Columnists: Sarah Keay-Bright, SKB International Energy & Environment Consulting

Published on: 25 Feb 2019

Energy Charter reforms – Recognising DSM as an investable energy resource

This year, countries that have signed or acceded to the Energy Charter Treaty (ECT) and the Protocol on Energy Efficiency and Related Environmental Aspects (PEEREA) – including all EU countries except Italy - are discussing policy options for Treaty reform. What does this mean for demand-side management (DSM) investments, including energy efficiency, demand response and strategic load growth?

The current design of the Treaty discriminates against DSM investments such as insulation and intelligent building management systems. Reforms must also address a whole host of other well-known issues associated with disputes between investors and states. In the end, ditching the Energy Charter for alternatives may be the better option for efficiency and a sustainable energy future

The Energy Charter process was set up at the end of the cold war to enable economic cooperation in the energy sector between the former Soviet Union, its Central and Eastern Europe satellite states and the EU. Over the last 20 years, membership of the process has expanded globally. When countries accede to the ECT, they also accede to PEEREA – both were first signed in 1994 and entered into force in 1998. The Protocol is a non-binding legal instrument providing high-level principles and guidance to promote improved energy efficiency and reduce environmental impact across the whole energy value chain.

The principles and guidance on energy efficiency set out in PEEREA are robust and still hold today though the concept of flexible energy consumption is absent. Even so, that the Protocol describes energy efficiency “as a considerable source of energy” illustrates thought leadership in its drafting during the 1990s. Unfortunately, this was not matched by the hard law of the ECT concerning investment protection provisions as they do not regard DSM measures, which reduce or shift energy consumption, as an investable energy resource for energy sector market actors.

The ECT’s investment protection provisions are intended to address political and regulatory risks. They grant investors with rights that safeguard against specific political risks including discrimination between foreign and domestic investors, expropriation and nationalisation, breach of individual investment contracts, damages due to war and similar events, and unjustified restrictions on the transfer of funds. The Treaty only protects investments once established, at which point they are protected for 20-years even if the country leaves the ECT. Investment protection and investors’ rights are enforced through the Treaty’s state-state and investor-state dispute provisions (ISDS), involving arbitration in various international courts.

DSM is explicitly excluded from the ECT’s investment protection provisions. To fall within the ECT’s protection provisions, an investment must be associated with economic activity related to supplying “energy materials (or) products”. The latter is a defined list of fuels such as coal, lignite, oil, gas, nuclear fuel and electricity, among others. The list does not include any materials or products related to managing energy demand and the economic activity definition makes no reference to managing the consumption of these materials or products. Energy efficiency investments in the value chain up to the point of supplying the customer (“supply-side efficiency”), however, are covered.

At the time of drafting the Treaty, demand-side energy efficiency investments were regarded as belonging to the building, industry and transport sectors, not the energy sector. A “charter efficiency project” concept was therefore incorporated into the ECT to enable the protection of demand-side energy efficiency investments. It is unworkable, however, as countries must notify each investment to the Energy Charter Secretariat and there exists no functional mechanism to enable such notifications. Indeed, the approach is surely impractical given the scale of investment needed in DSM and furthermore unfair as this requirement is not imposed on supply-side energy resources. 

Investment in DSM at the pace and scale needed, if a least cost energy transition is to be achieved, cannot possibly be delivered without the help of the private sector, including international corporations. Managing and mitigating political and regulatory risks will certainly be important for some of these investments.

Treaty reform options might include redefining economic activity in the energy sector but the complexity and integrated nature of demand-side energy markets and investments makes it difficult, if not impossible, to draw a boundary around the energy sector. In delivering sustainable energy investments, the dividing lines between economic sectors are becoming increasingly blurred as end-use sub-sectors of the energy sector expand and all sectors begin to invest in sustainable energy. This is a good reason not to delineate an energy sector boundary for the purposes of applying investment protection provisions and begs the question of whether an investment treaty dedicated to the energy sector is at all appropriate for the future.

Given that the ECT is the most frequently invoked International Investment Agreement (IIA) in the world, the last thing many countries might want to do is expand the scope of the Treaty to include more energy resources. In addition, member countries that are energy producers will be concerned about security of energy demand. For some time, international institutions and NGOs, such as UNCTAD, IISD, TNI and Client Earth have been calling for reforms to International Investment Agreements, including the ECT, to address the imbalance of investors’ versus states’ rights and the legitimacy, transparency, impartiality, independence, accountability and high costs regarding investment protection provisions and the ISDS process. As energy efficiency investment is reliant on strong policy, ensuring Treaty reforms give Governments enough regulatory space will be particularly important. To add to this, it is necessary to ensure a level-playing field between different types of energy resource and investor (small/large, foreign/domestic, incumbent/new entrant) as this is essential to achieving an affordable and secure sustainable energy future.

Treaty amendments can generally only be adopted if members present and voting are unanimous in their support. Countries should therefore be ready to evaluate the ECT against alternatives, which do exist.

Other columns by Sarah Keay-Bright