Leigh Crestohl examines the uncertain fate of the ECT in International Water Power & Dam Construction

Leigh's article was published in International Water Power & Dam Construction's May 2023 Issue and can be found here. 

The uncertain fate of the Energy Charter Treaty

At a time when public attention is focused on European energy security, it may seem surprising that the future of the Energy Charter Treaty (“ECT”) should elicit controversy.  Nevertheless, despite 5 years of efforts to modernise the 1994 treaty, the EU has recently advocated a mass withdrawal, and other states may follow. 

Momentum for withdrawal certainly seems to be growing. Following Italy’s lead in 2016, France, Germany and Poland have notified their withdrawal.[1]  Other member states are said to be considering withdrawal, and the ECT recently received robust criticism in a UK House of Commons debate.[2]

At the core of the controversy is a perception that the ECT favours fossil fuel investment and restricts governments from pursuing renewable and clean energy initiatives to meet commitments under the Paris Agreement (2015).  There is concern that such initiatives have and will continue to provoke large claims under the ECT’s investor-state dispute settlement (“ISDS”) provisions, a process criticised by some as producing disproportionate monetary awards in favour of fossil fuel investors.

Whilst the Energy Charter’s Secretary has challenged EU Member States to support the agreed modernisation in order better to meet those concerns,[3] the process is now at best delayed, if not entirely stymied.

This article briefly discusses the ECT, modernisation and possible implications that the EU position may have for future developments in this area.

What is the ECT?

The ECT is a multilateral treaty signed in 1994 that establishes "a legal framework in order to promote long-term cooperation in the energy field, based on complementarities and mutual benefits, in accordance with the objectives and principles of the Charter” (Art. 2). [4] It emerged following the collapse of the Soviet Union, and with a view to western investment in the transitioning energy markets of Eastern Europe and central Asia.

There are 53 Contracting Parties, including the EU (as a “Regional Economic Integration Organisation” (REIO)), its individual member states, EEA members and the United Kingdom.  Ukraine and Turkey, and several Balkan states are signatories, as are central Asian countries.  Japan is the most notable member outside those regions.  Since 2018, Russia no longer considers itself a member. 

The ECT includes guarantees commonly found in investment protection treaties. For example, investments must be accorded fair and equitable treatment.  In the case of a breach, an investor may at its election submit a dispute either to a national court or to arbitration. In this respect it is like many bilateral investment treaties (“BIT”) currently in force. 

A Contracting Party may withdraw from the ECT.  However, under article 47(3) the ECT continues to apply to covered investments for a 20-year period following withdrawal.  This “sunset clause” is now highly controversial, as discussed below

ECT Modernisation

Modernisation discussions began in 2017, and by June 2022 there had been 15 rounds of multilateral negotiations resulting in an agreement in principle on 24 June 2022.[5] Although an exhaustive review is beyond the scope of this article, a few elements deserve mention. 

Firstly, a “flexibility mechanism” was agreed.  This permits a Contracting Party to exclude investment protection for fossil fuels when considering its individual energy security and climate goals.  The UK and EU intend to apply this to existing investments after a period of 10 years, and to all new investments within the scope of the ECT made after August 2023.

Secondly, the “right to regulate” was further emphasised, and a stand-alone article included to reaffirm a Contracting Party’s right to regulate for “protection of the environment, including climate change mitigation and adaptation”.

Thirdly, proposed changes to the arbitration process are intended to address transparency concerns including a requirement that parties disclose third-party financing of their costs.  In addition, monetary damages are to be limited to the loss suffered by the investor and the award of punitive damages is to be prohibited.

Modernisation needs to be ratified by 75% of the Contracting Parties.  The EU and its member states alone represent a sizeable voting bloc, calling into question whether ratification is achievable.

Criticisms of the ECT

The ECT is seen as a creature of its era, and thus an outdated obstacle to transition to renewable energy. Recent large arbitration claims and awards against western European states under the ECT fuel concerns about “regulatory chill”, leading one former UK minister to describe the ECT as a “relic from a bygone age” that “is being weaponised by fossil fuel companies to sue governments for introducing climate policies”.[6]

There does seem to have been a perceptible turning of the tables over the last decade.  Claims are now increasingly being made by EU investors against EU member states, rather than non-EU states as was envisaged when the ECT was signed. Rockhopper's successful £210 million award last year arising from Italy’s 2015 coastal offshore oil drilling ban is a recent example of such a claim where, critics note, the damages awarded greatly exceeding the initial investment.[7]  Likewise, there are around 50 cases pending against Spain following a change to its renewable energy policy in 2013. It is said that such “intra-EU” claims represent two-thirds of ECT claims since 2014.[8]  

This trend worries EU legislators who view the ISDS system generally as undermining the coherence and autonomy of EU law.  In a landmark 2018 ruling the EU’s Court of Justice concluded that investment arbitration under a BIT between two EU member states was contrary to EU law.[9]  A further 2021 ruling extended this rationale to intra-EU arbitration proceedings under the ECT.[10] Although EU member states have tried to resist arbitral jurisdiction on these grounds and EU rules against state aid, Spain recently failed to secure the annulment of a €30,875,000 award made in 2020 against it by an ICSID tribunal under the ECT in favour of Swedish/Liechtenstein investors in 33 hydropower generation plants in Spain.[11] 

Each of these criticisms could be the subject of a full-length article. However, the issues may also be somewhat overstated, and appear either to overlook the impact that modernisation may bring, or proceed on the premise that it is doomed to fail. Others, such as the suggestion that claimant investors should not be able to recover loss of profit as part of a treaty breach claim, are not specific to the ECT regime, and are moreover difficult to justify on legal grounds.

The ECT already reflects each Contracting Party’s right to “take precautionary measures to prevent or minimise environmental degradation” (Art. 19). The “right to regulate” would strengthen this and potentially mitigate the risk of future claims.  In any event, apparently only 4 out of the 157 known ECT cases arose from environmental policies.[12] Moreover, the majority of those cases (59%) concerned renewable energy investments. Only 39 cases of that total led to an award with compensation.[13]

The “flexibility mechanism” in the agreement in principle also provides a path to an eventual phase-out of protection for fossil fuel investment under the ECT.  Whether and the extent to which the timeline to achieve this is in line with the Paris Agreement and EU climate objectives remains open to debate, and is beyond the scope of this article.  However, the EU now appears to take the position that this phase-out must begin immediately, a position which is irreconcilable with the agreement in principle and which now represents an existential threat to the ECT.

EU position and withdrawal proposal

The EU and UK played an important role in the modernisation negotiations.  On 24 June 2022, the EU Directorate-General for Trade praised the agreement in principle:

it provides legal certainty and ensures a high level of investment protection while reflecting clean energy transition goals and contributing to the achievement of the objectives of the Paris Agreement.

The statement concluded that “we have thereby aligned the ECT with the Paris Agreement and our environmental objectives”, noting also the phasing out of fossil fuel investment protection in a shorter period than the 20 years which would otherwise result from withdrawal.

It will therefore have come as a surprise to many when the EU Parliament on 24 November 2022 adopted a lengthy resolution calling upon the EU Commission and member states to withdraw from the ECT (“Resolution”).[14]  The Resolution is in direct opposition to the above statement and contradicts its conclusion that the modernised ECT was aligned with the Paris Agreement and the EU’s climate objectives.

The Resolution appears premised upon the almost certain impossibility of modernisation being approved, although this of course is a by-product of the paralysis the EU has caused. It moreover betrays evident hostility towards the ISDS system in general, both under the ECT and BIT’s.  The prominence given to these issues, and the stated threat of claims by fossil fuel investors, suggests that risk mitigation is central to the EU’s position.

It is also relevant to observe that even before the adoption of the Resolution, certain individual EU member states voiced their opposition.  In October 2022, France announced its intention to withdraw from the ECT, following the Netherlands, Germany and Poland.  President Macron was quoted in the press speaking of the ECT leading to “…significant compensation for certain actors”[15] confirming that the “regulatory chill” issue is an important political consideration.

The Resolution is echoed by an unofficial EU Commission "non-paper" that was leaked in February 2023.[16]  It advocates an immediate withdrawal from the ECT by way of a separate treaty between the withdrawing parties agreeing inter se not to give effect to the ECT's 20-year sunset clause. This might be complemented by a further treaty with other non-EU states withdrawing from the ECT, on a reciprocal basis, to disapply the sunset clause. Central to this position is the Commission’s assessment that most energy investment within the EU comes from investors in other EU member states who cannot, in light of the EU jurisprudence mentioned above, bring claims against EU member states under the ECT dispute settlement provisions.

The EU position is somewhat lacking in coherence. Firstly, the ECT is not the only available international investment protection. The Resolution records that EU member states have concluded around 1,500 BITs which are likely to protect fossil fuel investments.  Similarly, recent multilateral agreements negotiated by the EU, such as CETA, did not expressly carve out protection for fossil fuel investment.

Secondly, the ISDS system will continue to exist for some time to come, notwithstanding the EU position.  As the non-paper recognises, arbitration tribunals need not accept EU law objections and, although EU courts may refuse to recognise those awards, a non-EU court can take a different view.  Since Brexit, the United Kingdom seems a natural forum for such enforcement proceedings. Indeed, in January 2023 the English Commercial Court denied the EU Commission’s application to intervene in such an enforcement case to advocate the EU law position.[17] The solution the non-paper proposes is to bring countries like the UK and Switzerland (both frequent arbitration venues) into a separate agreement to neutralise the ECT.  It is not clear whether there would be any appetite for this, and the proposal is therefore less effective than a modernised ECT which would by its plain terms prohibit intra-EU dispute settlement.

Avoiding the “sunset clause” may also be subject to legal difficulties. Without descending into the legal technicalities, there are at least doubts as to whether the proposed inter se agreement would be lawful considering other provisions in the ECT.  A difficulty also arises given that Italy already left the ECT and other EU members will have done so before an inter se treaty is concluded.  If these concerns are valid, and the issues are obviously debatable, then there is a risk that some fossil fuel investments will in fact obtain 20-years of protection, which is more advantageous than were modernisation approved and a phase-out introduced in line with the “flexibility mechanism”.  Any investments from investors in non-EU member states will also obtain full benefit of the sunset clause, unless persuaded to join in a separate inter se agreement.  There is no evidence that any other state might be intending to do so.

What next?

The ECT modernisation process is in a state of paralysis.  With the largest bloc of its members preparing to abandon modernisation, the fate of those states that remain in the un-modernised ECT is uncertain.

It would be open to the EU to proceed with modernisation and then withdraw from the ECT.  This option is preferred by the Energy Charter Secretary-General.[18]  Although considered as the “third option” in the non-paper, its authors discounted it.  However, the reasons for doing so are not very compelling: it would contradict political statements made to date and would be “disingenuous” towards the remaining non-EU Contracting Parties. 

It is not clear what route the EU will follow but there is a risk that this crisis may impede the promotion and protection of investments in renewable and clean energy.  The “non-paper” expresses the view that the EU is such a desirable energy market, and its justice system so exemplary, that the absence of international treaty protection should not trouble investors.  This may or may not be the case, but it surely reflects a Eurocentric view that ignores the risks that European investors will need to assess when considering renewable energy investments in non-EU countries.

There is also likely to be a period of substantial uncertainty, which is never desirable. In the event of a withdrawal according to the EU blueprint, one can easily foresee complex and costly jurisdiction debates before arbitration tribunals about whether the “sunset clause” continues to apply as a matter of international law.  Withdrawing nations may have to wait out a relatively lengthy period of uncertainty before eventually free of the ECT.  The risk of enforcement in non-EU jurisdictions may mean that withdrawing EU states may never fully be free until the expiry of the “sunset clause”.

The EU position is, on one possible view, an assault on the global ISDS system of international arbitration.  The system is not unique to the ECT or the energy sector, nor the exclusive preserve of fossil fuel investors.  However, assertions by critics and interested politicians, specific to one economic sector that have been neither tested empirically nor challenged, risk undermining the investment dispute settlement system. It may not be a perfect system, but it has numerous advantages that do not seem to have been much considered in this debate.