UK announces withdrawal from Energy Charter Treaty

On 22 February 2024, the UK announced its intention to withdraw from the Energy Charter Treaty (ECT), following what it says has been a failed modernisation process. Jessica Thomas and Karel Daele discuss the implications for investors below.

Background to the ECT

Signed in 1994, the ECT was introduced to promote international investment in the energy sector by providing protections for investors in fossil fuels. Under the Treaty, investors are able to commence an investor-state dispute settlement (ISDS) procedure against the host state of their investment if they feel the state has breached the ECT.

The ECT is the most litigated of all investment protection agreements, with damages claims frequently running into the hundreds of millions of pounds, if not billions. The often-debilitating threat of legal proceedings has therefore been known to result in state inaction on climate policy, or 'regulatory chill'. This state of inertia ultimately means contracting states risk falling behind on their net zero ambitions. 

Proposals to modernise the Treaty came in the wake of the Paris Agreement and called for better support for states wishing to introduce cleaner technologies. These proposals aimed to remove the risk of investors initiating ISDS arbitrations against contracting states. For example, if they felt a state-backed move towards greener technologies had failed to treat the investor fairly and equitably, or may have unlawfully expropriated an investment, leading to an adverse impact on the value of their investment.

The ECT Secretariat led the modernisation process, with a proposed modernised text announced in June 2022. But adoption of the text was postponed after EU Member States failed to agree on a common position.

The UK position 

Since the postponement a number of states have announced their intention to withdraw from the ECT including Germany, France, Spain and the Netherlands. 

In February, the UK was the latest to announce its intention to withdraw, expressing its concern that modernisation 'could now be delayed indefinitely'. Graham Stuart, Minister of State for Energy Security and Net Zero, remarked on the withdrawal that 'Remaining a member would not support our transition to cleaner, cheaper energy, and could even penalise us for our world-leading efforts to deliver net zero.'

Those sentiments appear to reflect the general feeling, at least within the EU, that the ECT no longer aligns with modern climate policy. Notably, a leaked non-paper from the European Commission in April last year confirmed that the protection granted by the unmodernised ECT to fossil fuel investments would 'clearly undermine EU efforts to decarbonise its energy mix and achieve climate neutrality by 2050' and therefore that 'membership of the unmodernised Treaty is neither legally nor politically sustainable.'

What it means for investors

The withdrawal will mean that any protections under the ECT for new energy investments in the UK will cease one year from the date of formal notification of withdrawal (which at the time of writing has not yet taken place). The government was, however, at pains to assure commercial parties that the UK still remains an attractive destination for investors across all technologies, and that it is committed to ensuring fairness and support for UK investors operating abroad.

What the announcement did not mention is Article 47 of the ECT, also known as the sunset clause. Article 47(3) provides that the provisions of the Treaty will continue to apply to existing investments (ie those already in existence at the date of the state's withdrawal) for a period of 20 years from the date of withdrawal (ie one year from the date of formal notification of withdrawal). 

That is valid for both foreign investments made in the territory of the former contracting party, and for investments made by the former contracting party in the territory of the other remaining contracting parties. Therefore, while the latest announcement might raise concerns among UK investors, pre-existing investments within the UK by contracting parties, or UK investments already made in any remaining contracting parties, would continue to have access to recourse via the ISDS mechanism until at least 2045.

While Article 47(3) will provide comfort to many investors, the fact that it provides long-lasting protection to investors long after a state's withdrawal from the ECT has faced criticism from many commentators. Indeed, the European Commission prepared a draft inter se agreement which clarifies that the ECT and its sunset clause do not (and never did) apply in an intra-EU context. 

The impact of such an agreement, if reached between the relevant Member States, would result in the application of the sunset clause being excluded between willing contracting parties. Practically speaking, it would mean that investor protection under the ECT would no longer continue in any of the territories which sign up to the inter se agreement for the usual 20 years following a state's withdrawal from the Treaty.

It is, however, currently unclear whether any such inter se agreement will ever be finalised, and if it is, whether it would be legally enforceable by an arbitral tribunal. It is therefore highly likely that investor protections under the ECT are to remain in place for a significant period of time, despite its critics.

If you'd like to know more about what this might mean for you or your business, reach out to a member of our Disputes and Investigations team.

A version of this article was published in Law360 (behind paywall).