The windfall tax is changing, but the decarbonisation allowance will remain – suggesting the new government’s priorities.

The Labour Party had signposted an increase to the Energy Profits Levy (EPL) well before it arrived in government. It did not provide an update in the King’s speech, which set out the political agenda for the year. The news came towards the end of July.

The plan is to increase the EPL to 38% as of November this year. This will bring the total tax rate on upstream oil and gas to 78%.

It is the removal of the 29% investment allowance that has caused some consternation among companies in the sector. The government said this allowance was “unjustifiably generous”.

The notice also said it would reduce the “extent to which capital allowance claims (including first year allowances) can be taken into account in calculating levy profits”.

It will provide more details on the changes in the Budget, due on October 30. This will also provide further details of proposals to drive the shift to net zero.

Ideological issue

Industry has largely opposed the changes. Former Serica Energy CEO Mitch Flegg summed up the mood when he said changes were intended to kill the industry.

“If it is some sort of ideological issue here that they want to stop oil and gas production for net zero or for green reasons then they are going the right way about it,” Flegg told Energy Voice.

Serica’s current chairman David Latin called out the uncertainty around capital allowances, in comments on Radio 4. This uncertainty means the sector is “left not knowing how big those may or may not be”.

Treasury Minister James Murray, who visited Aberdeen this week, maintains the government is working to protect jobs. He said the government’s energy transition position was focused “in a way that protects investment and jobs in the energy sector in Scotland”.

Murray held conversations with industry officials during his visit.

Decarbonisation

The EPL does also have another allowance, on decarbonisation. This will be retained. The allowance applies only to capital expenditure and must have the aim of reducing greenhouse gas emissions.

RSM UK head of renewables and cleantech Sheena McGuinness said it was the removal of the investment allowance that will change behaviour in the short term.

“Previously businesses had both options to claim relief, but with the decarbonisation allowance being the last man standing in terms of relief against the EPL it is likely we will see an increase in the amount of relief that is claimed. However, that is different from an increase in spend on decarbonisation expenditure.”

Ithaca Energy and Enquest both noted the decarbonisation allowance in their 2023 reports. Enquest had said it was holding discussions with owners of West of Shetland fields. It said some these owners “could take advantage of the EPL decarbonisation allowance available for this investment”.

Neither company responded to requests for comment on their current plans around the allowance.

Predictably, environmental NGOs have taken umbrage at the decarbonisation allowance. Oxfam, for instance, has criticised the use of the decarbonisation allowance in supporting renewables to power fossil fuel extraction.

Direction of travel

EnergyPathways CEO Ben Clube has talked of how his company sees the upside from the decarbonisation provision.

The government’s changes are “confirmation of the signal that was previously made that conventional oil and gas investment is, let’s say not being encouraged”, he said. “However, investments and projects which are bringing forward solutions for energy transition are still being encouraged with the retention of the decarbonisation allowance in the energy profits levy.”

Clube went on to say retaining the allowance was a signal of the projects that are being supported. “We’ve sought to design and develop our project in a manner that we think is meeting the expectations of the UK government’s plans for energy transition.”

There are signs that decarbonisation plans still find favour. Norway’s SeaTwirl announced an agreement to work on potential floating wind with Serica this week.

McGuinness said the allowance would need to increase to have a real impact. This, she said, would need a “super deduction of tax relief at over 100% of spend, which would incentivise businesses to think about decarbonisation and accelerate progress”.

Book balancing

Treasury will hold further talks with industry as it works to develop the Budget. Murray said the government intended to find a balance between the need to raise revenues and the need to maintain offshore investments.

The government has defended its EPL changes on the grounds it must secure additional revenues for its plans. These include GB Energy.

A number of Conservatives have come out against the windfall tax. Kemi Badenoch, for instance, said she had opposed it while in government, as did Kwasi Kwarteng.

Ed Reed and Kwasi Kwarteng in conversation on the windfall tax

It is certainly easier – from a government perspective – to increase tax, rather than cut it. This is particularly true when considering the challenges to the public purse.

McGuinness said the changes to the EPL may provide a short-term increase in tax revenues.

“Although, this is not reflected in the tax revenue data, which indicates a steady decline. The revenue from this tax has been on a downward trajectory since its inception, seeing a 40% drop between 2022-23 and 2023-24, and a 15% decrease between average quarterly take in 2023-24 versus estimated figures for Q1 2024-25.”

She cited “historical trends” and concerns on the shrinking tax base. These “cast further doubt on the assertion of a £1.2 [billion] per annum windfall tax increase, which the government have ear marked to fund GB Energy”.

Longer-term squeeze

Investment in North Sea oil and gas is likely to fall, McGuinness predicted, which would reduce revenues.

“The likelihood of existing fields bringing forward decommissioning is also a strong possibility, not just because of the change in project economics due to the recent announcements, but also the uncertainty and concern of further adverse changes,” she noted. “Combine this with a reduced buyer pool due to the risk of the existing tax allowances not being transferable to the new owner under the revised regime and the opportunity for investment decreases further.”

Accelerating decommissioning will see the government have to stump up funds. As such, McGuinness warned there were stresses ahead. In the “medium to long term it is likely these will result in an even sharper downward trajectory leading to a greater borrowing need to offset the EPL shortfall that was planned to fund GB Energy”.

The Office for Budget Responsibility (OBR) will provide its next outlook for the economy on October 30. In this, it will pass judgement on the Budget.

The OBR expects EPL receipts to fall as a result of expected lower oil and gas prices and production. The government would find it advantageous to squeeze some additional revenues from the sector. But such a move will exacerbate future stresses.

If the government is serious about safeguarding jobs and investment, balancing out the loss of the investment allowance with an increase in the decarbonisation allowance would be a signal of intent.

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