The windfall tax was supposed to rein in fossil fuel profits. Instead it has saved corporations billions

Last week the Office for Budget Responsibility (OBR) released new data which highlights how little this government’s ​‘windfall tax’ has actually done to rein in the profits of fossil fuel companies.

Back in May 2022, the UK government announced the energy profits levy, as a response to the growing pressure for a ​‘windfall tax’ on the massive profits being generated by companies pumping oil and gas in the North Sea. These profits were fuelled by skyrocketing fossil fuel prices in the wake of the Russian invasion of Ukraine. The levy raised the effective rate of corporation tax paid on oil and gas profits from 40% to 65%, and again to 75% in November 2022.

But, it came with a caveat. Despite the UK’s urgent need to kick its addiction to expensive fossil fuels, this government didn’t want to discourage investment in more oil and gas extraction. So they included a tax loophole to ensure that companies investing in new projects to pump fossil fuels out from under the North Sea would see their tax relief (already generous by most standards) rise to 91%. In other words, fossil fuel companies could deduct 91% of their capital investment costs from their corporation tax bill. The ​‘windfall tax’ may have, on the surface, attempted to tackle the grotesque profits being raked in by massive companies in the midst of the cost of living crisis – but it also made it cheaper for these companies to extract the fossil fuels contributing to the sky-high cost of living in the first place.

At NEF, we analysed last week’s new OBR data, and found that the loophole included in the energy profits levy has massively increased the amount of tax relief which fossil fuel companies will potentially receive. We estimate that oil and gas extractors could receive up to £18.1bn in tax relief between 2023 and 2026. That’s a massive increase of £10.5bn, or 136%, from the £7.6bn they were expected to receive before the energy crisis. This is an enormous amount of lost revenue that could go to the government to be spent on lowering our energy bills or improving our public services. The OBR expects the UK oil and gas industry to pay £24.3bn in tax between 2024 and 2027, meaning that closing the tax loophole in the energy profits levy could almost double the amount of tax revenue our government could receive – and the businesses in question would still walk away with billions.

“Despite the UK’s urgent need to kick its addiction to expensive fossil fuels, this government didn’t want to discourage investment in more oil and gas extraction.”

Last week’s OBR data also shows that, despite international commitments to cut our dangerous carbon emissions, overall investment in drilling for fossil fuels has risen. Two years’ ago, the OBR forecast that the North Sea oil and gas industry would deliver investment of around £16.3bn from 2023 – 2026. Last week, that forecast was revised to around £19.8bn. That’s a 21% increase worth £3.4bn, which comes as a result of the spike in oil and gas prices, and the new layer of tax relief introduced in the energy profits levy.

Even if you accept the government’s warped logic, which seeks to encourage greater North Sea extraction, the policy appears to be failing. While total potential for tax relief has risen by £10.5bn, total forecast investment has risen by just £3.4bn. This would represent an abysmal return on a government tax measure. Relief has largely been extended to investments which were expected to occur anyway, suggesting the policy is (intentionally or not) little more than a vehicle for oil and gas companies to keep most of their explosive profit growth, while the windfall tax sustains an illusion of fairness.

The energy profits levy helped pay for the government’s emergency cost of living support measures – in theory. But our energy bills remain extortionate, costing 50% more than they did in early 2022, prior to the Russian invasion of Ukraine. With the poorest households over £200 a week short of the amount they need for an acceptable standard of living, this government has still not provided enough support. Looking forward, removing the perverse tax reliefs extended to the oil and gas industry could free up almost £13bn of tax revenue between 2024 and 2026: enough to give every household in the country three £150 annual payments to help cover their energy costs.

Alternatively, for a more long-term, progressive solution, these funds could be funnelled into fixing the way our energy bills work. A National Energy Guarantee would put a protective ring around every household’s essential energy needs, providing half for free, and half at pre-crisis prices. Excessive consumption would be charged at a premium rate, and households with additional needs, such as those with children or disability disabled member, would be provided an extra allocation of free energy. This could reduce bills by up to £700 a year for the poorest fifth of households and, alongside a proper windfall tax on North Sea profits, would mean the windfall tax and wider energy bill system provide more than just an illusion of fairness.

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