The energy sector is no stranger to sovereign risk. Heavily reliant on long-term, capital intensive investment, and giving rise to potentially lucrative revenue streams, upstream oil and gas projects, in particular, have regularly been subject to interference from host state governments. It is for that reason that the oil and gas sector has been the single biggest user of the international investment arbitration regime, which allows investors to rely on international law protections to obtain relief from state actions such as suspension of drilling permits, revocation of exploration licences and abusive tax audits. In tandem, the oil and gas sector has also pioneered the use of contractual provisions known as 'stabilisation clauses' (typically in production sharing contracts) to protect against the change of law risk that arises when an investor enters into a long-term contract with a state or a state-owned entity.
But sovereign risk is not the preserve of upstream oil and gas. In fact, as a rash of recent investment treaty arbitrations against a number of European countries have shown, renewable sector investments are exposed to similar risks, which can jeopardise the predictable revenue streams on which such investments rely. Strategic investment planning – benefiting from the lessons learnt in the oil and gas sector over several decades – can ensure sovereign risk is minimized for renewable energy investments. This article considers two key options.
Investment treaty planning
The past few years have seen a surge of renewable energy claims by foreign investors against EU Member States, principally Spain, Italy, the Czech Republic and Bulgaria. These claims, predominantly by investors in either photovoltaic or concentrated solar power projects, were triggered by the unilateral withdrawal by states of attractive feed-in tariff (FiT) regimes after investors had made their investment in the country.
In these cases, investors typically relied on the Energy Charter Treaty (ECT), a multilateral investment treaty for the energy sector, as the basis to bring their claims. However, similar claims can also be brought under bilateral investment treaties (BITs), which, in their modern form, typically contain (a) a suite of substantive international law protections, including safeguarding an investor in the relevant host state against the uncompensated expropriation – or taking – of its investment, as well as ensuring them 'fair and equitable' treatment; and (b) the procedural right to bring a claim directly against the host state under the BIT in a neutral arbitration forum, with no need for privity of contract with the state.
A number of claimant investors against Spain have already secured awards of hundreds of millions of dollars in damages, arguing successfully that Spain's abrogation of its FiT regime frustrated the investors' legitimate expectations, as well as their entitlement to a degree of stability in the regulatory environment, thus failing to accord them fair and equitable treatment. Such protections are not limited to the EU context. The ECT has numerous non-EU signatories, including Kazakhstan, Japan and Australia, while several countries in Africa, Latin America, and the Middle East are on paths towards accession to the ECT. These include a number of attractive renewable energy investment destinations, such as Chile, Nigeria, and Jordan. Moreover, in many countries that are not party to the ECT, investment protection is already in place by virtue of other investment agreements. The worldwide network of BITs runs to over 3,000, of which China and India, both of which have introduced large-scale incentive schemes to attract foreign direct investment in their rapidly growing renewable energy sectors, have signed 145 and 83, respectively.
Against this back-drop, the key lesson for investors in renewable projects is to engage in effective treaty planning, to ensure that their investments benefit from access to a modern and broadly worded investment treaty offering the full range of substantive and procedural rights, at least at one level of the investment structure. This can be achieved by incorporating an investment vehicle in a jurisdiction that has in place an attractive investment treaty with the target country. Treaty planning is ideally carried out at the time of structuring the investment and can be done in conjunction with the tax planning of the investment, with legal counsel liaising directly with tax advisors. This allows the strategic aims of the treaty planning to be aligned with and, if necessary, subordinated to, the investments' broader commercial objectives. Investments can also be restructured subsequently to take the benefit of investment treaty protection, provided, however, that the dispute in respect of which the investor wants to invoke the treaty has not already arisen and is not foreseeable.
Contractual stabilisation clauses
Investment planning to ensure the protection of investment treaties is not the only precaution investors in the renewable energy sector can take to hedge against sovereign risk. Where the investment involves a long-term contract with a state or state-owned counter-party – a concession, or an offtake agreement, for example – the sovereign risk includes the fact that the state has the power at any time to change the legal regime applicable to the contract. The watch-word in these circumstances is 'stabilisation'.
As the name suggest, stabilisation clauses seek to 'stabilise' – or fix – the fact or effect of the legal and regulatory regime applicable to the subject matter of the contract at the time the contract is entered into. Earlier forms of stabilisation clauses, known as 'freezing clauses', froze the provisions of the host State's national system of law as at the date of the contract. More recently, freezing clauses, which were often perceived as placing too great a constraint on a state's sovereign discretion to adapt its law, have given way to more flexible forms – 'economic equilibrium clauses' and 'allocation of burden clauses'. Economic equilibrium clauses, rather than freezing the legal regime applicable to a contract, instead aim to deal with the consequences of a change in law by providing for the negotiation of amendments to the contract to reinstate the initial economic balance of the contract. Allocation of burden clauses act in a similar way but, instead of requiring the parties to negotiate revisions to the terms of the contract in order to restore the economic equilibrium, provide that a state entity (or the state itself) will indemnify the foreign investor for any loss or damage resulting from a change in legislation.
Tried and tested in long-term petroleum contracts, in either format these clauses could also provide investors in renewable energy projects involving long-term contracts with states or state-owned entities with a highly effective route to international recourse – one which has been applied in practice by a number of international tribunals in oil & gas cases, including in an important recent decision in which a change in the application of an existing law was found to be a change in law such as to trigger the investors stabilisation rights. To maximise the benefit of such clauses they need to be properly worded and twinned with a binding arbitration clause, ideally providing for a neutral forum – or seat – of arbitration outside of the host state. The wave of recent regulatory changes which have been found to be in breach of investment treaties could offer renewable investors leverage in negotiations regarding the inclusion and scope of such clauses.
Planning your route to international recourse
Well-capitalised market participants, such as oil majors shifting their portfolios towards renewables or maturing renewable energy companies, may be comfortable with the deployment of resources required to pursue these avenues to international recourse. For newer market participants, however, this may be a more troubling prospect, and one that poses greater challenges in terms of cash-flow and on balance sheet liabilities. The increasingly mature and sophisticated market in legal claims funding, in which, amongst other options, contingent legal claims can be collateralised to fund litigation, offers a way to manage these issues. However, the ability to attract such funding will be a function of the strength of the legal claim. This underscores the key point, which is to engage in timely strategic legal planning to put in place the mechanisms to address sovereign risk.