In June 2022, the Contracting Parties to the Energy Charter Treaty ("ECT") announced an agreement in principle on the text of a modernized treaty. This modernization may have material consequences for state regulation and investments related to the energy transition.

The ECT, which came into force in the early 1990s, is a multilateral treaty for international cooperation in the energy sector, including the protection of foreign investments. With more than 50 signatories, the ECT is the largest investment treaty in existence today. It is often invoked to arbitrate disputes arising out of the energy transition toward low-carbon and renewable energy sources. Since 2010, investors in the renewable energy sector have initiated more than 70 cases under the ECT.2

The Contracting Parties concluded a five-year process to modernize the ECT in June 2022, when they announced an agreement in principle on the text of a modernized treaty.3 Although this modernized text has not yet been published, the main proposed changes are summarized in the June 2022 announcement. The modernization illustrates the Contracting Parties' concern for advancing this transition while respecting the rights of investors that are impacted by it. Some of the key proposed changes in this respect are summarized below.

Excluding protection for fossil fuel investments

The ECT currently protects qualifying investments in fossil fuels and allows investors to bring arbitration claims against host states to enforce those protections. The UK-headquartered oil and gas company Rockhopper Exploration, for instance, recently prevailed in an ECT arbitration against Italy in connection with an investment in oil and gas exploration off the Italian coast.4 Rockhopper had acquired an Italian company that benefitted from an exception to a ban on offshore drilling in Italy. The Italian Ministry of Environment and Protection of Land and Sea took steps to approve Rockhopper's application for an exploitation concession, but another Italian Ministry later rejected that application based on a new law that eliminated the exception to the drilling ban. An arbitral tribunal held in August 2022 that, in the circumstances, the denial of the application was an "immediate and complete deprivation" of the company's investment in Italy, which amounted to an expropriation under the ECT.5

The modernized ECT allows Contracting Parties to "exclude [the treaty's] investment protection for fossil fuels in their territories," thanks to a novel "flexibility mechanism."6 This mechanism may substantially narrow the ECT's scope of protection and investor-state arbitration. Investors would be well advised to monitor which Contracting Parties will invoke the flexibility mechanism and how this may affect the protection of existing and future investments related to fossil fuels.

The June 2022 announcement indicates that the EU and the UK will use the flexibility mechanism to carve out fossil fuels from the ECT's protection in their territory, "including for existing investments after 10 years from the entry into force of the relevant provisions and for new investments made after 15 August 2023."7 According to the announcement, there will be no automatic reciprocity for this exclusion – fossil fuel investments by investors from the EU and the UK will continue to enjoy ECT protection in the territory of other Contracting Parties, unless they invoke the flexibility mechanism as well.

The Rockhopper arbitration and other recent ECT cases illustrate the types of investor-state arbitrations that the flexibility mechanism may preclude going forward. Last year, for instance, energy companies RWE and Uniper brought ECT arbitrations against the Netherlands in connection with investments in coal-fired power plants. Both companies asserted that a Dutch law phasing out coal power by 2030 violated the ECT, reportedly seeking billions of euros in compensation.8 It remains to be seen how the modernized ECT's flexibility mechanism might impact such claims in the future.

Protecting investments in energy transition technologies

The ECT's investment protections apply to "Economic Activities in the Energy Sector." The modernized ECT amends the definition of this term to clarify that it covers investments in energy transition technologies, such as the "capture, utilization and storage of carbon dioxide (CCUS) in order to decarbonize the energy systems."9 Further, the definition of "Energy Materials and Products" – the sale of which is an "Economic Activity in the Energy Sector" – is updated to include renewable or low-carbon energy sources such as hydrogen and biomass.10 The modernized ECT also introduces a regular five-year review mechanism that allows the Contracting Parties to amend the list of Energy Materials and Products covered under the ECT.11

States' right to regulate

The modernized ECT will include new provisions on states' right to regulate. According to the June 2022 announcement, a new stand-alone article will – "[f]or legal certainty" – affirm the right to regulate "in the interest of legitimate public policy objectives," such as "the protection of the environment, including climate change mitigation and adaptation, protection of public health, safety or public morals."12

The right to regulate in the interest of climate change and the energy transition is also captured in other proposed changes to the ECT, including substantive protections afforded to investments. The modernized definition of indirect expropriation, for example, will reflect a "general rule" that non-discriminatory measures adopted to protect the environment "do not constitute indirect expropriation."13

Amending the definitions of “investor” and “investment”

Under the modernized ECT's definition of "investor," a qualifying investor must satisfy a "substantial business activities" test in its home state based on an "indicative list" of criteria set out in the ECT, "such as physical presence, employment of staff, turnover generation or payment of taxes" in the host state. The new definition also "excludes the [ECT's] coverage of individuals who hold the nationality, or are permanent residents, of the host Contracting Party at the time of making an Investment."14

Under the modernized definition of "investment," an investment enjoys ECT protection if it satisfies an "indicative list of characteristics, such as the commitment of capital, the expectation of gain or profit, a certain duration or the assumption of risk." According to the June 2022 announcement, this "new definition excludes the coverage of judicial and administrative decisions and arbitral awards as well as limits the coverage of claims to money and credit arising solely from commercial transactions for the sale of goods and services."15

Excluding intra-EU investor-state arbitration

The modernized ECT's will carve out intra-EU arbitrations (brought by investors from one EU member state against another EU member state) from the treaty's investor-state dispute resolution provision. This carve-out is consistent with the EU's position that the ECT's investor-state arbitration provisions do not apply between EU member states, which position was affirmed by the Court of Justice of the European Union in its Komstroy decision of September 2021.

The road ahead

The modernized ECT is set to be formally adopted at the Energy Charter Conference in November 2022. It will enter into force 90 days after being ratified by three-quarters of the Contracting Parties.16

The ECT's modernization may have material consequences for state regulation and investments in the energy industry. Both states and investors would be well advised to consider the provisions of the modernized treaty when assessing potential ECT disputes relating to the energy transition. White & Case has extensive expertise in assisting clients in this process, including by developing strategies to avoid disputes, preserving and enhancing claims and defenses, advising on amicable dispute resolution, and if necessary pursuing claims or defending them in international arbitration.