The Energy Transition and the Future of Energy Disputes

As the global energy transition progresses, energy leaders and their advisors should prepare for disputes in three key areas: supply and pricing, capacity commitments, and shareholder investments.

Over the last decade, and especially since the Covid-19 pandemic, we have witnessed momentous changes in energy investment, markets, and economics. In 2015, global investment in fossil fuels and conventional energy exceeded that of clean energy by more than 23 percent, but global spending on clean energy technologies and infrastructure is on track to hit $2 trillion this year, or approximately twice the amount of spending on fossil fuels.

However, the energy transition and its market and economic impacts do not exist and cannot be understood in a vacuum. At present, they are deeply entangled with—and vulnerable to—geopolitical strife, resource battles, trade conflicts, technology change and development, policy and regulatory uncertainty, supply and demand shocks and disruptions, and energy price volatility.

These uncertainties are not far from the surface in a variety of international legal disputes. In a 2022 energy arbitration survey conducted by Queen Mary University of London, respondents ranked price volatility as the leading cause of future energy disputes, followed by the construction of energy infrastructure and government policy instability. If the speed and breadth of energy transition continue apace, climate-related disputes arising from such uncertainty or volatility likely will proliferate and deepen over the coming decades.

Until now, disputes arising from energy transition have existed as a relatively limited subset of investment arbitration and have typically been lodged by:

• investors seeking damages from states as a result of their phasing out of existing fossil fuel infrastructure
• investors against states due to the roll-back of investment incentives for renewable energy
• state governments at local and national levels against investors and private corporations for their role in propagating anthropogenic climate change

However, we anticipate that energy transition–related commercial arbitration and litigation will become increasingly more common. The economic impacts of the energy transition will disrupt or upend the economic foundations and prices of fuel and power contracts for energy sale and purchase, project development, financing, and shareholder and equity arrangements, among others, across energy and infrastructure industry segments such as natural gas and liquefied natural gas (LNG), oil and liquid fuels, coal, conventional and renewable electricity generation, critical mineral mining, and refining.

 

1. Supply and Pricing Disputes

A first wave of climate-related disputes may center around new and existing gas and LNG sale and purchase agreements. When price volatility in spot and short-term markets causes gas and LNG prices to diverge substantially from long-term contract prices on a sustained basis, disputes regarding the failure to deliver (or, conversely, the failure to take) are some of the first to arise.

[W]e anticipate that energy transition–related commercial arbitration and litigation will become increasingly more common.

As demonstrated in 2020, the low-price environment of the Covid-19 pandemic created opportunities for buyers under long-term gas sale agreements and LNG sale and purchase agreements (SPAs) to procure supply more cheaply on the spot market than under their existing long-term contracts. Similarly, in high-price markets such as that experienced in mid- to late 2022, sellers with long-term supply obligations found it more advantageous to sell on the spot market than under their term contracts—in some cases generating profits that far exceeded the limited liability damages provisions for supply shortfalls under those contracts. In these circumstances, parties may use arbitration to rebalance the economics of the contract and/or recover damages related to the undersupply or underdelivery of LNG.

Additionally, as the energy transition leads toward permanent and structural market change for gas and LNG, we could foresee increasing numbers of disputes arising as a result of long-term fuel supply agreements becoming onerous or even uneconomical. For example, as solar and wind power installations rise in LNG-dependent countries (and/or progress much more rapidly than expected), LNG importers could find themselves oversupplied with firm long-term contract LNG that had been contracted based on prior expectations of lower and/or slower penetration of renewables in the energy grid. In these cases, parties might pursue claims of force majeure, hardship, or frustration of purpose, where the entire value of the supply contract may be jeopardized.

2. Capacity Commitment Disputes

As renewables, natural gas, and LNG replace coal and coal’s role in power generation is substantially and permanently reduced—and, over a longer horizon, as gas consumption is potentially also reduced—we envisage a second wave of climate-related disputes involving capacity holders with unused (or underused) infrastructure.

We have already seen disputes arising from the phase-out of coal-fired generation, including the NAFTA claim brought by Westmoreland against Canada and Energy Charter Treaty (ECT) claims brought by RWE and Uniper against the Netherlands. Although these cases were dismissed (Westmoreland), withdrawn (Uniper), or discontinued for inadmissibility (RWE), they signal a broader forthcoming trend of claims in Europe and North America as these regions systematically replace coal with cleaner forms of generation.

Over a longer time horizon, if the energy transition reduces the use case for gas or LNG infrastructure (import or export facilities, storage and regasification facilities, pipelines), we could foresee arbitration claims made by private parties with fixed capacity commitments for such infrastructure (i.e., where such capacity must be paid for, even if unused over the long term). The scale of commercial arbitration for underutilized gas and LNG assets could easily put billions of private dollars at stake.

3. Shareholder/Investment Disputes

Finally, we note that the large amount of proposed LNG export capacity in North America, as well as new import capacity in Europe to alleviate energy security concerns over Russian gas, could face political and regulatory headwinds in the form of climate change policy. Given the massive amount of capital behind these projects, their long lead times, and regulatory uncertainty in the intervening period before reaching commercial operations, disputes could arise from their delay or mothballing.

This area may be particularly ripe for future investor-state claims, but knock-on commercial arbitration claims may arise from the myriad commercial parties involved in the development of fossil fuel projects—fuel suppliers, project financers, shareholders, foundation customers with whom SPAs were signed, and engineering, procurement, and construction contractors, among others—for the failure of such projects to move forward or reach commercial operations.

Expert witnesses can play a crucial role in analyzing the merits and quantum of damages in future energy transition-related disputes. As we have discussed in other publications, we expect that a formidable task in forthcoming arbitrations will be isolating the harm caused by state-led policy, regulatory, or fiscal actions that form the crux of alleged breaches with the effects of broader economic factors that are not attributable to any state action.

Looking forward, legal counsel, tribunals, and commercial parties may grapple with whether and how to integrate the cost of carbon (i.e., through carbon offsets or import duties) into traditional damages tools or commercial contracts. Commercial parties will also need to address the challenge of who is responsible—the importer or exporter—for emissions generated at each phase of the value chain. The experts who can combine knowledge of traditional commercial practices for LNG contract pricing with experience in lifecycle analysis (LCA) of GHG emissions will be well suited to tackle these challenges.

Future arbitrations will require integrated damages expertise that marries traditional tools of industry and damages analysis with deep understanding of the new markets, commercial practices, and trade patterns borne out of the energy transition. Such an approach will be critical for legal counsel and tribunals that seek to adequately respond to and resolve the forthcoming wave of climate change–related commercial disputes.