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Article: January 2020: International Arbitration Update

Business Litigation Reports

Investor-State Dispute Settlement and Renewable Energy

 Investment in renewable energy is currently an important topic for investors, States, and energy companies.  In Australia, a country which is typically associated with fossil fuels, an innovative solar project in the Northern Territory is making headlines.  The Sun Cable project involves a 15,000 hectare solar photovoltaic (“PV”) array near Tennant Creek exporting clean energy to Singapore via a subsea high voltage direct current cable. The project has the support of the Northern Territory government, Singapore's largest independent electricity retailer, and a number of Australia’s richest citizens. Renewable energy is also an important topic for the arbitration community, particularly in the context of the tension between those that are supportive of investor-state dispute settlement to facilitate and encourage investment in renewable energy, and the proliferation of arbitrations in the sector brought by investors against states that, for good reasons and bad, change their renewable energy policies.

            This  update discusses the suitability of existing foreign investment protection regimes, specifically the Energy Charter Treaty, for disputes involving renewable energy.

The Energy Charter Treaty and Investor Protections

            The Energy Charter Treaty (“Treaty”), which entered into force in 1998, has over 50 member states, including the European Union (except Italy, which recently withdrew in 2016), Japan, Russia, Turkey, and Australia (although Russia and Australia never ratified the Treaty). Key to the Treaty’s success in promoting foreign investment in the energy section is its foreign investment protection regime.  By this regime, the Treaty affords protection to “Investors” (being a natural citizen or resident or company incorporated in a signatory country) in “Investments” (broadly defined as every kind of asset owned or controlled by an Investor) in other signatory countries (Articles 1 and 10).  These protections include the Investor’s right to “fair and equitable treatment” (“FET”), “full protection and security”, a prohibition on a signatory country imposing “unreasonable and discriminatory measures,” and “unlawful expropriation” (Article 10).  The FET standard, which primarily involves the protection of an Investor’s legitimate expectations, is the most commonly invoked Investor protection in the Treaty.

Policies Around Renewable Energy Projects

            As governments implement new policies to incentivize investment in renewable energy and discourage the use of traditional fossil fuels, they often run into difficulties with foreign investment protection regimes in their international investment agreements, such as the Treaty and the FET standard.  The economics of renewable energy projects have historically been dependent on incentive schemes (although this is changing as renewable energy becomes more cost-effective).  Owing to the relative novelty of renewable energy projects, as compared with conventional fossil-fuels projects, incentive schemes which encourage these projects are often difficult to effectively design and implement.

The Spanish Experience

            The recent experience of Spain illustrates these policy problems.  In 2007, Spain introduced new incentives to encourage investment in renewable energy, specifically solar PV energy.  One incentive that Spain offered was a feed-in-tariff which principally permitted solar PV investors to sell electricity at a higher rate for the first 25 years, which reduced thereafter for the remainder of the project’s life.  The policies were a great success to encouraging renewable investment. 

            Due to a ballooning tariff deficit, which occurred because the costs of generating and distributing power exceeded what utilities could lawfully recover from ratepayers, and the fallout of the 2008 financial crisis, Spain wound back the incentives in the original regulation.  Initially, the regulatory amendments applied only to new solar PV projects, but as the magnitude of the issue became apparent, Spain acted to apply new and amended regulations retroactively on existing projects.  These regulations took effect over a period commencing 2008 through 2013 with increasing severity.

            Unsurprisingly, the new and amended regulations were not met favorably by solar PV investors who had made their investment decision based an expectation that the incentives would continue for the life of their project.  The key issue for determination by the Tribunal in each of the published decisions is the FET standard and the legitimate expectations of the solar PV investors. As of March 2019, investors had filed over 30 arbitration claims against Spain under the Treaty.  Spain has had mixed success, winning some cases but having to pay out more than €350 million to investors on the cases it lost.  Most recently, in December 2019, two decisions were handed down with Spain winning one and the other resulting in a stalemate.

            Spain is not alone in defending investor-state disputes arising from foreign investments in renewable energy.  Italy, the Czech Republic, and Slovakia have all been the subject of Treaty claims in relation to renewable energy investments.

Investor-State Dispute Resolution and Fitness for Purpose

            Given the commitments that states have made to renewable energy, the question as to whether the investor-state dispute settlement regime is still fit for purpose is a question that many are considering.  To meet climate reduction targets, states are required to act swiftly in both incentivizing investment in renewable energy and discouraging the use of traditional fossil fuels.     In late 2018, the Treaty’s member states gave the green light to a process of modernizing the Treaty.  That process is underway with certain members pushing reforms in relation to renewable energy.  To remain relevant, it would be desirable if the modernization process amended the Treaty to allow states to implement policy to address climate change without falling afoul of the investor protection regime.  This does not necessarily need to come at a significant cost to investors in fossil fuels as the amendments could allow for some fair level of compensation.  An amendment along these lines would go some way towards resolving the tension discussed in the introduction to this note.