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The Judgment in the Permanent Court of Arbitration in the Yukos

case in July 2014 marks the end to any hope that Russia will

return to the Energy Charter Treaty Process. Discuss.

In July 2014 the permanent Court of Arbitration gave the final

decision in a series of cases commonly referred to as ‘Yukos1’,

with the ruling finding that the Russian Federation had acted

contrary to Energy Charter Treaty, by expropriating the

investment of the Yukos Oil Company. The decision was the

latest chapter in a continually unstable relationship between

Russia and the Energy Charter Treaty process. While Yukos

represents a sizeable victory for the jurisdictional power of

the ECT it should not be viewed as the end of Russia’s

involvement in the process, as the future of their energy

trade holds a great deal of uncertainty and there are a

variety of ways in which it would be bolstered by the legal

certainty provided by the ECT. The vital need for foreign

investment, the falling price of oil and gas and the emergence

of alternative sources of energy all provide incentive enough

to persuade Russia to reconsider its 2009 withdrawal from the

process, irrespective of the decision in Yukos.

The legal ramifications of the recent decision should be

considered alongside earlier the 20092 decision by the

permanent court of arbitration tribunal to allow the claim

1 Hulley Enterprises Limited v. The Russian Federation (PCA Case No. AA 226), Yukos Universal Limited v. The Russian Federation (PCA Case No. AA 227), Veteran Petroleum Limited v. The Russian Federation (PCA Case No. AA 228), July 18 20142Hulley Enterprises Limited v. The Russian Federation (PCA Case No. AA226), November 30, 2009

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which was made despite the withdrawal of provisional

application of the ECT by Russia. The tribunal applied article

45(1)3, which provides that signatories provisionally apply the

treaty as long as there is no conflict with domestic law,

therefore Russia was still bound by the treaty and all

investments made prior to the withdrawal are to be protected

for twenty years as per 45(3). This, coupled with the final

decision and $50 billion final award show that the decision to

withdraw from the ECT is ineffectual as a means of escaping

obligations, but also restricts Russian access to the

advantages of ECT membership, a situation described as ‘the

worst of all possible worlds’4.

The Russian dissatisfaction with the terms of the ECT had

emerged far in advance of Yukos, many of which related to the

transit provisions5 and later, the proposed changes made in the

draft transit protocol. The view from Russia was that the

provisions would function in a manner that was contrary to

their interests6, and would allow central Asian competitors,

particularly Kazakhstan and Turkmenistan access to existing

infrastructure in order to supply Europe with cheaper gas,

potentially undercutting Gazprom. However, the Russian

interpretation of the transit regulation was misguided, as the

Treaty explicitly states that it ‘does not oblige any

3 45(1) Energy Charter Treaty4Alan Riley, The EU‐Russia Energy Relationship: Will  the Yukos Decision Trigger a Fundamental Reassessment  in Moscow? (2010) 2 IELR 36‐405 Art 7 ECT6Talseth, LC. ‘The EU-Russia Energy Dialogue: Travelling Without Moving’ (2012) Working Paper FG 5 2012/01 April 2012 SWP Berlin < http://www.swp-berlin.org/fileadmin/contents/products/arbeitspapiere/talseth_20120402_KS.pdf > accessed 9 November 2014

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contracting party to introduce mandatory third party access ’7.

The clause in the draft protocol regarding REIO8 has also

proved to be a sticking point for Russia as this would change

the character of transit to an issue of internal transport,

which would be governed by the EU. This is viewed unfavourably

by Russia as it would find itself subject to the rules of an

organisation which it is not a member of and not able to

influence9 and has been described as rendering the Russian

relationship with the ECT as ‘blocked forever’10.

The benefits of having a legal framework to regulate the

energy industry have not been overlooked by Russia with an

attempt at trying to redress the perceived faults of the

treaty coming in the shape of the Draft Convention11. Presented

as an alternative to the ECT, the draft has been criticised as

reflecting the Russian position on the ECT and being too

narrow in its focus. Some of the alterations offered by Russia

are completely counter to aims of the EU, namely the anti-

monopoly competition rules and as a result this is unlikely to

be accepted by ECT members. Furthermore, the amount of time

that has gone into developing the ECT, both in its current

form and through proposed modernisation12, it does not,

therefore seem feasible that the process would be abandoned

in favour of the Russian proposition. The points of contention

7 Preamble to the ECT8 Regional Economic Integrated Organisation 9Doran Doeh, Sophie Nappert and Alexander Popov, ‘Russia and the Energy Charter Treaty: Common Interests or  Irreconcilable Differences?’ (2006) 7 IELTR 189‐19110 Talseth, loc. cit.11 The Draft Convention on International Energy Security 12 The Road Map for Modernisation of the Energy Charter Process (2010)

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that Russia have with the existing process would be better

negotiated within the existing framework of the ECT.

Aside from the reasons for the rejection of the ECT there are

far more compelling reasons for Russia to reconsider its

stance. Russia is a main supplier of oil and gas for many ECT

members, particularly the EU and this position of power has

allowed Russia to wield influence over regional politics with

examples of this coming in the Ukraine and Belarus. As recent

as this year, the price hike placed on gas to the Ukraine as a

result of the Crimean crisis has illustrated the willingness

of Russia to politicise its energy production. However, the

relationship between Russia and other member states cannot be

simplified as one of one way dependency but ‘one of

interdependence…which means that Russia needs (the EU) as much

as (the EU) needs Russia13. In terms of gas export markets, the

EU is by far Russia’s largest, accounting for 40% of the

federal budget14. Ensuring the security of this market should

be a top priority for Russia and in order to do so, there

needs to be a solid legal framework regulating the trade.

While the ECT is not solely an arrangement between EU states,

it is important to consider the impact that the treaty has on

the relationship between the EU and Russia as such a large

proportion of the trade is made between the two. Continuing in

this vein, the benefit of the ECT process for Russia is all

the more pertinent when considered alongside the changing

landscape of the global market.

13 Umut Turksen, Euro-Vision of Energy Trade With Russia: Current Problems and Future Prospects for EU Solidarity in Energy Trade, (2014) Vol. 12 Issue 4 OGEL p. 714 Ibid.

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The proficiency of unconventional gas production in the United

States continues to grow to a point where the US produces more

gas then it imports and unconventional sources account for

over half of domestic production15. As a consequence, there is

a surplus of LNG which, when combined with the projected

increases in global LNG production over the coming years, is

expected to lead to not only a fall in the price of gas but

also a decline in Russia’s market dominance of Europe16.

Furthermore, Europe is expected to follow the lead of the

United States and begin to exploit the estimated 35tcm of

unconventional gas across the continent, an amount which is

approximately two-thirds of the total Russian gas reserve17,

moving Europe further away from being energy dependent on

Russia. Gazprom have invested heavily in both Nordstream and

Southstream pipeline projects in an attempt to directly reach

markets throughout Europe, circumventing the requirement for

transit through the Ukraine. However, this is an expensive

strategy which adds cost at a time of increasingly precarious

profits and leaves Gazprom at the mercy of the changing

market. The transit protocol which Russia had so vehemently

rejected previously may in fact be the better business option

as it offers the protection of the ECT dispute resolutions18 It

appears that Revisiting the ECT would support an

‘internationalisation of the Ukrainian pipeline network’19 and 15Mikhail Levinbuk and Vasily Kotov, Changes in the Structure of Consumption of PrimaryEnergy Resources in the USA One of the Challenges to the Energy Security of Russia, (2014) Vol.12 Issue 4 OGEL16Alan Riley, The EU/Russia Energy Relationship: Will  the Yukos Decision Trigger a Fundamental Reassessment  in Moscow? (2010) 2 IELR 36‐4017 Ibid.18 Energy Charter Treaty 7(7)19 Riley, Loc. Cit

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a lowering of costs, allowing for a more competitive Russia in

the future.

If Russia is to remain competitive as a supplier to the region

there needs to be vast investment in the development of new

fields as there is a decline in the previously abundant gas

reserves in the Nadym Pur Taz region. These new fields,

particularly those in the remote Yamal peninsula in Siberia

are characterised by arduous climatic conditions, in addition

to vast distances from the consumer 20, all of which creates a

high cost for both the extraction and transit of the gas,

estimated to be in the region of $200 billion21. Furthermore,

as Russia moves toward development of its infrastructure,

there is a requirement for improvement in the existing

electricity generating capacity, with an estimated $550

billion worth of investment needed in that sector22. The source

of this much needed investment is uncertain as the current

global economic climate ‘remains fragile…and financing energy

investment will certainly be more difficult’23 in the future.

Domestically, Russia has found its economy devastated by

falling prices of late 2014 and it seems unlikely that this

capital could be raised, which points to a reliance on foreign

investment to facilitate the aforementioned projects. Given

the series of events leading to Yukos, any prospective

investors would likely be concerned for the security of their

20 5521 Milov, Russia and the West: The Energy Factor (Washington DC: CSIS, 2008), 1022 Think Bric! Key Considerations for Investors Targeting the Power Sector of the World’s Largest Emerging Economies-Russia(Moscow, KPMG: 2009).23 Riley,loc. cit

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investments in the Russian energy sector. In order to

encourage investment, a return to the ECT may be the most

appropriate step, especially considering the effectiveness of

the investment protection of article 10, demonstrated in Yukos.

As the EU and the wider world make strides toward energy

security, there is a very real possibility of Russia losing a

once strong bargaining position in the formation of a new

system to regulate the transport of and investment in energy.

The existing structure of Gazprom’s business, which is based

on long term supply contracts is in danger of falling foul of

market liberalisation policies under the EU’s third policy

package, which further exemplifies the need for Russia to

produce gas for cheaper. While Russia and China have recently

agreed large supply contracts for gas, this deal will not

start flowing until at least 2018, meaning that Russia cannot

afford to sever ties with the ECT members in the meantime.

Yukos will damage the pride of Russia from a legal and

political point of view but given the position it finds

itself, somewhat isolated politically and not guaranteed of

its short to mid-term financial stability, the ECT process

should remain on the radar in Moscow and attempts should be

made to influence the process while there is still some

influence to use.

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Bibliography

Case Law

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1. Hulley Enterprises Ltd. (Cyprus) v. The Russian

Federation. PCA Case No. AA 226. Permanent Court of

Arbitration

2. Yukos Universal Limited v. The Russian Federation. PCA

Case No. AA 227

Journal Articles

1. Belyi A. (2009). A Russian Perspective on the Energy

Charter Treaty. ARI. Real Instituto Elcano.

2. Belyi A. (2011). Modernising the Energy Charter Process?

The Energy Charter Conference Road Map and the Russian

Draft Convention on Energy Security. Vol. 9 Issue 5, OGEL

3. Doeh D. et al. (2006). Russia and the Energy Charter

Treaty: Common Interests and Irreconcilable Differences?

7 IELTR 189-191

4. Koloplyanik A. (2007) Energy security: the role of

business, governments, international organisations and

international legal framework. 6 IELTR 85-93.

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5. Koloplyanik A. (2009). A Common Russia-EU Energy Space

(The New EU- Russia Partnership Agreement Acquis

Communautaire , the Energy Charter and the New Russian

Initiative). Vol. 7 Issue 2 OGEL.

6. Koloplyanik A. (2014). What is the Future of Russian Gas

Strategy for Europe after the Crimea? Vol.12 Issue 4 OGEL

7. Kotov V. and Levinbuk M. (2014). Changes in the

Structure of Consumption of Primary Energy Resources in

the USA One of the Challenges to the Energy Security of

Russia. Vol.12 Issue 4 OGEL

8. Riley A. (2010). The EU-Russia Energy Relationship: Will

the Yukos Decision Trigger a Fundamental Reassessment in

Moscow? 2 IELR 36-40.

9. Szlagowski P. (2010). Review of the ‘New Legal Framework

for Energy Cooperation’ and Dispute Resolution Mechanisms

in Energy Transit. 5 IELR 147-154

10. Turksen U. Euro-Vision of Energy Trade With Russia:

Current Problems and Future Prospects for EU Solidarity

in Energy Trade, (2014) Vol. 12 Issue 4 OGEL

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Working Paper

Lars-Christian U.Talseth , ‘The EU-Russia Energy Dialogue:

Travelling Without Moving’ (2012) Working Paper FG 5 2012/01

April 2012 SWP Berlin <

http://www.swp-berlin.org/fileadmin/contents/products/arbeitsp

apiere/talseth_20120402_KS.pdf > accessed 9 November 2014

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