20 September 2022
An international treaty that hamstrings governments’ ability to make climate policy is still in force – and an attempted overhaul has not worked. This is why the EU and its member states need to walk away from the Energy Charter Treaty.
The Energy Charter Treaty (ECT) is an outdated international investment agreement that allows foreign companies to claim compensation from governments for introducing policy changes and laws that impact their profitability.
That includes when critical action is taken to protect our planet, like coal phase-outs, bans on offshore drilling, or fracking restrictions.
Designed in the 1990s to protect foreign investment in the energy sector, the ECT has more than 50 signatories globally. Today, it is one of the most often used treaties in investor-state dispute settlement (ISDS) processes where corporations side-step domestic courts to sue governments in secretive tribunals.
The fossil fuel industry has used this mechanism more than any other, challenging a wide range of policy measures but critically those designed to protect the environment and climate.
And with no cap on compensation pay-outs, fossil fuel companies can sue for billions – creating a catastrophic chilling effect for governments that want to take necessary steps to curb dangerous global heating but fear reprisals by industry.
Now, its future in the European Union looks uncertain. Following a number of member state exiting the treaty in 2022, it was reported that the European Commission saw a full bloc withdrawal "appears inevitable" in early 2023.
The ECT’s members recently sought to tackle the treaty’s inherent climate problem, negotiating reforms to “modernise” it and bring it in line with the goals of the Paris Agreement.
The European Commission has been very active in the negotiations, trying to secure an outcome that would fix the treaty’s incompatibility with EU law and ensure consistency with its own climate targets.
The result, announced in June, falls woefully short. Rather than end protection for fossil fuel investments entirely, parties agreed a ‘flexibility mechanism’ that allows individual ECT members to remove protection for fossil fuel investments when it contradicts their respective climate goals.
As it stands, the EU and UK are the only parties to make use of this mechanism, phasing out the protection of existing fossil fuel investments 10 years after the reform enters into force.
With years until the new treaty enters into force, this means that foreign coal, oil and gas companies will still be able to sue EU and member state governments over their climate policies until the late 2030s – stifling progress in the very window we need to accelerate action. Meanwhile, fossil fuel investors abroad will continue to benefit indefinitely – at least for now – from the ECT’s protection.
The EU also decided to exclude the protection of new fossil fuel investments made after August 2023, but with significant exceptions for certain types of gas projects.
And then with the addition of biomass, hydrogen, ammonia and carbon capture storage to the scope of investment protections – which present significant sustainability concerns or are unproven – the new ECT will further constrain the regulatory space necessary to adapt energy transition policies.
“The bottom line is that we are still left with a dangerous agreement that will obstruct urgent action to tackle the climate crisis for years to come. The EU must finally do what is necessary for the climate, and legally right: walk away.”
The downfall of the modernisation was that it only focused on cosmetic language changes that have proven ineffective in practice and kept structural reforms out of the negotiations entirely.
Critical changes such as removing the controversial ISDS mechanism, addressing the issue of excessive compensations, imposing obligations on investors, or cancelling the sunset clause which prolongs the treaty’s existence for a period of 20 years after a party decides to leave it, were in fact never on the table.
As a result, ECT parties will continue to be at risk of litigation if they adopt climate policy measures. And as we’ve seen recently, with Italy forced to pay €250m in compensation to UK oil company Rockhopper over a ban on oil drilling near its shores, there’s a lot at stake.
The modernised ECT therefore still has the potential to interfere with the objectives of the European Green Deal and the EU’s international emission reduction commitments.
ECT members have agreed that EU investors will not be able to use the treaty to claim against EU countries under the new agreement, a practice judged illegal by the European Court of Justice, the EU’s top court.
Whether this will prove effective in practice remains uncertain. Arbitral tribunals have a history of ignoring the authority of EU judgments. But these judicial and political developments send a very clear message: there is no place for investor state disputes in the EU. And the rationale behind that – that ISDS undermines the rule of law – could expand to non-EU jurisdictions too.
Although an agreement has been reached in principle between ECT members on the reforms, considerable hurdles remain before the new treaty kicks into action.
The Commission faces an uphill struggle in securing support of both the Council and the European Parliament. Poland has initiated the move to exit the treaty. Italy already left in 2016. In 2022, Spain, France and the Netherlands all announced their intention to leave the treaty - making member states' buy-in all the more difficult.
The new ECT also clearly does not meet the standards set by the European Parliament in its resolution on the future of EU international investment policy that was passed last June.
At ECT level, the agreement is still subject to a unanimous decision of all ECT members present that was set to take place in November but has now been postponed to April 2023.
Any ECT member may therefore decide to veto the new agreement, which would thwart the modernisation at the last minute. And even if adopted, the new ECT will only enter into force once a majority of the ECT members have ratified it and only among those that ratify.
Ultimately, it’s going to be a long game, for little reward. There is no conclusive evidence the ECT in its modernised version would benefit the energy transition in any way, yet the costs for climate action are real.
The only viable answer is for the EU and its member states to leave, together with the UK, and use its leverage to develop solutions to remove the legal effects for the sunset clause, among themselves and with other parties.
Every delay to climate action costs. This is the only way to bring an immediate end to fossil fuel protection among all states that withdraw, and finally end the ECT’s chilling effect on the EU’s climate progress.
Given the momentum now building in the EU, the Commission now has the opportunity to encourage other ECT members, such as the UK, to neutralise the sunset clause and agree to end fossil fuel investment protection in their states for good.