18 January, 2024 / Research

How overlooked climate litigation risks should be assessed

Recommended framework lists five ways to factor law into climate-related financial risks

How overlooked climate litigation risks should be assessed

Assessment of climate litigation risk in investee companies must be overhauled in light of the trillions in damages polluting companies could be liable for, according to Oxford Sustainable Law Programme.

A paper by the programme, published in Science, said few investors are taking these risks into account when looking at companies’ climate-related financial risks and offers a framework with which they could do so.

As an example of risks companies face, the report authors pointed to their estimate US oil and gas giant Chevron could be liable for up to $8.5trn where between 1990-2019 the company’s profits were $291bn.

“It’s possible that Chevron’s business may in fact be net value destroying,” said co-author and senior research associate at the Oxford Sustainable Law Programme, Dr Rupert Stuart-Smith.

The framework presented in the paper sets out five ways climate-related legal risks could be assessed by investors and regulators.

Market-impact analysis

The market impacts of legal judgments can be seen by, for example, assessing stock price movements around climate litigation events, the report stated. This analysis can act as a baseline indication of the impact of climate litigation on company value.

Caution is advised by the authors, however, as each event is context specific and findings may extrapolate poorly to other firms, jurisdictions, and causes of action. They pointed out this is especially so given rapidly evolving climate litigation strategies, legal precedents, and societal expectations.

Analysis using the social cost of carbon

Assessing companies this way allows the investor to put a figure on the legal risks linked to how much that company has contributed to climate change, either based on the social cost of carbon or on the attribution of specific impacts.

An analysis using the social cost of carbon is how the Oxford Sustainable Law Programme estimated Chevron’s emissions to 2010 produce a potential liability of more than $8.5trn.

Attribution of climate change damages

This method shows companies’ contributions to specific climate-related disasters. In this way the study found Shell would have an annual liability of $0.55bn if it was held liable for its contribution to two events with attributable losses equal to those of Hurricane Harvey.

Companies could also face punitive damages – those awarded in excess of the claimant’s actual loss – but the estimates could be expected to be lower.

Estimating costs of accelerated climate mitigation

Climate change mitigation could be accelerated with legal action making the faster pace mandatory for companies. The financial impact of this can be assessed using sector-specific or technology-specific abatement cost estimates, according to the Oxford Sustainable Law Programme.

The approach allows investors to estimate companies’ transition costs with and without specific legal decisions.

Though not many countries have obligations like this around sector-level or firm-level transition pathways, the authors noted Article 15 of the EU’s proposed Corporate Sustainability Due Diligence Directive which could mandate firm-level transition plans. This, they stated, would “harden legal expectations around the speed of firms’ transitions.”

Until more explicit obligations exist, the legal view of how well aligned companies are with their transition plans depends a lot on judges’ interpretations of national and international law. These interpretations can move quickly and unpredictably, the study stated, using the Milieudefensie vs Shell judgement as an example.

Qualitative analysis

The framework suggested qualitative assessments can be used to inform and contextualise quantitative assessments, showing the scale and reach of legal risk and potentially helping risk management in investment portfolios, for example.

Investors can look at how judicial doctrine and precedent are developing, legislation and scientific advances and trends in litigation outcomes.

Scale of the issue

With more than 2485 climate lawsuits filed worldwide since 2015 and looking at the kind of figures polluting companies could be liable for, the Oxford Sustainable Law Programme said investors are “flying blind” to the risk of climate lawsuits.

And it is not just companies and investors at risk, the group noted an estimate that oil and gas investors may seek in excess of $340bn in legal claims because of governments’ climate policies.

Despite it being “increasingly untenable” to omit the law from climate risk evaluations, the study stated 93% of central banks surveyed in a recent study do not yet quantify its impact.  

The authors also lamented the fact climate-related legal risk is treated as a subset of physical and transition risk by international bodies like the International Sustainability Standards Board and the Network for Greening the Financial System. These groups, the paper noted, provide little or no detail on how to evaluate climate-related legal risk.

Investing in the wrong things

Associate Professor Thom Wetzer, lead author and Director of the Oxford Sustainable Law Programme said:

“Against a backdrop of increasingly impactful climate litigation and regulatory enforcement actions, which shift and amplify climate risks, we argue that current climate risk assessments misrepresent the distribution and scale of climate-related financial risks.

“That means investors end up investing in the wrong projects and run risks that neither they nor regulators understand, thereby further aggravating the financial risks climate change entails.”

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