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The Energy Charter Treaty – is it make or break?

  • Market Insight 24 June 2022 24 June 2022
  • UK & Europe

  • International Arbitration

The Energy Charter Treaty (ECT) has made headlines again this week. Scrutiny of the 1994 multilateral investment treaty, which protects and enables foreign energy investors (including fossil fuel investors) to seek financial compensation from states whose changes in energy policies negatively impact their investments, is ramping up – from all directions. But is there a more nuanced view than some of those attacking the ECT would admit?

Amidst EU member states’ threats to withdraw from the treaty and wider calls for its complete abandonment, negotiations to modernise the 1994 multilateral investment treaty, which formally commenced in July 2020, come to a head today in Brussels. The Energy Charter Secretariat and signatories will meet today to announce an agreement over the modernisation of the treaty.

At the same time, earlier this week a group of five young individuals launched a claim in the European Courts of Human Rights (ECtHR) against 12 states (Austria, Belgium, Cyprus, Denmark, France, Germany, Greece, Luxembourg, the Netherlands, Sweden, Switzerland and the UK) for their active membership of the ECT. The claimants argue that the states’ continued ECT membership:

  • violates Article 2 (the Right to Life) and Article 8 (the right to and respect for private and family life) of the European Convention of Human Rights (EHCR);
  • is inconsistent with the Paris Agreement goals; and
  • impedes the urgent transition away from fossil fuels.

These arguments are not new, but this is the first time the ECT debate will come before the Strasbourg courts for deliberation.

What is the ECT?

The ECT is a multilateral investment treaty with 53 signatories (including the EU and Euratom) that establishes a legal framework for energy trade, transit, and investment between member states. The ECT affords foreign energy investors substantive protections, including fair and equitable treatment (FET) (Article 10), freedom from expropriation (or measures having equivalent effect) and compensation (Article 13).

Investors can bring claims against ECT member states before international arbitration tribunals like ICSID for violations of substantive ECT rights. Although this investor-state dispute settlement (ISDS) mechanism has been criticised as “secretive” or “untransparent”, this is arguably not the case. Article 20 (Transparency) of the ECT requires ECT awards to be published “promptly and in such a manner as to enable Contracting Parties and Investors to become acquainted with them”, and at least 75 ECT tribunal awards are publicly available and 150 are known.

What is the criticism of the ECT?

It is said that the ECT is energy-agnostic, meaning it affords equal protection to investment in all energy forms, including fossil fuel investments such as coal mines, oil and gas extraction, pipelines, refineries, and power stations. This, critics argue, discourages governments from introducing policies to phase out these high-polluting investments – as is required to reach the Paris Agreement temperature goals – for fear of legal action. Five energy companies including Germany energy companies RWE AG and Uniper and UK firm Rockhopper Exploration PLC have launched ECT claims in the Netherlands, Italy, Poland and Slovenia for an estimated €3.7bn following those states’ decisions to phase out coal and to ban new drilling. Estimates suggest that an unreformed ECT could allow companies to sue governments for €1.3tn by 2050 in compensation for early closure of coal, oil and gas plants. Such vast sums would, critics say, significantly hinder the green transition.

Arguments for the ECT

A false fear?

However, just because fossil fuel investors could claim protection under the ECT and hinder the energy transition, it doesn’t mean they will receive the damages they seek.

Looking beyond the widely cited RWE, Uniper and Rockhopper claims, a March 2022 report challenged the widespread expectation of a wave of ECT cases arising out of state regulatory actions adopted to phase out fossil fuels.

The Climate Change Counsel report – which reviewed 64 of the 75 known ECT arbitral awards rendered before August 2021 to assess the ECT’s actual effect on the energy transition –  found that over half (34) of the awards, in fact, related to investments in renewable energy (for example, U-turns on renewable incentive schemes in Spain and Italy). This compares to only 20 awards relating to fossil-based energy investments. Of that 20, none addressed policy issues related to the energy transition, climate change, or obligations under climate law. Such issues were mentioned only as background in the 32 awards that related to incentive schemes in the renewable energy sector.[1] What’s more, none of the awards reviewed addressed climate change in substance and no tribunal considered international climate law when interpreting the ECT’s investment protections.

This suggests that the ECT isn’t giving rise to a raft of claims from fossil investors, let alone significant damages awards, which stymie regulatory changes to phase out coal and other fossil-investments and place the financial burden on the taxpayer.

Sovereignty and environmental protection

What’s more, there is no guarantee that investors bringing claims will even have grounds to succeed. In fact, to describe the ECT as energy agnostic isn’t really correct: Article 19 ECT (Environmental Aspects) imposes a number of obligations on contracting states with regard to sustainable, ecologically-friendly energy policy, including obliging signatories to “strive to minimise in an economically efficient manner harmful Environmental Impacts occurring … from all operations within the Energy Cycle in its Area”. Many of the ECT’s provisions are qualified by Article 24 (Exceptions) which states that the ECT’s provisions shall not preclude signatories from “adopting or enforcing any measure (i) necessary to protect human, animal or plant life or health”.

Moreover, the ECT makes it clear that signatory states can legislate freely to govern their energy policy and resources (Article 18, Sovereignty over Energy Resources) and can deviate from existing regulations and incentive schemes so long as this is “in the public interest” (Article 13). All ECT national signatories ratified the 2015 Paris Agreement and submited national commitments (Nationally Determined Contributions) to reduce their greenhouse gas emissions. As such, national carbon reduction plans and measures to phase out fossil fuels can convincingly be argued not only to be necessary but also “in the public interest” of complying with commitments under international law.

Legitimate Expectation

Investments under the ECT are only protected to the extent that investors have a reasonable and legitimate expectation of legislative and regulatory stability for the lifetime of the investment. Although there is, for obvious reasons, no reference to the Paris Agreement in the ECT (which has not been updated since its inception in 1994), an ICC Commission on Arbitration and ADR found in 2019 that “international treaty obligations are usually interpreted on a progressive basis, and it is likely that the Paris Agreement, and NDCs, will inform the investing party’s legitimate expectations in determining, for example, a fair and equitable treatment claim.” This is affirmed by recent ECT jurisprudence, which requires investors to conduct reasonable due diligence on regulatory stability when effecting an investment. Although it remains to be seen what approach tribunals will take to legitimate expectation arguments, ICC guidance suggests that “climate change policy, commitments and law should not be overlooked in the resolution of climate change related disputes”. In the absence of express assurances given by a state, it will, therefore, be hard for investors to argue that states’ policy shifts away from fossil fuels were unforeseeable and hence that they had a legitimate expectation of continued support.

Importantly, even if investors do successfully establish legitimate expectation and succeed in their claim for compensation under the ECT, this does not materially impact the underlying legislation itself. States remains free to legislate and govern in line with Paris Agreement targets. However, under Article 13 of the ECT, they must compensate the investor for the “fair market value” of their investment. In a world where the value of coal mines, oil and gas pipelines, refineries, and power stations is rapidly in decline, the question arises as to what is the fair market value of a stranded asset? Is it such a burden on taxpayers as the ECT’s critics suggest?  

The Case for Reform

This narrative underpins the EU and its Member States’ attempts since 2018 to modernise the ECT. The European Commission has described the ECT as “outdated”, saying that its provisions are “no longer sustainable” and “no longer corresponded to modern standards”, including the Paris Agreement. Open letters in 2020 and 2022 from over 500 scientists and climate leaders also condemn the ECT as “a major obstacle to the implementation of the Paris Agreement and the European Green Deal”, and highlighted the findings of the 2022 IPCC Report that the ECT may “limit countries’ ability to adopt trade-related climate policies”.

The EU’s goals for implementation are threefold:  

  1. Ensure the ECT is not an obstacle to the energy transition or reaching Paris Agreement goals
  2. Reform the ECT’s ISDS system (to align with international and EU law)
  3. Align investment protection with EU standards.

Today, 24 June 2022, the Energy Charter Secretariat and signatories will meet for the 15th and final round of negotiations to announce an agreement over the modernisation of the treaty. It is unclear whether decision has been reached on any of these goals.

This takes place amidst ramped up calls by European states to withdraw from the treaty and a decisive stance taken by the European Parliament only yesterday, 23 June 2022. The European Parliament report clearly assessed the possibility of reaching agreement on the ECT modernisation and called for a coordinated exit in the absence of an ambitious agreement today. But this also has to be seen in the context of the EU’s opposition to investor-state arbitration concerning EU parties, on the basis that only the European Court of Justice can decide matters involving EU law, as established in Slovak Republic v Achmea BV (Case C-284/16); and its campaign for a Multilateral Investment Court (Multilateral Investment Court). Earlier this week a tribunal dismissed an intra-EU ECT investment arbitration claim for the first time on Achmea grounds i.e. the selection of the seat of the arbitration in an EU state “attracts the application of EU law”, which overrides EU member states obligations under other treaties, including the ECT(Green Power Partners and SCE Solar Don Benito v Spain).

The Case against Withdrawal

But withdrawal from the ECT is not panacea and certainly is not without complications.

Firstly, total withdrawal from – or indeed total abandonment of – the ECT would leave renewables investors (at least temporarily) without any form of reliable protection in foreign states. As stated, the ECT protects all energy sources equally, and in recent years, renewables have been some of the greatest beneficiaries. Foreign direct investments (FDI) are central to the massive renewable infrastructure and advanced energy technology projects required for the energy transition. FDI in clean energy can only work with stable regulatory regimes and protections for investors – heretofore provided by the ECT. If we strip this out completely, clean energy investors will have little protection (besides costly political risk insurance and doubtful contractual bargaining power) for the much-needed investments in high-risk projects in hydrogen, floating wind and battery storage etc.

Secondly, the ECT contains a 20-year sunset clause (Article 47(3)) which means investors could continue to challenge and seek compensation from states for green climate policies for twenty years after their withdrawal. Further, if the ECT is amended after the states’ withdrawal, such amendments would not bind the withdrawn state (for example, Italy, who withdrew in 2016) because they did not ratify the new terms. Withdrawal would therefore mean the survival of the unreformed ECT.

The ECT is far from perfect. The situation is far from simple. The long-standing debate between the ‘reform’, ‘withdraw’ or ‘terminate’ camps may today be decided. Hold on to your seats… 

End

Additional authors:

Sarah Hill-Smith

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