How the energy transition will impact Energy Charter Treaty arbitration

A recent report by the Climate Change Counsel has highlighted this, citing the prospect of an increase in investor-state arbitration as states seek to transition away from fossil fuel-based energy in pursuit of ‘net zero’ emission economies.

What is the Energy Charter Treaty?

The Energy Charter Treaty (ECT) is a multilateral treaty with 53 signatories that came into legal force in 1998. At its core, the treaty was established to advance all commercial energy activities and encourage foreign investment in the energy sector. The treaty requires states to provide fair and equitable treatment (FET) to investors and provides investors with a right to seek damages where the actions of states are unreasonable or discriminatory and harm their interests.

The treaty’s investor protections apply regardless of the source of energy in question. This means that 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.

The energy transition and the ECT

The extent to which the ECT continues to protect foreign investors in fossil fuels has been called into question in recent times as signatory states seek to transition away from their reliance on fossil fuels and support ‘green’ energy projects. This energy transition has been spurred by the climate crisis and the resultant response from governments – perhaps most notably the adoption of the Paris Agreement in 2015 and the subsequent stream of legislation, accords and protocols that have been agreed to give effect to climate change commitments and targets to achieve ‘net zero’ emissions.

Tension between the global ‘green’ agenda and the protections afforded to fossil fuel-based investors under the ECT was highlighted in the Climate Change Counsel’s recent report into the ECT, climate change and the clean energy transition.

The Climate Change Counsel conducted lengthy analysis, reviewing 64 out of 75 known ECT awards rendered before August 2021. The report also explored future projections of ECT arbitration through the lens of climate-positive, sustainable energy objectives. The challenge facing arbitral tribunals on how to balance the ECT protections of individual foreign investors and the sovereign rights of states to promote and achieve a successful clean energy transition has been brought into sharp focus by the report.

The tension between foreign investor ECT protections and state rights to regulate

The report predicts that a wave of “phase-out” cases will be brought by foreign investors that are caught in the regulatory web of the international energy transition. The first of these phase-out cases was filed against the Netherlands in 2021. With cases of this nature in their infancy, it is unclear what number of claims will be raised in future and whether claims will succeed,.

It is clear, however, that there is chasm between the interests of fossil-based energy investors, seeking to safeguard their investments, and the desire of states to regulate to facilitate the clean energy transition. Confronted with the realities of climate change and an acceleration in the production of new, renewable energy technologies, states are keen to compete for clean energy investment. In turn, states pursuing climate neutrality and net zero carbon emissions by 2050 are marginalising fossil-based energy investments. New laws and regulations passed to incentivise and drive through the clean energy transition will doubtless attract legal proceedings from aggrieved investors.

Importantly, of the 64 ECT awards reviewed by the Climate Change Counsel, there is no case law that directly addresses climate change or the clean energy transition in the context of investor ECT protections. In the absence of that case law, the Climate Change Counsel assessed analogous, international arbitral cases to draw out thematic conclusions around how such new laws and regulations may be received.

Predictions for ECT arbitration

Historically, bilateral investment treaty (BIT) tribunals have applied legal doctrine to ascertain whether a host state’s regulatory conduct could amount to a breach of the FET standard. Typically, this test dictates that state regulation that is verified to be reasonable and motivated by rational and logical public policy cannot amount to discriminatory behaviour under FET. It is likely to be argued by states in future ECT arbitrations that their regulation to decarbonise energy emissions is reasonable and logical.

However, investors have equally argued a right to regulatory stability by way of legitimate expectations. For future ECT arbitral tribunals, this would principally be a question of fact. Investors would be well-advised to conduct considerable due diligence to accurately assess the foreseeability of a changing regulatory landscape. Nevertheless, there is a caveat to a state’s right to regulate. Tribunals have recognised investor’s legitimate expectations to gain reasonable and equitable returns on their investments despite changing regulation. This question of investors’ legitimate expectations will continue to be raised in ECT arbitrations.

It may also be possible for ECT tribunals to creatively apply principles of customary international law, such as the ‘no harm’ principle. Under the no harm principle, states are prohibited from allowing any use of its territory in such a manner that may cause injury to persons, property or territory of another state. The report envisages that this principle could be argued by states that have implemented regulation to phase-out fossil fuels so as to mitigate against any cross-border harm that may be caused by carbon emissions produced by fossil fuels.

What next for the ECT?

There has been ongoing negotiation between ECT signatories since 2017 with a view to aligning ECT provisions to those of the Paris Agreement to accord with clean energy and climate-positive objectives. Reportedly, minimal progress has been made to this effect, causing a great deal of frustration amongst signatories, with several considering resigning from the ECT altogether.

The Climate Change Counsel’s report explored the potential for intervention in ECT arbitral proceedings through third party ‘amicus curiae’ submissions. The amicus curiae mechanism enables persons or entities not party to a claim to provide information or expertise to assist a tribunal in rendering a determination.I In the context of climate change disputes, the availability of this mechanism can be very helpful.

Investment treaty arbitration has a longstanding history of amicus curiae participation by NGOs or other public interest actors in proceedings. However, there has been very minimal third party participation in ECT arbitrations, according to the report. Notwithstanding, a recent amicus curiae application has been filed jointly by several NGOs in respect of a fossil fuel phase-out ECT claim against the Netherlands.

While the significance and impact of ECT amicus curiae intervention remains to be seen, future ECT tribunals could help to redress more general concerns around the transparency and credibility of investor-state arbitration proceedings by regularly including and accepting amicus curiae interventions – particularly in those claims relating to climate change and the clean energy transition.

What does this mean for investors?

Fossil-based energy investors should tread carefully and cautiously in the arena of energy investment. Almost certainly, states will continue to regulate and legislate a path towards a carbon-emissions-free future. Less certain is the approach ECT arbitral tribunals will follow when assessing their claims in the context of the energy transition.

The lack of binding legal ECT precedent provides scope for tribunals to flexibly apply legal principles and case law that could further facilitate the clean energy transition. This flexibility exposes investors to legal uncertainty. Lengthy and drawn-out arbitral proceedings of this nature could prove costly and potentially reputationally damaging to investors too.

For tribunals convened to hear future ECT claims, there will be a challenge in how to appropriately balance protections for foreign energy investments with states’ pursuit of internationally binding climate commitments on a case-by-case basis.

Co-written by Hannah Archer of Pinsent Masons.