Gas exemption from generator levy branded ‘inexplicable’

The government has justified exempting fossil fuelled-fired plants from its new windfall profits tax on generators, which one critic has branded “inexplicable”, amidst widespread concerns that the new levy will damage investment in UK renewable energy.

A technical note setting out the details of the new Electricity Generator Levy, published by the Treasury on Thursday (17 November) alongside the chancellor of the exchequer’s Autumn budget statement, confirms that the new tax will apply to nuclear, renewable and biomass electricity generation.

The tax will be charged on 45% of the revenues that these plants receive for output sold above £75/MWh.

However, coal, gas and oil-fired power plants will be exempt from the new levy as will pumped storage hydroelectricity and batteries.

The note says that while gas generators are receiving increased revenue from the “substantial” rise in the market price of electricity, they are also experiencing “severely inflated” fuel costs.

As a result, the document says it would be “inappropriate” to include gas generation because doing so could haven “unintended consequences” on pricing and dispatch decisions. It says similar concerns apply to pumped and battery storage.

Both coal and oil comprise an “extremely small and declining” proportion of the market and are subject to “very volatile” fuel costs.

The note also states that the levy will not be deductible from profits subject to corporation tax. The revenue used for calculating the levy will include forward contracts and power purchase agreements as well as prices received from selling unhedged output in the day-ahead and intraday markets, the document says.

However, revenues received from Renewables Obligation Certificates or Capacity Market payments will not be included.

The levy will only apply to electricity generated in the UK and not power imported via interconnectors.

Justifying the decision to impose the new levy, the paper says the price some electricity generators are receiving “well exceeds the price needed to provide investors with a reasonable return on the costs of production and exceeds any reasonable expectation of prices when capital was invested”.

The paper also says the government will be setting out next steps “shortly” on its Review of Electricity Market Arrangements, which it consulted on recently.

However, the government’s new windfall tax could “severely deter” investment in renewable energy projects, warned Dan Mc Grail, CEO of RenewableUK.

He said: “This windfall tax on low carbon power risks deterring investment, at a time when the chancellor should be incentivising clean energy. Unlike in oil and gas, under this levy companies which are making significant investments in renewables will get no tax relief and will be hit by a higher windfall rate.

“Any new tax should have focussed on large, unexpected windfalls right across the energy sector. Instead profits at fossil fuel plants are inexplicably exempted from the levy. Many renewable generators are on long-term, fixed price contracts and most others sold their power for this winter over a year ago, so they haven’t been making excess profits.

“We need to attract more than £175 billion in new wind farms and our supply chain over the course of this decade, so we need to make the UK one of the most attractive destinations for private investment in renewables. Ministers now need to work with the industry to ensure that the implementation of these plans ensures a level playing-field, rather than imposing unfair burdens on renewables.”

The Association for Renewable Energy and Clean Technology (REA), said the government has sent the “wrong signals” to investors with renewable energy taxes which compare unfavourably with the oil and gas sector.

It said that while gas prices have risen in the past nine months, so too have pellets and waste feedstocks for biomass plants.

Frank Gordon, director of policy at the REA, said: “While the REA and its members recognise the immense economic challenges facing this country, we would question the wisdom of subjecting the cheaper, greener renewable power sector to a more punishing tax system than its oil and gas counterparts.”

Dhara Vyas, Energy UK’s director of advocacy, said: “The proposed Electricity Generator Levy will effectively penalize much needed low-carbon generation over polluting fossil fuel extraction. A windfall tax on generators lasting 6 years stands in stark contrast to the 6 months duration of the European equivalent, making the UK a much less attractive destination for investment. Whilst reaffirming our commitment to decarbonising our economy, which will require billions of pounds of private investment in new energy infrastructure, it seems odd to have taken this approach.

However, SSE chief executive Alistair Phillips-Davies was less critical of the levy: “SSE has always believed in paying our fair share of tax and think a well-designed levy on extraordinary profits, where they are actually realised, is reasonable.”

Frank Elsworth, head of UK onshore development at wind energy company Vattenfall, said: “The Russian invasion of Ukraine has put pressure on energy markets across the world and we recognise that we have a role to play to help deal with the economic problems the country’s facing.”

Ed Birkett, head of energy and climate change, at right of centre thinktank Onward, tweeted that the government has reached a “sensible place” on the levy because extraordinary profits in some element of the electricity sector meant that it “had to act”.

However, he said the process leading up to Thursday’s announcement, including new legislation for the now abandoned cost-plus revenue cap, had caused “huge uncertainty” for the industry, which the government must now build bridges with to secure future investment.

“A good start would be to repeal the extraordinary powers that government took through the Energy Prices Act, which gives the business secretary the power to overrule the independent regulator,” Ofgem,” he added. 

Wealth management company Hargreaves Lansdowne noted that share prices for energy generating companies have “retreated rapidly” following the government’s announcement.

Matthew Hodkin, tax partner at Norton Rose Fulbright, said a “key missing piece” is how joint venture projects will be treated under the new rules.

He said: “A particular issue, both for the projects themselves and in terms of the relationship between the joint venture partners, arises when the status of one of these causes a project to fall within the scope of the levy when it would not otherwise have done so.”

The note on the Electricity Generator Levy says consideration will be given to how it is applied to joint ventures, which could possibly be subject to bespoke rules.