Windfall levy shouldn’t blow UK’s green ambitions off course

The UK government’s reputation for fiscal competence has taken a hefty blow of late.

Jeremy Hunt’s windfall levy on power producers, which kicked in on January 1, might seem to be following in the same track. But, despite the predictable outrage, the tax is designed to avoid the worst of the potholes.

It certainly takes a brave chancellor to target the renewables sector. Some solar, wind and nuclear plants may have made huge profits as high gas prices drove up the price of electricity. But they also have huge investments to make — renewables and batteries will need to attract £67bn by 2030, according to Aurora Energy. Nuclear power will also require billions. The risk is that, by swooping in to spirit profits away when times are good, the government might scare investors away, and derail Britain’s net zero ambitions.

It isn’t hard to see where such concerns come from. Rising interest rates, supply chain snafus and cost inflation are already affecting new projects. Recent reports that the windfall tax might affect EDF’s efforts to extend the life of two older power plants, currently slated to be phased out in March 2024, also haven’t helped. But the tax may have a smaller impact on investment than feared.

Firstly, it only kicks in above £75 per megawatt hour. That’s below where the power price is expected to be between now and 2028. But, until a couple of years ago, developers were forecasting power prices of £60/MWh and making projects stack up.

Secondly, new renewable projects have long lead times, especially offshore wind plants, which account for the lion’s share of Britain’s decarbonisation strategy, and the tax is only expected to run to 2028.

That may also contain its impact on future investment. After all, a project that’s already being built is hardly going to be left unfinished. And an offshore plant looking to take a final investment decision now won’t be operational until 2025 or 2026, leaving it with little exposure to the levy. Moreover, such projects typically operate under a contract for difference scheme with the government, and these are protected from the windfall tax.

Capital intensive work on plants that are already on stream is the segment of the market that will be most affected. EDF’s potential extension of the life of Hartlepool and Heysham 1 falls squarely into this category, requiring money up front for two extra years of — taxed — production.

But even here, the impact might be smaller than feared. Cash costs at such plants are typically in the £40-50/MWh range. If one assumes that extending the life of each plant cost £100mn and enabled production of 16 terawatt hours over two years that would add just over £6 per MWh to running costs, leaving room for a reasonable return. It is worth pointing out that the life of the plants has already been extended, at forecast power prices lower than those of today.

That’s not to say that there won’t be any distortions, of course. One concern is that the tax may deprive us of a surge in projects with shorter lead times — such as solar plants, which only take a year to build, and might have rushed to market to benefit from price rises. That is indeed unfortunate. But it isn’t easy to estimate just how much new solar we could have built in the absence of the tax. Planning regulations were already slowing this market down.

The structure of the tax may also encourage developers to fix revenues through contracts for difference or long-term purchase agreements.

There is a wider point to make, of course. Windfall taxes, of any sort, hurt sentiment, and investors’ views of the UK have already been severely impaired. This heightens the risk that developers might prefer to put their money to work elsewhere. The US, for example, is already attracting investment in renewables thanks to its Inflation Reduction Act.

But the truth is that the dwindling attractiveness of the UK as an investment destination is a broader problem that badly needs fixing in its own right.