Breaking Barriers: Integrating Energy Justice to Overcome Investor-State Dispute Settlement (ISDS) Roadblocks to Climate Change Mitigation Efforts

Abstract

This chapter examines the relationship between investment, energy security, and the investor-state dispute settlement (ISDS) regime, an area often overlooked in energy justice conversation. The ISDS regime, designed to safeguard foreign investments, faces a legitimacy crisis exacerbated by its perceived misalignment with climate change mitigation efforts. Through the lens of energy justice, this chapter explores the criticisms against the ISDS regime by framing them as “energy injustices”. Distributive injustices manifest in unfair cost allocation, favouring investors over just transition efforts and placing a disproportionate burden on developing nations. Restorative injustices arise from the potential for opportunistic claims and excessive compensation claims, hindering the just transition. Cosmopolitan injustices occur when tribunals fail to address human and environmental rights issues in investment disputes. The chapter proposes that the ongoing reforms of the ISDS regime be guided by energy justice principles, emphasising equitable cost-sharing, clear criteria for damages, and integrating human and environmental rights into investment agreements. Aligning reforms with energy justice principles can help legitimise the regime, ensuring it plays an effective role the transition to a low-carbon economy and contributing to global energy justice.

1 Introduction

Investment is essential to obtaining energy security, addressing energy poverty, putting the world on a path to net-zero emissions, stimulating post-COVID-19 economic recovery, and ensuring sustainable development in developing nations.¹ As such, the investor-state dispute settlement (ISDS) regime, a contract or (but mostly) treaty-based regime of rights, principles, and standards that imposes obligations on host states to foreign investments in their territories, is a vital aspect of the energy sector. Though often overlooked in the energy justice discourse, the ISDS regime is particularly relevant to the energy sector as it mitigates political risks associated with energy projects.²

However, the regime is currently facing a legitimacy crisis.³ The criticisms of the ISDS regime are myriad, but most relevant to the energy justice conversation is the claim that the regime is at odds with climate efforts.⁴ Considering the symbiotic relationship between the ISDS regime and the energy sector,⁵ this chapter analyses the criticisms of the ISDS regime through an energy justice lens and examines how justice principles may legitimise the regime.

2 Legitimacy Criticisms of the ISDS Regime as “Energy Injustices”

Energy justice comprises central tenets, including distribution, procedural, recognition, restorative, and cosmopolitan justice.⁶ Many criticisms of the ISDS regime can be represented as energy injustices within these tenets.

2.1 Distributive Injustice in ISDS

Distributive justice is concerned with the fair and equitable distribution of the costs and benefits in the energy system.⁷ Within the ISDS regime, distributive justice concerns are raised in two dimensions. First, distributive injustice arises from unfair cost allocation between host states and foreign investors,⁸ benefiting investors at the expense of just transition efforts. The implication of this is that states can be and have been challenged for actions taken in furtherance of the just transition to a low-carbon economy.⁹ The other dimension is the disproportionate burden developing nations bear within the regime.¹⁰ Regulatory chill, for instance, is more likely to occur in developing nations¹¹ and even more so for climate-related policies.¹² Furthermore, the criticism of high litigation and liability costs¹³ imposes a more significant burden on developing nations. While substantial damages have been granted against both developed and developing countries, the amounts awarded constitute a larger percentage of the income of poorer nations. Two of the most widely criticised awards in terms of the quantum of damages are in relation to energy-related disputes in developing nations. Recently, Pakistan and Nigeria had US$4 billion and US$6 billion awarded against them, respectively.¹⁴ Compared to the €1.4 billion claimed by RWE against Netherlands, the 17th largest economy in the world, it appears that developing nations get the shorter end of the stick. Concerningly, the Pakistani award was comparable to the value of International Monetary Fund’s (IMF) bailout that had only recently been negotiated to prevent the collapse of the Pakistani economy.¹⁵ Also, a recent study which anticipated financial risk from possible ISDS claims found that more than two-thirds of the risk is borne by nations in the Global South.¹⁶

2.2 Restorative Injustice in ISDS

Restorative justice is concerned with rectifying injustices arising from energy decision-making.¹⁷ It seeks to restore claimants to their original position prior to a damaging activity.¹⁸ In the ISDS regime, this is what happens when tribunals instruct states to pay investors for their wrongful interference with investments. However, the regime is vulnerable to exploitation by unscrupulous investors seeking financial gains rather than engaging in legitimate business activities. In fact, the awards against Nigeria and Pakistan were in relation to projects that never got off the ground, highlighting the potential for opportunistic claims within the ISDS system. This exploitation has led to ISDS awards being treated as speculative financial assets, with financial speculators purchasing corporations with potential winnable ISDS claims, and even hedge funds financing ISDS cases.¹⁹ A study has shown that a majority of the claimants in the Spanish renewable energy investments disputes saga were portfolio investors,²⁰ some of whom profited both from an increase in value of their stake and from the ISDS awards.²¹ Restorative injustice also occurs with respect to liability costs. Damages claimed by investors have increasingly become higher over the years with more incidents of claims in excess of US$ 1 billion.²² These “mega claims” are a consequence of the structural bias in the ISDS regime in favour of claimants,²³ the huge discretion wielded by tribunals,²⁴ and the underdeveloped body of rules pertaining to valuation of damages.²⁵ The challenge this poses with respect to the just transition is that the exorbitant amount of compensation that investors receive serve to raise the cost of the transition and reduce the public funding available for green investments.²⁶

2.3 Cosmopolitan Injustice in ISDS

The cosmopolitan view considers injustice to be a universal problem that applies to all human beings in all nations²⁷ and necessitates the adherence to universal principles.²⁸ It is particularly concerned with the protection of global human rights,²⁹ an idea at the core of Heffron’s energy justice circle.³⁰ In ISDS, cosmopolitan injustice manifests when tribunals decline to address human and environmental rights issues in investment disputes. Increasingly, national courts have been instrumental in upholding energy justice by safeguarding human rights in response to diverse energy activities throughout the energy life cycle.³¹ Unfortunately, the ISDS regime has lagged in this regard, facing criticism for its failure to align with the protection of human and environmental rights.³²

Although it has been argued that Article 31(3)(c) of the Vienna Convention on the Law of Treaties³³ could be invoked to incorporate international human rights law in investment arbitration, tribunals have been hesitant to venture beyond the specific investment treaty at hand in addressing human rights issues.³⁴ Even when they do consider such matters, tribunals have typically concluded that corporations bear the obligation to refrain from actions that infringe upon human rights, but they are not obliged to take affirmative actions to promote human rights.³⁵ This represents a missed opportunity for the ISDS regime to advance energy justice, particularly as the foreign investor tends to be cosmopolitan, having business interests in several states.³⁶ If ISDS can hold multinational corporations accountable and responsible for human rights violations and protections in one host state, it will influence corporate behaviour in other host states.

3 Retooling Energy Justice Principles for ISDS Reform

Recognising the shortcomings of the ISDS regime, various reform proposals have been put forward.³⁷ To ensure meaningful reform, energy justice principles should guide these efforts.

Proposed amendments to underlying investment treaties should adopt firstly a distributive justice approach. This will ensure that costs and responsibilities are equitably allocated under the regime by imposing reciprocal obligations on investors, such as the inclusion of human rights and environmental issues in IIAs such as in the Nigeria-Morocco BIT. Secondly, restorative justice principles can help strike a balance between protecting investments and preventing opportunistic behaviour. Establishing clear criteria and guidelines for determining damages can prevent inflated compensation claims that hamper the just transition.³⁸ Another valid suggestion that aligns with restorative justice is a gain-based calculation which suggests that compensation be limited to the investor's actual expenditure, taking into account whether the host state benefitted from the investment before breaching its obligations. The approach aims to discourage opportunistic conduct while allowing host states to adapt to changing circumstances.³⁹ Lastly, cosmopolitan justice entails a collective moral obligation and responsibility towards others, thereby encompassing ethical responsibilities that apply to all actors capable of comprehending, facilitating, and acting upon them.⁴⁰ This should include arbitrators on ISDS tribunals. Human rights and investment concerns are not mutually exclusive and should not be compartmentalised, particularly considering the track record of energy investors in violating human and environmental rights, especially in the Global South.

4 Conclusion

The shortcomings of the ISDS regime present a real threat to the just transition agenda and the pursuit of energy justice. Distributive injustices pose a challenge by allowing claims against climate policy and set back energy access goals in developing nations. Restorative injustice can circumvent climate finance and cosmopolitan injustices undermine environmental efforts.

Following the backlash against ISDS, states have been withdrawing or exiting from the regime.⁴¹ This is not a particularly welcome development as investments remain a key part of achieving net-zero targets. Studies have shown that foreign investors value access to non-state dispute resolution methods as it depoliticises disputes. In the absence of the ISDS regime, investors might seek alternatives in political risk insurance with the high cost of premiums being transferred to the final consumer. This may make clean energy less affordable and further exacerbate energy poverty and lower living standards, especially in poorer nations and amongst the less privileged in developed countries. ISDS thus plays an important role in balancing the interests between states and foreign investors, thus achieving global energy justice.

Yet, it can lose its effectiveness without legitimacy and energy justice can help to legitimise the regime. This is important because rules that align with a general sense of justice are more likely to be respected.⁴² Energy justice is proving increasingly useful as a means of bringing together disparate but clearly linked causes under a shared discourse.⁴³ Overall, reforming the ISDS regime in alignment with energy justice principles positions it as an effective tool in the just transition to a low-carbon economy.