Windfall tax: Could Rishi Sunak’s package be good for billpayers, but bad for climate?
Chancellor Rishi Sunak’s decision to impose a windfall tax on fossil fuel giants will give all UK homes at least £400 off their annual energy bill. But his choice to also offer tax relief on new investments has some questioning whether new oil and gas production is being incentivised, not penalised.
Sunak delivered a speech in the House of Commons on Thursday (26 May), in which he confirmed that fossil fuel companies operating in the North Sea will have their profits taxed at 65%, up from 40%, until oil and gas prices return to a “historically more normal level”. The tax hike came into effect immediately.
Companies including BP and Shell posted record quarterly profits in the first quarter of 2022, with Sunak acknowledging that this was “not as the result of recent changes to risk-taking, innovation or efficiency, but as the result of surging global commodity prices, driven in part by Russia’s war”.
The decision to implement a windfall tax was a major U-turn for the Conservative Party. The idea of such a tax was first proposed by Labour and has been supported by the Greens and the Liberal Democrats. Top Tories had called the approach ‘unconservative’.
But the Party clearly felt it had no other option amid rising pressure to help households weather the rising cost of living. Funding raised through the so-called ‘Energy Profits Levy’ will help to foot the bill for grant schemes that will help British households pay their rising energy bills. Ofgem confirmed this week that it will be increasing its domestic energy price cap to around £2,800 in October, up from £1,278 last autumn and winter season.
Every UK household will receive at least £400 in the form of grant payments, with disabled people, pensioners, benefits claimants and other vulnerable groups receiving more. The Treasury had initially intended to make £200 available to every UK household and to ask for this money to be paid back over a period of years.
While many citizen’s groups and charities supporting the disabled and elderly have generally welcomed the new approach, concerns remain about whether funding goes far enough in the short-term, and whether the Treasury will need to come up with a similar package again next year.
And, just as complex as the social implications of the spending – if not more so – are its potential impact on emissions from the energy sector.
All in all, is this a tax hike or tax relief?
At first glance, the windfall tax appears to be a win for the net-zero transition. Groups such as Greenpeace have argued that fossil fuel production should be more highly taxed to help prompt producers to invest more in clean energies instead – especially given that the Petroleum Revenue tax has been zero-rated for six years now.
It bears noting that the Energy Profits Levy only applies to fossil fuel extraction. Electricity generation and distribution will not be subject to any additional tax, which should come as a relief to generators, distributors and any firm promoting the electrification of transport and heating.
But, alongside the Energy Profits Levy, Sunak also announced that energy companies will be able to claim an investment allowance that will effectively give them 91% in tax relief on new investments.
Senior Tories including Prime Minister Boris Johnson himself had resisted implementing a windfall tax by arguing that energy majors needed to retain profits to ensure they were ready to invest in renewable energy, electric vehicle (EV) charging and other low-carbon solutions (despite the fact that numerous studies have found that most of this sector’s investment keeps going into fossil fuels).
Yet the factsheet and technical note released by the Treasury this week indicate that the tax relief will only apply to new fossil fuel extraction – not to investments in projects related to the energy transition. The factsheet lists an example of £100 of CAPEX for an oil and gas extraction major, but gives no other case studies and lists no other information about which projects are included and excluded
This approach has raised eyebrows across the green economy. WWF has called it “nonsensical”, with head of climate policy Isabella O’Dowd stating: “Climate change does not adhere to country borders; fossil fuels are fossil fuels, and wherever they are extracted they stoke the cost of living crisis and cause horrendous damage to our planet”. Similar sentiment has been expressed by IPPR, the Green Party and a great many other groups and individuals.
edie has reached out to the Treasury for clarification about which projects are eligible for the ‘Investment Allowance’.
It bears noting that the Conservative Party has, in recent times, taken other steps to incentivise investment in North Sea oil and gas. Published last month, the Energy Security Strategy confirmed the Government’s intention to launch a new licencing round for new oil and gas fields this autumn. This could result in at least seven new projects being approved this year.
Going forward, gas extraction and gas-fired electricity production may well be included in the UK’s green finance taxonomy, with the Prime Minister and Energy Minister Kwasi Kwarteng both currently standing in favour of their inclusion. The taxonomy is due for publication by the end of 2022.
What is the climate impact of UK oil and gas?
Opponents of new North Sea oil and gas fields often point to the International Energy Agency’s (IEA) roadmap to net-zero for the global energy sector. Published in spring 2021, the roadmap states that delivering a 1.5C-aligned transition to net-zero by 2050 will require no additional investment in new fossil fuel supply projects beyond decisions already made.
More recently, the Intergovernmental Panel on Climate Change’s (IPCC) Sixth Assessment Report on the Mitigation of Climate Change stated that, if all new fossil fuel infrastructure that is in the current pipeline is completed, the global temperature increase is likely to exceed 2.8C. The report calls for a major scaling back of planned and existing fossil fuel extraction, lest at least one-third of the population face an ‘unliveable future’. The IPCC’s findings were built upon in The Guardian’s recent ‘Carbon Bombs’ investigation into planned fossil fuel investments.
Proponents of new North Sea oil and gas fields sometimes point out that the UK is a comparatively small extractor of oil and gas in the global context. Data from the US EIA shows that the UK was the world’s 20th largest oil producer in 2021, with the US, the top producer, extracting more than 13 times as much oil every day.
A common counter-argument to this point is that the UK is a wealthy nation – a G20 and G7 member which many other nations look to for inspiration on the energy transition. This is particularly true given the UK’s current holder of the COP Presidency, which will not be transferred to Egypt until November. As such, the UK’s decisions could create a domino effect of policy changes, investment and, ultimately, global energy-related emissions.
With this in mind, the UK Government’s Climate Change Committee (CCC) recently sought to quantify the global climate impact of the UK’s decisions on North Sea oil and gas. However, it was unable to conclude, beyond doubt, that any and all new licencing would undermine the UK’s domestic climate goals and/or global efforts to deliver the Paris Agreement.
The CCC did, however, argue that the UK Government’s current approach to North Sea extraction is likely to lead to the permitting of new projects that will result in emissions that ultimately jeapordise the delivery of net-zero by 2050 domestically – and of adhering to the carbon budgets set out for the coming decades. It is calling for the Government to tighten requirements for climate “stress tests” on future projects, and widening the scope of the tests to cover production as well as exploration.
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