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Trick and treaty: The ECT’s role in climate change

On 15 March 2022, the Stockholm-based think tank Climate Change Counsel (CCC) released its report on the role of the Energy Charter Treaty in climate change and clean energy transition policy.

The report highlights the inherent tension between the ECT’s investment protections on the one hand, and the global commitment to shift away from coal and reduce emissions on the other. The implementation of new policy and regulations to meet the ambitious net zero goals that have been pledged by numerous governments will likely have an adverse impact on fossil fuel projects. But the ECT’s investment protection provisions protect foreign fossil-fuel investment. The ECT is currently undergoing a revision. In order to properly understand the ECT’s capacity to support the global clean energy transition, the CCC report looks at the language of the ECT, as well as how arbitral tribunals have weighed the investor protections against its environmental provisions and the energy policies of host states.

The key conclusions of the report are as follows:

  • State obligations toward foreign investors under the ECT may conflict with their obligations under the Paris Agreement, and under EU and human rights law. Arbitral tribunals have the power to integrate these two areas of international law or to decide that one trumps the other.
  • The ECT’s investor protections are broadly drafted and leave it up to tribunals to set the boundaries for state regulatory conduct. States may find that to provide certainty, treaty revision or withdrawal is necessary.
  • Climate change and energy transition policy are generally absent from the ECT jurisprudence. Previous awards in regulatory disputes may not be sufficiently analogous to predict how tribunals will rule in future cases challenging regulations passed to reduce carbon emissions. This leaves investors with uncertainty until the first fossil phase-out cases are decided, and possibly also thereafter.

These key findings of the report are discussed further below.

The issue of the ECT in the net zero era

The report starts by outlining the tension between climate law and investment protection in the energy sector. All of the ECT contracting parties are signatories to the Paris Agreement. They have all therefore agreed to try and cut emissions significantly by 2030, and to achieve “Net Zero” carbon emissions by 2050.

Climate change and energy transition policy in ECT jurisprudence

The report concludes that climate change and energy transition policy are, so far, generally absent from the ECT jurisprudence. Of the 64 ECT awards reviewed for the study, only one used the phrase “energy transition” and none discussed climate change in any substance.

However, while energy transition has not been an explicit issue to date, the report advises that the potential impact of the ECT on energy transition should not be ignored. For example, the report proposes that the renewables claims against Spain and Italy could impact energy transition by creating a disincentive for states to pass bold energy transition policies or by deterring renewable energy investors from relying on similar incentive schemes in the future.

Interaction between the ECT and other areas of law

In order to evaluate how a tribunal would weigh the ECT’s investment protections against state obligations under the Paris Agreement and other climate change treaties, the report looks at how past tribunals have dealt with the interplay between the ECT and other areas of law.

Even though the majority of awards mentioned an international agreement other than the ECT, the review showed that the only substantive analysis carried out by tribunals related to EU law. While one award found that EU law prevails over the ECT in the event of inconsistency, several awards found the opposite. Other awards declined to make a finding about the supremacy of EU law and instead took EU law into account as a “fact”.

The report also found that customary principles of international law have not played a central role in ECT awards to date but that principles such as the precautionary principle, the prevention principle, the polluter pays principle, or the no-harm principle may eventually gain status similar to that of the principle of good faith.

Investor protection versus the right to regulate

In order to try and anticipate the outcome of future fossil phase-out disputes, the report looks at how past tribunals have evaluated whether a state’s regulatory action (more generally) constitutes a breach of the ECT.

The report distinguishes between cases relating to regulatory conduct prior to 2016 on the one hand, and the wave of disputes related to renewable energy incentive schemes on the other.

In the pre-2016 cases, the report found that tribunals were generally protective of the state’s right to regulate even where regulatory measures negatively impacted foreign investments provided that the measures were reasonably and proportionally related to a rational public policy.

By contrast, many of the more recent renewable energy cases have been decided against the states. For example, 16 of the 20 awards against Spain and three of the seven awards against Italy found in favour of the investor.

The report draws the following conclusions:

  • Although tribunals differ on the issue of legitimate expectations, they generally agree that regulatory changes that were foreseeable at the time of investment do not breach the standard. In light of the evolution of international climate law over the past three decades, regulatory measures to phase out fossil fuels may be considered foreseeable.
  • Tribunals have consistently dismissed indirect expropriation claims where the investor remained in control of the investment and the investment continued to generate revenue. Even if such claims were to succeed, there would be uncertainty around the valuation of fossil-related assets in a rapidly decarbonizing economy.

 

 

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