges against bail-in and bail-out measures adopted in the context of Cyprus' reaction the 2008 financial crisis, where shareholders of the bailed banks tried to blame on the governmental rescue a loss of value which, however, had been generated already by the excessive financial risk undertaken by the banks (Marfin and others v. Cyprus; Aleksandrowicz and Częścik v. Cyprus; Adamakopoulos and others v. Cyprus). The energy transition will have major distributional impacts leading, for instance, to unprecedented job losses across the fossil value chain. Governments will then likely intervene through measures comparable to bail-ins and bail-outs, in order to ensure a “just transition” to a greener economy (e.g. nationalising the affected companies in the context of recapitalisation plans meant to reduce social costs in the default of carbon-intensive companies). In case they do so, as was the case in the Cypriot cases, the defaulting companies might use those measures as a sovereign hook arguing, for instance, that they amounted to direct expropriation, or that they were carried out in a discriminatory fashion. By so doing, those companies would be able to shift the financial burden of the energy transition on the intervening government, framing in terms of political risk what is in fact a default caused by intensified competition from renewable sources.
2) Challenges against clean energy subsidisation policies in Canada by companies falling short of the relevant qualification requirements (Mercer International, Inc. v. Canada). When governments subsidise renewable energy, they internalise in the price of the energy so produced the positive environmental externalities resulting from the use of clean sources. Using renewable energy reduces CO2-equivalent emissions in the atmosphere and thus contributes to mitigating climate change. However, end-users are generally unwilling to pay higher prices for such beneficial effects because they do not benefit directly therefrom. When governments subsidise producers, end-users pay lower prices and consume larger quantities of renewable energy. The environmental positive externality is thus internalised in the transaction between producer and end-user in the form of a lower energy price. If more polluting competitors are squeezed out of the economy because of intensified competition from the subsidised producer, this amounts to the materialisation of commercial risk. The non-subsidised producer is less competitive vis-à-vis the non-subsidised one on economic terms, which the internalisation of the externality through the subsidy has restored in its unaltered competitive dynamic (formerly distorted by the failure to internalise the positive externality). However, as in Mercer v. Canada, producers excluded from the subsidisation scheme may challenge the latter as discriminatory, arguing that they should benefit therefrom in turn. Again, an economic analysis of the scheme would be revealing of how the subsidy would merely amount to a sovereign hook for the company to shift the burden of intensified competition on the government. Considering how crucial the subsidisation of renewables is in restoring fair competition between “brown” and “green” energy producers, it is to be expected that, when renewables take over on fossil sources, companies relying on the latter will challenge green subsidies as discriminatory (or even expropriatory).
3) Challenges against anti-dumping and countervailing duties imposed by the USA on Canadian softwood lumber products, in the context of the long-standing USA-Canada dispute on alleged subsidisation of Canadian timber harvesting (Canfor v. USA; Tembec v. USA; Terminal Forest v. USA; Domtar v. USA). Anti-dumping and countervailing duties aim at internalising in the price of the end-product the negative externalities deriving from the dumping/subsidisation practice underlying the transaction, offsetting the benefit deriving therefrom in the form of unfairly low prices. In the cases concerned, the companies having to face fiercer competition from US competitors challenged the duties internalising said negative externalities as expropriatory and/or discriminatory. However, if the underlying economic analysis is accepted, such duties did no more than restoring a commercial risk which was previously “concealed” by dumping and subsidisation. A similar scheme may be used by brown companies to challenge carbon pricing measures. Governments worldwide are increasingly resorting to carbon pricing, precisely in order to internalise into carbon-intensive economic activities the negative externalities associated with the underlying high emissions. Once prices are thereby raised and companies face fiercer competition by cleaner producers, brown companies may use the sovereign hook provided by carbon pricing to try and recoup the value of their assets, also pointing to their allegedly discriminatory or expropriatory nature. However, carbon pricing is, again, best viewed as an instrument merely redressing a market failure and restoring a commercial risk which that failure unduly prevented from materialising, and should accordingly not be found to breach the rights of investors.
Although not all of the claims hereby surveyed were successful, they evidence how IIL standards of protection are malleable enough to be used to “politicise” commercial risk. Those cases also prove the willingness by companies to use such “politicisation” strategy to minimise losses. The paper thus submits that a more rigorous conceptualisation of causation in IIL is needed, if such politicisation of commercial risk is to be prevented in the context of the foreseeable litigation on the energy transition. In cases where an economic analysis can show that the loss was generated by market dynamics, and the governmental conduct complained of amounts to no more than a preposterous sovereign hook, the causal link between State conduct and investor loss should be deemed to be non-existing, and the claim should accordingly be rejected. Considering the magnitude of the losses projected to be borne by brown companies through market-driven stranding, it is only likely that those companies will try to recoup the value of their market-driven SFFAs deploying all tools at their disposal. The paper thus calls on all stakeholders in the IIL community to resist such attempts at socialising losses, for the energy transition not to be hampered.

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