A landmark legal ruling in the Hague has ordered Royal Dutch Shell to move faster to bring its emissions in line with the Paris Agreement on climate. Thomas Tayler, a trained lawyer and senior manager at Aviva Investors’ Sustainable Finance Centre for Excellence, assesses the fallout.
Major listed companies are finding themselves the target of legal action designed to make them move faster in lowering their carbon emissions. In the latest and what some are calling game-changing development, on May 26 Royal Dutch Shell was ordered to cut scope 1, 2 and 3 emissions by 45 per cent from 2019 levels by 2030.
The decision could open the floodgates for similar action
The judge ruled action is necessary to avoid Shell breaching its duty of care to prevent harm and to respect human rights. While the company will appeal, environmental lawyers and campaigners believe the decision could open the floodgates for similar action against other major corporate emitters.
In this Q&A, Thomas Tayler looks at the judgement and the implications for oil majors and investors holding carbon-heavy assets.
What is the significance of the judgement against Royal Dutch Shell?
It's the first time a private company has been ordered by a court to cut greenhouse gas emissions. Previously, climate litigation led to countries having emissions targets imposed by the courts, most notably in the Netherlands, but this is the first time a company has been ordered to act.
Litigation is contributing to the transition to a low-carbon economy, encouraging governments and companies to go further and respond to society's need to tackle climate change. It is part of a wider pattern, where we have seen more climate cases being brought to the courts. (Read about trends in climate litigation, here).
The judgement was based around the concept of civil wrongs, grounded in a particular part of the Dutch Civil Code which incorporates duty of care. It makes it unlawful for an entity to act in conflict with a generally accepted standard of care. That means Shell must act in a way consistent with what society would expect.
That is not the case in the UK. We have different classes of negligence, and they can evolve, but we do not have the same kind of catch-all. There are certain, specific things a court would need to be persuaded of by a litigant to allow it to find a new class of duty of care.
The judge combined some bold assumptions about what society believes about climate change, what society believes about human rights and what society expects of businesses; in doing so they have really moved the debate forward.
For example, the court said there was no dispute about the fact Shell’s actions were contributing to global warming. This was still something oil and gas majors were debating a few years ago. That acceptance of climate science and climate attribution is where the next wave of climate litigation will come from.
Our climate engagement escalation programme highlights there are about 30 companies responsible for around one third of global emissions. They will be looking at these issues extremely carefully.
It has taken a long time to reach the point where a court has ruled against a major oil and gas company. Were there any specific factors that made it possible?
The judge used principles from conventions on human rights and the global norms around them in an elegant way. Article Two of the European Convention of Human Rights (the right to life) and Article Eight (the right to private and family life) were the pertinent ones.
It reads across to everyone, because of the global nature of the problem
She did not consider the impact of Shell’s actions across the whole world, but solely in the Netherlands, considering how global warming is affecting citizens there. But it reads across to everyone, because of the global nature of the problem.
The fact the Dutch government had been ordered by the courts to cut emissions was cited as a precedent for the fact that Articles Two and Eight gave protection against the consequences of climate change. This judgement builds on the previous decision.
The judge also referred to the UN guiding principles on business and human rights and OECD guidelines for multinational enterprises as standards for what businesses should do. This is another area where the judge was bold, because although it is universally accepted businesses should respect human rights, this ruling sets out clearly that doing so should not be passive.
The responsibility covers the whole of Shell’s value chain, including Scope 3 emissions – the emissions generated from users of Shell’s products. Shell argued that it did not have a legal obligation to reduce these, but the court disagreed. That is a big step forward.
There is recognition of the climate science, and the first part of the judgement is a useful summary. The judge acknowledged Shell was only partly responsible for warming, but that did not absolve it of its responsibility to act. They rejected Shell’s argument that if it was made to reduce emissions, one of its competitors will simply fill up the space as an excuse not to make those reductions.
Making a 45 per cent reduction might be costly but the need to reduce emissions trumped that
One of the most staggering things the judge said related to how much the emissions reductions might curb Shell’s growth. She accepted that making this 45 per cent reduction might be costly from a commercial perspective, but the need to reduce emissions trumped that. This is an incredibly important conclusion and one that others will be sure to want to use as a precedent in future actions.
The judge acknowledged Shell is not currently breaking any laws. But if the reductions in emissions are not made, that will breach this unwritten standard of care. Hence the need to change tack and rethink the strategy laid out to investors. She was quite scathing about those plans, which she said had too many caveats; she wants something concrete to reduce emissions.
How important might legal action be relative to other tools to address the climate emergency, like carbon taxes or investor pressure?
Litigation has enormous power to signal what society is happy to tolerate. Sometimes the threat can be as important as the litigation itself. If companies and governments believe they are going to face sanctions if they do not fulfil their responsibilities, that is a powerful incentive to do the right thing.
There are other levers that signal to the markets that assets not aligned with the transition will not be good investments in the long term
But there are other levers that might be more powerful, including specific targets and policy changes. Those are the things that signal to the markets that assets not aligned with the transition will not be good investments in the long term.
We also need to reorientate the global financial architecture to achieve a smooth and just transition and add to the focus on disclosure with a focus on transition planning. There is already reference to consideration of legal risk within the principles set out by the Task Force on Climate-related Financial Disclosures. Perhaps that has been a little bit overlooked so far due to the understandable focus on physical and transition risks, but people have to take it more seriously.
We need more forward-looking scenario analyses and assumptions built into investment and risk decisions. Think about what happens when you are driving and you spend all your time looking in the rear-view mirror, not the windscreen. You will crash.
So, investors need to think differently about litigation risk?
A private company has been told by the court its transition plans are not good enough. Hopefully this event has signalling value and will help companies realise they need to make changes consistent with where society needs to get to.
Do you see the risk of asset stranding increasing in the light of the Shell judgement, shareholder revolts at ExxonMobil and Chevron, as well as the Bank of England signalling the carbon price could reach $150 by 2030?
It's hard to judge the long-term impacts, but it will make people bolder in using the tools available. We are going to see more shareholder resolutions and litigation, and companies and their investors need to prepare for that.
It is sometimes more effective for companies to look for collaborative solutions
When facing litigation or a shareholder resolution, it is sometimes more effective for companies to look for collaborative solutions. For example, the BP shareholder resolution that we co-led was effective because management collaborated and supported it.
Oil majors need to start making production cuts, and that will potentially influence their stranded asset risk. The International Energy Agency recently published its 1.5 degree pathway, which stated there is no need for new oil or gas exploration in the energy transition. Most majors, with perhaps the exception of BP, assumed they could keep finding new reserves and keep pumping while the energy transition got under way. However, it is clear that further exploration to find new gas or oil is inconsistent with the 1.5-degree trajectory.
The Bank of England’s forward guidance on the cost of carbon can be factored into investors’ scenario analyses. They need to be asking: ‘Is this business viable if it has to pay a carbon price of $150, or are there sufficient carbon credits out there to let this business continue as it is? Or do we need to see a clear plan from management about how it is going to transition?’ It gives a powerful signal.
Do you expect changes to the cost of capital for oil majors?
I believe there will be effects for heavy polluting industries, caused by carbon prices and subsidy shifts. We've had a lot of government rhetoric and pledges on these things going right back to the Rio Declaration in 1992. But we're running out of time and governments can’t keep kicking the can down the road.
The sooner countries take the necessary steps the smoother the transition is going to be
Will countries eventually take the necessary steps to fulfil the objectives of the Paris Agreement? If they do, we will see significant changes. The sooner they happen, the smoother the transition is going to be.
But if they continue to delay, we will either get a disorderly transition with a lot of disruption of value or end up in a hothouse scenario where warming is out of control. It might be that if we cross two or two and a half degrees then we breach tipping points and experience a set of feedback loops that put warming out of control. We could suddenly find ourselves with five or six degrees of warming. In that scenario, the financial system in its current form will not exist and even humanity’s existence will be threatened.
Is there a role for litigation to play in carbon offsetting, in ensuring the validity of the credits?
Yes. The science tells us the emissions we do not put up now give us a little longer to deal with things. We will need offsets for some hard-to-abate industries in the medium term. Whether that's based around nature-based solutions or applied technologies, we will have to work out on the way.
Ensuring the integrity of the offset market is something we need to focus on
Litigation may be useful if you find people gaming the system. You may have a forest with a fence around it, but it might have been ‘sold’ six times to different parties. So, ensuring the integrity of the offset market is something we need to focus on.