Modernising the Energy Charter Treaty: agreement in principle reached on a “greener” treaty

The 54 signatories to the Energy Charter Treaty (ECT) have reached agreement upon the principal terms of its modernisation.  In a communication on 24 June 2022 following the fifteenth round of negotiations (a process launched in 2017), the Energy Charter Conference approved a summary explanation of the main changes.  These changes seek to rebalance and modernise the ECT, and are widely considered necessary to secure the treaty’s ongoing relevance, making it more apt to support the global energy transition by allowing states greater policy and regulatory space to fulfil their commitments under the Paris Agreement and other international environmental instruments.  

The treaty text is in the process of editorial and legal review, and will be shared with the contracting parties by 22 August 2022, with a view to its adoption at the Energy Charter Conference session on 22 November 2022.  Unanimity is required to amend the ECT and this will be established by a so-called “silence procedure”, whereby if no party voices its objection before that November session, the text can be adopted.  The new treaty will then enter into force 90 days after it is ratified by 75% of the contracting parties.  As such, the timing of the modernised ECT actually replacing the existing version is uncertain, but could conceivably even take a number of years.   

Further precision regarding the changes – both their substance and how practically they are intended to take effect – will no doubt be available in the coming months but, in the meantime, the revisions (like the ECT itself) continue to attract an equal measure of support and criticism: from both critics who wish to maintain the scope of particular protections that are being reduced, and those who consider the changes do not go far enough to redress the balance between investors’ interests and environmental policy goals.

Background

The ECT was signed in 1994 and entered into force in 1998.  Its signatories include the EU and Euratom.  It created, in the aftermath of the cold war, a multilateral framework for cooperation in the energy sector, including provisions protecting foreign investments in the sector in the territories of signatory states, providing for investor-state dispute settlement (ISDS), and promoting energy security and efficiency. 

Since its inception, more than 150 ISDS cases have been brought under the treaty, with 117 of these being in the past 10 years.  Approximately 52% of those cases that have resulted in an award have been decided in the investor’s favour.  Notably, 60% of claims have been brought by investors in renewables and there have been 13 and 51 claims against Italy and Spain respectively, most regarding their roll-back of previous incentives for investments in renewables.  This has led Italy to withdraw from the ECT (although it continues to face claims based upon ongoing protection under the ECT’s 20-year sunset clause). 

However, the treaty has faced criticism due to claims being brought against states targeting measures aimed at promoting the energy transition (such as the Netherlands’ phasing out of coal power), and the fear of a chilling effect on states wishing to change their sectoral policy in furtherance of environmental commitments.  Indeed, notwithstanding that only 33% of claims were brought by fossil fuel investors, damages awarded in those cases have accounted for 97% of all damages awarded under the ECT.  The broad definition of “investor” also attracts negative commentary in that it enables claims to be brought by “mailbox” companies domiciled in signatory states, thus potentially extending ECT protections to parent companies and shareholders that are not ECT signatory state nationals.

The modernisation discussions were premised on three “pillars”: updating the list of energy materials and products covered (to include hydrogen, for example); creating a “flexibility” mechanism enabling states to exclude or limit protections for fossil fuels; and a more regular (five-yearly) review process enabling the parties to react to technological and political developments more rapidly going forward.      

An important aspect of the negotiations has been the position of the EU, which has been a leading advocate for reform, submitting two draft proposals for revised text.  Indeed, a large number of claims have been brought by EU-domiciled investors against EU member states, clearly demonstrating the conflict between the ECT’s ISDS provision and the Commission’s position that intra-EU investment arbitration agreements contravene EU law.  The Commission’s view was confirmed by the CJEU in its 2018 decision in Slovak Republic v. Achmea B.V. (Case C-284/16)) and, in September 2021, the CJEU held in Komstroy v. Moldova (Case C-741-19) that intra-EU investment arbitration proceedings under the ECT are similarly contrary to EU law.  We therefore do not foresee EU investors bringing future ECT claims against EU member states under the existing ECT (since the courts of member states may set aside or refuse to enforce the relevant award), save potentially under ICSID Rules, which give rise to an award that is automatically enforceable and cannot be set aside by domestic courts.  It is intended that the revised ECT will contain a provision specifying that the dispute settlement provisions will not apply to members of a Regional Economic Integration Organisation such as the EU, thus expressly ruling out intra-EU claims going forward.

Indeed, the Commission has considered withdrawal from the ECT altogether, but acknowledges this would trigger the sunset clause.  That could mean existing investments would continue to enjoy protection for 20 years, and it is not settled under international law whether sunset clauses can be mutually dis-applied by state parties to an investment treaty (for instance, by the EU and its member states).  The EU has therefore instead remained committed to the modernisation process. 

“Greening” the treaty: shift in energy products covered

The ECT applies to “Economic Activity in the Energy Sector”, which is defined by reference to a list of “Energy Materials and Products”.  A number of new such materials and products, largely renewables and other sources considered important to the energy transition, are to be expressly covered by the modernised ECT and its investment protection provisions (removing current uncertainty regarding some of these solutions).  These include:

  • hydrogen (notably the agreement in principle does not distinguish between fossil-based and renewable hydrogen);
  • anhydrous ammonia;
  • biomass;
  • biogas; and
  • synthetic fuels.

We would therefore expect to continue to see a high proportion of ECT claims being brought by investors in renewable solutions.  One can see these arising based on states either removing or changing specific incentives (as in the cases against Spain and Italy which, given the various pressures on public finances, appears very possible) and possibly even on states failing to implement certain aspects of their Paris commitments in a timely way.  

At the same time, under the modernised treaty it will be possible for states to carve out fossil fuels from the investment protections altogether.  Indeed, a number of contracting parties (and observers) had called for the phasing out of fossil fuels from the scope of the treaty’s protections altogether.  This proved too controversial to attract the necessary support, and so instead the “flexibility” mechanism will allow states to adopt bespoke carve-outs.  For instance, the EU and UK have indicated they will carve out fossil-fuel-related investments from protection: (a) for new investments made after 15 August 2023, with limited exceptions; and (b) for existing investments, after 10 years from the entry into force of the relevant provisions in the new ECT which permit the carve-out.  The current ECT does not contain a definition of “fossil fuels” and the final text will need to include a formulation to clearly define specifically what may be carved out.  For instance, the EU’s proposal envisaged carving out protection for petroleum, gas and coal investments as well as power generated from those sources, with the exclusion of certain infrastructure investments powered by lower-emission natural gas (particularly where these replace coal).  

Further, practical questions regarding how the carve-outs will be drafted and effected, and when they will enter into force, remain to be addressed.  Subject to those points, one can envisage claims being brought by existing investors in fossil fuels perhaps earlier than planned, in an effort to avoid the effect of the carve-outs.  Those investors might also look to restructure their investments via ECT states that have not adopted any carve-out.  However, the prospects for successful structuring would appear to be limited by amendments restricting protections for “mailbox” companies discussed below, general investment treaty law principles prohibiting abusive “treaty shopping” and an envisaged special provision for the dismissal of claims submitted as a result of investment restructuring for the “sole purpose” of submitting a claim under the Treaty.

Focusing the investment protections

Agreement has also been reached in principle upon certain amendments and clarifications to the scope of the investment protections themselves.  Some of these are aimed at increasing legal certainty (by expressly setting out principles derived from case law).  Others seek to rectify perceived problems with these from the contracting parties’ perspective and redress the balance between investment protection and states’ ability to regulate.  The final text will warrant further review (and, no doubt, debate), but to highlight a few points of interest:

  • Requirement for an investor to have “substantial business activities” in its home state: This is aimed at removing so-called “mailbox” companies from the ECT’s scope, thus ending effective protection for non-ECT state nationals who hold investments via such companies.  It remains to be seen what the timing will be for such a requirement to take effect.
  • New definition of “fair and equitable treatment” (FET):  The ECT contains an FET provision, which is by far the most regularly invoked standard in ISDS.  International investment tribunals have found that FET encompasses multi-faceted protection covering a wide range of situations, sometimes creating uncertainty for states as to what actions are permissible.  The new FET provision will aim to clarify this, and avoid further expansion, through a list of specific measures that will be designated as violating the standard (although it appears the list will be indicative, not closed).  For instance, the new provision will contain a description of circumstances that give rise to legitimate expectations on investors’ part, and in what circumstances these may be considered by states in taking policy decisions. 
  • New definition of “indirect expropriation”: Both the notions of “direct” and “indirect” expropriation will be clarified, with a new definition of “indirect expropriation” being introduced.  In investment treaty case law, this has been developed as covering cases where legal title to an investment is not taken away from the investor, but through a state measure or series of measures that substantially deprive the investor of its value, whereby it is unable in reality to benefit from its investment.  The new ECT definition will set out a list of factors to be considered when determining whether an indirect expropriation has occurred and will provide that, as a general rule, non-discriminatory measures adopted to protect legitimate policy objectives (including the environment) do not constitute indirect expropriation. 
  • “Most constant protection and security”: It will be clarified that this standard relates (presumably exclusively) to the obligation for states to protect the physical security of investors and their investments, and not to provide other non-physical (or “legal”) protective measures, as certain investment arbitration tribunals have interpreted it.   

These and the other revisions to the investment protection provisions are likely to require greater focus by investors in formulating claims for their breach.  However, the more precise articulation of applicable standards in the ECT’s articles and the guidance this will provide to tribunals will likely lead to greater certainty of outcomes in ISDS (reducing the risk of wasted time and cost), which should be welcomed by states and investors alike.

Conclusion

The agreement in principle signals a rebalancing of focus from protecting the interests of investors in traditional energies (in furtherance of the ECT’s original aims) towards encouraging and protecting renewable energy investments, coupled with an increased freedom for states to regulate in order to reach their climate-related targets.  Though outside the scope of this post, changes to the dispute settlement provisions are further aligned with these goals, including increased transparency (to help combat the perception of secrecy around the treaty and its effects).  However, many questions remain as to the precise scope of the changes, how and when they will come into effect, and the number of contracting parties that will take advantage of the increased flexibility to depart from the treaty’s historical scope.  The efficiency with which these can be resolved will likely be determinative of the ECT’s ongoing pertinence in the years to come.    

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