Energy companies prepare for ‘third wave’ as climate litigation risk gathers momentum

Nadine Coudel and Robert Gardner look at the climate liability risks facing the energy sector and what steps companies can take to identify and reduce these threats to support long-term success.

The risk posed by climate change and sustainability disputes is a fast-moving area and part of corporate reality. Such claims could inspire copycat cases around the globe.

The response of insurance markets will be of particular interest to carbon-intensive energy companies, those transitioning to renewable energy, as well as organisations already operating in the renewables sector that will want to keep abreast of how climate liability is impacting energy sector peers.

Some insurers are already starting to introduce climate harm exclusion clauses on some public liability policies, a trend we expect to continue. These clauses allow insurers to deny cover in the event of liability arising from negative impacts of climate change or instances where an organisation has failed to meet greenhouse gas (GHG) emission targets. Even where insurance policies don’t explicitly exclude climate harms, the policy intent to not cover liabilities around climate change may be implied.

As well as having clarity over policy wordings, risk managers and CFOs of energy companies are well-advised to understand the range of climate liability claims that could potentially face their organisation.

Commentators have already reported on the demise of companies due to climate change, with many anticipating that earlier cases would just be the beginning of more businesses failing due to climate liability costs.

Meanwhile, recent research by the Geneva Association, the London School of Economics and Clyde & Co indicates a so-called ‘third wave’ of climate litigation – characterised by the expansion of litigation to more jurisdictions, increases in volume and pace, and new types of claims targeting the private sector – is well underway.

Climate liability underestimated

High-profile instances where energy companies have faced climate liabilities include a Canadian renewable energy company filing a lawsuit against a multinational financial services company in 2021, after it had rejected force majeure declarations during a February winter storm and billed the energy firm over $100mn for replacement power when its wind turbines had to be halted during an arctic deep freeze.

This demonstrates the need for energy companies to understand their climate-related physical and transition risk exposure, and how to improve their resilience and preparedness for climate-related liability risks.

In February this year, environmental activism organisation ClientEarth filed a case in the UK against the board of directors of a multinational energy company for failing to manage the material and foreseeable risks posed to the company by climate change.

The lawsuit alleged the organisation’s directors breached their legal duties under the Companies Act by failing to adopt and implement an energy transition strategy that aligns with the Paris Agreement. Although the case has since been dismissed, the action had the backing of a range of institutional investors and we can expect to see this being tested again.

The rise of climate litigation

A report by The Centre for Climate Change Economics and Policy and The Grantham Research Institute on Climate Change and the Environment showed that globally, the cumulative number of climate change litigation cases has more than doubled since 2015. Just over 800 cases were filed between 1986 and 2014, and more than 1,200 cases have been filed in the last eight years, bringing the total to over 2,300. That roughly one-quarter of these were filed between 2020 and 2022 indicates an acceleration in claims.

Liability risks arise from a range of areas, including failure to mitigate GHG emissions, adapt to physical impacts, disclose climate-related risks, comply with changing legal and regulatory expectations, and consider future impacts on services. Risk also arises from greenwashing, where an organisation’s claims made about their green credentials do not match the realities.

Understanding future exposure

Carrying out a climate liability risk assessment can be a starting point for an energy company to understand their current and potential future climate liability risks. Such assessments can also reveal financial impacts of both physical climate risks (those arising from risks such as increasing temperatures, wildfires, storms and floods) and transition risks (those emerging from policies, regulatory or market responses to transition the economy away from fossil fuels).

Liability assessments can consider the unique features and commercial landscape specific to a business model. This can give an organisation the opportunity to test and improve their resilience and preparedness, helping to outline next steps to reduce exposures or where it might be possible to transfer specific risks. These exercises can also incorporate climate scenario analysis to direct longer-term strategy and how to manage climate risks over extended time horizons.

Climate liability risk to strategic opportunity

Getting ahead of climate liability risk can not only help manage insurance costs but also uncover new competitive opportunities. By using risk management tools like scenario analysis and analytic modelling, it is possible for a company to understand what slow-onset and severe climate events are now within the realms of predictability, checking the outcomes of these scenarios against their current business model, as well as their cover and/or contracts before disputes arise.

Assessing potential climate liabilities also represents a chance to interrogate a firm’s existing business continuity planning. This can narrow the openings where competitors could potentially steal a march in the event of disruptive, climate-related claims.

As targets and legislation become embedded, this not only heightens the risk of climate litigation, but increases the expectations on energy companies. By showing a commitment to good climate-related risk management in the round – including climate liability risk – a company will be able to position their business for more long-term investment as well as develop recruitment strategies more likely to attract the talent of tomorrow.