A new front in the fight against climate change
The last four years have been the hottest on record. Since the start of 2018 there have been blazes inside the Arctic Circle, record high temperatures in Europe and the deadliest wildfire season in California’s history. The science linking global warming and greenhouse gases continues to grow, yet so does global carbon output. It is against this backdrop that businesses are being hit by lawsuits demanding greater disclosures on climate risk, strategy change to reduce future environmental impact – and compensation for historical emissions.
Climate change raises a number of risks for business. The first is physical – the threat to assets posed by more intense storms, floods and fires that are associated with rising global temperatures. This risk is growing as the world’s population expands and more wealth is accumulated in low-lying coastal areas. According to Aon’s latest weather, climate and catastrophe insight report, 2017 and 2018 were the costliest back-to-back years for weather-related losses on record. This direct economic impact is magnified by the associated disruption to supply chains – if temperatures continue to increase at current rates, whole regions could soon be waterlogged or suffer prolonged droughts, threatening agricultural outputs, public health, labour supplies and social stability.
Then there is transition risk associated with decarbonising society. We have been dependent on fossil fuels for so long that too rapid a withdrawal could destabilise the global economy and undermine investments in renewable energy and emissions-reducing technologies. But switch too slowly and the world will be subject to even greater climaterelated threats. The most recent report from the UN’s Intergovernmental Panel on Climate Change (IPCC) concluded that the 2°C limit on global temperature rises – established for decades as a line humanity crossed at its peril – is both too high to prevent serious environmental consequences and unattainable at current rates of progress. In the IPCC’s view we cannot go beyond 1.5°C, and we have just over a decade to act before we reach the point of no return.
Sir Nicholas Stern described climate change as ‘the greatest market failure the world has ever seen’ in a 2006 study that helped focus political debate on the cost of climate change. But today, economic forces are starting to offer a glimmer of hope. Partly in response to consumer demand, companies are building more sustainable portfolios and pouring money into emissions-reducing technologies. Research from the Global Commission on the Economy and Climate estimates that if the $90tn expected to be invested in infrastructure between now and 2030 were spent on sustainable infrastructure, an additional $26tn in economic growth could be unleashed.
Investors are also beginning to exert their influence. Research from McKinsey shows that more than a quarter of the $88tn assets under management are now channelled according to ESG (environmental, social and governance) principles. This dynamic has brought with it demands for businesses to release more detailed information on their climate-related risk profile. With access to better data, the logic goes, funds can make more accurate investment decisions; climate risk will be better priced into asset valuations; insurance products will evolve; and, ultimately, the market will act to drive emissions down. A recent climate summit at the Vatican ended with a commitment from the world’s biggest oil companies to publish the carbon and methane intensity of their businesses at regular intervals. The announcement built on publicised efforts by the Oil and Gas Climate Initiative to develop a standardised reporting methodology that enables these figures to be benchmarked.
Policy pressure
Pressure, too, is being applied by policy. Huge volumes of legislation have been introduced around the world in a bid to reduce carbon emissions. All existing international laws can be traced back to the 1992 Rio Earth Summit, from which the United Nations Framework Convention on Climate Change emerged. The UNFCCC set the ground rules for all subsequent international treaties, from the 2005 Kyoto Protocol to the 2016 Paris Agreement. The latter is the most ambitious accord of its kind and is intended to limit global temperature rises to less than 2°C above pre-industrial levels. All 176 signatories to the treaty have at least one law in place designed to limit global warming, with more than 100 introduced since the agreement came into force. But Paris imposes no hard commitments on the speed or scale of emissions cuts, leading to a significant variation in responses at national level. And governments have so far found it impossible to reach an international consensus on the measure many of the world’s biggest energy companies believe is essential to drive change – a global price for carbon.
The rise of litigation risk
Alongside physical threats, energy transition and policy change, businesses face another fast-evolving risk.
According to analysis from Columbia Law School, there are more than 1,100 climate-related lawsuits in play around the world, with more than 120 – and counting – aimed directly at companies. These cases can be split into two groups. The first are a series of common law tort- and public nuisance-based cases that target corporates in relation to past environmental conduct. The second try to influence their future conduct by demanding greater transparency over climate-related risks and changes in strategic direction around things like greenhouse gas (GHG) emissions. Rather than seeking to prove individual companies are responsible for future climate-related damage, these suits instead test corporate conduct by reference to things like disclosure requirements and obligations under human rights laws.
The tort and nuisance suits – particularly those in the US – have received significant media coverage. Some were launched before President Trump’s withdrawal from the Paris Agreement in 2017, but the decision led to a spike in litigation from New York to Oakland. More than a dozen claims were filed in 2018 alone. The New York case took aim at five of the world’s biggest oil companies, alleging that for years they continued to promote fossil fuels and discredit climate science despite accepting in private that GHG emissions contributed to global warming, allegations they strenuously denied. As a result, it argued, they should have to cover the cost of preparing the city for the impact of man-made climate change. At the launch of the suit, the city government also announced its pension fund was to sell its fossil fuel holdings.
There is clearly concern in coastal cities about the risk of rising sea levels, but this rush of litigation must also be seen against the backdrop of America’s increasingly polarised politics and a lawyer-led litigation culture. In the White House sits a president who has reversed many of his predecessors’ climate policies, while each of the cities, counties and states that have filed suits against energy companies since the start of 2018 has a Democrat attorney general and a Democrat-led government.
In 2050, something like 50 per cent of the energy mix will still come from fossil fuels. That means society clearly needs some businesses to be active in oil and gas – predominantly moving towards gas from oil over time. The challenge is how to ensure these businesses are not seen as pariahs.
Energy firms shouldn’t apologise for producing something that the world still needs but they must also play a major role in helping wean society off fossil fuels, particularly via the decarbonisation of oil and gas.
Let’s hold the production companies to the highest technical standards of behaviour but remember they are also well placed, because of both their financial resources and world-leading technical and project management skills, to play their part in driving the energy transition.
Their position is not the same as a business that knowingly leaks chemicals into waterways. They were creating a fuel that when used by customers created CO2, and the world had not yet appreciated the impact on the climate over a long period of time.
Steve Holliday
Former chief executive of National Grid and president of the Energy Institute
Shareholders raise their voice
The possibility of shareholder litigation presents a further complication. Oil companies that prioritise investments in emissions-reducing technologies over immediate profits run the risk of shareholder suits from short-term investors. They therefore face the twin risk of being sued, including via class action litigation, whatever they do. They are, in a sense, damned if they do and damned if they don’t, and argue that this is not a dynamic that helps accelerate the transition to a lower-carbon future.
Plaintiffs bringing common law tort and public nuisance claims are now seeking to rely on academic studies that attempt to quantify individual actors’ contribution to man-made emissions since the start of the industrial era. Researchers are developing models in a bid to tie climate change to extreme weather at a local level – and to predict where those events might strike next. The federal judge hearing a case in San Francisco was so intrigued by developments in causation and attribution science that he staged a day-long ‘teach-in’ to prepare for legal arguments. While he ultimately ruled his court was not the right forum for such a case (and stated in his judgment that the current slew of nuisance suits could harm attempts to reach international consensus on climate change), it brought these developing theses into the spotlight.
No climate-related public nuisance case has yet reached trial in the US, largely due to the pre-emption doctrine, the legal principle that federal law takes precedence over state legislation. In federal courts, such claims are constrained by the Supreme Court decision AEP v Connecticut, the first global warming case based on a public nuisance claim, which was brought to court in the Southern District of New York in 2004. The unanimous ruling states that the management of emissions is the responsibility of the Environmental Protection Agency, not corporations.
Advances in Europe
In Europe, however, a case has reached a more substantive phase. In 2015 Saúl Luciano Lliuya, a Peruvian farmer, filed a suit against German energy company RWE arguing that it must pay to help protect his property from the risks of glacial flood. The case – funded by the NGO Germanwatch – has its roots in the US geographer Richard Heede’s Carbon Majors study, which attempts to calculate individual entities’ GHG emissions since the start of the industrial revolution. Mr Lliuya’s case alleges that because the risk of flooding in the Andes has been heightened by global warming – and because the Heede study claims RWE is responsible for 0.47 per cent of post-industrial emissions, RWE should cover 0.47 per cent of his mitigation costs.
A district court dismissed the claim in 2016 on legal grounds. But the following year the German Court of Appeal held that it was possible to bring the suit under broad principles in national tort and nuisance law (in essence that if a neighbour’s actions are causing a threat to your property, you have the right to seek damages). The court is now appointing experts to look at the extent of the risk to Mr Lliuya’s land and whether that risk can be directly tied to RWE. The sum in dispute may be less than €20,000 but the precedent-setting potential is clear.
The current make-up of the Supreme Court means any US nuisance suit is unlikely ultimately to succeed, but merely taking such claims to court keeps business in the spotlight. Whether the cases are brought in the US or elsewhere, one thing is clear – any claimant would have to overcome very significant and multidimensional hurdles in order to succeed, involving the detailed testing (initially at a threshold level) of theories of liability, causation, attribution and loss.
Cost consensus proves elusive
Calculating the future cost of climate change has long confounded economists. Arriving at a consensus figure is seen by many as an essential step towards energy transition, helping policymakers set a price for carbon and define fuel efficiency standards. But agreement on the ‘social cost of carbon’ – that is, what it’s worth paying now to avoid a bigger financial hit in the future – has so far proved elusive. The range of variables that inform the modelling is so vast and complex that estimates range between tens of dollars and thousands of dollars per tonne of CO2. And without agreement on the cost of climate change, is it possible to determine how much individual actors should pay?
It is questions like these that run to the heart of the debate. Plaintiffs have aimed their fire at the corporations they believe have the deepest pockets and bear the greatest responsibility for historical emissions. But is it fair to view multinational energy companies as disproportionate contributors to this effort? And if not, who else should be in the frame?
These questions are controversial. Those that answer ‘yes’ will argue that what constitutes lawful, regulated activity has been influenced by targeted advocacy efforts. Those that say ‘no’ will point to the fact that energy production accounts for around 15 per cent of GHG emissions, with the remainder released by downstream consumption by every person who drives a car or travels by plane – and every industry that uses power.
Then there are issues around the mechanisms being used to bridge the funding gap. Are the courts – and the legal concept of civil liability – the right way to arrive at a figure? Is the plaintiff, lawyer-led litigation model, where cases can take years to reach a resolution, the most efficient approach? And does drawing corporations into fighting suits on multiple fronts focus minds or distract them from investment and research that could have a greater impact?
Just like the scientific processes that drive it, tackling climate change requires a complex and multifaceted response in which governments, businesses and citizens all have a role to play. The challenge will be finding a way for them to do that together.
Climate change is a pressing problem for the world with significant consequences and challenges, and energy is relevant to almost every environmental and social issue the world faces. Holding energy companies solely accountable for climate change raises many issues, as fossil fuel companies were founded on energy needs at a time when the effect of fossil fuels on the climate was unknown. As we move to a cleaner-energy world the transition issues are complex, driven by government legislation, politics and economics, and led in large part by continued demand and supply.
Litigation risk is certainly a consideration for investors with regard to ESG issues, including climate change. One problem though is around accountability, particularly for activity undertaken decades ago when climate change wasn’t on the agenda. That said, investors do expect management to have risk frameworks in place to control and monitor the environmental impact of their operations.
Companies in all sectors have a central role to play in developing alternative, affordable solutions and products that reduce climate change impacts, and in making their own operations as resource efficient as possible. Major fossil fuel producing and consuming countries are implementing stringent environmental regulations to address these challenges.
Energy efficiency makes economic and environmental sense and the world’s dependence on oil and gas will continue to reduce as alternatives are sourced and developed. But we would caution that the new development of fossil fuels needs to take into account the risks that developing those reserves may pose. For investors it is about the mitigation of risk and harnessing the power of capital markets to invest in companies that are forward-looking, embrace new technology and are adapting their business models to be more sustainable. As active long-term investors, we believe that engagement with management teams is vital to influence corporate strategy and hold companies to account, and work to enhance disclosure around the impact a company has on the environment.
On fossil fuel disinvestment, the impact will be different depending on what areas you are looking at. From an investment perspective, the cost of capital could rise as more of our clients wish to move out of oil and coal. It will also be dependent on which types of fossil fuel the disinvestment is focused on. For long-term investors, such as fixed-income investors who hold bonds until maturity, the risk parameters may affect the decision on which bonds to buy, and therefore where to allocate capital. Equity investors may see less impetus initially, given the trading ability in and out of stocks. However, in general it may be harder for companies to raise capital in certain markets and from certain asset classes.
Amanda Young
Head of global ESG research at Aberdeen Standard Investments
As we move to a cleaner-energy world the transition issues are complex, driven by government legislation, politic and economics.
