Jake Landman

The consultation is part of the government’s broader strategy regarding the future of the North Sea. It follows the government’s commitment made during the Autumn Budget 2024 to end the energy profits levy (EPL) by 2030 or earlier if the energy security investment mechanism is triggered.

The EPL, introduced in response to the profits made by oil and gas companies during periods of high prices, is a temporary measure. The new proposed oil and gas price mechanism aims to replace the EPL, providing a permanent solution that will activate only during periods of unusually high oil and gas prices.

The primary objective of the consultation is to gather feedback from stakeholders, including the oil and gas sector, investors, and the public, to design a mechanism that balances the needs of the industry with the government’s fiscal requirements.

The policy options are currently split between a Revenue-Based Model (RBM), which targets the excess revenue a company receives for its oil and gas above threshold prices, and a Profit-Based Model (PBM), which targets a proportion of profits arising from unusually high prices, with unusual being considered by reference to average market prices and thresholds.

The government emphasises the importance of creating a mechanism that is predictable, sustainable, and which minimises distortion in investment decisions when prices are not unusually high.

The RBM would have two thresholds, one for oil and one for gas. The tax would apply to revenue above that threshold, with revenue determined by realised prices rather than any market price, recognising that many oil and gas companies use forward contracts and hedging such that the market price at a given time does not necessarily reflect the realised price.

Under the RBM, no deductions for costs would be allowed. However, the government suggests that the thresholds will be set at a high enough level that recognises the costs of doing business in the North Sea. Additionally, the tax point will be the first point of sale following the extraction to avoid double taxation.

The PBM would have a number of different features, including identifying a slice of profits that will be deemed to be attributable to price shocks. The PBM would only kick in when the average market price over the accounting period exceeds the threshold that applies at the end of that accounting period.

When that has happened, the percentage of profits to which the tax applies would be determined by dividing the difference between the average market price and the threshold, by the average market price. This percentage would then be applied to the company’s profits, which will be an adjusted ring fence profit similar to the existing EPL calculation.

The mechanism chosen must seek to balance the need for fiscal stability with continued investment in the sector, and alignment with environmental objectives. The industry may feel that the balance is not quite struck if their tax burden, which has historically been much higher than other companies in any event through the operation of ring fence taxation and related measures, remains even higher over the longer term.

Jake Landman is a partner at Pinsent Masons