1. Introduction

On 26 May 2022 the Chancellor of the Exchequer, Rishi Sunak, announced a package of measures to provide £15 billion of government support to help with rising costs of living. The package was funded in part through the introduction of a new tax, the Energy Profits Levy (“the Levy”, or “EPL”), which was expected to raise £5 billion over its first year.

The Energy Profits Levy increased the combined rate of tax on UK upstream oil and gas operations from 40% to 65%. On introduction the government stated that the Levy was to be a temporary measure, expected to be phased out no later than 31 December 2025, or sooner “when oil and gas prices return to historically more normal levels”

2. Proposed changes at Autumn Statement 2022

Today, 17 November 2022, the government announced its intention to change several aspects of the Levy. While drafting of the changes is still in process, the key points are as follows:

• The Levy will apply at a rate of 35% (up from 25%) for profits earned from 1 January 2023;
• The Levy will be extended by at least two years to cover between 1 January 2026 and 31 March 2028 on top of the currently enacted 26 May 2022 to 31 December 2025;
• The premise that the Levy could end sooner than its sunset date (31 March 2028, previously 31 December 2025) if oil and gas prices were to return to “historically more normal levels” has been dropped;
• The Levy Investment Allowance for spend incurred on/after 1 January 2023 will be reduced to 29% (from 80%) other than for decarbonisation expenditure (i.e. modifying existing infrastructure to use power from offshore windfarms) which will retain the original 80% incentive. We understand the government will engage stakeholders on the correct targeting for “decarbonisation expenditure” in short order;
• Otherwise, the tax base for this calculation appears to be unchanged based on published documents, namely:
  • Finance costs are left out of account (akin to the calculation of adjusted ring fence profits which are subject to the Supplementary Charge);
  • Ring fence CT and SCT losses are not available for offset against the Levy, and
  • Decommissioning costs are not deductible.

• The new rules come into effect on 1 January 2023, companies with accounting periods that straddle this date will need to apportion their profits accordingly to ensure that profits are taxed at the correct rate.

These changes are expected to raise a further £19.4 billion from 2025-2028 on top of the £22.4 billion attributable to the EPL as originally introduced, to raise £41.8 billion in total.

3. Our view

Today’s announcement drives the combined headline tax rate on UK oil and gas companies to 75%. This action, on top of the previous introduction of the Levy, risks diverting investment from the UK continental shelf to other countries, particularly given the relative maturity of the UK continental shelf as a producing basin.

The fall in the rate of investment allowance is a blow to industry, although the value of it in tax terms should be broadly equal (91.4% vs the previous 91.25%) due to the corresponding increase in the rate of the Levy. There has been a clear policy signal around decarbonisation, with such expenditure relievable at rates up to 109.25% (30% Ring Fence Corporation Tax deduction, 10% Supplementary Charge deduction, 35% Levy deduction, 6.25% effect of Supplementary Charge Investment Allowance and 28% effect of Levy Investment Allowance) which should help incentivise incremental activity once it becomes clear what expenditure would qualify for this. The government will need to ensure there are sufficient safeguards to ensure this is not abused, as government would in effect be fully subsidising all such expenditure through tax relief.

Upon introduction of the Levy in May 2022, the government undertook to remove the Levy at the end of 2025 and that the allowance would be an uplift of 80% on capex. Companies across the basin have been taking investment decisions on the basis that the Levy would not apply to profits earned from 1 January 2026 onwards.

The original EPL in May 2022 as well as the current proposed changes, do not impact companies in the sector evenly, and much will depend on the extent of, and profiles of, income and expenditure.

It is also of particular note that the EPL is now proposed to operate until the close of the government’s policy costings horizon in 2028, calling into question whether these will indeed be “temporary” measures or are indicative of a longer-term high tax environment for those in the energy supply chain. This has been compounded by government withdrawing its intention to remove the tax earlier if prices were to revert to more normal levels.

No doubt the government is seeking a delicate balance between:

• redistributing the benefit of extraordinary profits (along with a new levy on electricity generation), which by its reckoning have not been the result of changes to risk taking, innovation or efficiency, rather an incidental surge in global commodity prices; and
• safeguarding investment in the UK oil and gas sector.

But the macroeconomic factors and market expectations for commodity price have decreased since the peak spot and forward prices observed in August 2022 and it is arguable whether an additional “windfall”, commensurate to the changes in the Levy, has come into existence.

Although there is a clear pressure for the UK to balance its books, and to do so in-part through increases of tax, the damage to the UK’s hard-won reputation as a fiscally competitive place for oil and gas companies to operate could be significant and long lasting. Even in the event that the tax burden was to fall over the coming years, the changes in 2022 will have knocked investor confidence.