This year the Energy Charter Treaty (ECT) is being reviewed by its signatories. It’s the most invoked international investment agreement in the world, and it needs either to be reformed or abandoned, says Sarah Keay-Bright. Created at the end of the cold war, it was designed to protect international energy investments – in a fossil fuel world – from political risk. Today, its wording and mechanisms are failing to protect investors that are vital to a rapidly evolving sector but fall outside its remit; for example energy efficiency, demand-side management, prosumers, domestic and smaller investors. She says the ECT’s limited protections now bias the playing field against some of the best pathways to Paris 2050 as the lines become blurred between “energy investments”.

This year, countries that have signed or acceded to the Energy Charter Treaty (ECT) – the most frequently invoked International Investment Agreement (IIA) in the world – are discussing policy options for Treaty reform and the whole International Energy Charter organisation will undergo review. (The EU countries, except Italy, are Contracting Parties to the Treaty and together account for just over half of the ECT’s membership.)

This presents a major opportunity to fix well known issues associated with the legal protection of existing energy investments and investor-state dispute settlement process (ISDS). Although most recent disputes involve renewable energy and retroactive policy change, most investments currently protected by the ECT are associated with fossil fuel infrastructure. Some of these assets may need to be retired early to ensure compliance with the Paris climate agreement, potentially leading to disputes.

At the same time, the ECT needs to be reformed so it is fit for the future, able to deliver on the investment needs of the energy transition including achievement of the Paris Agreement temperature goal.

Outdated: Energy Charter Treaty was created for a fossil fuel world

The Energy Charter process was set up in the early nineties at the end of the cold war to enable economic cooperation in the energy sector between the former Soviet Union, Central and Eastern Europe and the EU, though Russia withdrew from the Treaty in 2009. Nevertheless, the establishment of the ECT was, at the time, an extraordinary multilateral achievement. As it was drafted in the 1990s, however, the Treaty’s law is framed around a centralised fossil-based energy system; so it is now time to align the ECT with a sustainable energy future.

The ECT grants investors with rights that safeguard against specific political risks including discrimination between foreign and domestic investors, regulatory change, expropriation and nationalisation, breach of individual investment contracts, damages due to war and similar events, and unjustified restrictions on the transfer of funds. The Treaty only protects investments once established, at which point they are protected for 20-years even if the country leaves the Treaty. Investment protection and investors’ rights are enforced through the Treaty’s ISDS provisions, involving arbitration in various international courts. Countries wanting to limit the potential costs and damages of disputes, relating to existing protected investments, have an interest to see Treaty reform negotiations through to the end even if they do not want to use the ECT in future.

The ECT should be reformed, replaced or dissolved

Numerous commentators have criticised the ECT in relation to the imbalance of investors’ versus states’ rights and the legitimacy, transparency, impartiality, independence, accountability and high costs regarding the ECT’s investment protection provisions and the ISDS process. The ECT is just one of thousands of IIAs in force today, many of which need to be reformed, replaced or terminated. The UN Conference for Trade and Development (UNCTAD), which places sustainable development at the heart of its agenda, leads a comprehensive international effort to reform these IIAs.

For many countries, the opportunity to reform the ECT is about preventing disputes with investors, establishing and retaining investor confidence, and limiting the costs and time associated with disputes should they occur. Reforms must ensure a state’s right to regulate to protect society, the environment, and to achieve the temperature goal of the Paris Agreement.

From an investor’s perspective, policy change needs to be predictable, transparent, based on sound principles and long-term objectives that are coherent with international commitments. A well-defined, fair methodology for calculating investors’ compensation is needed. Risks and costs must be fairly allocated between investors, states and energy consumers.

In reforming the ECT, countries must also look beyond disputes and consider how the Treaty could help mobilise the right kind of investments. Reforms should target promotion of investments in sustainable energy, prevent the lowering of environmental and social standards, ensure compliance with domestic laws and strengthen corporate social responsibility. Furthermore, as a strong promoter of open and competitive markets, the ECT should be reformed to ensure a level-playing field between different types of investor and energy resources, pre-requisite for an affordable and accelerated energy transition. The current form of the ECT, however, favours fossil fuels and excludes many sustainable energy resources, in stark contrast to the present day reality as countries act to exclude high carbon, unsustainable energy resources from their markets.

Energy Efficiency investments are not protected

For example, demand-side management (DSM) – involving energy efficiency, demand response, storage and strategic load growth – is widely recognised as crucial for a least cost energy transition. DSM investments require private sector investment, the engagement of international corporations and investments over long timeframes; mitigating political risk will certainly be important for some DSM investments.

To fall within the ECT’s protection provisions, however, an investment must be associated with economic activity related to supplying “energy materials (or) products”, which is a defined list of fuels (that omits several important sustainable energy sources). The economic activity definition, however, makes no reference to managing the consumption of these materials or products, effectively excluding DSM investments from investment protection.

The ECT attempts to protect demand-side investments (energy efficiency only) through its “charter efficiency project” concept. It is unworkable, however, as countries must notify each investment to the Energy Charter Secretariat and there exists no functional mechanism to enable this. This approach is not only discriminatory but impractical given the scale of DSM investment needed.

While the definition of economic activity in the energy sector could be reformed to include DSM, it is perhaps not possible nor appropriate to do so. The dividing lines between economic sectors are becoming increasingly blurred as end-use sub-sectors of the energy sector expand and all sectors begin to invest in sustainable energy. This begs the question of whether an investment treaty dedicated to the energy sector is still appropriate when economy-wide alternatives for political risk mitigation are available.

Domestic and small investors are disadvantaged

The major role of domestic investors in demand-side energy markets raises concerns in relation to ISDS if this mechanism gives foreign investors more favorable rights or conditions compared to domestic investors. In addition, small investors cannot afford to access ISDS involving arbitration.

IRENA’s ‘A New World’ report provides evidence that the democratisation of energy is well underway and the geopolitical and socio-economic consequences of a new energy age are likely to be profound. The legal rights and responsibilities of key stakeholders (investors, states, consumers, prosumers, communities, citizens, future generations) – with attention to different investor types (domestic, foreign, incumbents, new entrants, large, small) – must therefore be redefined to ensure genuine, fair competition while providing appropriate safeguards. Alternatives to ISDS also exist.

Treaty amendments can generally only be adopted if members present and voting are unanimous in their support. Countries should therefore be ready to evaluate the ECT against available alternatives in relation to achieving a sustainable energy future.

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Sarah Keay-Bright is an independent international energy consultant.