Energy majors, cement producers, utilities and financial services providers are among the latest targets of legal action designed to make them move faster towards a lower carbon world. Could this be an inflection point, as the conversation turns to specific responsibilities rather than vague commitments to change?
Achieving net zero stands prominently in Royal Dutch Shell’s corporate strategy, just behind its commitment to shareholders. The oil major has already agreed to reduce the carbon intensity of the energy it sells and aims to become a net-zero emissions business by 2050. Shell says its ambitions are “in step with society’s progress”1 towards a lower carbon world. But is this enough?
In a game-changing development, the company was on May 26, 2021 ordered by a judge in the Hague to cut scope 1, 2 and 3 emissions by 45 per cent from 2019 levels by the end of the decade. This captures operational emissions as well as emissions generated from the fuel sold by Shell on the forecourt.
“This is very significant,” explains Tom Tayler, senior manager at Aviva Investors’ Sustainable Finance Centre for Excellence. “Previously, climate litigation led to countries having emissions targets imposed by the courts, most notably in the Netherlands, but it is the first time a company has been ordered to cut emissions by the courts.”
The judgement2 was based around the concept of civil wrongs established in the Dutch Civil Code. It makes it unlawful for an entity to act in conflict with a generally accepted standard of care. Shell, and others, must act to prevent harm and in a way consistent with what society expects. [Detailed analysis of the judgement can be found here.]
“The judge combined bold assumptions about what society believes about climate change, what society believes about human rights and what society expects of businesses; in doing so, she really moved the debate forward,” Tayler says.
“One of the most staggering things she said related to how much the emissions reductions might curb Shell’s growth. She accepted the 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 others will be sure to want to use as a precedent in future actions.”
While Shell will appeal, comments from its CEO Ben van Beurden suggest the climate message has landed. “We will seek ways to reduce emissions even further in a way that remains purposeful and profitable,” he said in an interview in June. “That is likely to mean taking some bold but measured steps over the coming years."3
While legal manoeuvres may continue for months, the judgement is seen as a major step forward by environmental campaigners. The man behind the case was high-profile environmental lawyer Roger Cox, author of Revolution justified: Why only the law can save us now.4
In representing Milieudefensie (the Dutch arm of Friends of the Earth) against Shell, Cox argued Shell was “on a collision course” with the climate target set out by the international scientific community and numerous governments. To meet the Paris Agreement, where the goal is to limit global temperature increases to below two degrees Celsius above the pre-industrial average, and ideally to 1.5 degrees, Shell has been told to do more.
Testing the law as a governance tool
Meanwhile, the volume of climate-related litigation around the world is stepping up. Since the Rio Earth Summit in 1992, a large body of climate legislation has been developed (see maps in Figures 6 and 7), with assorted stakeholders and pressure groups prepared to test it.
Cases have almost doubled from 884 to 1550 since 2017.5 Most litigation (79 per cent) has been in the US; just 10 per cent has been directed at corporates. The majority of the 135 businesses facing challenges are energy and natural resources companies, with litigation concentrated in six areas: the rights to life and a clean environment, the need to keep carbon in the ground, areas of corporate responsibility, enforcement of climate targets, adaptation impacts and climate disclosures. The last category includes a growing number of financial markets cases, focusing on financial risks, fiduciary duty and corporate due diligence, affecting banks, pension funds and asset managers.6
Figure 1: Direct and indirect cases involving the private sector7
Source: Grantham Research Institute on Climate Change and the Environment, July 2021
At this stage, the financial consequences are unclear. “Our understanding of the potential costs arising from climate change litigation is very poor,” wrote Javier Solana, a lecturer at University of Glasgow’s School of Law, in an academic paper last year.8 “Contrary to popular understanding, not all direct costs will arise at the end of legal proceedings.” Ultimately, total costs may be much higher than headline fines or court orders, particularly if litigation results in negative publicity and long-lasting reputational damage.
The younger generation wants to see more action; they are taking this much more seriously
The action is testing the role of the judiciary and reflects important social questions around values and expectations. “There is a definite generational shift underway,” says Paul Pritchard from sustainability consultant Iken Associates. “People have been talking about climate for 25 years, but it is only recently that views have started to crystalise. The younger generation wants to see more action; they are taking this much more seriously,” Pritchard says.
For Tayler, the nature of the language being used by the courts to support calls for fairer treatment and intergenerational fairness is worth noting. In Australia, for example, a recent judgement suggested failure by the environment minister to take climate action on coal could wreak “devastation” on children, forming part of part of “the greatest intergenerational injustice ever inflicted by one generation of human upon the next”.9 Germany’s Constitutional Court has also deemed the 2019 Climate Change Act unconstitutional for placing too much of the decarbonisation burden after 2030. It declared that one generation could not be given the right to consume a large share of the CO2 budget if it left radical reductions to others and exposed them to “comprehensive losses of freedom."10
Pritchard believes the underlying value shift will become increasingly apparent in consumer action: “They will reflect their values and choices in their behaviour, where they work, where they invest their money and so on.”
Figure 2: Climate-related litigation: Total cases 1986-201911
Note: Each dot represents one case.
Source: Freshfields Bruckhaus Deringer, December 2019
Figure 3: Climate-related litigation: Cases against companies 1986-201912
Source: Freshfields Bruckhaus Deringer, December 2019
So, how do experts view Cox’s latest crowdfunded challenge? “The Shell case in the Netherlands is important, because it addresses whether Shell is going to deliver on its targets. Those that brought the case said: ‘It does not look as if you are going to do that’ and are really calling on Shell to change its core business model,” says Joana Setzer, assistant professorial research fellow at the Grantham Research Institute on Climate Change and the Environment at the London School of Economics. (Read a detailed interview with Setzer here.)
The key analytical tool that might prove pertinent is climate attribution. This rapidly evolving science allows human impacts on climate change to be assessed (within certain data constraints), right down to the individual company level. By taking a pre-industrial climate scenario, then comparing it with one that takes man-made emissions into account, it may be possible to define the human contribution in a particular scenario.
These developments are significant because until recently it was not possible to be definitive about causative relationships: to establish that a single company’s actions might have contributed to a particular weather event.
“Because of the causation issues, quantifying damages for acceleration of climate change may be difficult,” noted law firm Norton Rose Fulbright.13 The evolution of climate attribution has gripped the legal profession; a judge hearing a case in the US is reported to have asked for a relevant ‘teach-in’, to help him prepare.14
“This is where the work of Dr. Friedereike Otto, Richard Heede and others has made a real difference,” Setzer says. (More from Otto here). “They have developed attribution science, but they are also producing science that is useful for courts. We had science produced prior to that, but lawyers couldn’t readily use it. Now the lawyers and scientists are talking, the scientists are producing information that is purposeful and this is already making a difference.”
One important consideration in legal action is whether greenhouse gas emitters can be shown to have known about environmental risks but pressed ahead with harmful activities regardless. If evidence like this coexists with information from an internationally recognised body like the Intergovernmental Panel on Climate Change, companies may find it harder to have the cases against them dismissed.
“The ruling against Shell is game changing,” says Sora Utzinger, senior environmental, social and governance (ESG) analyst at Aviva Investors. “Prior to now, most of the behaviour change related to climate has come about from top-down regulation. More governments have announced plans to reach net zero, and companies have changed their behaviour accordingly, to reflect what society wants to achieve. This is different; it makes company commitments binding.”
Meanwhile, environmental consultants warn of oversimplifying the analysis, making it all about the few. “One concern I have is about the need for quite a simple narrative, about good guys and bad guys,” says Pritchard. “It is not particularly helpful to demonise a small group of companies. The oil majors are not the only ones involved here.
“They might be supplying a product, but lots of others are using it, and perhaps those individuals could be doing more to look for alternatives themselves,” he adds. “I hope the discussion becomes broader. There are companies that need to be held to account, but hopefully that does not lead to the conclusion that only a handful are the problem. It is much bigger and more complex than that. We need to be asking more questions, like who burns the gas and puts the aviation fuel in the planes?”
Facing up to responsibility for the global commons
Meanwhile, in Germany, another climate case is being played out. A small-scale Peruvian farmer, Saul Luciano Lliuya, is taking on the German utility RWE, backed by the sustainable development organisation Germanwatch.15
German regulations require an end to coal-fired energy generation by 2038
RWE is one of Europe’s largest carbon dioxide emitters, giving out around 100 million tonnes of CO2 annually from fossil-fuel fired power stations and other assets. It has plans to phase out coal and be carbon neutral by 2040.
“German regulations require an end to coal-fired energy generation by 2038,” says Utzinger. “RWE plans to use one of the dirtier fuels right up to that regulatory deadline. Other European peers seem to be moving faster in the energy transition, although generally they are all ahead of their equivalents in the US.”
Lliuya lives in the Andes, about 280 miles north of Lima, where rising temperatures have led a glacier to retreat. The melting ice is feeding a glacial lake, which threatens to burst. If it does, it will affect Lliuya and the lives of thousands of other local residents.
“This is the first lawsuit in Europe where a person affected by the hazards of climate change has sued a private company,” Germanwatch says.16 Lliuya is seeking damages from RWE to compensate for the investment he has made to protect his home. The amount itself is not vast – less than half of one per cent of the total cost incurred by himself and the local authorities. That’s the same percentage as RWE’s estimated contribution to global greenhouse gas emissions since industrialisation began.17 If Lliuya’s legal team is ultimately successful using a ‘general nuisance’ clause in the German Civil Code, it potentially opens the floodgates to countless other claims.
Litigation like this presents both a risk and an opportunity from an ESG perspective
“Litigation like this presents both a risk and an opportunity from an ESG perspective,” says Utzinger. “Companies can differentiate themselves through the progress they make as they move towards an effective low-carbon transition. But we should not underestimate the risks. These cases could set quite wide-ranging precedents in terms of establishing a company’s liability towards society, not based on a specific locale.”
To clarify, RWE is in the dock for impacts in Peru, although it has no operations there at all.
In a story of many twists, RWE has now taken legal action against the Netherlands in a Є1.4 billion corporate/state dispute. It is looking to offset the cost of retiring a coal-fired power station early;18 that decision came about after Cox’s successful case against the Dutch government. RWE is the subject of climate litigation and also using it.
The complex web linking social values and risk
So, what does this imply? “We see the right to environment emerging globally,” says Laura Burgers from the Amsterdam Centre for Transformative Private Law at the University of Amsterdam.19 “We see the environment as a foundation of society, as a part, a necessary condition, of constitutional democracy, as a condition to be able to exercise the other rights you have.”
Many defendants in climate cases point out they are not responsible, but it is rather a global responsibility
Because environmental issues transcend national boundaries, there is an obvious governance challenge. “It is interesting that many defendants in climate cases point out they are not responsible, but it is rather a global responsibility,” she says. “And they are right – climate change is a global issue that can only be addressed effectively if everyone is on board. At the same time, it means we all should actually be on board!”
The analytical framework that has developed to encapsulate the changing environment involves an intricate web of physical, transition and litigation risk. “As physical risks become larger, so does the litigation risk,” Setzer says. “But transition risks also increase litigation risk. This is why it is important for private actors to track cases against states, not just cases against companies they invest in or insure.”
Important implications flow from this. Recent analysis by the UN Environment Programme points to six key areas where litigation may step up, as shown in Figure 4.
Figure 4: Future trends in climate litigation
Consumer and investor fraud claims increase
Claims against companies for failure to disclose or inadequate disclosure are expected to increase. Greater regulatory requirements and scientific advances mean climate events are more likely to be foreseeable, leaving companies at higher risk of litigation for failure to disclose.
Greater attention on climate attribution
Few climate-litigation cases have reached evidentiary stage, where courts have scrutinised whether alleged loss or injury is directly caused by climate change and the defendants’ contribution to it. The science of climate change is becoming more robust. Attribution of responsibility is central to climate litigation; expect climate attribution to receive more attention.
Increased use of international adjudicatory bodies
Judgements may be sought from international adjudicatory bodies rather than domestic regimes which may not be effective at holding governments to account. Opinions from international bodies may not be enforceable, but they can influence how judges and other stakeholders view the law.
Source: UNEP Global Climate Litigation Report: 2020 Status Review, January 2021
Where might these various risks present? What mechanisms might be lightning rods for risk transmission?
No clear answers emerge. A high-profile case could prove a tipping point, but Pritchard believes a more likely outcome is that litigation will “pick up laggards, rather than drive change fundamentally”. Perhaps controversially, he suggests attention is being directed at climate risk “because it has universal metrics; it can be measured in terms of greenhouse gases”.
In his view, other nature impacts connected with climate change, such as biodiversity loss, need attention too. “In some ways, a focus on nature-related impacts rather than greenhouse gases might afford an easier route to litigation, not least through geographic dependencies that allow cause-effect pathways to be constructed,” he says.
If carbon-heavy businesses accelerate towards transition, will their return on capital fall?
There is plenty of stakeholder tension to contemplate as well. If carbon-heavy businesses accelerate towards transition, will their return on capital fall? Could that leave emitters open to criticism from climate change activists as well as disgruntled shareholders, with risk on both counts?
“They are, in a sense, damned if they do and damned if they don’t,”20 as law firm Freshfields Bruckhaus Derringer puts it.
“Climate transition risks are being taken much more seriously by the oil majors,” Utzinger says. “They are factoring them into the capital budgeting process, resulting in a higher cost of capital. Those on the path to net zero know they have to de-risk their traditional upstream business; that’s why they talk about ‘advantaged resources’, where there is a sweet spot between low breakeven prices and lower emissions intensity.
“Of course, returns on invested capital (ROIC) vary across hydrocarbon and low-carbon energy sources,” she adds. “We think companies should not just focus on ROIC but on the underlying risk profile – ultimately knowing where to play and understanding where established capabilities can create value in the low-carbon space is going to be a critical component of strategy.”
Figure 5: Assessing litigation risk21
|Metrics and targets
|Litigation risk role:
|Incorporation of climate-related litigation risk into the governance of an organisation, including in relation to the senior management and directors' responsibilities.
|Consideration of climate-related litigation risk when defining the sustainability and overall business strategy for ensuring a robust and forward-looking business model.
|Incorporation of climate-related litigation risk into the risk management function, including identification, assessment, mitigation, monitoring and reporting.
|Definition of metrics and targets for climate-related litigation risk management.
Source: UNEP, January 2021
All this suggests an environment that requires thoughtful handling, particularly as there is little consistency with carbon disclosures yet. Ultimately, best practise means companies that could be targets of climate action need to inform their shareholders, build provisions, and ensure material risks are reported. In the background, they need to recognise the potential to be challenged in jurisdictions in which they do not operate.
Institutional investors need to think carefully about their duties to clients
Institutional investors also need to think carefully about their duties to clients, how their risk exposures are being presented and their ability to verify any claims being made about environmental credentials. Cases to bear in mind include McVeigh vs. REST, where a 25-year-old member of an Australian pension scheme won a case after suggesting the scheme was not doing enough to protect his savings.22 Ultimately, the scheme agreed climate change implied a “material, direct and current financial risk”, to align its portfolio to net zero by 2050, and report using the guidelines agreed by the Task Force on Climate-related Financial Disclosures.
Insurers also need to prepare for detailed scenario analyses with forensic scrutiny of underwriting decisions and the assets they hold, to help mitigate the uncertainty.
These changes reflect the complex way the environment is changing, how environmental protest has become global and how climate action is part of an evolving social debate.
“Litigation is being used in every direction, and we are going to see more of it,” Setzer warns. “The terrain becomes complex, risks and uncertainty are high, and the players involved are powerful. It will be a hard fight.”