Energy prices: How will the £5bn windfall tax work?

·4 min read
Offshore drilling rig in Scotland
Offshore drilling rig in Scotland

Chancellor Rishi Sunak has announced a windfall tax on energy firms that could raise around £5bn.

UK energy firms will now pay an additional 25% tax for the next 12 months.

The calls for such a tax were amplified when BP and Shell both reported big profits increases as global oil and gas prices surged.

What is a windfall tax?

A windfall tax is a one-off tax imposed by a government on a company.

The idea is to target firms that were lucky enough to benefit from something they were not responsible for - in other words, a windfall.

Energy firms are getting much more money for their oil and gas than they were last year, partly because demand has increased as the world emerges from the pandemic and partly because of supply concerns due to Russia's invasion of Ukraine.

How will the new windfall tax work?

The chancellor described the new tax as a 25% Energy Profits Levy.

The important feature of this extra tax is that any money the companies may have lost in previous years, or money they are spending on things like decommissioning North Sea oil platforms cannot be used to reduce the amount of tax they pay.

In recent years, such methods have meant that BP and Shell, for example, have paid almost no tax in the UK.

How much tax do oil companies pay?

Oil and gas firms operating in the North Sea are taxed differently to other firms.

Taxes on their profits are higher - they pay 30% corporation tax on their profits and a supplementary 10% rate on top of that. Other firms pay corporation tax at 19%.

But the amount they have actually paid in the UK recently has been low. This is because they spent enough money on things like decommissioning North Sea oil platforms to cancel out any profits they were making in the UK.

BP and Shell both received more money back from the UK government than they paid every year from 2015 to 2020 (except 2017, when Shell paid more than it received).

How much have energy firms been making?

BP's profits more than doubled in the first three months of the year while Shell's profits nearly tripled.

But both also wrote off a lot of money as a result of exiting from investments in Russian oil firms following the invasion of Ukraine.

BP and Shell have both spent billions recently on what are called share buybacks, which is what companies do when they have money they can afford to spend on boosting their share price.

Would a windfall tax affect investment?

BP plans to spend a maximum of £18bn on the UK's energy system by the end of 2030.

Chief executive Bernard Looney was asked by The Times on 3 May which of BP's planned UK investments would not go ahead if there were a windfall tax.

Bernard Looney replied: "there are none that we wouldn't do."

Shell plans to spend £20-25bn on UK energy over the next 10 years.

What have politicians being saying?

The government has now adopted the policy, having previously rejected it. A windfall tax had been championed by Labour, Liberal Democrats and the SNP.

The prime minister had previously said such a tax would deter investment: "I don't like them. I don't think they are the right way forward. I want those companies to make big, big investments."

Chancellor Rishi Sunak had previously said he was not "naturally attracted" to it, but was "pragmatic" about introducing it.

Critics of a windfall tax argue that it might affect the money paid out to pensioners by some pension funds - as these funds benefit from energy firms' profits.

But it is important not to overstate the impact of this. Pension funds invest across countries and industries, so such a tax is unlikely to make a noticeable difference.

Gordon Brown about to deliver his first budget, 1997
1997: Gordon Brown announced a windfall tax in his first budget

Have we had UK windfall taxes before?

The UK's best-known windfall tax was in 1997, when Labour Chancellor Gordon Brown placed the tax on companies formed after the Conservative governments' earlier privatisation of nationalised industries, including BT, Scottish Power and United Utilities.

The tax raised £5.2bn over two years (£8.7bn in today's money) according to the Institute for Fiscal Studies.

Conservative Chancellor Geoffrey Howe imposed a similar levy on banks in 1981, arguing they had benefited from high interest rates. He also imposed a special tax on North Sea oil and gas firms.

Our goal is to create a safe and engaging place for users to connect over interests and passions. In order to improve our community experience, we are temporarily suspending article commenting