Lessons from the Great Recession by Emerald will be published in the Spring, containing my Chapter on Spain’s recent ISDS cases.
I have frequently discussed on this blog the effects ISDS is having on nations in the European Periphery. See here for example for a discussion of a wave of investor claims against Spain for changes in the FiT system.
Do the effects of these actions against Spain, and other actions against states in the European Periphery, depend solely on whether the claimants will be successful? It is possible that from an environmental policy perspective, either way, the situation is unlikely to improve (and by improvement we mean renewed emphasis on pushing forward green energy generation). If the investors are successful, the result is likely to be fiscally damaging (for Spain specifically) and unlikely to further the cause of environmental sustainability. Why would this be, one may ask, considering that a win for green energy investors at investment arbitration will offer legal backing to the drive towards sustainable energy production? The answer is that the fiscal impact of solar incentives (to take this one specific example) is so large, that no state in the European Periphery is expected to fund it in the medium term. A win for the investors in this context will not serve to re-establish a tariff system that favours green energy. What it will do instead is weaken the fiscal position of Spain and possibly deter European nations from investing again in sustainable energy through price support systems. Evidence to support this view comes also from the decision of Italy in late 2014 to notify its intention to withdraw from the Energy Charter Treaty. This is rumoured to be due to the impact the solar claims are likely to have in Spain. The proffered reason, from the Italian side, seems to be cutting the costs of its membership in international organizations due to recent budget restrictions. Yet Italy is likely inevitably to be next in line for the lawyers of solar generation companies due to the 2014 so-called “Spalma incentive” decree which changed Italy’s FIT system. Whether Italy withdraws or not from the ECT is indeed irrelevant to any current claims in preparation, as investor rights and access to ISDS survive any withdrawal from the Treaty for 20 years.
It seems possible therefore that neither a win nor a loss for the investors will advance the spread of clean energy generation in Europe for the foreseeable future. Are investors nonetheless projected to win the argument that their investment has been expropriated, or that they have been treated unfairly? Defining what constitutes a violation of the FET standard and expropriation has been a matter of significant controversy both in dispute resolution fora and in national courts. It is important to remember that expanded definitions of expropriation that include regulatory measures that affect profitability (in an effort to protect investor expectations), harm states’ capacity to govern their sovereign territories and are deemed to constitute part of an emerging global constitutional order that rates market freedoms as more important than other social and political objectives. As we saw earlier however, in the European context at least, there are not many examples of successful actions where investors have complained for non-compensated expropriation with reference to loss of profits, or regulatory measures that adversely affect business prospects. Nonetheless, ISDS Tribunals hear disputes even when the alleged violations have led to losses stemming from measures falling short of outright expropriations and there is consistent case law that considers energy infrastructure investments as coming under BIT definitions of protected investments. We already mentioned that arguments based on economic necessity have hardly swayed tribunals in the case of Argentina. Should we extrapolate that investors suing Spain for the cancellation of photovoltaic subsidies are confident that the Spanish economic collapse did not constitute enough of an ‘emergency’ to lead to a legitimate rewriting of their contracts?
I need to re-emphasise here that these actions may not coming to tribunals because investors expect to win substantial amounts in compensation. Rather, they could be surfacing at increasing volumes because of the political leverage they create. Countries battling economic crises, like Greece, Spain, Italy and Cyprus, need investors on their side. As Argentina has discovered, keeping investors complaining for a decade old default, is not conducive to market stability. Perhaps investors are paying their lawyers good money, not to gain compensation, but to keep the shadow of a Griesa type judgement over European policy makers, hoping that this forces settlements. Shifting focus from investors to policy makers, we see the huge challenges investment treaty arbitration can pose for Spain and the rest of the European Periphery. Investment treaties have the effect of locating the sanctity of property and contract (together with definitions of human rights that include the un-assailability of individual property rights) in constitutional-like structures that are impossible -or near impossible- to amend. The market protective framework is then completed by the subsequent creation of ‘politically independent’, international dispute resolution mechanisms that can bypass government legislation that allegedly violates corporate and investor rights. This legal/ institutional framework safeguarded by investor friendly tribunals means that regulatory reforms are very difficult to implement if they offend the basic pro-market politico-economic status quo. This is the case even if reforms aim at fiscal consolidation, shying away from more radical socially targeted reforms.
In short, the investor protection framework is leading to resistance to policies aimed at combating the crisis. It is for this reason why Investor-State Dispute Settlement clauses are so controversial, as evidenced in the widespread reaction against the proposed TTIP. Indeed, governments should be weary of ISDS. As the experience of Spain shows, litigating in Court is not the same as arbitrating at ICSID. The reason is that Courts have to take into account public policy considerations. Investment tribunals do not. One has to ask whether there is a compelling interest in handing dispute resolution over major state-corporate deals to a body that does not have to worry itself with the common good. Would a solar energy firm such as those mentioned in earlier posts, win a case against Spain? It may well do, but perhaps a more pertinent question is to ask what the fiscal impact of a favourable decision will be for the prospects of recovery in the European Periphery.
No doubt that the last three years have been quite busy for the Energy Charter Treaty (ECT) and for the Energy Charter Conference.
The number of investor-state arbitration cases under Article 26 of the ECT doubled in this time span, going from thirty known cases to sixty-eight (as reported on the website of the Energy Charter Secretariat). Thanks to the “solar claims” against Spain and the Czech Republic. The “solar claims” relate to a series of measures taken by these states which retrospectively reduced the tariffs in the solar energy sector (the “feed-in tariffs”) and withdrew other incentives and benefits. Other states which adopted similar measures, such as Italy (already facing one “solar claim”), Romania and Bulgaria are expected to have the fate of Spain and the Czech Republic. The “solar claims” also brought an interesting development – much discussed under the provisions of the ICSID Convention -, which is the number of claimants in a single procedure. In PV Investors v. Spain (UNCITRAL Rules), a group of 16 investors commenced arbitration against Spain.
See here for my blog post on ISDS claims against Spain.
At the very end of 2014, rumors circulated that Italy was considering withdrawing from the ECT. Time has passed and although there is no official confirmation with the Energy Charter Secretariat, numerous sources confirm that, indeed, on 31 December 2014, Italy notified the ECT Depository (the Government of Portugal, according to Article 49 of the ECT) of its intention to withdraw from the ECT. Although there we voices claiming that such action was motivated by the potential high number of “solar claims”, apparently, the real reason was Italy’s budgetary constraints and, in particular, the substantial contribution to the budget of the Energy Charter Secretariat of EUR 450,000 starting with 2016 (see Law no. 190 of 23 December 2014). What are the consequences of such withdrawal? It is worth mentioning here that the ECT faced a similar situation in August 2009 when Russia, at that time applying the ECT on a provisional basis, notified the Depository that it did not intend to become a Contracting Party to the ECT. In that case, the provisions of Article 45 applied. Since Italy is a Contracting Party to the ECT, the provisions of Article 47 of the ECT are relevant. Under this Article, the withdrawal takes effect upon the expiry of one year after the date of the receipt of the notification by the Depository, i.e. 1 January 2016. Nevertheless, the provisions of the ECT shall continue to apply to investments made in Italy by investors of other Contracting Parties and to investments made by Italian investors in other Contracting Parties to the ECT for a period of twenty years as of the effect of the withdrawal (the so-called “sunset clause”). Given this provision, it is unlikely that Italy decided to leave the ECT because of the threat of the “solar claims”. (Especially since Italy also has a large number of BITs which would offer similar protection to the investments in the solar energy sector.) Perhaps the real concern following Italy’s withdrawal is the prospect that other states, in particular EU Member States, would follow Italy’s example and leave the ECT.
But looking at the bright side of the Energy Charter Treaty and Process, on 21 May 2015, over 65 states and organizations, including the EU and EURATOM, signed the International Energy Charter. The International Energy Charter is a political declaration aiming at strengthening the energy cooperation between the signatories, having as objectives (a) to facilitate the expansion of the Energy Charter Treaty and Process; (b) to modernize the European Energy Charter (which currently has sixty-six signatories) (c) to support political cooperation and early accession of observer states to the ECT etc. The International Energy Charter reflects the geopolitical realities and the challenges of the 21st century (remembering that the European Energy Charter was adopted in 1991, when, just to give an example, the renewable energies were not among the priorities of the signatories), such as the need of diversification of energy sources and routes, the role of energy trade for sustainable development, the role of the developing countries in the global energy security etc. As to the promotion and protection of investments, the International Energy Charter provides, in line with the provisions of the European Charter, that the signatories will make every effort to remove all barriers to investment in the energy sector and provide for transparent legal framework for foreign investments, in conformity with the relevant international laws and rules on investment and trade. In addition to the European Charter, the International Charter affirms the importance of full access to adequate dispute settlement mechanisms, including national mechanisms and international arbitration.
After Russia’s farewell, many rushed to place the bets on the end of the ECT and of the Energy Charter Process. Even with the withdrawal of Italy from the ECT, facts show that the agenda of the Energy Charter Secretariat is busy and perhaps the best is yet to come for the ECT.
Read my full assessment of Spanish Solar claims here: http://ssrn.com/abstract=2511222
Spain is facing a critical situation with pretty much every foreign investor in the energy sector running to investment arbitration to claim compensation for recent changes in the legal framework. Spain fully embraced Photovoltaic (PV) energy through the first half of the 2000s and by 2008 it was responsible for half of the world’s solar power facilities in terms of wattage. The FiT in Spain consisted of the implementation of a regime by which each kWh of electricity produced from renewable sources was paid to the producer at a special price – higher than the market one. In addition, renewable energy producers received preferential treatment and could sell all their electricity to the grid at the prices agreed. This system had its origins in the legislative framework for early renewable technologies instituted in the 1980s (Law 82/80 for Energy Conservation). Since then, a variety of instruments have been used to support the development of renewables, mainly legislative measures and financial support. The history of legislative initiatives is as follows. The renewable energy framework received a significant boost in 1997, through the Electric Power Act (Royal Decree 2818/1998), and in the mid 2000s with Royal Decree 436/2004. This reform was completed with the liberalisation of energy markets, considered to be one of the most significant innovations with effects on renewable energy generation (Royal Decree 436/2004), bringing market mechanisms to the field of energy production and distribution. The liberalisation of the sector however coincided (perhaps contrary to economic theory which pre-supposes a drop in prices after processes of de-monopolisation) with a strong rise in electricity prices. In order to ameliorate pressures on consumers, especially households, the Spanish system was revised in spring 2007 by the introduction of the Royal Decree 661/2007.
The reform described above came right before the general economic downturn caused by the banking crisis which hit Spain in 2008. The financial crisis, which began in 2007 and deepened in 2008, hastened the end of Spain’s expansive fiscal cycle and triggered a severe adjustment of the imbalances accumulated during the previous decade. It is generally agreed that the rapid deterioration of the international macroeconomic context highlighted the structural weaknesses of the Spanish economy, especially after 2008. Betting on a growth model heavily dependent on domestic demand, and more specifically on construction and property development activities, has proved to be (predictably one might argue) a failure. Despite the impression during the boom years that Spain was growing due to reform and openness to markets, the disproportionate growth in the real estate sector, coupled with the expansion of credit needed to finance it, lay at the basis of severe economic imbalances. The massive credit granting to construction and property development activities caused an excessive exposure of the banking industry to those sectors. This exposure was the means of transmission of the housing crisis to the banking sector, whose business was very constrained by the inadequate risk policy and the deficits of supervision of the pre-crisis period. While this crisis was one of private indebtedness, the state sector was not immune to its effects. Spanish sovereign debt went from 40% of GDP in 2007 to more than 100% of GDP in the first six months of 2013.
The financial downturn in late 2008 had major repercussions for Spain’s energy market. The pricing crisis in electricity was caused by the fact that Spain’s system capped end-user prices of electricity to several consumer groups under a regulated tariff system. With the generation costs rising faster than the tariff during the crisis years however, this system generated a huge tariff deficit that the government owed to utilities, estimated at billions of Euros already in May 2009. As a response, the government gradually reduced the eligibility for the tariff, and since the beginning of 2009 moved to revise (repeatedly) the whole tariff system to ensure costs are covered. Despite efforts at reform however, the government’s growing deficit in its energy budget had already reached around €4.5 billion by 2012. Considering Spain’s deteriorating fiscal position, due to support to the collapsing banking sector, the gradual removal of FiTs, cutting subsidies and capping the rate of return for investors, were the only fiscally viable options.
As the above presentation suggests, Spain’s regress from its commitment to support renewable energy generators did not stop with the 2007 Act. In November 2010, the Spanish government published Royal Decree 1565/2010, which limited the entitlement of solar photovoltaic plants to the incentive feed-in tariff (under Law 661/2007) to the first 25 years of operation, later extended to 30 years (Organic Law Complementing the Sustainable Economy Law of 4 March 2011). These new rules would probably result in lower project-life revenues for PV plants, which after the reform were limited to selling electricity on the spot market as of year 31 of operation, rather than benefiting from the (already reduced) incentive feed-in tariff that was provided for in Royal Decree 661/2007. In addition, in December 2010, the Spanish government published Royal Decree 14/2010 which imposed a production cap for solar generation, retroactively affecting existing PV plants. This latter law limited the maximum annual number of hours of operation on a regional scale for plants registered under Royal Decree 661/2007 and Royal Decree 1578/2008. Plants entitled to the particularly beneficial tariff under Royal Decree 661/2007 became subject to an even lower uniform cap from 1 January 2011 to 31 December 2014. These measures, which were finally approved by the Spanish parliament on 10 March 2011 after a turbulent legislative process, are blamed for jeopardising the financial viability of many existing PV projects because of their immediate financial impact.
The changes noted above show the extent to which the regulatory framework in Spain changed in just the space of a few years as regards renewables. Yet, notwithstanding the significant interventions already discussed, these were not the end in this list of regulatory changes. On 12 July 2013, the Spanish Council of Ministers approved a package of urgent legislative measures aimed at eliminating the apparently intractable Spanish electricity tariff deficit. On 13 July 2013, the Spanish Government approved Royal Decree 9/2013 which abolished entirely the special regime having its origins in the 2007 law and replaced it with a new remuneration system. As a consequence of the adoption of Royal Decree 15/2012 and Royal Decree 2/2014 Spain is now in a situation where the feed-in tariff system has been abolished. The last intervention to the legal framework to date, Royal Decree 413/2014, approved in June 2014, implemented the FiT cuts and provided guidelines on the calculation of solar PV project income. This is now to be assessed separately per project and is based on a series of parameters that take into account a plant’s ‘efficient operation.’ The parameters were established via a separate ministerial mandate in July 2014. The effect of this latest change is that renewables installations will receive the electricity market price plus ‘specific remuneration’, until they are capable of competing in the market. Under the new ‘specific remuneration’ scheme, renewable energy installations will be paid on the basis of their installed capacity and their exploitation costs and not by reference to their electricity production. The new remuneration scheme is intended to enable a ‘reasonable return’ which is calculated by reference to a ‘standard facility’. That is to say, the proposed remuneration is to be calculated as a market price differential. Such ‘reasonable return’ will be calculated by reference to the average yield of 10-year Spanish Government Bonds on the secondary market plus a spread. Finally, the new remuneration scheme will be backdated to 14 July 2013. Thus appropriate adjustments might be made on feed-in tariffs already received, giving rise to backdated collection rights or payment obligations for adversely affected companies.
It is understandable therefore that PV generation companies view the Spanish scheme, as it stands at the moment, as a significantly less attractive business proposition, compared to its original versions, including its 2007 incarnation. Spain’s FIT reductions already triggered significant asset impairments, which motivates investors in solar and wind energy to launch international arbitral proceedings to claim economic loss. To learn more about ISDS actions against Spain, click here.