UK energy tax breaks are at odds with cost of living crisis

The government long insisted it was not going to introduce a windfall tax on soaring energy company profits. It has now done one and repeatedly threatened another. All while various ministers mutter that they do not believe in the entire endeavour.

Electricity generators came under government pressure this week to show plans to boost investment in green energy, rather than paying out more to shareholders. This, at least, makes marginally more sense than the same conversation with oil and gas producers.

Big investment decisions in North Sea production are years (if not decades) in the making. Investment or upgrades to green infrastructure like wind or solar farms could possibly be rustled up more quickly. That is if the planning system allowed it, which it does not. And if politicians did not object in nimbyish fashion, which they have a tendency to do.

Threats aside, the question of how technically to extend the oil and gas levy announced in May to generators, given the variety of contracts and generation across the industry, has not been resolved. In any case, the likely future prime minister Liz Truss does not appear keen on the idea.

More generally, the conflation of two policy goals is increasingly unhelpful. The first is the short-term desire to raise more money from sectors seen as making outsized profits to help households survive a period of terrifyingly high energy prices. (And that is something some senior energy figures will quietly concede is justified). The second is the longer-term need to boost investment in gas production for energy security and renewables for both climate and security reasons.

In an attempt to stop the first affecting the second, the government boosted investment incentives as part of its three-year windfall levy. The latter adds a 25 per cent tax on to the existing regime that includes 30 per cent corporation tax on ringfenced profits from the North Sea plus a 10 per cent “supplementary charge”. The overall tax rate at 65 per cent remains below the average globally.

The bolstered investment incentives look somewhat absurdly generous. These were already ample pre-levy: a company investing £100 in North Sea oil and gas could cover £46.25 with a tax deduction. After the new investment allowance is included, the government is effectively covering £91.25 of every £100 spent.

“I struggle to see why you would want to give companies that large a tax deduction,” says Stuart Adam at the Institute for Fiscal Studies. “It is a big subsidy to projects that otherwise would just not be commercially viable.”

This is counterproductive to the goal of raising money to spend on the immediate crisis. It also risks warping incentives to spend on oil and gas (to which the relief is limited) over other options. The reality is that it probably also will not have the desired effect.

The UK heads of BP and Shell last month told a parliamentary committee that the companies would not significantly accelerate their spending plans. “To speed up and slow down is very difficult,” said Shell’s David Bunch.

Louise Kingham added: “We at BP don’t think that the profits levy will impact our investment plans in the North Sea.” That suggests generous tax breaks will largely go on spending that would have happened anyway.

The industry argues, with some justification, that higher investment is needed to sustain the North Sea, after a crash in spending in the pandemic. Of the £26bn of investment opportunities to 2030, less than a quarter is currently approved, according to Offshore Energies UK. But a three-year tax break is not the type of long-term framework needed to encourage decisions (not least because the levy and the investment allowance could yet vanish if prices return to earth). 

The issue with windfall taxes was never that investment instantly evaporates. It is that the sense of unpredictability damps corporate and investor appetite in the future. Neptune Energy’s results on Thursday included a waspish aside that future investment would “favour projects in countries with supportive and stable fiscal and regulatory regimes”.

The government’s investment giveaway sits uncomfortably against the current cost of living crisis, while doing little to help with longer-term priorities around energy security and transition.

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