The Government said it would raise £5 billion from the windfall tax it announced on oil and gas companies on Thursday, but it left a back door for companies to avoid much of the charge if they invest in new oil.
Energy companies already pay 40% of their profits in tax, but the extra levy announced by Chancellor Rishi Sunak will bring this up to 65% until December 2025.
The added tax bill might also be phased out before then if oil and gas prices return to more normal levels, although when contacted the Treasury refused to say what these normal levels are.
But companies can also avoid almost all their tax bill after the Chancellor doubled the relief they can get for investing in new oil and gas extraction.
In the past companies could receive 46p of tax relief for every £1 they invested in the UK, this will rise to 91p.
“Like previous governments, including Conservative ones, we will introduce a temporary targeted energy profits levy, but we have built into the new levy … a new investment allowance similar to the super-deduction that means companies will have a new and significant incentive to reinvest their profits,” Mr Sunak said.
One senior oil source said that relief was “very positive”.
He added that “the percentage (of the tax was) a bit higher than expected, but not too bad” and was also positive about it being done though an existing system.
A spokesperson for Shell said: “We have consistently emphasised the importance of a stable environment for long term investment.”
They added: “The Chancellor’s proposed tax relief on investments in Britain’s energy future is a critical principle in the new levy.”
But the relief also sparked fears from environmental campaigners that more oil will flow from the North Sea as a result.
The International Energy Agency has previously warned that investment in new oil and gas projects must be halted to help tackle the climate crisis.
Ami McCarthy, political campaigner for Greenpeace UK, said: “This is utter stupidity. Rewarding oil and gas extraction while doing nothing to encourage investment in renewables will not provide energy security, push bills even higher and pour fuel all over the climate crisis.”
She called for investment in green energy and home upgrades such as insulation.
Meanwhile, the boss of Offshore Energies UK, the trade body for the oil and gas sector, said that investment would be hurt by the new levy.
“This is a disappointing and worrying development for industry, the shockwaves of which will be felt in offshore energy jobs and communities, and by consumers, for years to come,” said Deirdre Michie.
“(The levy) will drive away investors and so reduce UK energy production. That means less oil, less gas and less renewables. It also makes it much harder for the UK to reach net zero by 2050.”
Calls for a windfall tax have been growing for months to help with the cost-of-living crisis.
A big chunk of the inflation that is hitting households in the UK and around the world has been caused by runaway oil and gas prices.
The unprovoked Russian invasion of Ukraine pushed up energy prices, but they had already been rising.
In a note on Wednesday morning analysts at JP Morgan argued that “sustained underinvestment” in energy have sown the seeds of a “supercycle” – a sustained period of expansion as demand grows beyond supply.
Politicians have been debating for months if some of this money should be funnelled back to struggling households though a windfall tax.
The oil companies argue that because of their increased profits they are already paying billions more in tax this year. They also say that a windfall tax could make investors think twice about putting their cash into the UK.
But once they were resigned to the possibility of a windfall tax, a key question for the businesses was how the tax was levied.
Industry insiders were keen to be able to offset the tax against investment that they put into the UK, a wish that was granted.
There had been speculation earlier in the week that the companies who generate power would also be brought under the new tax.
They were left out of the package for now, but Mr Sunak still kept the door open to changing that.
“Certain parts of the electricity generation sector are also making extraordinary profits,” he said.
“We are urgently evaluating the scale of these extraordinary profits and the appropriate steps to take.”
Shares in SSE, one of the UK’s biggest electricity from gas generators, dropped significantly as that announcement was made, they were trading down 3.9% shortly after the speech finished.
Shares in its rival Drax were also under pressure, dropping 2%.
One key debate was how much could actually be raised from a windfall tax on the UK’s dwindling North Sea reserves.
JP Morgan said on Thursday that over the past six years the taxman has only collected £520 million per year on average from the oil and gas sector. In the six years prior to that it took in £6.3 billion per year.
“We caution that a windfall tax in the first/second year of industry recovery may risk deterring future investment in both O&G (oil and gas) and low carbon industries (given O&G and utilities are significant actors in energy transition), which may ultimately compromise the UK’s ability to deliver on its transition pivot,” they said.
The new 65% tax compares with 78% in Norway and 64% in Denmark.