By Aida Bektasheva, Phd Candidate  in Law, University of Miskolc

On 24 November 2022, the European Parliament adopted a resolution calling for a coordinated withdrawal from the Energy Charter Treaty (ECT) by the EU and its Member States by 303 votes to 209 with 63 abstentions rather than, joining the modernized ECT,  since it does not align with the Paris Agreement and the EU’s policy on investment protection , EU Climate Law in particular the EU Green Deal. The resolution says the most adequate option would be for the EU and its 27 member states to leave ECT, which makes it possible to see a more assertive position of the EU for now. Political debate in the EU has shifted the focus of the ECT modernization discussion squarely onto the issue of withdrawal. Even in the case of withdrawal of the EU from the Energy Charter Treaty, it would trigger a “sunset clause” which means the treaty would still protect existing fossil fuel investments for 20 years. Meanwhile, other seven countries such as Poland, Spain, the Netherlands, France, Slovenia, Luxembourg and Germany announced their intention to withdraw from the treaty due to dissatisfaction with the new modernized text of the ECT.  Today we see that the EU Council failed to adopt a common position regarding the modernized ECT or withdrawing. ECT is becoming increasingly controversial ever since its entire existence and under intense criticism not only in Europe but also among other partner countries.  What we see today is that EU states are divided on how to deal with ECT and what will be the implications and behavior of those who are going to withdraw from the treaty and who have not left the ECT yet and there will be completely different scenarios.

Withdrawal from ECT without modernization 

The backlash against ECT has been a long time coming. Consequently, these days, we are witnessing a historical breakup of ECT, historical notifications of withdrawal from the ECT, which will take effect on the following dates: France: 8 December 2023, Germany: 21 December 2023, Poland: 29 December 2023. However, simply leaving the Treaty does not mean that the treaty’s controversial part on investment protection can no longer be used by foreign investors. If a party leaves, there is a “sunset clause” that ensures that the investment provisions shall continue to apply for an additional 20 years after withdrawal (Art. 45(3), the ECT Treaty). The 20-year survival clause could put the urgent action needed to achieve Paris commitments at risk. For example, Italy, even despite having left the ECT treaty in 2016, UK investor Rockhopper filed an ECT claim, alleging that Italy breached a number of the rights accruing to it under the ECT for having stopped drilling for oil. Italy still had to pay compensation of   €250 m to Rockhopper, which is without doubt eight times greater than its investment of almost €28m and not just compensated for the money they had already invested in explorations, but even for potential future profits. We must admit that Italy lost the case with dramatic damage under ECT even after the withdrawal.

According to Art.  47 para. 1 ECT, a contracting party is allowed to declare its withdrawal and withdrawal and supplemented by the international law of treaties as codified in the 1969 Vienna Convention on the Law of Treaties (“VCLT”) to which most EU Member States are parties and, moreover, it reflects customary international law. Here is an important and subtle condition that withdrawal is only possible in the case of “fundamental change of circumstances” (Article 62 of the VCLT) and that international jurisprudence has held that new developments in the state of environmental knowledge and of environmental law are insufficient to meet that threshold. In this context, the reasons given by a Contracting Party for its withdrawal may need to be assessed against Article 62 of the VCLT criteria on an individualized basis.  

On the EU side, withdrawal involves a procedure in Article 218 TFEU, parallel to the one for the conclusion of EU agreements. In the case of EU withdrawal by individuals, EU Member States would be subject to the applicable domestic rules also. In addition, withdrawal, according to Art. 47 para. 1 ECT, would trigger the ‘sunset clause’. The European Commission has itself already prepared a draft inter se agreement to clarify that the ECT and its sunset clause do not apply, and never applied to intra-EU relations. This draft could be modified to allow other withdrawing contracting parties outside the EU to join and limit the sunset clause. So, there are timely attempts to neutralize the sunset clause, which means under article 41 VCLT, as long as it does not affect the rights of other parties, precisely the bilateralism assumption underlying the ECT which enables this, and finally, it does not affect the pacta sunt servanda principle. Thus, it will support the easy withdrawal process and at the same time give a boost to other EU members who are still silently waiting and thinking about next steps for a prompt decision.  But at the same time, it should be noted that an inter se modification removing the sunset clause prior to withdrawal is fraught with legal uncertainty. 

In sum up, it is also important to emphasize that withdrawal challenges also, such as investors can bring claims in international arbitration against parties that have purported to withdraw from the ECT. Moreover, an EU resolution calling for a coordinated withdrawal from the ECT is not binding and the Council of the EU would need to formally approve a withdrawal from the ECT by the EU.  

Why do EU members want to leave ЕСТ and what are the reasons?

In recent years, it has been used to challenge policies that require fossil fuel plants to shut, raising concerns that it is an obstacle to addressing climate change, the EU Green Deal  which is underlying the EU bloc’s efforts to decarbonize the bloc’s energy mix and to achieve climate neutrality by 2050  and also the treaty’s provisions on investment protection with investor-to-state dispute settlement (ISDS). 

There are two main reasons for withdrawal from ECT: 1) ECT threatens to undermine the European Green Deal and the EU’s climate law. 2) EU member states are at the receiving end of costly claims and high dissatisfaction with investor-to-state dispute settlement (ISDS).

Firstly, EU concerns over the ECT have been growing, especially the provisions relating to investment protection and climate protection, biodiversity protection, disrupted nutrient cycles and pollution problems, since the European Green Deal  involves a huge transformation in EU energy markets, including a vast scale-up in the promotion of renewable energy sources and energy efficiency measures, and an almost total phase-out of fossil fuel use by 2050.

Secondly, dissatisfaction with the ECT in certain EU Member States and in the European Parliament has focused on the ECT’s investor-State dispute settlement (ISDS) mechanism providing eligible investors with a direct right of redress against their host countries under international law,  so favoring investors is unpredictable, and the fines that governments can be hit with are catastrophically large. In 2021, the European Court of Justice ruled that claims under the ECT under international law are incompatible with EU law, Konstroy’s judgement (C-741/19) is in line with the 2018 Achmea judgement (C-284/16). The European Court of Justice ruled the arbitration system violates EU law and must not be used to settle disputes between member states. The ECT allows foreign investors in the energy sector to sue governments for decisions that might negatively impact their profits.

Modernization of ECT without withdrawal 

 After ongoing multilateral negotiations held during the year 2019-2022 (15 rounds), an “agreement in principle” to close negotiations was reached at the extraordinary Energy Charter Conference of 24 June 2022 in Brussels.  It will enter into force only if three-fourths of the members of the 53 Contracting Parties ratify it, 90 days after that happens, and only for those that ratify it.  For example, some EU countries like Cyprus, Malta, Finland and several Eastern European countries still support ECT treaty reform.

For sure, the main achievement of a novel flexibility mechanism allows parties, based on a conference decision, to exclude investment protection for fossil fuels in their territories, considering their individual energy security and climate goals. At least initially, only the EU and United Kingdom will use Annex NI to carve out fossil fuel protection, with Switzerland merely limiting the inclusion of new energy materials and products. At the same time, it needs to create a more fair-balanced international investment regime for all ECT parties. Moreover, in relation to the intra-EU application of the ECT, the new modernized ECT contains a clause that clarifies the understanding of all contracting parties that provisions on investor-state and state-to-state dispute settlement, notably, do not apply to intra-EU cases.

What types of consequences for those who are still with ECT even if the EU withdraws? 

While the European Parliament appears to believe that the only option for the European Union is a coordinated exit from the ECT, it is questionable whether this approach will really achieve the Parliament’s desired purpose. The EU Member States will not be able to terminate all investment protection commitments in relation to fossil fuels simply by withdrawing from the ECT. Therefore, some EU members may want to stay and adopt the modernized version of ECT. In this case, it will be the most difficult and there will be lot of disagreements among EU members, here it is discussed what differences and consequences are possible:

  1. New asset-based definitions of investment and investors with substantive economic interests further blur the lines between the concepts of existing investments (investments made before August 15, 2023) and future investments (investments made after August 15, 2023) as laid out in the EU carve-out. It will require tribunals to decline jurisdiction where а) the dispute was very likely to arise when the claimant acquired ownership or control of the investment, and (b) such acquisition of ownership or control was for the main purpose of submitting a claim under the ECT.
  2. Definition economic activity in the energy sector is now extended to cover the capture, utilization and storage of carbon dioxide in order to decarbonize the energy systems and will count protected investment pursuant according to the Article 1(6) of the current ECT. So, at the same time it must be said it will determine an investor’s ability to bring a claim for compensation using investor-state dispute settlement (ISDS) also.
  3. The modernized ECT clarifies the notion of direct expropriation and further introduces a definition of indirect expropriation together with a list of factors that are required to be considered for the determination of the existence of an indirect expropriation in each case (such as economic impact and character of the measure).  This new inclusion of this requirement could be highly problematic to the value of this exception for countries’ energy transition policy measures.
  4. New inclusion of additional energy materials and products such as carbon capture, utilisation and storage, hydrogen, anhydrous ammonia, biomass, biogas and synthetic fuels increases the risk of arbitration claims and also. They might not be climate neutral at the consumption stage. In addition, the EU, the United Kingdom, and Switzerland have limited the extension of the ECT’s protection to those energy materials and products in their area. We also cannot exclude regulatory chills like a reluctance to introduce policies to encourage renewable energy, for fear of costly arbitration. As a result, this increases the risk of future compensation claims, which could cost taxpayers billions and hamper the clean energy transition.

If arbitral tribunals continue to find that the sunset clause applies even after an inter-se agreement saying the opposite is concluded, then this will increase the pressure between   EU members both who are in and outside of ECT. Mostly negative feature of the reform package is that it extends investment protection to controversial new energy sources, such as biomass or biofuels, which will be a big gap for both EU members who have the potential and those who do not. 

Conclusion 

If the Modernized ETC is adopted this adopted this year, during 2023, an ECT Contracting Party can choose both to ratify the Modernized ETC and pursue withdrawal in parallel, since these are independent issues. 

Despite the modernization efforts, the updated ECT still brings considerable risks for governments in their environmental, climate and energy policies. Several EU members states have indicated their intentions to withdraw from the ECT as it is not sufficiently aligned with the Paris Climate Agreement.  Therefore, if the EU withdraws, individual member states cannot remain contracting parties of the ECT. The EU would first have to authorize such a unilateral step in a separate EU Council decision. However, since the revised ECT violates the EU climate protection targets and the old ECT also violates EU law, this is not a legally viable scenario – yet another sign that a coordinated withdrawal is without alternative.

And the most winning scenario would be a joint withdrawal of all remaining EU member states and other non-EU members of the ECT would have an even greater positive impact as they could neutralize the so-called sunset clause.