Written by 2:13 pm EU Investment

Is the Energy Charter Treaty at odds with a green future?

In 2015, Italy announced that it would adopt a ban on oil drilling near its coastline following years of campaigning by local environmental pressure groups. So when, in 2016, oil and gas company Rockhopper applied for a concession to drill for oil off the Adriatic Coast, the answer they received was “no”. A year later, the company, which is headquartered in the United Kingdom, sued the Italian government, claiming compensation for the money it had already invested in a local oil field drilling project and anticipated lost profits.

This August, a Washington, DC-based tribunal ordered the Italian government to pay €240m in damages plus interest to Rockhopper. German energy giant RWE has filed a similar €1.4bn arbitration claim against the Netherlands for the closure of its local power plant under the government’s plans to phase-out electricity production from coal by 2030, while Ascent Resources is suing Slovenia for a reported €120m over changes to the country’s fracking rules.

The companies were able to bring these claims thanks to the Energy Charter Treaty, a decades-old investment agreement that gives energy investors the right to sue national governments before private international tribunals over losses suffered as a result of policy about-faces.

With more and more European countries banning offshore drilling, adopting fracking restrictions and closing oil and gas plants as part of the transition towards cleaner energies, more fossil fuel companies are expected to file claims to recoup investment losses.

At such a moment, the Energy Charter Treaty appears to be at a crossroad: the European Commission has undertaken efforts to negotiate a modernised agreement, with a decisive vote set to take place at the next ECT meeting on 22 November. Yet the reforms may not go far enough, with some European Union Member States announcing their intention to withdraw from the treaty.

The rise in claims has thrown into sharp relief the difficulty of balancing governments’ obligations under existing investor protection agreements with their obligations to bring down greenhouse gas emissions under the Paris Agreement and the European Green Deal, as well putting a spotlight on an investment court system that critics say is past its sell-by date.

“If you’re an elected government and you make a policy choice, you’re basically bound to some other policy framework that another government set years ago when, for example, climate change wasn’t an issue yet,” Anna Cavazzini, an Italian MEP, told The Parliament. “This is what this investment court system does – it cements old policy decisions and makes it really difficult to change paths,” she added.

 “This is what this investment court system does – it cements old policy decisions and makes it really difficult to change paths”

Adopted in the wake of the Cold War, the Energy Charter Treaty was meant to boost fossil fuel investment in former Soviet countries by offering Western investors protections against hostile government decisions and actions such as discriminatory treatment, expropriation and breach of contract. It allows energy investors to submit disputes – including compensation claims for lost investment and future profits – to international arbitration.

Pointing out that the treaty was adopted at a time when the prevailing mood was to protect and expand fossil fuel investments, Ivana Damjanovic, a fellow at the ANU Centre for European Studies in Australia, said: “That is exactly the problem of the ECT and generally of law – law doesn’t always follow the developments of times.”

Since proceedings can be kept confidential, it is impossible to know how many lawsuits fossil fuel companies have brought against EU Member States over assets protected by the treaty. But experts say the number of claims targeting climate-related measures is on the rise.

Beyond the financial cost of future successful claims over the phase-out of fossil fuel projects – estimates put forward by researchers have ranged from €107bn to €523bn per claim – NGOs and climate lawyers have warned that the mere threat of a lawsuit can cause governments to reverse their policy plans, a process known as regulatory chill.

“The threat is probably the most common use of the ECT. And we don’t know anything about [the number of threats made]. Because you don’t have to register your threat,” said Amandine Van den Berghe from the environmental law charity ClientEarth.

According to a report from the French law firm Baldon Avocats, both Dutch and Danish lawmakers have admitted that the shadow of legal action caused them to set lower climate action targets, while Slovenia weakened fracking rules after Ascent Resources filed its claim.

The increase in claims filed under the Energy Charter Treaty has also raised questions about the larger investor-state dispute settlement mechanism it relies on, a feature of many bilateral investment treaties. Critics say that this mechanism affords international investors special privileges, while the compensation awards granted by these tribunals tend to dwarf the sums awarded by national courts.

According to Cavazzini, the Italian MEP, if a company believes an EU government’s decision harms the investment it has made into an energy facility, it should rely on the traditional legal process and file a claim before a local court. “This is the normal way,” she said, pointing out that local investors and citizens are not able to bypass local courts in the way that the ECT allows foreign investors to do. The investor-state dispute settlement mechanism is “really a weird system that gives extra protection to a small group of businesses,” she said.

But lawyers say there are good reasons international companies prefer international arbitration. It is far easier to enforce an arbitral award than it is to enforce a foreign court judgement in another country, said Simon Maynard, a senior associate at King & Spalding, a law firm that has handled many ECT disputes and which defended Rockhopper in its recent dispute against Italy.

As a legal system, arbitration moreover has neutrality “at its heart”, he said, pointing out that an ECT tribunal might be made up of members from three different countries, while the seat of arbitration might be located in a yet another country. “With arbitration, any given party is able to refer a dispute to an effectively delocalised body if you like, a body that doesn’t have a national affiliation,” he said. “That is often quite an attractive thing for an international investor.”

As awareness of the treaty has grown, it has also started to face political and legal headwinds. Most of the claims brought under the treaty have been intra-EU, with an investor in one EU Member State suing the government of another Member State. The European Court of Justice has twice ruled that intra-EU arbitration disputes violate EU law. In June, five young people also filed a lawsuit against 12 European countries before the Strasbourg-based European Court of Human Rights, arguing that the ECT violates their human rights.

As awareness of the treaty has grown, it has also started to face political and legal headwinds

In 2019, the European Commission also began efforts to modernise the treaty with the goal of “greening” it, updating its investment protection standards and fixing its incompatibility with EU law.

Fifteen negotiation rounds later, 53 countries in June agreed to a “flexibility mechanism” that allows individual countries to exclude new fossil fuel-related investments made after August 2023 from investment protection and to phase out protection for already existing investments. It also prohibits investors in one Member State from filing claims against another Member State.

“What the revisions to the ECT seek to do is, on the one hand, increase the integration of climate law into the investment treaty regime, but at the same time continue to provide the legal protections that encourage the very investment we need to propel energy transition,” said Maynard, the lawyer at King & Spalding. “If you forget the latter objective, then you’re missing something.”

But NGOs have criticised that the scope of protected investments has expanded to include experimental energy products that governments are incentivising at the moment but may want to abandon in a few years following public debate and evolving scientific knowledge. “The new ECT adds biomass; it adds biofuel, hydrogen… all those controversial energy products that are going to be regulated most likely over the next years. So, why are we shooting ourselves in the foot like this?” Van den Berghe from ClientEarth asked. “Why are we protecting investments that we may not want any more within the next years?”

The reforms negotiated by the Commission must be unanimously adopted at the next meeting of the Energy Charter Conference on 22 November. It’s far from certain that the Commission will get the go-ahead from the Parliament or the Council. Because the EU and Member States are parties to the agreement in their own right, the proposed reforms require approval from the Council and the Parliament as part of the standard EU legislative process for the reforms to become law.

Poland is in the process of leaving the agreement, while last month Spain, France, Germany and Netherlands all announced their intention to withdraw from the treaty. Many MEPs also think it’s too late for reforms, and in June the European Parliament adopted a resolution calling on the Commission and national governments to withdraw from the treaty. The Parliament also voiced its general opposition to investment protection treaties that include the investor-state dispute settlement mechanism in this resolution.

“Why are we protecting investments that we may not want any more within the next years?”

The proposed reforms are not a moot point, however, because even if EU countries leave the treaty, they will still face the threat of lawsuits: the ECT contains a sunset clause that allows investors to take countries to court for another 20 years after their exit. Although experts say Member States could agree amongst themselves not to allow intra-EU disputes, this would not stop foreign investors from bringing claims in the future.

If the reforms are adopted, the phaseout of protection for fossil fuel investments would be accelerated – protection for existing fossil fuel investments would be phased out after 10 years under the modernised rules, compared to after 20 years if Member States withdraw.

But Van den Berghe, whose organisation has called on the EU and Member States to leave the treaty, said the EU shouldn’t underestimate its clout. Pointing out that EU countries make up more than half of the parties to the treaty, she asked: “If the EU leaves and the Member States leave, is the ECT itself going to survive?”

Italy, for its part, left the treaty in 2016, but still had to cough up €250m in compensation to Rockhopper, a figure eight times greater than its investment of almost €28m into the oil drilling project (Italy has applied for an annulment of the award). Rockhopper has said it plans to put the money towards its plans to build another oil field.

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