Catch-22: Canada's attempts to phase out fossil fuel might result in it paying the polluters

US$20 billion: That’s how much American investors think Canadian taxpayers should fork over to compensate them for their failed bid to develop a liquefied natural gas (LNG) facility in Québec.

That’s almost a fifth of the province’s total budget for this year.

Ruby River Capital LLC, the U.S.-based owner of GNL Québec Inc., filed a claim against Canada under the North American Free Trade Agreement (NAFTA) after its Énergie Saguenay project failed to pass a federal environmental impact assessment.

The proposed LNG terminal had already been rejected by the Québec government over concerns that it would increase greenhouse gas emissions and negatively impact First Nations and marine mammals.

Canada faces a no-win situation — a catch-22. If the government does not rapidly phase out fossil fuels, it will fail to meet its commitments under the Paris Agreement to address the climate crisis. But when it takes steps to do so, foreign investors invoke international trade and investment agreements like NAFTA and threaten to drain public coffers.

Paying the polluters

Unlike environmental treaties, trade and investment agreements have teeth. They are enforceable through a system known as Investor-State Dispute Settlement (ISDS) that allows foreign investors to bypass local courts and bring claims for monetary compensation to a panel of three arbitrators. More than 1,200 ISDS cases have been launched against governments around the world in the last 25 years.

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Between 1996 and 2018, Canada was sued more than 40 times by American investors through the investment chapter in NAFTA. To date, Canada has lost or settled (with compensation) 10 claims. Canadian governments have paid out more than $263 million in damages and settlements.

When NAFTA was replaced in 2018 with the U.S.-Mexico-Canada Agreement (USMCA), it did not include an ISDS mechanism between Canada and the U.S. Chrystia Freeland, the then-deputy prime minister of Canada, noted at the time that the removal of ISDS “strengthened our government’s right to regulate in the public interest, to protect public health and the environment.”

Ruby River was only able to launch its case because USMCA allowed firms that had made investments before NAFTA’s termination — on July 1, 2020, — to continue to bring ISDS claims for three years — until June 30, 2023.

Importantly, Ruby River spent only about CDN$165 million on the Énergie Saguenay project proposal. However, the firm is permitted within the ISDS system to seek “lost future profits” based on speculation about the performance of notoriously volatile oil and gas markets.

Risks to climate policy

Québec is a member of the global Beyond Oil and Gas Alliance and is the first jurisdiction in the world to ban all oil and gas production. The province is being sued over this ban by several fossil fuel firms — seeking more compensation than was offered — in Québec’s Superior Court.

Had these companies been foreign, and thereby qualified for the protection of an investment treaty, they likely would have chosen ISDS instead. This is because ISDS generally provides broader scope for claims — and larger awards — than domestic courts.

Other jurisdictions need to follow Québec’s lead. The global carbon budget has no room for new coal, oil or gas developments. Construction of new fossil fuel infrastructure also needs to be limited, as it would lock in continued extraction long into the future.

Despite clear messages to this effect from the Intergovernmental Panel on Climate Change and the International Energy Agency, investors continue to propose new fossil fuel projects. They do so in full knowledge that governments need to act to curb emissions in line with their international commitments and that future climate policies may negatively impact their investments.

Allowing these companies to demand billions in compensation creates moral hazard and could dampen necessary policy action.

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Governments are increasingly aware of this risk and many are taking action. The European Union is seeking to withdraw from the Energy Charter Treaty, the largest investment treaty in the world, because it “is not aligned with the Paris Agreement, the EU Climate Law or the objectives of the European Green Deal.”

The Biden administration is committed to not signing up to new agreements with ISDS and a number of Democrats are calling for the removal of the mechanism from existing deals. Other countries such as Australia and New Zealand have worked to exclude ISDS from some of their trade agreements.

Future threats

Canada will soon escape from the legacy of NAFTA. However, the government remains exposed to the threat of ISDS through other trade agreements such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), as well as dozens of bilateral investment treaties.

When the U.K. officially joins the CPTPP, the risk of ISDS claims from fossil fuel firms will increase dramatically.

The idea that public finance, desperately needed for the energy transition and climate adaptation, will be redirected to compensate fossil fuel firms currently making record profits is offensive.

In light of the increasing body of evidence that documents how the industry has actively obstructed climate action and helped to spread disinformation about climate science, it is communities impacted by climate change that should be compensated by fossil fuel firms, not the other way around.

The Canadian government should adopt a consistent approach to ISDS. The exclusion of ISDS from USMCA should be emulated in any future agreements, and Canada should work with treaty partners to remove access to the system in all current ones.

This article is republished from The Conversation, an independent nonprofit news site dedicated to sharing ideas from academic experts. The Conversation has a variety of fascinating free newsletters.

It was written by: Kyla Tienhaara, Queen's University, Ontario.

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Kyla Tienhaara receives funding from the Canada Research Chairs Program and SSHRC (Government of Canada). She collaborates with and provides pro bono advice for a number of non-profit organizations working on climate and investment issues.