Natural gas is the single largest contributor to the UK’s energy mix with half of it coming from domestic sources and the other half imported from various sources.
According to the the National Grid Electricity System Operator, 38.5% of the electricity it generated in 2022 using natural gas, significantly higher than the contributions from wind energy (26.8%) and nuclear power (15.5%).
This excludes the use of gas for heating, which increases the proportion of gas used for all energy and the amount of gas imported.
Given its importance, oil and gas operators were undoubtedly stunned when the ruling Conservative Party introduced an Energy Profits Levy (EPL) in May 2022 as a way of helping households facing rising bills following the rapid rise in energy prices due to Russia’s invasion of Ukraine earlier that year.
This 25% surcharge – essentially a windfall tax – increased the overall tax burden faced by UK oil and gas producers up to 65% and raised an extra £2.6bn in tax revenues in its first year.
While originally intended to expire on 31 December 2025, it was raised to 35% – for a total tax of 75% – and extended to 31 March 2028 in November. This was further extended by another year to 31 March 2029 last week.
Encouraging new gas investment
At first blush, the EPL appears to be a massive strike against further investment in the UK’s oil and gas sector.
However, the levy was accompanied by a new investment allowance designed specifically to incentivise oil and gas investment.
While affected companies would still see their earnings slashed by the EPL, the actual cost of getting the project off the ground would receive a major boost from the tax relief of 46-91p for every £1 of capital expenditure.
Fast forward to when the EPL ends and the returns from the project that was effectively subsidised by the investment allowance would improve significantly.
Demonstrating just where operators stand with this, Shell signed off earlier this year on the Victory gas field about 47km northwest of the Shetland Islands.
At the smaller end of the market, Hartshead Resources (ASX:HHR) is progressing the Phase 1 development of its UK Southern Gas Basin assets towards FID.
A change could be coming and not for the better
However, changes might be on their way that could really prove detrimental to oil and gas companies.
The UK Labour Party, which is currently significantly ahead of the Conservative Party in polling for elections to be held before 28 January 2025, has flagged that it will further increase taxation on the sector and reduce tax relief for gas developments.
It plans to increase the tax rate to 78% and cancel the investment allowance, reduce the tax relief on capital expenditure to ~46%.
Proceeds from these changes will be used to fund a £23.7 billion uplift in green spending over five years.
Rather predictably, these planned changes should Labour win government in the UK has oil and gas companies concerned with industry body Offshore Energies UK saying that they would likely result in no new investments being made into the country’s oil and gas industry, imperil thousands of jobs and cost the UK £26 billion in “economic value”.
It is not a stretch to believe that oil and gas companies would take a serious hard look at their development plans and determine if it is still economical to continue should UK Labour win the coming election.
HHR for instance has flagged that it is assessing project economics associated with Labour’s proposed tax changes.
Takeaways for gas exploration and development
The developments in the UK provide a clear picture of just how important government policies are for gas development, particularly offshore projects that are expensive to both explore and develop.
The right policies can provide companies with the incentives to actually carry out exploration then when the right field has been found, to proceed with its development.
With gas demand still high and supply starting to be constrained in many countries due to a lack of investment, this is an issue that is becoming increasingly urgent particularly since renewables (along with batteries and electrification) adoption is still a ways from being able to supply our energy needs.
Bad policies, such as overly onerous tax regimes will do the exact opposite and discourage investment, which could well – in this instance at least – impact on the very tax revenues that UK Labour are looking to collect.
Of course getting the right policies in place isn’t always the easiest thing to do, especially when there are competing concerns, so governments will have to weigh up just what they are willing to sacrifice in order to achieve their main objectives.
At Stockhead we tell it like it is. While Hartshead Resources is a Stockhead advertiser, it did not sponsor this article.
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