Is the sun setting on the Energy Charter Treaty? An update on the modernisation process

On 2 December 2020, the European Commission (the “Commission”) indicated that if “core EU objectives” are not met as part of the ongoing negotiations to modernise the Energy Charter Treaty (the “ECT”), the EU may consider withdrawing from the ECT altogether.

This development arises out of the perceived conflict between the EU’s climate change commitments and the raison d’être of the ECT. Given the ECT’s protection of cross-border investments in the energy sector (including fossil fuels), the contention is that the ECT works against the EU’s efforts to build a sustainable energy economy through the European Green Deal and to keep the increase in global temperature to well below 2°C above pre-industrial levels, as agreed at the 2015 UNFCCC Conference of Parties (“COP”) 21 in Paris (the “Paris Agreement”).

Background – criticisms of the ECT

The ECT is a multilateral framework for cooperation in the energy sector. Concluded in 1994, it establishes common rules governing investment protection, trade in energy materials and products, transit and dispute settlement. There are currently 56 members and 42 observers to the ECT. The EU is the only intergovernmental organisation that is a party to the ECT.

It is widely recognised that the ECT is a product of its time. The ECT is based on principles set out in the European Energy Charter signed in 1991 with the aim of integrating former Soviet countries and central and eastern European states into the western European and world energy markets. The broad criticism is that the ECT is not a climate-friendly agreement. Pro-environment EU parliamentarians have stated that the ECT would protect €2.15 trillion in investments in fossil fuels by 2050 if those fossil fuels are not phased out of the ECT’s scope of protection.

Dissatisfaction with the ECT has also focussed on its investor-state dispute settlement (“ISDS”) mechanism providing covered investors with a direct right of redress against their host states under international law. Critics argue that the fact that the ECT enables foreign investors in oil and gas to sue governments in private arbitration proceedings means the fossil fuel industry can take legal action against countries passing laws aimed at reducing or eliminating the use of non-renewable sources of energy.

Indeed, the ECT has provided a platform for energy companies to bring or threaten to bring claims against government regulation in this area. Examples include Rockhopper’s case against Italy after the Italian Parliament’s ban on all new oil and gas operations near the country’s coast, Uniper’s claim for up to €1 billion compensation in response to a Dutch government plan to phase out coal power by 2030, and Ascent Resources’ €50 million claim against Slovenia for alleged delays in issuing an operating permit due to concerns of environmental damage from hydraulic fracturing.

Modernisation of the ECT

The first efforts to bring the ECT up to date took place with the adoption of the International Energy Charter in 2015, which was a declaration of political intention aimed at strengthening energy cooperation among the signatory states and reflecting the changes in the energy markets since the 1990s. The Energy Charter Conference (the governing and decision-making body for the Energy Charter process) embarked on consultations regarding the second phase of modernising the ECT in 2017, and in 2019 it was agreed that a “Modernisation Group” would commence formal negotiations. Three rounds of negotiations have since taken place in 2020, most recently in November 2020, with the Commission negotiating on behalf of the EU and all EU Member States.

The Commission’s statement

On 12 October 2020, members of the European Parliament submitted a question to the Commission on the timeline for the ECT’s ongoing modernisation process. They stated that the ECT “undermines any regulatory attempt to change the crashing course of fossil fuel consumption and forces EU citizens to pay for the life insurance of fossil fuel investors”. They further noted that the parties to the Paris Agreement (including the EU) are due to set out their efforts to reduce national emissions and to adapt to the impacts of climate change by submitting enhanced “Nationally Determined Contributions” in advance of COP26 in Glasgow in November 2021. The EU Parliamentarians asked (1) what the deadline for the modernisation process was; and (2) whether the EU would commit to withdrawing from the ECT, as Italy did in 2016, if the modernisation process had failed to align the treaty with the Paris Agreement by COP26.

In its response to the question on 2 December 2020, the Commission noted that the negotiations for the modernisation of the ECT are still at an “early stage”. It considered that the “best possible outcome” of the process is a “reformed ECT” and it reiterated that one of the objectives of the reform is to align the ECT with the Paris Agreement and the objectives of the European Green Deal. Indeed, the Commission has already demonstrated that it is aware of the various policy tensions and upcoming deadlines. In May 2020, the Commission published its proposal on the ECT’s modernisation, which included the addition of a new article on sustainable development and the clean energy transition. The Paris Agreement was specifically referenced in this new article.

The Commission went on to note that unilateral withdrawal of the EU and its Member States from an unreformed ECT would trigger the “sunset clause” in the ECT, pursuant to which the ECT would continue to apply to existing investments during a 20-year period. This would result in new investor-state disputes being adjudicated under the unreformed rules, including in relation to existing investments in fossil fuels. As such, the Commission confirmed that it was “strongly committed” to pursuing the ongoing modernisation negotiations, but that if the core EU objectives outlined above were not attained within a “reasonable timeframe”, the Commission may consider proposing other options, including withdrawal of both the EU and the Member States from the ECT.

Comment

We consider that the Commission’s statement is unlikely to be a substantive threat; there is unlikely any appetite on the part of the EU to withdraw from the ECT, not least because of the impact of the sunset clause. Rather, the Commission is likely using the opportunity to reiterate its commitment to the modernisation process and to encourage engagement from all stakeholders, whilst acknowledging its international obligations in the Paris Agreement and seeking to allay concerns from EU parliamentarians.

Modernising the ECT is undoubtedly in the EU’s, and the UK’s, overall interest – the shift away from reliance on fossil fuels is but one of the many pressing topics under negotiation. As noted in our previous Law-Now article describing the Court of Justice of the EU’s decision in Slovak Republic v Achmea BV (Case C-284/16), questions on the compatibility of the ECT’s provisions with EU law have fuelled calls for a reform of its ISDS mechanism.

The Commission’s reference to the ECT’s 20-year sunset clause is also a relevant consideration. Unilateral withdrawal by the EU (and potentially the EU Member States) from the ECT would likely be counterproductive to the modernisation efforts, given that those parties would still be exposed to arbitration resulting from new investor-state disputes, including in relation to fossil fuels, for a further 20 years. A case in point is Italy, which withdrew from the ECT in 2016 and faced a number of post-withdrawal arbitrations. Under the ECT’s sunset clause, investors continue to be able to bring ECT-based claims in relation to investments made in Italy prior to that date up till 2036. However, it is important to note that, even if the EU withdrew from the ECT, this would arguably not automatically prompt the withdrawal of those EU Member States who are also signatories, even though the EU is negotiating on those Member States’ behalf and they are required to express themselves in accordance with the EU’s negotiating directives for the modernisation of the ECT. The EU is an independent international body with its own legal personality and its exit from the ECT would only affect its own obligations.

The authors would like to thank Maxie Chopard, trainee solicitor at CMS, for her assistance with the preparation of this article.