UK to exit the Energy Charter Treaty – what does this mean for energy sector investors?

On 22 February 2024, the UK Government confirmed it will withdraw from the Energy Charter Treaty (the ECT), referring to an alleged "failure of efforts to align it with net zero"¹. The ECT is a multilateral investment treaty that protects investments in the energy sector in more than 50 signatory states. In this article we consider the background to the UK Government's announcement, as well as the implications for energy sector investors. 

What you need to know

• The UK Government has confirmed that it will withdraw from the ECT, joining other state signatories, including France, Spain and Germany, in exiting the treaty.
• This exodus by state signatories will impact those who have invested in the European energy sector, investors from withdrawing states who have invested elsewhere, and those seeking to make new investments in the energy sector. It is imperative that they consider alternative means to protect investments against political risks, including by way of contractual mechanisms and/or bilateral investment treaties.
• Energy sector investors with existing problems with the host state in relation to their investments are in a particularly difficult position and need to act quickly to mitigate the negative fall out of the withdrawals.

Background

Several signatory states have cited environmental concerns as the reason behind their withdrawal from the ECT, claiming that the ECT's investment protection provisions constrain their ability to regulate for climate action and thus inhibit the transition to Net Zero. 

At the core of this "concern" are the obligations the ECT imposes on host states to treat foreign investors in accordance with fundamental rule of law standards such as the fair and equitable treatment standard, the need to observe obligations assumed vis-à-vis foreign investors and the obligation to compensate investors at fair market value for any measures with expropriatory effect. Expropriation involves depriving an investor of the value of their investment, a concept which includes but is far wider than just physical seizure. 

The ECT gives foreign investors a direct avenue to pursue their rights against the host state in a neutral forum: international arbitration. Accordingly, steps taken by signatory states in their attempts to reach Net Zero (e.g. introducing regulations to limit fossil fuel production and energy generation) could be challenged by energy sector investors via the ECT (as are such measures generally in the energy sector) and, if they were found to be incompatible with the rule of law standards enshrined in the ECT, monetary compensation for damages suffered could be awarded. 

A recent example in which a foreign investor seeks such judicial review is a case brought by London-listed oil and gas company Ascent Resources PLC against the Republic of Slovenia in relation to state measures including a fracking ban, which Ascent Resources claims "have destroyed the value of [its] investments in the Slovenian energy sector, and which have de facto deprived [it] of its right to produce gas in Slovenia"². The company believes that the measures adopted by Slovenia breach its rights under the ECT and the UK-Slovenia bilateral investment treaty, and have caused damages in excess of EUR 500 million which it seeks to recover in international arbitration under the rules of the International Centre for Settlement of Investment Disputes, a specialised public international law organisation that exists under the auspices of the World Bank Group. A decision is pending. 

Other high-profile cases under the ECT include claims by Swedish energy group Vattenfall which sought compensation from the Federal Republic of Germany in relation to the accelerated phase-out of nuclear energy for the commercial generation of electricity in Germany, and a series of claims by renewable energy investors from around the globe against Spain, the Czech Republic, and Italy in relation to (retroactive) changes to the remuneration framework for existing solar /PV and wind farms. 

States initially focussed on reforming the ECT, including with a view to better support the transition to Net Zero and the ECT signatory states even reached an 'agreement in principle' in June 2022, which concluded the modernisation talks. Several EU Member States effected by such claims rejected the modernised ECT in late 2022 and subsequently announced plans to withdraw altogether. This was followed by a proposal from the European Commission in July 2023 for a coordinated withdrawal of the EU and all its Member States. With the UK being the latest signatory state to announce an intention to exit, modernisation negotiations are now at an impasse. 

Implications for energy sector investors

In light of these latest developments, energy sector investors in withdrawing states (and investors from withdrawing states investing elsewhere) should consider the following: 

1. Those looking at making new energy sector investments should not delay making their investments. Withdrawal from the ECT takes effect at least one year after written notification. From then, new energy investments (both in, and by investors from withdrawing states) will not be protected by the ECT. However, investments already made at this point in time will likely continue to enjoy protection for a period of 20-years under the so-called 'sunset provision' of the ECT.
2. There is, however, a risk that withdrawing states also abandon the sunset provision (although whether this is achievable under international law is a controversial point). Investors therefore should take steps to maximise the protection of their investments through different mechanisms. Most importantly, it would be prudent for investors to seek to negotiate appropriate investment protections with the host-state in their contractual agreements related to the investment. For example, so-called 'freezing' or 'stabilisation' clauses can be used. These clauses specify key regulatory parameters for the foreign operations that would otherwise be subject to changes of the domestic regulatory framework, or taxation, and guarantee them for the life of the investment. Having robust contractual protections will become more important in the absence of ECT protection.
3. It will also be crucial for investors to consider whether they can benefit from investor protections contained in bilateral investment treaties (BITs), as an alternative to the ECT (the investment protection chapter of which operates as a multilateral investment treaty). Many states maintain a broad network of BITs which typically include similar protections to those contained in the ECT, including an obligation to accord fair and equitable treatment to foreign investors, and not to expropriate their investments without effective compensation. For example, Spain is a party to more than 80 bilateral investment treaties and France is a party to more than 100. Ideally, investors would look to rely on BITs entered into between the relevant withdrawing state and a non-EU Member state. Where BITs are not available under the current corporate structure of the investment, investors should consider restructuring. If such restructuring is done before a specific dispute arises, it is typically considered permissible and helps attract the highest protection possible.
4. Investors with existing disputes should accept the host states' offer to arbitrate that is included in the ECT as quickly as possible. This will help ensure that a neutral dispute resolution forum remains available if the dispute further escalates, even in cases of withdrawal and termination of the sunset provision. At least as a first step, it is not necessary to initiate a full arbitration to preserve the corresponding rights.
5. Notably, while the EU made a proposal in July 2023 for the coordinated withdrawal of the EU and all EU members states, the EU Parliament has not yet given its consent to the EU withdrawal and it remains a signatory to the ECT. It might be that investors will seek to bring claims against the EU. In October 2023, the first ever ICSID claim against the EU was registered and the ECT has been listed as the applicable instrument in that dispute³.
6. The ECT covers much more than protection of foreign investments: its stated purpose is to provide a legal framework to promote long-term cooperation in the energy sector. As matters stand, there is no multilateral instrument that replaces the ECT's legal framework, and so the latest developments are likely to have a significant impact on international cooperation in the energy sector more generally.

Looking forward – actions to take

Withdrawing signatory states must send a written notification of withdrawal to the depositary of the ECT for the withdrawal to take effect. It is not clear when the UK Government intends to send such notification, but in the meantime it maintains that it remains an attractive destination for energy sector investors across the board, including in continuing to support investment in North Sea oil and gas⁴. This, however, is subject to change in the event of a change in government, which may leave UK energy sector investments vulnerable. 

It is unlikely that the withdrawals from the ECT will end here, not least because of the impact on other signatory states of those who originally promulgated the treaty being seen to eschew its protections and assert its inconsistency with Net Zero aims. There are few similar examples of Western democracies advocating the removal of international law protections. 

Energy sector investors should follow the developments closely and be on the lookout for further exits. It is crucial they remain alive to these developments and obtain early legal advice to ensure their investments continue to attract the maximum scope of available investment protection and that any available causes of action are pursued in a timely manner.

^{1. Department for Energy Security and Net Zero and The Rt Hon Graham Stuart MP press release, 22 February 2024.}

^{2. Ascent Resources PLC press release, 15 August 2022.}

^{3. Klesch Group Holdings Limited & others v. European Union (ICSID Case No. ARB(AF)/23/1), investorstatelawguide.com.}

^{4. Department for Energy Security and Net Zero and The Rt Hon Graham Stuart MP press release, 22 February 2024.}