Sustainable Development Goals and Reactive Legal Limitations Pervade the Draft Modernised Energy Charter Treaty

On 24 June 2022, the 53 Contracting Parties of the Energy Charter Treaty (ECT), a key multilateral treaty protecting cross-border energy investments that was originally concluded in 1991, reached a tentative agreement regarding the modernisation of the ECT and approved a Public Communication explaining the main changes in their agreement-in-principle (the “Communication”). This milestone marks the end of a nearly five-year-long period of discussions and negotiations. The Communication states that “[t]he agreement in principle is without prejudice regarding its final assessment by the Contracting Parties” and that, following an editorial and legal review, the final draft text will be submitted to the Contracting Parties for adoption by the Energy Charter Conference on 22 November 2022. Once adopted, the modernised ECT will enter into force 90 days after the ratification by three-fourths of the Contracting Parties.

Background

In November 2017, the Energy Charter Conference launched discussions regarding the potential modernisation of the ECT. In July 2020, formal negotiations started within a Modernisation Group. The alignment of the ECT with the 2015 Paris Climate Accords and the individual energy security and climate goals of the Contracting Parties were at the heart of the modernisation process. On 2 December 2020, the European Commission indicated that, if “core EU objectives” were not met as part of the ongoing modernisation negotiations, the EU may consider withdrawing from the ECT altogether.

The negotiations proceeded in parallel with the fast-pacing judicial and legal developments in the European Union on the incompatibility of EU law with the arbitration of intra-EU investment disputes under the ECT. Such developments recently led to a landmark ruling by an ECT tribunal denying its jurisdiction over an intra-EU arbitration subject to the Arbitration Rules of the Arbitration Institute of the Stockholm Chamber of Commerce. The negotiations also proceeded in the context of a global trend aimed at reforming existing international investment agreements to ensure their alignment with sustainable development-oriented policy goals.

Sustainable Development Goals and Reactive Legal Limitations Pervade the Draft Modernised Energy Charter Treaty

The Communication states that the modernised ECT will allow Contracting Parties “to exclude investment protection for fossil fuels in their territories, considering their individual energy security and climate goals.” It adds that “[f]or example, the EU and the UK have opted to carve-out fossil fuel related investments from investment protection under the ECT, including for existing investments after 10 years from the entry into force of the relevant provisions and for new investments made after 15 August 2023 as of that date with limited exceptions.” The Communication further notes that “[t]he envisaged exclusions will not, as a matter of principle, affect investment protection in the territory of other Contracting Parties, unless they opt to apply them vis-à-vis investors from the aforementioned Contracting Parties reciprocally.”

In line with other “new-generation” investment treaties, the modernised ECT will contain provisions aimed at safeguarding the Contracting Parties’ right to regulate “in the interest of legitimate public policy objectives. Such objectives may include the protection of the environment, including climate change mitigation and adaptation, protection of public health, safety or public moral.”

Multiple new provisions on investment protection and dispute settlement will address host States’ concerns arising from over two decades of investment arbitration jurisprudence on the current ECT, echoing the regulation of these concerns in other new-generation international investment agreements. For example, the key definition of protected investment will include an indicative list of characteristics known in the jurisprudence as Salini criteria (the commitment of capital, the expectation of gain or profit, a certain duration or the assumption of risk) and will exclude arbitration awards and judicial decisions. The modernised ECT will limit “treaty shopping” to gain investment protection by excluding the protection of dual nationals and by introducing the need to meet “the requirement of substantial business activities by demonstrating the circumstances from the indicative list included in the Treaty (such as physical presence, employment of staff, turnover generation or payment of taxes in the Area of a host Contracting Party).”

Substantive investment protection standards will be clarified or circumscribed in the modernised ECT. For example, in relation to the oft-invoked fair and equitable treatment (FET) standard, the modernised ECT will contain “a list that designates certain measures or series of measures that constitute a violation of this protection standard. Among such measures or series of measures, the new provision specifies the frustration of Investor’s legitimate expectations and it describes circumstances that give rise to Investor’s legitimate expectations and the conditions under which legitimate expectations may be considered.” The modernised ECT will also tackle the split jurisprudence on the operation of the denial-of-benefits clause in the current ECT. In this regard, “the Treaty envisages the timeline for invoking the denial-of-benefits clause, including possibility to invoke it after the commencement of an arbitral proceeding. The denial-of-benefits clause will not be subject to an advance formal notification. The new provision clarifies the situations when the protection to an Investment may be denied, notably for maintenance of international peace and security, including the protection of human rights.”

In relation to investor-State dispute settlement, in line with EU law, the modernised ECT will carve out intra-EU claims. The new provisions will also stipulate that the 2014 UNICTRAL Rules on Transparency shall apply “with further additions envisaged in the Treaty.” Moreover, the modernised ECT will address frivolous claims, third party funding, security for costs, and valuation of damages and it will introduce the costs-follow-the-event rule in relation to the costs of the arbitration proceedings. The new ECT will curb treaty shopping also through a special provision “for dismissal of claims submitted as a result of investment restructuring for the sole purpose of submitting a claim under the Treaty.”

The modernised ECT will contain an updated list of energy materials and products, including hydrogen, anhydrous ammonia, biomass, biogas and synthetic fuel. It will introduce a five-year review mechanism concerning such list of materials and the optional carve-out mechanism for fossil fuels, giving the contracting parties “the possibility to react to technological as well as political developments.”

Comments

The modernised ECT, once adopted, will reflect a broad consensus among its Contracting Parties, and incidentally also in the energy investment community, as to the need to align its provisions to technological developments and the sustainable development global agenda, including the Paris Climate Accords. The optional carve-out of fossil fuels from investment protection is a compromise between the EU and the UK, on the one hand, and remaining Contracting Parties, on the other hand, on their divergent views as to how the new ECT should respond to the challenges arising from the Contracting Parties’ energy transition. As the large number of cases brought by renewable energy investors against host States demonstrate, the ECT serves an important purpose in the energy transition. Fossil fuel investors will also remain protected, but the temporal and territorial scope of that protection will vary. Energy investors will be well-advised to factor in the new ECT in their long-term investment planning and structuring.

We will publish one or more detailed Law-Now(s) on the new ECT upon the publication of the final adopted text.