Energy prices: What is the windfall tax on energy companies in the UK?

Energy companies are reporting record profits while families struggle to pay their bills amid the spiralling cost of living crisis. The solution? Campaigners and experts urged the government to introduce a windfall tax on oil and gas companies to help ordinary people pay their bills. 

Following weeks of government indecision on the policy, former chancellor Rishi Sunak eventually announced a £5bn tax on oil and gas companies. 

Labour’s shadow chancellor, Rachel Reeves, accused the cabinet of being in “complete chaos” over windfall tax. Reeves claims that when the government u-turned, “they decided to hand billions of pounds back to producers in tax breaks”. 

But what actually is windfall tax, and what impact will it have as the cost of living soars in the UK? Here’s everything you need to know.  

What is a windfall tax? 

A “windfall tax” is any tax levied on an unexpectedly large profit which is usually regarded as unearned because circumstances outside of the company’s control created it.

In recent months, the soaring cost of wholesale oil and gas globally has led to surging profits for oil and gas companies, who have benefitted from the rising prices. 

BP has reported huge profits of £6.9billion between April and June. It is the second highest in the company’s history and triple the figure made in the same three months last year.

Shell made £4.7bn in profit in the final quarter of 2021, with annual profits exceeding £14.2bn – up from £3.57bn the year before. 

In spite of these large profits, the oil company paid no tax on its operations in the north sea in 2021 for the fourth year in a row thanks to tax refunds paid by the UK Treasury for the decommissioning of old oil platforms. 

These exceptionally high profits led the Labour Party and a number of campaigners to call for a windfall tax to help ease the cost of living for ordinary people, whose energy bills have risen dramatically since the price cap was removed at the start of April.

Is there a windfall tax in the UK?

The Conservatives – eventually – announced a 25 per cent windfall tax on energy companies in May after sustained pressure from campaigners. Previously, Sunak had said that a windfall tax would deter investment in the UK. 

The tax on oil and gas companies makes up £5billion of a £15billion household support fund to help families through the cost of living crisis. But Sunak’s windfall tax is a temporary measure, set to be “phased out when oil and gas prices return to historically more normal levels”.

Sana Yusuf, of Friends of the Earth, said: “Ministers must impose a much tougher windfall tax on massive oil and gas firm profits. It beggars belief that these companies are raking in such huge sums in the midst of a cost-of-living crisis. 

“The money raised should be used to help hard-up households with soaring energy bills and provide funding for a free home insulation programme – focusing on those most in need. “It’s astonishing that energy efficiency has been given such a low priority. A nationwide insulation programme would cut bills, reduce energy-use and slash climate-changing emissions.”

Tory leadership candidate Liz Truss has already rejected suggestions of another windfall tax on the profits of energy companies if she becomes Prime Minister.

Truss said: “I don’t believe in windfall taxes . . . What we should be doing is encouraging Shell and other companies to invest in the UK because we need to get our productivity up.”

A number of other ministers have spurned the idea of a windfall tax, with current chancellor Nadhim Zahawi saying in January that “a windfall tax on oil and gas companies that are already struggling in the North Sea is never going to cut it”.

During Prime Minister’s Questions in early March, Boris Johnson insisted that a windfall tax would only lead energy prices to rise further for ordinary people.  “The net result of that would simply be to see the oil companies put their prices up yet higher,” he said. 

Earlier in the year, Sunak accused Labour of “political opportunism” after calling for a windfall tax, saying that the idea seems “superficially appealing” but would ultimately deter investment in the UK.

Why do we need investment in ‘energy security’?

The UK and a number of other western countries have been scrambling to reduce their reliance on imports of Russian oil and gas in order to avoid inadvertently funding Putin’s war in Ukraine.

As such, ministers have been looking for ways to boost production of energy in the UK to avoid reliance on foreign imports. 

Energy produced domestically – particularly renewable energy – is also cheaper, meaning extra production will drive down energy bills for ordinary people.

An Energy Security Bill was announced this year with the aim to “propel the UK’s transition to a cleaner, affordable, home grown energy system”.

Business and energy secretary Kwasi Kwarteng said: “We’re going to slash red tape, get investment into the UK, and grab as much global market share as possible in new technologies to make this plan a reality.

“The measures in the Energy Security Bill will allow us to stand on our own two feet again, reindustrialise our economy and protect the British people from eye-watering fossil fuel prices into the future.”

But energy experts and campaigners are concerned the Energy Bill will fail in the same ways as the energy strategy, focusing on the long-term at the expense of fixing higher costs for households.

Simon Cran-McGreehin, head of analysis at the Energy Climate and Intelligence Unit, said: “With the Energy Security Strategy focusing on technologies like nuclear that might play a role but not for years to come, there’s a risk that the government is distracted trying to pass new legislation to fund those costly options, when it could instead be focusing on steps that will give more immediate help to hard-pressed households struggling with rising energy bills.”

Have other countries used windfall taxes?

Countries in Europe, including Bulgaria, Italy, Romania and Spain have imposed windfall taxes on power generators in recent months.

The revenue raised from these taxes has gone towards financing measures to assist citizens with the cost of living. 

Britain has also used windfall taxes before – most notoriously in 1997 with chancellor Gordon Brown’s budget.

Brown levied windfall taxes on companies which had been privatised by previous Conservative governments including power utilities, water companies and telephone company BT. 

Labour’s argument for the taxes was that these companies had been undervalued when they were privatised.