Energy Charter Treaty reform stalemate sparks uncertainty for investment treaty arbitration

However, regardless of the final outcome, climate change litigation and arbitration are expected to increase and counterclaims could be increasingly used by states as an opportunity to raise climate change-related claims in investor-state arbitrations.

The UK announced its intention to withdraw from the ECT on 22 February, due to what it described as the failure of efforts to align the Treaty with its net zero commitments. The announcement does not itself have legal force, and the UK must give one year’s formal written notice should it wish to proceed with its stated intention. The ‘sunset clause’ at article 47(3) of the ECT would continue to protect foreign investors with covered investments in the UK made prior to the expiry of the notice period for 20 years following any formal withdrawal.

The most reported criticism of the ECT, a multilateral treaty that came into force in 1998, is that it favours fossil fuel investments. The treaty requires states, among other things, to provide fair and equitable treatment (FET) to investors, to avoid discrimination and to compensate investors in case of expropriation. It also provides investors with a right to seek damages through international arbitration where their actions violate the minimum standards set out in the treaty.

The treaty’s investor protections apply regardless of the source of energy in question. They apply to fossil-based energy, nuclear energy and electricity-producing renewable projects. While efforts are ongoing to update the ECT in response to the climate agenda, fossil-based energy investments are still protected under the current provisions of the treaty.

It is also commonly said that the ECT is incompatible with its member states’ Paris Treaty obligations, which include a goal of limiting global warming to between 1.5C and 2C above pre-industrial levels.

However, the majority of the ECT investor-state cases initiated over the last 15 years relate to renewable investments. In fact, no known ECT or other investment arbitration award has been made against any state as a result of action taken by that state in compliance with that state’s Paris Treaty obligations, although a few such claims have been threatened.

While the extent to which the ECT should continue to protect fossil fuel investors has been called into question in recent years, withdrawal from the ECT would mean that renewable investors would lose important investment protection too.

The renewable energy sector has been subject to frequent legislative, regulatory and tax changes, which have given rise to numerous ECT investment arbitration claims. It is clear that renewable investors, like fossil fuel investors, are vulnerable to changes of government policy.

The EU’s position on the Energy Charter Treaty

The past two years has seen the EU’s position with regard to the ECT take a few sudden turns. After years of negotiation led by the EU, in June 2022 the Energy Charter Conference reached an agreement in principle on a package of amendments to the treaty – the so-called “modernisation” process to phase out protection for fossil fuel investments in certain member states while continuing investment protection for renewable energy investments. However, the final vote on these amendments, which was scheduled for November 2022, was postponed indefinitely because EU member states were unable to agree among themselves on whether to proceed with the modernisation package.

In July 2023, the European Commission proposed a coordinated EU withdrawal from the ECT, saying the treaty, which is largely unchanged since it was agreed in the 1990s, is no longer compatible with the EU’s climate ambitions under the European Green Deal and the Paris Treaty. But the Commission is not competent to decide on this course of action alone. A qualified majority of EU member states is required in order to approve any decision either to support the proposed modernisation of the ECT or for the EU to withdraw from the treaty. It is now clear that there is no qualified majority in favour of the first course of action, but this does not imply that there is a qualified majority in favour of the second.

EU member states are divided on the ECT’s future. Certain EU member states have given notice of withdrawal or announced their intention to do so, while others do not wish to withdraw and continue to support its modernisation.

Even if a qualified majority of EU member states favour EU withdrawal, so that the EU as an international organisation does ultimately withdraw from the ECT, it is not clear that the EU can legally require that every EU member state also withdraw from the ECT.

To summarise, there is not at present a clear agreed EU position regarding the ECT.

Climate change and investment treaty arbitration

There is a common recognition that avoiding and mitigating climate change requires investment – including foreign investment – in renewable energy, which in turn requires investment protection in order to offer security to foreign investors. Therefore, any state or civil society actor genuinely motivated to encourage clean energy transition and thereby tackle climate change should arguably support investment protection, at least of renewable energy investments, via bilateral investment treaties (BITs) and multilateral investment treaties (MITs) providing for investor-state arbitration.

It is legitimate to enquire whether investor-state arbitration can be, or has been, used to stifle action intended to mitigate climate change. To date, however, no investment arbitration decision has in fact sanctioned any such action. On this basis, abolishing investor-state arbitration in the energy sector as a response to climate change concerns cannot be justified.

At the same time, an increasing number of states have asserted counterclaims against investors in the context of investment arbitration proceedings. Such counterclaims have been used as an opportunity to raise climate change-related or other environmental claims against those investors.

More broadly, the rise of environmental, social and governance (ESG) disputes will continue to be a prominent feature of the business and regulatory landscape in 2024. The number of climate change arbitrations has increased rapidly over recent years, as both states and investors prioritise ESG issues and the climate crisis. Disputes might arise, for example, where investors suffer loss as a result of changes in a state’s policy on supporting green technology, where newly-constructed facilities using new technology fail to comply with contractual standards, or where the transfer of carbon credits under an emission trading scheme is not completed.

Two recent UK court cases also illustrate this trend. In July 2023, Glencore’s investors filed a claim against the mining giant, seeking damages from the company based on allegations that the company made misleading or untrue statements in past prospectuses to cover up corruption. ClientEarth’s derivative action on behalf of oil group Shell, of which ClientEarth is a minority shareholder, against Shell’s directors is another example of how companies and associated individuals could face climate change-related legal challenges. In the Shell case, ClientEarth alleged that Shell’s directors had failed effectively to address the risks of climate change.

Investors in the energy sector, like states involved in regulating that sector, will increasingly need advice and training on how to manage and mitigate the risks of ESG disputes in the years ahead.