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25 May 2022

Renewables trapped in UK windfall tax proposals

For every day that UK energy generators continue to profit from the ongoing crisis, while failing to update their transition strategies, the case for a windfall tax grows stronger. But with the UK’s Chancellor, Rishi Sunak, starting to eye up his options, it is crucial that he provides an exemption for those providing renewable power.

On Monday, Sunak ordered officials at Downing Street to draft plans for a windfall tax, after months of shouts from the left to use the elevated earnings of the country’s oil and gas companies to address the rising cost of energy for its people. With regulator Ofgem raising its price cap for consumer bills, the average household has seen its energy spend rise by 54% over the past year.

However, Sunak’s early windfall plans are taking an unexpected shape, with early signs that it will tax the profits of more than £10 billion across the country’s electricity generators – including operators of wind and solar farms.

The logic is that the rising cost of oil and gas – partially caused by the conflict in Ukraine – has led to windfall profits across all types of electricity generation. By taxing all generators, the government will bring in more revenue that it can use to offset the rising cost of living; energy suppliers have warned that 30% to 40% of UK households could end up in fuel poverty this coming winter.

Sunak has previously been reluctant to impose a windfall on oil and gas companies. Diving into the pockets of the likes of BP and Shell will reduce their respective budgets to transition away from oil and to ultimately reduce global emissions.

But despite a quarter of bumper profits in Q2 2022, their sentiment about this transition has been stagnant. Rather than pledging more investment in renewable energy, they’ve reignited talks of new oil and gas projects across their portfolio. Shell, in particular, managed to pay zero tax on its oil and gas production in the North Sea last year, for the fourth year in a row and despite annual profits of $14.7 billion. It instead received £92 million in tax refunds paid by the UK Treasury for the decommissioning of old oil platforms. A windfall tax has now become a move of populism.

Taxing the North Sea oil and gas producers alone is not a meaty enough measure for the conservative government. It is only predicted to bring in around £2 billion to the treasury. If Sunak is going to upset his oil and gas chums with a windfall tax, it’ll have to be worth it. With gas prices pushing up wholesale power prices across the UK, it is estimated that electricity producers could have experienced a similar windfall of over $10 billion, so he’s going after them as well.

The problem here is that many of the UK’s big generation companies – SSE, ScottishPower, EDF Energy and RWE – actually are investing heavily in renewable energy. They are key facilitators in the UK’s bid to reach net zero emissions by 2050.

In response to the proposals, SSE touted its potential investment plans, which could total more than £24 billion across the UK by the end of 2030. Having boosted profits by 44% to £3.5 billion in 2021, the company is more likely to pump this cash flow into new projects than its oil and gas counterparts, which are blindly focusing on immediate shareholder returns.

Interestingly, Italian oil major Eni, announced plans to spend at least €2.5 billion in the UK over the next four years, despite limited historic activity in the North Sea. Eni said 80% of this investment would be spent on carbon capture and renewable energy projects, with 20% allocated to oil and gas production. The company made £254 million in profits from its UK business last year, on which it paid £139 million in tax.

With the risk of a windfall tax looming, shares in firms that could be affected fell sharply on Tuesday, with Centrica down 11% and SSE down 9%.

The Spanish government announced a similar tax on its electricity companies last year, through an “excess profit levy,” which has since been watered down amid signs that it was hindering investment in the country’s renewable energy projects.

Going after renewables makes zero sense, with domestic clean technologies providing an across-the-board solution to the triple threat of climate change, rising energy prices, and dependency on Russian imports. Many generators also sell their power on forward markets, meaning that as much as three-quarters of their energy is sold well below current spot prices.

With the windfall tax looking increasingly likely, it is crucial that either investment in the energy transition qualifies for some sort of exemption or that the rate of tax is adjusted based on the type of power generation. This would require a complex scheme that dives into the framework of power purchasing in the UK and appears unlikely.

In an ideal world, if looking to target generators, the UK would impose a retrospective carbon tax hike on the production of power. With those supplying fossil-fuel derived power taking the hardest hit, this would raise revenues while also incentivizing an acceleration in clean energy investment.

Sunak’s windfall tax model for North Sea oil and gas producers is likely to be similar the one introduced George Osborne back in 2011. Then, the “supplementary charge” levied on oil and gas production was increased, allowing the government to raise £2 billion before oil prices returned to a trigger price of $75 per barrel.

Oil and gas producers in the North Sea typically pay a 30% corporation tax rate, with a 10% supplementary charge. This sits above the 20% corporate tax rate for most sectors, with the oil and gas sector expected to pay £7.8 billion in taxes this year.