On 24 June 2022, following years of negotiations, the Contracting Parties of the Energy Charter Treaty (“ECT”) reached an ‘agreement in principle’ for its modernisation and a public communication, of the key changes, was released (the “Communication”).

The ECT is a multilateral investment treaty with 53 signatories. It was signed in December 1994 and envisaged as a means of fostering East-West energy policy cooperation at a time when the fossil-fuel industry dominated energy production. As such, it was agnostic to the type of energy investments under its protection and made no meaningful concession to climate policy commitments.

Since that time, global attitudes have significantly shifted, and it has become the most heavily litigated investment agreement in the world. All parties to the ECT are also signatories of the 2015 Paris Climate Agreement which seeks a global temperature rise limit of 1.5 degrees Celsius. Legislative change to decarbonise energy supply chains has followed to great effect. In the UK, renewable energy contribution went from 0.3%, when the ECT was signed, to 40% today. Domestic courts are increasingly used to air grievances on climate inaction, such as in the ‘case of the century’ which saw France found guilty of exceeding greenhouse gas emissions or the successful action brought against Royal Dutch Shell to cut its CO2 emissions by 45%.

The role of the ECT in this context was brought sharply into focus just last week as five individuals brought a claim to the European Court of Human Rights arguing their governments’ membership of the ECT (including France’s, Germany’s and the UK’s) was a dangerous obstacle to action on the climate crisis. They are in good company as France and Germany, amongst other EU member states, have already instructed the European Commission to investigate how the EU could withdraw from the ECT.

The modernisation of the ECT

The ECT provides protections to investors who make energy-related investments in the territory of a Contracting Party. Important provisions in the treaty provide for the fair and equitable treatment of investors (Article 10), freedom from expropriation of investors’ assets (Article 13), compensation (except where Article 13 applies) (Article 12) and mechanisms for the settlement of disputes (Articles 26 & 27). Additionally, there is a provision on ‘Environmental Aspects’ (Article 19) requiring Contracting Parties to “take account of environmental considerations throughout the formulation and implementation of their energy policies”.

Some critics have suggested the ECT is a contributing factor to ‘regulatory chill’ in relation to the clean energy transition. Although the majority of claims under the ECT are brought in relation to renewable energy, and not fossil fuel, production, the Stockholm-based Climate Change Counsel, in a recent report on the ECT’s effect on energy transition, predicted a wave of “phase-out” cases as governments pursue policies detrimental to fossil-fuel investors’ investments. Already leading energy producers are instigating such claims, as in the case of RWE v Kingdom of the Netherlands (ICSID Case No. ARB/21/4), where RWE has sought €1.4 billion in compensation following a ban on coal usage in electricity generation.

The ’agreement in principle’ to modernise the ECT was reached following 15 rounds of negotiations held over two years.

Below is a summary of the main achievements reached:

1. Economic Activity in the Energy Sector: this definition has been revised to cover carbon capture, storage and utilisation, envisaging “how investments in different sources of energy will be protected under the ECT against the backdrop of clean energy goals”.
2. Energy materials and Products: new ‘green’ items have been introduced for protection, such as hydrogen, biomass and biogas.
3. A “flexibility mechanism”: this allows the voluntary exclusion of investment protection for fossil fuels. The EU and the UK have opted to carve-out fossil-fuel related investments from protection for both existing and new investments. Existing investments will have 10 further years of protection whereas new investments made after 15 August 2023 will have no protection.
4. Fair and Equitable Treatment: a new list of measures constituting a violation of this protection standard, including the frustration of an investor’s legitimate expectations and the circumstances giving rise to such expectations, will be included.
5. Indirect Expropriation: this term is now defined, including a list of factors that will indicate when such expropriation has taken place. Notably, “non-discriminatory measures, that are adopted to protect legitimate policy objectives, such as public health, safety and the environment (including with respect to climate change mitigation and adaptation), do not constitute indirect expropriation”.
6. Denial of Benefits: the new provision includes a timeline for invoking the clause, including the possibility of invoking it after the commencement of arbitral proceedings and without the need for advance notification. It also clarifies the situations when protections may be denied, notably for maintenance of international peace and security, including the protection of human rights.
7. Right to Regulate: a specific article is introduced in Part III “to reaffirm the right in the interest of legitimate public policy objectives”. Such objectives “include the protection of the environment, including climate change mitigation and adaptation”.
8. Transparency: the UNCITRAL Rules on Transparency in Treaty-based Investor-State arbitration, of 1 April 2014, will apply to disputes between Contracting Parties and investors. Greater transparency is also introduced for disputes between Contracting Parties ensuring that procedural documents and some hearings be made public.
9. Frivolous Claims: to ensure efficiency and cost reduction, claims manifestly without legal merit as a matter of substance or jurisdiction may be dismissed at the outset; claims unfounded as a matter of law on merits will be subject to an expedited dismissal mechanism. A new provision is included addressing the restructuring of investments to gain the benefit of the ECT’s dispute resolution mechanisms.
10. Sustainable Development and Corporate Social Responsibility: a number of provisions were introduced reaffirming respective rights and obligations of the Contracting Parties under environmental and labour agreements, such as the UNFCCC and the Paris Agreement. Promotion of investment aligned with sustainable development objectives and an agreement not to lower environmental and labour protection laws and standards was also reached. Commitment to the clean energy transition was reaffirmed, including promotion of low-carbon technologies and cooperation in implementing climate change-related policies. A dedicated dispute settlement scheme for such issues was also introduced.
11. Regional Economic Integration Organisation (REIO): a new provision clarifies that certain provisions will not apply to Contracting Parties that are members of the same REIO. In particular, investment disputes shall not be settled using the provisions of the ECT for parties in REIOs. The only REIO under the ECT is the EU. Therefore, intra-EU investor-state disputes are now expressly forbidden by the ECT, in line with recent EU case law.

Implications of the modernisation

These amendments are most notable in the context of a clean energy transition. In many of the provisions specific reference is made to “clean energy goals” and revisions being made with the objective that they acknowledge the need for “climate mitigation and adaptation”. To further emphasise the point, the Paris Agreement has been explicitly referenced in the modernised ECT. Significantly, an entire new provision on sustainable development and corporate social responsibility has been introduced reaffirming Contracting Parties’ commitments to developing laws underpinned by the clean energy transition and claims for indirect expropriation in light of environmentally inspired policy changes will also fall on deaf ears.

This may, therefore, seem a boon for governments who appear to be gaining a great deal of regulatory latitude. However, only the EU and UK have agreed to the carve-out in relation to fossil fuel investments, and even then, existing investments will retain protections for a further 10 years. For investors this will be positive news.

It is possible that some Contracting Parties will prefer to withdraw from the ECT completely rather than sign the modified version. Spain had previously signalled a strong desire to leave on the basis that the modernisation fell short of alignment with EU energy targets. However, such withdrawal would still be subject to the 20-year sunset provision in the ECT.

The draft text will now be sent to the Contracting Parties for adoption by the Energy Charter Conference on 22 November 2022. Following adoption, the modernised ECT must be ratified by three quarters of the Contracting Parties before entering into force. The outcome of this process is uncertain, with the decision likely to have significant consequences for future investor-state energy disputes.