Reducing IIA Risks to Climate Change Rules Using Permits

Using Permits and Contracts to Reduce International Investment Agreement (IIA) Risks to Climate Change Regulations: The Washington Gas Purchase.

On April 4, 2018, the Maryland Public Service Commission (Maryland PSC) issued an Order approving the purchase of Washington Gas in the State of Maryland by AltaGas, a Canada-based natural gas company.

The Order of the Commission, which was subject to negotiation with AltaGas and involved public hearings and inputs from expert witnesses, acts as a regulatory approval by the responsible government for the purchase. In the United States, decisions permitting foreign investment are almost exclusively taken at the state level rather than the national level, due to the division of powers in the U.S. constitution. The negotiating process leading to the decision also makes it similar to a contract negotiation process.

Washington Gas is a subsidiary of WGL Holdings. AltaGas acquired WGL Holdings in full, completing the process in July 2018. Other WGL Holdings subsidiaries include New Hampshire Gas, though Washington Gas is the largest. The Maryland PSC Order is binding over this purchase. AltaGas, upon completing the acquisition, said that the value overall of WGL Holdings was USD 9 billion.

Eliminating risk from future climate change regulations

What made the Maryland PSC’s Order to approve the purchase unique was the inclusion of legally binding conditions, negotiated with AltaGas, designed specifically to address the potential of future regulatory decisions to reduce or prohibit carbon-based energy use in Maryland. (The author of this blog was an expert witness on behalf of the Office of Public Counsel of the State of Maryland and drafted the preliminary version of the conditions of the Order discussed here,  ultimately agreed to by the investor.)

These potential actions would be primarily, though not exclusively, for climate change purposes.

The need to tackle carbon-based pollution, including from energy, has been a recurring topic in Maryland. It has become widely recognized that ongoing climate change policy-making processes could lead to future regulatory limits and prohibitions. Hence, the issue was very much a live issue during the Maryland PSC approval process.

In investment treaty terms, the Maryland PSC’s decision—specifically the conditions involving future regulatory decisions to lower or ban carbon-based energy use in the state—acts as a means to eliminate the risk of actions against the government for breach of fair and equitable treatment (FET) and expropriation obligations. The conditions also act as the antithesis of a regulatory stabilization provision. Each of these issues is discussed briefly below.

The text of Conditions 20-21 of the Order is found at p.A-11:

NAFTA

20. Notwithstanding any other provisions of these conditions, AltaGas, Washington Gas, and WGL recognize that the State of Maryland and the Government of the United States retain the full right to enact bona fide laws and regulations in relation to the production and distribution of natural gas and other carbon-based energy sources. Nothing in these conditions or the Commission’s orders restrict or alter these rights, or creates or implies any limitation on the State of Maryland or its agencies, or on the Government of the United States and its agencies, with respect to future measures in this regard. This includes measures to address climate change and other public interest issues such as air quality.

21. AltaGas, Washington Gas, and WGL expressly acknowledge that the Commission, by approving the Merger, is not creating any special expectations to induce AltaGas, as an entity covered by North American Free Trade Agreement (“NAFTA”), to close the Merger.

Expropriation

Some interpretations of expropriation include a concept of “regulatory expropriation.” Under this theory, which itself is far from unanimously accepted as part of the meaning of expropriation, a change in regulations that impacts a business’s profitability can be an act tantamount to expropriation. This notion relies on the view that investors have some form of right to operate in perpetuity in the same manner as when the investment was made. Enacting a new regulation would thus be akin to removing such a right.  

The conditions quoted above make it clear that the investor, AltaGas, has no extended rights to operate as it did at the start of the investment, at least as it relates to laws and regulations to reduce carbon-based energy use. By expressly denying any such right, the conditions act to preclude any effective claim to regulatory expropriation under NAFTA’s Chapter 11, Article 1110.

FET

The provision above has the effect of preventing a claim that a new measure to reduce natural gas use would constitute a breach of FET obligations in Article 1105 of NAFTA or under FET language. These provisions have been found, under some readings, to create barriers to new legislation on the basis that the investor had a “legitimate expectation” to be free of future regulations that would negatively impact its investments.

A less stringent reading of the legitimate expectation concept has held that, where the investor had been given reason to expect a government will act or refrain from acting in a certain way and this specific expectation is then frustrated by the government, a claim under FET would hold.

The conditions above make it clear that the investor could have no expectation that the government will not act to reduce greenhouse gas emissions from carbon-based energy sources. The text acknowledges that the government has the right to do so and could act accordingly. Thus, at a substantive level of interpreting and applying an FET clause, both stricter and more flexible readings of legitimate expectations have been negated by the conditions.

Antithesis to a regulatory stabilization provision

At a functional level, these legally binding conditions act as the exact opposite of a regulatory stabilization provision that would either prohibit a government from enacting new laws or regulations that impact an investment or would require the government to compensate the investor for any negative economic effects resulting from the new measure. Such stabilization provisions are fraught with difficulties for governments but remain a demand of many companies, especially in the oil and gas sector, when making investments.

The conditions imposed by the Maryland PSC Order in this case produce precisely the opposite result: rather than the government assuming the risk of introducing new laws or regulations, and thus being disincentivized from doing so, the above provisions make it clear that the investor is the sole actor that bears this risk.

Special importance in the oil and gas sector

That this provision is by an investor in the oil and gas sector is especially important. Analysts from around the world have forecast literally trillions of dollars in “stranded assets” in the sector due to necessary and foreseeable restrictions to combat climate change. Stranded assets are production, transportation and transmission facilities that lose economic value after legal measures restrict or prohibit their ability to continue producing, transporting or delivering their products. 

Who covers the costs of these stranded assets is a key question. In many cases, analysts anticipate that the cost of these assets would be part of a claim under a regulatory expropriation or FET provision in an investment treaty. Thus, claims could stretch easily into the billions of dollars for climate change regulations. In the Washington Gas case, the above provision negates this risk, clearly allocating the risk of stranded assets to the investor.

Acting in the public interest

The fact that a top-tier oil and gas company agreed to this precedent-setting provision shows that the demand for a stabilization provision in this sector can be counter-acted by a provision recognizing governments’ right to take measures to protect the environment. 

Given this precedent, governments should thus feel more empowered to protect the public interest, including on environmental issues and including in relation to oil and gas investments.