International Investment Treaties: Curse or Blessing for the Energy Revolution? – Part II

This article was written for the University of Westminster.

International law on the protection of foreign investment may impose excessive constraints on the freedom of states. But without international treaties, global companies may not invest in foreign countries – think about security, change in political administrations, shift in public perception, etc. This applies especially for the energy industry where contracts are signed for long-term periods. So: Are International Investment Treaties (IITs) a curse or a blessing for the governments and their plans for the energy revolution?

Read part one to learn more about the history and function of International Investment Treaties.

Why IITs are essential for foreign investors

It is understandable that a private company needs certain securities when making new investments. As described in the first chapter, this security is provided by national laws in its own country. However, if the investment is made abroad, other levers must be used. Of course, the company can also sue abroad directly at the national court if it feels unfairly treated. However, this is often regarded as too little objective – because ultimately even the most objective national court still represents the interests of its country. For this reason, IITs have been developed which guarantee the foreign investor greater security, fair and equitable treatment and the protection of expropriation – and at the same time define the framework conditions for an appeal. Most IITs give the investor the right to sue the host country directly at an international arbitration court – often the ICSID in Washington. As an independent body, this should serve to ensure a fairer arbitral award. In the energy industry, very large investment sums are often required to build up the sector. This applies equally to the oil industry, nuclear energy, and for renewable energy sources (e.g. on- and offshore wind farms). These high sums mean that the break-even point lies in the far future. For this reason, contracts in the energy sector are usually very long-termed and often guarantee rights for several decades. The companies are thus profiting very strongly from IITs, as they minimize the threat of a large economic loss due to changed political conditions. In Europe, this usually proceeds under the responsibility of the ECT. The next paragraph describes a concrete case which is currently pending at ICSID and involves two European parties: The Swedish energy company Vattenfall AB and the Federal Republic of Germany.

In 2011, Japan was struck by a tsunami that caused a nuclear catastrophe at the Fukushima reactor. For weeks, newspapers were full of new articles about this nuclear accident and the public perception about the “dangerous nuclear energy” manifested itself. In Germany, this debate led the government to add the 13th Amendment to its Atomic Energy Act. The 13th amendment stated to phase out nuclear power until 2022 and to shut down the oldest reactors in the country immediately (The Federal Office for Radiation Protection (Bundesamt für Strahlenschutz – BfS), 2013), although the official runtime was not yet over. This had consequences for some German energy operators and also for a foreign investor. Vattenfall AB, the national Swedish energy group, held large shares in two nuclear power plants which were asked to shut down immediately (Bernasconi-Osterwalder and Dietrich Brauch, 2014). For Vattenfall, this decision meant severe cuts in its business activities. This becomes obvious when analysing the company’s key figures for the German market, Vattenfall employs over 6,000 workers and achieved a turnover of € 6.19 billion in 2016. In addition, nuclear energy is responsible for over 40% of the company’s energy production matrix. While the German companies had to sue at the Bundesverfassungsgericht (national court), Vattenfall was able to choose a different path and submitted a request for arbitration at ICSID in May 2012. Vattenfall invoked three provisions in the Energy Charter Treaty (Bernasconi-Osterwalder and Hoffman, 2012):

  1. The provisions for protection against expropriation without compensation
  2. The obligation on fair and equitable treatment and the non-impairment through unreasonable or discriminatory measures
  3. The duty to observe any obligations vis-à-vis an investor or investment (umbrella clause)

The secretary-general of ICSID registered the request and agreed to be responsible for this issue (ICSID, 2019). Case No. ARB/12/12 was set up and now deals with the claims arising out of Germany’s enactment of legislation to phase out nuclear power plants in the country by 2022. The claimed sum is estimated to be around € 4.8 billion, however, since most negotiations are taking place behind closed doors only little is known and the claim, in reality, could be substantially higher. According to the arbitration rules of the ICSID convention, both parties, the claimant (Vattenfall AB) and respondent (Germany) appointed one arbitrator each and agreed jointly on a president (Albert Jan van den Berg). Over the next few years, the court gathered evidence and held negotiations with both parties, with the first official arbitration attempts finally taking place in Washington in October 2016. This, as a matter of fact, was broadcasted live. Apart from that, the public is in the dark and although it was expected that the arbitration would be swift, the court has not yet come to a decision. This is mainly caused by Germany, which repeatedly tried to delay the court’s decision (application to have all arbitrators disqualified) and even tried to withdraw jurisdiction from the ICSID (based on the ACHMEA verdict by the Court of Justice of the EU). All those attempts failed, though, but it shows how uncertain Germany is about the outcome of the tribunal.

This case study displays in what a difficult situation a foreign investor in the energy sector can find itself in if host countries make short-term changes to legislation due to changing environmental situations. Although this specific case may only be linked to the energy revolution to a limited extent (nuclear energy is rather clean), it becomes clear what a dilemma both parties can find themselves in. In addition to a large financial loss for Vattenfall, there is more at stake. For instance job security and general uncertainty about future investments, and also their general reputation in Germany. It is difficult for a company to explain to its customers in the host country why they are suing the host country for damages, which would consequently be paid with taxpayers’ money. The next chapter shows the advantages and disadvantages of IITs from the point of view of the host country and will again use the Vattenfall AB vs Federal Republic of Germany case to illustrate the impact.

Opportunities and threats for countries’ energy transition plans

Foreign Direct Investment (FDI) can provide a great service to a country in both the short and long term. Of course, this applies to different sectors of the economy, but it is of high importance to the energy sector. Especially energy-exporting and developing countries, which do not have the necessary capital themselves, may benefit as foreign investors can boost the energy sector, improve the economic performance, create jobs and thus improve welfare. But energy-importing countries, too, are dependent on investors who often do not come from their own countries. Think, for example, about expensive gas pipelines, the operation of nuclear power plants and, more recently, the development of renewable energy sources such as wind farms, solar and thermal power plants, or also hydroelectric power plants. Last but not least, investors often bring with them urgently needed knowledge and technologies that are simply not available in the host country. As explained in the previous chapter, contracts with investors are usually concluded on a very long-term, ensuring that the business is worthwhile for the investor. And this is where the challenges for the host country begin. Political, economic, ecological or social situations may change quickly, and the host country must adapt its framework conditions. While the local companies have to adapt to these changed conditions and have to resort to the national court in case of replacement claims, the foreign investor can invoke international law under the conditions described in the previous chapters. The next paragraph takes up again the case study of Vattenfall AB v. the Federal Republic of Germany and shows this time the perspective of the host country.

Nuclear energy has always had a hard standing in Germany as Appunn (2018) describes. 28.000 people occupied the construction site of a new reactor in Wyhl in 1975, 200.000 people demonstrated in Hannover and Bonn in 1979 after the Three Mile Island accident in the USA. The Chernobyl catastrophe in 1986 further fuelled the fear of a nuclear catastrophe in Germany. And in the 1990s, there were more demonstrations devoted mainly to final storage sites. As we can see from a political point of view, nuclear power plants have been a hot potato for a long time. The Fukushima catastrophe in 2011 consequently brought back the fear of a nuclear accident in Germany. At the same time, intensive discussions took place on how to achieve the energy revolution and how to move the best towards a low-carbon economy (Appunn, 2018). Having all this background, the Bundestag (German parliament) decided in the same year to carry out a radical nuclear phase-out, whereby eight plants were ordered to shut down immediately as well as all others until 2022. Over 80% of the parliamentarians voted for this request, which was added as the 13th Amendment to the Atomic Energy Act. Various newspaper polls showed that a large majority of the population agreed with this policy, too. In the industry, on the other hand, this decision was controversial, especially of course among the participating energy operators, who accused the federal government of breaching existing contracts. Those national energy companies subsequently sued the Federal Republic of Germany at the Bundesverfassungsgericht (German Federal Constitutional Court) and, some four years later, in December 2016, were partially justified. The court ruled that the 13th amendment was at least partially unconstitutional, but not an expropriation (Bundesverfassungsgericht, 2016). However, the court also found that “accelerating the nuclear energy phase-out and thereby limiting the residual risk associated with nuclear energy was a legitimate objective. Furthermore, setting fixed end dates and striking the previously granted additional electricity output allowances were suitable means to fulfil this objective” (Gesley, 2016). As already described in detail in chapter two, a foreign investor, Vattenfall AB, decided to file a complaint before the ICSID. The officially known claim amounts to € 4.8 billion, which is an extremely high sum even for an economically strong country like Germany. The outcome of this case is elementary for the country on several levels. In addition to the financial outlay, politicians will have to explain why they neglected or oversaw contracting rights of private companies while voting for the 13th amendment. Also, the question is raised as to what extent international law takes precedence over German law, which allows Germany to carry out its energy revolution in a self-determined manner. In the future, Germany would like to separate itself not only from nuclear power but also from coal power and may run into similar issues. If ICSID should rule against Germany, the verdict may have a significant influence on how Germany will administer its energy policy in the upcoming years. And not only Germany is concerned by it, the other signatories of the ECT, too, wait for the judgement, fearing that they may have to deal with similar complaints soon. Italy, as an example, announced to withdraw from the ECT and literature identifies the recent wave of ECT arbitrations and the fear of lawsuits as one of the reasons (Iacob and Cirlig, 2016). However, Italy does not get off easily as the ECT, as many other BITs and MITs, contains a so-called sunset clause. Article 47(3) states that “the provisions of this treaty shall continue to apply to investments made in the area of a contracting party by investors of other contracting parties or in the area of other contracting parties by investors of that contracting party as of the date when that contracting party’s withdrawal from the treaty takes effect for a period of 20 years from such date.” This widespread clause was established to safeguard investors right in a fast-changing political climate and means that Italy will still have to face potential legal claims for almost the next two decades (Iacob and Cirlig, 2016).

Conclusion

Does international law on the protection of foreign investment impose excessive constraints on the freedom of states to regulate their energy sector in the national interest? And are IITs more of a curse or blessing for the Energy Revolution? This essay has attempted to shed light on those two questions while analysing different perspectives and also highlighting the interests and fears of the parties involved. For foreign investors, disputes usually involve financial losses and security aspects. Points that have been assured to them contractually, and often in the long term. And for their country of origin, it is a matter of ensuring that national companies can also be protected abroad to the best of their ability. For the host country, one might argue, there is much more at stake. With increasing frequency, they have to justify themselves before international arbitration tribunals and more often they have to pay out high awards. The outcome of the described case study is also eagerly awaited by other nations because it can have a fundamental influence on their energy revolution strategies, too. If Germany is found guilty, the planned energy transition could be postponed by years. This puts developed countries, in particular, in a dilemma because they have signed internationally binding agreements such as the Paris Agreement and committed themselves to reducing greenhouse gas emissions and to working towards a low carbon economy with appropriate measures. In the current situation, it can, therefore, be argued that IITs such as the ECT have a negative impact on the energy transition and thus stand in sharp contrast to the climate change debate. However, one can also argue the other way around and say that it is IITs that make global investments in renewable energy sources possible and thus taking a central role in a rapid energy turnaround.

In my view, the answer to the opening question is “yes”: International law, linked with the signing of IITs and potential ISDS cases, can indeed represent a major hurdle for states, especially in the energy sector and in the context of climate change. The implementation of set climate targets can actually be slowed down by international law, and the question arises whether the well-being of multinational companies should take a higher priority than the well-being of the planet earth. Finally, companies may also be accused of having been passive about the energy revolution for too long and of actually having had the chance to prepare for legislative changes a long time ago. Moreover, it is legitimate to ask how “fair and equitable” international arbitration tribunals are for local companies which cannot appeal to these courts. And last but not least, it is difficult to have to explain to the public that under international law their taxpayers’ money is invested in awards for foreign multi-million dollar corporations. The growing criticism on the impact of ISDS claims from the point of view of the host country is therefore justified, so yes, international law on the protection of foreign investment imposes excessive constraints on the freedom of states. And yet I believe that IITs are important for the economic development, for supporting developing countries, for the energy revolution, and that it can increase overall welfare. They provide a clear framework, increase security for investors and define the rules of the free market (Iacob and Cirlig, 2016). They make it easier for knowledge, technology, and capital to be available worldwide, and for several decades IITs have been relatively uncontroversial and very useful. The fact that international arbitration courts are responsible for dealing with those claims rather than national courts, and hence apply international law, is also justified. National courts can hardly judge objectively in such important cases, especially since in some countries of the world there is no classical separation of powers, as is customary in democratic countries. It is also a fallacy to believe that a country can simply withdraw from treaties and then lull itself into a sense of safety from international lawsuits. As this essay showed, sunset clauses often oblige countries to comply with existing treaties for a further 20 years.

I would like to conclude this essay with a final look at climate change and the energy revolution, which is so important for it, arguing that while international law can generally restrict national governments, it is still a blessing. Because just as the ECT is subject to international law, so was the UNFCCC, the Kyoto Protocol and now the Paris Agreement. In my view, international law will play a major role in the future in achieving jointly formulated climate targets and sustainable development goals. Schrijver (2011) describes climate change as one of the greatest challenges currently facing international law. As early as 2008, the UN published a report stating that global warming may have implications for human rights. The rise in sea levels may also shift maritime borders and several island states risk losing their entire land. Last but not least, climate change also entails high costs and the question arises as to what extend the main perpetrators of climate change can be fined for these costs. All these issues will ultimately have to be regulated by international law if we want to tackle the climate challenge together.

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