Debunking the Myth that ISDS – and the ECT – are Important for a Low-carbon Future

By Rachel Thrasher

The European Union (EU) Commission recently proposed that all EU member countries withdraw as a bloc from the Energy Charter Treaty (ECT), an investment treaty with the specific goal of facilitating investment and protecting investors in the energy industry. The ECT has attracted increasing criticism for its misalignment with Europe’s energy and climate goals, most notably because of a controversial legal tool known as investor state dispute settlements (ISDS), which provides foreign investors the option of pursuing claims for monetary compensation in international arbitration when a government measure negatively impacts their investment. Recent research by the Boston University Global Development Policy Center shows that the possible total liability of ISDS for policies aimed at phasing out fossil fuels under the ECT could be as high as $111.5 billion.

The EU’s potential exit thus presents a huge opportunity for climate action by removing the legal and financial risk of being challenged in international arbitration. However, several key ECT members – both within and outside of the EU – have resisted withdrawing from the treaty.

One reason often cited for countries wishing to remain in the ECT is that ISDS could be used to protect renewable energy (RE) investors from capricious governments attempting to get out of their legitimate legal commitments to protect investors and their property. Others argue that investment agreements like the ECT encourage investment and all possible capital flows – public and private – are vital to restructuring the global economy toward a low-carbon future. 

While it is true that more than a third of all ISDS cases under the ECT have been brought by RE investors, the ECT does not support or incentivize RE investments nor is it essential for a low-carbon future. This argument is a myth, divorced from reality in three ways. First, evidence demonstrates that investment treaties do not generally produce investment and thus energy investment treaties do not produce more energy investment. Second, statistics that seem to show that renewable energy investors are benefiting ISDS protection are skewed, based only on a handful of identical or substantially similar sets of facts. Finally, case studies from Spain demonstrate that the cases were a response to rational government regulation in a crisis, rather than poor or corrupt government action.

The ECT will not bring in new investment

As noted elsewhere, foreign direct investment flows are not correlated with investment treaties, but rather with other country indicators like institutional stability, large consumer base and economic growth. Additional research highlights the ineffectiveness of treaties in accomplishing dual aims of encouraging investment and advancing the rule of law in host countries.

ECT statistics do not show increased reliance on ISDS by RE investors

Although the argument that investment treaties lead to investment has been roundly defeated, ECT supporters continue to assert that, at the very least, these treaties can be used to protect the rights of foreign investors that decide to set up shop in ECT member states.

At face value, the number of ECT cases involving RE investors does seem to signal hope for the possibility of using ISDS to force countries to create a positive investment environment for the investment needed to help complete the energy transition. Unfortunately, these aggregate numbers obscure a more complex truth about RE cases. As of January 2023, 59 percent (93 cases) of all ECT cases involve RE investors – even more than what was claimed by former UK government investment negotiator James Manning. Of those, 49 cases (53 percent of RE cases) were brought against Spain for the same set of measures – scaling back RE incentives due to financial instability brought about by the 2008 global financial crisis and over-saturation of the market. RE investors have brought similar cases against Italy, Bulgaria, Romania and the Czech Republic. Cases against those five respondent countries (Spain included) amount to 54 percent of the total number of ECT cases and 85 percent of those cases are predicated on facts identical to or similar to Spain’s. Table 1 shows the country-by-country breakdown of ECT cases similar to the Spanish cases (described in more detail below) as a percentage of the ECT cases where each country listed is the respondent state.

Table 1: Percentage of ECT cases based on scaled-back RE incentives, by country

Source: Energy Charter Treaty.

The Spanish cases were a response to rational government regulation in a crisis

The Spanish cases are emblematic. Spain had to meet EU renewable energy targets of 29.4 percent renewable energy consumption by 2010 and put in place laws to meet those targets. The primary law was Royal Decree 661/2007, which established “fixed feed-in-tariffs [guaranteed prices] for qualifying photovoltaic facilities, to be paid over the lifetime of the facility, and priority access and dispatch to the electricity grid.”

Implementation was initially wildly successful and within four months the installed photovoltaic capacity was already 85 percent of the target set in the Decree. The downside is that this rapid amount of uptake resulted in a “tariff deficit,” whereby there was a widening gap between the amount that retail customers paid for their electricity and the costs to Spain of the whole electricity system. Spain had to react quickly to avoid strain on the already struggling financial system and repealed the Decree, replacing it with an alternative incentive regime designed to achieve a “reasonable rate of return” for investors. In response to these changes, Spain faced almost 50 ISDS cases. 

What is clear from the data and the facts of these cases is that RE investors have not relied on the ECT to defend their rights against corrupt, capricious or incompetent governments, but to push back against legitimate government regulation during a financial crisis. The ECT is not necessary to encourage investments in renewable energy, nor is it important to protect RE investor rights during the energy transition. Instead, even in these RE cases, foreign investors have sought to protect the economic rights of private firms over the sovereign right to regulate held by national governments under international law.

The story is not yet over. Now that the EU has taken this important step, the European parliament must approve the decision by a “reinforced qualified majority,” which includes “at least 72 percent of the members of the Council representing 65 percent of the EU’s population.” Although the timeline of that vote is not yet determined, EU members states should take seriously the concerns highlighted by the Commission, approving the withdrawal, and other ECT member countries should follow suit.

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