Going green? Modernizing the Energy Charter Treaty

Introduction

Dating from 1994 and with over 50 signatories, including the UK, EU and Japan, the Energy Charter Treaty (ECT) is a multilateral investment treaty which aims to promote security, competition and cross-border investment in the energy sector. In recent years, however, the Treaty has been criticised as ‘anti-climate’, posing a threat to the energy transition by protecting fossil fuel investment and acting as a buffer for climate action. It is perceived as being too investor-friendly and infringing states’ right to regulate to combat climate change.

The EU, in particular, has advocated for change to make the ECT ‘greener’ and has produced a draft proposal for its modernization

(the Proposal). One of its objectives is to align the ECT more closely with the goals of the United Nations Framework Convention on Climate Change (UNFCCC) and the Paris Agreement in order to support the energy transition. So far, there have been eleven rounds of negotiations, with more to come.

In this article, we look at one of the key challenges of the modernization process: balancing the goals of net zero with the protection of international investment. Striking this balance will be essential to securing the enormous investment of financial capital required to facilitate the energy transition.

Climate policies and the ECT

The ECT is seen by climate activists as an obstruction to the energy transition

giving fossil fuel companies the power to sue states when climate policies are perceived to be inconsistent with their investments. Like other investment treaties, the ECT contains a mechanism for dispute resolution which allows investors to commence arbitration directly against states for alleged breaches of the ECT. The confidentiality of these claims has exacerbated the perception that the ECT protects private investment whilst exposing states to potentially large damages claims arising from green policy-making.

This is not a theoretical threat, examples of climate related claims against states under the ECT include:

• In May 2017, the British-Italian oil and gas company Rockhopper commenced ICSID arbitration under the ECT against Italy, following Italy’s decision not to award the company a production concession in the Ombrina Mare field due to the state’s ban on oil and gas exploration and production along its coastline. The proceedings are ongoing.
• More recently in 2021, two energy companies have commenced ICSID arbitrations under the ECT against the Netherlands following its announcement that it will be phasing out coal power plants by 2030. Together they are claiming billions of euros in compensation from the Netherlands.
• Numerous claims have been brought against Spain, Italy and the Czech Republic when feed-in tariff regimes to support renewables investment were withdrawn in the early 2010s. As states try to encourage the investment that will be essential to meeting the challenges of the energy transition, renewables claims may well keep pace with those arising out of traditional fossil fuel investments.

The Proposal

The EU’s Proposal is ambitious, covering a wide range of potential amendments, including:

Implementation of the Paris Agreement and enforcement

One of the most radical proposals by the EU is a new article requiring contracting states to “effectively implement” the UNFCC and the Paris Agreement.

It also creates a positive obligation for signatories to cooperate on climate change mitigation and adaptation in order to accelerate the transition towards a low emission, clean energy and resource efficient economy, as well as to climate resilient development. These obligations would become enforceable through state to state dispute resolution, thereby giving the obligations in the Paris Agreement, as between contracting states at least, ‘teeth’ for the first time. Currently the treaty is self-regulating, relying on states voluntarily meeting their commitments.

Economic Activities in the Energy Sector

Article 1(5) of the ECT protects “Economic Activities in the Energy Sector”.

As part of the modernization process, some have called for treaty protection for fossil fuels to be abolished.

The EU’s proposed solution is to exclude all future fossil fuel investments from investment protection, with a limited carve out for natural gas-fuelled power infrastructure investments if they either:

• emit less than 380g of CO2 per kWh of electricity and can use low-carbon gases (these investments are protected until the end of 2030); or
• replace coal, on the basis that coal is a more harmful pollutant (these investments will benefit from protection for ten years after the treaty amendment takes effect (until the end of 2040 at the latest)).

The Proposal also suggests that newer technologies, such as hydrogen, biomass and others, are expressly covered so as to widen the scope of protected investments in line with green objectives and boost investor confidence.

Impact assessment

In order to promote transparency and greater stakeholder engagement in the energy transition, the Proposal introduces a requirement to carry out an environmental impact assessment before granting authorization for any energy infrastructure project. The assessment must cover: human health; biodiversity; land; soil; water; air; and, cultural heritage and landscape. The results of each assessment will be publicly available.

Fair and Equitable Treatment

Fair and Equitable Treatment (FET) provisions are a fundamental protection for investors under bilateral and multilateral investment treaties. The ECT provides that states must “encourage and create stable, equitable, favourable and transparent conditions for Investors of other Contracting Parties [States] to make Investments in its Area. Such conditions shall include a commitment to accord at all times to Investments of Investors of other Contracting Parties fair and equitable treatment.” The Treaty does not define what constitutes a breach of the FET standard and some argue that FET standards have been interpreted too broadly, protecting investors to the detriment of states’ right to regulate. The EU has therefore suggested adopting a narrow list of breaches comprising:

• Denial of justice in criminal, civil or administrative proceedings.
• Fundamental breach of due process, including a fundamental breach of transparency in judicial and administrative proceedings.
• Manifest arbitrariness.
• Targeted discrimination on manifestly wrongful grounds, such as gender, race or religious belief
• Abusive treatment, such as harassment, duress or coercion.

When applying the FET standard to the actions of states, tribunals would be able to take into account specific representations made by a state to an investor in order to induce an investment covered by the ECT, that “created a legitimate expectation, upon which the investor relied in deciding to make or maintain the covered investment, but that Contracting party subsequently frustrated”. However, this would not be a free standing obligation.

Right to regulate

One of the challenges of modernizing the ECT is striking the balance between encouraging investment in the energy transition through the protection and promotion of a stable regulatory regime, whilst also affording contracting states the right to regulate to achieve “legitimate policy aims” without the threat of legal action and large damages awards.

In the Proposal, the EU reaffirms the right to regulate to achieve “legitimate policy aims” relating to the protection of the environment, and expressly references “combatting climate change”.

This may encourage states to align themselves more closely to the UNFCCC and the Paris Agreement by providing comfort that steps taken to facilitate the energy transition may, when properly taken, not give rise to investor claims.

Dispute resolution

The Proposal introduces a new method for tribunal appointments whereby an independent body would create a robust selection procedure and provide a list of arbitrators for the parties to select, with a requirement for those arbitrators to have specific expertise in labour or environmental law.

The Proposal also introduces a two court system to allow for appeals, which has the potential to lengthen already notoriously protracted and costly ICSID proceedings. However, the Proposal also seeks to address the criticism that the ECT’s dispute settlement provisions do not adequately safeguard against, or quickly dismiss, frivolous claims by introducing a mechanism allowing for parties to file a preliminary objection allowing for early dismissal of unmeritorious claims, and a statute of limitations clause so that there is a time limit on bringing claims.

The Future of the ECT

The modernization process is a balancing act between green objectives and the protection of investors.

It is evident from some of the amendments in the Proposal that aligning the ECT with the Paris Agreement and the UNFCCC is not just about restricting the protection of investments in fossil fuels but also about encouraging green investments, thereby ensuring that the protection of investors is still at the forefront of the ECT’s objectives.

The modernization process is ongoing, with the next round of negotiations scheduled to take place in April 2022. The European Commission has made it clear that, although it considers a reformed ECT to be the best outcome, it may consider recommending that the EU and its member states withdraw from the ECT entirely if core EU objectives are not met within a reasonable timeframe. The long sunset provision in the ECT however means that the impact of any withdrawal may not be felt for many years.