UK: Energy Cooperation in the Asia Region

The Asia Pacific region’s major energy-importing economies – Japan, China and the Republic of Korea – share a common interest in reducing their present reliance on energy imports from the Middle East, through diversifying the range of energy resources they consume and by encouraging inward investment to finance the infrastructure projects that will be required to achieve such diversification. The most obvious way to achieve such diversity is to develop closer links with the energy producing states of Russia which have the potential to become major suppliers of energy to consumer markets in the Asia Region. Russia, for its part, is actively looking to expand its energy export potential in Asia, given the relative proximity of its major oil and gas reserves in East Siberia and Sakhalin. There has been some recognition of the importance of energy cooperation in the Asian region. However, very little real progress appears to have been made. By contrast, in other parts of the world, such as in Europe, Southeast Asia, South America, North America, and Africa, power sector cooperation has provided many benefits.

To develop a suitable environment both for inward investment and facilitating the creation of a platform for cross-border energy flows the states of North-East Asia need to generate a consensus on three key issues: the desirability of inter-government cooperation in the energy sector; a commitment to the development of regional energy markets with transparent

regulatory regimes and ready commercial access to international financial markets; and a recognition of the criticality of fostering stable market conditions to encourage the flows of international investment capital necessary for substantial production and infrastructure projects.

Non-commercial and political risks play a significant role in investment decisions, and in acting together in relation to these key issues, governments of the region can play a major part in reducing such risks thereby fostering confidence that can support major investment decisions

by private industry and the financial community. The more that these mechanisms for risk reduction are legally binding – and reinforced by access to international arbitration in case of disputes – the greater the impact on investor confidence.

In Europe the need for regional co-operation in the energy sector to encourage energy diversity and security was well recognised and positive steps were taken following the end of the cold war to promote more transparent and competitive energy markets, in particular relating to the reliability of cross-border flows between producer countries and consumer countries. The Energy sector in North-East Asia, whilst not identical, is in a remarkably similar position to the Europe of the late 1980's and early 1990's both in terms of the need to encourage diversity and foster energy security whilst finding sufficient funding to finance the necessary infrastructure development. It is also looking in the same direction to resolve some of these problems - towards the states of the former Soviet Union.

The Energy Charter Treaty ("ECT") was one of the solutions adopted by Europe to serve its energy needs and has been signed by 51 countries (although some have only ratified in part) including producer, transit and consumer states across Europe and Asia. It has since grown to encompass parts of Asia and is perhaps the best available model for a multilateral

legal framework in Asia for the protection of investments and the encouragement of development in the energy sector. A further benefit is that its provisions are supported by access to binding international arbitration.

The policy and effect of the ECT is clearly set out in Article 2 of the treaty. Its aim is to establish a legal framework to promote long term co-operation in the energy field and to ensure an open and non-discriminatory energy market between the contracting parties. The 51 states (and the EU) who have signed or acceded to the ECT are also members of the Energy Charter Conference, the independent inter-governmental organization that serves as the ECT’s governing body. Among them are: Australia, Japan, Mongolia, the states of Central Asia (Kazakhstan etc) and Russia. By subscribing to the ECT, these governments have conveyed a positive economic and commercial message to potential investors, underlining their commitment to observe the principles of openness, transparency and non-discrimination in energy markets. This message alone can foster significant foreign investment interest in a state’s energy sector.

The ECT focuses on five key areas :

(i) Protection of Foreign Energy Investments

The ECT provides multilateral investment protection agreements in the energy sector and is based on the fundamental anti-discriminatory principle of extending national treatment, or most-favoured nation treatment, whichever is more favourable, to energy sector investors from other signatory states. Important provisions include protection in cases of expropriation, preservation of contracts with governments and the free transfer of funds relating to investments.

(ii) Free Trade In Energy Materials, Energy Products and Energy-Related Equipment

The ECT applies World Trade Organisation (WTO) rules to energy trade among the Treaty’s signatories, even if they are not members of WTO. The issues which have come up concern mainly restrictions of electricity imports from countries which are members of the ECT, but not of the WTO as yet (for example, Russia, Ukraine). Such import restrictions have to be compatible

with GATT rules which in the main prohibit import restrictions based on production processes (for example, nuclear power or power produced under sub-standard environmental rules) but not on intrinsic qualities of the product.

(iii) Cross-Border Energy Transit and the ECT Transit Protocol

These provisions encourage the facilitation of energy transit by States through pipelines and grids and provide safeguards against restrictions on new transit capacity. There is also a "conciliation" procedure to help facilitate the interim settlement of transit disputes (preventing the disruption of transit).

(iv) Dispute Resolution

The ECT provides for binding international arbitration in the case of disputes between governments, or between an investor and a host government. Where the ECT has been ratified by a member country, case law has shown that the arbitration provisions can provide an effective remedy for private investors in dispute with host states.

(v) The ECT Protocol on Energy Efficiency and the Environment

In addition to the ECT’s provisions on mitigation of the environmental impact of the energy cycle, a separate legal instrument has been adopted, called the Energy Charter Protocol on Energy Efficiency and Related Environmental Aspects, which requires participating states to formulate and implement clear strategies and programmes for improving energy efficiency.

The Protocol is largely a manifesto rather than a set of legally binding and enforceable obligations; it encompasses good environmental practices tempered by considerations of commercial feasibility.

In the Asian region, Australia, Japan and Russia, as well as Mongolia and the states of Central Asia, are ECT signatories and are active participants in the work of the Energy Charter Conference. Efforts are continuing to strengthen the "Asian dimension" of the Charter process.

In December 2001, the Energy Charter Conference officially granted observer status to the People’s Republic of China. The Energy Charter process may hold special potential for China, which stands to play an increasingly important role in international energy cooperation in Eurasia over the coming decades, not only as a market for energy exports but also as an investor in energy projects, in particular in neighbouring states.

The countries of Asia Pacific region might instead prefer to see the development of an equivalent or similar treaty applying to the energy sector of a particular region. However, the ECT has the practical advantage of being able to provide a ready-made package. Some steps have been taken to develop a similar multilateral model in Northeast Asia, but at present China has not apparently demonstrated great enthusiasm.

Although the ECT is an excellent platform from which to build closer energy cooperation in Asia, there are potentially some drawbacks. The more such countries eventually accede, the more the balance between importing and exporting countries would have to shift away from the original energy-import and EU-energy security focus. Nevertheless, the countries of North- East Asia including China will undoubtedly benefit from a system that encourages discussion between consumers and other producers; fosters a co-operative approach to resolving energy transit issues and promotes the resolution of trade and investment disputes through internationally recognised procedural and legal mechanisms. Similar considerations apply to other Asian countries. They would all benefit from an institutionalised system for investment, trade and transit promotion. They have so far been unable, in the APEC or ASEAN context, to create anything comparable to the ECT.

A potential stumbling block to further Asian involvement (but also the ECT's greatest strength) is the accountability of members for investment disputes resulting from Article 26 investor-state arbitrations. After a slow start, Article 26 investment arbitration appears to now be more widely accepted (and pursued). The first case - Nykomb v Latvia – dealt with a situation that will be familiar to private energy investors - the problems faced by a small (in this case Swedish) company in protecting its capital investment when in dispute with a large (Latvian) state concern. This case (and others) provide a good example of the dispute resolution potential inherent in the ECT. However, investor protection is only one of a number of positive benefits that the ECT could bring to the Asia energy market. The potential environmental benefits of China's membership of the ECT could be significant bearing in mind the huge demands its economic growth is placing on the world's natural resources. The real challenge for Asian governments is to recognise the potential advantages to the energy sector that the ECT or a similar Asian model would provide in resolving the region's pressing energy problems .