Energy companies will face a 65% tax on profits until 2025, but can reduce their liabilities through investments in new oil and gas extraction.

The UK government has announced a windfall tax on oil and gas companies, aiming to raise £5 billion to help with the cost-of-living crisis exacerbated by high energy prices. This new levy, set at 65% of profits, will remain in place until December 2025. However, businesses can avoid much of this tax by reinvesting in the sector, with a significant increase in tax relief for new oil and gas extraction projects.

Currently, energy companies are already taxed at 40% of their profits, but this new tax hike is designed to curb the windfall gains brought about by soaring energy prices, particularly after Russia’s invasion of Ukraine. Chancellor Rishi Sunak has provided a back door for these companies, doubling the relief available for reinvestment. Previously, for every £1 invested in the UK’s oil and gas sector, companies received 46p in tax relief; this will now rise to 91p.

Sunak emphasised that this temporary, targeted energy profits levy includes a new investment allowance to encourage reinvestment in UK energy. The government’s goal is to ensure long-term investment in the nation’s energy sector, though critics have raised concerns about the environmental implications. Some fear that the incentive for oil companies to continue extracting more oil from the North Sea could undermine efforts to tackle the climate crisis. Greenpeace UK’s Ami McCarthy criticised the policy, calling it “utter stupidity,” arguing that it rewards oil extraction while ignoring the need to invest in renewable energy sources.

The oil and gas industry, on the other hand, has welcomed the tax relief. Shell, for example, highlighted the importance of a stable investment environment, calling the relief “critical” to the new levy. However, there are warnings from within the sector that such a tax could deter future investment, particularly in offshore energy jobs and communities, as noted by Deirdre Michie, CEO of Offshore Energies UK. She added that the levy could reduce UK energy production, making it harder for the country to meet its net-zero target by 2050.

The government’s decision to introduce a windfall tax follows months of pressure amid rising inflation, much of which has been attributed to the skyrocketing cost of energy. While oil companies have argued they are already paying billions in taxes due to their increased profits, they worry that the windfall tax will make the UK less attractive to investors.

Despite this, there is still uncertainty surrounding the specifics of the tax and whether it could be extended to include electricity generators. Chancellor Sunak alluded to this possibility, stating that certain sectors of the electricity generation industry are also making “extraordinary profits,” and that steps will be taken if necessary. This has caused fluctuations in the stock prices of companies like SSE and Drax, who are part of the electricity generation sector.

The new 65% tax rate for the oil and gas sector is somewhat in line with other countries, with Norway and Denmark having similar rates of 78% and 64% respectively. However, concerns about deterring future investment remain, especially in light of the challenges the UK faces in transitioning to a more sustainable energy model.