Fossil fuel investment protection – it’s time for actions to speak louder than words

The G7 commitments to climate change action on 28 June 2022 were announced shortly after the 30th anniversary of the United Nations Framework Convention on Climate Change being opened for signature. The announcement adds to the increasingly vocal support for climate action by political leaders and multinational companies around the world.

Unfortunately, the time for viewing these public commitments as a victory for climate change becoming part of mainstreamed agendas, has passed. What is sorely needed is the proverbial “putting your money where your mouth is” approach to urgently reform or even restructure prevailing systems which present obstacles to climate action.

One cannot help but notice that the G7’s “endorsement” of an international Climate Club which will be established is substantially more wishy-washy than its commitment to energy security, or that it makes no mention of the agreement in principle to modernise the Energy Charter Treaty that was announced just days before.

The Energy Charter Treaty – which provides for the protection of cross-border investments in the energy sector, particularly fossil fuels – is one of the international investment agreements that has attracted growing criticism that these types of agreements, together with their associated investor-state dispute settlement arrangements, pose a significant threat to climate action. The filing of a number of high-profile investment disputes – such as RWE Energy v the Netherlands, in which RWE Energy is claiming €1.4-billion in compensation from the Dutch government because of its coal phase-out laws – shows that these concerns are not unfounded.

Cases such as these which rely on the protection afforded by international investment law to claim substantial amounts of compensation where progressive climate policy is implemented, and the often pro-investor outcomes of the disputes, have led to increasing calls by civil society and certain countries for fundamental reforms of the contemporary international investment law regime.

South Africa has been among these countries and has been a strong advocate for reforms at the United Nations Commission on International Trade Law (Uncitral) Working Group III, which has been convened to spearhead multilateral reform efforts. However, the recently concluded negotiations on the ECT reform dampen hopes that the type of significant reform South Africa and others have called for can emerge from Uncitral Working Group III.

The momentum to reform the Energy Charter Treaty has been growing for some time. Civil society’s warning, long before investors filed the first case, of its potential use to challenge climate change mitigation measures, has been followed by other advocacy efforts, including a petition signed by more than a million people in its first two weeks calling on states to withdraw from the treaty, and similar concerns expressed by countries such as Italy. This pressure resulted in negotiations for the reform of the treaty being initiated in 2020. They have now resulted in the agreement in principle on the modernisation of the treaty, which was announced on 24 June 2022.

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The agreement, sadly, falls well short of the reform that many wanted, especially as protection for fossil fuel companies has hardly been rolled back. In terms of the agreement, the European Union and the UK will stop offering protection to new fossil fuel investments made after 15 August 2023. However, this so-called fossil fuel carve-out is subject to several exceptions, including investments in gas-fired power stations where these replace coal-fired power installations.

In addition, existing fossil fuel investments will continue to enjoy protection – and the ability to claim compensation in response to climate regulation – for 10 more years counted from the date that three-quarters of the parties ratify the changes. The amendments also do not apply to those who do not ratify the changes.

Another point of concern is that the fossil fuel carve-out does not apply to other contracting parties to the Energy Charter Treaty unless they elect to apply the carve-out vis-à-vis European Union and UK investors. This has particular consequences for African states who have signalled their commitment to joining the treaty. While these states would be free to exclude protection for fossil fuel investors from the European Union and the UK, they would have to offer protection to fossil fuel investments from any of the other contracting states.

In short, the carve-out agreement does little to align the Energy Charter Treaty with the Paris Agreement and to address criticisms that it is a barrier to the implementation of the agreement. The continued protection of existing fossil fuel investments means that compensation claims can be made against countries implementing climate legislation well into the period of urgency which experts have indicated as being the critical window for climate action to be taken if there is to be any hope of arresting the climate trajectory currently at play.

The panacea is theoretically that the reformed agreement will add new wording throughout and in its preamble which recognises all states’ rights to regulate in the public interest. This includes an agreement to include a specific article recognising that states are permitted to regulate investments to achieve objectives such as the protection of the environment and climate change mitigation and adaptation. The right-to-regulate clause is intuitively attractive in its express recognition of climate change mitigation and adaptation, but it is unlikely to rebalance the interests of investors and host states.

Right-to-regulate clauses are not new to investment treaties and have been inserted in several treaties in the past. These clauses are generally interpreted as codifying the police powers doctrine under customary international law. This doctrine recognises that the state may regulate in certain circumstances without having to compensate investors.

In principle this is not a problem for climate change initiatives, but in practice it is subject to various restrictions and very narrow interpretations by tribunals considering disputes related to governments adopting environment-related legislation and policy. These narrow interpretations by tribunals result in countries still having to pay compensation when environmental measures are imposed.

For example, the tribunal in Eco Oro Minerals Corp v Colombia, adopted a very narrow interpretation of Colombia’s right to regulate in the interest of the environment. The dispute concerned restrictions imposed on mining in an ecologically sensitive area. The tribunal found that Colombia had not justified why, in protecting the environment, it could not offer investors any protection (compensation) because of the environmental measures that it had taken.

The implication of the tribunal’s reasoning in this case is that a state is effectively only exempted from liability if it can prove that not compensating investors is necessary to protect the environment. To put it mildly, this is a more onerous burden on the state than merely proving that the regulations are required to protect the environment, and retains the approach that governments must factor in a budget for paying those who contribute to climate change if they want to meet their obligations in terms of the Paris Agreement.

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In reality if pro-investor decisions such as these are followed, which they often are, it may well create a chilling effect on a state’s willingness to impose climate change measures because, while their right to do so is recognised, the default status quo of compensating investors where these measures are imposed remains intact.

The take-home of the Energy Charter Treaty reforms is that they largely follow the template reforms that have become commonplace in recent investment practice, the weaknesses of which existing arbitral practice has already laid bare. They are, in truth, nothing more than window dressing masquerading as reform, and should certainly not be used as a model for the reform of international investment law more broadly.

As negotiations at the Uncitral Working Group III continue, developing countries must accept nothing more than real reform. There needs to be a demand that actions speak louder than words and that statements of commitment to meaningful climate action be translated into actions with the urgency that is required. DM

Louis Koen is an assistant lecturer and PhD candidate at the University of Johannesburg. Dr Jenny Hall is a senior lecturer in the Faculty of Law at the University of Johannesburg. The views expressed in this article are the authors’ and not necessarily those of the University of Johannesburg.

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