How the Energy Charter Treaty risks undermining the outcomes of COP 26
As states reconvene for the 11th ECT modernization round without a breakthrough in sight, legal implementation of the climate pledges made at the 26th United Nations Climate Change Conference of the Parties (COP 26) in Glasgow last year could risk generating new arbitration claims based on the treaty. The ECT is a multilateral treaty that provides foreign investors in the energy sector with certain substantive and procedural guarantees. Due to concerns about the compatibility of the treaty with their respective climate agendas, the treaty’s contracting parties started a process of reforming the ECT in 2017. This modernization process has so far remained unsuccessful.
The crucial pledges made by states in Glasgow emphasizes the urgent need to finalize the amendment process, and, if no satisfactory agreement can be reached, to consider other options such as withdrawing from the ECT to safeguard the progress made at COP 26. During the climate summit, governments pledged to phase down unabated coal power and fossil fuel subsidies, while several governments also made individual commitments to phase out coal power. In addition, some states and subnational states announced the Beyond Oil and Gas Alliance (BOGA) and committed to not issuing any new licences for gas and oil extraction and to phasing out these energy sources entirely in the coming years. A large group of states also pledged to drastically reduce methane emissions.
Implementing these pledges through action at the national level will impact foreign investments in the energy sector, thereby increasing the likelihood of disputes between states and investors. With the ECT remaining unchanged, aggrieved fossil fuel investors—such as coal power plant operators—will continue to make use of the treaty’s investor–state dispute settlement mechanism to challenge such decisions. These claims are further facilitated by the fact that the ECT grants foreign energy investments broad substantive standards of protection, allowing investors to claim billions of euros in damages. These liabilities will add to the unprecedented expenses states already incur regarding the transition toward a clean energy future.
This article provides an initial assessment of the ECT-based arbitration risk flowing from the COP 26 pledges due to their impact on fossil fuel investments in ECT contracting parties. It will furthermore estimate how these impacts could translate into investor–state arbitration claims based on past and ongoing ISDS cases in the energy sector.
While states are yet to determine the precise means of implementation of their commitments at national and regional levels, recent IISD research shows that the fossil fuel industry has a long and active history of using ISDS and that arbitration claims challenging environmental measures, including climate measures, are on the rise. Moreover, the sums awarded in ISDS cases are significant, suggesting that fossil fuel companies will likely consider using the ISDS mechanism as a tool to limit their loss due to climate action.
II. The pledges at COP26 will impact fossil fuel investment in ECT contracting parties
At COP26 in October and November 2021, states made a set of commitments. While some delegates and experts expressed disappointment with the overall outcome of the summit, states did make certain concrete pledges that are likely to impact investments in the energy sector when implemented nationally. These include a commitment by some states to phase out coal, an alliance to halt new drilling for gas and oil reserves ultimately aimed at a full phase-out of these energy sources, and a pledge to reduce global methane emissions.
Commitment to phase out coal
45 states and the European Union signed the Global Coal to Clean Power Transition statement, with some of them undertaking to “transition away from unabated coal power generation” albeit at different speeds. Some countries committed to phasing out coal by 2030 and some by 2040. Importantly, there are 20 contracting parties to the ECT, including the European Union, among the signatories of the statement. Similarly, seven new member states, including four ECT signatories, also joined the Powering Past Coal Alliance, committing to phase out coal. To implement these commitments, states are likely to take measures that will impact the entire value chain of coal-based power generation, from upstream exploration and extraction activities to the operation of coal-fired power plants.
States may, for instance, adopt legislation forcing operators to shut down power plants or to retrofit them for combustion of biomass. However, ISDS could threaten states’ ability to pass such legislation. A Dutch legislative measure to that effect has already generated two arbitration claims in 2021, when Uniper and RWE commenced ISDS proceedings against the Netherlands based on the ECT. Uniper, for instance, claims that it had legitimate expectations that its plant in Maasvlakte would be allowed continued operation throughout its lifecycle and states that the Dutch decision to phase out coal was “unforeseeable.” It also decries an alleged lack of fair, adequate, and effective compensation, which might indicate a claim for indirect expropriation.
Arbitral tribunals have adopted increasingly sweeping interpretations of the substantive standards of protection afforded to foreign investments under the ECT. A supposedly straightforward provision such as the protection against expropriation has thus been construed to encompass “indirect forms of expropriation,” including government measures that in some way or form adversely affect the profitability of an investment. Similarly, “legitimate expectations” have been understood to mean that states may not alter entire regulatory frameworks that apply to an investment in question. RWE bases its claim on similar premises. In addition, Uniper and RWE argue that a power plant conversion from coal to biomass would be so costly as to render their investments unprofitable. Collectively, the two investors are claiming monetary compensation in excess of EUR 2 billion.
BOGA Initiative—Alliance to halt new drilling for oil and gas
At COP 26, 11 national and subnational governments announced a new alliance, with the eight (core members) committing to “end new concessions, licensing or leasing rounds for oil and gas production and exploration.” In addition to ending licensing, the core members have also committed to completely ending production by an end date that is aligned with the objectives of the Paris Agreement. This date remains to be determined. There are at least five alliance members that are also parties to the ECT.
State measures to put an end to oil and gas exploration activities have prompted foreign investors to sue contracting parties to the ECT in the past. For instance, the British oil and gas exploration and production company Rockhopper commenced arbitration against Italy based on the ECT in 2017. Rockhopper challenges the Italian government’s refusal to grant a concession for oil production at the Ombrina Mare oil field less than 10 km off the Adriatic coast. Italy’s Ministry for Economic Development had cited environmental concerns about the project that would have produced substantial amounts of waste, drilling mud, and combustion fumes. While the arbitration is still pending, Rockhopper is said to claim USD 275 million in monetary compensation. In similar factual circumstances, moratoriums on hydrocarbon exploration in Alberta and Quebec have led the foreign investors Westmoreland and Lone Pine to sue Canada in arbitration. This does not mean that every affected investor will bring an ISDS claim in the future, and a more detailed case analysis is required regarding the type of regulatory measure in question, promises or assurances made by the host state, or the affected stage of a production project. It is, however, a clear indication that there is a real risk that significant resources could be diverted from climate action due to such proceedings.
It is likely that foreign oil and gas investors will consider a full phase-out of production to amount to an even stronger interference with their investments. An early phase-out could, for instance, imply cancelling concessions prematurely, prompting investors to seek redress. The ECT would allow such investors to argue that the host state’s conduct amounts to “indirect expropriation” and to ask for compensation to be paid based on the projected operating cycle of their investment. In recent years, arbitral tribunals have been increasingly willing to base their quantification of damages on hypothetical operating cycles of several decades after the alleged expropriation. This has led to increasingly high amounts of compensation being awarded.
Global Methane Pledge
A new coalition of states and private sector organizations spearheaded by the European Union and the United States—the Global Methane Pledge—has also undertaken to reduce global methane emissions by 30%. According to the IEA, in 2020, fossil fuel operations accounted for almost one-third of the anthropogenic part of these emissions. The major causes are methane leaks at oil and gas pipelines and other infrastructure, methane venting and flaring, and methane release occurring at inactive fossil fuel sites (e.g., abandoned coal mines and oil and gas wells).
While it remains to be seen which concrete steps states will take to implement their pledge, expert recommendations suggest that there could be a significant impact on foreign investment in fossil fuels. Generally, the IEA has stated that the cost of remediating methane pollution could in part be offset by the capture and sale of the gas. However, foreign investors may be inclined to argue that the IEA is merely conducting a theoretical exercise of economic modelling that does not align well with the real investments that they have to make.
Some states have already begun legislative implementation of plans to reduce methane pollution. In its recent Orphaned Well Cleanup and Jobs Act 2021, the U.S. Congress has, for instance, imposed requirements on the private sector to plug and remediate orphaned oil and gas wells, as well as abandoned coal mines, with the goal of reducing methane emissions. If such measures were adopted by ECT host states, investors could argue that the costs of remedying these leaks would negatively impact profitability, as some methane leakage occurs too far from markets or involves too little infrastructure. Also, much of the leakage arises from using relatively low-cost equipment, and investors may argue that replacing it, or using more high-quality equipment from the outset, would lead to additional costs. Other states might find inspiration in the Norwegian venting and flaring ban, which requires operators to pay a special flaring tax and take measures to capture excess and associated gases. Foreign fossil fuel investors affected by such measures could claim violation of the so-called “fair and equitable treatment standard” guaranteed under the ECT and argue that they had “legitimate expectations” that no such requirements would be imposed.
Heightened environmental protection standards imposed on fossil fuel projects have led to ECT-based ISDS cases in the past. The British company Ascent Resources, for example, has brought an arbitration claim against Slovenia in relation to a project to produce natural gas by hydraulic fracturing in Petišovci. The case concerns a disagreement between Ascent and Slovenia on the existence of a requirement to conduct an environmental impact assessment before issuing permission to commence hydraulic restimulation of a gas well at which the investor had already produced gas in previous years. It also argues more generally that Slovenia impaired the enjoyment of its investment in an unreasonable, arbitrary, and discriminatory manner. The case highlights the importance for states to take particular care when revising existing regulatory frameworks to impose new environmental standards—as might be required to avoid methane pollution in the future.
As states implement their COP26 commitments at the national level, fossil fuel companies will likely try to mitigate negative impacts and losses in numerous ways, including through international arbitration. Research shows that fossil fuel companies have been particularly active users of investor–state arbitration, especially under the ECT. Investor–state arbitration, available only to foreign investors, could make the implementation of ambitious climate pledges expensive to an extent not foreseen in the national constitutional and legal context.
This risk was recognized by the ECT contracting parties in 2017 after the conclusion of the Paris Agreement, leading them to begin a process of amending and modernizing the treaty. However, the process has yet to show tangible results. With even more concrete and ambitious commitments coming out of COP26, concerned states should carefully assess their options and take reform action with immediate effect, including a coordinated withdrawal from the ECT, as is already under serious consideration by several EU member states. We have shown elsewhere that such a coordinated withdrawal could be designed to almost immediately rule out arbitration between the withdrawing states in accordance with public international law rules.
Lukas Schaugg is an international law advisor at IISD and a PhD-researcher in investment law at Osgoode Hall Law School, Toronto, Canada.
Greg Muttitt is a senior policy adviser, Energy Supply at IISD.
The authors would like to thank Nathalie Bernasconi-Osterwalder, Peter Wooders, and Suzy Nikièma for their valuable feedback on this article.
 To date, 137 known ISDS cases have been brought on the basis of the ECT, see: https://investmentpolicy.unctad.org/investment-dispute-settlement/; two more recent cases have not yet been counted in the UNCTAD database: RWE AG and RWE Eemshaven Holding II BV v. Kingdom of the Netherlands (ICSID Case No. ARB/21/4), and Uniper SE, Uniper Benelux Holding B.V. and Uniper Benelux N.V. v. Kingdom of the Netherlands (ICSID Case No. ARB/21/22). For an additional quantification of the future arbitration risk resulting from the closure of coal power plants, see our recent analysis: Schaugg, L., & Di Salvatore, L. (2021). Reform or withdrawal from the ECT: What does it mean for coal? Investment Treaty News. https://www.iisd.org/itn/en/2021/10/08/reform-or-withdrawal-from-the-ect-what-does-it-mean-for-coal/
 They are Albania, Azerbaijan, Belgium, Croatia, Cyprus, Denmark, the EU, France, Finland, Germany, Hungary, Kazakhstan, Liechtenstein, Netherlands, North Macedonia, Poland, Portugal, Slovakia, Spain, and the United Kingdom
 Ukraine, Azerbaijan, Slovenia, and Estonia.
 Disclaimer: IISD is currently hosting the Secretariat of BOGA. However, the authors of this article are not involved in the initiative, and the current analysis has been conducted independently.
 For a more detailed analysis of these cases see Di Salvatore, L. (2021). Investor-state disputes in the fossil fuel industry. International Institute for Sustainable Development. https://www.iisd.org/system/files/2022-01/investor–state-disputes-fossil-fuel-industry.pdf; See also Tienhaara, K. & Cotula, L. (2020). Raising the cost of climate action? Investor-state dispute settlement and compensation for stranded fossil fuel assets. International Institute for Environment and Development. https://pubs.iied.org/sites/default/files/pdfs/migrate/17660IIED.pdf
 See for instance the final award in the case of Tethyan Copper Company Pty Limited v. Islamic Republic of Pakistan, ICSID Case No. ARB/12/1, in which the arbitral tribunal awarded USD 6 billion to a foreign investor. The compensation was calculated on the basis of a projected operating cycle of a copper mine that had not even entered the production phase at the time of the alleged state interference.