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Pulling the Energy Charter Treaty Through the Crisis


Energy Charter Treaty

Abstract

The Energy Charter Treaty (the “ECT” and/or the “Treaty”) has been under intense criticism for over a decade now, and the Energy Charter Secretariat’s modernisation efforts unfortunately could not result in a consensus to address the concerns deriving from the practical difficulties in application of the ECT. This Article analyses the three most raised objections against the ECT in view of the relevant regulatory framework of the European Union (the “EU”) and its environmental targets and proposes solutions to address the concerns stemming from these objections. Three key issues examined in this Article are (i) the ECT’s incompatibility with the EU law, (ii) the legal protection it provides to fossil fuel investments, and (iii) the signatory states’ reluctance to enact progressive climate legislation due to the prospect of costly legal action under the Treaty. This Article argues for the revival of the ECT through comprehensive reforms that preserve the uniform interpretation and application of the EU law, prioritise sustainable investments over environmentally hazardous ones, and preserve regulatory spaces of signatory states allowing them to pursue ambitious energy and environmental policies.


A. Introduction

Signed in 1994 with the objective of creating a welcoming atmosphere for cross-border energy activities, the ECT is the only international legal mechanism that is customised to the unique requirements of energy generating, trading, and transit operations. To achieve this goal, the Treaty’s signatories take on three key commitments: safeguarding foreign energy investments against non-commercial risks; facilitating and maintaining the security of international energy transit flows; and, last but not least, reducing the adverse ecological and climate effects of all energy-related activities. Its provisions cover a wide range of energy resources, applying from solar, wind, and hydropower-based energy generation facilities to nuclear and fossil fuel investments.[1]


Despite looking good on paper, the abovementioned characteristics of the ECT have been a source of long-standing political and academic controversies. The ECT has been surrounded by severe criticism for almost two decades for conflicting the EU law, defying the objectives of the 2015 Paris Agreement by unduly protecting carbon-intensive investments, and posing an obstacle in the path of transition to clean energy.

The discussions surrounding the ECT attracted even greater attention when close to 150 members of European and national parliaments requested the provisions that protect fossil fuel investments be removed from the ECT in September 2020, emphasising the importance of phasing-out fossil fuels and alignment with the Paris Agreement. The parliamentary members also appealed to the EU Member States to jointly withdraw from the Treaty unless a thorough modernisation is achieved.[2] Multiplied by the effects of Achmea[3] and Komstroy[4] judgments, the demand for reform has grown even further.


The negotiations for the modernisation of the ECT were carried out against this background, but only to result in significant dissatisfaction.[5] The final text of the modernised ECT reflecting the Agreement in Principle reached on 24 June 2022[6] was published on 13 September 2022,[7] shortly before the European Parliament’s resolution outlining the deficits of the modernised text and call for a coordinated withdrawal from the ECT by the EU and its Member States.[8] The European Parliament even proposed a way to neutralise the ECT’s trouble-making sunset clause: a reciprocal revocation by an agreement of all withdrawing EU/non-EU parties.[9]


In addition to the European Parliament, the disappointment caused by the modernised ECT that was formed after long-continued efforts provoked negative reactions from several EU Member States, which announced their intention to withdraw, citing the modernised ECT’s lack of compliance with the Paris Agreement and the EU law.[10] While the Russian Federation and the Italian Republic remain within the scope of the sunset clause, France, Germany, and Poland have notified Portugal, the Depositary of the Energy Charter Treaty, of their withdrawal from the Treaty[11] and Spain,[12] the Netherlands,[13] Slovenia,[14] and Luxembourg[15] have announced their intention to exit without making an official written notification.


This Article makes no attempt to speculate on the reasons behind the present ECT abandonment movement, nor does it seek to refute the criticisms against the ECT. Instead, it focuses on understanding and recognising the ECT’s shortcomings and offering adequate solutions. Arguing for the revival of the ECT, the Authors of this Article are of the opinion that a throughout revision of the Treaty is the best course of action to continue the possibility of bringing disputes arising from the energy projects in the host States to an independent and neutral arbitration forum and that withdrawal from the Treaty, whether unilateral or coordinated, is no cure to the problems the current ECT raises and is criticised for.


B. The Energy Charter Treaty’s Shortcomings and Proposed Solutions

The ECT has been under fire from all sides since the Russian Federation left in 2009. It is now commonplace to say of Russia’s withdrawal that it has reduced the ECT to a mere intra-EU treaty, rendering it weak and irrelevant in view of its incompatibility with the autonomy of the EU law. Had been designed to contribute to the sustainable development of the earth, the ECT is now accused of guarding fossil fuel investments in a world committed to combatting the threat of climate change. Critics further suggest that the blame for the slow transition to renewable energy lies with the Treaty, which is abused by big fossil energy companies to discourage governments from enacting progressive legislation. Among others, these issues are widely regarded to be the ECT’s main setbacks that triggered Italy’s exit in 2016 and acted as the driving force behind the more recent withdrawal of seven additional European states. This chapter will analyse these flaws of the ECT and how to effectively address them to revive the Treaty.


1. The Criticism on the Incompatibility of the ECT With the EU Law

On 21 September 2021, the Court of Justice of the European Union (the “CJEU”), with its well-known Komstroy Judgement, held that Article 26 of the ECT (dispute resolution provision of the ECT), is incompatible with the EU Law. In its Komstroy Judgement, the CJEU has determined that although the establishment of a court under an international agreement which is responsible for the interpretation of its provisions and whose decisions are binding on the EU institutions, including the CJEU, is not in principle incompatible with the EU law, the exercise of the EU’s competence in international matters cannot extend to permitting, in an international agreement, a provision according to which a dispute between an investor of one EU Member State and another EU Member State concerning the EU law may be removed from the judicial system of the EU such that the full effectiveness of that law is not guaranteed.[16]


The CJEU has further stressed in its Komstroy Judgement that although the ECT may require Member States to comply with the arbitral mechanisms for which it provides in their relations with investors from third States who are also Contracting Parties to that treaty as regards investments made by the latter in those Member States, preservation of the autonomy and the particular nature of the EU law precludes the same obligations under the ECT from being imposed on Member States as between themselves. Due to the foregoing reasons, the CJEU concluded that Article 26(2)(c) of the ECT must be interpreted as not applicable to disputes between an EU Member State and an investor of another EU Member State in relation with an investment made by the latter in the first EU Member State.[17]


However, despite this milestone judgement of the CJEU, many investment arbitration tribunals hearing the disputes between an EU Member State investor and another EU Member State continued to hold that Article 26 of the ECT is applicable to intra-EU disputes.[18] To this day there are no fewer than 31 arbitration awards holding, in one way or another, that Article 26 of the ECT applies intra-EU.[19] For instance, on 10 June 2022, an ICSID Annulment Committee in RREEF Infrastructure (G.P.) Limited and RREEF Pan-European Infrastructure Two Lux S.A.R.L. v. Kingdom of Spain[20] dismissed an attempt by Spain to annul the award rendered in 2019 within the scope of the ECT. The Annulment Committee held that the CJEU could not unilaterally amend the plain text of a multilateral treaty and that, in any event, ICSID “has no national juridical seat” and thus is not bound by the EU law.[21]


In view of the foregoing, the jurisdictional fight between the CJEU and the investment arbitration tribunals hearing intra-EU investment disputes based on the ECT seems to continue. On the other hand, the Authors of this Article are in the view that a collective withdrawal of the EU Member States from the ECT would not be the right legal action, since it is a reality that the ECT is the sole and only international legal instrument in the field of energy providing extensive legal protection to the investors which is not limited with the EU law but also contains well-known standards in international investment law such as fair and equitable treatment, full protection and security, most favoured nation treatment and the protections against discrimination and unlawful expropriation. Hence, instead of making the ECT inoperable for the EU Member States through a complete withdrawal, creating a new dispute resolution mechanism within the ECT for intra-EU disputes could be more practical and beneficial. By doing so, the investors based in the EU Member States may continue to enjoy the extensive investment protections prescribed under the ECT with respect to their investments made in the non-EU Contracting States, while the Contracting States may sustain the favourable investment environment in their territories and remain attractive to foreign energy investors.


The new mechanism can be realized by establishment of a specific European investment arbitration centre under the auspices of the CJEU which will consider the EU law together with international investment law while hearing an ECT dispute between an investor based in an EU Member State and another EU Member State. On the other hand, another option may be inserting a specific provision into Article 26 of the ECT which specifically prescribes that in cases where both the investor’s home state and the host state are EU Member States, the arbitral tribunal shall be under the obligation to primarily consider the EU law in terms of protection investments. These possible amendments may mitigate the concerns of the CJEU mentioned in its Komstroy Judgement as it will prevent the arbitral tribunals from dispensing from the judicial system of the EU and the full effectiveness of that law can be guaranteed.


2. The Criticism on the Legal Protections for Fossil Fuel Investments Under the ECT

Safeguarding fossil fuel investments is by far the most repeated criticism against the ECT. While the threat of ECT claims against Italy over renewable energy was counted among the most influential reasons for its decision to exit,[22] a majority of European states now appear to be complaining about the exact opposite.[23]


The main reason why the modernised ECT fell short of expectations is its failure to exclude fossil fuel investments of big oil, gas, and coal companies from the scope of protection. While the ECT covers carbon-intensive energy activities, when one dives deeper down to the premises of this criticism, shortcomings and contradictions of this argument also show up. The ECT is neutral in protecting all energy investments, including fossil fuels, renewables, and nuclear, as Dr Urban Rusnák pointed out during his term as the Secretary General of the Energy Charter Secretariat,[24] and the modernised version preserves this neutrality. The modernised ECT does not rule out fossil fuel activities but introduces provisions which enable the signatory states to omit certain energy activities from its scope. In other words, had the modernised ECT been adopted, the Contracting Parties would be able to identify fossil fuel investments of their choice as not being “economic activity in the energy sector” for the purposes of Part III of the Treaty and the protection of existing fossil fuel investments would be limited to a period of approximately 10 years, rather than the current sunset clause’s 20 years.[25]


Furthermore, arbitration records and research reports suggest that the ECT provides the greatest protection to renewable energy investors. As statistical data compiled by the Energy Charter Secretary on investment arbitration cases under the ECT reveal, to date, 59% of all ECT-based investment arbitration cases have concerned the generation of renewable energy, while oil and gas investments have accounted for only 27% and coal investments for 7%. The statistics also indicate that small or medium-sized enterprises and individual investors have enjoyed more protection from the ECT by bringing 63% of all investment cases, as compared to large oil, gas, and coal corporations, multinational holdings, banks, and investment funds.[26]


Moreover, according to the Stockholm-based think tank Climate Change Counsel’s study examining the ECT, climate change, and clean energy transition in light of 64 (of the 75 known) arbitral awards rendered before August 2021, only 10 fossil fuel investment arbitrations have seen arbitral tribunals assume jurisdiction and rule for investors, whereas the figure for awards finding in favour of renewable energy investors was twice as high.[27]


Also, the ECT has been the most invoked treaty by 2023 for renewable investment protection, providing the legal basis for 70% of all claims related to renewables according to a report by the World Bank published in April 2023.[28] Given that 23 out of 27 Member States of the EU have signed in May 2020 the agreement for the termination of Bilateral Investment Treaties between them,[29] the ECT has remained the only treaty between the EU Member States providing protection to renewable energy investments.


While it is true that the modernisation process failed to satisfy the EU Member States’ expectations by not entirely leaving fossil fuel investments out of its scope, the ECT provides the only treaty-based international protection mechanism to renewable energy investors. Considering the modernised ECT allows the signatory states to exclude carbon-intensive investments from its scope and proposes to limit the protection period for existing fossil fuel investments, exiting from the ECT contradicts the stated purpose of withdrawing states by leaving small and medium-sized renewable energy enterprises unprotected while preserving a 20-year protection period for big oil, gas, and coal corporations. Furthermore, the proposed revisions to the ECT could be an incentive for big corporations to phase out carbon-intensive investments and shift to green energy, and the signatory states could use the revised ECT to help them reach the goals of the Paris Agreement, which does not provide any promotion or protection to foreign renewable investors and wants for the support of a bilateral or multilateral investment treaty.[30]


However, there is not much doubt that the ECT has potential for further improvement. In view of the EU’s worldwide objectives of contributing to the sustainable development of the earth, protection of human rights and fundamental freedoms, and the development of international law,[31] certain aspects of the ECT remain to be in need of revision. A rather fundamental revision the ECT still requires is redressing the balance between investors, states, and third parties in investment arbitration. To this end, recognizing the right of host states to bring counterclaims against investors that do not comply with local regulations, public policies, and environmental measures should be the first step. Secondly, the investor-state dispute resolution mechanism provided for by the ECT needs to involve domestic courts and regulatory authorities in the determination of matters related to domestic law. Lastly, affected third parties should be granted full and effective rights to participate in the arbitration process beyond amicus curiae.[32]


Another comprehensive revision to the ECT should be adopted for the effective and concrete promotion of responsible investments which do not cause social or environmental damage and worsen climate change. In addition to the possibility of exclusion of fossil fuel investments, such revisions should include differentiating the protection standards applicable to low-carbon and carbon-intensive investments, obligating investors not to cause environmental damage and tribunals to take any non-compliance into account for the determination of compensation, and restricting the use of technologies producing high carbon emissions as well as promoting the employment of carbon-neutral practices.[33]


Implementing the aforementioned revisions will undoubtedly assist the EU Member States in fulfilling the objectives outlined in the EU Treaties, as well as providing significant support for reaching the climate targets set by the Paris Agreement through initiatives that further encourage the effective use of renewable energy resources. These modifications will also address the EU Member States’ criticisms levelled against the ECT, preserving its survival as the only treaty safeguarding renewable energy investments in the EU.


3. The Criticism on the Threat of Arbitration Under the ECT Preventing the Governments From Enacting Progressive Climate Legislation

Arbitration under Article 26 of the ECT is undoubtedly the most valuable instrument in the hands of mistreated energy investors seeking redress against host states. Despite being encouraged to be brought legitimately as it is a rather expensive procedure, arbitration under the ECT is, more often than not, vulnerable to being exploited by energy corporations or perceived as a risk by governments.


As Climate Change Counsel’s study suggests, the history of arbitrations related to renewable energy incentive schemes may have a chilling effect and be a deterrent for governments attempting to implement progressive energy legislation.[34] Supporting this suggestion are two distinct arbitrations brought by Sweden’s state-owned power company, Vattenfall, against Germany, which was alleged to have prejudiced the former twice, first by refusing to issue environmental permits for a coal-fired power plant[35] and then by choosing to accelerate the phase-out of nuclear energy.[36] The coal-energy power plant dispute was settled after Germany awarded controversial permits,[37] and the one over nuclear was discontinued when Germany agreed to pay €1.4 billion in damages.[38]


The criticism that fossil fuel investors abuse the ECT to challenge clean energy transition, regulatory measures, and phase-outs of controversial types of energy is only reinforced by recent RWE and (now withdrawn) Uniper claims in two ICSID arbitrations against the Netherlands over its decision to discontinue to allow coal power activities.[39]


Although we are not aware of any arbitral award made under the ECT that grants compensation to a fossil fuel investor for damages prompted by regulatory measures aiming at promoting environmentally responsible low-carbon energy production activities, the fact that rendering such awards is unprecedented does not preclude tribunals from doing so in the future and certainly does not allay the “regulatory chill” and governments’ concerns.[40]


Seemingly in an effort to overcome the signatories’ reluctances, the modernised ECT adds a new article that reads: “The Contracting Parties reaffirm the right to regulate within their territories to achieve legitimate policy objectives, such as the protection of the environment, including climate change mitigation and adaptation, protection of public health, safety or public morals.”[41] Despite how well intended it may be to uphold states’ right to regulate, the proposed article falls short of mitigating the concerns as the Contracting Parties need assurance to confidently rely on rather than a reconfirmation of a soft policy preference.


Similarly ineffective is an attempt to withdraw from the ECT, be it individual or collectively by the EU Member States, given that the ECT’s so-called sunset clause prevents the withdrawing states from dodging the threat of investment arbitration for 20 years unless it is jointly terminated by the EU and the EU Member States, as well as all non-EU signatories.[42]


As the above reveals, reforming the ECT is not an option but a necessity. The modernised ECT should preserve regulatory space and the signatory states’ right to regulate by restricting investment protection standards and encouraging regulatory measures aiming at the promotion of sustainable energy activities. Needless to say, these revisions need to be stated explicitly as mandatory provisions, rather than mere suggestions, to successfully ease governments’ concerns about costly legal actions.


4. Using the Vienna Convention on the Law of Treaties as a Guide in the Amendment of the ECT

Although the purpose of this Article is not to enter into the procedural details of the suggested amendments which can be made in the ECT, we are of the opinion that the Vienna Convention on the Law of Treaties (the “VCLT”) may be considered as a guide to realize this amendment in the ECT.[43]


Article 41 of the VCLT provides that:


Two or more of the parties to a multilateral treaty may conclude an agreement to modify the treaty as between themselves alone if (a) the possibility of such a modification is provided for by the treaty; or (b) the modification in question is not prohibited by the treaty and (i) does not affect the enjoyment by the other parties of their rights under the treaty or the performance of their obligations; (ii) does not relate to a provision, derogation from which is incompatible with the effective execution of the object and purpose of the treaty as a whole.


Since there is no provision under the ECT which explicitly prohibits the possibility of modification of the Treaty and since we are in the view that the above suggestions in this Article as to the possible amendments that can be made in the ECT will neither affect the enjoyment by the Contracting Parties of their rights under the Treaty or the performance of their obligations nor will they result in preventing the effective execution of the object and purpose of the ECT as a whole, such amendments in the ECT can be made duly and properly in accordance with Article 41 of the VCLT.


D. Conclusion

The first major problem analysed in this Article is the incompatibility of the ECT’s dispute resolution mechanism with the EU law, which has prompted legitimate criticisms and calls for immediate reforms to preserve the ECT’s effectiveness. As suggested in this Article, by way of establishing a new European arbitration centre under the auspices of the CJEU or inserting a provision prescribing an obligation for the arbitral tribunals established within the scope of ECT to hear the intra-EU disputes to primarily apply the EU Law, the criticisms about the incompatibility of the ECT’s dispute resolution mechanism with the EU Law may be mitigated.


The second criticism concentrates on the protection provided by Treaty to fossil fuel investments despite the worldwide commitment to promoting renewable energy generation activities. A nuanced examination is provided for this issue as the distinct studies and reports consistently suggest that the ECT protects renewable energy investors significantly more. While the records show that this criticism is not entirely justified, it still touches on certain substantial issues which might be mitigated by redressing the balance between investors, states, and third parties in investment arbitration by way of recognising the host states’ right to bring counterclaims and third parties’ right to participate in the arbitral proceedings, and increased involvement of domestic courts and authorities in the dispute resolution process.


The last objection concerns the abusive exercise of the right to arbitrate under the ECT which brings about a chilling effect that dissuades governments from enacting progressive climate legislation and phasing out carbon-intensive practices. In relation with this criticism, we suggest an explicit revision in the ECT enabling it to preserve the signatory states’ regulatory space with more limited investment protection standards and encourage regulatory measures aiming at the promotion of sustainable energy activities.


About the Authors

Mr. Turgut Aycan Özcan is the founding partner of Özcan Legal. Özcan has been dealing with international arbitration for more than 10 years. His main practice areas are International Investment & Commercial Arbitration, Public International Law and Energy Law. Until today, he has represented many Turkish investors in their ICSID arbitration cases filed against several Central Asia and Middle East countries. On the other hand, Özcan was also involved in the teams representing sovereign states before ICSID. Turgut Aycan Özcan has managed the legal team representing the Republic of Türkiye in two major ICSID arbitration cases. Mr. Özcan completed his LL.M. degree at the University of London (Queen Mary & UCL International Programme) on international dispute resolution.


Mr. Esad Çatak is a legal associate specialising in international investment arbitration and commercial arbitration. He received his honours degree from the prestigious law faculty of Bilkent University in Ankara as a full scholarship student and completed his legal internships in the international arbitration department of a leading Turkish law firm representing the Republic of Türkiye before ICSID. Esad’s main practice areas are investment law and construction law within the scope of investment and commercial arbitration.

 

Managing Editor: Naman Anand

Editors-in-Chief: Muskaan Singh & Jhalak Srivastava

Senior Editor: Abeer Tiwari

Associate Editor: Kaushiki Singh

 

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