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Energy Security, Investment Protection and Future Developments

TRANSIT DISPUTES AND

THE ENERGY CHARTER TREATY

Ana Stanič18 September 2008

11th Investment Treaty Forum Public Conference

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Outline of Presentation

1. Transit obligations under the ECT

2. ECT’s DR mechanism in respect of transit disputes

3. Recent transit disputes

4. Why the ECT DR mechanism is not used

5. Energy security and transit: Future Outlook

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1. Transit Obligations under Article 7

• No right to transit or obligation to grant transit

• Transit obligations are imposed on a transit state:

1. take necessary measures to facilitate transit consistent with the principle of freedom of transit (para.1)

2. not to discriminate on the basis of origin, destination or ownership when taking measures to facilitate transit

(para.1)

3. act reasonably: measures adopted to facilitate transit must not result in the imposition of unreasonable restrictions and delays (para.1)

4. Encourage relevant entities to cooperate to increase in capacity and interconnection (para. 2)

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1. Transit Obligations under Article 7

5. No less favourable treatment: when adopting measures concerning transportation and use of pipelines. NB. Quasi national treatment (para.3)

6. Not to place obstacles for the establishment of new capacity (paras. 4 and 5)

7. Secure established flows to, from or between the territories of other states (para. 5)

8. Not to interrupt or reduce or permit any entity subject to its control to interrupt or reduce the existing flow of oil and gas in transit in the event of a dispute over any matter arising from that transit prior to conclusion of conciliation (paras. 6 and 7)

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2. Settlement of Transit Disputes under ECT

• Conciliation under Article 7(7): “in the event of a dispute over any matter arising from transit” a state may refer the dispute to conciliation

• Ad hoc State to State arbitration pursuant to Article 27:All though there is some uncertainty, the better view is that all disputes concerning the transit obligations set out in Article 7 can be referred to

• In particular, if in the event of a dispute over any matter arising from transit a transit’s state interrupts or reduces the existing flows of oil and gas before the conclusion of conciliation such an interruption or reduction can be referred to Article 27 ad hoc State-State arbitration

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3.1 Dispute between Russia and Ukraine

Background

• On-going disputes concerning supply of gas and oil to Ukraine and the transit of gas and oil to Europe

• At present commercial agreements for purchase and transit of oil and gas to Europe are negotiated every year

• Gas Transit War I – January 2006 Gazprom cut gas flows to Ukraine for 3 days due to Ukraine’s

refusal to agree to an increase in price of gas

Once shipment resumed on 4th Jan., Ukraine started skimming gas intended for Europe, supposedly diverted 223.5 mcm

Agreement reached on 4 Jan (further annexes agreed in Oct. 2006)

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3.1 Dispute between Russia and Ukraine

• Gas Transit War II - 3 to 13 March 2008 On 3 and 4 March Gazprom cut supplies to Ukraine by 25%

respectively claiming USD 600 million was owed to it and that no agreement concerning the price of gas in 2008

Gazprom resumed supplies on 5 March No interruption in supplies to Europe Partial agreement reached on 13 March

• Gas Transit War III – July 2008 On 22 July 2008 Gazprom accused Naftogaz Ukrainy of siphoning

off 1 bcm of gas more than its contracted volumes Gazprom claims that USD 2 billion owed to it for supply of gas No interruption in gas supply to Europe

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3.2 Dispute between Russia and Belarus

Background: Similar arrangements concerning supply and transit of oil and gas as with Ukraine

• Gas Transit War I – 18 to 19 February 2004 Dispute over the price of gas paid to Gazprom Russia cuts gas supplies to Belarus Belarus siphons off gas from export pipes for its own use Supply of gas to Poland and Lithuania affected

• Gas Transit War II – Early 2007 End of Dec. 2006 dispute re. 2007 prices to supply and transit gas Gazprom threatened to cut off supplies to Beltransgaz on 1 Jan. Interruption avoided; agreement reached on 31 Dec.

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3.2 Dispute between Russia and Belarus

• Oil War – 3 to 10 Jan. 2007

Belarus introduces customs duty on Russian oil transported by Belarus pipelines in response to export tax on oil imposed by Russia

Transneft refuses to pay duty and accuses Belarus of siphoning off oil destined for Europe as payment in kind for customs duty

Transneft stops deliveries

Belarus blocks oil deliveries to Germany and Poland

Russia announces it will impose custom duties

Slovakia announces it will have to start tapping into reserves unless transit through Belarus resumes. German refineries reduced to operating at 60% capacity

Transneft resumes oil deliveries on 10th Jan.

Agreement resolving dispute signed on 12th Jan.

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3.3 Other Transit Disputes

1. 2006 dispute between Russia and Bulgaria

Under a long- term agreement, Bulgaria received gas in lieu of transit costs

Gazprom wished to increase the price of gas and switch from barter transit to money

Agreement reached at the end of 2006

2. Gazprom/EuroPolGaz dispute: On-going dispute concerning the transit fee charged in respect of the Yamal Pipeline

3. Potential disputes concerning the decision of Russia not to use Baltic ports for export of oil and coal by 2015

4. In July 2008 Russian supplies to Czech Republic through Druzbha pipeline cut by half a few days after the latter Republic signed the missile defence system agreement

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4. Why DR mechanism is not used

1. Article 7(6) trigger too narrow

• Ukraine’s siphoning off of gas does not trigger Article 7(6): Not in response to “a dispute over any matter arising from …transit”

(“Dispute”) Is in response to Russia’s refusal to supply Ukraine with oil and gas,

which in turn due to its failure to pay/debts owed for such gas/oil Even if it had been a response to Dispute, Russia would not have

invoked the ECT

• Russia’s reduction in supply of gas to Ukraine potentially triggers Article 7(6): If Ukraine could show that at least part of the gas originated in one of

the Central Asian countries However, unlikely to succeed since the dispute related to Ukraine’s

failure to agree new gas prices at which Gazprom would supply Ukraine with gas, even though such gas originated from Central Asia

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4. Why DR mechanism is not used

• Beltransgaz interruption of supplies to Germany and Poland potentially triggers Article 7(6) Clearly in response to dispute concerning transit However, neither Russia or Belarus have ratified the ECT

2. The conciliation mechanism is unsatisfactory

• The right to resort to conciliation only arises after all other remedies have been exhausted so the DR process is not fast track

• Given the immediate and severe consequences of interruption and reduction, a 90-day conciliation process to resolve disputes is inappropriate

• Since the conciliator’s role changes if no agreement is reached to that of an

adjudicator, the chances for a facilitated settlement are reduced

• Unclear what happens if no settlement is reached

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4. Why Transit DR mechanism is not used

3. Enforcement of transit obligations accorded to States only

4. Availability of alternative remedies

• Companies involved in transit are able to invoke rights accorded to them under transit/host government and other agreements

• In practice ECT Investment DR mechanism is likely to be a more important tool for addressing transit issues

5. Imprecision of other substantive obligations

• The other transit obligations imposed on states under Article 7 are “soft”, their scope imprecise

• The substantive issues concerning transit such as access to pipeline capacity,right to construct new capacity and ownership of pipelines are not dealt with (only partially addressed in the Transit Protocol)

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5. Energy Security and Transit: Future Outlook

• At the time ECT was negotiated EU saw the issue of secure transit of oil and gas as key to enhancing its energy security

• Future outlook: It seems Gazprom will be successful in securing the purchase of

most of the oil and gas produced in Central Asian countries going forward

Goal posts moved with accession of Central and Eastern European countries

Key transit countries have not ratified the ECT and some not even parties

The Caucasus may no longer be a viable transit route Key oil and gas producing countries not parties to the ECT India and China are fast becoming EU’s competitors for the oil

and gas produced in Central Asia and Russia; they are not parties to the ECT

Growth of LNG as a energy source