Simple changes to the UK energy levy can help restore confidence

Back in April, investors cheered the UK government’s energy security strategy. After years of uncertainty, they finally had a clear and supportive policy that would secure domestic energy supply, while helping to address the challenges of net zero and the cost pressures facing consumers.

However, their optimism proved shortlived. Just weeks later, the chancellor introduced the energy profits levy, an additional 25 per cent tax on UK oil and gas profits on top of the existing 40 per cent headline rate, taking the combined rate to 65 per cent.

As investors review their plans for the UK once again, the chancellor faces an uphill battle to restore confidence while mitigating the cost of living crisis.

But he still has an opportunity to ensure the levy does not send the wrong signals to companies looking to invest in the UK.

First, he must provide clarity on when the energy profits levy will end. A review mechanism should be built in, akin to the way other tax measures are checked regularly to ensure they are delivering on cited aims and not leading to unintended consequences.

A review of the tax measure every six months that includes an assessment of the amount raised, and its impact on long-term investment in UK energy security, domestic production levels and emissions reduction targets, would ensure it is delivering as intended.

We must avoid a situation where a tax change holds back the start of production from new projects, which could occur under current proposals. Uncertainty is the enemy of investment, which tax reliefs alone will not offset.

Second, he should bring recent investment into scope of the new investment allowance.

As well as a challenge for new investment, the energy profits levy sends a negative signal for production projects due to come online in the next 12-18 months. The proposed elimination of the ability to deduct legitimate project costs means that the levy is effectively a revenue tax rather than a profits tax — a very troubling precedent that goes well beyond the oil and gas sector.

The limited timescale of the investment allowance means that previous investment in new projects that are going to support the UK’s short-term energy security will not be able to access the tax relief that future investments will.

This sends a contradictory signal to investors, penalising companies that have been progressing with investment plans to date. To ensure fairness across the sector, the allowance should cover projects in which investment has already been made but which are yet to come on stream.

Finally, he should update the investment allowance to support lower-carbon technologies.

Abrupt changes to the North Sea oil and gas tax regime have an impact on long-term investment priorities that are critical to the outlook for domestic energy supply and the transition to net zero, such as carbon capture, use and storage (CCUS) and electrification.

It is vital the allowance avoids the unintended consequences of reducing private investment in the energy transition by including provision for a wider range of investments, particularly lower-carbon projects.

The scale of financial backing required to decarbonise the sector, which will underpin the government’s ambitions for CCUS deployment and low-carbon hydrogen production, will be harder to secure without reasonable provision to support investment in these technologies.

The UK is competing with other markets for this support. If we fall behind, we risk missing out on the economic value of being an early mover.

While the chancellor’s levy makes its way through the legislative process, he must avoid inadvertently creating distortions that run counter to the long-term priorities that have been developed in partnership between industry and government.

Only in so doing will he achieve the important objectives of mitigating the cost of living crisis without compromising energy security.

Sam Laidlaw is executive chair of Neptune Energy

The Commodities Note is an online commentary on the industry from the Financial Times