Chancellor Rachel Reeves’ first budget sets the stage for two energy sectors to head in different directions.

Amid the discussion of windfall taxes, much of the industry debate focuses on that on oil and gas, the Energy Profits Levy (EPL).

There is another such tax, though. The Electricity Generator Levy (EGL) was brought in at the same time as the EPL.

The EGL looks set to fade away ahead of schedule, as power prices normalise. Meanwhile, the EPL on oil and gas will not only continue but has been increased, despite industry protests.

Chancellor Rachel Reeves has aimed to walk a line between taxation and attempts to deliver growth in her first Budget. Her approach to energy sector taxation shows a clear preference for electricity over hydrocarbons – but she is gambling that it can help deliver the UK’s needed growth.

Into the numbers

There are some green fiscal shoots for the electricity sector. The Office of Budget Responsibility (OBR) now forecasts the EGL will end a year sooner than projected. This 45% tax on companies producing over 50 GWh was due to run between 2023 and 2028.

The windfall price was set at electricity over £75 per MWh. Recent prices are close to this point.

EGL payments will end by 2025-26, the OBR said, as a result of lower wholesale spot prices. While lower taxes are welcome, the resulting lower prices will have an impact on power producers.

What’s good for industry is less good for the public purse. The EGL will provide £1 billion in 2024-25, the OBR said, falling to £0.3bn in 2025-26.

The EGL had proved controversial when the previous government introduced it, in 2022. At that time, energy prices were high following Russia’s invasion of Ukraine. Those in the industry complained that taxing electricity – particularly renewable generation at a time of energy insecurity – would do little to help the UK’s prospects.

As electricity prices fall, though, it provides an opportunity for the government to take the brakes off the power sector. This is how a windfall tax should work. As high prices fall, taxes diminish.

What windfall

The same cannot be said for the oil and gas sector. If oil and gas prices fall below set levels for two consecutive quarters, the Energy Profits Levy (EPL) would end sooner.

Currently, the crucial price is $74.21 per barrel for oil and £0.57 per therm for gas, rising with CPI.

While oil prices may fall, gas is expected to remain above the trigger price. So, the EPL is likely to continue – unlike the EGL.

As was widely expected, the windfall tax on hydrocarbons was extended and increased in Reeves’ budget.

Calculations from the OBR show the sector’s ability to pay tax declining. The forecaster sees Treasury’s returns only registering a minor bump this year, before falling.

Reeves increased the EPL by 3% and cut allowances. The OBR said extending it by one year will raise £1bn in 2029-30. “However, the changes to the EPL regime will lower the post-tax return from investment, reducing capital expenditure and production,” it said.

Price volatility makes it hard to determine the EPL cost, the OBR said. It assumes capex over the period falls by 26%, while oil production falls by 6.3% and gas by 9.2%.

The OBR also noted “uncertainties” around the licensing regime and the Supreme Court ruling on Finch.

Balance of power

Energy will be crucial to the UK’s growth plans. But the government’s trajectory sees it shifting away from producing commodities for export – oil and gas – and towards domestic concerns.

Oil and gas producers may feel their relationship with the government can’t deteriorate further. The EPL extension and increase will hit smaller developers with less capacity to invest and capture what’s left of the allowances.

Reeves needs growth to balance the books. She has set national priorities and must wait and see for the market response. The OBR has allowed for some growth over the period but it continues to look anaemic.

The government is signalling that if growth comes from the energy sector, it will come from electricity generators, not hydrocarbons. Energy security will certainly suffer in the near term. Gas production will fall in the North Sea, even while demand does not. As such, the country will become more reliant on imports, via pipeline and LNG.

Reeves’ Budget shows two related gambles. The first is that her plan can provide scope for growth. The second is that it doesn’t matter if oil and gas declines as fast as the OBR expects, because of the shift to electrification.

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