Valuing Fossil Fuel Assets in an Era of Climate Disruption
There have been more than 150 known ISDS cases brought by claimants whose businesses involve extracting, transporting, refining, selling, or burning fossil fuels for electricity. Some of these cases have been triggered by measures aimed at addressing climate change; others have been brought in response to environmental measures more broadly; some have arisen from disputes regarding the distribution of public and private costs and benefits from extractive industry projects; and others have been triggered by different scenarios, including contract disputes between host state-owned firms and foreign investors. Seven of the top 10 all-time largest ISDS awards (according to UNCTAD data)—all exceeding USD 1 billion—have been granted in cases involving fossil fuel investments.
Each type of dispute raises its own set of policy questions, including whether and under what circumstances ISDS is a proper forum for resolving the case. ISDS claims challenging measures adopted and implemented to advance climate change solutions appear to be the most widely critiqued type of case. A number of commentators have argued for a climate-measure carve-out in IIAs, similar to those that have been introduced in other policy areas such as tobacco control. This would be designed to prevent investors from using ISDS to stop, slow, change, or shift the cost of climate-related policies. Some have also argued that the fossil fuel industry, as a general matter, should not be further “subsidized” through IIAs and the broad and free risk insurance the treaties provide. Under this approach, certain types of projects, such as development of new fossil fuel reserves or infrastructure, would be excluded from ISDS (or IIAs), meaning that investors in those projects would not be able to challenge government action irrespective of its purpose. Whether a government’s new tax was motivated by a desire, for instance, to increase government revenues or to curb the use of fossil fuels would be irrelevant. Companies seeking to challenge the measure would need to do so through routes other than ISDS.
There is, therefore, a broad issue of whether fossil fuel sector investors should be ISDS claimants, and the narrower question of whether climate measures should be open to attack under ISDS. Presently, investment law answers “yes” to both questions. Given that reality, there is a third important—but generally unrecognized—issue to consider regarding fossil fuel-related claims. This is the question of how valuation and damages should be approached in light of climate change considerations and the contested value of fossil fuel resources. We believe that it is timely to consider this question due to the frequency and impact of claims involving fossil fuel assets, as well as the urgency of the climate crisis. It is also timely because delegates to UNCITRAL have already agreed that damages represent a “cross-cutting” issue to be considered in its work on ISDS reform. Here, we offer an initial and high-level outline of some issues and considerations. We hope to encourage further research, dialogue, and debate on these complex topics and the development of practical approaches that integrate climate change considerations into investment law norms.
How is compensation determined in international investment arbitration?
When it comes to determining compensation, there are very few constraints on investment arbitrators. Treaties are largely silent. They often direct that governments should pay the fair market value (FMV) of expropriated assets, but do not dictate the precise methods to be used to determine FMV nor specify what approaches should be used for other types of breach. Tribunals have attempted to fill this silence and, in doing so, have consistently reiterated two principles. One is that the Chorzów factory standard should apply, under which “reparation must, as far as possible, wipe out all the consequences of the illegal act and re-establish the situation which would, in all probability, have existed if that act had not been committed.” A second principle is that speculative damages should not be awarded.  Overall, the treaties’ silence and these principles leave significant room for tribunals to adopt climate-informed approaches to valuation and damages.
What are the particular issues associated with valuing fossil fuel assets?
Fossil fuel prices are affected by a number of factors and are vulnerable to shocks. The volatility in the oil price over the past few months provides a dramatic illustration of this point. The measures taken to halt the spread of the coronavirus have led to a massive contraction in economic activity and fossil fuel consumption. The oil industry has been particularly hard hit as the crisis has coincided with a price war initiated by Russia and Saudi Arabia in March. The IEA suggested that the “scale of the collapse in oil demand…is well in excess of the oil industry’s capacity to adjust” and that was before West Texas Intermediate (the U.S. benchmark price for oil) went negative in late April.
Although the current situation is, in many respects, unprecedented, it is interesting to contemplate how the tribunal in ConocoPhillips v. Venezuela might have addressed the issue of valuation if it were delivering its award in March 2020 instead of March 2019. The tribunal speculated a 2020 oil price for the investment of about USD 58 per barrel and a 1.2% increase per year thereafter. The calculation of the expected price was based on a 0.4% differential from the Maya crude index (Mexican benchmark). In actual fact, for the month of March 2020, Maya crude was hovering around USD 15 per barrel, and in April it plunged to USD 5.15 per barrel, the lowest level in its history. It is difficult to predict when and by how much oil prices will rebound, but at the moment the USD 8.7 billion award is looking like a substantial windfall for ConocoPhillips.
How does climate change further complicate valuation?
While the 2020 pandemic and oil crash would have been impossible for the ConocoPhillips tribunal to predict, climate-related risks are widely discussed and modelled by academics, central banks, and financial regulators. These include physical risks (e.g., risks associated with severe weather events like flooding, droughts, storms, and extreme heat), which result from ongoing climate change, and transition risks (e.g., risks arising from legal change, reputational harm, and shifts in market preferences and technology). The implications for fossil fuel investments of commitments and action governments and other stakeholders take to keep the world within the “carbon budget”—the amount of greenhouse gas emissions that we can afford to burn while remaining within the warming limits set by the Paris Agreement—are particularly important to consider in ISDS valuation exercises.
In order to have a reasonable chance of keeping below 1.5 °C of warming, the majority of remaining fossil fuel reserves must remain unused. In addition, “little or no new CO2-emitting infrastructure can be commissioned, and … existing infrastructure may need to be retired early (or be retrofitted with carbon capture and storage technology).” Thus, climate action will create stranded assets, which are “assets that have suffered from unanticipated or premature write-downs, devaluations, or conversion to liabilities.” There appears to be consensus that thermal coal assets (thermal coal is already in structural decline) as well as high-cost oil reserves (for example, Alberta tar sands) and related infrastructure are at highest risk for stranding in the near term. If an asset in dispute in an ISDS case cannot be further exploited or utilized if we are to remain within the carbon budget, then the cost of stranding should not be shifted from the investor to the state through a damages award.
If it remains possible to continue to extract a resource or utilize an asset without exceeding the carbon budget, it is still important for a tribunal to consider how climate risk affects the value of the resource or asset. For example, under certain policy scenarios, oil demand is expected to drop significantly between 2025 and 2050 as a result of the rapid uptake of electric vehicles. As the current crisis demonstrates, reduced demand can depress the price of oil. Other studies also predict a decline in the oil price but on the basis of over-supply rather than reduced demand.  This type of scenario results from a “use it or lose it” mentality, which sees firms race to exploit their reserves as quickly as possible in order to avoid future government restrictions on extraction. Both the reduced demand and over-supply scenarios cast doubt on the validity of the assumptions by tribunals (e.g., in ConocoPhillips v. Venezuela) that oil prices will increase over time or that they can be estimated on the basis of how they have behaved in the recent past.
There is clearly a high degree of uncertainty about the future value of fossil fuels and related infrastructure. Some have argued that the nature and scope of risks to particular sectors and actors are so uncertain that the costs are simply incalculable and should be approached through a “precautionary” approach that assumes the existence of risks. This uncertainty arguably makes certain approaches to determining FMV unduly speculative. As previously noted, one principle that tribunals have widely articulated is that awards should not provide for speculative damages. Under this principle, trying to assess FMV by identifying what a hypothetical willing buyer would pay a hypothetical willing seller on the market for the fossil fuel assets, forecasting future profits under discounted cash flow (DCF) methods, or applying so-called “modern DCF” approaches would be inappropriate given climate change uncertainty.
Indeed, even alternative methods, such as assessments of sunk costs, would likely amount to overcompensation in certain cases, given that investors arguably can and should have anticipated that any investments made in the last 25 years would be exposed to transition risk.
Opportunities and tools for recovering the social cost of carbon
If tribunals want to follow the principle that an award should put investors in the place they would have been “but for” the government’s wrongful measure, then they should also ensure they do not provide fossil investors socially harmful subsidies. Thus, the awards should take into account the fact that investors are increasingly expected (e.g., through carbon pricing and climate litigation) to pay for the costs inflicted on society by climate change. In our view, if a tribunal finds liability and awards compensation in a case involving fossil fuel assets, in addition to considering the issues outlined above, it should subtract these societal costs from the damages awarded.
To adjust awards, one practical option for tribunals would be to employ the social cost of carbon—a metric developed by academics and adopted by a number of governments. The social cost of carbon (as well as the social cost of methane and nitrous oxide) has also been approved by U.S. domestic courts. These metrics can be used to assign a dollar value to the potential impacts of greenhouse gas emissions. They offer estimates of costs, primarily based on predictions of future impacts (which vary by country) and a range of discount rates. Taking the example of the U.S. at the high end of the possible impact spectrum, with a moderate discount rate of 3%, the social cost of carbon in 2020 is USD 123/tonne in 2007 dollars.
The impact on awards could be significant. One study estimating the total and unpaid social cost of carbon from 1995 to 2013, for instance, found that it exceeded the fossil fuel sector’s profits, “indicating the fossil fuel industry would not be viable if it was made to pay for damages to society.” Absent approaches such as this, treaty awards would perpetuate the fossil fuel industry’s “legal looting” of society.
When an investment treaty decision awards compensation, there are financial and potential behavioural effects on the disputing parties, as well as for policy-makers and market actors not party to the case. Effects on investors can be to over-induce investment; and, on governments, to chill regulation. While these issues are relevant regardless of the nature of the ISDS case, they are especially true when the investment in question is linked to the fossil fuel sector.
There is already concern that over-investment in the sector is creating a “carbon bubble” that, when it bursts, could cause a financial crisis. An investment law regime that insulates investors from transition risks perpetuates the over-investment problem, with the potential to artificially prop up prices and unduly encourage (re)investments in assets that should be stranded and activities that should be discontinued.
A government that has to pay an investor the value of future years’ profits may also feel strong pressure to develop or use the assets. Leaving the oil, gas, and coal in the ground—after the government has effectively paid for its sale—could be politically and financially challenging. Thus, to the extent that arbitral valuation of fossil fuel assets fails to take into account these issues, awards will be further driving the climate crisis.
Given the silence of many treaties on issues of valuation and damages, even under the current regime, states and their counsel have wide leeway to raise these points, and arbitrators have wide discretion to integrate them in their assessments. Additionally, when considering reforms to ISDS, governments participating in the UNCITRAL process can seize the opportunity to address these issues at a multilateral level by advancing work on damages generally, and damages for fossil fuel-related investments more specifically.
Finally, it remains crucial to consider whether and to what extent IIA privileges for investors—particularly investors in the fossil fuel sector—align with countries’ priorities and produce public benefits that outweigh their public costs. Where risks and costs are deemed unduly high, then other actions, such as withdrawal of consent to ISDS and termination of treaties, remain important options for policy-makers to consider.
Kyla Tienhaara is Canada Research Chair in Economy and Environment at Queen’s University, Kingston. Lise Johnson is Head of Investment Law and Policy at the Columbia Center on Sustainable Investment (CCSI). Michael Burger is the Executive Director of the Sabin Center for Climate Change Law at Columbia University.
 Based on a search of UNCTAD’s Investment Dispute Settlement Navigator for the terms “oil,” “gas,” “petroleum,” “hydrocarbons,” and “coal” on April 16, 2020. Available at https://investmentpolicy.unctad.org/investment-dispute-settlement
 Hulley Enterprises v. Russia, PCA Case No. 2005-03/AA226; Veteran Petroleum v. Russia, PCA Case No. 2005-05/AA228; Unión Fenosa Gas v. Egypt, Case No. ARB/14/4. (ICSID. 2014); Yukos Universal v. Russia, PCA Case No. 2005-04/AA227; Occidental v. Ecuador, Case No. ARB/06/11. (ICSID. 2006); Mobil v. Venezuela, Case No. ARB/07/27 (ICSID. 2007), ConocoPhillips v. Venezuela, Case No. ARB/07/30. (ICSID. 2007). Data available at: https://investmentpolicy.unctad.org/investment-dispute-settlement
 Van Harten, G. (2015). An ISDS carve-out to support action on climate change. Osgoode Legal Studies Research Paper Series, 113. http://digitalcommons.osgoode.yorku.ca/olsrps/113
 Johnson, L., Sachs, L. & Lobel, N. (2020). Aligning international investment agreements with the sustainable development goals. Columbia Journal of Transnational Law, 59, 71–79. https://www.jtl.columbia.edu/journal-articles/aligning-international-investment-agreements-with-the-sustainable-development-goals; Brauch, M. D., Touchette, Y., Cosbey, A., Gerasimchuk, I., Sanchez, L., Bernasconi-Osterwalder, N., Torao Garcia, M. B., Potaskaevi, T. & Petrofsky, E. (2019). Treaty on Sustainable Investment for Climate Change Mitigation and Adaptation: Aligning international investment law with the urgent need for climate change action. Journal of International Arbitration, 36(1), 7–35.
 For a discussion of other alternatives, see, e.g., Johnson, L., Coleman, J., Güven, B., & Sachs, L. (2019, April). Alternatives to investor–state dispute settlement (ISDS). CCSI Working Paper 2019. http://ccsi.columbia.edu/files/2019/04/Alternatives-to-ISDS-11-April-2019.pdf
 Columbia Center on Sustainable Investment (CCSI), International Institute for Environment and Development (IIED) & International Institute for Sustainable Development (IISD). (2019). UNCITRAL Working Group III on ISDS reform: How cross-cutting issues reshape reform options. https://www.iisd.org/sites/default/files/uploads/uncitral-submission-cross-cutting-issues-en.pdf
 For a discussion on Compensation under investment treaties, see, e.g., Bonnitcha J. & Brewin S. (2019, october). Compensation under investment treaties. IISD Best Practices Series. https://www.iisd.org/sites/default/files/publications/compensation-treaties-best-practicies-en.pdf ; NIKIEMA H. S. Compensation for expropriation. L’indemnisation de l’expropriation, ( 2013, March). IISD Best Practices Series. https://www.iisd.org/sites/default/files/publications/best_practice_compensation_expropriation_en.pdf
 Factory at Chorzów (Ger. v. Pol.), 1928 P.C.I.J. (ser. A) No. 17 (Sept. 13) (Judgment No. 13, Merits) (“Chorzów”), p. 47.
 Beharry, C. (ed). (2018). Contemporary and emerging issues on the law of damages and valuation in international investment arbitration, 106–107, 136, 210–211, 337–340 (containing various chapters that refer to tribunals’ refusal to award unduly speculative damages).
 Hussain, Y. (2020). Posthaste: It may be time to make up. The ill-timed oil war could cost Saudi Arabia and Russia $260B this year alone. Financial Post.
 IEA. (2020). The global oil industry is experiencing a shock like no other in its history. https://www.iea.org/articles/the-global-oil-industry-is-experiencing-shock-like-no-other-in-its-history
 Reed, S. & Krauss, C. (2020). Too much oil: How a barrel came to be worth less than nothing. New York Times. https://www.nytimes.com/2020/04/20/business/oil-prices.html?action=click&module=RelatedLinks&pgtype=Article
 ConocoPhillips v. Venezuela, Case No. ARB/07/30. (ICSID. 2007). Award, 8 March 2019, p. 221.
 Eschenbacher, S. & Parraga, M. (2020). Mexico’s Maya crude lowest in almost two decades – Platts. Reuters.
https://www.reuters.com/article/health-coronavirus-mexico-oil/update-1-mexicos-maya-crude-lowest-in-almost-two-decades-platts-idUSL1N2BB38D; Garcia, M. (2020). Mexico’s Maya crude price for USGC shipments hits record low $5.15/b on NYMEX futures plunge. S&P Global.
 See, for example, the Bank of England’s website on climate risk. Available at https://www.bankofengland.co.uk/knowledgebank/climate-change-what-are-the-risks-to-financial-stability
 Tong, D., Zhang, Q., Zheng, Y., Caldeira, K., Shearer, C., Hong, C., Qin, Y., & Davis, S. J. (2019). Committed emissions from existing energy infrastructure jeopardize 1.5 °C climate target. Nature, 572(7769), 373–377.
 McGlade, C., & Ekin, P. (2015). The geographical distribution of fossil fuels unused when limiting global warming to 2 °C. Nature, 517(7533), 186–190; SEI, IISD, ODI, Climate Analytics, CICERO, & UNEP. (2019). The production gap: The discrepancy between countries’ planned fossil fuel production and global production levels consistent with limiting warming to 1.5°C or 2°C. http://productiongap.org/
 Tong et al., supra note 15, p. 373–377.
 Caldecott, B., Howarth, N., & McSharry, P. (2013). Stranded assets in agriculture: Protecting value from environment-related risks. Smith School of Enterprise and the Environment, University of Oxford, p. 7.
 Buckley, T. (2019, November 25). IEEFA update: Global coal power set for record fall in 2019 (IEEFA Press Release). https://ieefa.org/ieefa-update-global-coal-power-set-for-record-fall-in-2019
 According to Carbon Tracker (2019), “in a Paris-aligned world, no oil sands projects would go ahead in at least the next 20 years.” Carbon Tracker. (2019). Breaking the habit – Why none of the large oil companies are “Paris-aligned,” and what they need to do to get there. https://www.carbontracker.org/reports/breaking-the-habit
 Detailed modelling has been done by academics and organizations such as Carbon Tracker to indicate precisely when assets such as coal-fired power plants need to be decommissioned to keep within the Paris climate targets. See, e.g., Cui, R.Y., Hultman, N., Edwards, M.R. He, L., Sen, A., Surana, K., McJeon, H., Iyer, A., Patel, P., Yu, S., Nace, T., & Shearer, C. (2019) Quantifying operational lifetimes for coal power plants under the Paris goals. Nature Communications 10: 4759; Carbon Tracker. (2020). How to waste over half a trillion dollars: The economic implications of deflationary renewable energy for coal power investments. https://carbontracker.org/reports/how-to-waste-over-half-a-trillion-dollars/
 International Energy Agency (IEA). (2019). World energy outlook 2019. https://www.iea.org/reports/world-energy-outlook-2019; UN Principles for Responsible Investment. (n.d.). Inevitable policy response scenario: Forecast Policy Scenario: Macroeconomic results. https://www.unpri.org/inevitable-policy-response/forecast-policy-scenario-macroeconomic-results/4879.article
 Barnett, M. (2019). A run on oil: Climate policy, stranded assets, and asset prices. https://www.frbsf.org/economic-research/events/2019/november/economics-of-climate-change/files/Paper-7-2019-11-8-Barnett-240PM-1st-paper.pdf
 Kotlikoff, L., Polbin, A. & Zubarev, A. (2016). Will the Paris Accord accelerate climate change? (NBER Working Paper No. 22731). https://www.nber.org/papers/w22731.pdf
 Cullen, J. (2018). After ‘HLEG’: EU banks, climate change abatement and the precautionary principle. Cambridge Yearbook of European Legal Studies, 20, 61–87.
 As has been well-documented, fossil fuel companies have been aware of the reality of climate change and its implications since the 1960s. See further https://exxonknew.org
 States could also pre-empt this issue by launching counterclaims to cover these costs at the outset of any ISDS case with a fossil fuel company. States have recently begun to use counterclaims to cover the costs of remediating environmental damage that has directly resulted from investment projects, including those in the fossil fuel sector (see, for example, Perenco v. Ecuador). We recognize that counterclaims often fail and may be especially difficult to advance where the nexus between the claim and the challenged measure is unclear. However, launching them, at the very least, forces tribunals to address the issue head-on and provide justification for why they are not willing to at least consider imposing the costs of dealing with climate change on industry. Moreover, reforms to widen the scope of counterclaims are also possible through the UNCITRAL WG III process.
 See Zero Zone Inc. v. United States Department of Energy, 832 F.3d 654 (7th Cir. 2016) (upholding use of methodology for calculating social cost of carbon used by the Interagency Working Group on the Social Cost of Carbon).
 Ricke, K., Drouet, L., Caldeira, K. & Tavoni, M. (2018) Country-level social cost of carbon, Nature Climate Change 8, 895–900.
 United States Environmental Protection Agency (EPA). (2016). Factsheet: Social cost of carbon. https://19january2017snapshot.epa.gov/climatechange/social-cost-carbon_.htm
 Linnenluecke, M., Smith, T., & Whaley, R.E. (2018). The unpaid social cost of carbon: Introducing a framework to estimate “legal looting’ in the fossil fuel industry. Accounting Research Journal, 31(2), 122–134, p. 123.
 “Looting is a term used in the economics and finance disciplines to refer to a situation in which society, through its government, agrees to an inefficient contract that persists through time. Looting occurs in the fossil fuel industry where companies are not required to fully pay for CO2 emissions damage.” Ibid., p. 124.
 Bonnitcha, J., & Brewin, S. (2019). Compensation under investment treaties (advance draft) (IISD Best Practices Series). https://www.iisd.org/sites/default/files/publications/compensation-treaties-best-practicies-en.pdf ; Tienhaara, K. (2018). Regulatory chill in a warming world: The threat to climate policy posed by investor–state dispute settlement. Transnational Environmental Law, 7(2), 229–250.
 Mercure, J. F., Pollitt, H., Viñuales, J. E., Edwards, N. R., Holden, P. B., Chewpreecha, U., Salas, P., Sognnaes, I., Lam, A., & Knobloch, F. (2018). Macroeconomic impact of stranded fossil fuel assets. Nature Climate Change, 8(7), 588–593.
 See, for example, Columbia Center on Sustainable Investment (CCSI), International Institute for Environment and Development (IIED), and International Institute for Sustainable Development (IISD). (2019). Draft treaty language: Withdrawal of consent to arbitrate and termination of international investment agreements: Submission to UNCITRAL Working Group III on ISDS Reform. https://www.iisd.org/sites/default/files/uploads/uncitral-submission-termination-withdrawal-en.pdf; Johnson, L., Coleman, J., & Güven, B. (2018). Withdrawal of consent to investor–state arbitration and termination of investment treaties. Investment Treaty News, 9(1), 7–10. https://www.iisd.org/itn/2018/04/24/withdrawal-of-consent-to-investor-state-arbitration-and-termination-of-investment-treaties-lise-johnson-jesse-coleman-brooke-guven