Analysts have warned of a potential £5 billion funding hole in Chancellor Rachel Reeves’ proposals to finance the green prosperity plan.
The government is relying on extra taxes on oil and gas profits to help finance the energy transition, having pledged to extend and raise the levy on North Sea oil producers, while closing a loophole that provides tax relief for domestic oil exploration.
“At least £4.9 billion, or roughly half of what Labour are looking at targeting, could be considered at risk from lower brownfield activity in the North Sea,” Dane Inglis, a management consultant at Rystad Energy, said in an interview.
The independent research firm warns that, of the approximately £10.8bn which the government expects to raise through higher taxation on oil and gas profits alone, about half of the sum could be at risk.
According to the firm’s analysis, nearly 50% of the extra tax revenue that the government expects to generate by raising the Energy Profits Levy (EPL) this November is on shaky ground if oil and gas developers cease activity or pull out of the UK market due to the loss of incentives.
Rystad Energy estimates the government’s target for potential tax revenue that could help fund the green plan is “risky”, because existing oil and gas projects could cease while new projects might not go ahead due to taxes perceived as unfavourable to the industry.
“They are not going to be able to realise the £10.8bn they are budgeting for in the green prosperity plan,” Inglis said.
“There’s about £10bn [in tax revenue] they can realise from producing assets, about half of that is very risky business because it’s impacted by ongoing activity levels.”
Impending tax changes are expected to rake in up to £17.7bn in cumulative tax revenue from 2025 to 2029, including future taxes on oil and gas projects such as Equinor’s Rosebank and Shell’s Victory, which the government intends to invest in its green plan.
That sum involves about £5.8bn of extra tax revenue that is expected to be reaped from the upcoming extension to the ‘sunset clause’, bringing the levy’s end date to at least 2029 or later, combined with the uplift in taxes from the tax hike.
Climate think tank E3G has said that the targeted amount still “falls well short” of the £30bn a year of public investment in the energy transition called for by the National Infrastructure Commission.
Windfall tax
The Chancellor hopes to raise billions of pounds in extra tax revenue through higher taxes on oil and gas profits to plough into clean energy infrastructure alongside public borrowing.
A majority of the extra tax revenue is expected to come from an increase to the levy on oil and gas profits to 38%, up from 35%, from 1 November, when the government plans to raise the tax and extend its scope to 31 March 2030.
The levy, known as the ‘windfall tax’ on oil and gas producers, was introduced by the Conservatives in 2022.
While a three-percentage point increase in the levy to 38% appears small, according to analysts, that change alone could reap billions of pounds in additional revenue to fund the energy transition.
Although the tax on oil and gas profits will increase by only three percentage-points to 38% from November until its slated end date, it will effectively increase all taxes on oil and gas producers to 78% (up from 75%).
Catch-22
A reliance on fossil fuel companies to help fund the energy transition, while bold, is potentially risky if there are not enough new oil and gas developments to provide the hike in tax revenue on which that funding depends, analysts argue.
The government has pledged to invest £8.3 billion in clean energy through publicly owned Great British Energy, £6.6 billion over the course of parliament in a reduced warm homes plan and £7.3bn in electric vehicles, hydrogen and clean steel through the National Wealth Fund.
Analysts estimate that over £10bn could be raised from higher taxes on oil and gas firms, but only in a business-as-usual scenario.
Research firm Rystad Energy estimates that half of the forecast future tax revenue from the increase to the windfall tax might not materialise if existing oil developments simply cease.
If oil and gas producers flee the UK market, as early signs indicate, that money will be lost, according to Inglis.
The UK government has also declined to defend potential money makers like Rosebank from legal challenges.
Existing brownfield oil developments are particularly unstable, according to the research firm’s projections.
North Sea oil and gas exploration company Deltic Energy said on Monday that it is pulling away from the UK market, warning that the UK is “not the ideal place” to invest in new oil and gas.
The North Sea operator said the company is moving its focus away from the UK towards geographies with “more supportive policies” for oil and gas development.
The energy company said that the government’s plans to raise the windfall tax on North Sea oil and gas companies were behind its decision.
Its decision follows similar moves by other oil exploration companies such as Serica Energy, which have argued the levy makes further investment in the UK unviable.
Serica Energy’s Chairman David Latin said earlier this year that “companies like Serica won’t invest”.
New greenfield oil and gas projects in the North Sea are also in jeopardy, as many developers “don’t believe” the sunset clause will ever end, Inglis said in an interview.
“There’s no real way around that: It is going to be horrible,” he said separately while speaking at an event in London last week.
Norway
Following the proposed tax changes, the UK’s tax system is expected to be less generous for oil and gas developers than other countries such as Norway.
Under the current tax system, oil and gas producers get back most of what they pay in taxes in the form of tax relief on new exploration. This is a loophole that Labour wants to close.
Government has pledged to close the tax loophole on oil and gas companies, which provides tax relief to new North Sea oil developments.
Reeves has said the government will abolish the 29% investment allowance for qualifying expenditure from November.
In July, Reeves set out a plan to remove the “unjustifiably generous investment allowances” that oil and gas firms receive from the EPL.
Analysts warn that even a slight increase to the tax on oil and gas profits, when combined with the loss of tax relief, will make the UK’s North Sea less competitive than other countries.
According to Rystad Energy, “the proposed fiscal regime significantly increased break-even prices” for oil projects including greenfield projects, brownfield drilling and life extension projects.
Inglis told investors last week that Norway offers a type of “cost symmetry” where oil and gas companies effectively get back what they pay in taxes through tax relief on new developments, combined with the oil price.
He explained that the UK, under the old model introduced in 2022, handed back in tax relief the costs that oil and gas developers spent in taxes.
“Under the Norwegian system, you are ideally balancing effectively your tax rate with the relief,” Inglis said. “The fact is that under the new system, in the proposed system, we’re going to be taking away that kind of policy.”
Decommissioning
Government has a tricky balancing act to fill the funding required to reinvest in the country’s clean energy infrastructure.
Earlier this year, Reeves warned of an almost £22bn “black hole” in the UK’s public finances left over as a hangover from the last government.
While part of the money the government wants to use to fund the green prosperity plan is expected to come from increased taxes on oil and gas firms, decommissioning costs could erode the amount available for the energy transition from the public purse further.
Oil and gas producers get 40% of the money they spend on decommissioning back under the current regime, so the decommissioning of old oil fields could have a knock-on effect on money put towards the green prosperity plan, which Inglis warns could “go negative”.
According to the North Sea Transition Authority (NSTA) the state of North Sea oil decommissioning is already lagging behind, with only 70% of planned decommissioning going ahead in 2023.
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