Why the UK windfall tax on energy companies is a good decision - for some

The government’s 25% levy on oil and gas producers will raise $6.3bn to help fund its support package

A smart energy meter, used to monitor gas and electricity use, at a home in London. Rishi Sunak, Britain's Chancellor of the Exchequer, has bowed to pressure for a windfall tax on oil and gas companieShow more

Rishi Sunak, British Chancellor of the Exchequer, bowed to political pressure on Thursday and took an excellent decision. He will impose a tax on “extraordinary” profits from North Sea oil and gas production. This move is great news for energy exporters to the UK.

Excess profit taxes are one of the brilliant energy policy ideas from the 1970s that made the oil crises more painful for consumers and more lucrative for Opec.

The Conservative Party’s Mr Sunak, born in 1980, shied away from being seen to copy the opposition Labour Party’s proposal by calling his scheme a “windfall tax”. But it is.

An extra 25 per cent will be levied on profits on the UK’s offshore oil and gas production, aiming to raise about £5 billion ($6.3bn) this year.

Despite heavy losses in 2020 and 2021 when prices collapsed, companies enjoy no “windfall rebate”: they cannot deduct previous losses or expenditures on decommissioning old facilities against the levy. And if oil prices remain above “historically normal levels”, the tax will continue until the end of 2025.

It is paired with a credit intended to encourage companies to spend on new projects, but this does not apply to reinvestment in renewable or other low-carbon energies.

The tax will help pay for £15bn of support for consumers’ energy bills, £400 per household, more for low-income people.

The UK North Sea is already more heavily taxed than other British businesses, some of which have enjoyed their own windfalls, such as pharmaceuticals. Oil and gas producers pay 40 per cent of profits, versus the standard 19 per cent — even though this level is not high compared to many other oil-producing states. It is a mature and high-cost area where oil and gas output is just a third of its 1999 peak. But new entrants and incentives had kept production quite stable since 2012.

Downing Street needs to be seen to do something about inflation and energy bills, after a series of scandals and local election losses. In the face of total budgeted government expenditure of £1.08 trillion in 2022-2023, the £5bn raised is insignificant. But North Sea oil makes an easy target.

Environmentalists want to end the UK’s petroleum extraction as soon as possible and are sceptical of promises to transition into low-carbon energy. The left-wing detest corporate profits in general, particularly ones that look “excessive”. Public anger over high energy prices has been directed against the “big” oil companies.

But they aren’t so big any more. The “supermajor” oil corporations TotalEnergies, BP and Shell do still occupy the second to fourth places among petroleum producers in the UK, but previous American mainstays, ExxonMobil and ConocoPhillips, have gone.

The leader, Harbour Energy, is a new independent listed company backed by private equity. NEO Energy, Ithaca and Spirit, also independent, bring up the next three places.

These companies, without international assets, rely on their UK cash flow to fund new projects. The windfall tax will gum up the shift of assets from the supermajors to such new operators, who are often more aggressive in investment and maximising recovery from tail-end assets. As platforms and pipelines come to the end of their life, the window of opportunity closes for developing new fields using existing infrastructure.

The tax might stay in place for the next four years — or it might continue or even rise, since the next general election has to be held by January 2025 and the pro-windfall tax Labour Party looks in a good position. This makes it very hard to agree on transfers of assets, or to commit to new projects.

As opposed to complaints about erratic government policy in places such as Argentina and Nigeria, the UK has had probably the world’s most volatile petroleum tax system.

Since 2001, rates have been everywhere from 30 per cent to 62 per cent for new fields, and more than 80 per cent for older fields.

The counter-example is next door: Norway, which has high but stable tax rates, and where estimated investment this year has just been revised up 5 per cent.

Mr Sunak considered a tax on renewable energy producers such as wind farms, some of which are also benefiting from record high electricity prices. As much renewable electricity is already sold on fixed-price deals, it is much harder to identify a literal windfall. But he indicated that electricity producers are next in line.

Investors in renewables, which includes oil companies transitioning into low-carbon, will be concerned about raids on any profits they make deemed “excessive”. And they have abundant offshore wind opportunities in the other countries around the North Sea, as well as in the US.

The package of compensation to energy consumers is better-designed, focusing on less well-off households. But it will still encourage consumption. Energy exporters to the UK can be relieved it did not focus instead on insulating homes, replacing boilers with heat pumps to save gas, or encouraging the purchase of electric cars. About 2.3 million British homes were insulated in 2012, the last year before the government cut support, causing insulation rates to fall by 90 per cent.

So, this legislation is a boost to other global energy producers: Gulf countries, Iraq, Norway and others. The UK may have banned importing Russian oil and gas, but the windfall tax indirectly helps Moscow by disadvantaging competitors and boosting demand. With global oil exports increasingly dominated by Opec+ on one hand and the US on the other, the signal is clear: there is less risk that high prices will encourage a lot of new production.

The package also keeps energy-intensive long-distance imports in play, despite their higher carbon emissions than domestic British production. If new renewable investment is deterred, that helps sustain the UK as a major gas market.

Mr Sunak is understood to have argued hard against a windfall tax before short-term political imperatives forced him to accept it. His approach offers some relief to UK energy consumers at the cost of long-term national and environmental interests. The world’s big hydrocarbon exporters may hope that more of their customers make their life easy by copying Britain’s approach.

Robin M Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis