If the oil and gas industry was hoping for some kind of Budget boost, it was sorely disappointed.
Chancellor of the Exchequer Jeremy Hunt announced that the Energy Profits Levy would be prolonged by another 12 months to March 2029, which he estimates will raise an extra £1.5billion for HM Treasury.
He justified the move by stating that because energy prices are ‘expected to last longer, so too will the sector’s windfall profits.’
Windfall levy: Oil and gas companies pay a headline tax rate of 75 per cent on profits from North Sea oil and gas production
While he also vowed to abolish the tax should market prices retreat ‘to their historic norm for a sustained period’, the levy’s extension raised further question marks regarding the UK’s attractiveness for investment.
Tumbling oil and gas prices, combined with eye-watering tax rates, have already significantly impacted the profits of energy producers and given them less incentive to drill in the North Sea.
Things could potentially worsen if the Labour Party wins the next General Election, as current polling suggests, and implements what it calls a ‘proper’ windfall tax.
But whether or not that happens, could the existing windfall tax cause the North Sea oil and gas industry to shrink faster than originally anticipated?
What is the Energy Profits Levy?
Calls for a windfall tax mounted in early 2022 as energy prices soared in response to loosening Covid-related restrictions and Russia’s invasion of Ukraine.
Oil and gas firms already paid a 40 per cent headline tax rate, but mounting cost-of-living pressures led to considerable public outcry as soaring prices supercharged profitability.
Then-Chancellor Rishi Sunak succumbed to pressure and introduced a ‘temporary’ levy on the profits made from North Sea production.
Extension: In his recent budget speech, Chancellor of the Exchequer Jeremy Hunt announced that the Energy Profits Levy would be prolonged by another 12 months to March 2029
Initially set at 25 per cent, Hunt increased the EPL to 35 per cent in January 2023, meaning oil and gas producers pay a headline rate of 75 per cent.
At the same time, they can claim back over 91 pence of tax relief for every £1 they invest in new UK oil and gas extraction.
In addition, the windfall tax will no longer apply if oil prices average $71.40 per barrel and gas £0.54 per thermal unit for two consecutive quarters.
The EPL raised an extra £2.6billion in its first year of operation, approximately half the amount HM Treasury predicted, although total government revenues from North Sea oil and gas output still shot up over sixfold to £9billion.
Are oil and gas businesses still making windfall profits?
Skyrocketing energy prices provided a much-needed financial rejuvenation for the UK petroleum sector following huge losses in the first year of the pandemic.
In 2022, oil supermajors BP and Shell doubled their full-year earnings to a record £23billion and £32.2billion, respectively.
Mid-cap players posted similarly impressive results: Ithaca Energy tripled its pre-tax profits to £2.2billion, while fellow mid-cap firm Harbour Energy saw a comparative eightfold rise to $2.5billion.
However, Harbour’s total post-tax profits shrank to $8million, versus $101million the prior year, due to the group setting aside a $1.5billion charge related to the EPL.
For 2023, the Edinburgh-based company saw its profits virtually wiped out again by the levy, with a $597million pre-tax profit becoming $32million after tax.
Britain’s largest independent oil producer, EnQuest, blamed the EPL for swinging to a $21.2million loss in the first six months of last year.
BP and Shell are still posting healthy results, but a small fraction of their business is North Sea-based, so the windfall tax does not seriously impact their bottom line.
But many British oil and gas firms with significant North Sea operations are now struggling to turn a profit, so they are hardly reaping a windfall at the moment.
‘The industry is being taxed on windfall profits that no longer exist,’ says Ross Dornan, a market intelligence manager at trade body Offshore Energies UK, which vehemently opposes the levy.
Extraction: Harbour Energy saw its pre-tax profits rise eightfold to $2.5billion last year. But it made just $8million after tax due to setting aside a $1.5billion charge related to the EPL
How has the windfall tax affected oil and gas investment?
While energy prices remain higher than their historical average, oil and gas companies with a North Sea presence almost universally appear to have scaled back activity due to the levy.
Ithaca said last October that the EPL had forced it to cancel or defer some projects, including halting further infill drilling in the Harrier gas field.
It warned investors that production would decline in 2024, with the Greater Stella Area hub, where Harrier is based, expected to turn out 5,000 fewer barrels of oil equivalent per day (boepd).
Ithaca’s interim boss, Iain Lewis, told investors on Wednesday: ‘The EPL continues to have a direct impact on investment in the UK North Sea, with projects across our operated and non-operated deferred or cancelled.
‘The extension of the levy by a further year to a sunset date of March 2029 highlights the continued fiscal uncertainty our sector faces.’
Harbour also anticipates producing less this year as a consequence of the EPL, between 150,000 and 165,000 boepd, against 186,000 in 2023 and 208,000 the year before.
In late 2022, the group decided not to participate in the UK’s exploration licensing round to focus on its existing portfolio and diversify overseas.
Since then, it has bought the non-Russian upstream assets of Germany’s biggest oil and gas producer, Wintershall Dea, which covers countries such as Egypt, Norway and Argentina.
The cutback in domestic investment by firms like Harbour contributed to North Sea oil and gas output falling to its lowest level since the mid-1970s last year.
Yet Jamie Maddock, equity research analyst at Quilter Cheviot, notes that North Sea output was already in long-term decline owing to ‘its relatively unappealing economics.’
He says the EPL is just accelerating ‘an existing trend of majors withdrawing and juniors looking for ex-UK investment opportunities unless they have little to no alternatives.’
On the decline: UK oil and natural gas production has gradually fallen since the pandemic despite resilient demand
How could Labour’s ‘proper’ windfall tax affect production?
In a briefing note published in February, Labour said it would hike the EPL to 78 per cent and ‘end the loopholes’, presumably referring to the investment allowance.
It estimates the measure would raise £10.8billion over five years to fund ‘clean power to cut bills for families.’
Unsurprisingly, the oil and gas sector expressed uproar, a concern heightened by uncertainty over whether Labour will ban new drilling licences and how far ahead the party is in the political polls.
David Whitehouse, OEUK’s chief executive, said: ‘Labour either can’t do the maths or haven’t considered the alarming jobs impact that will be felt up and down the country.’
His organisation thinks the plans would likely result in no new investment, costing the UK 42,000 jobs and £26billion in ‘economic value.’
Robin Allen, chair of the Association of British Independent Exploration Companies, accused Labour of ‘creating a hostile environment for offshore investment.’
He also described the party’s proposals as ‘confusing’ because they are ‘actively undermining’ investment while accepting that oil and gas would still be used after 2050, when the government hopes to reach net zero emissions.
Higher rates: In February, the Labour Party said it would hike the Energy Profits Levy to 78 per cent and ‘end the loopholes,’ presumably referring to the investment allowance
Will the windfall tax accelerate the demise of the North Sea oil and gas sector?
Even before the EPL was introduced, renewable energy’s growing preponderance was leaving the future of North Sea fossil fuel production in doubt.
As technologies like solar and wind become cheaper and more efficient and Britain’s net zero deadline draws ever closer, drilling for extra oil and gas looks increasingly unappealing.
Yet the UK will continue relying on oil and gas while transitioning to net zero, as the government’s Climate Change Committee acknowledges.
If energy producers find it cheaper to source oil and gas from abroad, the North Sea oil and gas industry could experience a ‘sudden demise’ as Ryan Crighton, the head of policy at the Aberdeen & Grampian Chamber of Commerce, warned last year.
Drilling for gas in the North Sea is also slightly less polluting than imported gas, not to mention a major jobs and tax revenue generator.
And experts warn that a windfall tax could impede oil and gas companies from playing a crucial role in developing the green energy sources of the future.
Alex Campbell, communications lead at fintech platform Freetrade, says the EPL ‘has set a precedent for governments to intervene directly in capital-intensive industries that go through cyclical periods of “over-earning.”
‘These are precisely the periods that generate surplus cash that can be poured back into renewable energy projects as well as infrastructure modernisation,’ he adds.
Campbell suggests that three-quarters of oil and gas firms’ profits be reinvested in modernising the National Grid or building wind farms and nuclear power plants.
‘There’s a huge opportunity for bold and disruptive policy to secure the UK’s energy future,’ he says.
‘But so far, the main parties have just offered up a damp squib that may move the needle in the wrong direction.’
Hundreds of billions will be needed to achieve net zero, and good tax incentives are crucial to ensuring that happens.
Those billions are unlikely to come from mid-sized oil and gas businesses with high exposure to the North Sea as long as the Energy Profits Levy remains in place.
Dominant providers: Oil and natural gas remain the UK’s largest sources of energy
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