Explainer: How the Energy Charter Treaty works

Credit: Alexia Barakou

The framework of the ECT covers energy transit, trade and efficiency, and it is applicable to coal, oil, gas and nuclear projects. Signatories to the ECT include more than 50 countries, stretching from Western Europe through Central Asia to Japan, plus the European Union and the European Atomic Energy Community. Russia has signed the treaty but not ratified it, and yet, has been sued in six cases so far. Italy left the ECT in 2016.

Coming into existence in the 1990s — in the aftermath of the collapse of the Soviet Union — the ECT was designed to offer protection for Western companies investing in energy initiatives in former Soviet states. Many of these former Soviet republics, formerly behind the Iron Curtain, were deemed risky for potential investors, and thus, the ECT was signed in 1994 and came into existence four years later. Today, despite the threat of being sued, the incentive for states to join the ECT is the hope that it will attract foreign investments.

The workings of the ECT are managed by its administrative body, the Energy Charter Secretariat, while all governing and decision-making is done by the Energy Charter Conference, of which all member states are a part of. The Secretariat is located in Brussels, and its current head is the Slovak energy expert Urban Rusnák, who has been holding the position since 2012.

Far-reaching consequences

Despite being a little-known agreement, the ECT has the potential to determine whether the EU and its Member States will succeed in achieving their ambitious climate targets.  

Under the ECT, investors and energy companies from one state are able to sue other member states if they feel that they have been treated unfairly, be it when the country tries to phase out fossil fuels, cancel controversial oil or gas pipelines, limit the use of nuclear power, or push for lower electricity prices. As more and more EU states phase out fossil fuels — thanks to increasing pressure driven by their climate targets — operators of coal-fired power stations and gas infrastructure can invoke the ECT to sue states. Their claims, which would include not just compensation for investments already made — but also lost future profits — could total billions of Euros.

International arbitration

The ECT provides for Investor State Dispute Settlement (ISDS) arbitration to resolve disputes between a foreign company and a state. ISDS is a system of legal mechanisms, designed to offer foreign investors protection from expropriation (such as when a government takes over private property) and discriminatory treatment in countries that might be considered risky places to invest in.

The history of ISDS is older than the ECT’s. It was established in the mid-20th century to protect the assets of former colonisers in newly-independent states. At the time, investors argued that such an international arbitration system was needed because the judicial systems in these newly-independent states would not guarantee a fair trial. Thus, companies were given the right to file claims before an international tribunal to settle their legal disputes with states. Within the ISDS framework, the ECT is one of the most-used legal instruments.

The ECT allows foreign investors to choose between ad hoc and institution arbitration. The later is provided by a specialised institution under its own rules – for example the International Centre for Settlement of Investment Disputes (provided under the World Bank) or Arbitration Institute of the Stockholm Chamber of Commerce. In case there is no institutional arbitration, the parties must use the rules of the United Nations Commission on International Trade Law (UNICTRAL — a UN body).

Usually, both the investor and the state take part in choosing the arbitration tribunal, which is made up of three arbitrators. One is appointed by the claimant, the other by the state, and the third one — the president of the tribunal — is nominated by the other two arbitrators or the two parties in a dispute.

The amounts of money awarded in these trials are large and have only increased with time, according to a report, conducted by The International Institute for Sustainable Development, IISD, an independent think tank whose goal is to promote and environmental sustainability. Under the ECT, the largest compensation amount to-date is $50 billion, awarded in the Yukos v. Russia case.

“The ECT, like any other investment treaty, provides a set of basic protections for investors,” says Sarah Brewin, an international law adviser with the IISD. “It requires that the state compensate investors when they breach those obligations, to fulfill their promises set out in the treaty. But treaties do not typically say how a tribunal should go about determining the amount that is compensated.” When it comes to compensation, Brewin adds, arbitrators “have been left relatively unconstrained to develop the principles they think should apply”.

One example of an ongoing proceeding is the lawsuit brought against Germany by Vattenfall, the Swedish energy group. Because the company had to shut down two nuclear power plants in Germany, it is demanding compensation to the tune of €6.1 billion from the German state. The verdict is expected in May 2021.

As of December 2020, 60 per cent of resolved lawsuits were been decided in favour of the investor, according to Energy Charter Dirty Secrets.

Lucrative for some

Lured by the option to file claims worth millions (and even billions) of Euros, an arbitration industry has emerged, and the number of known ECT cases has surged in recent years. Representation for a single case can cost the parties up to millions of euros in legal fees.

However, it is not just the current signatories to the treaty who are subject to the risk of legal action by companies. Even if a state opts to leave the Energy Charter Treaty, investors can still sue it for 20 more years.

With states facing expensive lawsuits as they try to become more climate-friendly, the European Union has indicated that it would like to modernise the ECT, but with no results so far. Any modification must be unanimously decided by all the member states of the treaty, but some individual countries — like coal-friendly Japan — have already indicated that they will not agree to modernisation reforms.

Read more about our investigation into the ECT and find out more about our national publications here.