Modernising the ECT: Stalemate whilst EU prepares to withdraw

After fifteen rounds of negotiations that took place over the last five years, the modernised text of the Energy Charter Treaty (“ECT”) was scheduled to be voted on 22 November 2022, during the 33^rd Meeting of the Energy Charter Conference.

However, in the weeks leading up to the summit, Belgium, France, Germany, Luxembourg, the Netherlands, Slovenia, Spain and Poland announced their intention to withdraw from the ECT, dissatisfied with the outcome of the negotiations and claiming that the modernised version of the ECT does not make sufficient progress towards environmental protection. On 18 November, EU countries failed to reach a majority vote in favour of the modernisation and the European Commission requested the removal of the adoption of the reform from the agenda of the summit and the vote on the adoption of the amendments to the ECT was postponed to April 2023.

Adding to the uncertainty surrounding the future of the ECT’s modernisation, on the 24 November 2022 the European Parliament passed a resolution calling on the European Commission and the Member States to start “preparing a coordinated exit from the ECT and an agreement excluding the application of the sunset clause between willing contracting parties.” In the motion adopted, the European Parliament states that the ECT is “an outdated instrument which no longer serves the interest of the European Union, especially with regard to the objective to become climate neutral by 2050” and although welcoming the efforts made by the EU and its Member States to drive the modernisation process, it concludes that the modernised ECT is still “not aligned with the Paris Agreement, the EU Climate Law or the objectives of the European Green Deal”. The position of the majority of EU Member States’ governments remains to be seen.

Against this background, and in light of the material consequences that both the EU and its Member States’ withdrawal and the approval of the modernised ECT may have for investors in the energy sector, we take the opportunity to recall what is at stake and to go through the main changes to the ECT that are still scheduled to be voted on in April 2023.

The ECT

On 24 June 2022, the Contracting Parties to the ECT reached an agreement in principle regarding its modernisation towards a greater alignment with clean energy transition goals. Having entered into force in April 1998, the ECT was designed as a multilateral framework for energy cooperation promoting energy security in competitive markets and protecting foreign investments in the energy sector.

With 53 signatories and contracting parties, the ECT is the most litigated of all investment protection agreements and is frequently invoked by foreign investors in disputes related to transition to renewable energy against the Contracting Parties. According to the Energy Charter Secretariat, as of 1 June 2022 at least 150 investment arbitration cases have been instituted under the ECT, 50 of which relate to fossil fuel investments and 91 to investments in renewables.

The proposal to modernise the ECT

The revisions mainly intend to reform the investor-state dispute resolution mechanisms envisioned in the original Treaty and to allow states to pursue regulatory actions aligned with their clean energy transition goals which might also have an impact on existing and future investments.

Whilst the modernised text of the ECT has not been published, the public communication of the Ad Hoc meeting of the Energy Charter Conference explains that the forthcoming amendments cover three pillars: (i) an updated list of energy material and products (which should now also include hydrogen, anhydrous ammonia, biomass and synthetic fuels), (ii) a novel “flexibility mechanism” allowing for the exclusion of protection for fossil fuel investments and (iii) a “review mechanism” allowing a review of the list of protected energy materials and products and the application of the new flexibility mechanism to be reviewed every five years.

• Flexibility Mechanism: A novel feature

The novel “flexibility mechanism” allows Contracting Parties to exclude investment protection for fossil fuels in their territories, considering their energy security and clean energy goals.

However, this flexibility mechanism should only apply to:

1. existing investments (which should also cover projects in the exploration phase and their potential future exploitation) after 10 years from the entry into force of the new provisions - a period that would begin on 15 August 2023 if Contracting Parties were to agree to provisionally apply the agreement or, otherwise, after ratification by three quarters of Contracting Parties;
2. new investmentsmade after that date.

The EU and the UK, for example, indicated their intention to use this flexibility and to exclude investment protection for (i) existing investments in fossil fuel after 10 years as of 15 August 2023 and (ii) new investments made after 15 August 2023 (with limited exceptions).

• Exclusion of intra-EU disputes from arbitration under the ECT

Another feature of the modernised ECT relates to the exclusion of intra-EU arbitrations, preventing investors from Contracting Parties part of a regional economic integration organisation such as the EU from bringing arbitration claims under the ECT against another Contracting Party belonging to the same regional economic integration organisation.

• Revision of key definitions

According to the modernised ECT, in order to qualify as a relevant “investor”, investors will have to meet the requirement of having substantial business activities in the host contracting State, such as a physical presence, employment of staff, turnover generation or payment of taxes.

Moreover, a qualifying “investment” will also have to comply with additional requirements to enjoy protection under the treaty such as the commitment of capital, the expectation of gain or profit, a certain duration, or the assumption of risk, which may limit the broad scope of the investments currently covered by the ECT and, in particular, exclude coverage of claims arising solely from commercial transactions for the sale of goods and services.

The definitions of some of the rights accorded to investors are also expected to be amended with the aim of clarifying their exact scope. In particular, the modernised ECT will include a definition of “indirect expropriation” clarifying that, as a general rule, non-discriminatory measures that are adopted to protect legitimate policy objectives, such as public health, safety and the environment (including with respect to climate change mitigation and adaptation), do not constitute indirect expropriation.

• Dispute Settlement

The modernised ECT also includes a clarification of dispute settlement provisions, including mechanisms which enable the dismissal of frivolous claims, as well as claims submitted as a result of investment restructuring for the sole purpose of submitting a claim under the Treaty.

What next?

The more recent developments have brought additional doubts and uncertainty on the future of the ECT and its modernisation. The discussions that will take place in the next few months will be crucial and should be closely monitored by all those potentially affected.