Introduction

The UK’s offshore energy sector, a critical pillar of the country’s economy, is facing a potential crisis. On September 2, 2024, Offshore Energies UK (OEUK), the leading trade body representing the industry, released a detailed analysis modeling the impact of the UK government’s proposed changes to the Energy Profits Levy (EPL). The findings are stark: the proposed fiscal policy could result in a £13 billion loss in economic value, a dramatic reduction in capital investment, and the loss of tens of thousands of jobs.

This report comes at a crucial time, as the UK government prepares for its Autumn Statement in October, where these tax changes are expected to be a central issue. The data presented by OEUK highlights the potentially devastating consequences of these changes, not just for the oil and gas sector but for the broader UK economy.

The Energy Profits Levy: A Controversial Measure

The Energy Profits Levy, often referred to as the windfall tax, was introduced in May 2022 as a temporary measure to capture a portion of the extraordinary profits being generated by oil and gas companies due to the surge in energy prices. Initially set at 25%, the levy was intended to help fund government initiatives aimed at alleviating the cost-of-living crisis, which had been exacerbated by rising energy bills.

However, in 2023, the government announced an increase in the EPL to 35%, bringing the total tax rate on the sector to 75% when combined with existing taxes. This move was met with significant opposition from industry leaders, who argued that the high tax burden would discourage investment in the UK’s oil and gas sector, ultimately harming the country’s energy security and economic growth.

The latest proposal, which OEUK’s report addresses, suggests an even stronger EPL, with the potential removal of key allowances that currently enable companies to offset some of their investment costs. According to OEUK’s analysis, this would lead to a reduction in capital investment from £14 billion to just £2 billion between 2025 and 2029, significantly undermining the sector’s ability to contribute to the UK’s economic growth.

Economic Impact: A £13 Billion Loss

OEUK’s data modeling paints a grim picture of the potential economic impact of the proposed tax changes. The analysis shows that the UK economy could lose around £13 billion in value between 2025 and 2029 due to the anticipated decline in investment. This loss is not just a theoretical figure; it represents real money that would have been spent on developing new oil and gas projects, supporting supply chain companies, and creating jobs.

The reduction in investment is expected to have a ripple effect across the economy. The oil and gas sector is a major employer in the UK, directly supporting around 150,000 jobs and indirectly supporting many more. OEUK’s report warns that up to 35,000 jobs could be at risk over the next five years if the proposed tax changes are implemented. These job losses would not only affect those working directly in the industry but also those in the wider supply chain, including engineering, manufacturing, and services companies.

Tax Revenue: A Double-Edged Sword

One of the government’s primary justifications for increasing the EPL is the potential for higher tax revenue in the short term. OEUK’s analysis confirms that there would indeed be an increase in tax receipts initially. However, the report also highlights a critical downside: this short-term gain would be offset by a significant long-term loss.

Under the current windfall tax regime, the sector’s tax contribution is expected to remain stable over the next few years, providing a steady stream of revenue to the Treasury. However, if the proposed changes are implemented, the report predicts that tax receipts will peak in 2026 before beginning a sharp decline. By the end of the decade, the government could face a £12 billion loss in tax revenue compared to the current scenario.

This decline in tax revenue is directly linked to the expected reduction in production caused by the lack of investment. As existing oil and gas fields mature and new projects are not brought online, the UK’s domestic energy production will fall, reducing the amount of taxable income generated by the sector. This could have serious implications for the UK’s fiscal position, especially at a time when the government is grappling with high levels of public debt and significant spending commitments.

Energy Security: A Growing Concern

Beyond the economic impact, there are also serious concerns about the potential impact of the proposed tax changes on the UK’s energy security. The UK is already facing a challenging energy landscape, with domestic production declining and reliance on imports increasing. OEUK’s report warns that the proposed changes could exacerbate this situation, making the UK even more dependent on foreign energy supplies.

The report estimates that 63% of additional production that could be sanctioned under the current regime would become uneconomic under the proposed changes. This means that much of the potential new oil and gas production in the UK Continental Shelf (UKCS) could be lost, leaving the country more reliant on imports to meet its energy needs.

This increased reliance on imports could have several negative consequences. Firstly, it would expose the UK to greater geopolitical risks, as it becomes more dependent on energy supplies from potentially unstable regions. Secondly, it could lead to higher energy costs for consumers, as imported energy is often more expensive than domestically produced energy. Finally, it would undermine the UK’s efforts to achieve energy independence, a key goal of the government’s energy strategy.

Comparisons with Norway: A Misleading Benchmark

In the ongoing debate over the EPL, some have pointed to Norway as a model for how a high-tax regime can coexist with a thriving oil and gas sector. Norway’s tax system allows companies to claim a maximum of £78 in relief for every £100 of expenditure, compared to the proposed £46.25 in the UK. This significant difference in tax relief is one of the reasons why the Norwegian oil and gas sector continues to attract investment, despite a high headline tax rate.

OEUK’s report argues that the UK cannot simply adopt the Norwegian model without significant modifications. The UK’s offshore energy sector faces different challenges, including higher operational costs and a more mature resource base. As a result, the proposed tax regime, which removes key allowances, would likely have a much more detrimental impact on the UK sector than a similar regime would have in Norway.

Industry Response: Calls for a Balanced Approach

In response to the findings of the OEUK report, industry leaders have called on the government to reconsider its approach to taxing the oil and gas sector. David Whitehouse, OEUK’s Chief Executive Officer, emphasized the need for a balanced approach that recognizes the sector’s importance to the UK economy while also addressing the government’s fiscal needs.

Whitehouse warned that the proposed changes could trigger an “accelerated decline of domestic production,” leading to a corresponding reduction in jobs, tax revenue, and economic value. He called for an “honest conversation” between the government and the industry to find a way forward that supports both economic growth and the transition to a low-carbon future.

OEUK has also highlighted the need for a clear and consistent policy framework that provides certainty to investors. The continued uncertainty around the timeframe of the sunset clause for the EPL and the treatment of capital allowances has already undermined investor confidence. Without a stable and predictable tax regime, the UK risks losing out on critical investment in its offshore energy sector.

A Path Forward: Leveraging the Strengths of the UK’s Offshore Energy Industry

Despite the challenges posed by the proposed tax changes, OEUK’s report also outlines a potential path forward for the UK’s offshore energy sector. With the right policy framework, the sector can continue to play a vital role in the UK economy, supporting jobs, generating tax revenue, and contributing to the country’s energy security.

One key element of this path forward is the development of a comprehensive industrial strategy that leverages the strengths of the UK’s offshore energy industry. This strategy would involve close collaboration between the government and the industry to identify and support key areas of investment, innovation, and technology development.

For example, the UK has the potential to become a global leader in offshore wind energy, building on its existing expertise in offshore oil and gas. By investing in new technologies and infrastructure, the UK can harness the full potential of its offshore energy resources, creating jobs and economic value while also contributing to the country’s net-zero ambitions.

Conclusion: The Need for a Rethink

As the UK government prepares for its Autumn Statement, the findings of the OEUK report serve as a critical reminder of the potential consequences of the proposed changes to the Energy Profits Levy. While the government’s fiscal challenges are real, the proposed tax increases could have far-reaching and unintended consequences for the UK’s offshore energy sector and the broader economy.

Photo source: Google

By: Montel Kamau

Serrari Financial Analyst

3rd September, 2024