The Energy Charter Treaty: Reform or Retreat?

By: Brian Japari, Staff Editor

The Energy Charter Treaty is incompatible with the global community’s climate goals. The treaty operates by providing investment protections to foreign investors in the energy sector. Originally, these protections were intended to facilitate energy security and cooperation in the former Soviet states after the USSR collapsed. Currently, these protections impose liability on states for substantially regulating energy sector investments thus creating a regulatory chill. While many of its signatories, including most EU member states, want to terminate the Energy Charter Treaty in its entirety, the treaty’s provisions prevent unilateral withdrawal and practical modifications. To mitigate the Energy Charter Treaty’s most adverse impacts, climate-conscious states should engage in inter-se agreements between themselves to terminate Energy Charter Treaty protections for their counterpart’s investors, engage in inter-se agreements with non-terminating states to limit the Energy Charter Treaty’s potency, and bolster energy security through green financing and research and development cooperation.

Major Departures from the Energy Charter Treaty

Last November, the global community came together for Cop 27 to draw attention to the impact of climate change and the lukewarm efforts to decarbonize. Despite the high-minded rhetoric, the global community failed to eradicate one of the most potent protections for fossil fuel investments: the Energy Charter Treaty. The ECT’s protections infringe upon the effort of its signatories to regulate carbon emissions by allowing foreign investors to pursue claims against governments for disrupting the status quo. While many signatories, particularly those in the EU, wish to terminate the ECT, the ECT is structured such that modification and termination require unanimity.

After Cop 27, Germany’s cabinet approved withdrawing from the ECT. Germany joins France, the Netherlands, Poland, and Spain as EU member states pulling out of the controversial treaty in 2022. In addition to Germany’s withdrawal, the European Parliament passed a resolution urging the European Commission to begin coordinating an exit from the ECT. The Council of Europe, the EU’s legislative body, would still need to approve a withdrawal from the ECT. Even if the EU and its member states withdrew from the ECT, those states would remain bound to its ECT obligations to existing investments from countries that have not withdrawn from the treaty because of the treaty’s “sunset” provisions. The “sunset” provisions extend the ECT’s protections for 20 years in states that unilaterally withdraw from the ECT.

To better align its climate goals with policy, the EU and its member states should utilize diplomatic channels to achieve unanimous termination of the ECT. Simultaneously, the EU member states and similarly minded states should conduct inter-se agreements between themselves that limit the ECT’s effects to the fullest extent they are willing. Therefore, for countries that are willing to terminate the ECT, they could agree to do so by terminating protection for investors from their counterparts. For countries that aren’t willing to fully terminate ECT protections, their governments could conduct inter-se agreements between themselves to mitigate the ECT’s most adverse impacts. Countries that are not willing to withdraw from the ECT should narrow the scope of the ECT’s substantive protections, carve out exceptions for regulations in the interest of public health and the environment, and remove protections for classes of energy investments that are most detrimental to decarbonization efforts.

What is the ECT and Why are Countries Withdrawing

The ECT is a multinational framework designed to protect foreign investments in the energy sector — principally, fossil fuel investments. Emerging from the end of the Cold War, the ECT was created to foster a stable environment for rebuilding the energy sector of formerly Communist states. Using the ECT, foreign investors can invoke Article 27 of the treaty to bring a claim against the host state of the investment in a process called Investor-State Dispute Settlement (ISDS). Notably, although agreements establishing the right to utilize ISDS are conducted between states in International Investment Agreements, only investors can initiate ISDS proceedings and receive the International Investment Agreement’s substantive protections. The ECT has been very popular with investors who tend to invoke it quite often. To this date, the ECT has been invoked in at least 135 investor-state arbitrations and is the most invoked ISDS instrument.

Using an ISDS, an investor can file claims for violations of Fair and Equitable Treatment (FET), Expropriation claims, and other claims. Critics of the ISDS framework question whether it is appropriate that certain protections under International Investment Agreements, like the FET and Expropriation clauses, privilege international investors relative to domestic investors. Additionally, critics contend that ISDS provides substantive protections to investors that infringe upon a sovereign's authority to regulate in areas such as public health and the environment.

Environmentally minded scholars, government officials, and nonprofit groups argue that investors under the ECT utilize these outsized protections to protect investments that are incompatible with the global community’s stance on addressing climate change. In particular, the ECT’s FET clause is maligned for its open-ended language that has been interpreted as a “catch-all” provision. Tribunals have interpreted the FET clause to protect an investor’s legitimate expectations which may prevent states from modifying the legal and investment environment. Legal scholars believe that the FET clause’s broad and ambiguous language caused a “regulatory chill” in the energy sector, thus impeding the transition to a more sustainable energy sector. Politicians, legal scholars, and activists have all criticized the ECT for providing too large of a scope of protection for fossil fuel investments while leaving the rights afforded to renewable investments ambiguous and failing to explicitly protect a state’s right to engage in environmental and social regulation.

Reforming the Treaty: Draft Proposals and Roadblocks

In response to these criticisms, and recognizing that the 1994 framework was outdated, the EU began to reform in 2017, producing a set of reform proposals. On June 17, 2022, the Contracting Parties had an agreement in principle to modernize six elements of the ECT. The modernized ECT(1) aligns the treaty’s protections with the Paris Climate Agreements which, among other things, would shorten the application of the “sunset” provisions from 20 to 10 years for EU states and the UK. (2) Bans the use of ISDS to pursue an ECT claim among contracting parties of the same Regional economic integration organization. For example, an investor from an EU member state cannot pursue a claim against an EU member state. (3) Narrows the scope of the definition of “investment” and “investor.” (4) Specifies the measures that violate the ECT’s FET clause and formalizes the elements of a FET grounded in “legitimate expectations. (5) Clarifies the elements of an “indirect expropriation” claim. (6) Narrows the application of the umbrella clause, which elevates a contractual violation to a treaty violation, to situations where the government makes specific promises to the investor.

Although the European Commission has indicated support for these proposals, it may all be moot because amending the ECT requires a unanimous vote and some countries have indicated their opposition to ECT reform. Even though the modernized elements are agreed upon in principle, ECT contracting parties will vote in April 2023 on whether to formally adopt the Modernized ECT.

Announcing France’s departure from the ECT, President Macron noted that its departure from the ECT was “coherent” with the country’s Paris Climate Agreement goals and broader climate policy. Similarly, the Dutch Minister for Climate and Energy Policy noted the dissonance between the ECT and the Netherlands’ Paris Climate Agreement goals along with the frustrating reform process as primary reasons for departing the ECT. In addition to the European states that have already announced their intention to leave the treaty, Belgium has signaled potential departures despite the European Commission’s urging member states to stay in the ECT and back the reforms.

The Merits and Drawbacks of Unilateral Withdrawal

Although states can unilaterally withdraw from the ECT, the treaty’s sunset provisions bind states to their obligations for existing investments under the ECT for 20 years from the date of withdrawal. States can get around the sunset provisions by relying on Article 41 of the Vienna Convention on the Law of Treaties to conduct bilateral modifications to a multilateral treaty as applied between the two states. For example, Spain and the Netherlands, if they were still party to the treaty, could agree to waive the sunset provisions thus removing protections for fossil fuel investments for Spanish investors in the Netherlands and vice versa.

However, this is of only limited utility, as in addition to being limited in scope to the parties to the amendment, inter-se agreements are limited because such agreements cannot “affect the enjoyment by the other parties of their rights under the treaty or the performance of their obligation.” Consequently, a third-party state could challenge an inter-se agreement between two states because their amendments affected the third-party state’s enjoyment of treating and pointing to economic reasoning like preventing economies of scale for energy generation or another argument based on difficult-to-quantify economic effects.

Since withdrawing countries will be bound by the sunset provisions, their governments are rejecting the inter-se method of bilateral modifications and are pushing for an en masse withdrawal of countries that share similar views on climate, with Spain, Poland, and the Netherlands have advocated for a unified EU withdrawal from the ECT. This would dramatically reduce the power of the ECT because unilateral withdrawals could be used as political pressure against states that are nominally aligned with the withdrawing states on climate issues but remain in the ECT. Furthermore, the economic incentives to remain within the agreement shrink with each country that leaves the ECT since new investments cannot rely on ECT protections in withdrawing states. Although the ECT will technically be intact if all EU member states withdraw, the remaining parties will be left with a shell of an agreement without much economic utility. With Germany and Belgium contemplating departures, the political liability of remaining in the ECT for climate concerned States could rapidly diminish relative to the economic benefit of remaining.

While withdrawals from multiple signatories increase the political and moral pressure on remaining states, it comes at the cost of preserving protections for existing investments. As an alternative, EU member states and other climate-conscious states should conduct inter-se agreements between themselves terminating all ECT protections. Terminating ECT protections between EU member states is powerful on its own because it mitigates the impact of the ECT’s regulatory chilling effect. In 2017, the French government scaled back its regulation of fossil fuel extraction after Vermillion, an oil and gas company, threatened to litigate under the ECT. Hoping to avoid litigation, New Zealand and Denmark designed weaker oil and gas phaseout plans to avoid ECT scrutiny. Countries that unilaterally withdrew from the ECT would remain subject to these claims for 20 years upon their unilateral withdrawal; however, remaining countries that have conducted inter-se agreements between themselves could agree to deny all ECT benefits to their counterpart’s investors.

Simultaneously, climate-conscious signatories could pursue more moderate inter-se agreements with signatories unwilling to terminate the ECT. These packages could be narrowly tailored to the extent that a particular signatory is willing and able to limit ECT protections. Member States should adopt portions of the 6 elements that comprise the modernized ECT. Additionally, states could terminate protections for the most carbon-intensive elements of the energy sector, like petroleum and coal, while maintaining protections for the natural gas industry as a stopgap. The natural gas stopgap is particularly worthwhile to explore because of Europe’s energy crisis in the aftermath of the Russian invasion of Ukraine. In the background, states should explore other avenues of cooperating on sustainable energy security such as grid integration, green financing, and research and development collaboration.

A Window of Opportunity: Post-COP 27

In the latest iteration of the UN Climate Change Conference (COP), UN Secretary-General Guterres began with the State of the Global Climate Report which he referred to as a “chronicle of chaos.” The report noted that the global temperatures have now risen by 1.15°C and the effects of that temperature rise have been devastating as evidenced by heatwaves, accelerating sea level rise, and glacier mass loss. Despite promises made during COP 27 to strengthen emission reduction targets to cap global temperature rise to 1.5 °C, given current emission reduction promises, global temperatures are expected to rise to between 2.1°C and 2.9°C by 2100. During COP 27, representatives from 208 countries negotiated with one another to expand their efforts to prevent global temperature rise above 1.5°C. For the first time, high-income countries expressed openness to climate reparations— payments from high-emitting countries to low-emitting countries that have borne the brunt of climate change. In previous climate negotiations, high-income countries refused to even consider climate reparations.

Given the promises that follow each COP iteration, this is the time when political pressure and the political payoff for climate action are at their apex. Withdrawing nations must capitalize on this moment to rally non-withdrawing countries with sympathetic views to terminate the ECT as it is presently constructed and negotiate with unsympathetic countries into withdrawal through bargaining, pressure, and pointing to the waning economic benefits of the current ECT. In its place, the global community should create an investment framework, whether multilateral or a series of bilateral agreements, that provides substantive protections to renewable investments to meet the green finance gap while mitigating the power asymmetries afforded to investors at the expense of a state’s regulatory prerogative.

Brian Japari is a second-year at Columbia Law School and a Staff member of the Columbia Journal of Transnational Law. He graduated from the University of California-San Diego in 2020. Before law school, Brian worked as a political-economics intern for the U.S. State Department in Auckland, New Zealand.

Henry BloxenheimJanuary 15, 2023