European Union: We'll Always Have Paris? European Commission Formally Proposes The Withdrawal Of The European Union From The Energy Charter Treaty, Invoking The Paris Agreement

On 7 July 2023 the European Commission published a formal proposal for the withdrawal of the European Union (EU) from the Energy Charter Treaty (ECT or the Treaty). The move comes after many years of intensive efforts (notably by the EU) to modernize the ECT, in response to concerns that the Treaty prevented ECT Contracting States from meeting their climate change mitigation obligations as set out in the Paris Agreement. The European Commission's current proposal leaves much to be desired in terms of clarity and legal certainty. Energy companies covered by the ECT should therefore be well-advised to explore alternative sources of protection to ensure that their investments enjoy adequate coverage in case of disputes.

The ECT at a glance

The ECT is a multilateral trade and investment agreement focused specifically on the energy sector. It was signed in 1994 and entered into force in 1998. The Treaty contains various provisions on investment protection, trade, and transit in energy materials and products, and allows for arbitration in case of disputes, amongst various other dispute settlement options. The Treaty was designed to promote energy security through the operation of more open and competitive energy markets. It also established the Energy Charter Conference, an inter-governmental organization which meets on a regular basis. Since 1998, the ECT has become one of the most frequently invoked investment treaties in the world, and has given rise to the largest investment arbitral awards in history. While initially intended to protect EU energy investments in external markets, ironically EU Member States in practice have been the principle target of investor claims.

The ECT and the European Union

The ECT and the European Union have a long mutual history. The Treaty was originally focused on the European continent. Following the collapse of the Soviet Union in the early 1990s, Western European States sought to secure energy supplies from former Soviet countries rich in hydrocarbons resources. In exchange for protecting European investors, these former Soviet countries had the prospect of enhanced foreign direct investment, technical assistance, and infrastructure investment, as well as enhanced trade flows to Europe. Unsurprisingly in this context, both the European Union and the European Atomic Energy Community (Euratom) became Contracting Parties to the ECT, in addition to (almost all) EU Member States.

The ECT's geographic coverage soon expanded to include non-EU countries such Afghanistan, Japan, Jordan, Mongolia, Uzbekistan, Turkey, and Yemen. As of the time of writing, there are 53 Contracting Parties to the ECT.

Over the past few years, the Energy Charter Treaty has come under pressure from various quarters. First Russia terminated the provisional application of the ECT in 2009, following the first Ukraine-Russia gas crisis, and after being hit by an arbitration claim brought by the shareholders of the expropriated Russian energy company Yukos, which led to a multi-billion dollar arbitral award. Italy followed suit in January 2016, justifying its withdrawal from the ECT as part of a broader strategy to minimize the costs of Italy's membership in international organizations. Australia also terminated the ECT's provisional application in 2021, in the course of the modernization process of the Treaty. In June 2022, the provisional application of the ECT was suspended in relation to Belarus due to the 'material breach' by Belarus of its obligations vis-à-vis Ukraine's sovereignty over energy resources, following the former country's involvement in the ongoing armed conflict between Ukraine and the Russian Federation.

As for the EU, the potential application of the ECT as between EU Member States has for some time been seen a threat to the autonomy and effectiveness of EU law. Indeed, contrary to initial expectations, EU investors have increasingly relied upon the Treaty to bring arbitral proceedings against other EU Member States – the most striking example being claims brought against Spain by EU investors following its tariff reforms in the solar power and wind farm industries.

Since Mach 2018, the Court of Justice of the European Union (CJEU) has sought to exclude the application of investor-State dispute settlement clauses between EU Member States. In the 2018 case of Achmea, the CJEUheld that the arbitration clause found in bilateral investment treaties signed between EU Member States was incompatible with EU law as it would undermine the exclusive jurisdiction of the CJEU to interpret EU law. The CJEU extended the Achmea ruling to the intra-EU application of the ECT on 2 September 2021 in the Komstroycase: in that case, the CJEU held that EU Member States are precluded from entering into investor-State arbitration agreements with investors from other EU Member States. As a result, the EU has taken the position that EU law precludes the application of the ECT in the relations between EU Member States.

The ECT and efforts to address climate change

Another source of opposition to the Energy Charter Treaty has arisen based upon the argument that the ECT's investment regime is an obstacle in addressing climate change. At the time of its conclusion in the 1990s, the ECT specifically focused on foreign investment in fossil fuels. As a result, the ECT has been criticized by various groups as posing an obstacle to the achievement of the objectives set out in the Paris Agreement. In its 2022 Report on the 'Mitigation of Climate Change', the Intergovernmental Panel on Climate Change (IPCC) expressly stated that the ECT is 'designed to protect the interests of investors in energy projects from national policies that could lead their assets to be stranded'. Calls for reform of the ECT were amplified when foreign investors relied upon the ECT to institute proceedings against governments pursuing the phase-out of coal production or nuclear energy for electricity supply (see, for example, the case of Uniper v. Netherlandsand the case of Vattenfall v. Germany II). As the IPCC suggests, such claims arguably were based upon considerations of fair treatment with regard to the allocation of costs in relation to the energy transition. Regardless, the mere fact that energy industry actors might enjoy the right to bring such claims has attracted the ire of environmentalists anxious to accelerate that transition.

Efforts to modernise the ECT

In the wake of such critiques, in November 2018 the Contracting Parties initiated a process for the modernisation of the ECT. Amongst the most ambitious proposals put forward was the EU's suggestion to carve out fossil fuels from investment protection, to ensure that the ECT is in line with the Paris Agreement.

After 15 rounds of multilateral negotiations held between July 2019 and June 2022, the ECT Parties reached an 'Agreement in Principle' on 24 June 2022. The Agreement in Principle seeks to recalibrate the rights and obligations set out in the ECT, introducing language that reflects the more recent practice in the drafting of investment agreements and recent developments toward transparency in international arbitration and the efficient management of proceedings. Crucially, the Agreement in Principle also contains several innovative features aimed at aligning the ECT with the goals set out in the Paris Agreement. For example:

• Under the Modernised ECT, the definition of 'economic activity in the energy sector' covers the capture, utilization and storage of carbon dioxide in order to decarbonize the energy systems. Moreover, the definition of 'energy materials and products' includes new green sources of energy, such as hydrogen, anhydrous ammonia, biomass and biogas, as well as synthetic fuels.

• While the EU and the UK's proposal to entirely exclude fossil fuels from investment protection was unsuccessful, the Agreement in Principle introduced a new 'flexibility mechanism'. This mechanism allows each Party to exclude investment protection for fossil fuels in its territory, taking into account its individual energy security and climate goals. On that basis, the EU and the UK opted to carve out new investments in fossil fuels from ECT investment protection after 15 August 2023, while maintaining protection for existing investments during a 10-year transitional period.

• The Modernised ECT provides additional flexibility by creating a mechanism for reviewing the list of energy sources, materials, and products covered by the ECT every five years, so as to accommodate technological developments and political dynamics.

• Moreover, the Agreement in Principle re-affirms the sovereign right of Contracting Parties to regulate within their territories in the interest of legitimate public policy objectives, including the protection of the environment, climate change mitigation and adaptation, and the protection of public health.

• Finally, the Agreement in Principle includes new provisions on sustainable development and corporate social responsibility, which clarify and strengthen the provisions on environmental impact assessment of energy investment projects in accordance with domestic law.

Viewed as a whole, these modernisation efforts resulted in a rebalanced and fully updated agreement meant to more effectively address the goal of mitigating climate change while maintaining protection for foreign investors against fundamentally unfair and inequitable and/or discriminatory treatment, and uncompensated takings. By expressly adding new forms of technology and clean sources of energy in the definition of 'investment', the Modernised ECT is aimed at encouraging investments in energy transition and building synergies between climate change mitigation and economic growth.

Despite these intensive diplomatic efforts and the arguable success of their outcome, in the end the European Union decided not to support the Modernised ECT.

EU decides to withdraw from the ECT...

The Modernised ECT was meant to be adopted at the 33rd meeting of the Energy Charter Conference on the 22^nd of November 2022. But the events leading up to that date derailed this process, resulting in a political deadlock.

On 10 August 2022, Poland adopted a 'Draft Law on the Termination of the Energy Charter Treaty' proclaiming its withdrawal from the Treaty, asserting that the ECT was incompatible with EU law and that Poland was increasingly hit by investment claims that entailed significant defence costs. Between 12 October and 18 November 2022, six more EU Member States announced their intention to withdraw from the ECT, including Spain, Slovenia, and Luxembourg. Germany, Poland, and France formally notified their withdrawal from the ECT in December 2022, which is expected to take effect in December 2023. The principal reason advanced by these countries was that the Modernised ECT did not go far enough, posing an 'obstacle for change' and a 'blockade for climate protection'.

On 18 November 2022, the EU Permanent Representatives Committee rejected the Commission's proposal to adopt the 'modernisation package' at the Energy Charter Conference, following the abstention of a blocking minority of four Member States (Germany, France, Spain, and the Netherlands). As a result, the modernisation package was taken off the agenda of the 33rd meeting of the Energy Charter Conference scheduled for November 22^nd 2022.

The European Parliament quickly followed suit. In a resolution dated 24 November 2022, the Parliament 'called on the Commission and the Member States to start preparing a coordinated exit from the ECT and an agreement excluding the application of the sunset clause between willing contracting parties'.

Following these events, the modernisation of the ECT became legally and politically impossible for the EU. Without the participation of the EU and Euratom, the requisite voting quorum in the Conference cannot be met and the modernisation package cannot be adopted. It follows, according to the European Commission, that 'there is no legal and/or institutional avenue for the modernisation of the ECT to be adopted and produce its effects, a condition for the EU to remain party to the Treaty.' At the same time, the Commission reaffirms that '[r]emaining a Contracting Party to the current, unmodernised ECT is not an option for the EU or its Member States, as the current, unmodernised Treaty is not in line with the EU's investment policy and law and with the EU's energy and climate goals.'

Taking stock of these developments, in its proposal of July 7^th 2023 the Commission concludes that 'the withdrawal of the EU from the ECT is the only available solution.' According to the Commission,

On that basis, the EU, Euratom and the remaining EU Member States are expected to withdraw from the ECT in the coming months in a 'coordinated exit'.

... but mind the sunset clause

The EU's proposed coordinated withdrawal from the ECT is not the end of the story. Simply withdrawing from the ECT does not automatically put an end to its application.

A key issue arises from Article 47(3) of the ECT, also known as a 'sunset clause', which regulates the consequences of a Party's withdrawal. According to this provision, when a Party to the ECT decides to withdraw from the Treaty, the provisions of the ECT continue to apply to investments that were made in its territory and existed at the time of withdrawal, for a period of 20 years. For example, Italy has been sued no less than five times since its withdrawal from the ECT, precisely in reliance upon the 'sunset' provisions extending investor protection notwithstanding its withdrawal.

In assessing the implications of this provision, one must distinguish between the application of the ECT in the intra-EU context, and the application of the ECT between the EU and third States.

As far as the application of the ECT amongst Member States is concerned, the EU has taken the view that the 20-year sunset clause is of no consequence for intra-EU investment. In its most recent proposal, the Commission reaffirms that 'Article 47.3 of the ECT would have no impact on intra-EU relations, to which the ECT has never, does not and will never apply, including its Article 47.3.'

Notwithstanding this strong language, the implications of EU law for the ECT's sunset clause are more complicated. Arbitral tribunals established under the ECT have consistently held (with one recent exception) that EU law does not preclude the institution of arbitration proceedings under the ECT between an EU investor and another EU Member States. As pointed out by the ICSIDannulment committee in the case of Antin v. Spain, more than 56 arbitral tribunals have dismissed the intra-EU jurisdictional argument raised by the Kingdom of Spain, 35 of which considered the intra-EU argument in the context of the ECT.

The Commission is of course aware of this jurisprudence. In its most recent proposal, the Commission acknowledges that there remains 'a risk of legal conflict that must be eliminated'. It therefore proposes the conclusion of an inter se agreement between the EU, Euratom, and its Member States, codifying the non-applicability of the ECT in the intra-EU context in a separate treaty, also meant to exclude the operation of the sunset clause as between EU Member States. Ironically, the Modernized ECT provides for the very same outcome: it states 'for greater certainty' that the investor-State dispute settlement clause of the ECT 'shall not apply among Contracting Parties that are members of the same Regional Economic Integration Organisation in their mutual relations' — the only such organization in the ECT being the EU.

The extent to which the proposed EU inter se agreement will achieve its desired objective remains to be seen. Ultimately, the legal effect of the sunset clause is a matter of interpretation of the relevant treaty, in accordance with the customary rules of treaty interpretation.

As far as the application of the ECT outside the EU is concerned, the situation is even less straightforward. Non-EU Member States (including the United Kingdom) will need to agree to a separate agreement that will exclude the operation of the sunset clause in respect of their investors operating in the European Union and vice versa. It is presently unknown whether non-EU countries will be amenable to such an agreement. The outcome of negotiations in the Energy Charter Conference suggests that non-EU ECT Contracting Parties may not be as accommodating to the European Union's agenda. Since its inception, the ECT was meant to protect high-value investments in natural resources and critical infrastructure over a long period of time. Foreign investors therefore have undertaken investments in the expectation that they would enjoy treaty protection for a defined period of time, based on the language of the Treaty itself. Arguably, doing away with the 20-year sunset clause and leaving vested interests unprotected would be overturn such expectations and generate instability, to the detriment of investors both inside and outside of the EU.

Key take-aways

Whilst it is difficult to make predictions at this stage, energy companies covered by the ECT are well-advised to closely monitor these developments and assess whether they are protected under the relevant ECT provisions and the sunset clause. Either way, foreign investors should examine alternative sources of protection to ensure that their investments enjoy adequate coverage in case of disputes. Apart from the Energy Charter Treaty, thousands of bilateral and multilateral investment treaties are in force, including a vast number between EU Member States and third-party countries. Consideration of this network and related proactive restructuring can typically provide a more than adequate alternative to proceedings under the ECT. Thus, while the ECT is entering unknown territory, there remain many routes to protect foreign investors operating within the EU, and many options for EU investors seeking to protect their energy investments abroad.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.