United Kingdom

Rishi Sunak’s North Sea levy prompts call for energy tax overhaul

Rishi Sunak’s windfall tax on oil and gas profits is set to break records, showering the UK government with more revenues from the North Sea than at any time since fossil fuel reserves were discovered there over 50 years ago.

The almost £13bn to be raised in total this year exceeds the next highest figure of £10.5bn in 2008-09, according to the Office for Budget Responsibility, the fiscal watchdog. Separate data from HM Revenue & Customs, which goes back further, suggest the windfall will top the highest ever revenues collected in the past, which was close to £12bn both in 2008-09 and in 1984-85, when tax rates sometimes exceeded 80 per cent.

With oil and gas prices rising far higher than anyone expected in the past year, the Treasury has not only found that the North Sea is once again something of a cash cow, but that it is facing calls for a fundamental overhaul of the UK’s taxation of fossil fuel extraction.

Wood Mackenzie, the global energy consultancy, is suggesting that tax rates in the North Sea should vary automatically with the price of oil and gas so that companies would face a predictable system rather than the whims of politicians.

Separately, the Institute for Fiscal Studies criticised Sunak for making the investment allowances in the North Sea too generous so that heavily loss making projects would be viable after tax — doing no good to the environment or taxpayers.

The scale of the change in income from the North Sea is remarkable. From negative net tax revenues in 2015-16 and 2016-17, the chancellor now hopes to raise £13bn, the highest ever in nominal terms.

After adjusting for inflation or as a share of national income, however, the peak of North Sea revenues came in the mid 1980s, helping to finance the Thatcher government’s economic reforms and income tax cuts. At there peak revenues accounted for 3 per cent of gross domestic product, compared with an expected 0.5 per cent in 2022-23.

The Treasury’s hopes of raising £5bn from the windfall tax are based on the OBR’s forecast from the spring that the existing North Sea tax regime would raise £7.8bn this year, assuming an oil price of $94 a barrel and a wholesale gas price of £2.80 a therm.

Market prices have not moved much since then — gas has become cheaper, while oil more expensive — so the main calculation assumed that a 25 per cent surcharge would raise the same amount proportionately as the existing 40 per cent rate, with some adjustments for the slightly different way the new tax will work.

That brings the Treasury’s estimates to £5bn, although the receipts will depend on the path of profits and the level of production this year.

Stuart Adam, senior economist at the Institute for Fiscal Studies think-tank, saw little reason to disbelieve the OBR’s revenue forecast methodology. He said that the 65 per cent total rate of tax on profits was “broadly typical of the historical rates of North Sea taxation since the 1970s”.

Line chart of Tax rates on company profits (%) showing North Sea tax rates will return to more typical historical levels

But even though the new tax rate is broadly in line with the past, oil and gas producers have complained this week that they face destabilising chaos in taxes, which undermines long-term financial planning.

An alternative may be to introduce fixed tax bands in advance — low rates when oil and gas prices are low, higher rates when oil and gas prices are high — so companies have certainty over the rates they will face.

The UK oil, gas and renewables lobby group, Offshore Energies UK, warned this week that windfall taxes risked creating a climate of uncertainty that “could undermine investments for years ahead”.

“Right now, the key task is to prevent a flood of investment formerly earmarked for UK energy projects now being diverted to Norway, Saudi Arabia, and Qatar,” said Deirdre Michie, OEUK’s chief executive.

Wood Mackenzie suggested this week that tax banding would give greater clarity to the sector.

“No oil and gas company is going to come out and ask to be taxed more,” said Graham Kellas, head of fiscal policy. “But tax bands would deliver one thing the industry does ask for, and that’s predictability in the fiscal system to enable long-term planning.”

But the amount of tax taken through the levies could also be lower than predicted, perhaps counter-intuitively, if investment should rise in the North Sea. To offset the impact of the windfall tax, Sunak included a so-called “super deduction” allowing companies to offset up to 91 per cent of taxes paid under the levy against new investment.

This gives companies the option of ploughing their windfall profits into future oil and gas production, boosting UK supply security and potentially lowering prices, rather than handing them over to the taxman.

Adam, at the IFS, was critical of this incentive for oil companies, describing the investment allowances in the new windfall tax as too generous.

“A massively lossmaking investment could still be profitable after tax,” he said, adding that it was, “hard to see why the government should provide such huge tax subsidies and thereby incentivise even economically unviable projects”.

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