The Future of Energy – Risk Management Trends

As cross-border dispute resolution lawyers, we outline below four of the major risk factors we see facing the Energy Sector as it navigates these threats and opportunities towards a renewable future.

The stalled modernisation and EU abandonment of the Energy Charter Treaty (ECT)

The ECT, once a vehicle for co-operation and stability in developing the energy sector, faces an uncertain future as an increasing number of EU states have announced their intention to withdraw, which in turn has undermined the efforts to modernise the ECT to reshape it towards the energy transition. France, Germany, Spain, Belgium, the Netherlands, Luxembourg, Poland and Slovenia have all announced their intention to withdraw, and the European Commission has reportedly told member countries that a joint EU exit appears inevitable. The EU Parliament has also passed a resolution calling for withdrawal from the ECT.

The ECT had been due to be modernised to align it with the Paris Agreement and more contemporary environmental objectives. Changes include a flexibility mechanism for contracting states to end protections for existing fossil fuel investments after 10 years from the entry into force of the new provisions. 

So what now, and what protection is there for new investments? 

While withdrawing parties will be released from obligation under the ECT one year from notification of withdrawal, it is important to note that ‘sunset provisions’ in the treaty will  continue to extend treaty protections to existing investments for 20 years.  This includes investment in renewable energy which have, in fact, made up the bulk of the claims brought under the ECT since its inception compared to traditional energy.  A trend which perhaps reflects the shifting political landscape of many countries’ efforts, and then altered efforts, to creates incentives and disincentives within their energy policies.

For now investors should not assume that the ECT has ceased to apply or will not protect their existing investments.  However, energy investors within the EU should be in little doubt of the direction of travel including the obstacles likely to arise in enforcing any award made under an intra-EU investment protection regime such as the ECT or an intra-EU bilateral investment treaty, as exemplified by the decision of the ECJ in Komstroy (Case C-741/19, Republic of Moldova v. Komstroy LLC) which held that ECT based intra-EU arbitrations are contrary to EU law.

Supply Chain risks

Supply chain issues continue to have a huge impact on the sector presenting numerous challenges and risks which must be continually assessed as the landscape changes. Each issue interlinks and impacts on others and cannot be dealt with in isolation. There is increased competition worldwide to obtain raw materials and equipment. For example, the war in the Ukraine has had a profound effect on the worldwide supply of lithium which is needed for many projects connected to energy transition. Shortages lead to price inflation for these materials and machinery, combined with elevating project costs, also resulting from delays in obtaining the same raw materials inevitably creating a cycle of lengthening delays and escalating costs. As these supply chains inevitably cross many jurisdictions, enforcement of contracts – or, conversely, amendment of clauses or milestones that cannot be met in practice – is often very complicated.

Other factors affecting the energy supply chain include ESG considerations linked to modern slavery issues, cyber risks where JVs share their data and digital processes and a lack of insurance solutions to deal with these very new and real issues (discussed in more detail below). Businesses need to consider their supply chain risks triaging these issues. This may include severing ties with old suppliers, seeking out new partners and finding new ways of working. These decisions could, however, lead to increased risk of disputes and therefore ways need to be considered of trying to minimise these threats. Terms of business may benefit from a refresh, in particular the terms regarding force majeure, unforeseen circumstances and penalties/liquidated damages.

Insurance – transition and climate related litigation risks

Energy transition and the pursuit of a net-zero emissions demand that insurers innovate and create products that will provide cover for these speciality risks. Investors and insurers need to continue to work together to produce solutions to new needs such as “stranded assets due to governmental policy change” (CFRF: Scenario analysis working group: climate litigation risk chapter (fca.org.uk)) and to price these competitively. A challenge for insurance companies is the lack of sufficient historic data, so it can be complicated to obtain sufficient insurance coverage for the hazards of new technologies in the sector.

Also on the claims and liability side, global developments will have an increasing impact on the risk portfolio of companies in the energy & utilities sector. It is important to understand the different types of climate liability claims they can face.

Climate related litigation risk is a growing area with the possibility to affect a company’s share price, creditworthiness, the value of its asset portfolio and reputation, not to mention the amount of time taken up in dealing with claims by management and damages and costs to be paid ultimately affecting the balance sheet. This type of litigation is now being seen as a way to effect changes in company policy and actions regarding climate change. Where previously it was directed towards governments, it is now being pursued against companies and even individual directors  (See our recent article on Client Earth v Shell). Looking at the insurance side of climate-related risks, some insurance policies already contain climate harm exclusion clauses, and this is predicted to be a growing trend. These clauses block cover in the event of claims arising from the effects of climate change or where a business has failed to comply with changing legal or regulatory requirements. Lack of protection in these areas must be added to a company’s risk register.

The advent of new types of disputes

The transition from traditional forms of energy towards greener technologies will create an environment in which new types of disputes will emerge. Some of these we have alluded to above such as climate related litigation, impacts from the ECT and challenges to supply chains. But there are other factors at play which will also create conditions where disputes linked to energy transition will develop. These include, but are not limited to, the decommissioning of assets and the unwinding of long-term JVs, the impact of the war in Ukraine on energy security leading to governmental changes in policy together with the related impacts of increasing reliance on domestic and renewable energy supply. This latter trend may lead to pressures on planning and building consents, large scale infrastructure and construction projects, competition over tenders and resulting effects on supply chain providing a fertile ground for disputes to arise.

Greenwashing is another area in which companies must assess their risk. From financial reporting to advertising copy, what a company says must match what it does on the ground. Worries around supply chain and how the end product reaches the consumer is also a concern. As mentioned above, shareholder activism is on the rise, with directors now specifically targeted for both their action but also inaction and while these cases are yet to be successful, the pursuit of them is on the increase in many jurisdictions as is the number of claimants willing to challenge the ESG credentials of those in the sector.

Practical Considerations to minimise risks

While trends are interesting there are always practical matters to consider that help parties navigate disputes as they arise no matter what the origin. It is important that these are not forgotten at the contracting stage as they help to minimise risk.  The allocation of risk in terms of performance, delay and defects is particularly important as are the warranties and dispute resolution procedures agreed.

Existing dispute resolution tools will work whether the parties are involved in a huge petroleum infrastructure joint venture or navigating their way exploring an aspect of energy transition. In our volatile world, it is more important than ever, that contracting parties consider how their disputes will be resolved and mechanisms are constructed to prevent disagreements from escalating ensuring the continuing life of the contract. Parties should look at best practices – also in other sectors such as Construction and IT – and must consider dispute resolution boards, escalation clauses, expert determination and arbitration to resolve domestic and cross-border disputes in addition to court litigation.