A Levy That Made Sense Once
Britain taxes North Sea oil and gas profits at 78 cents on the dollar. Producers have already pulled out of projects. Around 1,600 wells are set to close this decade. The windfall tax is not free money from greedy companies. It is a tax on the investment that would keep the lights on.
In 2022, prices spiked after Russia’s invasion of Ukraine, and the government introduced the Energy Profits Levy. The purpose was straightforward. Extraordinary prices were producing extraordinary profits, and a share of those profits would fund bill support for households. That was the case for the levy, and it was a real case. Let us state it fairly before we examine it.
A windfall tax on windfall profits is not a foolish idea. When an industry earns more than anyone expected, taxing the unexpected part does not distort the expected part. The company did not plan on the windfall, so it will not change its plans to avoid the tax. The levy was designed that way - a charge on profits above a threshold, aimed at the extraordinary part rather than the ordinary part.
The question is what happens to that logic as the levy ages. A windfall is temporary by definition. The tax that was supposed to end with the windfall has been raised and extended. At some point the temporary tax stops taxing the unexpected and starts taxing the expected - the ordinary investment itself.
The Arithmetic Stacks
North Sea profits already carried a headline rate of 40 percent: 30 percent ring fence corporation tax plus a 10 percent supplementary charge. The Energy Profits Levy added 38 percentage points on top, and was extended to March 2030. The combined marginal rate is 78 percent. The BBC’s explainer notes that the rate applies whether oil and gas prices are high or low.
Let us be precise about what 78 percent means. Of every additional pound of profit a North Sea project earns, 78 pence goes to the state. The remaining 22 pence must pay for the capital, the risk, the maintenance, and the search for the next barrel. A windfall tax that collects at ordinary prices is not a windfall tax. It is the tax code, applied to an industry the government has decided to wind down.
That is the point where the levy stopped collecting windfalls and started taxing the investment decision itself. A company deciding whether to develop a field, drill a well, or extend a platform’s life now knows that three quarters of everything it earns on the margin belongs to the Treasury. The threshold that was supposed to protect ordinary profits is reached in ordinary conditions. The calculation that made the tax sensible is gone.
What the Evidence Shows
The producers are leaving. BP, after sixty years in the North Sea, has put its North Sea business up for sale. The Guardian reports its chief executive calling North Sea investments “not competitive” within the company’s portfolio. Harbour, the UK’s largest producer, said the levy has “all but wiped out” its profit for the year.
The chairman of INEOS Energy put it plainly: the levy, coupled with the ban on new drilling, “has effectively shut down investment, while the Norwegian sector continues to grow, investing at ten times the rate of the UK.” Norway taxes its petroleum sector heavily. The difference is not taxation per se. It is what the tax does to the investment decision.
Around 1,600 wells are set for closure and decommissioning this decade, with decommissioning set to become the industry’s main activity. The industry lobby warns of an investment slump of more than 80 percent. And in February, the Treasury held talks with producers about ending the levy early - because even the government can see the base shrinking. A tax on a shrinking base collects less than the arithmetic promised, and then it collects less than the policy costs.
In our last article, we asked this question about Scotland. Scotland raised its top income tax rate to 48 pence and watched the revenue collapse, because the base moved, changed form, or left. The Laffer curve is arithmetic: revenue is the rate times the base. Scotland’s 48p appeared to lose money in its first year. The North Sea’s 78 percent is the same experiment at industrial scale, with the country’s lights attached to the outcome.
The Bill Everyone Pays Later
The levy funds the price cap. That is the seen part: the state takes money from producers and returns it to households through the energy price cap. A transfer from producers to consumers, routed through the Treasury, announced as relief.
The unseen part is what happens to production on the way. Wells close early. Fields are never developed. The supply that would have been there is not there, and Britain imports the difference at world prices - prices set by wars, pipelines, and decisions made in other capitals. The second inflation wave showed what that looks like: energy is an input to everything, and the cap smooths the shock without removing it.
The households the cap protects pay twice. Once through the transfer, because the cap is paid for by the levy. And again through the investment that never happened, because the domestic production that would have paid for itself - and held prices down - is gone. The second payment is invisible. It arrives later, in winter bills, spread so thin across a decade that nobody connects it to a tax decision made in 2022.
That is the seen and the unseen in one policy (Bastiat’s lesson). When a cost is not in the price, people do not respond to it, as we noted in the externality primer. The windfall tax severs the price signal in the same way: the household never sees the cost of the production being taxed away, because the state stands between producer and consumer. And when real supply falls while the money supply does not, the mechanism we traced in the money and inflation primer does the rest - the same money buys less.
The timing is not abstract. Ofgem’s fourth-quarter price cap announcement is due in late August, and the decision on the winter cap will land while the closures accelerate. The two events are one story: the state collecting the investment on one side of the ledger and paying the bill on the other. Whether the levy should stay or go is not a question for this column - that is a political judgment, and it belongs elsewhere. The economics is simpler and sterner. A tax of 78 cents on the dollar taxes the investment decision, and taxing the investment decision produces less investment. That is arithmetic, and the arithmetic is already in the wells.
The Lens
Next time someone says the windfall tax is free money, ask: free for whom, and what did the investment that would have paid for itself just cost?
This is the second in a series on the Laffer curve in British tax policy. Start here: The Laffer Curve, Alive and Well in Scotland