On Friday 24 June, the Energy Charter Conference reached a landmark “agreement in principle” to modernise the 1994 Energy Charter Treaty (ECT) amidst mounting pressure and scrutiny. The modernised treaty, which is due to be signed in November 2022, grants contracting parties flexibility to exclude fossil fuel investments from ECT protection and has a much stronger focus on clean, affordable energy and protecting states’ sovereignty to govern their energy resources. This is a much-needed step forward, but does it go far enough? 

The announcement concluded two years of “intense” modernisation negotiations, which began after mounting criticism of the ECT’s use by investors to protect fossil fuel investments against regulatory changes and secure hefty compensation from states for actual and future lost profits in investor-state dispute settlement (ISDS) arbitrations. For example, the Netherlands is currently facing challenges from German energy companies RWE and Uniper for over €3.5bn over its decision to phase out coal by 2030. This taxpayer money could, critics claim, be used to fund national climate action.

Modernisation talks were fraught with tension, including opposition by Japan and Kazakhstan to amendments. Many EU states threatened withdrawal if no agreement was reached. The stakes were high. Nonetheless, an agreement was reached, with “novel” mechanisms for aligning the ECT with the Paris Agreement and states’ climate objectives.

A Modernised Treaty

The modernised terms will contain a “flexibility mechanism” enabling contracting parties to exclude fossil fuel investment protection in accordance with national energy security and climate goals. Notably, the EU and UK secured a fossil fuel carve out, which withholds ECT investment protection from all new fossil-fuel investments after August 2023 and all existing fossil fuel investments after 10 years from the date the revised treaty comes into force. Other states may well follow suit.

The modernised treaty will also extend investment protection to technologies like carbon capture, utilisation and storage (CCUS) and cleaner energies including hydrogen, anhydrous ammonia, biomass, biogas and synthetic fuel. This should boost private sector confidence and investment in these technologies, which are critical to the energy transition.

Importantly, the modernised treaty will contain a review mechanism, giving contracting parties the chance to react to and incorporate technological and political developments in treaty terms every 5 years.

The agreement similarly strengthens states’ sovereignty to regulate energy in the interest of public policy objectives like “the protection of the environment, including climate change mitigation and adaptation”. This accompanies a general attempt to clarify concepts such as investors’ legitimate expectation of regulatory stability, the scope of fair and equitable treatment, and expropriation.

Finally, the modernisation proposals also address the EU’s objections to intra-EU claims being dealt with via the ECT’s arbitration process. Such claims will now be impossible, and redress would need to be sought through the courts of EU Member States.

But is it modern enough? 

Although the modernised terms aim to “limit costly challenges” from fossil investors to new climate policy measures, critics argue it is not enough. The revised treaty will still protect existing fossil fuel investments for at least a decade in the EU and UK – and perhaps longer elsewhere. This means fossil investors can continue to claim compensation for lost profits from states’ regulatory changes and climate policies. In circumstances where the IEA stresses the need to stop all new fossil fuel investment, the IPCC calls for emissions to peak by 2025 and fall 43% by 2030, and new research shows that phasing out oil and gas production and consumption must happen at a much faster rate, if we are to limit warming to 1.5°C, it is highly likely that these ‘protected’ fossil fuel investments will be shut down in coming years, giving ECT investors the right to sue. Over the agreed ten-year window, this exposes the UK to £9.4bn in potential legal claims from fossil fuel investors.

Furthermore, there is no guarantee that other states will follow the EU and UK’s lead, nor is the agreement fait accompli. The treaty will be proposed for adoption in November 2022, but entry into force requires ratification by at least 3/4 contracting parties, which could take years. Further, if any state opposes the modernised treaty, they can reject the amendments or withdraw at any time.

Having said all that, the need to compromise in international treaties such as the ECT, and the rule of law, which militates against retrospective changes to legal rights, limit what realistically could have been achieved. Moreover, doubts remain about whether the ECT really has a deterrent effect on signatory states reforming energy policy to phase out fossil fuels and reduce emissions. Many signatory states continue to subsidise or otherwise encourage fossil fuel projects alongside clean energy, and some might argue that this is a bigger obstacle to emissions reduction than potential investor-state claims.

Finally, whether the provision for intra-EU disputes provides a fair and neutral source of dispute resolution remains to be seen, because this would entail investors suing Member States in their national courts.

Evidently, although the first hurdle is cleared, the pre-existing arguments still run strong, and the race is far from over.