Global record investments in the energy sector continue to make headlines. After a halt in 2020 due to the COVID-19 pandemic, sector investments increased in 2021 followed by projections of a similar trajectory by mid-2022. The momentum is associated with the renewables sector which accounts for the majority of these investments. Countries that have committed to achieve net-zero emissions and meet Paris targets will have to maintain this trend – or, potentially, a higher one – if they intend to fulfill those commitments. But net-zero also implies a gradual phase-out of traditional fossil fuel technologies and assets. This is where the Energy Charter Treaty (ECT) could hamper the transition towards climate neutrality essential ways. Legal and energy specialist Lekë Batalli has the details.

Beyond its policy dimension, the challenge is also a legal one. A significant share of fossil fuel investments in Europe are protected by the Energy Charter Treaty. Europe, especially EU member countries, are now at crossroads and will have to demonstrate their global climate leadership.

The ECT came into force in 1998 and was preceded by political initiatives to ensure the coordination of international energy activities. The liberalization of economies that had been inaccessible until the 1990s, especially in the former Soviet countries, offered opportunities, among others, in the energy sector prompting European countries to advocate for an international treaty that regulated these interactions. The ECT aimed to strike a balance between the countries’ need to attract investments and the investors’ focus on the security of their projects over the longer term. To date, the ECT remains the biggest multilateral framework for energy consisting of over fifty signatories.

And while ECT incorporates a wider range of energy activities, including third-country transit and energy efficiency, its main objective to ensure the stability of investments in the sector gradually brought to the surface the tension between the protection of climate against that of investors.

The ECT protects the investors by allowing them to take contracting parties to international arbitration if they find that any of the investment related ECT provisions have been violated. These provisions include fair and equitable treatment as foreseen in Part III of the Treaty, and can be translated into financial compensation in cases where a policy has changed and has negatively affected the investment. Consequently, the biggest issue faced by the countries pursuing ambitious climate agendas, especially most of the EU member states, is that they cannot eliminate previous projects related to fossil fuels without running the risk of having to pay for what becomes stranded assets.

Although the exact number of cases is unknown because of the confidentiality of the procedures, the ones that have become public were widely discussed. Currently, the Netherlands is being sued and could be liable to pay over €1.5 billion to RWE for its decisions to phase out a coal by 2030 that will affect their power plants.

An investigation has shown that the fossil fuel investments throughout the EU, UK, and Switzerland are worth €344 billion, and they all are offered protection of the investments in accordance with the ECT.

The legal regime of these investments is at odds with the EU’s recent Climate Law that has formalized the net-zero ambition by 2050. The EU, through its executive arm, the Commission, has advocated for changes that would accommodate sustainability and climate efforts as well as more up-to-date investment protection provisions into the treaty, but the chances are grim that the condition of unanimity of all ETC members will be achieved for such a change. This has increased the likelihood of an EU bloc withdrawal.

This does not change the position of the investors, however, that will continue to benefit from the protection of the Treaty for another 20 years as foreseen in Article 43. Absent of a unanimous agreement between all signatories of the Treaty, countries will have to face the consequences notwithstanding their decision to continue their membership or withdraw.

The ECT quandary has added a layer to the complexity of achieving climate goals that focus heavily on projections of additional clean energy generation and other measures but less on the legal reality faced by the countries. The EU is yet to prove whether it will act cohesively or let each member country and countries in the EU integration process to deal on their own.

If the former will be chosen, it could have a long-term effect on the EU’s plans. The member states that have more resilient economies are going to be less affected by the investor compensation that may be needed. Whereas for other members, compensating investors could strain resources that would otherwise be directed to public investments related to clean technologies while providing strong arguments against withdrawal and making climate targets elusive. These countries are then faced with a Catch-22 situation as remaining in the treaty would continue to afford the same protection to new investors.

In this regard, the European Commission’s push in early February to prepare a joint EU-exit and to suggest to EU member states to leave the treaty seems is encouraging. It builds on a growing political momentum of more and more EU member states announcements to quit the agreement.

The EU, led by its biggest economies, should prioritize climate diplomacy over singular approaches to ECT. The first step would be to form a coherent approach agreed upon between all members of the EU that focuses on direct negotiations with individual ECT members that oppose modifications to the treaty and investors over an acceptable solution should. This step could be followed by grouping the types of fossil fuel investments in the European continent based on each individual country’s energy mix and structure their gradual elimination in a way that would allow achieving net-zero as a bloc. The countries that risk their decarbonization agendas due to these ECT associated costs should be supported financially, including the countries that are in the accession process and that have committed themselves to the EU’s climate objectives.

The ECT is testing how far the EU is willing to go to achieve its climate ambitions and whether its motto of solidarity that “no one will be left behind” is genuine while reminding everyone of the unprecedented challenges to overcome the climate emergency.

 

Lekë Batalli is a legal and energy specialist at the consulting and engineering firm Tetra Tech.