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EU targets reform of anti-greening Energy Charter Treaty

01 March 2021 Cristina Brooks

The EU is in danger of falling short of its Paris Agreement emissions target if the bloc fails in proposed reforms of the contested Energy Charter Treaty (ECT), say opponents of the move.

The treaty allows investors to penalize EU states for making climate and energy regulations, an ability the EU seeks to minimize in a reform proposal outlined on 15 February, ahead of talks with other signatories on 2-5 March. The treaty as it stands is "obsolete considering not only modern international investment law, but also the objectives of the Paris Agreement on Climate Change and the United Nations' Sustainable Development Goals," according to a blog by Martin Dietrich Brauch, a senior legal and economics researcher at the Columbia Center on Sustainable Investment in New York.

European, Central Asian, and Asian states signed the treaty in 1994 to protect foreign investments from political upheavals in the former USSR. There have been more than 100 treaty proceedings in global arbitration tribunals like the World Bank's International Centre for Settlement of Investment Disputes (ICSID) since 2001, mostly brought by EU investors against EU states. Since 2013, a boom in disputes launched by both renewable and fossil fuel investors has led to states paying damages in the hundreds of millions of euros at a time.

Through the treaty, investors can seek damages above and beyond the value of their projects, including for future profits. They challenge energy-related regulations, for example, ending Feed-in-Tariff subsidy regimes or requiring environmental impact assessments for fracking. German power plant operator RWE opened proceedings in the ICSID against the Netherlands for requiring the biomass conversion of its Eemshaven coal-fired power plant amid a phase-out of coal, according to a 2 February filing.

The EU has been attempting to negotiate a revamp of the treaty since 2019, but a requirement within the text for signatories to unanimously agree to the change throws up a significant roadblock. This is despite EU states making up nearly half of the treaty's signatories.

The EU tried to negotiate for reforms at three meetings in 2020. In October, the European Parliament voted in favor of amendments to European climate law to require an end to fossil fuel protections under the treaty.

The EU first distributed a reform proposal to the other signatories in May last year. In October, a revised proposal was leaked, and then in February the final proposal was published.

"What is interesting about the most recent additional proposal is that it envisages a phasing out of the investor protections of the ECT, including the right to claim compensation through arbitration, for certain types of energy projects — specifically those based on coal, natural gas, and petroleum, and electricity derived from these sources," said Daniel Meagher, an international arbitration specialist and partner at law firm Winston & Strawn who represents both investors and states. Meagher advised solar companies in a dispute with Italy over its ending of feed-in-tariff subsidies for new solar power plants.

Cutting back on natural gas power

Gas demand in EU markets has been stable across the past seven years, and is expected to decline in the future, according to IHS Markit data.

A hot-button issue in the reform is its proposal for the phasing out of current treaty protections for gas infrastructure over the next one or two decades. Environmental groups say this is not fast enough to help achieve the EU's Paris Agreement-aligned emissions goals. Three-quarters of the treaty's historically protected fossil fuel infrastructure is gas and oil fields at $176 billion (€126 billion) and pipelines at $206 billion (€148 billion), according to non-profit Investigate Europe.

The latest proposal ends protections for certain new fossil fuel projects immediately, and others would become excluded in 10 or 20 years.

"As I understand it, the proposal is saying that the investment protection provisions of the ECT will not apply to oil, gas, or coal Investments made after the date of entry into force or provisional application of the EU-proposed amendment to the treaty, but there are significant exceptions to this for certain gas power plants and gas pipelines, extending the application of the investment protection provisions of the ECT to those investments up to 10 years after entry into force of the EU-proposed amendment, but not later than 31 December 2040," said Meagher.

Among the few significant changes between the leaked October draft and the final proposal is the removal of protection through 2030 for all but the most efficient gas-fired power plants, according to the Columbia Center on Sustainable Investment's Dietrich Brauch.

Specifically, the prior draft protected gas-fired power generation emitting less than 550 grams of carbon dioxide of fossil fuel origin per kWh of electricity, while the final proposal reduced the figure to 380 grams/kWh, said Dietrich Brauch. But the EC plans even stricter emissions limits for gas plants under its proposed taxonomy regulation.

The EC's reforms will not be effective in achieving its Paris Agreement goals because it would continue protecting fossil fuels for at least one or two decades, and even encourage disputes for the remaining years, he said.

"This result is troublesome because climate action needs to happen as of now—and not in one or two decades — for countries to achieve the goals of the Paris Agreement on Climate Change," said Dietrich Brauch.

The best-case scenario is to terminate the treaty for all parties so the signatories can negotiate with a "clean slate," he said. The second-best scenario is to withdraw after negotiating a removal of the sunset clause forcing states quitting the treaty to continue protections for 20 years. Both terminating and reforming the treaty require unanimous approval of all signatories.

For Meagher, the reform is not certain to be a success in stopping disputes, not least because there are other bilateral investment treaties that would apply. "Whether the broader EU-proposed reforms have an impact to prevent disputes which EC states have seen in the past, that remains to be seen. If it looks like the EU proposed reforms will go ahead, there will certainly be a flurry of claims as investors rush to benefit from the existing ECT text," said Meagher.

Leaked minutes of signatory state discussions show Japan does not support changing the treaty's level of investment protection. Japan's banks and public bodies have invested about $23.4 billion internationally in gas pipelines and LNG projects since 2017, according to NGO Global Energy Monitor.

The treaty reform has the potential advantage of swapping gas protections with protections for lower emissions technologies. Both the leaked and final proposals add hydrogen and biomass in an annex of protected investments, but only the final proposal includes definitions specifically for low-carbon hydrogen and renewable hydrogen as well as biogas.

But not everyone is in favor of protecting hydrogen investments in this way. "Based on the initial leaked negotiation position of the European Commission, a large share of fossil fuel investments would continue to be protected under the treaty for a long period and most controversially, the EU intends to even expand the definition of economic activity to new technologies," said green group coalition CAN Europe in a blog this month. Adding more protections expands the risk of investor-state disputes, it said.

Proposals to quit

The EU's reform proposal is considered a gentler alternative to a bloc-wide departure from the Energy Charter Treaty.

Calls for the EU to leave have accelerated since December 2019, when two co-authors of the Intergovernmental Panel on Climate Change (IPCC) Sixth Assessment Report, Julia Steinberger and Yamina Saheb, urged doing so in an open letter. The letter attracted 278 environmental group and trade union signatures.

EU member states France, Spain, and Luxembourg have become the loudest voices calling for an exit from the treaty. Italy left in 2016 after several proceedings, of which Spain is now a major target.

A cross-party coalition of EU parliamentarians issued a joint statement in September, saying that the EU should look into leaving the treaty by the end of 2020.

Environmental groups like CAN Europe have said leaving is the only option as there is "no hope" for climate-friendly reform.

But both Luxembourg Energy Minister Claude Turmes and European Commissioner for Energy Kadri Simson have urged cooperation and negotiation, insisting quitting is the last resort. Simson wrote in an open letter that negotiation is the only way the EU can escape 20 years of continued investment under the so-called "sunset clause."

Despite a growing movement to leave the ECT, it is just one of several that protect coal, oil, and gas investments in Europe, explained Meagher. "The EU-Canada CETA is one example in terms of investments into the EU. Other examples to which the EU is a party include the Investment Protection Agreements concluded between the EU and Vietnam, and the EU and Singapore. As you will know, there are many, many more of these types of treaties worldwide," he said.

There are likely to be many more Paris Agreement-linked disputes, as well as climate change implications, arising from the 2,000-plus bilateral investment treaties worldwide.

Posted 01 March 2021 by Cristina Brooks, Senior Journalist, Climate & Sustainability, IHS Markit

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