Pressure is building for European Union (EU) member states to execute a coordinated withdrawal from the Energy Charter Treaty (ECT). As of March 2024, the European Council of Ministers approved such a move, considering that the treaty is “too protective of fossil fuel investments” and “incompatible with Europe’s climate ambitions.” This follows last summer’s European Commission proposal that the EU and its member states “withdraw in a coordinated and orderly manner.”
However, a full EU withdrawal from the ECT is still uncertain. At least nine ECT member states have announced their intention to withdraw from the treaty, but a final decision rests with members of the European Parliament (MEPs). Some countries, like Hungary and Cyprus, are still holding out hope that an appropriate modernization of the treaty is possible. Moreover, given the ECT’s 20-year sunset clause, simple withdrawal from the ECT does not immediately or automatically remove the legal risk for concerned countries.
Comprehensive research from the Boston University Global Development Policy Center provides significant evidence to support a coordinated withdrawal by the EU and its member states, along with a mutual agreement to nullify the sunset clause, in order to reduce the legal risk associated with supply-side climate policies.
The risk of investor-state dispute settlement (ISDS) is high, even more so when the investors are in the fossil fuel industry. Fossil fuel investors make up 20 percent of total ISDS cases and receive a higher than average amount of compensation when they win. Quantitative research has shown that the high end potential government liability for policies limiting fossil fuel supply is $340 billion. Legal risk under the ECT is particularly high, amounting to 19 percent of the total (ranging from $5 to $20 billion), as it protects the most oil and gas production of any investment treaty worldwide. In addition, if the membership expands as planned to an additional 32 members, many of which are low- and middle-incomes countries (LMICs), the overall risk to those countries will also increase.
Even more concerning, the current quantitative studies are underestimates of the potential risk. In the first place, the above research does not include coal or fossil fuel infrastructure investments. The estimates for ECT also do not include projects covered by multiple treaties and the ECT, which would increase liability by between $10 billion to $35 billion. The data likewise does not account for complex multinational corporate structure and the ability of these firms to restructure their investments strategically through subsidiaries so that they can take advantage of ECT protection. These realities indicate that all projects in ECT states, even if the investor is not an ECT member, could carry between $31.5 billion and $111.5 billion worth of potential liabilities.
To avoid these costs, EU member states, and indeed all ECT countries, could initiate a coordinated withdrawal. In that case, the membership could decide to collectively sidestep the sunset clause through mutual agreement. Taking such a step would eliminate 100 percent of all possible claims against EU member states and mitigate 99 percent of the risk for the United Kingdom.
Below, explore the research that investigates the legal risk embodied in international investment agreements (IIAs) and the ECT more specifically, including policy proposals for avoiding such risk and making space for much-needed climate policy at a global level:
Oil rig off Hungtington Beach by Arvind Vallabh. Photo via Unsplash.
If global warming is to be kept below 1.5C, states need to rapidly phase out fossil fuels. But government efforts to limit fossil fuels, such as cancelling pipelines and denying drilling permits, will impact asset holders and demands for compensation will ensue.
Considering the costs of in/action on climate, what are the legal and financial risks associated with potential government action to limit oil and gas production?
Astudy publishedinScienceby a team of researchers at the Boston University Global Development Policy Center, Colorado State University and Queen’s University in Canada estimates the costs of possible legal claims from oil and gas investors in response to government actions to limit fossil fuels. They find legal claims could reach $340 billion, a substantial amount that would divert critical public finance from essential mitigation and adaptation efforts to the pockets of fossil fuel industry investors. The authors argue governments should take measures to prevent fossil fuel investors from accessing ISDS, including moving quickly to terminate agreements. Read the journal article and read the summary blog.
What is the potential liability of Global South countries to ISDS claims? And how does ISDS compound the ability of these countries to mobilize resources to invest in adaptation and mitigation and justly transition to net-zero economies?
A study published inClimate Policyby a team of researchers at the Boston University Global Development Policy Center, Colorado State University and Queen’s University in Canada calculated the financial risk of ISDS by the average net present value (NPV) of all treaty-protected oil and gas projects as a percentage of gross domestic product (GDP), compared with climate vulnerability.
The authors find that more than two-thirds of the calculated financial risk through potential ISDS claims is borne by countries in the Global South, resulting in a de facto transfer of wealth from the Global South to the Global North that undermines global climate finance commitments. Read the journal article.
In their study in Science, the researchers reported that the ECT is the greatest contributor to potential ISDS claims over the forced stranding of oil and gas assets that do not fit in a 1.5°C carbon budget. The authors found that the ECT applies to 19 percent of all treaty-protected oil/gas assets that would be excluded from the International Energy Agency (IEA) Net-Zero by 2050 energy transition pathway. The NPV of the assets covered solely by the ECT was found to be between $3 billion to $16 billion (depending on the oil price used in the calculation). A further $2 billion to $4 billion worth of projects were “under development” and would need to be cancelled in a more aggressive climate mitigation scenario. However, these findings were based on a methodology with limitations.
A recent policy brief by the same researchers addresses some of these limitations in more detail and provides evidence that the original figures are an underestimate of the true extent of the ECT’s protection of 1.5°C-incompatible oil and gas assets. Read the policy brief.
One reason often cited for countries wishing to remain in the ECT is that ISDS could beused to protect renewable energy investors fromcapricious governments attempting to get out of their legitimate legal commitments to protect investors and their property. Othersargue that investment agreements like the ECT encourage investment and all possible capital flows – public and private – are vital to restructuring the global economy toward a low-carbon future.
In a recent blog, Rachel Thrasher argues that this argument is a myth, divorced from reality in three ways. First, evidence demonstratesthat investment treatiesdo not generally produce investment and thus energy investment treaties do not produce more energy investment. Second, statistics that seem to show that renewable energy investors are benefiting from ISDS protection are skewed, based on a handful of identical or substantially similar sets of facts. Finally, case studies from Spain demonstrate that the cases were a response to rational government regulation in a crisis, rather than poor or corrupt government action. Read the blog.
Despite findings such as those in the Science and Climate Policy studies detailed above, many proponents of the investment treaty system, and ISDS more specifically, have argued that IIAs are amuch lesser threatthan they seem as long as states are engaged in good faith public policy and not imposing disguised restrictions on foreign investment. Moreover, they argue that IIAs areessentialto the renewable energy transition because of the large amount of private investment needed.
In response to these concerns, Rachel Thrasher answers frequently asked questions and debunks misunderstandings on ISDS and IIAs, seeking to provide clarity on the connections between investment treaties, ISDS and climate policy. Read the blog.
In Social Europe, Rachel Thrasher makes the case that the costs of the ECT clearly outweigh its benefits. She argues that the key claim that treaties like the ECT promote investment isnot supportedby the evidence. Furthermore, efforts to modernize the treaty do not have substantial support among its signatories and its impact so far has been overwhelmingly to block or delay progress towardclimate goals. She writes that, rather than continue with thestatus quoor seek reform, ECT members should simply withdraw—collectively, if possible, but individually if necessary—to decrease the future risk of ISDS claims and facilitate a sustainable energy transition for all. Read the op-ed.
In an August 2022 op-ed for Thomson Reuters Foundations’ Context, Rachel Thrasher and Kyla Tienhaara explain the consequences of UK-based oil firm Rockhopper being awarded more than 190 million euros in compensation for the Italian government’s refusal to grant it an offshore oil concession.
They write that theRockhopperruling sends a chilling message to governments: if you cancel oil and gas projects in line with climate science, you could end up having to pay hundreds of millions, or even billions, in compensation.
They argue that acoordinated withdrawalfrom the treaty that neutralizes the sunset clause for those leaving would be far preferable to a modernization deal that is too little, too late during such a critical decade for climate action.
