Energy Charter Treaty

READING TIME 15 mins
Energy Charter Treaty

About the Energy Charter Treaty

The Energy Charter Treaty is a legally-binding plurilateral agreement for the energy industry, which was developed after the end of the Cold War and entered into force in 1998. The treaty aims to, “catalyse economic growth by means of measures to liberalise investment and trade in energy.” Fifty-two countries have signed up, including the countries of the EU, but not including major oil producers such as the US and Saudi Arabia.

The treaty offers protection to foreign investors in energy, promotes the progressive liberalization of international trade in energy, and has a long-term objective of transferring its provisions to the WTO, thereby giving them global reach. The provisions of the ECT offer significant protections for investors, including rules in several articles stating that all investors must be treated as well as those from a country’s closest trading partners (Most-Favoured Nation), and must also be afforded the same advantages as local companies (National Treatment).

So what's the problem?

Perhaps most problematic are the clauses relating to ‘expropriation’ and ‘fair and equitable treatment’. ‘Expropriation’ was originally intended to protect companies from outright nationalisation. However, it is often interpreted as including any measure that significantly affects an investment, such as a regulation that causes the company’s market share to substantially decrease. Claims of expropriation have been made by Vattenfall, who run a number of Germany’s nuclear power stations for instance, after the country decided to phase out nuclear power more quickly than planned following the Fukushima disaster. ‘Fair and equitable treatment’ is defined especially broadly in the ECT, which insists that investors enjoy ‘stable’ and ‘favourable’ conditions, making it difficult for countries to introduce new laws or regulations that could affect the profits of foreign energy investors.

The ECT is also remarkable for what it is not. As a legally-binding energy treaty, we might assume that important issues would be sincerely addressed, such as the finite nature of fossil fuels, sovereignty and access rights for indigenous people and developing countries, and the need to immediately reduce carbon emissions. Instead, these matters are relegated to weakly worded statements that make no meaningful commitments. It is shocking (though perhaps no longer surprising) that protecting investors is seen as sufficiently important to warrant a legally-binding international treaty, but real energy security, human rights and climate change are not. 

Under this agreement, countries cannot require energy companies to hire local people as staff or use local materials. No limits can be placed on how much money is transferred out of the country. Countries must facilitate the transit of energy resources, including by allowing new pipelines to be built, unless they can prove it is against their national law to do so, and prove that those laws don’t discriminate according to the energy source’s origins or other factors.

The ECT – which has been signed by 54 states – is the most extensive international agreement specifically regulating practically all energy issues

Nikos Lavranos, European Federation for Investment Law and Arbitration.
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In depth

Energy sovereignty, ‘fair and equitable treatment’ and the freedom to regulate

Like many treaties, the ECT includes statements that appear to offer reassurance that government and citizens’ rights to make decisions about their own resources are not under threat. Article 18 of the ECT declares that, “The Contracting Parties recognise state sovereignty and sovereign rights over energy resources.” However, this is immediately followed by a declaration that puts sovereignty firmly in its place, as it states that this “shall not be construed to allow the circumvention of the application of the other provisions of the Treaty.” Sovereignty over energy resources is therefore a secondary concern, to be considered once the investor protections contained in the treaty have been fulfilled.

Notwithstanding conciliatory statements about sovereignty and the right to regulate, lawyers making use of the ECT are clear that its purpose is to restrict regulatory space. An article by senior lawyers at Allen & Overy LLP explains, “While bilateral investment treaties (BITs) offer many of the same substantive protections contained in the ECT, BITs [...] rarely impose an express obligation on States to create stable, predictable and transparent conditions for investment.” They note that, “In fact, some BITs specifically preserve a State's power to regulate.” They then continue, “The Contracting Parties included just a few exceptions to the ECT’s robust investment protections. Even those exceptions that were included to preserve a State’s regulatory freedom are hedged with qualifications. [...] One of the key exceptions designed to preserve regulatory space (i.e. regulatory measures necessary to protect human, animal or plant life or health) does not apply to any of the substantive investment protections at all.” Insiders clearly feel confident that the treaty places the protection of investor profits far ahead of governments’ right to regulate in the public interest.

Democratic decision-making is further constrained by the rules on ‘fair and equitable treatment’ (FET). Because of the huge scope for interpretation of these terms, a wide range of state conduct can be found to violate the fair and equitable standard. The FET provisions in the ECT are particularly problematic, as they go beyond requiring that conditions are fair and equitable to also specify that member countries will create “stable” and “favourable” conditions for foreign investors (Article 10).

Citizens and national businesses have no legal right to expect that laws, regulations or business conditions will be unchanging. We expect that these may change, and we take risk-based decisions and buy insurance policies accordingly. Even less do we assume that the government will make rules that are especially favourable to us. Yet the FET provisions in this treaty mean that companies can sue governments if the rules change in ways they do not like. This is an astonishing privilege for foreign investors and corporations, and the cost is ultimately borne by the people in two ways. Firstly, when governments are successfully sued, it is ultimately taxpayers who end up bearing the cost of what are essentially business risks. Secondly, the risk of being sued can create ‘policy chill’, as governments do not dare to make changes that could harm company profits, even where such changes are important for equity, social goals or environmental protection.

In this way, the FET provisions within the Energy Charter Treaty may restrict governments’ freedom to regulate. Other provisions of the treaty more specifically limit this freedom. Article 14 bans restrictions on money transfers, which means that companies can transfer offshore all of the profits and other money made in a country’s energy industry. This has the potential to cause balance-of-payments issues for governments, and removes a potential development tool that has been used by many countries to ensure money circulates locally and creates employment. Article 11 prevents governments from mandating that energy companies employ local people. Subject to the usual visa rules, foreign companies must be allowed to ship in consultants and construction crews, potentially leading to zero job creation in the community where an energy installation is being built. Article 5 bans local content requirements, so a government cannot insist, for instance, that a biomass power station burns local timber or paper waste instead of imported trees. The Energy Charter Treaty aims to give investors freedom and protection, but in doing so it may reduce the ability of citizens to choose freely and protect themselves through democratically-agreed rules such as these. 

Environmental goals, indigenous peoples and small farmers

Although the preamble to the ECT, recognises “the increasingly urgent need for measures to protect the environment,” and recalls, “the United Nations Framework Convention on Climate Change,” the commitments on environmental matters are so weakly phrased as to be meaningless. Countries “shall strive to minimise in an economically efficient manner harmful Environmental Impacts,”. They agree to the ‘polluter pays’ idea only “in principle”, but this must be done “without distorting Investment in the Energy Cycle or international trade.” Unlike in other parts of the treaty, where strict rules are imposed on governments by the agreement, countries are allowed to decide for themselves whether or not to bother assessing environmental impacts: “It is for each Contracting Party to decide the extent to which the assessment and monitoring of Environmental Impacts should be subject to legal requirements.” These statements essentially require no action from member countries on environmental goals. The ECT is therefore a major missed opportunity to create binding international laws to drive energy transition and address climate change.

Energy installations such as mines, rigs and pipelines can take up and degrade large areas of land, often in rural areas that may belong to (or be subject to customary rights of) indigenous people or small-scale farmers (whose generally low incomes may class them as a ‘disadvantaged group’). There is just one mention relating to this issue, in Article 24 on General Exceptions, which states, “The provisions of this Treaty shall not preclude any Contracting Party from adopting or enforcing any Measure designed to benefit Investors who are aboriginal people or socially or economically disadvantaged individuals or groups provided that such measure has no significant impact on that Contracting Party’s economy,”.

This statement is weak in several ways. Firstly, only measures to protect aboriginal or disadvantaged investors are allowed – people from these groups who do not possess any energy investments get no consideration.  Secondly, protective measures are allowed only if they barely impact the wider economy. Where indigenous people and farmers own a decent amount of land, regulations to protect them may well have a significant impact on the country’s economy, but in this case the ECT does not allow governments to create rules to protect their land-holdings or rights. Protections are even further restricted in that the Articles on compensation and expropriation are exempted, so claims can still be raised by corporations on these grounds.

A final weakness in the ECT relating to environmental goals, indigenous peoples and small farmers comes from Article 7, the Transit of Energy rules. Governments are obliged to, “take the necessary measures to facilitate the Transit of Energy Materials and Products [...] without distinction as to the origin, destination or ownership of such Energy Materials and Products [...] and without imposing any unreasonable delays, restrictions or charges.” If the necessary pipelines and other infrastructure is not already in place, “the Contracting Parties shall not place obstacles in the way of new capacity being established, except as may be otherwise provided in applicable legislation which is consistent with paragraph 1.”

These statements risk obliging governments to allow the building of pipelines and other infrastructure when they might otherwise have denied permission. As the rules insist no distinction can be made based on the origin of the energy source, this may mean governments have to allow the building of infrastructure for fracked gas or tar sands oil, even if the population is against the use of such technologies. An ISDS case brought under a different trade agreement (NAFTA), TransCanada vs USA, gives an example of how such rules might cause problems. In this case, Canadian company TransCanada is suing the US government for US$15 billion after they were denied permission to build a pipeline between Canadian tar sands and refineries in the USA. The pipeline was denied not because it was against US law, but because a long period of public consultation convinced Secretary of State John Kerry that building it would not significantly lower gas prices, boost the economy or improve energy security, and that “if we’re going to prevent large parts of this Earth from becoming not only inhospitable but uninhabitable in our lifetimes, we’re going to have to keep some fossil fuels in the ground.” The US is not part of the ECT so is not subject to Article 7 rules on Energy Transit, but it seems likely that if it were, the case against the USA would be even more likely to succeed. In this way, rules of this nature may prejudice decision-making, make public consultations pointless, and lead to the creation of energy infrastructure that is not felt to be in the public interest.

Disputes and compensation – ISDS and the logic behind paying ‘fair market value’

Article 12 of the ECT covers ‘Compensation for Losses’ and Article 13 provides rules relating to ‘Expropriation’. These articles ensure that if a foreign investor loses part or all of their investment as a result of it being requisitioned or nationalised (‘expropriated’) by the country’s government, they will receive compensation that is ‘prompt, adequate and effective’ and equal to the ‘fair market value’ of the investment.

There are various ways in which ‘adequate’ compensation could have been defined. The rules might have stated that companies should simply be paid back the money they actually invested in buying and developing an energy installation, with interest to cover inflation. History shows us more radical approaches. When reforming land and company ownership following the 1959 Revolution, the Cuban government offered compensation based on the company values that companies had themselves declared for tax purposes (which may be deliberate underestimates, designed to keep tax bills low). These approaches to compensation look at the real contributions made by foreign companies. The approach taken by the ECT instead looks at companies’ expectations of profit (a key component of ‘fair market value’), and seeks to compensate them for the gains they hoped to make in the future. This is likely to be advantageous for companies, while increasing the costs of nationalisation for governments. By requiring ‘fair market value’ as compensation, the ECT may therefore make it very costly for countries to bring energy infrastructure back into public ownership.

Ultimately, the amount of compensation that any company receives under the ECT will be decided through an arbitration claim known as Investor-State Dispute Settlement (ISDS). In Article 26 of the Treaty, countries give their “unconditional consent to the submission of a dispute to international arbitration.” In this way, governments hand decision making to international lawyers, most of whom have no background in public international law.

Companies have been enthusiastic users of the ECT as a basis for suing governments. Of 739 known ISDS cases to date, based on all bilateral, regional and multilateral trade treaties, ninety-five have been ECT cases. The average cost of defending an ISDS case is US$8 million and awards are generally in the millions, if not billions of dollars. 

Taking it further – The ECT becomes the International Energy Charter

It seems that for many participants the ECT does not go far enough, as in 2015 the International Energy Charter (IEC) was introduced. The Charter is not binding, but rather describes itself as, “a declaration of political intention aiming at strengthening energy cooperation,” although the preamble ‘recalls’ their intention to adopt an updated version of a previous binding charter. By the end of 2016 seventy-four countries had signed, including the US and China, neither of whom are covered by the ECT. The Charter therefore expands the reach of energy liberalisation to cover the many major energy corporations that are based in these two countries, significantly increasing the number of corporations that could raise ISDS claims against governments.

Signatories agree to, “avoid imposing discriminatory rules on operators, notably rules governing the ownership of resources, internal operation of companies and taxation.” This may discourage measures such as enforced local community ownership of a proportion of energy company shares, and windfall taxation of energy profits. Countries also agree to enable the use of investment risk guarantee schemes, so that company risks can be underwritten by taxpayers. Furthermore, they must, “recognise the right to repatriate profits,” and, “recognise the importance of the avoidance of double taxation.” Tax avoidance behaviour by global energy corporations does not, however, warrant a mention. Like the ECT, only vague and weak statements are made about energy security and climate change, and once again the Charter also makes no reference to the globally-agreed goal of reducing and phasing out the use of fossil fuels.

The IEC explicitly seeks to “strengthen the dialogue with the private sector on the main directions of the Charter Process, with a particular focus on risk mitigation and improvement of the business climate.” For this purpose it has established an Industry Advisory Panel made up of private-sector representatives. There is no parallel advisory panel on environmental or human rights issues.

What is TJM calling for?

TJM is taking the lead on analysing the Energy Charter Treaty and the links between trade policy, energy issues and climate change.

We are calling for trade policy that is consistent with energy security and climate change goals, and that supports the rights of indigenous people and small farmers. Specifically, we are lobbying the UK government to achieve ‘policy coherence’, as mandated in the Sustainable Development Goals, to ensure that trade treaties do not get in the way of policies aimed at benefiting people and planet.

Some new trade agreements, such as the IEC on energy and TiSA on services (including energy) are directly undermine these policy coherence goals, and we are therefore working with MPs to persuade them to reject these deals.