The Energy Charter Treaty is breaking up. Here’s why:

Last week, France announced its plans to withdraw from the Energy Charter Treaty. This decision followed similar announcements of countries such as the Netherlands, Spain and Poland to withdraw as well. The treaty has been decreasing in importance and could even be argued to be problematic. Yet, the question remains why these decisions have been made now and what the risks will be for France, other countries, companies, and energy (security) in general.

The Treaty

The Energy Charter Treaty (ECT) was initially designed to promote energy cooperation between Eastern and Western Europe, after the Cold War. It is a multilateral agreement, ratified by 53 countries, solely dedicated to the energy sector. The ECT allows for a common energy market and offers a forum to discuss energy-related issues. It also provides guarantees to energy companies with regards to their foreign investments, mainly compensation in the face of regulatory or policy changes. 

Nowadays, the ECT’s role extends beyond east–west cooperation. Rather it is aimed at stimulating FDI and trade in the energy sector globally (at least between all its signatories). Its objectives are to contribute to energy geopolitics, energy security, and to overcome economic divisions. It does so through 1) binding provisions, related to investment protection, free trade, freedom of transit and a mechanism for dispute resolution and 2) non-binding provisions related to environmental protection and the promotion of energy efficiency.

The importance of the ECT, however, has decreased significantly over the years. Firstly, because of Russia’s withdrawal from the provisional application in 2009. As the country remained Europe’s main supplier of energy products throughout the years, it marked a certain obsolescence for the treaty that was specifically designed for energy cooperation. 

Secondly, because of the rise of new global, regional, and bilateral treaties and partnerships. It has led to a fundamental question of what will happen to the ECT’s trade provisions, once all ECT members accede to the WTO. Does it become obsolete or will the risk of overlap create tension between the treaties during certain instances? It is not clear which norms will prevail, as there exists no explicit hierarchy. 

Thirdly, the ECT failed in attracting FDI into non-EU countries. As such, it failed in one of its main policy objectives. Moreover, the main reason behind FDI in Europe had little to do with ECT provisions. Rather EU energy policies seemed to be the driving forces of FDI in EU member states, suggesting that the ECT’s impact there had been rather limited.

France’s decision

Yet the main reason behind the withdrawal plans of France and other countries is not the ECT’s decreasing importance, although that may have played a role in it. Rather, it has to do with some problematic aspects of the treaty, namely its dispute settlement mechanism. According to a report, this made the treaty a particularly attractive tool for foreign investors. It is one of its main fallacies. While it protects investors against states, it does not protect states against investors, specifically when they fail to meet contractual obligations. This one-sided guarantee has been controversial.

More importantly, however, are climate considerations. Although plans lie on the table to modernise the ECT’s agenda, it would not include phasing out fossil fuels. This in turn would mean that by 2050 at least one third of the remaining global carbon budget would still be protected by the ECT. Moreover, energy corporations would be incentivised to use the dispute settlement mechanisms as new national plans threaten their industry. Therefore, climate activists argue that governments will delay or even cancel their plans for fear of legal action. In other words, the dispute settlement mechanism provided will lead to “a regulatory chill effect”. Ironically, energy demand reduction is not protected by the ECT. For governments it marks the contradicting nature between their green plans and the ECT. 

Following this, it seemed logical that France withdrew from the treaty. As French President Emmanuel Macron said last week: "we have decided to withdraw from the Energy Charter Treaty, first because it's in line with the positions we've taken, notably the Paris Accord and what it implies.” Yet, the Paris Accord was adopted almost seven years ago and the contradictions were well known years beforehand. So why now?

The reason seems to be strategic. With the need to find alternatives to Russian gas, France seems to be well aware of the opportunities that lie ahead. Combined with plans to speed up renewable energy developments, its withdrawal from the ECT marks a new energy strategy that should attract investors to France’s ‘green’ energy sector. 

What are the risks?

Withdrawing from the treaty is not without consequences. France and other countries that have decided to leave will remain vulnerable to litigation for 20 years. This is a part of the ECT’s sunset clause. While the European Commission has proposed to limit that clause to 10 years, that will only apply to signatory countries. Hence, the Netherlands will opt for a third way, where they will sign the reformed treaty and then pull out. France has indicated to do the same.   

Less protection for fossil fuel investments, however, will also lead to less incentives to invest. Hence, in the long-term foreign investments in the sector are likely to decrease. This is in line with decarbonisation plans, but the impact for energy security will be questionable. If renewable energy plans fail to deliver the needed supplies, the fossil fuel sector might not be able to supply them immediately as well. Inevitably, this will lead to tight markets and high prices, both for renewables and non-renewables. 

There also is a geopolitical risk involved with leaving the treaty. It will create a vacuum, where other countries might be able to jump in. A major withdrawal from France and other countries might open up the door to China, according to some analysts. If China accedes, it will benefit from the treaty and it will be able to accelerate its BRI project on the Silk road. Hence, the decision of France and other countries might have consequences that go beyond a break-up with the protection of fossil fuel investments.