Modernisation of the Energy Charter Treaty: A necessary turning point for investment protection in the energy sector?

By Agata Daszko[1] and Kilian Wagner[2]

Introduction

The Energy Charter Treaty (“ECT” or “Treaty”), signed in December 1994 in Lisbon, has its origins in the 1990 proposal of the Dutch Prime Minister, Ruud Lubbers, which first resulted in the European Energy Charter of 1991 as a political declaration and continued in the negotiations for a binding instrument. The ECT was concluded on the heels of the dissolution of the Soviet Union; at the time Russia and her neighbours, rich in energy resources, were in dire need of investment and Western European countries were in search of options to limit their energy dependency on the Middle East. Against this backdrop, the ECT, as the only multilateral investment treaty to exclusively regulate cooperation in the energy sector, fostered a win-win situation. Besides European (including the EU) and Eurasian States, its 54 signatories notably also include Japan, Jordan and Yemen. Although participating in the negotiations, the United States ultimately refrained from signing the Treaty.

Overall, the ECT is considered the biggest multilateral investment treaty in the world. Part III of the Treaty governs protection of investments, with many standard substantive provisions (such as FET, FPS, MST) included in Article 10, and the provision on expropriation enshrined in Article 13. Indeed, the ECT does not actually go beyond the protection afforded to foreign investment (in the energy sector or otherwise) in other international investment agreements (“IIAs”) of the time. Perhaps unsurprisingly, it is also the most-oft invoked international investment agreement in ISDS proceedings. It has been the basis for at least 150 claims, out of the total of around 1,200 known ISDS cases. Due to this notoriety, the exclusive subject-matter and its clear aim of promoting “long-term cooperation in the energy field, based on complementarities and mutual benefits” (Article 2 ECT), the ECT has been attracting growing criticism, including calls for its abandonment. A modernisation process eventually started in 2017 and is currently moving towards finalisation with an ‘Agreement in Principle’ concluded in June 2022.

In this blog post, we aim to first highlight some statistics of ECT case law (I.) which often stand in slight contrast to how the Treaty is presented in the media and political discourse (II.). Against this backdrop, we will then discuss the modernisation process and its perceived outcomes thus far (III.), before making some concluding remarks.

I. The ECT in statistics: devil’s (not) in the numbers

In June 2022, the Energy Charter Secretariat updated the statistics on the ECT case law, providing for a rather interesting read. The Secretariat puts the number of publicly known arbitration cases brought under the ECT at 150. The last five years (2017-2022) have given rise to 43 cases. Over a third of all known ECT cases (51), have been brought against Spain, most of which followed the State’s 2010 modification of its incentive regime on renewable energy. Indeed, a clear majority of cases brought under the Treaty concern investment in renewables (91), with fossil fuels being the underlying energy source in 50 cases, and nuclear energy in 5. Of the 82 final awards rendered, the Secretariat knows the outcomes of 80. According to the Secretariat, the tribunals found a breach of the ECT and awarded damages in 37 cases. As for the remaining 43 cases, the tribunals found on 11 occasions that they had no jurisdiction and on 23 occasions that there was no breach of the ECT. In a further 3 cases, a breach was found but no damages were awarded and on 4 occasions the settlement agreement was embodied in an award. Perhaps one of the most oft-discussed issues relating to ECT arbitration, is the question of damages. Here too the Secretariat’s statistics paint an interesting picture. Notwithstanding the Yukos arbitration, where EUR 87 billion was claimed and EUR 40 billion awarded, in all ECT arbitrations combined, claimants have sought approximately EUR 40.1 billion in damages. And all in all, they were awarded around EUR 1.79 billion. The Secretariat further lists 34 cases where it provides statistics for ‘claim vs. award’ ratio, from the reading thereof it appears that tribunals tend to award on average 43% of the sum claimed (in only 7 of the 34 cases listed did the tribunal award at least 75% of the sum sought). Of course, statistics can be interpreted in many different ways – the most recent IPCC Report singles out the ECT in a few parts, and states that “transactions in the energy sector show a high level of investor protection also against much needed climate action which is also well illustrated by share of claims settled in favour of foreign investors under the Energy Charter Treaty”. Moreover, legal costs of arbitral proceedings and their allocation may be considerably burdensome for public funds and are likewise part of the criticism.

II. The ECT’s portrayal: the root of all evil

Despite what some would call somehow balanced statistics, the ECT has attracted an unprecedented amount of criticism in recent years. Perhaps it is due to its exclusive subject matter: the energy sector, or maybe because of the most prolific (pending and (about to be) discontinued) cases: RWE v. The Netherlands, Uniper v. The Netherlands, Vattenfall v. Germany, but the perceived ‘evils’ of the ECT seem to be on everyone’s lips. The platforms for criticism tend to range dramatically: from blog posts, newspaper articles and even (at least) one graphic novel and one cartoon, to tweets, political manifestos and climate change litigation claims.

Thus, in the middle of COP26 in Glasgow, one British newspaper described the ECT as “an obscure international agreement that allows energy corporations to sue governments over policies that could hurt their profits.” In October 2021, lawyers of a leading environmental NGO have advocated for the EU to “exit the climate-sabotaging” ECT describing it as “an outdated investment treaty which contains a controversial ‘investor/state dispute settlement’ mechanism – a tool which allows companies to bypass national courts and sue states for billions in compensation in secretive tribunals”. Another respected NGO proclaimed the ECT as “the biggest climate action killer nobody has ever heard of”, others called it “the world’s most dangerous investment agreement.” On the climate-change litigation front, recently five individuals have reportedly brought a case in front of the European Court of Human Rights against 12 states to exit the ECT, seemingly alleging that ongoing membership to the treaty constitutes violation of their rights to life and to private and family life under Articles 2 and 8 of the European Convention on Human Rights. Politically too, a number of State parties have recently voiced opposition to the ECT, also in the context of many protracted arbitrations – with the Netherlands supporting Spain’s call for a “coordinated withdrawal”.

Without claiming universality, the criticisms of the ECT stemming from the media and NGOs frequently reflect those that are sometimes aimed at the ISDS system as a whole – the lack of transparency, obscure sums sought in damages and the ‘secretive court system’ the ECT seemingly promotes. Environmental activists and politicians tend to also focus on the ECT’s potential chilling effect on climate change legislation and argue that the current protection of fossil fuels investments is contrary to the Paris Agreement. Practitioners often concentrate more on the vague provisions found in the ECT, notably that of legitimate expectations under FET, as well as on potential for carve outs for fossil fuels in the modernisation process. Given the range and scope of criticism against the ECT, all eyes are currently on the modernisation process.

III. The ECT modernisation process: outline and outcomes

The modernisation process dates back to 2017 when the Energy Charter Conference launched discussions for substantial reform. After initial consultations, the Conference adopted a list of topics for modernisation in November 2018. The Conference approved suggested policy options by Contracting Parties and, after establishing the modernisation group as a subsidiary body, negotiations took off in July 2020. While the objective of the modernisation is to adjust the ECT to modern investment law, the policy options – most prominently the EU’s text proposal – unveil the overarching considerations on climate change mitigation and adaptation. Despite the EU’s transparency policy, it seems that the modernisation group opted for negotiations behind closed doors as the Contracting Parties’ positions vary significantly. Nevertheless, continuous Public Communications provided an overview of discussed issues and hinted at controversies.

On 24 June 2022, the Contracting Parties reached an ‘Agreement in Principle’ after fifteen negotiation rounds. The text will be submitted for approval to the Energy Charter Conference on 22 November 2022 if no party objects along the way. While the draft remains undisclosed, a Public Communication outlines the prospective changes, allowing for a first assessment against initial expectations and Contracting Parties’ policy suggestions. This part will take a closer look at some aspects, including the envisaged flexibility for States to carve-out fossil fuels, a clarification on intra-EU disputes, limits to the FET standard, and provisions on the right to regulate and sustainable development seeking to transform the ECT’s objectives.

1. Fossil fuel carve-outs

A pivotal motive for the EU was to align the ECT with the Paris Agreement and its climate objectives. In an additional proposal, on the one hand, the EU sought to introduce a general phase-out plan for fossil fuels from investment protection by a redefinition of “Energy Materials and Products” and, on the other hand, to cover new carbon-neutral resources. Phasing out fossil fuels turned out to be one of the most controversial aspects, with some Contracting Parties calling for consideration of individual climate goals and energy needs. The agreement adopts a ‘flexibility mechanism’ allowing States to individually carve-out new fossil fuel investments from the scope of the treaty and to end protection for existing investments ten years after the entry into force. Carve-outs are typical instruments in modern investment treaties to retain regulatory space over policy areas, such as taxation, or sensible industries and economic sectors. The EU and the UK have already announced that they will make use of this option. Fossil fuel investments by investors from the EU or the UK in other States would remain protected unless these Contracting Parties apply the exclusion reciprocally. This is a limited compromise in scope, but it tightens the phase-out timelines compared to the EU’s additional submission which secured protection for some fossil fuels until 2040. If the ratification proceeds expeditiously, this mechanism will shield Contracting Parties from ISDS claims by fossil fuel investors arising from domestic phase-out measures. In contrast, withdrawal from the current ECT would trigger the sunset clause and protect existing investments for another 20 years.

2. Intra-EU disputes

Albeit not explicitly on the list of topics for modernisation, debates on intra-EU ISDS accompanied the negotiations. Following the CJEU’s Komstroy judgment, which extended the groundbreaking judgment in Achmea outruling intra-EU ISDS to the ECT, a response in the modernisation process was inevitable. While arbitral tribunals have constantly rejected intra-EU jurisdictional objections, the decision in Green Power v. Spain declining jurisdiction in an intra-EU dispute marks a cornerstone. The basis for the tribunal’s reasoning was inter alia Article 25 of the ECT which sets out exceptions for members of an Economic Integration Agreement. The Agreement in Principle seems to build on this mechanism. A new Article shall once and for all clarify that alongside Article 26 on Dispute Settlement, also Article 7 on Transit, and Article 29 on trade with non-WTO members do not apply between members of the same Regional Economic Integration Organization (“REIO”). The EU is the sole REIO Contracting Party to the ECT. Presented as a ‘clarification’, these provisions do not appear as new developments but rather seal what has been the legal status in view of the EU ever since and aim to close the remaining loopholes for intra-EU ISDS.

3. FET and Legitimate Expectations

According to the Public Communication, “[t]o increase legal certainty, the new article providing for fair and equitable treatment under the ECT will provide for a list that designates certain measures or series of measures that constitute a violation of this protection standard.” In addition, “[t]he new provision specifies the frustration of Investor’s legitimate expectations and it describes circumstances that give rise to Investor’s legitimate expectations and the conditions under which legitimate expectations may be considered.” In its proposal, the EU did indeed provide for a list of measures that would constitute a breach of FET (Article 10(1)(i) EU Proposal). This list encompassed denial of justice, fundamental breach of due process, manifest arbitrariness, “targeted discrimination on manifestly wrongful grounds” and abusive treatment. This corresponds to the EU’s approach in other treaties and, if accepted, could indeed help to increase legal certainty.

As for the question of legitimate expectations, the EU Proposal defines it as a “specific representation to an investor to induce a covered investment”, on which an investor relied and which the State subsequently frustrated. This clarification seems to follow how the majority of tribunals in renewable energy cases have summarised the concept. Of course, whether the final text on legitimate expectations will include the EU’s proposal or perhaps expand on it remains to be seen. Although the concept of legitimate expectations has been a core element of the FET standard, especially in renewable energy cases, it has yet not been applied in a post-Paris Agreement fossil fuel case under the ECT. With the recent news regarding the potential withdrawal of Uniper’s claim against the Netherlands, we might have to wait a little longer for this to play out, unless the claimants in RWE v. The Netherlands present the argument in their case.

4. Making the ECT greener

One of the more ambitious aspirations of Contracting Parties in the negotiation process was to make the ECT greener. As the Public Communication states, the Parties did recognise “the urgent need to effectively combat climate change”. Consequently, the modernised ECT will now contain provisions that reaffirm Parties’ commitments to the Paris Agreement and ILO fundamental conventions and that explicitly commit them to sustainable development and clarify corporate social responsibility. Whilst the exact wording of such provisions is still unknown, the EU’s Proposal contained some interesting changes. In line with several ‘new generation’ BITs, the EU hopes to incorporate an explicit provision on environmental impact assessment (EIA) (Article 19(j) EU Proposal). The provision takes a step further and even lists the factors that EIAs need to identify and assess. Encouragingly, the Public Communication confirmed that the new provision on EIAs will ensure “higher level of environmental protection and wider public participation”. A potential consequence of non-compliance by an investor could be the loss of investment protection.

Concluding remarks: managing expectations

Notwithstanding the success of concluding the Agreement in Principle, modernisation is anything but set in stone. Upon unanimous approval by the Energy Charter Conference, amendments enter into force according to Article 42(4) of the ECT on the ninetieth day after ratification of three-fourths of Contracting Parties. For the EU and its member states ratification requires an agreement of the Council of the European Union and the consent of the European Parliament. Moreover, ratification by the Member States is necessary, as all except Italy are Contracting Parties to the ECT. However, not all Member States endorse modernisation and, amid growing concerns over compatibility with EU law and climate goals, some are exploring how to depart from the ECT. However, the sunset clause of Article 47(3) ECT hangs as a sword of Damocles over withdrawal options. Withdrawal – in contrast to amendment – triggers the sunset clause and protects existing investments for another 20 years. While an inter se modification among EU Member States “neutralizing” the sunset clause is conceivable, doubts remain whether it relieves member States entirely from the perceived “claws” of ISDS. Also successful ratification of three-fourths of Contracting Parties could impose problems if it takes longer in the remaining States. According to Article 40(4) VCLT, the amended treaty will not bind States which have not ratified the amendment and thus will create asymmetric treaty relations. Between States having ratified and States that have not ratified, the current version of the ECT would continue to apply pursuant to Article 30(4)(b) VCLT. Thus, non-ratification of some Contracting Parties does not frustrate amendment per se but obstructs the underlying objectives. While provisional application of the amendment among all Contracting Parties would be an option, it is unclear whether this can give full effect to all of the changes sought.

Although advocates of the ECT should refrain from celebrating too early, staunch critics of the ECT should also curtail their appetite for burying the Treaty. With regard to the latter, an important factor cannot be ignored – when the Treaty was concluded in 1994, there were around 660 IIAs in force, today this number stands at around 2230 (UNCTAD Statistics). Investors could avoid the effect of a withdrawal from the ECT en masse as it is easier for an investor to bring a claim against the host State under a different IIA today than in 1994. Perhaps, aligning the ECT with climate goals is the best option. While the targets to limit temperature increase justify exclusion of fossil fuels from investment protection, the Paris Agreement in Article 2(1)(c) likewise calls for “[m]aking finance flows consistent with a pathway towards low greenhouse gas emissions and climate-resilient development”. The transformation of the energy sector towards carbon neutrality demands significant investments in renewables and the channelling of public and private funds. Perhaps looking at the ECT statistics, we could argue that the Treaty has been, at least partially, a successful instrument for the protection of renewable energy investments, which is a function that should be retained. Of course, criticism should never be ignored – as this could lead the modernisation towards the same fate as other unsuccessful negotiations of the past decade.

  1. Agata Daszko is a PhD candidate and Research Fellow at the University of ​Göttingen as well as interim Editor-in-Chief of the EFILA Blog. The views expressed in this post are of the authors alone and do not reflect the views of the organisations the authors represent.

  2. Kilian Wagner is a PhD candidate and Research Fellow at the University of Vienna.

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