Legally Sound Oil and Gas Phase-Outs

In December 2023, the 28th UN Climate Change Conference concluded with a landmark decision from 198 governments to “transition away from fossil fuels” in a just, orderly, and equitable manner. Phasing out fossil fuels is vital to avoid the catastrophic impacts of climate change.

Economic factors also underscore the importance of phase-out strategies. Amid geopolitical uncertainty, prioritizing renewable energy and reducing dependence on imported fossil fuels helps protect economies from volatile energy markets.

As clean energy technology costs continue to decline, fossil fuel demand is becoming increasingly uncertain. This means that countries that rely on hydrocarbon revenues must adjust their oil, gas, and coal production plans to ensure long-term economic and fiscal stability. Proactively managing production declines is key to mitigating adverse transition effects on producer economies.

Some governments have already taken action. Denmark, France, Italy, Schleswig-Holstein in Germany, Quebec in Canada, and the United Kingdom have ended the licensing of new exploration and, in some cases, approved new field development as well.

However, the threat of investors suing under ISDS clauses in investment treaties can pressure governments to scale back their fossil fuel phase-out ambitions. ISDS is a legal mechanism included in many treaties that allows foreign investors to sue governments before arbitration tribunals. It is frequently used to sue states for perceived violations of international obligations, which are often interpreted broadly and inconsistently.

For example, ISDS provisions under the Energy Charter Treaty have been invoked in Germany, the Netherlands, Slovenia, and other EU countries to challenge decisions to phase out fossil fuels and related infrastructure. ISDS is frequently criticized for being opaque, unpredictable, inconsistent, and very costly — often requiring governments to pay billion-dollar compensation. Consequently, ISDS is widely recognized as a major obstacle to climate action.

This issue has led UN agencies, civil society organizations, and think tanks, including IISD, to call for a reform of ISDS. There is an urgent need to align it with the need for ambitious climate action.

Yet governments cannot afford to delay phase-out policies until ISDS reforms are complete. IISD’s recent report explores concrete strategies for governments to move ahead with fossil fuel phase-outs, specifically in oil and gas production, while mitigating ISDS risks.

Analyzing arbitral tribunal decisions on fossil fuel and nuclear phase-outs, as well as drawing on consultations with experts, the report finds ISDS risks vary depending on which stage of the oil and gas life cycle is targeted. Risks are notably higher for measures affecting later stages of the production cycle (such as the production phase) compared to earlier ones (such as the acquisition and exploration phases).

Oil and gas production life cycle and associated ISDS risks

Timely interventions targeting the earlier life-cycle stages—such as ceasing the award of new exploration licences — carry lower arbitration risks. Delaying these measures, in contrast, exacerbates tensions between avoiding legal risks and achieving climate targets.

Every delay shrinks the remaining carbon budget available to prevent warming, breaching the Paris Agreement‘s 1.5°C goal. Postponed action increases the need for harsher, legally riskier measures at a later stage to avert catastrophic climate change.

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While ISDS risks are significantly higher at later stages in the life cycle, governments can still employ effective mitigation strategies. Policy-makers should clearly reference international climate obligations and point to evidence on why production restrictions are essential for achieving greenhouse gas emissions targets, among other strategies.

The report outlines five essential principles for policy-makers:

• no new licences. Stop creating new exploration and production rights. This is the single best way to prevent new arbitration risks from arising.
• manage expectations. Set a long-term framework for phasing out oil and gas production, signalling the end date well in advance. Avoid making any official statements that could be interpreted as encouraging investment in the sector.
• build broad authority. Implement phase-out policy through legislation rather than executive orders. Ground policies in scientific evidence, national constitutions, and legally binding international treaties wherever possible.
• use existing powers. Leverage existing environmental or social regulations. In recent years, courts have also been driving a wider consideration of the climate impacts of new fossil fuel projects.
• be consistent. Apply a phase-out policy equally to all investments in the sector, irrespective of investor nationality.

Governments are already applying some of these approaches in practice. In 2020, Denmark became the first important producer to set an end-date for oil and gas exploration and extraction, 2050, referencing the country’s commitments under the Danish Climate Act.

In 2024, the German state Schleswig-Holstein announced that it would end oil exploration and development in the Wadden Sea, a UNESCO-designated natural heritage area, while the Canadian province Quebec has codified an oil and gas development ban into law referencing its obligations under the Paris Agreement, commitment to carbon neutrality, and membership in the Beyond Oil and Gas Alliance.

Prompt action, grounded in international obligations with clearly communicated production end dates, not only maximizes the likelihood of limiting warming to 1.5°C but also significantly reduces the risks of ISDS suits threatening phase-out action.

You can download the report here.