Why the energy charter treaty is a threat to the global transition effort

An obscure international trade pact, which has protected investments in the energy sector since the 1990s, is deterring governments from taking decisive action on climate changeu0026nbsp;
Energy Charter Treaty illustration

In April, a report by the United Nations’ Intergovernmental Panel on Climate Change (IPCC) warned that international trade agreements could obstruct government-led decarbonisation projects. 

It cited the energy charter treaty (ECT) – a legally binding pact protecting investments in activities such as oil and gas extraction, coal mining and petroleum refining – as the most egregious case, largely because several claims brought under the ECT had been “settled in favour of foreign investors” at the expense of “much-needed climate action”. 

The 1994 treaty, which took effect in 1998, has 53 signatories, including the UK and the EU. Its original purpose was to protect western firms that were investing in newly independent former Soviet states, but the ECT’s reach has broadened to include countries such as Cyprus, Jordan and Yemen. 

This is a huge problem for transparency and democracy

“Its main goal was to promote energy security where investors were unsure about going into new places, because there was a chance of having their assets expropriated or nationalised,” says Rachel Thrasher, a researcher at the Boston University Global Development Policy Center.

Aside from its “neo-colonial historical context”, as Audrey Changoe, trade campaigner at Friends of the Earth Europe, puts it, the biggest problem with the treaty is a mechanism called the investor-state dispute settlement (ISDS) system. This allows energy firms to sue foreign governments privately in courts of arbitration. 

“It’s done behind closed doors,” she says. “Documents aren’t publicly accessible and many of the arbitrators are corporate lawyers, even though a lot of taxpayers’ money is at stake. This is a huge problem for transparency and democracy.”

Climate was neither high on the global political agenda nor especially relevant to the ECT in the mid-1990s, but that has changed in recent years. When the Slovenian government required British energy firm Ascent Resources to conduct an environmental impact assessment to obtain a fracking licence, for instance, the company refused and brought a €120m (£103m) compensation claim under the ISDS in 2020. Early this year, Slovenia appeared ready to back down to allow small-scale fracking, though instead instigated a full ban on the practice in May. Ascent Resources immediately filed a Notice of Arbitration to Slovenia, claiming millions of taxpayers’ money in damages under the ECT, to pressure Slovenia to reverse its decision. A state’s weakening of environmental law in fear of having to pay out big sums is an example of what’s become known as ‘regulatory chill’.

Claims brought under the ISDS can go into billions, which is money that could be used for the green energy transition. After the Dutch government revealed its plans to close all coal-fired power plants in the Netherlands by 2030. German energy firms RWE and Uniper issued lawsuits in 2020 for €1.4bn and €1bn respectively to compensate them for their impending loss of business there.

Changoe notes that governments are “phasing out fossil fuels because of pressure from civil society. Dutch citizens had actually sued their own government in 2015 for failing to protect them from the climate crisis. This is a democratic process that big fossil-fuel companies are seeking to undermine.”

The British government’s exposure to ECT litigation risk is also significant. According to research by Thrasher and her colleagues at Boston as part of work published in Science, if Westminster were to cancel all projects that don’t fit the International Energy Agency’s pathway to net zero, it would render the UK liable for potential ECT compensation claims totalling £9.4bn.

The mere threat of such litigation can often lead to regulatory chill. In 2017, for instance, Canadian firm Vermilion Energy indicated that it would sue the French government if it went through with its proposals to end oil and gas extraction by 2040. Subsequently, France’s environment minister, Nicolas Hulot, watered down his plans considerably. He resigned in frustration the following year, complaining that corporate interests had too much power over environmental policy-making.

Thrasher notes that some law firms are even advising clients to restructure their businesses in such a way that entitles them to use the ISDS system. This practice can’t realistically be viewed as in the spirit of the treaty and it “feels underhanded”, she says.

The problem of ISDS liability is compounded by the presence of a so-called sunset clause, which allows firms to continue filing claims against any government that leaves the treaty for up to two decades thereafter. This means that a country cannot expect to walk away unscathed. For instance, Italy dropped the ECT in 2016 and banned gas drilling along its coastline, yet the country was still sued by UK firm Rockhopper Exploration a year later. 

The European Commission is working to modernise the ECT and align it with the UN’s Paris accord on climate change, but Changoe doesn’t hold out much hope of a satisfactory solution. Any reforms must be approved unanimously – and some member states still want to protect the fossil-fuel industry. Bearing in mind that the sunset clause could be neutralised if countries decide to drop the treaty en masse, she believes that the best solution could be for governments to withdraw from it at the same time. 

Changoe is concerned that the ECT secretariat is seeking new members and trying to bring oil-producing countries from the global south – including Bangladesh, Colombia and Nigeria – into the fold. That outcome, she predicts, would “lock developing countries into this fossil-fuel spiral again”.

Thrasher points out that the poorest signatories don’t often get sued, as it’s not usually worth the effort. “It’s the middle-income countries that get sued more, according to the data on ISDS disputes,” she says. “They lose about half of the time, while higher-income countries lose about a quarter of the time.”

When it comes to reforming the treaty, Thrasher says that legislators could ensure that environmental concerns take precedence over ECT claims or even remove the ISDS, which she describes as “a departure from what’s usually allowed in international law”.

Ultimately, other forces may play a part in deterring companies from suing countries that are trying to decarbonise. Given the explosion of interest in ESG principles among the investment community and the wider world, might the risk of bad publicity be enough to make the more far-sighted firms think twice? 

“If public opinion forces them to behave better and has a chilling effect on their bringing these kinds of cases”, Thrasher says, “that would be a favourable outcome.”