1. Introduction
On 27 February 2024, a client insight from a leading arbitration law firm highlighted that, ‘[r]enewable energy investments generally thrive on stable policy frameworks. Faced with unwelcome policy changes or the withdrawal of investment incentives, prudent investors will investigate the investment protection treaties available to them’.Footnote 1 It further noted that, ‘[e]xperience shows that securing investments through investment protection agreements can effectively ensure the profitability of foreign investments’.Footnote 2 This client insight provided reflections on the lessons learned from the storm of investment treaty claims faced by Spain and Italy in response to the alteration of their renewable energy (RE) support frameworks more than a decade ago.
At the time of writing, over 190 publicly knownFootnote 3 investment treaty claims have been filed by RE investors against host states. A large chunk of these claims has been filed against Spain and Italy, under the Energy Charter Treaty (ECT), to seek compensation for reduction in profit margins resulting from measures altering RE incentive programmes.Footnote 4 The exact measures challenged vary among jurisdictions, and to a lesser extent among different types of RE projects (e.g. photovoltaic, concentrated solar, onshore or offshore wind);Footnote 5 however, regardless of the variations, the measures were challenged for having reduced investors’ expected returns. The central claim presented by investors was that changes to the incentive schemes amounted to a breach of their legitimate expectations under the fair and equitable treatment (FET) standard found in the ECT’s Article 10. Respondent states argued that these alterations were made due to growing tariff deficits created by the generosity of incentives and the rising cost of electricity for consumers, threatening the sustainability of the entire electricity system.Footnote 6 More crucially, they have argued that RE investments have remained profitable despite the alteration of incentives.Footnote 7 In resolving these disputes, arbitral tribunals had to decide whether investors had a legally protected expectation, enforceable under international law, to generate a certain profit margin throughout the life-cycle of an investment. As is typical for investment treaty arbitration,Footnote 8 and as will be discussed later in this article, different and inconsistent lines of decisions have emerged in relation to this question.
In this article, I assess how investment treaties have been interpreted to safeguard strong profit margins as legal entitlements for ‘green’ investments and query the extent to which the interpretation and treatment of profit margins in this context may interfere with just transition goals. Implementing a transition towards a low-carbon economy requires huge transformations of economies and societies with significant distributional impacts.Footnote 9 For this major transition to be just and equitable, policies and practices should work towards ensuring that the move to a low carbon economy does not exacerbate existing inequalities and leave people, workers, places, sectors, countries or regions behind.Footnote 10
There is an ongoing academic and policy debate on the role of investment treaties in shaping climate action.Footnote 11 With the energy sector and the energy transition being at the heart of global and national climate policies, a large chunk of the analysis focuses on this dimension of climate action. Thus far, concerns have primarily – and rightfully – been raised about the role of international investment law in protecting fossil fuel investments and the impact of such legal standards on delaying or raising the cost of climate action.Footnote 12 Here, questions remain over whether fossil fuel investments should receive legal protectionFootnote 13 and, if so, how these assets should be valued by investment tribunals.Footnote 14 As far as climate-friendly investments are concerned, the focus of the debate has largely been on the role of investment treaties in incentivising renewable energy investments.Footnote 15 Whether relying on investment treaties to protect RE investments can be conducive to just transition outcomes has not been the subject of much academic discussion.Footnote 16 For RE investment disputes, much of the scholarly writing has focused on how these awards have dealt with the interpretation and scope of legitimate expectations and the FET standard, but without critically engaging with the issue of profitability and its relevance to just transition goals.Footnote 17
In an article taking a more critical stance, Matteo Fermeglia reviewed how RE awards engaged with the issue of damages and found that they largely failed to take equitable considerations into account.Footnote 18 This article contributes to the debate in this field by critically examining the role of profit rates in RE arbitral awards and how profit rate entitlements protected under investment treaties can undermine just transition goals. To do so, it situates investment treaties within the ‘de-risking’ ecosystem dominating energy transition policies.Footnote 19 De-risking refers to the policy prescription to mobilise private finance for public goals by rendering public infrastructure, such as renewable energy networks, investable and profitable – that is, bankable – through alleviating long-term risks and boosting long-term returns.Footnote 20 States are expected to absorb long-term risks to profitability through fiscal and regulatory enablers that enhance business profitability.Footnote 21 Situating investment treaties within the de-risking ecosystem and analysing their impact within the energy transition context from this lens help to reveal a more comprehensive understanding of the pitfalls facing states – particularly developing states – in crafting just transition policies. There is a growing reliance on the de-risking model in climate financing deals offered to developing states.Footnote 22 The reforms enacted to implement these deals and create bankable project pipelines are likely to form the basis of investor expectations for strong long-term returns. This is particularly so because investment treaties act as long-term legal guarantors of these de-risking measures by codifying strong profit margin expectations as legal entitlements,Footnote 23 as is apparent from the analysis of European RE case law in Section 3. In addition to the codification of strong profit margins in case law, an important finding emerging from the RE case law is the dominant role played by the financial sector, rather than renewable energy firms themselves, in shaping profit expectations and investment treaty claims.
The legal safeguards offered by investment treaties shape the extent to which states are expected to ‘absorb long term risks to profitability’, and thus threaten equitable burden sharing necessary for a just transition. To better understand the relationship between investment treaties and just transition goals, this article charts the interaction between de-risking policies, codification of long-term profit margins as legal entitlements under investment treaties and just transition principles. In light of the findings presented in the article, it offers a new pathway for integrating profitability questions and considerations of burden-sharing into proposals for rethinking the future of investment governance.
Section 2 discusses the key features of scaling up clean energy, financing models and the de-risking approach. Here, it situates investment treaties within the de-risking ecosystem to illustrate how they function within it as a legal regime serving to lock in strong profit margins. Section 3 then maps out how profitability levels factor into the implementation and interpretation of investment treaty protections in the context of RE disputes. To illustrate how investment treaties operate as a de-risking device in the RE sector, this section delves into an analysis of arbitral awards from the Spanish renewables saga. This helps reveal the operation of the FET standard to codify long-term strong profit margins as legal entitlements. Section 4 argues that investment treaties’ role within the de-risking ecosystem disrupts possibilities of equitable burden-sharing demanded by a just transition approach. It then reflects on the possible alternative approaches for profits factoring into an investment governance model compatible with a just transition.
2. Scaling up clean energy, the de-risking paradigm and investment protection
To strengthen the global response to the climate emergency, contracting states to the Paris Agreement have committed to ‘making finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development’.Footnote 24 The UN Framework Convention on Climate Change (UNFCCC) and the Paris Agreement enshrine the principles of equity and common but differentiated responsibilities and respective capabilities (CBDR-RC).Footnote 25 These are recognised as guiding principles of the international climate regimeFootnote 26 and they place a greater responsibility on developed countries to take action due to their historic and current levels of contribution to climate change as well as their stronger economic position.Footnote 27 The CBDR-RC principle informs various commitments under the international climate treaties with the effect, inter alia, that developed states have an obligation to provide financial resources and technology transfer to developing states for the latter to be able to meet their mitigation commitments and adaptation needs.Footnote 28
Within global and national climate policies, decarbonising energy systems takes centre stage, and within energy transition, electrification of energy use and decarbonisation of electricity generation remain central objectives.Footnote 29 Taking urgent steps towards energy transition is not only necessary to fulfil international legal commitments under various international climate change agreements, but also essential for states to fulfil their obligations under international human rights law and prevent human rights harms caused by a changing climate.Footnote 30 As the climate emergency poses significant threats to the enjoyment, realisation and protection of the entire catalogue of human rights, states have a duty to prevent harms to human rights that may result from the climate emergency.Footnote 31 Decarbonisation is therefore crucial for preventing and mitigating such harms.
To achieve decarbonisation goals, the world needs to scale up renewable energy capacity and ensure greater access to minerals that are critical to an electrified world. It is estimated that enhancing renewable energy capacity to sufficient levels requires annual financing of US＄1.55 trillion to invest in power generation and US＄720 billion to invest in and upgrade power grids until 2030.Footnote 32 Overall, a 2024 analysis by the UNFCCC Standing Committee on Finance estimates that the financing needed for developing countries to implement the Convention and the Paris Agreement goals is at least between US＄5 trillion and US＄6.8 trillion until 2030.Footnote 33 Given that 2030 is rapidly approaching, this is a tall order to achieve within a very short timeframe, with financing needs growing and the climate deteriorating further each year without meeting the annual targets.
Given the human rights imperative to tackle the climate emergency and scale up RE investments, and the value ascribed to investment treaties in catalysing such investments, there may be an ostensible confluence of functions between investment treaties and just transition goals as far as climate-friendly investments are concerned. In the following sections, I look behind this apparent confluence to assess whether investment treaties can facilitate a just transition, particularly when situated within the de-risking policy ecosystem. In assessing this ostensible confluence, it is important to bear in mind that, while facilitating climate-friendly investments is imperative for states to fulfil their obligations under international human rights law and international law, there is also a human rights imperative to ensure that such investments do not undermine a just transition.Footnote 34 A just transition approach is generally understood to require inclusive and participatory decision-making,Footnote 35 enable the creation of decent work for communities and respect the human rights of investment affected communities.Footnote 36 While there are different conceptualisations of what just transition entails, a common thread among these approaches is a focus on the alleviation of existing socio-economic inequalitiesFootnote 37 and ensuring equitable burden-sharing among actors as well as across generations.Footnote 38 In its recent Advisory Opinion, the ICJ clarified that, under the customary international law duty to cooperate, states are required ‘to continuously develop, maintain and implement a collective climate policy that is based on an equitable distribution of burdens in accordance with the principle of [CBDR-RC]’.Footnote 39 Further, the IACtHR clarified that in developing climate policies, states are under an enhanced due diligence obligation that, among other things, requires ‘the integration of the human rights perspective into the formulation, implementation and monitoring of all policies and measures related to climate change to ensure that they do not create new vulnerabilities or exacerbate preexisting ones’.Footnote 40
I argue that even if investment treaties might play a role in supporting climate-friendly investments,Footnote 41 they disrupt the human rights imperative that the transition to a low carbon economy be just. They do so by acting as long-term legal guarantors of de-risking measures that construct enabling regulatory environments conducive to long-term profit maximisation. Modes of financing and the legal frameworks applicable to transition investments shape the terms of burden-sharing and the allocation of risks and benefits within the energy transition.Footnote 42 If investors are disproportionately shielded from long term risks to profit maximisation, as is apparent from many arbitral awards concerning RE disputes discussed in Section 3, the cost of maintaining that protection bubble will be shouldered by the public. This model of international investment governance is incompatible with the duty of states to ‘ensure an equitable distribution of the burden of climate action … [and] avoid the imposition of disproportionate burdens on members of both future and present generations … the latter would happen if, for example, the costs of the energy transition are allocated without taking into account the vulnerability of certain groups of the population today’.Footnote 43
A. Financing energy transition through de-risking
Despite significant reductions in renewable energy generating costs over the past decade, making it cheaper than fossil fuel-based power generation,Footnote 44 a multitude of reasons prevent the acceleration of renewable energy generation – particularly from solar and wind power – at the pace required.Footnote 45 The extent and reasons of these vary between different regions or countries, depending on their economic and political risk profile, as well as the mode of operation of their electricity market.Footnote 46 Developing countries are particularly vulnerable to the reluctance of financiers to invest in renewable energy projects within those geographies.Footnote 47 Key among the reasons for this are lack of access to low-cost capital, risks arising from inadequate grid infrastructure and inadequate domestic regulatory frameworks for the sector to ensure proper functioning, transparency and stability.Footnote 48 As renewable energy investments require high up-front costs to set up, even though they have low operating costs,Footnote 49 they typically need to be financed.Footnote 50 It is more challenging for projects to secure financing – that is, be bankable – if the proposed investment is in a developing country.Footnote 51 In the words of one expert, ‘[t]here are large parts of the world where renewables investment is disproportionately costly specifically because finance is disproportionately costly’.Footnote 52
To address barriers to scaling up clean energy investments in the developing world, the de-risking approach has become a central policy prescription to catalyse private finance to support foreign investment in clean energy projects in developing countries.Footnote 53 Governments are unable to fund the energy transition from public budgets, as they do not have sufficient resources, and therefore the so called ‘Wall Street Consensus’ calls governments to mobilise private finance by ‘rendering green infrastructure assets investible and green manufacturing assets profitable, which in turn means meeting capitalists’ demands for lower – and more calculable – risk’.Footnote 54
De-risking requires states to absorb long-term risks to profitability involved in clean energy investments to boost risk-adjusted returns.Footnote 55 To de-risk and encourage investment, governments are urged to develop new or reform existing fiscal policy tools, such as carbon pricing, tax incentives and renewable energy support schemes such as feed-in-tariffs, or offer long-term power-purchase agreements.Footnote 56 In addition to fiscal policy, governments are expected to develop enabling institutional and regulatory structures that will ensure stability, predictability, transparency and respect for the rule of law.Footnote 57
Regulatory de-risking would entail dismantling regulatory barriers to profitability, ensuring the structure of the electricity industry allows private actors to partake, compete and maximise profits.Footnote 58 This calls for the elimination of vertically integrated and state-owned electricity sectors in favour of unbundled electricity marketsFootnote 59 that are governed in line with the above-mentioned principles. Because clean energy investments need to be perceived as bankable by financial institutions to go ahead, de-risking measures are ‘as much about intervening in, and shaping, markets for finance, as [they] are for shaping markets for electricity’.Footnote 60 In this respect, profit margin expectations in the RE market are largely shaped by the finance sector rather than by RE companies. This reality is also present in Spain’s RE investment dispute saga, discussed below.
To operationalise the de-risking approach in the energy transition context, various initiatives are emerging to mobilise large-scale private finance to invest in the renewable energy sectors of developing countries.Footnote 61 Just Energy Transition Partnerships (JETPs) are currently the leading model focusing on financing energy transitions in developing countries.Footnote 62 JETPs aim to generate financial resources and prescribe a range of fiscal policy tools and regulatory reforms to prepare host countries to attract large-scale clean-energy investments from the private sector.Footnote 63 JETPs also support moving away from coal in the energy sector and dedicate a small amount of funding to social and economic costs of the transition on communities.Footnote 64 However, their most significant feature is their policy prescriptions to create enabling regulatory environments that enhance the bankability – that is, profitability – of clean energy projects. These include prescriptions of privatisation and marketisation, unbundling of the electricity sector and the introduction of tariff incentives such as feed-in tariffs to secure strong profit margins for investors.Footnote 65
B. Investment treaties as de-risking devices
Generating profits is the core objective of business. For financiers and renewable energy developers to invest in large scale renewable energy projects, they must have some level of confidence that the business will be profitable, at levels they deem satisfactory, throughout the life-cycle of the project. Profit maximisation objectives are even more pronounced in the case of institutional investors and asset managers where fund managers’ fiduciary duties often impose a duty to maximise the value of their clients’ portfolio.Footnote 66 As discussed in the previous section, despite the dramatic falls in the cost of generating renewable energy, the sector still needs varying levels of incentives to attract investment and grow. One key reason for this is explained by Brett Christophers: ‘[D]espite the dramatic falls in costs … renewable energy sectors dominated by private capital nevertheless remain stuck on economic support from the state … For such support in practice is less about effectively keeping prices down than it is about keeping profits up’.Footnote 67
There is an even greater concern for developing states due to the impact of their economic and political risk profiles on future profit streams of renewable energy firms and their financiers.Footnote 68 A submission from the claimants in PV Investors v Spain is telling in this respect: ‘when effecting their investments in the PV sector, [claimants] also relied on Spain’s reputation as a safe place to invest, as Spain was a Western European country and EU Member State with a track record of protecting foreign investments’.Footnote 69 To alleviate concerns about investing in developing states, the standard prescription is to rely on policy and legal interventions (among others) to de-risk renewable energy investments as much as possible in order to instil confidence that satisfactory levels of profit will be flowing in the long term.
Climate financing arrangements themselves leave room for states to engage in regulatory experimentation over time to adjust de-risking measures so they can find the right mix. There is a concern, however, that investment treaties that protect investors who are benefiting from such arrangements will not be forgiving of such regulatory experimentation if it leads to reductions in investor profits. Investment treaty protections can assure investors that an enabling regulatory environment promising predictability and stability, created under climate finance frameworks, will be maintained unfettered by the host state.Footnote 70 Investment treaties support de-risking by obliging host states to accord certain legal protections to investors, such as non-discrimination and FET. If the host state fails to uphold these standards to the detriment of investor profits, it might be liable to pay compensation to remedy the losses of the investor. Moreover, the methods relied on by arbitrators in calculating compensation, namely the reliance on the discounted cash flow formula, have served to award investors the value of expected future returns.Footnote 71 In this respect, we can situate investment treaties and arbitration as part of the de-risking infrastructure.Footnote 72 Similar to the role that investment treaties were assigned in the context of the Washington Consensus to support the private sector becoming central actors in economic development of developing countries,Footnote 73 investment treaties are again viewed as guardians of stability for green investments within the Wall Street Consensus. However, the crucial question we should ask concerns the extent of de-risking or stability that is on offer under this framework and its potential impact on just transition objectives.
The dominant view among investment law scholars and key policy-makers is that investment treaties remain a crucial and necessary mechanism to facilitate climate friendly investments.Footnote 74 In fact, the wave of investment treaty claims filed by RE investors in response to alterations in several EU Member States’ renewable energy incentive structures may indicate that investment treaties are doing their job protecting climate friendly investments.Footnote 75 Still, we should not lose sight of the fact that investment treaties protect investments regardless of the business’s contribution to greenhouse gas emissions (fossil fuels) or its contribution to decarbonisation (renewable energy and transition minerals). Investment treaties also protect investments regardless of an investment’s contribution to the development of a host state,Footnote 76 and regardless of the investment’s human rights and environmental impacts.Footnote 77 In other words, their de-risking function is more comprehensive than the derisking present in climate financing frameworks aiming to mobilise private finance for a public purpose. While this has wide ranging implications on the function of investment treaties,Footnote 78 in the case of climate-friendly investments, it shows an amplification of the derisking prescriptions in climate finance by potentially shielding RE investors from the consequences of the harms their operations might cause on local communities.Footnote 79
The challenge this article addresses is not whether investors should receive legal protection and the promise of a transparent regulatory environment, but the level and extent of protection and de-risking offered and how the type of protection offered can compound privileges and vulnerabilities among different segments of society. It is clear from the emerging jurisprudence of international courts and tribunals that climate policies should be designed in ways that avoid exacerbating pre-existing vulnerabilities and inequalities within and among states.Footnote 80 It is important to scrutinise what investment treaties are de-risking, to what extent and for whose benefit. The answers to these questions can tell us more about how investment treaty protections relate to just transition principles and whether they are compatible with state obligations on climate change. The following sections address these questions through a review of the investment treaty case law (Section 3) and an analysis of its findings against just transition principles (Section 4).
3. Profit rates as legal entitlements under investment treaties
In this section, I delve into how far levels of profitability factor into the implementation and interpretation of investment treaty protections in the context of renewable energy disputes, particularly the interpretation of the FET standard. Many of the existing claims were filed against Spain and Italy under the ECT, for having altered their renewable energy incentive schemes due to growing tariff deficits created by generous incentives and the rising cost of electricity for consumers, at a time of financial crisis, threatening the sustainability of the entire electricity system. Investors have argued that these changes amounted, inter alia, to a breach of their legitimate expectations under the FET standard found in the ECT’s Article 10. A crucial argument made by respondent states was that the investments remained profitable despite the alteration or rollback of incentives.Footnote 81 Italy invoked the principle of fair remuneration embedded in its legislationFootnote 82 and the Spanish law refers to the concept of reasonable rate of return as the expectation set by incentive frameworks.Footnote 83
In a seminal paper, Matteo Fermeglia criticises the approach and methods adopted by several tribunals in assessing damages, where investments remained profitable undertakings, but not as profitable as they would have been had the alterations not taken place.Footnote 84 Building on his critique, here I trace the role played by profits and profitability in shaping arbitral decisions on FET and legitimate expectations, as a matter separate from the formulas and standards used in assessing damages. In doing so, it is important to bear in mind that ‘support policies for renewable energy are complex instruments designed to operate over long periods of time and in different economic circumstances’.Footnote 85 What emerges from the case review is: (1) inconsistency in terms of what constitutes a protected legitimate expectation under the FET standard in the renewable energy context; (2) the dominant role played by financial sector investors in initiating claims and the tribunals’ lack of engagement with this crucial fact when evaluating profit rate expectations; and (3) a concerning picture of the codification of strong profit margins as internationally protected legal entitlements.
In the remainder of this section, I discuss key lessons on profits and FET emerging from awards involving Spain as a respondent in RE disputes to illustrate the warning signs emerging from these awards for the future of just transition, especially for the developing world – which are being made to follow a similar kind of de-risking approach that was followed by European countries over the past two decades.Footnote 86 A review of 30 publicly available awards from the Spanish renewables saga shows three major lines of decision taken by tribunals in disputes largely involving the same or sufficiently similar factual matrix and the application of the same types of measures that led to a reduction in RE investor returns.
In a nutshell, investors have argued that after attracting RE investments through a generous incentive regime, which the investors were made to believe would remain unchanged for the operational life of plants, Spain has adopted successive regulatory amendments that eventually culminated in the replacement of the original incentive regime with a different incentive regime offering less favourable terms.Footnote 87 The disputes boiled down to the issue of whether Spain violated the FET standard found in the ECT, including whether it violated the legitimate expectations of the investors. Spain argued, inter alia, that the incentives were subject to an overarching ‘principle of reasonable profitability’.Footnote 88 It further argued that the amendments to the incentive regime did not alter the essential characteristics of the regime, which was designed to provide a reasonable rate of return to investors (RRoR)Footnote 89 with reference to the cost of money in the capital market.Footnote 90
Throughout the various disputes, Spain argued that the RRoR was around 7%.Footnote 91 This was the case when the regime was initially established, and it was the case under the amended regime. Spain argued that, under the original scheme, investors were making windfall or luxury profits, or were being over-remunerated.Footnote 92 The measures led to a reduction in returns but complied with the foundational principle of RRoR, while ensuring it did not over-burden consumers during a severe financial crisis.Footnote 93 Investors argued that the FET standard provided them with an entitlement to the rates of return they were receiving at the time of making the investment, for the entire lifespan of the project, even if this was above the RRoR. Alternatively, some claimants have argued that if tribunals held that they could merely have a protected expectation to receive a RRoR throughout the life-cycle of their investment, the new regime significantly reduced the RRoR. This gave rise to losses to the investor and therefore breached the FET standard.Footnote 94 Overall, investors argued that the changes undermined their entitlement to a stable and predictable regulatory environment that secured, for the life-cycle of their projects, either the generous returns under the original scheme or at least a higher RRoR than that offered under the new scheme. According to investors, the measures were unreasonable and disproportionate, and if Spain’s goal was to ensure the economic sustainability of the system, it should have raised the cost of electricity for consumers.Footnote 95 Spain, in response, argued that the cost of electricity was raised multiple times to address the tariff deficit, that it already had one of the highest costs of electricity among similar European countries and that the severity of the financial crisis already made electricity less affordable for the public.Footnote 96
Three main strands of decisions emerged from tribunals in these claims: the first group found that investors had a legitimate expectation protected under the FET clause to have access to the original incentive regime with high rates of return (above 7%) for the useful life-cycle of the project. Spain’s actions altering that regime constituted a fundamental change that undermined the FET standard and breached the ECT.Footnote 97 In the view of these tribunals, whether investors were still receiving a RRoR under the new regime was irrelevant, as the changes altered the essential characteristics of the original regime in breach of investors’ legitimate expectations. Some tribunals did not assess whether the measures were reasonable or proportionate, as they found that Spain made an explicit promise via its permission process to maintain the regime unchanged for the lifetime of qualified projects.Footnote 98 Other tribunals found the measures excessive and disproportionate.Footnote 99
A second group of tribunals found that the only legitimate expectation that investors could have would be to a RRoR as stipulated in relevant Spanish legislation.Footnote 100 On this basis, they found no breach of the FET standard due to Spain merely altering the original regime. Investors were entitled to a stable and predictable environment, but this did not mean that no changes could take place.Footnote 101 The state retained the right to regulate in a balanced way. Footnote 102 However, for these tribunals Spain did breach investors’ legitimate expectations to receive a RRoR throughout the lifespan of the investment, as the new regime provided returns below the original RRoR. This was not balanced regulation.
In evaluating this, some tribunals engaged in detailed quantum assessments, merging the question of substantive breach into a discussion of damages.Footnote 103 Parties submitted detailed expert assessments on the returns offered under the new regime and compared this with the original regime. Spain’s contention that efficiently operating plants would receive returns of approximately 7% (pre-tax), and even above, under the new regime did not convince the tribunals. Some of these tribunals found that while the original regime set the RRoR at 7 per cent post tax, the new regime targeted 7% pre-tax, and this was an unreasonable change to the calculation of the rate, despite Spain’s argument that overall profit margins would roughly remain the same at the end of the day due to the application of other tax breaks and incentives to these investments.Footnote 104 For other tribunals, the problem was that the new regime was providing returns below 7% (pre-tax), and that the respondent was liable to pay compensation to account for the difference. In one case, the Tribunal found that the average post-tax returns presented by the parties for certain assets were between 5.55% and 5.65%, which was below the 6.86% RRoR accepted by the tribunal, calculated based on the weighted average cost of capital plus 1%.Footnote 105
In the minority are a third group of decisions and several dissents, which found that the actions of Spain in the RE sector did not amount to a breach of the FET standard.Footnote 106 According to these tribunals, Spain introduced the original RE incentive scheme in good faith, and when negative consequences emerged from the regime, modifications were introduced to maintain the sustainability of the system.Footnote 107 According to this view, while the corrective actions taken by Spain to safeguard public finances and the electricity system may have had ‘unpleasant consequences’ for claimants, the measures do not constitute a failure to provide a stable regulatory system that violates the FET standard.Footnote 108 Notably, the StadtWerke tribunal stated that Spain’s adoption of a ‘shared sacrifice approach’ meant that the investors were ‘required to forego a modest amount of revenue for the sake of preserving the electricity system’.Footnote 109 These tribunals found that investors continued to receive a RRoR and the different methodologies adopted by the parties’ experts in assessing rates of return led to divergent percentages;Footnote 110 it was found that certain crucial aspects of the claimant’s expert’s calculation did not provide any supporting evidence.Footnote 111
From the foregoing arbitral case law, uncertainties emerge as to whether investors have an internationally protected legitimate expectation, and if so under which conditions, to receive a certain rate of profit throughout the life-cycle of their projects. What was labelled mere unpleasant consequences and modest reduction in revenue by one tribunal was considered a breach of international law and a violation of the FET standard by many others. It is also striking that the tribunals that codified profit margins into entitlements protected under international law failed to explicitly consider the financial sector’s dominant involvement as claimants on the formulation of investor expectations in the RE sector. According to one study,Footnote 112 89% of the claimants were not RE companies, but financial sector actors.Footnote 113 A question remains regarding the extent to which profit margin expectations of institutional investors and other investment funds, which can be speculative and ignore actual ‘economic conditions or the cost of capital’,Footnote 114 should be defining for state duties under investment treaties. It is not possible to ascertain from the texts of the awards whether this point was raised by defendant states or considered by tribunals in assessing what constitutes a protected legitimate expectation. Since the financial sector has a defining role in setting profit expectations in the RE sector, this crucial fact should not be ignored by respondent states and tribunals.
While in almost all cases tribunals referred to state obligations under climate change treaties and relevant EU legislation, they largely ignored issues of equity and just transition principles. While it may appear from the minority of decisions that the system may accommodate approaches more compatible with just transition principles, this was not the approach taken by most tribunals. The approach taken in most awards shows that treaty standards are more likely to be interpreted to safeguard a generous level of profits in the RE sector as a legal entitlement if an investor (and its financiers) formed such an expectation when making the investment. The presence of at least three differing approaches in awards also offers little certainty to states regarding the legal consequences of crafting and reforming to energy transition policies.
The European RE saga should act as a warning sign for the future of energy transition policies – particularly in the developing world, where climate financing arrangements increasingly require de-risked regulatory environments that support the bankability of projects. The challenge here is not de-risking per se, but the type of enabling environment created and the extent of de-risking offered. Given the risk profiles of many host states in the developing world,Footnote 115 they will need to offer even greater incentives and more favourable regulatory environments than their European counterparts when incentivising RE investments. The likelihood of these enabling environments remaining unchanged for the life-cycle of projects is low given the complexity of the climate emergency and energy transition. Shielding investors from the uncertainties of energy transition and securing long-term strong profits via investment treaties undermines the equitable burden-sharing demanded by the just transition approach, as it can shift financial burdens disproportionately onto the public purse. To unpack these concerns further, I next turn to analysing the implications of investment treaties’ long-term de-risking of profit margins on just transition objectives.
4. Investment governance framework for fair profits and a just transition
There is no question about the urgency to scale up investments to accelerate energy transition across the globe – particularly in many parts of the developing world, where clean energy deployment is happening at a much slower rate.Footnote 116 There is a growing consensus that, in crafting energy transition strategies and policies, states should adopt a just transition approach, grounded in international human rights standards. This calls for integrating a human rights approach to achieve equitable mitigation trajectories and for mitigation policies to be rights-enhancing and to address inequality and discrimination.Footnote 117 In this vein, the ECtHR emphasised the need for a comprehensive and profound transformation of various sectors to achieve decarbonisation of economies and ways of life.Footnote 118 It further emphasised the need for social accommodation and burden-sharing within and across generations and segments of society.Footnote 119 Similarly, the IACtHR held that states ‘should be guided by the equitable distribution of the economic and environmental burdens resulting from the mitigation measures’.Footnote 120 The just transition approach requires ‘respect and dignity for vulnerable groups; creation of decent jobs; social protection; employment rights; fairness in energy access and use and social dialogue and democratic consultation with relevant stakeholders’.Footnote 121 As part of the legal framework governing climate friendly investments, are investment treaties conducive to a just transition?
The large body of scholarship that analyses the impact of investment treaties on the regulatory space of states,Footnote 122 democratic and participatory governanceFootnote 123 and human rights and environmental protectionFootnote 124 already provides strong indicators of how investment treaties might interfere with just transition goals. Investment arbitration awards’ exclusion of local community rights and interests, as well as their aversion to bottom-up change driven by local politics and democratic resistance, makes investment treaties incompatible with a just transition approach guided by inclusivity and equitable burden-sharing. Adding to those well-established concerns, in this article I raised one issue that emerges from the RE case law and focuses on the level of profits that investors may be deemed to be legally entitled to over the life-cycle of a project. Overall, the case law shows that, while the system accommodates multiple approaches on the assessment of long-term profit rates, the dominant approach results in the codification of long-term profit margins as internationally protected legal entitlements. This is problematic from a just transition angle.
Looking closely at the sector, the level of profits protected under investment law’s FET standard is set, in the first place, by the finance sector. The latter only consider projects bankable if it is assured that the generator will obtain strong profit margins over the investment’s lifespan.Footnote 125 As the cost of capital for renewable energy projects is much higher for projects in developing countries than it is for investing in the developed world, more intense levels of de-risking are required to decarbonise the developing world. These financial market demands are accepted as the norm, de-risked through climate finance deals, other legal arrangements such as public–private partnerships and, as a final measure, strong profits guarded by investment treaties. While there is an urgency to scale up clean energy transition in the developing world, the logic of profit maximisation embedded in this model undermines the human rights imperative that the process is just and equitable.
In their current formulation, investment treaties and their interpretation in arbitral case law stifle burden-sharing and tend to over-compensate investors,Footnote 126 even when states engage in legitimate regulatory evolution driven by public policy concerns and in pursuit of state duties under international human rights and climate law. In the case of RE investments, when states are required to pay generous levels of compensation to maintain strong profit margins demanded largely by the financial sector, they must divert resources from elsewhere in the public budget that serves to realise the essential needs and rights of the population. A 2022 study has found that compensation awarded in 21 publicly available awards in Spanish RE cases up to 2022 amounted to €1.2 billion, five times more than what Spain planned to spend to alleviate energy poverty in 2021.Footnote 127
The current model of investment protection, when viewed in the broader context of the de-risking agenda and the strong profit margins it aims to secure from energy transition in the Global South, is antithetical to a just and equitable transition, as it legitimises, codifies and locks in the expectation of strong profits in the long run. It may do so even if clean energy projects give rise to human rights harms on local communities – for example, due to displacement or interference with the right to an adequate standard of living.Footnote 128 It did so when governments took measures to manage public finances that resulted in profit reductions, not erasures.
To alleviate this risk, in international law we must move away from investment protection to a model of just and equitable investment governance.Footnote 129 There are proposals emerging to this effect, rightfully with a primary emphasis on embedding community rights and participation, environmental protections, investor obligations and other key concerns within such a framework.Footnote 130 These are essential ingredients of a better governance framework, but they may not fully capture the problems arising from the protection of profit maximisation, as these disputes may not directly concern the human rights of host communities, or the environment affected by an investment.
In a recent report, Ostřansky and Bonnitcha develop a roadmap on what policy problems investment treaties are deemed to address. They also analyse whether assessing these through a treaty or a different governance tool can better serve the intended goals.Footnote 131 They cover three key categories of policy problems: encouragement and support of sustainable investment; impact of investment protection and investment governance; and institutions and international cooperation. It is argued here that investment governance responding to this trio of policy problems in the context of just transition should be guided by the principle of equitable burden-sharing, the duty to cooperate in good faith and due diligence obligations of states to tackle the climate emergency.
Due diligence obligations of states in the context of the climate emergency call for ensuring ‘coherence between their domestic and international commitments and their obligations concerning the mitigation of climate change’.Footnote 132 This requires domestic and international standards on investment governance to be aligned with climate obligations, including when scaling up clean energy investments. When developing policies to fulfil their obligations on climate change, including those relating to RE investments, due diligence obligations require states to consider the long-term implications of such policies.Footnote 133 Additionally, the duty to cooperate in good faith in this context requires states to engage with and implement financial and technology transfer obligations towards developing states in good faith. Climate financing arrangements and investment treaties are components of the de-risking ecosystem that aims to scale up RE investments. Placing these mechanisms in Ostřansky and Bonnitcha’s roadmap of policy problems, we can see that the former operates to encourage and support RE investments and the latter protects investments and provides an international governance framework. Both sets of policy responses to the challenge of scaling up clean energy should be made compatible with the due diligence obligations of states, the principle of equitable burden-sharing and the duty to cooperate in good faith, if states are to comply with their international law obligations.
The existing investment treaty model is currently incompatible with states’ due diligence obligations, the principle of equitable burden sharing and the duty to cooperate in good faith. How can states inject these principles into investment governance? Due diligence obligations of states require them to revisit their investment protection frameworks and ensure their compatibility with their climate obligations. Duty to cooperate in good faith calls for states to assess the terms of their investment treaties and cooperate in making these compatible with their climate obligations. As this article has focused on the role of profit margins, the following discussion focuses on how states due diligence and good faith cooperation obligations require them to embed the principle of equitable burden-sharing in a new investment governance model that resists the profit maximisation logic. Embedding equitable burden-sharing within investment governance does not require investors to forgo profits altogether, but it requires abandoning the treatment of long-term strong profit rate expectations as legal entitlements under international law.
It could be argued that investment treaties can be reformed to attain these goals. Within the existing system of investment protection, assessment of investor expectations and proportionality of measures could integrate burden-sharing considerations. Going back to the RE case law, the StadtWerke tribunal’s endorsement of a shared-sacrifice approach aligns with this model, although it should be underlined that this approach is adopted only in a minority of arbitral awards from the Spanish RE disputes. Additionally, in assessing investor expectations, tribunals should not overlook the role played by the financial sector in setting profit expectations in the RE sector and factor in whether profit expectations are inflated because of their involvement.
Given the track record of investment arbitration awards in interpreting protection standards, particularly the FET standard and the concept of legitimate expectations, it is too risky for states to continue relying on investment treaties to promote green investments. Arbitral tribunals have often treated the regime siloed from other areas of international law. This approach ignores the complexity of the climate crisis and the response it requires by ‘breaking of siloes so that it can be resolved holistically’.Footnote 134 So far, investment treaty reforms have not achieved the kind of holistic approach required for just and equitable climate action because they have continued to be a framework for investment protection, with human rights and environmental issues being at best second-rate add-ons or exceptions. A new investment governance framework compatible with states’ due diligence, equity and cooperation duties should incorporate as one of its central guiding principles the fair and equitable allocation of available resources, prioritising those whose needs are more acute, and whose resources are far more limited.
Following the elements of Ostřansky and Bonnitcha’s roadmap, in encouraging and supporting RE investments, a just transition framework should contain clear terms on the host state’s ability to adjust policies to maintain the affordability, availability and accessibility of energy,Footnote 135 while still offering a fair remuneration and a transparent system of governance to investors. Such clarity would shape the contours of what investors can expect in the long term. In assessing the rights and obligations of investors, the equitable burden-sharing approach demands that the costs of regulatory change are distributed among relevant actors in a way proportionate to their economic power and ability to accommodate such costs. In this respect, financial investors or RE companies are better placed to accommodate a larger share of the burden than those with lesser means – for example, individual electricity users. This would help move away from an investor protection model where states are expected to raise consumer electricity prices to maintain profit expectations of investors. Fairness and equity within the investment regime should be understood not merely as fairness for investor interests, but as a compromise that accepts states may intervene to demand a greater contribution from economically powerful actors to a policy problem, such as solvency or sustainability of the energy system. This new type of proportionality should inform the work and decisions of institutions of investment governance and dispute-settlement in assessing state obligations towards investors and other key stakeholders. To enable this, institutions of investment governance and dispute-settlement should be opened to public participation and localised in the first instance to reduce costs, ensure full transparency and enable the participation of all relevant stakeholders. If states continue to disregard integration of adequate participation rights into their investment governance frameworks, they will fail to ‘[ensure] that, in the context of the climate emergency, decisions are made in a participatory, open and inclusive manner’.Footnote 136
5. Conclusion
There are many reasons why scaling up of clean energy is not happening at the scale and pace necessary to tackle climate change. This article has focused on the role of a key international legal framework – investment treaties – in shaping energy transition policies. It connected the dots between ‘profits’, climate finance policies and investment treaty standards to assess whether the latter’s role in the RE sector is supportive of a ‘just transition’. The central argument is that the layers of de-risking offered to climate-friendly investments in order to secure strong profit margins in the energy transition undermine the possibilities of equitable burden-sharing within climate action. Investment treaties play an important, but thus far overlooked, role as a legal arm of long-term de-risking by recognising interference with long-term profit maximization as a compensable breach of international law. If scaling up clean energy investments continues to happen under the existing frameworks that govern them, we risk reproducing and potentially worsening existing inequalities within society. As Chris Shaw put it in an interview with Break Down Radio, the current approaches to climate action are likely to ‘reproduce this world, minus the emissions’.Footnote 137
De-risking policies demanded from developing states to enable and attract clean energy investments risk creating unsustainable support frameworks, which are likely to require major adjustments in the future. Such adjustments are likely to reduce investor profits over time and give rise to investment treaty claims. In light of the analysis presented in this article, climate finance deals, when viewed in conjunction with investment treaty standards, are setting developing states and their communities up to fail. It is likely that the fallout will be more catastrophic for developing states than it was for European states, given that their starting point has even higher obstacles to climb to achieve financing. There are growing calls for the existing investment protection regime to be overhauled to be made more inclusive and respectful for the environment and human rights. In rethinking investment governance for the present and future of energy transition and climate action more broadly, just transition principles such as equitable burden-sharing, good-faith cooperation and participatory decision-making should be situated as guiding principles.
Acknowledgements
I would like to thank Toni Marzal for inviting me to think about the role of profits in international investment law and for rounds of feedback he provided on earlier drafts. I would also like to thank Swasha Fernando for excellent research support. I am grateful to Celine Tan, Gamze Erdem Türkelli, Basani Baloyi, Bhima Yudhistira, Tara Van Ho, Claiton Fyock, Oliver Hailes and Lorna McGregor for engaging with the ideas and arguments presented in this article. All errors and omissions are mine. The research underpinning this article was enabled by the British Academy ODA Challenge Oriented Research Grant ‘Equity and the Global Climate Finance Architecture: An Evaluation of the Just Transition Partnership (JETP) Framework’, Grant Reference IOCRG\100365.
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