Energy Transition and the Modernized Energy Charter Treaty | White & Case LLP

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In June 2022, the parties to the Energy Charter Treaty (“ECT”) announced agreement in principle on the text of a modernized treaty. This modernization can have significant implications for government regulation and investments related to the energy transition.

The ECT, which came into force in the early 1990s, is a multilateral agreement on international cooperation in the field of energy, including the protection of foreign investments. With more than 50 signatories, the ECT is the largest investment agreement in existence today. It is often invoked to settle disputes arising from the energy transition towards low-carbon and renewable energy sources. Since 2010, investors in the renewable energy sector have initiated more than 70 cases under the ECT.2

The parties completed a five-year process to modernize the ECT in June 2022 when they announced agreement in principle on the text of a modernized treaty.3 Although this modernized text has not yet been published, the key proposed changes are summarized in the June 2022 announcement. The modernization demonstrates the parties’ commitment to advancing this transition while respecting the rights of affected investors. Some of the main proposed changes in this regard are summarized below.

Excludes protection for fossil fuel investments

The ECT currently protects qualifying fossil fuel investments and allows investors to bring arbitration claims against host states to enforce these protections. For example, UK-based oil and gas company Rockhopper Exploration recently won an ECT arbitration against Italy relating to an oil and gas exploration investment off the Italian coast.4 Rockhopper had acquired an Italian company that benefited from an exemption from a ban on offshore drilling in Italy. The Italian Ministry for the Environment and Protection of Land and Sea took steps to approve Rockhopper’s application for a mining concession, but another Italian ministry later rejected that application on the basis of a new law that removed the exemption from the drilling ban. An arbitral tribunal ruled in August 2022 that denying the application in the circumstances constituted an “immediate and complete deprivation” of the company’s investment in Italy, which would amount to expropriation under the ECT.5

The modernized ECT allows contracting parties to “exclude [the treaty’s] Investment protection for fossil fuels in their territories” thanks to a novel “flexibility mechanism”.6 This mechanism can significantly limit the scope of protection of the ECT and investor-state arbitration. Investors are well advised to monitor which contracting parties are using the flexibility mechanism and how this may affect the protection of existing and future fossil fuel-related investments.

The June 2022 announcement indicates that the EU and the UK will use the flexibility mechanism to exempt fossil fuels from the protection of the ECT in their territories, “including for existing investments after 10 years after the relevant provisions come into force and for new ones Investments made after August 15, 2023.”7 According to the announcement, there will be no automatic reciprocity for this exclusion – fossil fuel investments by EU and UK investors will continue to enjoy ECT protection in the territories of other contracting parties unless they also invoke the flexibility mechanism.

The Rockhopper arbitration and other recent ECT cases illustrate the types of investor-state arbitration that the flexibility mechanism could rule out in the future. For example, last year the energy groups RWE and Uniper initiated ECT arbitration proceedings against the Netherlands in connection with investments in coal-fired power plants. Both companies claimed that a Dutch law to phase out coal-fired power by 2030 violated the ECT and were reportedly demanding billions in compensation.8th It remains to be seen how the flexibility mechanism of the modernized ECT will affect such claims in the future.

Protection of investments in energy transition technologies

The investment protection of the ECT applies to “economic activities in the energy sector”. The modernized ECT changes the definition of this term to clarify that it includes investments in energy transition technologies such as B. the “Capture, use and storage of carbon dioxide (CCUS) to decarbonize the energy systems”.9 In addition, the definition of “energy materials and products” – the sale of which constitutes an “economic activity in the energy sector” – is updated to include renewable or low-carbon energy sources such as hydrogen and biomass.10 The modernized ECT also introduces a regular five-year review mechanism that allows parties to change the list of energy materials and products covered by the ECT.11

States’ right to regulate

The modernized ECT will include new provisions on states’ right to regulate. Per the June 2022 announcement, a new standalone article – “[f]or legal certainty” – affirming the right to regulate “in the interest of legitimate public policy objectives” such as “protection of the environment, including climate change mitigation and adaptation, protection of public health, safety or public morals”.12

The right to regulate in the interest of climate change and the energy transition is also captured in other proposed changes to the ECT, including physical protection of investments. For example, the modernized definition of indirect expropriation will reflect a “general rule” that non-discriminatory measures to protect the environment “do not constitute indirect expropriation”.13

Changing the definitions of “investor” and “investment”

Under the modernized ECT definition of “investor,” a qualifying investor must pass a “substantial business activities” test in their home state based on an “indicative list” of criteria set out in the ECT, “such as physical presence, employment of personnel , generating revenue or paying taxes” in the host country. The new definition also excludes ” [ECT’s] Insurance coverage for persons who are nationals of, or permanently resident in, the receiving contracting party at the time of the investment.”14

According to the modernized definition of “investment”, an investment enjoys ECT protection if it meets an “indicative list of characteristics, such as the capital commitment, the expectation of profit, a certain duration or the assumption of risks”. According to the June 2022 announcement, this “new definition excludes the scope of judicial and administrative decisions and arbitral awards and limits the scope of monetary and credit claims arising solely from commercial transactions for the sale of goods and services”.fifteen

Without investor-state arbitration within the EU

The modernized ECTs will separate intra-EU arbitrations (brought by investors from one EU Member State against another EU Member State) from the investor-state dispute settlement provision of the treaty. This spin-off is consistent with the EU’s position that the ECT’s investor-state arbitration provisions do not apply between EU Member States, a position confirmed by the Court of Justice of the European Union in its September 2021 Komstroy decision.

Along the road

The modernized ECT is expected to be formally adopted at the Energy Charter Conference in November 2022. It will enter into force 90 days after ratification by three quarters of the contracting parties.16

The modernization of the ECT can have a significant impact on government regulation and investment in the energy industry. Both states and investors are well advised to consider the provisions of the modernized treaty when assessing possible ECT disputes related to the energy transition.

1 Sven Volkmer is a partner and Taylor Gillespie is an associate in White & Case’s International Arbitration Group, based in New York.

2 UNCTAD, IIA Issues Note: Treaty-Based Investor-State Dispute Settlement Cases and Climate Action, 5 September 2022.
3 Energy Charter Secretariat, Public Communication Explaining the Main Changes Contained in the Agreement in Principle, June 24, 2022.
4 Rockhopper Exploration Plc, Rockhopper Italia SpA and Rockhopper Mediterranean Ltd v Italian Republic (ICSID Case No. ARB/17/14).
5 The Rockhopper v. Italy was not publicly available at the time of writing this article. This warning is based on a summary of the award published by Investment Arbitration Reporter. See IAReporter, Analysis: Unpacking the Rockhopper v. Italy award, including the tribunal’s reasons for finding that denial of the hydrocarbon concession amounted to unlawful expropriation and awarding EUR190 million to plaintiffs, September 1, 2022.
6 Energy Charter Secretariat, Public notice explaining the main changes to the agreement in principle, June 24, 2022.
7 Energy Charter Secretariat, Public notice explaining the main changes to the agreement in principle, June 24, 2022.
8 In July 2022, Uniper announced that it would withdraw its lawsuit against the Netherlands. See Uniper, agreement on government stabilization measures – securing Uniper as a system-critical energy supplier, July 22, 2022.
9 Energy Charter Secretariat, Public notice explaining the main changes to the agreement in principle, 24 June 2022. See also White & Case, Carbon Capture, Use and Storage (CCUS).
10 Energy Charter Secretariat, Public notice explaining the key changes to the Memorandum of UnderstandingJune 24, 2022.
11 Energy Charter Secretariat, Public notice explaining the main changes to the agreement in principle, June 24, 2022.
12 Energy Charter Secretariat, Public notice explaining the main changes to the agreement in principle, June 24, 2022.
13 Energy Charter Secretariat, Public notice explaining the main changes to the agreement in principle, June 24, 2022.
14 Energy Charter Secretariat, Public notice explaining the main changes to the agreement in principle, June 24, 2022.
15 Energy Charter Secretariat, Public notice explaining the main changes to the agreement in principle, June 24, 2022.
16 See Energy Charter Secretariat, Public notice explaining the main changes to the agreement in principle, June 24, 2022.

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