UK Government announced its intention to withdraw from the Energy Charter Treaty

Why should I read this?

The UK is set to withdraw from the Energy Charter Treaty (“ECT”), a 1998 treaty for the promotion of investments in the energy sector ratified by more than 50 countries. However, due to the ‘sunset’ clause in the ECT, investments already covered by the ECT will remain protected for 20 years after the UK’s withdrawal takes effect. This briefing looks at the background to the UK Government’s decision to withdraw from the ECT, the potential implications it will have on the green energy transition, and what energy companies should do.

What is the ECT?

The ECT was signed in The Hague on 17 December 1991 and entered into force on 16 April 1998. It is a multilateral investment treaty, which aimed to establish a legal framework to encourage foreign investments and international cooperation in the energy sector.

The ECT affords standards of protection to foreign investors including:

• protection against expropriation without payment of a prompt, adequate and effective compensation (Article 13)
• fair and equitable treatment (Article 10(1))
• full protection and security (Article 10(1))
• protection against unreasonable, arbitrary or discriminatory measures (Article 10(1))
• guarantee that the State will not treat foreign investors or investments less favourably than the State’s own investors or their investments (national treatment) (Article 10(3))
• guarantee that the State will not treat foreign investors or investments less favourably than those of a third-country (most-favoured nation) (Article 10(3))

The ECT also importantly contains a binding dispute resolution mechanism, allowing an investor of an ECT Member State to bring investor-State arbitration against another ECT Member State to claim compensation for breaches of these protections.

Why is the UK leaving the ECT?

While the UK has never been sued under the ECT, there has been an increase in the number of ECT arbitration cases brought against other governments taking measures towards a clean energy transition. This has led to criticism of the ECT for stifling efforts to fight climate change. Examples of governmental measures that may give rise to claims include:

• the introduction of a new law banning oil and gas exploration and production
• a decision to reject a license application to develop a coal plant
• the refusal to renew a license to operate a mine
• tougher requirements for foreign investors operating in the energy sector

According to the ECT Secretariat, as of 1 June 2022, there have been at least 150 investment arbitration cases brought under the ECT, including 50 relating to fossil fuel investments and 91 concerning renewables investments.

Since the adoption of the Paris Agreement in 2015, ECT Member States who are also parties to the Paris Agreement and the European Green Deal have had to balance the need to comply with the Paris Agreement requirements to reach net zero and the risks of investment arbitration claims brought under the ECT.

As a consequence, in 2018, the EU and the UK called for a modernisation of the ECT to align the treaty with the Paris Agreement. Following negotiations between 2019 and 2022, an agreement in principle on the modernised text of the ECT was reached in June 2022, including a proposal to exclude fossil fuels from future ECT investment protection.

However, in parallel, due to certain ECT Member States’ discontentment with the ongoing negotiations, there has been a cascade of ECT terminations: Poland, France and Germany have already departed from the ECT; Luxemburg is due to leave the ECT by mid-2024; and the Netherlands, Spain, Denmark, Ireland, Portugal and Slovenia have also announced their intention to exit the ECT.

Due to these withdrawals, in November 2022, the ECT Member States failed to reach a sufficient majority to ratify the modernised text of the ECT, and in July 2023, the EU proposed a coordinated withdrawal from the ECT. However, more recently, on 1 March 2024, the EU Commission published a proposal for an EU Council decision, asking EU Member States not to prevent the adoption of a modernised version of the ECT while they consider potential exit solutions.

Given this recent proposal at the EU level, it remains to be seen if ECT Member States will agree a modernised ECT. Terminating the ECT without first agreeing an amended ECT text would leave the EU and exiting ECT Member States exposed to potential arbitration proceedings pursuant to the current 20-year sunset clause.

In the UK, the Energy Minister announced in September 2023 that the UK was reconsidering its ECT membership. On 22 February 2024, the Government confirmed that the UK would be exiting the ECT. However, the UK’s official withdrawal from the treaty will only be effective one year after the notification of the withdrawal to the ECT Depository.

What effect will this have on the green energy transition?

The UK and the other ECT exiting countries may increasingly feel freer to take steps towards a cleaner and greener energy transition. However, this effect may be limited to an extent in the medium term due to the 20-year sunset clause contained in the ECT, unless a modernised version of the treaty is agreed by ECT Member States in parallel to governments withdrawing from the treaty.

What should energy companies do?

Companies operating in the energy sector should keep abreast of ongoing developments concerning the ECT and the potential impact on their investments.

In the medium term, due to the 20 year sunset provision found in Article 47 of the ECT, the UK’s withdrawal from the treaty will not drastically change the situation with respect to existing investments. Foreign investors in the UK and UK investors abroad may still file arbitration claims against ECT Member States with respect to measures impacting existing investments until at least 2045.

However, new investments will not be protected under the ECT following the UK’s withdrawal. Foreign companies operating in the energy sector in the UK and UK energy investors abroad need to properly consider the risks associated with their investments and the measures they can take to maximise their protections under international law. They should obtain legal advice to review the protections offered under other treaties and structure their investments carefully at an early stage to secure the best protections and improve their negotiating position.

Eversheds Sutherland has broad experience in climate related issues and investor-State arbitration. In addition to its experience representing investors in investor-State arbitrations, the firm also provides advice on corporate structuring to maximise international investment protections, tax efficiency, and to manage corporate liability. The firm has also advised States on disputes avoidance and represented them in their defence of investment arbitration claims.