The current draft continues to allow arbitration claims that effectively block state action against climate change. | Photo:

New ECT could give teeth to Paris Agreement, but also continue fossil fuel protection

The energy charter’s modernisation process aims to fix clauses that could deter climate action or make it more expensive, but problematic provisions such as ISDS remain, which could continue to make climate action illegal across countries

On June 24, negotiations aimed at modernising the Energy Charter Treaty (ECT) drew to a close with an in-principle agreement. Signed into law in 1994, the treaty protects foreign investments in the energy sector. It covers more than 50 countries, mostly in Europe. 

In recent times, the fossil fuel industry has used investor-state dispute settlement (ISDS) mechanisms in ECT to argue in favour of securing their investments and profits against climate regulations. ISDS provisions allow foreign investors to bring direct claims against states in international arbitration tribunals, effectively making climate action illegal across countries. More specifically, ISDS provisions of ECT call for “fair and equitable treatment” of investors and “payment of prompt, adequate and effective compensation” in cases where governments take over their assets—clauses that could both deter climate action and make them more expensive. This is what the modernisation process aims to fix.

According to the European Commission, once the in-principle agreement is ratified and approved, it could facilitate “sustainable investments in the energy sector” by excluding protections for the fossil fuel industry in line with obligations under the Paris Agreement. The text is up for formal adoption at a conference scheduled to be held in November 2022 before which contracting parties have an option to raise objections. 

Some legal scholars argue that the modernisation process could give procedural teeth to the Paris Agreement. For instance, consider the EU’s proposed text for the draft agreement, which seeks the inclusion of an entire article obligating contracting parties to implement UNFCCC, Paris Agreement, specifically including nationally determined contributions. Additionally, the proposed article speaks of “sustainable development” in the form of promoting trade and investment in clean energy and resource efficiency. This is important given that a common criticism of international law is that it lacks enforcement mechanisms. But in what form this proposal will manifest, if at all, in the final text is up for debate.

Martin Jarrett, a senior research fellow at Max Planck Institute for Comparative Public Law and International Law, who works on investor-state disputes and international investment law, said it’s likely that phrases like “encouraged to comply” will be used in place of proposed text that states contracting parties “shall…” But, Jarrett added, if magic words like “shall” or “must” finally get included in the treaty, they have the potential to be “engines that could drive the Paris Agreement” because parties to the ECT could hold each other legally accountable in case of non-fulfillment of climate obligations. For settlement of disputes, Article 14 of UNFCCC allows for both arbitration and cases to be brought before the International Court of Justice.

But there is scope for improvement, to say the least.

Devil is in the details

The in-principle agreement allows for fossil fuel phaseouts by removing protections for these investments after 10 years i.e. if the amended ECT comes into force on January 1, 2023. Existing fossil fuel investments would be protected under the treaty only till 2033. The draft also states that new fossil fuel investment, i.e. those made after January 2023 in this case, would be protected only for nine months. These clauses are far more suited for climate action than even exiting the treaty altogether given that it contains a sunset clause of 20 years. 

But concerns of prolonged protection for fossil fuel investment remain.

Terming ISDS provisions “the most problematic part of the treaty,” Lukas Schaugg, a law analyst with International Institute for Sustainable Development (IISD), pointed out that by not reforming the treaty’s ISDS mechanism as a whole, the current draft continues to allow arbitration claims that effectively block state action against climate change. Schaugg is co-author of a August, 2022 IISD report that analyses what is publicly known about the in-principle agreement of the ECT in light of whether it’s a “modest modernisation” or a “massive setback.”

Elaborating on what it means to have no systemic reform of ISDS, Schaugg said that issues like lack of transparency in the arbitration process, controversial methods of loss of profit calculations, which result in unreasonably high damages and conflict of interest where arbitrators doublehat as party representatives or advisors to third-party funders to arbitration processes, will continue to plague the process. 

Experts also caution the exploitative use of ISDS provisions by new technologies like hydrogen and carbon capture and storage. By extending the definition of “Economic Activity in the Energy Sector” in ECT to cover such materials and technologies, parties to the ECT have granted investment protection for ‘climate solutions’ that are as yet unproven at scale. Not to mention the fact that carbon capture and storage has also been used for “enhanced oil recovery,” i.e. to a process wherein the captured CO2 is injected back into oil wells to raise reservoir pressure in order to extract more oil.  

As for hydrogen, the draft agreement does not distinguish between blue and grey hydrogen, i.e. hydrogen produced by renewable energy and by fossil fuels. 

“With new emerging technologies, it is important for states to have regulatory freedom,” Schaugg said, pointing to what states stand to lose if ECT coverage is extended. There’s also the risk of incentivising a distraction. For example, if 10 years from now, it turns out that carbon capture and storage is inefficient, “investors may choose to sue states for hypothetical loss of profits,” Schaugg explained.

The August 2022 IISD report flags issues with renewable energy-led ISDS claims, too. It states that renewable energy interests have brought on more than 45 arbitration claims against countries seeking a favourable environment for renewable energy investments. Interestingly, most of the 45 claims were brought against Spain in the wake of the 2008 financial crisis wherein renewable energy companies sought pre-crisis tariffs, which were higher than those they were offered thereafter. 

And so, ECT cover for fossil fuel investments or renewable energy ones or emerging technologies like hydrogen and carbon capture, means more litigation risk “which can restrict the regulatory flexibility that states need when regulating new energy technologies,” the IISD report states. 

An unreformed survival clause

The 20-year ‘survival clause’ is not part of the ongoing modernisation process. Essentially,  if a state withdraws from the treaty all together, the clause allows all aspects of the treaty, including ISDS provisions to remain in place for 20 years. This allows fossil fuel lock-ins even if states withdraw from the ECT. “At the outset itself, states failed to agree that the survival clause would also be modernised,” Schaugg said. 

Worth mentioning that since countries in the EU and the UK have agreed to end fossil fuel protections in the ECT after 10 years, they might find this route a better option than exiting the treaty as a whole, which retains fossil fuel investment protection for twice that time frame. 

Although even the EU and UK agreement to phase out fossil fuels after 10 years is insufficient to tackle the climate crisis. An earlier ISDS report had pointed out that there is no space at all for new oil and gas development if the aim is to reach global net-zero by 2050. In fact, the report states, “the world must decrease global oil and gas production and consumption by 30% by 2030… This is equivalent to an annual average decrease of 3% for both oil and gas until the end of the decade.” But the in-principle agreement leaves room for protection of existing oil and gas investments for 10 years in the EU and the UK when such investments ideally ought to be significantly drawn down by 2030. This means we could expect more cases in the next 10 years like the one brought on by RWE, the German coal giant, against the Netherlands for its plans to phase out coal. 

There’s also the question of what happens after 10 years. For example, consider an oil field that has enough reserves to be producing oil well beyond the 10-year period for which it enjoys ECT protection. “After the 10-year period, a government can decide to take over the oil field and hand over its operations to state-owned oil companies and continue pumping oil and emissions well into the future. It’s a question of [potentially] millions of euros,” Jarrett explained. And so, Jarrett added, there must be some clause in the modernised ECT to ensure that states cannot unduly benefit from carve outs for fossil fuel protections and takeovers are only a step to eventual phaseout of fossil fuel investments. 

Pays to note it remains unclear whether other ECT parties with significant fossil fuel investments like Kazakhstan, Armenia and Azerbaijan have also agreed to carve out protections for fossil fuel investments, even if it is after 10 years like the EU and the UK But it’s quite likely, Schaugg said, that more than a third of contracting parties to the ECT could continue protecting fossil fuel investments “indefinitely.” 

As a suggestion beyond reformation of the treaty, Schaugg pointed to possibilities of a coordinated exit from the ECT. “If countries in the EU and the UK withdraw from the treaty and also make the survival clause inapplicable among themselves, it could create a snowball effect,” he said, noting how ECT is “not a requirement for a clean energy future.” 

The snowball effect though is a political one. Strictly legally speaking, Jarrett said, in order to change the content of any part of the ECT, including the survival clause, all contracting states must agree to such a change. Suffice to say, this is easier said than done.

This story was developed as part of a journalism residency programme at Max Planck Institute for Comparative Public Law and International Law in Heidelberg, Germany

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