Russian Prime Minister Vladimir Putin issued a decree on 30 July 2009 declaring Russia’s rejection of the Energy Charter Treaty (“ECT” or the “Treaty”).

The origin of the multilateral ECT, which was signed in December 1994, was at the Conference of the European Energy Charter in 1991 (the “European Energy Charter”). The roots of the ECT date back to a political initiative launched in Europe in the early 1990s when the need for developing energy cooperation amongst the states of Eurasia was recognised at the end of the cold war1. The ECT first came into force in April 1998 for those countries that had signed and ratified the ECT by this date. Other states have joined since.

The Energy Charter (the “Energy Charter”) is based on the recognition that all countries stand to benefit from a balanced framework for co-operation in the energy sector. Countries with natural resources are able to (i) attract investment to protect their interests downstream, and (ii) ensure reliable transportation for their energy exports to consumers. Energy-importing countries, on the other hand, gain protection for their outward energy investments and mechanisms to promote security of supply. This results in all countries benefiting from the measures to use and encourage the efficiency of energy production and to minimise their environmental impacts2.

The Energy Charter has two distinctive features. First, the Treaty is the only body of international rules that is tailored to the specific needs of the energy sector. Secondly, the Energy Charter covers a broad and diverse range of countries across Eurasia (and others), including energy producers, consumers and transit countries3. The provisions of the ECT focus on the protection of foreign investments, ensuring non-discriminatory conditions for trade in energy materials, reliable cross-border energy transit and dispute resolution procedures between participating states and/or investors and states, as well as the promotion of energy efficiency4.

Russia is the world’s largest energy supplier, producing more gas than any other country (and almost a quarter of the gas to the EU), and is the second largest oil exporter after Saudi Arabia. Russia has previously said that the ECT was biased towards consumers5. It however signed the ECT in 1994, but never formally ratified the document, i.e. it had agreed to apply the ECT to the extent that it was consistent with its own constitutions, laws and regulations (this is discussed in more detail in the paragraph below). This had left some ambiguity on Russia’s legal rights and obligations under the ECT. The ECT has to date been signed by 51 countries, although, of the signatories, Australia, Belarus, Iceland and Norway are yet to ratify it6 (in addition of course to Russia).

It is interesting to note that the first step for a country wishing to join the Energy Charter is to sign the European Energy Charter. On the basis of this commitment to the principles of the Energy Charter, the country then becomes an observer to the Energy Charter, with access to all meetings and documents. The next stage, if a country wishes to take it, is accession to the Treaty itself. This is a more lengthy process, since a country must first assess the compatibility of its domestic legislation with the provisions of the Treaty. Once the relevant reports have been approved by the Energy Charter Conference - the Energy Charter’s governing body in which all member countries are represented - the applicant country is invited to accede to the Treaty. The Treaty is open for accession by any country that wishes to participate, that is ready to take on the obligations in the Treaty, and whose application is accepted by the Energy Charter Conference7.

There has been much discussion on Russia’s rejection of the ECT, particularly on the manner in which, and the time it will take for Russia to withdraw formally from the ECT. Some believe that the primary mechanism for withdrawal (under Article 47 of the ECT) requires Russia to ratify the ECT and then wait five years8.

However, as Russia only ever accepted provisional application of the ECT, having signed but not having ratified the Treaty, other commentators believe that under Article 45(3) of the ECT, Russia will be able to terminate their application of the ECT simply by giving written notification. On the other hand, it is explicitly set out in the ECT (in Article 45(3)(b)) that Russia’s obligations regarding investments made, whilst they did provisionally apply the Treaty, will remain in effect for twenty years after their notification of withdrawal. However, if the Russian government has decided to withdraw, it seems unlikely that it or the Russian Courts will give much regard to such legal niceties.

For commercial investors, the fact that the majority of the ECT members have separate Bilateral Investment Treaties with Russia, which give similar levels of protection as the ECT, should provide some comfort. However, any investor must understand that the risks are not merely legal but are also political, and government intervention and influence (actual or perceived) over the courts is a factor which has and will continue to loom large in any investment decision.

There is significant speculation over Russia’s motivation for withdrawal. Some commentators believe it is linked to the upcoming decision in the international arbitration between Russia and the former shareholders of the Yukos oil company. The Yukos shareholders are claiming over US$50 billion for alleged expropriation of their investments, whilst Russia submits that as a non-ratifying state it was not bound by the ECT provisions.

Another perspective is set out in the Russian Oil and Gas Report dated 10 August 2009 in its article “Russia officially refuses to ratify energy charter treaty”, which states:

“The main point in the ECT is the “obligation on member countries to facilitate energy materials and products transit across their territory, in line with the principle of freedom of transit.” In effect, this means that once Russia ratified the treaty, it would have had to permit free transit of Central Asian gas to Europe across Russian territory. The Russian authorities regard this prospect as completely unacceptable: Russia would only receive transit fees for Central Asian gas, and wouldn’t be able to control gas flows. At present Russia buys gas from Kazakhstan, Uzbekistan, and Turkmenistan before selling it to Europe - as Russian gas. Moreover, the ECT would require Gazprom to sell Russian gas to consumer countries at the border, so that subsequent sales would be handled by the gas companies of those countries. This would be extremely disadvantageous for Gazprom, which is striving for access to end consumers: that is, it seeks access to the domestic markets of its partner states.”

The same Report quotes the Galleon Capital analyst Alexander Razuvayev as stating:

“The official announcement is very well-timed. Russia has made its position clear against a backdrop of the Russian-Turkish talks in Ankara, where one of the most important issues is Turkey’s consent to let Russia’s South Stream gas pipeline cross its territory.”

In March / April 2009, Russia proposed a new energy charter, which is designed to try to resolve disputes such as the one with Ukraine, which cut off gas supplies to Europe in the middle of winter9. The new document is called “The integral approach to new legal base of international energy cooperation”. The new integral approach implies that either a new energy charter would be elaborated and approved or serious amendments to the current charter would be made10.

It will be interesting to watch the implications of Russia’s withdrawal from the ECT in the coming months and its impact on the global energy market.