How to tax in an energy crisis
Whether the government wants to maximise North Sea oil extraction or home grown renewables, tax policy can help, says Tim Sarson
Recent global events seem to have a knack of happening in places that send energy prices through the roof. Last time it was the loss of piped gas from Russia into Europe. Now it’s the long-feared choking off of the famous Straits of Hormuz.
In both cases the shock caused by an international conflict has led to inflationary pressure which, as sure as night follows day, soon becomes a fiscal headache for the government. That fiscal headache gets people talking about our energy policy again. And before long the talk turns to tax.
There are two reflexive political positions on how to deal with a hydrocarbons supply shock. One, let’s call it the “drill baby drill” response, is to blame our vulnerability on the collapse in North Sea oil and gas extraction and too much policy focus on net-zero. The other says au contraire: this shows how important it is to wean ourselves off volatile fossil fuels on to home grown renewables.
It seems to me that these options need not be mutually exclusive, but my aim today isn’t to opine on the right approach to combating climate change and relieving household bills. It’s to consider how our tax policy can and should adapt to nudge things along.
First, let’s consider the North Sea. Government policy on licences for new exploration and drilling has a long-term impact on UK production and potentially on energy security, though likely not on the actual oil price – and it’s what most of the recent debate has focused on. But there are existing operational fields that are not actively investing. For those, the economics are more important. Companies invest and expand production when their modelling shows it’s profitable to do, or more profitable than using the same capital in a different way.
North Sea profits are subject to a “ring-fence” tax regime, as is common in most countries with oil and gas extraction. On top of the main ringfence corporation tax rate of 30 per cent there is a supplementary charge of 10 per cent with some specific adjustments, and since the Ukraine war we’ve had a 38 per cent windfall tax, the Energy Profits Levy (EPL), on ring-fence profits less financing and decommissioning costs. That makes for a very high overall rate of around 78 per cent, but it’s not unique. Norway, much quoted in recent debates, has a rate almost identical to that of the UK.
That’s where the similarities end. Norway’s regime has been stable for decades; ours keeps jumping around, and we’ve had a “temporary” windfall tax for several recent years when there were no windfalls, making production uneconomic for many.
Stability helps companies to make long-term decisions. The industry and government have been consulting over a form of stabilisation mechanism which would seem to make much more sense. Tax would broadly go up when oil prices are high, but come down when they fall.
Norway also does more to share risk and reward with drillers. If you invest money in a Norwegian field and end up in loss, then some of that gets refunded to you by the government. That creates a symmetry between support at the investment stage and high taxes when the field comes good.
What’s uncontentious is that UK oil and gas production has materially declined, almost halving since 2019, while Norwegian output has grown substantially
Would introducing a new windfall tax regime to give more long-term certainty get us pumping again, and improve our foreign exchange balance? Almost certainly yes. Would it bring in more tax revenues to the Treasury, or leave a hole in our finances? Hard to say without seeing the Treasury modelling. But what’s uncontentious is that UK oil and gas production has materially declined, almost halving since 2019, while Norwegian output has grown substantially.
Renewables
Over, then, to renewables. It’s a high priority of this government and the last. Yet whilst there is substantial support for the sector through Contracts for Differences (“CFDs”) and other support mechanisms, the same priority really isn’t reflected in the tax system. Your corporate tax rate is reduced if you hold a patent, but it doesn’t matter whether that’s a patent for a nuclear fusion flux capacitor fed entirely on potato peelings, or a new type of coal-powered generator.
In this we are outliers. Last February the EU launched its Clean Industry Deal that supports tax measures to stimulate investment in clean technology and renewables. But member states had already been on the move. To take just two of several examples, since 2024 France has given a 20-45 per cent tax credit for expenditure on assets for renewable energy production and storage; Finland has a 20 per cent credit for broadly the same type of investment. And across the Atlantic not only did the last US administration roll out a huge credit programme for renewables, but Canada has got in on the act too.
Would a renewables-targeted tax credit or super-deduction be value for money? It would certainly send the right signals. It’s a little early to see the emissions impacts of recent measures elsewhere, but we can see the uptick in capex in the data. And that’s good anyway, isn’t it? Measures that can boost growth and investment, suppress inflation and increase our resilience to future shocks are the definition of not letting a good crisis go to waste.
Tim Sarson is head of tax policy at KPMG