Some Considerations on Hydrogen, Lithium, Renewables, and The Assessment of Damages in Early-Stage Disputes in These Industries
This article was featured in our 2023 Energy Arbitration Report, which is part of a series of industry-focused arbitration reports edited by Jus Connect and Jus Mundi.
This issue explores the energy industry, encompassing information on electricity & renewables, based on data available on Jus Mundi and Jus Connect as of September 2023. Discover updated insights into energy arbitration and exclusive statistics & rankings, as well as in-depth global and regional perspectives on energy projects, disputes, & arbitration from leading lawyers, arbitrators, experts, arbitral institutions, and in-house counsel.
THE AUTHORS:
Luiz Aboim, Partner at Mayer Brown
Benjamin Roux, Senior Vice President at Compass Lexecon
Antolín Fernández Antuña, Independent Arbitrator at Antuña & Partners
José Ricardo Feris, Partner at Squire Patton Bogs
Ruxandra Irina Esanu, Associate at Dechert LLP
As of September 2023, Latin America is home to over 8.28% of the world’s population and represents 6% of the global energy demand. The region is still powered mostly by fossil fuel, with the share of oil in energy production amounting to 43.8% in 2020, the share of natural gas to 18.6%, while hydro, biofuels, wind, solar and other renewable sources of energy jointly amounting to 31.3% (IEA Sustainable Development Goal 7). However, the share of fossil fuels decreased between 2016 and 2020, while the share of renewables has increased steadily. Latin America has attracted and continues to attract significant investment in the energy sector (for instance, energy sector investments grew by 50% between 2018 and 2019). This, in turn, means that there is potential for disputes to arise, from contractual arrangements pursuant to which such investment is made, from State regulations and intervention etc. In this context, the Energy Disputes panel of the first annual Latin American Arbitration Practitioners EU (LATAP EU) conference looked at four hot-button issues in the energy sector.
First, José Ricardo Feris discussed the potential for lithium-related disputes, taking into consideration, in particular, recent political changes in the region. A notable example is Mexican President López Obrador’s nationalization of the lithium industry in early 2023, after declaring lithium a mineral of public utility the previous year. The President’s indication that all lithium mining concessions granted prior to the reform would be scrutinized has borne practical results: the concession over Mexico’s largest lithium deposit was revoked in August. Other concessions may also come under the spotlight (e.g., for failure to comply with minimum investment levels, carry out consultations with the indigenous population, where applicable, etc.). This review process is not the only aspect worth following closely in the future; the evolution of Mexico’s own LitioMx, which is taking charge of developing the lithium industry following nationalization, may also prove interesting.
Second, Antolín Fernández Antuña discussed some takeaways that could be drawn from the Spanish renewables saga, a string of over 50 investor-State arbitrations that started in 2011, after the State had to adapt the incentives provided to renewable energies. With more than 30 final awards rendered already, a diversity of outcomes and approaches can be found in the case law. Bearing in mind that every case is different in its facts, circumstances, and submissions, several cases were brought up. Amongst other cases, as an example of how some tribunals have decided on the matter, the PV Investors v. Spain final award, after stating that “the analysis shows that the regulatory framework […] did not provide for a stabilization guarantee,” concluded that “[i]n the Tribunal’s view, the principle of reasonable return serves as the limit of ECT-compliant regulatory changes. […] the Claimants are only entitled to compensation under Article 10(1) of the ECT if they establish that the new regime violates the guarantee of reasonable rate of return. This approach strikes the right balance between, on the one hand, the protection of investors […] and, on the other hand, Spain’s right to regulate and adapt its framework to changed circumstances” (PV Investors v. Spain). Other tribunals have followed different approaches.
Another point of particular interest is that multiple economic, financial, and taxation variables can be decisive for the outcome of the arbitration process. For instance, again in PV Investors, the Tribunal observed that “[t]he guarantee provided […] is economic in nature. This being so, the Tribunal cannot verify whether or not such guarantee was observed without considering the economic impact of the Disputed Measures on the Claimants’ investment. Only once it has ascertained such impact will the Tribunal be able to determine whether or not there is a breach of the Treaty […] in this particular case the quantification of the harm, if any, informs the finding on liability,” i.e., the quantum not only determines damages, but can also define liability (PV Investors v. Spain).
Third, Luiz Aboim considered the potential for disputes in green hydrogen projects in Latin America, one of the world’s regions with the largest potential for the production of renewable hydrogen. The abundance of clean water, land, wind, and sun exposure, and access to the sea places the region as a net exporter of green hydrogen. While the region has a track record in the production of fossil-fuel-based hydrogen, in particular in Trinidad and Tobago, small green hydrogen projects are already operating in Chile, Colombia, and Costa Rica. Separately, two dozen large-scale projects have been announced across Brazil, Mexico, Paraguay, Uruguay, and other jurisdictions. The significant long-term investments needed to bring these new projects to financial investment decisions require a combination of adequate regulatory and legal frameworks in the host countries, as well as foreign investment in the form of equity and financing.
Given the absence of a global hydrogen market, a uniform taxonomy and global regulations on green hydrogen, different stakeholders will need to address technological, commercial, and project risks in their contractual documentation, and consider treaty protection against certain risks, such as regulatory risk. This includes ensuring that appropriate dispute resolution mechanisms are in place to address hydrogen-specific potential disputes, such as price reopeners, or host State measures affecting the investment in green hydrogen, such as the change in subsidies seen in the Spanish solar cases. International commercial and investment arbitration in their current form are natural candidates for any dispute resolution design strategy. Finally, investors in green hydrogen projects should also be prepared for challenges regarding the quantification of damages in commercial and investment arbitrations, as green hydrogen is a nascent market with little track record, where forecasts and data will be limited or non-existent.
Fourth, Benjamin Roux addressed some of the challenges posed by the valuation of early-stage energy projects at the quantum stage of international arbitration. Such projects may include a broad range of assets (some having been in operation for a short time, others not operational at all), in industries where markets are sometimes not fully developed and comparable transactions may be scarce. Their valuation is challenging, as such projects usually have no track records of operations. This poses the age-old question of the appropriateness of forward-looking income approaches (such as a discounted cash flow or DCF valuation) and market-based approaches. It also opens the door to the use of asset or cost-based approaches to remove the additional uncertainty related to assets which are not yet operational. In this context, parties and tribunals may be tempted to consider new applications of the so-called “modern DCF” method, used for example by the tribunal in the Tethyan v. Pakistan case. While the “traditional” DCF valuation is based on expected cash flows discounted at a risk-adjusted discount rate, the “modern” DCF involves computing risk-adjusted cash flows (through the use, for instance, of decision trees or probabilistic scenarios), which are then discounted at the risk-free rate. The “modern DCF” method, in effect, factors in the risks of the project in the cash flows rather than in the discount rate (as is the case in the “traditional” DCF approach).
Another relevant consideration relates to the date of valuation and the type of assumptions used. There are, in that respect, three main approaches commonly used when valuing early-stage projects, each of those having pros and cons: i) ex ante valuations assess damages at the date of the breach and disregard the information between that date and the date of the award, ii) ex post valuations provide an assessment at the date of the award and factor in all available information at that date, including those subsequent to the breach, or iii) hybrid approaches which account for hindsight but value the claimed damage at the date of the breach. Ex ante and hybrid approaches may have an additional layer of complexity in that if there are multiple breaches, there might be multiple dates of valuation. Overall, the specifics of each case should guide the valuer. There is no one-size-fits-all approach both in terms of methodology, date of valuation and type of assumption used when valuing early-stage projects.
The panel’s discussion concluded that it is worth following closely the development of the Latin American energy sector in the coming years. The “coming of age” of nascent industries (like green hydrogen) and the evolution of existing industries (like lithium) and regulatory measures affecting them may give rise to new disputes, both at the contractual and at the investor-State level. In that context, the Spanish renewables saga may provide valuable takeaways for counsel and tribunals alike, in terms of liability and quantum. In any event, it appears clear that such future disputes will pose particular challenges at the quantification stage, given the difficulties posed by accurately valuing early-stage projects.
ABOUT THE AUTHORS
Luiz Aboim is a Partner at Mayer Brown and an international arbitration lawyer with 20 years’ experience in disputes in the traditional energy space and specializing in hydrogen and other renewables related disputes. He is a member of the AIEN Hydrogen Task Force.
Benjamin Roux is a Senior Vice President at Compass Lexecon, based in Paris and London. He is a CFA Charterholder and has more than ten years of experience performing business valuation, economic and regulatory analyses, and damages assessment. He has provided expert testimony and participated in the production of expert reports on regulation and damages issues in more than 40 investment and commercial arbitration cases.
Antolín Fernández Antuña is an independent arbitrator with a background as a lawyer, economist, and tax inspector. Delegate for Spain at the ICC Arbitration Commission and arbitrator in commercial and Investor-State disputes in a wide variety of economic sectors, he has been considered “the most active arbitration practitioner in the field” by the Jus Mundi Electricity & Renewables Arbitration Report 2022.
José Ricardo Feris is a Partner at Squire Patton Boggs who specializes in international commercial arbitration, public international law, and investment arbitration. His practice focuses on disputes in the energy and construction sectors, and his clients include private and public entities, as well as sovereign states. He also regularly sits as arbitrator in international arbitrations administered under the rules of various international and regional institutions. He is a former Deputy Secretary General of the ICC International Court of Arbitration.
Ruxandra Esanu is an Associate at Dechert who centers her practice on international arbitration matters, working on both investment treaty and commercial matters. She has acted in over 20 international arbitrations arising out of the oil & gas, mining, telecommunications, real estate and construction sectors.
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