The windfall tax was introduced to protect households. Will its replacement?

An oil price spike is, to put it mildly, an odd moment for the oil and gas industry to lobby for lower taxes. Yet in March, as the US began bombing Iran, North Sea energy bosses sat down with Rachel Reeves to do exactly that – call for an end to the windfall tax – even as drivers queued at petrol stations and households were warned to fix energy tariffs before inevitable price hikes. 

Reeves signalled some sympathy for their case. But in the end she held firm; a decision that may have netted the Treasury up to £1 billion since conflict began.¹

However, a change in the fiscal regime still looks likely. The new Prime Minister has said he wants a "pragmatic" approach to the North Sea, and in August set out what he means by it: accelerating extraction so that it pays for the transition. Can the UK’s oil and gas tax regime deliver the money?

What does the windfall tax currently look like?

The Energy Profits Levy (EPL), as the tax is officially known, was introduced in May 2022 to capture the extraordinary profits flowing to oil and gas companies after Russia’s full-scale invasion of Ukraine – and to use them to protect households from energy bills they couldn’t afford.

Oil companies despise the levy, which pushes their tax rate to 78% (roughly in line with Norway). It is destroying investment, they claim, undermining the UK’s energy security and costing thousands of jobs. If the EPL is removed, billions of investment in new North Sea production will follow, they say.

Over the past three years, the industry and its allies have run a noisy campaign for the levy’s removal – even enlisting Donald Trump’s help – alongside a quieter effort to shape its replacement.

The proposed successor is the government’s Oil and Gas Revenue Levy (OGRL). In some respects it is an improvement: harder to game and applied to revenues rather than profits.

But the new tax contains a critical flaw.

What’s wrong with the proposed Oil and Gas Revenue Levy?

As currently designed, the OGRL would capture only the biggest price spikes. It would only kick in when oil exceeds $90 a barrel and gas exceeds 90p a therm, with both thresholds rising each year with inflation.

That means the mechanism would switch off precisely in the price range where households feel the squeeze – high enough to hurt on bills and at the pump, but still too low to trigger the surcharge. 

And when the OGRL is inactive, oil companies would revert to one of the lowest headline tax rates in the world.

That gap – higher bills but no extra tax – is where the public loses out. Even under the windfall tax the difference between oil taxes raised and public energy costs incurred is significant – roughly £12 billion has been raised since 2022 compared with the £78 billion the government spent shielding consumers during the last price crisis. A poorly designed replacement would substantially widen that gap.

The result could be billions more in profits flowing to the oil and gas industry.

Are oil and gas companies actually reinvesting their profits? 

For the Treasury, that might be acceptable if those profits were reinvested in new domestic production and securing jobs. Recent history suggests otherwise. In 2022 and 2023, as prices soared, North Sea operators paid around £5.6 billion in windfall tax but still recorded £31.8 billion in post-tax profits.

These profits were not reinvested in the UK, despite generous incentives deliberately built into the levy by then chancellor Rishi Sunak to encourage new drilling. Instead, major producers returned cash to shareholders and invested elsewhere. As one anonymous oil worker put it, the industry was “laying us all off whilst you pay shareholders billions and give yourselves massive bonuses”.

The industry’s case for scrapping the windfall tax rests largely on a promise of future investment that may never materialise. It is asking the Chancellor – and us – simply to trust them. When workers are laid off while shareholders receive billions, we would do well not to. 

The industry argues “a more dangerous world” strengthens the case for more domestic production. But new drilling does nothing to lower energy costs, which is the pressing concern today for people in the UK struggling with the cost of living crisis. Most of what's left in the basin is oil, the vast majority of which is exported, doing little for security of supply.

There is a more obvious rationale for their lobbying and it’s simply that, in the context of spiking energy prices (with gas above 150p a therm and oil hovering around $90)² the proposed OGRL threshold would be breached and the surcharge would apply. 

Ending the windfall tax rollercoaster and making the most out of a declining basin

But a spike is just that – it is not necessarily the new normal for consumers. If prices fall back, the OGRL would quickly switch off, producers would return to the low base rate, but households would still likely be paying much higher bills.

That is the yo-yo built into the current proposal: a windfall surcharge only at crisis levels and very little when prices are merely painful.

Volatility and lack of reinvestment aren't the only problems. Even setting the OGRL's thresholds aside, the overall tax revenue pot is shrinking. The Office for Budget Responsibility's March forecast has receipts from the existing regime – offshore corporation tax, petroleum revenue tax and the EPL together – falling from £4.1 billion in 2025-26 to just £0.1 billion by 2030-31.

This is happening for two reasons. The first is that if prices follow the forecast, they will drop below the EPL’s cutoff thresholds in early 2027 and by law the tax will end. The second is more structural, this is a high-cost, ultra-mature basin in terminal decline. As production falls, so does revenue. The UK oil and gas industry is unlikely to be a major tax contributor again outside of crises (Figure one).

This makes the choice of thresholds more consequential: with less revenue available overall, giving away what remains during the years prices sit in the "painful but not crisis" range is a mistake the Government can’t afford to make.

Given the weaknesses of the underlying oil and gas tax regime – one of the most generous in the world for oil and gas companies – presenting the change to the OGRL as "revenue neutral" would simply lock in today's shortfall as the new normal.

To truly design a tax system with public benefit at its heart, a Chancellor would eventually need to confront the underlying regime too, including the investment allowances and decommissioning relief, which could be made conditional on delivering jobs and environmental benefit. But given the politics around oil and gas at the moment, that’s a bigger fight and it’s unclear it is one which would deliver much revenue. And so for now, the main job is to get the windfall tax right.

Getting the OGRL right

In short, John Healey should – once the current price spike has passed – introduce a reformed Oil and Gas Revenue Levy as a permanent windfall tax. 

The Energy Profits Levy, while a good idea in principle, was introduced quickly during a crisis, is riddled with loopholes, and has been extended twice – both because prices remained high and the underlying regime was not fit for purpose. 

But its replacement must not be shaped by an industry that has spent three years lobbying against the original windfall tax and which has a history of prioritising shareholder returns over domestic investment.

Instead, the new mechanism should be designed to protect households from excessive price rises. That means lowering thresholds to the point where consumers feel the pain of unaffordable energy costs, not just moments of heightened crisis. It means ensuring the prices at which the levy triggers aren’t pushed further out of reach each year with inflation. And it means using the revenues to support fuel-poor households and fund a just transition for North Sea workers. 

The Prime Minister has argued that extraction can be accelerated to pay for the transition. The tax regime cannot deliver that. What the regime can still do is protect households when prices spike. Whether it does depends on where the Chancellor sets the thresholds on the new levy.

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