In May this year, the European Union announced that it would withdraw from the Energy Charter Treaty, an international investment agreement established in the wake of the Cold War with the purpose of “strengthening energy cooperation” amongst its signatories.
12 European member states – including France, Germany and Poland – had already left the treaty individually, in a trend described as “immensely important” and “a massive victory” by green politicians and civil society groups.
The controversy surrounding the Energy Charter Treaty (ECT) stems from its incorporation of investor-state dispute settlement (ISDS) mechanisms – an obscure component of international law that enables foreign companies to sue governments whose policies threaten their return on investments in that country.
ISDS is not unique to the ECT. As of 2023, more than 2,600 investment treaties are in force globally, most of which also include ISDS provisions.
However, given its high number of signatories, it is the ECT that has recently been branded “the most dangerous investment treaty to the energy transition” and responsible for protecting “over 300 megatonnes (Mt) of greenhouse gas emissions”, making it a flashpoint in discussions globally around ISDS and its impact on the energy transition.
The origins of ISDS
Investor state dispute settlements “first developed in the 1960s as a post-colonial form of compensation when former colonial investors saw their physical assets nationalised by governments who were emerging [into independence]”, says Dr Patricia Ranald, the convener of the Australian Fair Trade and Investment Network and an honorary research associate at the University of Sydney.
Initially, “organisations like the OECD started to develop this idea of compensation for when physical assets were actually taken by governments”, Ranald explains. But over the last 60 years, it has developed into an “enormous global legal system, which is not based on normal national court principles”.
Instead, ISDS relies on private arbitration principles. Investors’ claims – which are often worth billions – are heard in closed-door tribunals and decided by a panel of three arbitrators, one appointed by the company, one by the state and one by mutual agreement between the parties.
“With national court systems you have independent judges, you have a system of precedents”, Ranald continues. “ISDS doesn’t have any of that. The tribunal decisions are quite unpredictable depending on who the arbitrators are. The arbitrators are drawn from the top of the legal profession. They mostly come from the wealthier countries and there’s not many women or people of colour.”
The power that ISDS grants arbitrators has not been lost on the global legal sector. According to Fabian Flues, a trade and investment policy expert at German NGO PowerShift, it was in the wake of numerous investment treaty signings in the 1990s – in particular the North America Free Trade Agreement – that “law firms and arbitrators realised that they had this incredible tool to challenge any kind of regulatory action by governments”.
As awareness has grown around the scope of ISDS, so has the number of cases that are brought. According to UN Trade and Development (formally UNCTAD), ISDS claims have more than doubled in the past ten years, from fewer than 600 at the end of 2013, to more than 1,300 at the end of 2023.
“What we see these days is [cases being brought] more against policy measures that are in the public interest”, says Eunjung Lee, senior policy advisor at E3G. “That’s why climate measures and public health measures are being challenged and there are decisions in favour of investors, even if the policy measure is legitimate”.
It is no coincidence, then, that companies in the energy and extractive sectors have been the most consistent users of ISDS, accounting for around a third of all cases. What’s more, by the end of 2023, almost 20% (or 235) of all the ISDS cases ever brought related specifically to fossil fuels.
A recent example is the case brought by German energy giants RWE and Uniper against the Netherlands. In 2021, the Dutch government adopted a coal phase-out law that would ban coal-fired power generation by 2030. Since the companies owned coal-fired power plants in the Netherlands, they argued that such a policy would threaten their investments and so sued the Dutch government for a combined sum of almost €2.5 billion. The claims were eventually thrown out, but not before the Dutch government had paid €4.5 million in legal fees, all at the expense of the taxpayer.
"Unidirectionality"
While recent moves to leave the ECT might appear to signal an increasingly committed rejection of ISDS, some have identified a worrying trend in the world of international investment law that risks exacerbating the inequalities of the climate crisis.
The enthusiasm many wealthy Western countries have displayed in leaving the ECT has not been matched by their appetite for reforming their own bilateral investment treaties (BITs) with developing countries, many of which also include ISDS provisions.
“Western countries have realised that through the Energy Charter Treaty there could be a claim coming to [them] so they have to get out of there”, says Eunjung Lee. This is because other signatories are also predominantly wealthy countries, who are likely to be home to companies with investments abroad and so have significant capacity to bring claims. Essentially, there is a much greater risk of viable retaliation.
However, in a bilateral investment treaty between a wealthy nation and a developing one, it’s far less likely that the poorer country will be home to an investor that owns assets in the wealthy one.
“There’s much less risk of getting sued if you have a treaty with Zambia. There are not a lot of Zambian investments in, let’s say, the Netherlands – so that’s more a one-way street. But with the ECT, it’s a two-way street,” explains Bart-Jaap Verbeek, Senior Researcher at The Centre for Research on Multinational Corporations.
Fabian Flues described the lack of consistent policy on ISDS from governments that left the ECT as “particularly depressing.”
“It’s been really shocking and sad to see how a lot of countries that left the Energy Charter Treaty because they said it was a threat to their climate ambitions, [but] refuse to take up the same arguments when it comes to other investment treaties.
“Countries that left the ECT with a big announcement now suddenly become very reluctant to do anything more systemic about it, which would affect their BITs with countries in the Global South.”
UNCTAD’s latest report appears to confirm this trend, stating that reforms to international investment agreements have “had a limited effect on mitigating the risk of ISDS in developing countries”, and that in the least developed countries, foreign direct investment is largely not subject to reforms at all.
The impact that successful ISDS claims can have on developing economies is profound. In 2019, while Pakistan was enduring an economic crisis, it applied to the International Monetary Fund for a loan of $6 billion.
Two weeks later, the Australian mining company Tethyan Copper won an ISDS claim against Pakistan. The country was ordered to pay Tethyan Copper more than US$5.8 billion.
The case had first been brought almost a decade earlier over the refusal of a mining licence. From 2006, Tethyan Copper had been exploring gold and copper deposits in the Balochistan province of Pakistan under the Chagai Hills Exploration Joint Venture Agreement (CHEJVA). After discovering significant reserves of the two metals, the company applied for a mining licence in 2011 but was denied one.
When Tethyan Copper brought its ISDS claim in 2011, the government of Pakistan argued that, according to the Supreme Court, CHEJVA was invalid and so the investment did not respect Pakistani law and was outside the treaty’s scope. The tribunal rejected Pakistan’s argument, pointing out that Pakistan had failed to mention CHEJVA’s potential invalidity when Tethyan Copper first commenced operations in 2006.
The tribunal found that Pakistan had breached the fair and equitable treatment standard and that the denial of the licence was tantamount to expropriation, because it significantly decreased the value of Tethyan Copper’s investment.
“To have an award against a developing country of $6 billion – which was equivalent to an IMF loan – is outrageous. The whole system has become disproportionate”, says Dr Patricia Ranald.
That ISDS claims can have such a significant impact on a developing country’s economy risks creating a freezing effect on the rollout of climate policies and regulations.
“It is a mechanism that fossil fuel companies can use to prevent action to reduce carbon emissions, and they are using it in quite a systematic way, often against developing countries.
“Governments can plan to have regulation to reduce fossil fuel emissions or to move away from fossil fuels and the company can go to them and say, if you do this, we’ll sue you for billions of dollars,” Ranald adds.
What’s more, the potential for ISDS claims against developing countries can seriously jeopardise efforts to provide meaningful climate finance to those countries.
“If you’re giving grants and money to a country to help their energy transition but your one investor can bring a claim to the same specific country, then that could leave a big hole in that country’s finances, because [the claim] could be easily billions of dollars”, says Eunjung Lee.
Reform?
Meanwhile, at EU level, talks are underway over the establishment of a Multilateral Investment Court. Such a system that would establish a standing court of salaried judges to rule on ISDS claims, in the hope of limiting the powers afforded to arbitrators in the current system.
But for some campaigners, reform of this sort falls far short of what is needed. “The EU’s attempt has been to judicialise the system in a way to make it look more like a real court, to take away some of that power from those appointed arbitrators and move it into a setting where states have more power over the appointment of the decision makers”, says Fabian Flues.
“But then our main criticism is that this won’t tackle any of the underlying issues like who can sue whom, what’s the basis for it, and what does it mean for communities and people affected by an investment or investor? Should the most powerful group on this planet – the people who have internationally mobile capital – really have their own international court?
“Our line’s been very clear – ISDS and investment treaties as they currently are do not help countries that need investment.
“We think the best way for countries to move ahead is to get out of these treaties.”
Camille Corcoran is an Assistant Editor at Land and Climate Review. She has published investigations with outlets including BBC, The Guardian, Channel 4, The Times, Private Eye and openDemocracy.
Read more:
- Removals
