Europe

UK Windfall Tax Obscures Obstacles to Green Transition

Proposal attracts criticism that it could hinder shift to cleaner energy generation.

Consumers may find short-term relief via the UK government’s planned introduction of an energy windfall tax, but it risks sending mixed signals both to investors keen to support the energy transition and the energy giants themselves.

Amid reports that many households were emerging from the pandemic only to be faced with choosing between buying food and paying for heating, Chancellor Rishi Sunak announced a 25% surcharge on extraordinary oil and gas profits, following months of pressure from the opposition Labour Party.

The proceeds from what the government is calling an ‘energy profits levy’ – estimated at around £5 billion over the next year – are set to go towards cost-of-living measures at a time when wages aren’t keeping pace with historic price rises, which span fuel and many other goods.

There are long-term risks from the energy windfall tax for consumers as well as the climate, say observers from both the energy sector and those focused on a transition to renewables, and it could obscure the structural changes needed to encourage investors to support the transition to sustainable, affordable energy.

“The hotly-anticipated and much-needed package ended up being yet another short-sighted sticking plaster for fuel poverty, and a catastrophe for the climate,” said Ami McCarthy, Political Campaigner at Greenpeace.

Deirdre Michie, Chief Executive of representative body Offshore Energies UK, said: “It’s essential to help consumers through the cost-of-living crisis, but damaging the energy industry through sudden new taxes is the wrong approach.”

Fossil-Fuel Tax Relief Offers Claw-Back

The introduction, alongside the levy, of a ‘super-deduction’ style relief for investments in oil and gas extraction in the UK has drawn particular attention, coming at a time when governments and supranational bodies are warning that the funding of new fossil-fuel projects goes against plans to achieve net zero CO2 emissions by 2050.

This relief – a 91p tax saving for every £1 invested in extraction – could see companies in theory swiftly clawing back much of the financial impact of the levy while jeopardising the transition to green energy as well as the climate targets reinforced at COP26.

By introducing additional tax relief limited to oil and gas investment, HM Treasury is incentivising a slower transition and pushing companies to allocate profits towards new oil and gas developments instead of renewables, according to climate change think tank E3G.

Given that a significant share can be claimed back instantly, E3G argued, if this revenue had instead been spent on supporting energy-efficiency measures it would have had the potential to lift households out of energy poverty for good.

Gas and electricity in the UK have become more expensive largely due to rising import costs, compounded by a recent increase in the price cap set by Ofgem, the country’s energy market regulator, which pushed up the bills of a ‘typical’ household by 54%.

Energy shortages across Europe have highlighted the progress that still needs to be made in storage technology for intermittent sources of renewable energy, such as wind and solar power. Responding the need to reduce reliance on Russian gas, the European Commission has unveiled a strategy to accelerate the renewable transition, REPowerEU, while member states have invested in gas infrastructure to cover short-term needs.

But there have been warnings about returning to fossil fuels in reaction to the situation.

“The world doesn’t need to choose between solving the energy crisis and the climate crisis,” International Energy Agency Executive Director Fatih Birol told journalists recently.

“Large-scale fossil fuel investments can be risky from a climate point of view because they are going to eat up a large part of our carbon budget, but also they are risky in terms of their returns,” he added.

Concern Further Taxation Could Harm Renewables

Some analysts are focused on signals that this type of tax could be expanded to power utilities. The government is set to “urgently evaluate” the scale of extraordinary profits in the electricity-generation sector and the appropriate steps to take.

While the tax is currently aimed at the oil and gas industry, it is clear that electricity generators are within the government’s sights and this may well capture some renewable generators, said law firm Osborne Clarke.

Such a move could lead to a knock-on effect for consumers and could inadvertently tax renewable energy, since utilities generate electricity from a range of sources, which increasingly include wind and solar power.

“It could impede much-needed investment in the energy transition,” said Martin Young, Utilities Analyst at Investec, of the possibility of the tax extending to the sector.

“If the environment is one where there is a heightened risk of a change in the rules of the game, it’s not helpful for investment and it pushes up risk. Consumers could pay more,” he said. “Let’s hope that common sense prevails and they think again.”

Obscuring Structural Changes Needed for Energy Transition

Some of the key mechanisms that are needed to encourage investment in the clean-energy transition lie outside the taxation system, say analysts, from providing targeted support to vulnerable households for insulation to improving planning systems and reducing fossil-fuel subsidies.

“The UK will still have a highly competitive corporate tax regime even after this windfall tax is imposed,” said Professor Brian Scott-Quinn, Director of Banking Programmes at Henley Business School. “What is more likely to determine levels of investment in new offshore wind and nuclear projects is whether the planning system for clean energy projects is reformed.”

Also key to the energy transition is that policy mechanisms such as contracts for difference — the government’s main tool for supporting low-carbon electricity generation – need to be well structured, he adds.

Investors in the energy transition flag concerns over the potential long-term impact of the proposed tax.

“Clearly, there is an urgent need to ease the acute pressure on households from rapidly rising utility bills,” said David Osfield, Global Fund Manager, at EdenTree Investment Management.

”However, diverting cashflow already assigned for investing in long-term solutions to this energy security challenge seems counterintuitive,” he said.

“The UK doesn’t have a great track record for investing in climate solutions,” says Rob Lambert, Senior Analyst at BlueBay Asset Management, which invests over US$120 billion for institutional investors and financial institutions. “The 25% tax just makes the whole investment environment more opaque.”

Despite differences on the practicalities of the tax, there is agreement about the intention behind it.

“I think a lot of people are struggling with energy bills, basically it makes sense,” says Guy Turner, Chief Executive of specialist data, analysis and advisory firm Trove Research. “Society deserves it.”

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