Italian oil and gas prospection and exploration halted - what next for investors?

Introduction

On 13 February 2019, Italian Decree No. 135/2018, converted (with amendments) into Law No. 12/2019 (the Decree), entered into force. The Decree is of huge significance to those involved in upstream oil and gas sectors in Italy because it imposes a moratorium on both onshore and offshore oil and gas prospection and exploration. 

The moratorium will apply for up to 24 months while the Government seeks to conclude a plan to promote environmental, social and economic sustainability in energy exploitation (the Plan). According to the text of the Decree, the Plan will be formally enacted through a ministerial decree issued by the Ministries of Economic Development and Environment. The Technical Report to the Decree states that the objective of the Plan is to support the national energy system's transition to decarbonisation.

Depending on the specifics of the Plan, energy sector players may in due course find their prospection and exploration permits revoked and production concessions limited (and any new applications rejected). This article sets out the key legislative measures and the redress potentially available to investors affected by the Decree (and, in due course, the Plan). 

Key elements of the Decree

The Decree has a direct impact on all companies holding onshore or offshore prospection and exploration permits as well as those considering filing new applications for production concessions. As regards prospection and exploration permits (P&E Permits), pending adoption of the Plan:

• P&E Permits that have already been granted are suspended, with a consequent stay of their term and a requirement that affected operators immediately stop all related activities and safeguard the affected sites; and
• applications for new P&E permits, and those pending proceedings for their release, are suspended.

Applications for new production concessions are also suspended pending adoption of the Plan.. However, there is no suspension in respect of (i) applications for extensions of concessions previously granted, and (ii) proceedings in relation to the release of concessions that were pending on 13 February 2019. Existing production concessions will continue in force, although concession fees are to increase significantly (together with storage concession fees) with effect from 1 June 2019.

The moratorium is applicable for 18 months. An ultimate 'backstop' is also provided for, whereby, if the Plan is not adopted within two years from 13 February 2019, the suspended P&E Permits, and suspended P&E Permit and production concession applications and proceedings, will be reinstated.

Once the Plan is adopted, P&E Permits will be reinstated and applications for new production concessions will be considered only if they relate to 'eligible' areas. As mentioned above, it is anticipated that related concession fees will significantly increase from 1 June 2019. 

However, P&E Permits in respect of 'non-eligible' areas  will be revoked entirely and operators required to restore the sites. Applications for P&E Permits that relate to such areas, and applications for new production concessions which are pending adoption of the Plan will be rejected.  Production concessions already granted and/or extended at the time of adoption of the Plan will continue in force until their expiry date, although there will be no rights to further extensions thereafter. 

Redress for investors

Energy companies negatively impacted by the Decree may have a number of means of seeking redress under Italian law, EU law, and/or public international law. 

Italian law remedies

The Technical Report to the Decree refers to the possibility of disputes arising as a result of the Plan being submitted to national or international arbitration (including under the Energy Charter Treaty (ECT), as to which, see below). However, alternative means of redress may also be available under Italian or EU law.

Operators could seek to challenge the Plan before the competent Italian Administrative Court (TAR) on the basis that the Plan is an administrative act which negatively affects their interests and breaches Italian or EU law. The remedy sought would be annulment of the Plan and/or any administrative deeds affecting operators. In the course of the proceedings, claimant operators can:

• ask the TAR to trigger a challenge of the relevant legislative provision before the Italian Constitutional Court for breach of constitutional principles and have the provision removed¹; or
• ask the TAR to trigger a preliminary ruling from the European Court of Justice under Article 267 of the TFEU, in order to ascertain whether the provision is in breach of EU law and/or EU principles such as legal certainty and protection of legitimate expectations.²

Careful consideration would have to be given prior to commencing proceedings before the TAR in order to avoid any risk of the proceedings triggering the 'fork in the road' provision in the Energy Charter Treaty – this essentially provides that investors cannot submit claims to international arbitration if they have previously submitted the same claims to national courts (and so could preclude public international law claims being advanced under the treaty, although we note that the redress sought in TAR proceedings would likely be different to the redress sought under the ECT, as would any course of action relied on by investors, as explained below).

Public international law rights and sources of redress

Public international law may provide foreign investors in the Italian energy sector with redress in circumstances where they have no contractual basis for pursuing remedies and/or where the compensation afforded to negatively affected investors (either voluntarily by the Government or following claims under Italian law) is considered inadequate.

Public international law is the body of law that regulates how states interact with each other and with private companies and individuals. Its primary sources are treaties and customary law. It sits outside any domestic or EU legal system. There are two main bodies of treaty law that may be relevant: bilateral investment treaties (BITs) and the Energy Charter Treaty (the ECT).

• BITs are international agreements between two states, whereby each state grants reciprocal guarantees and protection for incoming investments made by investors from the other state.
• The ECT is a multilateral investment treaty (MIT) which applies specifically to investments in the energy sector (a MIT is an investment treaty signed by more than two states). The ECT also grants rights to investors from one contracting state in relation to their investments in another contracting state.

Notwithstanding having terminated all of its BITs with other EU member states, Italy has 60 BITs with non-EU member states which remain in force.³  It also presently remains bound by the investment protection provisions of the ECT, despite having withdrawn from the ECT with effect from 1 January 2016. That is because the ECT has a 'sunset clause' which expressly provides that protection shall continue to apply to investments made prior to Italy's withdrawal for a period of 20 years (i.e. until 1 January 2036).

By signing various BITs and the ECT, Italy has agreed to guarantee certain minimum standards of protection to investors from the other state party(ies). The protections likely to be of most relevant here are explained further below.  

Adequate and effective compensation in the event of expropriation

Article 13 of the ECT and Article V of Italy's 2003 Model BIT (the Model BIT)⁴ prohibit Italy from subjecting investments made by foreign investors to nationalisation, expropriation or measures that have an equivalent effect unless such measures are imposed for a purpose which is in the public interest,⁵ in a non-discriminatory manner, and under due process of law.⁶

Any expropriation must also be accompanied by the payment of compensation. The ECT requires the payment of 'prompt, adequate and effective compensation',⁷ while the Model BIT requires the payment of 'immediate, full and effective compensation'.⁸  While the Decree provides for the establishment of a fund⁹ and the Technical Report to the Decree clarifies that it do so as a means of addressing the financial burdens that the Government might face as a result of claims for indemnification and/or compensation¹⁰, investors may stand to recover greater compensation under public international law given that both the ECT¹¹ and the Model BIT¹² are clear that compensation is not limited to costs incurred and instead should represent the 'fair market value' of the investment immediately before the expropriation became known.

The provisions of both treaties are helpful in that they expressly refer to nationalisation as well as measures that have an effect equivalent to nationalisation or expropriation. That means that measures - such as fiscal measures - which would destroy the value of an investment but would not of themselves be considered as expropriatory in the ordinary private law sense may suffice to found a breach of the treaties. However, it is important to note that the treaties (in accordance with standard international practice) do not prohibit nationalisation or expropriation; instead they oblige the state to implement such measures fairly, and to pay proper compensation which reflects the fair market value of the investment.

For present purposes, it is worth noting that tribunals have held that regulatory measures by a state applied for the purposes of protection of health and the environment, do not necessarily give rise to a breach of the expropriation clauses included in investment treaties. Investment tribunals have also typically declined to award compensation for measures that are temporary and not permanent and irreversible¹³ (although opinion on this issue is divided and some tribunals have considered temporary measures as giving rise to a right to compensation).¹⁴

Fair and equitable treatment (FET)

Article 10(1) of the ECT contains a typical FET provision that obliges Italy to accord investors 'fair and equitable treatment' and prevents it from impairing 'by unreasonable or discriminatory measures their management, maintenance, use, enjoyment or disposal' of investments. Article II(3) of the Model BIT contains a similar provision.

FET is one of the most commonly invoked treaty protections and comprises several elements including obligations to act transparently and with due process, refrain from taking arbitrary or discriminatory measures, and refrain from frustrating an investor's reasonable expectations with respect to the legal framework adversely affecting its investment.¹⁵

Arbitration proceedings

The expropriation and FET protections provided for in BITs and the ECT have value because those treaties also give investors a direct cause of action against the State. Italy's Model BIT investor-State dispute settlement (ISDS) provision permits foreign investors to commence arbitration proceedings under the rules of either the International Centre for Settlement of Investment Disputes (ICSID), or on an ad hoc basis subject to the rules of the United Nations Commission on International Trade Law (UNCITRAL). The ECT also permits investors to commence arbitration proceedings – in addition to ICSID and UNCITRAL proceedings, arbitration under the rules of the Stockholm Chamber of Commerce (SCC), and/or under the ICSID Additional Facility is possible.¹⁶  However, proceedings must not already have been commenced before the national courts, as noted above.¹⁷ 

ICSID is a World Bank institution and ICSID arbitration is more 'public' than arbitration under other institutional rules.  ICSID proceedings therefore carry with them reputational issues. UNCITRAL arbitration can also be more public than is the 'norm' in international arbitration by virtue of the UNCITRAL Rules on Transparency in Treaty-based Investor-State Arbitration (although it is still relatively rare for States to agree to their application). The risk of a very public dispute, and one likely to be of interest to other energy sector investors considering similar action, is something that Italy may prefer to avoid. 

Whether or not Italy will remain bound by the ISDS provisions in certain of its BITs and the ECT remains to be seen.  In January 2019, EU Member States (including Italy) issued a declaration stating that intra-EU BITs are contrary to Union law and suggesting that 'sunset' clauses in such BITs will no longer be of any effect. Italy also declared the dispute resolution provisions in the ECT to be incompatible with EU law following the decision in Achmea,¹⁸ and is expected to discuss further with the European Commission the consequences that should follow from that declaration. It is therefore likely to seek to resist new claims brought under intra-EU BITs.  It remains to be seen whether it will take a similar approach to new claims under the ECT, on the basis that the sunset clause in that treaty (like those in its intra-EU BITs) should no longer apply.

Conclusion

There have been previous instances of foreign investors seeking to pursue claims against states under international investment treaties upon the imposition of moratoria on the development of energy projects. In Windstream Energy LLC v Government of Canada, a US energy company that had been awarded a contract to develop an offshore wind facility brought claims against Canada under the North African Free Trade Agreement (NAFTA, a MIT between the US, Canada and Mexico) after Canada imposed a moratorium on the development of offshore wind. Windstream claimed that the moratorium frustrated its abilities to develop the project in contradiction of the guarantees in NAFTA as regards (among other things) expropriation and fair and equitable treatment. While the tribunal dismissed the investor's expropriation claim on the basis that the moratorium had not 'substantially deprived' Windstream of its investment, it granted the claim relating to breach of the fair and equitable treatment standard and directed Canada to pay C$25 million.

Ultimately, operators and investors will have to consider their own circumstances in establishing the extent to which they can seek redress.  Much will depend upon how the Act, and in due course the Plan, are implemented, as well as the steps taken by Italy in light of Achmea and its January 2019 declarations.  

At this nascent stage, where there is presently a lack of clarity as to how matters are likely to progress (i.e. what form the Plan might take and the extent to which future compensation might be afforded to negatively impacted investors), investors are well-advised to be aware of their rights and entitlements under international law.  Detailed advice should be sought from lawyers experienced in the field both as to the protections available and how treaty protection might preserved. 

Authors:  Elena Giuffrè, Chiara Familiari , Emma Johnson and Harsh Hari Haran

1. Article 11ter of the Decree
2. A preliminary ruling was sought by claimants, and referred to the ECJ, by order of the TAR Lazio as of 20 November 2018 seeking an interpretation of compliance with the EU law and principles of the Italian 2014 legislation that reduced and/or decreased the FIT incentives in the renewables sector formerly granted by a previous law.
3. https://investmentpolicyhub.unctad.org/IIA/CountryBits/103
4. A Model BIT is typically used by the State as a basis for negotiating its BIT with another State.
5. Article 13(1)(a) of the ECT. The Model BIT (Article V(2)) uses the term 'public purpose' and 'national interest' which would likely have similar effect.
6. Article 13(1)(c) of the ECT. Article V(2) of the Model BIT uses the term 'in conformity with all legal provisions and procedures', which would likely have similar effect.
7. Article 13(1)(d) of the ECT.
8. Article V(2) of the Model BIT.
9. The Government has estimated the quantum of potential financial burdens arising from compensation claims to have maximum value of approximately €471,707,000.  It calculates (on a precautionary basis) that the financial burdens will more likely be in the region of approximately €282,424,200 (i.e. 40% of the highest estimated amount). Such calculations would not, however, preclude operators from recovering higher compensation amounts in formal legal proceedings.
10. The references in the Technical Report to establishment of the fund do not constitute any admission on the State's part that it is liable to affected operators; it merely represents a precautionary step by the Government to ensure it has allocated sufficient funds should damages be awarded to operators in due course.
11. Article 13(1) of the ECT.
12. Article V(3) of the Model BIT.
13. See, for example, Técnicas Medioambientales Tecmed, S.A. v. The United Mexican States, ICSID Case No. ARB (AF)/00/2, Award dated 29 May 2003 at paragraph 116.
14. Azurix Corp. v The Argentine Republic, ICSID Case No. ARB/01/12, Award dated 14 July 2006 at paragraph 313.
15. Electrabel S.A. v. Republic of Hungary, ICSID Case No. ARB/07/19, Decision on Jurisdiction, Applicable Law and Liability, 30 November 2012 at paragraph 7.74.
16. The ICSID Additional Facility permits the commencement of ICSID proceedings either by or against a non-party to the ICSID Convention.
17. ECT, Article 26(3) and Annex ID.
18. Slowakische Republik (Slovak Republic) v Achmea BV (Case C-284/16), March 2018. The European Court of Justice held that ISDS provisions in BITs between EU Member States are incompatible with EU law. That decision has also been relied on by a number of EU Member States seeking to preclude the recognition and enforcement of arbitral awards rendered against them under intra-EU BITs. See our briefing for more detail.