Published December 12, 2024

By Hélionor de Anzizu, Senior Attorney for the Environmental Health Program at the Center for International Environmental Law. 

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This is part two of a two-part analysis that unpacks the EU and the UK’s shift away from the Energy Charter Treaty (ECT), focusing on the Treaty’s misalignment with climate goals and the ongoing challenges related to fossil fuel investments.

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On December 3, the Energy Charter Conference adopted its proposal for modernizing the Energy Charter Treaty (ECT). Previously, and in reaction to the shortcomings of the modernized text, the EU and the UK took a bold step by withdrawing from the Treaty. These decisions were a critical first step, signaling that fossil-related climate measures must take precedence over continued investment benefits to fossil fuels. However, while these withdrawals are a landmark achievement, addressing the entrenchment of fossil fuels is far from over. Two critical challenges persist that could undermine the goals of the Paris Agreement: the ECT’s controversial “sunset clause” and the benefits provided to fossil fuels investments and the continued use of investor-State dispute settlement (ISDS) mechanisms under other treaties.

The “sunset clause” risks extending fossil fuel protections for another two decades, and countries are still bound by other outdated investment obligations. The question remains: how can we break free from the grip of fossil fuel investment protection and safeguard the future?

 The challenge of how governments can overcome these obstacles is exacerbated by several factors:

• Numerous States remain Parties to the ECT
• There are more than 2,800 bilateral investment treaties (BITs) (about 2,200 currently in force) and 450 treaties with investment provisions (TIPs) (about 390 in force) that provide similar benefits and obligations and allegedly bolster fossil fuel investments.
• Fossil fuel investments are further entrenched through long-term investment contracts and domestic laws. 

As a result, the problem extends far beyond the ECT — it is a systemic issue rooted in the current global investment regime that poses challenges in aligning with the implementation of international climate goals and obligations.

The Broader Context: A Structural Challenge

The need to align investment treaties with the Paris Agreement has gained increasing recognition, notably by the Intergovernmental Panel on Climate Change (IPPC) in 2022 and in stakeholder engagements conducted by the UNFCCC Standing Committee on Finance in 2023. The IPCC highlights that “[i]nvestment agreements, which are often integrated in FTAs, seek to encourage the flow of foreign investment through investment protection. While international investment agreements hold potential to increase low-carbon investment in host countries, these agreements have tended to protect investor rights, constraining the latitude of host countries in adopting environmental policies.”

Investment treaty protection benefits, often viewed as a safeguard against political risks, can provide investors with compensation for economic losses and facilitate the enforcement of payments. While these benefits, offered without cost to investors, support fossil fuel investments by mitigating financial risks — they inadvertently bolster fossil fuel investments. This poses numerous challenges to implementing climate obligations and is at odds with Article 2.1(c) of the Paris Agreement, which calls for aligning financial flows with climate objectives. Removing these treaty benefits would help align and redirect financial flows toward cleaner energy investments, ensuring better compliance with climate commitments and advancing global decarbonization efforts.

The Sunset Clause: A Lingering Legacy of Fossil Fuel Protection

The ECT’s sunset clause is a provision in Article 47(3) that allows treaty protections to remain in effect for up to 20 years after a country withdraws. This means that during that period, fossil fuel investments made before such withdrawal benefit from investment protections, and governments risk being sued by investments for implementing policies that impact these projects. 

This clause creates an “entrenchment effect” by binding governments to outdated obligations — limiting governments’ ability to be released from their treaty obligations immediately — and further exposes them to ISDS–related risks. Consequently, investors can submit claims against a State before an arbitral tribunal under the ECT after its withdrawal and within the survival period.

For example, despite withdrawing from the ECT in 2016, Italy faced an ISDS claim over its ban on coastal oil drilling. The outcome was a multimillion-dollar award in favor of the UK company Rockhopper, underscoring the financial risks of the sunset clause. 

In the context of the EU and UK withdrawals from the ECT, the application of the sunset clause would extend benefits to the fossil fuel industry up to at least 2043 (if not longer for some EU States) — a timeline that is far beyond a 2030 agenda and current climate obligations and commitments. There is also the possibility that during this sunset period, investors will scale up their activities to maximize profit, making current projections even worse.

For ECT withdrawing parties, addressing the legacy issues of the ECT has become a top priority. On June 25, 2024, EU Member States signed a declaration and initial inter se agreement clarifying that the ECT’s investor–State arbitration provision does not apply — and never has — to intra-EU investment disputes. 

While these steps clarify the inapplicability of the ECT’s investor–State arbitration mechanism within the EU, they do not prevent legacy arbitrations between the EU and the more than 20 non-EU ECT Contracting Parties. Therefore, an inter se agreement is needed between the EU, the UK, and the rest of ECT Members. Recently, the European Economic and Social Committee, a consultative body of the EU gathering representatives from trade unions and civil society organizations, urged the EU to pursue an inter se agreement with the UK and other third countries to neutralize the ECT’s sunset clause. This move is considered significant for aligning with the European Green Deal, mitigating the legacy risks associated with the ECT, and addressing potential challenges investment arbitration could pose to climate action. It is promising to see this issue gaining momentum and being highlighted as a priority for the next European Commission. 

Beyond the ECT: The Global Challenge of Fossil Fuel Investment Benefits

While there are many issues related to the remaining ECT Members — even in a modernized form — the ECT is just one piece of a larger puzzle. Thousands of BITs and treaties with TIPs remain in force, many of which include sunset clauses and ISDS mechanisms that continue to bolster fossil fuel investments and make it difficult for States to fully implement fossil fuel climate-related measures without the risk of facing legal and financial repercussions. For example:

• Turkey (an ECT Member) has a BIT with France (Turkey-France BIT 2006) that would allow Turkish investors to initiate ISDS against France under similar grounds as under the ECT. 
• Germany alone has 120 BITs (114 are in force) and 78 TIPs (63 are in force).
• Italy has 65 BITs (52 are in force) and 79 TIPs (64 are in force).
• Spain has 68 BITs (60 are in force) and 78 TIPs (63 are in force)
• The UK has at least 96 BITs (85 are in force) and 33 TIPs (26 are in force). 

Importantly, the fossil fuel industry operates within a deeply interconnected market and can find ways to forum shopping. Investors could opt to look beyond the EU altogether and establish operations in countries that are not considering withdrawal from the ECT or that are parties to other regional or bilateral agreements. 

For example, EU Member States made a significant step in 2020 by terminating 190 intra-EU BITs through a single termination agreement. Overall, while this regional reform is commendable and marks a noteworthy starting point, it does not fully resolve key issues. One significant limitation is that it leaves a potential loophole for forum shopping, as the termination only affects intra-EU BITs and does not extend to other investment agreements that EU Member States have with third countries. In the context of the EU, an investor from an EU Member State such as Spain may have investments in France. Given that there is no longer an intra–EU BIT, the investor cannot initiate ISDS proceedings against France. In that case, the investor could restructure their investment by establishing a company in Turkey and transferring their investments from France to Turkey, a non–EU country.

This is one of the many examples that exemplify that a piecemeal strategy — where individual countries or regions implement their own isolated measures — is akin to putting a Band-Aid over a bullet hole. To effectively deal with the issue, a coordinated global approach is needed to ensure the harmonization of policies across nations and align the global investment landscape with climate commitments and obligations. 

Solutions to Neutralize the Sunset Clause and Reform the International Investment Regime

Besides the challenges posed by the sunset clause, there are States that remain in the ECT and others entering into the ECT. The latter trend is rising, especially among developing countries. This development puts at risk their climate action and exposes these countries to ISDS claims that may cripple their economies. 

Although the EU and UK withdrawals are expected to diminish the ECT’s membership, the ECT Secretariat has been actively seeking to expand its membership, particularly targeting developing countries in Africa, Asia, and Latin America. So far, South Africa has been vocal about not joining the ECT, with a former government official stating that “[i]t is a really bad idea for any African country to consider signing up to this particular treaty,” but much more action is needed. 

Besides the ECT, States are bound by a network of thousands of agreements that provide similar legal effects to the ECT. However, a globally coordinated approach to align those agreements with climate commitments and obligations is urgently needed and feasible. Current reform processes are inadequate, as they fail to address substantive issues or take piecemeal approaches, leaving critical gaps that allow for continued fossil fuel protections and ISDS risks.

• UNCITRAL Working Group III: The United Nations Commission on International Trade Law Working Group III on Investor-State Dispute Settlement Reform (UNCITRAL WGIII) has been the primary body tasked to address ISDS reform for the last decade. However, UNCITRAL Working Group III has faced criticism for its slow progress and limited scope in delivering substantial reforms.

The group’s focus has primarily been on procedural improvements — such as enhancing transparency, consistency, and impartiality in arbitration — rather than on the more fundamental changes needed to address broader or substantial concerns, including climate change. Political and procedural complexities stemming from the diverse interests of participating States have slowed the pace of reforms, leaving stakeholders frustrated with the approach and lack of tangible outcomes after several years of discussions. Key climate-related issues, such as the protection of fossil fuel investments, have been left out of the reform agenda. 

• UN Trade and Development (UNCTAD): UNCTAD’s efforts to reform international investment agreements have made some progress, but much of this reform has occurred at the bilateral level, with countries negotiating treaty-by-treaty changes. This fragmented approach has made it difficult to achieve widespread, coordinated reforms that address global challenges like climate change, as the amendments often remain limited to individual treaties without a cohesive international strategy. These treaty-by-treaty amendments have failed to create a cohesive international strategy, often leaving fossil fuel protections largely untouched. 

 

• The World Trade Organization (WTO): Some WTO Members have been actively engaged in developing an Investment Facilitation for Development Agreement. This agreement seeks to enhance investment facilitation procedures and processes among its members, promoting a more conducive environment for investment flows. While the initiative aims to streamline regulations and improve transparency in investment processes, its scope primarily focuses on procedural improvements rather than addressing the substantive issues surrounding investment concerning global challenges, including climate change.

 

• The Organization for Economic Co-operation and Development (OECD): Future of Investment Treaties Track 1 (Investment Treaties and Climate Change) has acknowledged the need for investment agreements to be aligned with global climate goals, especially in light of international commitments such as the Paris Agreement. However, despite ongoing efforts and proposals to terminate agreements, carve out fossil fuels from the scope of international investment agreements (IIAs) or ISDS provisions, or propose other climate carve-outs, these attempts have not materialized at the OECD. 

Addressing Limitations Imposed by the Sunset Clause and ISDS Risks

To address the limitation imposed by the sunset clause and ISDS risks, as well as the fragmentation and inadequacy of current reform processes, governments should consider more coordinated and comprehensive investment law regime reforms. 

First, Parties to the ECT can explore the option of concluding an inter se agreement to neutralize the sunset clause. This legal instrument, permitted under Article 41 of the Vienna Convention on the Law of Treaties, allows a group of parties to a multilateral treaty to modify the treaty’s application among themselves, provided that the modification does not affect the rights of other parties or the overall purpose of the treaty.

The neutralization of survival clauses in IIAs is not without precedent. For example, Argentina and Indonesia reached a mutual agreement to terminate their BIT, reportedly neutralizing the sunset clause by mutual agreement before withdrawing from the treaty. In the context of the ECT, an inter se agreement offers a viable and politically feasible approach to neutralizing legacy arbitration risks between the EU and non-EU ECT contracting parties. IISD, with the support of CIEL and other legal experts, has prepared a model inter se agreement for the modification of the ECT.

Second, some global and regional initiatives demonstrate the potential to reform investment frameworks. However, they show that a coordinated strategy is necessary to avoid policy and reform fragmentation and ensure that substantive matters are addressed in a coherent and comprehensive manner within the investment law regime.

Despite a growing consensus on the need for reform, current reform processes are fragmented, leading to different approaches and scopes. The varying mandates and priorities of different negotiating forums further complicate the coordination or integration of ISDS reform. Therefore, if the world is going to reduce its reliance on fossil fuels and meet its climate objectives, a more proactive approach will be required in the realm of investment agreements and ISDS. 

Toward a Global Solution 

The ECT and its sunset clause are symptomatic of a broader issue: the misalignment of international investment frameworks with climate goals. The climate emergency also calls for urgent action. We do not have the time to amend agreements one by one. Efficiency, predictability, and coherence call for States to work together to find one solution instead of using resources to keep working on a piecemeal approach. 

Which Solution Can Be Effective?

International arbitration tribunals are bound by the terms of investment treaties or contracts, giving them the mandate to resolve specific disputes. Precedents show that tribunals do not always give significant weight to soft law or even judicial decisions. The only effective way to modify the obligations set by an international agreement is through another international agreement that applies between the parties and that retrofits into existing treaty obligations.

This approach is not entirely new. For example, in 2020, EU Member States terminated all 190 intra-EU BITs through a single termination agreement. Similar coordinated actions on IIA termination are emerging in other regions. In Africa, States collaborated on IIA policy and recently negotiated the African Continental Free Trade Area Investment Protocol, which calls for terminating existing intra-African BITs — including their sunset clauses — within five years of the Protocol’s entry into force.

Additionally, the legal mechanisms required to amend existing treaties are now well-established, with several successful examples to draw upon. 

Most recently, in September 2023, the OECD and the G20 Inclusive Framework on Base Erosion and Profit Shifting concluded negotiations on the Multilateral Convention to Facilitate the Implementation of the Pillar Two Subject to Tax Rule. Like the earlier 2016 OECD multilateral tax treaty, this new convention allows parties to incorporate agreed changes into numerous existing tax treaties. The 2016 OECD convention has seen significant adoption, with over 1,900 tax treaties matched for reform as of February 2024.

In the realm of investment agreements, a multilateral or plurilateral agreement presents a viable solution to address key issues in a global, comprehensive, and coherent way. Such an agreement could be crafted as an inclusive framework, which allows for consistent and harmonized obligations across various jurisdictions. Key features should also: 

1. Be legally binding: Safeguards must be legally binding to ensure that those measures are applicable between States. This involves creating clear, enforceable legal provisions that prevent the initiation of claims related to targeted measures, thus securing regulatory space for environmental and human rights obligations. Moreover, it would ensure that ISDS claims targeted measures are dismissed as early as possible, preventing costly and protracted arbitration.
2. Rooted in science and international climate and human rights obligations and commitments: Any reform must be directly linked to international climate and human rights obligations and grounded in the latest scientific knowledge, such as that provided by the IPCC and other authoritative sources. 
3. Effectively remove investment benefits to fossil fuel investments: Given that fossil fuels are the leading cause of the climate crisis, contributing significantly to global warming and environmental degradation, the agreement should ensure that fossil fuel investments no longer receive the benefits provided by investment agreements, including investment promotion, or recourse to arbitration against States under ISDS mechanisms. This would also be crucial to ensure that financial flows are aligned with the goals of Article 2.1(c) of the Paris Agreement.
4. Immediately applicable: The agreement should enter into force immediately for any country that ratifies it without the need for a specific number of ratifications. This would ensure swift action and prevent undue delays in addressing the current misalignment between the benefits that States provide to fossil fuel investments and their climate obligations.
5. If needed, start as plurilateral frameworks with the aim to be multilateral: If a multilateral root is not available in the short term, the path forward could involve initiating a plurilateral agreement with the long-term goal of achieving a multilateral framework. The agreement could establish key principles and legal mechanisms and lay the foundation for broader, multilateral adoption, creating a cohesive and globally coordinated framework that can effectively address the climate crisis. The success of the Paris Agreement, which started with a coalition of willing parties, demonstrates the potential of this approach, which can be applicable in the context of investment law reform.

A Global Mandate for Reform

The EU and UK withdrawals from the ECT are a milestone in climate action, but the fight to align investment agreements with climate obligations and commitments has only just begun. Addressing the sunset clause and the widespread network of investment treaties that favor fossil fuel interests requires urgent, coordinated global action. Inter se agreements and multilateral or plurilateral solutions offer practical pathways to neutralize legacy protections and realign global investment policies with the urgent needs of the climate crisis.

The climate emergency calls for structural reform. By placing climate priorities over entrenched investment protections, the world can break free from fossil fuel dependencies and pave the way for a sustainable future. This shift will require bold leadership and a commitment to policies that promote clean energy and environmental integrity over fossil fuel investments.

Read part one of this analysis at: The EU and UK Withdraw from the Energy Charter Treaty: A New Era for Climate Action