Project finance transactions in Europe in the energy field will be heavily influenced by the signing of the Energy Charter Treaty in December 1994.
The treaty is an exciting and ambitious development in global energy policy arising from three years of negotiations between 50 countries. It will come into force as soon as 30 contracting parties have ratified it, which is unlikely to be before the end of 1995. However, the treaty will come into force temporarily as soon as it is signed, except in states whose internal constitutional provisions do not allow this.
The treaty enshrines the principles of the European Energy Charter – a code of conduct drawn up in 1991 to ensure greater security of energy supply and to promote the creation of a large European energy market, with due regard to the protection of the environment. The treaty will have its own supervisory body – the Charter Conference and binding dispute resolution procedures.
The treaty aims to provide a legal framework to promote long-term co-operation in the energy field and has several aims. It addresses investment, trade, sovereignty over resources, transit, dispute settlement, environmental issues and technology transfer.
* Investment Protection
Promotion and protection of investment is one of the central aspects of the treaty. Closely linked with this is the provision of support for the programmes of market reform in Central and Eastern Europe.
In order to encourage foreign investment, some of these states have already begun legislating in the energy field. However, in some cases the legislators' lack of understanding of a market economy has meant that some key concepts are left undefined and decision-making powers have been split between different government and local authority departments, thereby providing ample opportunity for disputes. Until now, foreign investors have had to negotiate terms on a case-by-case basis. The lack of clarity has in some cases produced a negative public perception of foreign investment and privatisation.
The principles of protection of investment have only been developed in outline in this treaty. Stage two of the negotiations envisages a supplementary agreement being entered into within three years to govern the application of national treatment to the making of investments (ie treating foreign investment on terms no less favourable than those afforded to domestic investors).
'Investment' is widely defined by the treaty. Every kind of asset can be an investment which falls into a number categories: property; companies, enterprises etc.
The treaty only applies to investments existing at the date of entry into force of the treaty and only in respect of matters affecting them after that date. Investments must be associated with an economic activity in the energy sector.
The treaty requires contracting parties to encourage stable, equitable, favourable and transparent conditions for foreign investment. This requires that laws, regulations, administrative rulings and judicial decisions should be made public in an accessible manner.
The treaty deals with compensation arising from conflict or national emergency; and deals with expropriation. Host states must provide effective compensation for losses, whether by restitution, indemnification, compensation or other settlements.
The treaty recognises a state's right under limited circumstances to lawfully nationalise or expropriate property. However, expropriation must be in the public interest and without discrimination.
* Freedom to transfer payments
Investors must be free to transfer payments related to the investment into and out of contracting states. This will include capital for development and maintenance, revenue, payments under contract including loan interest and principal, remuneration of employees engaged from abroad, proceeds of sale or liquidation of an investment, settlement proceeds and compensation.
* Key personnel
Contracting states must allow investors from other contracting states to employ key personnel of their choice regardless of nationality or citizenship subject to the necessary work permits. Such a work permit policy can be crucial in developing good relations between an investor and a host government.
* Other aims
While protection of investment is arguably the most important objective of the treaty, it also aims to liberalise trade in energy by stimulating expansion of transmission grids, interconnection, removal of trade barriers and enforcement of a right of transit.
* Liberalising trade
The treaty is intended to facilitate trade in energy consistent with GATT by establishing an open market for energy products and services; by increasing access to resources and capital markets, technologies and transmission infrastructure; and encouraging removal of non-tariff barriers to trade.
It also encourages co-operation on energy policy by allowing mutual access to technical and economic data; formulation of transparent legal frameworks; co-ordination of safety policy; and exchange of information and know-how.
The treaty requires member states to promote access to local, export and international markets for trade in energy, materials and products. Non-tariff barriers are to be progressively removed and price formation is to be based on market principles.
Trade in energy products and services is brought within the GATT rules, except where the treaty explicitly provides otherwise. Where states are not yet members of GATT, trade relations will be governed by transitional rules based on a skeletal version of GATT.
The incorporation of GATT rules will apply a number of principles to the energy sector including: no discrimination against products in transit on the basis of countries through which they may have passed; quantitative restrictions are to be eliminated except in the interests of conserving exhaustible resources or of national security; subsidies will become notifiable; and tariff levels will be frozen.
The dispute resolution mechanism involves a reference to a GATT panel in relation to matters within GATT's jurisdiction, otherwise an ad-hoc tribunal can be formed.
In addition, the treaty addresses environmental considerations by requiring in Article 22 that non-member states strive to minimise harmful environmental impacts in all operations in the energy cycle. This must, however, be done in an economically efficient manner. Similarly, member states should strive to take measures to prevent or minimise environmental degradation.
The treaty will undoubtedly help lift constraints on investment. However, its success will depend upon successful ratification in 30 member states and on a subsequent agreement on national treatment.
Geoff Haley is a partner in SJ Berwin & Co and was part of the official delegation to Moscow in October 1994 on the European Energy Charter.