Windfall Tax Case Study

On the one-year anniversary of the United Kingdom’s windfall tax announcement, Energy in Depth examines the negative impact the tax has had on the North Sea oil and gas industry and continued investment.

The policy, which effectively brings the total tax on oil and natural gas production in the United Kingdom to 75 percent, has resulted in reduced investment and cancelled projects, ironically raising prices even higher for consumers.

Implementation of the Windfall Tax

On 26 May 2022, the Energy Profits Levy – also referred to as the windfall tax – was announced by then-Chancellor Rishi Sunak. The levy was originally 25 percent and was introduced as a temporary and targeted tax for oil and gas companies.

At the time, the government said that the levy was introduced following record-high oil and gas prices over the past year – driven largely by geopolitical factors and inflation – and that it would help to lower the cost of living for UK families.

In November 2022, Chancellor Jeremy Hunt announced changes to the EPL, increasing the rate of tax to 35 percent and stating:

“I have no objection to windfall taxes if they are genuinely about windfall profits caused by unexpected increases in energy prices. But any such tax should be temporary, not deter investment and recognize the cyclical nature of energy businesses.

Taking account of this, I have decided that from January 1st until March 2028 we will increase the Energy Profits Levy from 25 percent to 35 percent.”

When the EPL is added to existing levies, it brings the total taxes on oil and gas production to 75 percent, one of the highest rates in the world and by far the highest tax rate for any business sector in the UK.

In 2022/2023, the oil and gas industry is estimated to pay £7.8 billion in tax along with an additional £5 billion for the first 12 months of the EPL. That’s $9.7 billion USD and $6.21 billion USD, respectively.

The Fallout, So Far

When the UK Government announced the further 10 percent hike to the EPL, Offshore Energies UK (OEUK) warned that the UK offshore industry would be “hit hard”.

David Whitehouse, the chief executive of OEUK, said 95 percent of members had been “negatively impacted” by the levy and were “looking to invest elsewhere,” threatening to drive up imports and leave consumers increasingly exposed to global shortages.

Since then, supermajors, mid-sized operators, and smaller independents have all voiced concern regarding the new fiscal environment.

TotalEnergies, Equinor, Shell, and EnQuest all plan to reduce UK spending this year, while Harbour Energy blamed the tax changes on its recent job cuts.

Reports have also indicated that some of the planned greenfield projects, such as Ithaca Energy’sWest of Shetland Cambo development, may now also be in jeopardy of reaching a final investment decision (FID) due to the EPL.

Energy Companies Pull Investment

On 2 December 2022, France’s TotalEnergies SE, the second-largest operator in the North Sea, announced it would no longer invest around £100 million ($124.3 million USD) in its Elgin gas field, east of Aberdeen, marking a 25 percent decrease in planned spending.

More recently, Shell announced it was pulling out of the Northern Endurance Partnership, one of Britain’s largest CCS projects aimed at decarbonizing industrial clusters. This came after the UK’s National Grid quit the same NEP project in the North Sea.

EnQuest has also deferred drilling at its Kraken oilfield, while U.S.-owned Apache cancelled a drilling contract in the North Sea, arguing the tax had made the region “less competitive”.

Announcing its results for the 2022 Financial Year, Harbour Energy, the North Sea’s biggest producer, said the company would seek to invest and expand internationally because of the backdrop in the United Kingdom, after paying in UK windfall tax since it was introduced. The company also blamed the EPL as the reason behind its decision to cut 350 jobs.

Chief executive, Linda Cook, commented:

“The UK energy profits levy, which applies irrespective of actual or realized commodity prices, has disproportionately impacted the UK-focused independent oil and gas companies that are critical for domestic energy security. For Harbour, the UK’s largest oil and gas producer, it has all but wiped out our profit for the year. This has driven us to reduce our UK investment and staffing levels.”

Tax Triggers Political Divisions

Although some senior Tories previously opposed the introduction of a windfall tax, the Conservative Party bowed to external and internal pressures to launch the EPL in May 2022. Shadow Chancellor Rachel Reeves initially heralded a win for the Labour party which she said was “winning the battle of ideas” in Westminster.

While initially reticent, the Conservatives not only introduced a 25 percent levy last Spring, but also increased this to 35 percent in January and announced it will run until March 2028. But one year after the windfall tax came into play, and with a general election due to take place in 2024, Labour has called for significant changes to the structure of the scheme – despite the sizeable burden the tax is placing on the industry.

The party has made no secret of its stance on oil and gas; speaking at the World Economic Forum in Davos, Sir Keir Starmer MP declared there would be no new investment in the sector under Labour.

Regarding the EPL, the party has been vocal about its desire to drastically alter the current model. Earlier this year, Rachel Reeves set out ambitious plans when she said a Labour government would “extend the windfall tax, closing the fossil fuel investment loophole, and taxing oil and gas giants at the same rate at which they’re taxed in Norway.”

Reeves claimed that making these changes, coupled with backdating taxes to 2022 “when oil and gas giants were already making historically large profits”, would raise more than £13 billion ($16.1 billion USD).

Labour has taken particular issue with a perceived loophole that allows companies to reduce the amount of tax they pay if they invest in new UK oil and gas exploration. For every pound companies invest in their UK oil and gas business, they can write down their tax by 91 percent. In addition, Labour has said the tax should also apply to profits made from activities such as refining oil, and petrol and diesel sales. Under the current model, taxes are only levied on profits made from extracting UK oil and gas.

Following a record-breaking results season, with companies reporting record profits, senior Labour MPs re-iterated the need to rework the EPL.

However, an increase in the EPL would risk breaching global tax agreements and would not provide the help to consumers that the Labour Party claims it will.

For global oil and gas producers, UK operations will typically be just a fraction of their overall portfolio and they have more ability to scale up their operations in more competitive regions.

For smaller producers, however, the impacts of the EPL is being felt more acutely and the tax is directly impacting independent UK domestic oil and gas operators,

As the EPL is a blanket tax and does not consider the size or scale of the company, it hurts smaller producers the most – jeopardizing their ability to invest in their UK portfolio and decarbonization initiatives.

The Importance of North Sea Investment to the UK

The North Sea continues to play a significant role in the UK economy and is expected to for decades to come.

While the United Kingdom has seen an increase in the use of renewable energy, it still relies on gas and oil for 75 percent of its energy because of the intermittency of wind and solar power and limited battery storage.

In 2021, the United Kingdom’s offshore oil and gas industry produced the equivalent of 38 percent of the nation’s gas and 82 percent of the nation’s oil.

Crucially, the North Sea industry contributes significantly to the social and economic development of the United Kingdom, supporting 215,000 jobs, including 90,000 jobs in Scotland alone, and providing £28 billion ($35 billion USD) economic value per annum.

However, continued lack of investment driven by the EPL would see production fall by 80 percent by 2030, increasing reliance on imports, putting UK energy security at risk.

North Sea producers are also spending £30 billion ($37 billion USD) this decade on offshore wind projects that would nearly double UK capacity – demonstrating the industry’s commitment to support the ongoing energy transition.

If producers are forced out of the North Sea because of the UK government’s onerous tax burden, the impact will be felt across the country. While the UK government claims they do not want the tax to deter investment, its impact is clear and there will be a ripple effect across the industry – from supply to job losses to renewables capability.

Bottom line: One year in, the Energy Profits Levy is causing considerable harm to the North Sea oil and gas industry – while consumers are seeing little benefits and investment is shrinking, threatening everything from jobs to decarbonization initiatives.

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