UK energy sector and supply chain partners on a bumpy road to clean energy

The transition to clean energy in the UK is a complex process, requiring a shift from fossil fuels like oil and gas to renewable and low-carbon sources such as wind, solar, hydrogen, and carbon capture and storage (CCS). The UK government has announced a series of proposed changes to accelerate this transition, aiming to increase renewable energy generation, reduce reliance on fossil fuels, and implement new regulations and taxes on the oil and gas industry. 

However, these changes present significant challenges for the oil and gas sector, which remains a vital part of the UK’s energy mix and economy. As the government seeks to balance its environmental ambitions with energy security and affordability, these policy shifts pose substantial financial and operational risks to companies involved in exploration, production and distribution.

Government partnership to accelerate offshore wind and technology innovation

In September, the government will announce Scottish headquarters for GB Energy, a state-owned sustainable clean power company aimed at accelerating investment in renewable energy like offshore wind. This initiative will help ramp up Britain’s domestic renewable capacity, enhancing energy security and providing cheap, clean power. GB Energy will own, manage, and operate clean power projects while also aiding in the development of newer technologies such as carbon capture and hydrogen. It has partnered with the Crown Estate to support the development of offshore wind and boost technologies like carbon capture and storage, hydrogen, wave and tidal energy.

The Department for Energy Security and Net Zero believes this partnership could leverage between £30 to £60bn of private investment into clean energy projects. This significant potential investment highlights the economic scale of the transition and the substantial role of private sector involvement.

Near-term headwinds

In the near term, two significant challenges must be managed. First, the energy industry needs a clear strategy to meet the new government’s accelerated pledge to decarbonise Britain’s power system by 2030. This ambitious policy requires extensive coordination across industries and substantial private sector investment. The new deadline advances the previous government’s target by five years, creating pressure that could outpace the sector’s ability to adapt, as warned by industry CEOs and policy experts. Although about 50% of UK electricity now comes from renewable sources, this progress is insufficient to meet the accelerated target, according to the Institute for Government (IfG), which notes several bottlenecks that must be resolved to accelerate delivery:

• Limited grid capacity to handle all the renewable energy produced by wind and solar farms.
• Connection queues to the grid, including numerous ‘zombie’ projects that will never be completed but remain in the queue.
• Securing materials and equipment through international supply chains where the UK competes with other countries, and revitalising domestic supply chains weakened by inconsistent messaging and policies.
• Shortages of skilled labour needed to build the necessary infrastructure.
• Low capacity in the planning system, delaying key infrastructure projects, with approval times for nationally significant infrastructure rising from 2.6 to 4.2 years between 2012 and 2023.
• Insufficient public engagement to stimulate demand for sustainable energy.
  Difficulties in coordinating efforts across the energy sector.

While some of these challenges require long-term solutions, others, such as addressing connection queue inefficiencies, reforming the planning system, and improving public engagement, can be tackled more quickly. Companies will need to navigate these changes carefully to maintain profitability and operational stability while adapting to the evolving policy landscape. Progress in all areas is essential to achieve the goal of delivering clean power by 2030.

The second major headwind is the proposed changes to the Energy Profits Levy (EPL), a windfall tax on upstream oil and gas profits of UK power providers. In late July, the government outlined planned changes to the EPL, set to be introduced in the Budget and take effect from November. These changes include:

• An increase in the headline EPL rate to 78%: Critics warn this will add financial pressure on the oil and gas sector, which is already excluded from tax reliefs related to financing and decommissioning costs. This higher rate also contrasts with Norway’s regime, where fewer limitations exist, creating a competitive disadvantage for the UK.
• A two-year extension of the levy to March 2030: This extension means companies will face higher taxes for almost eight years unless oil and gas prices drop below specified thresholds to trigger an early cessation via the ‘Energy Security Investment Mechanism’. Companies must assess the prolonged financial impact of this extended levy on their profitability.
• The removal of the 29% investment allowance for general expenditure: This change risks reducing overall investment levels in the UK oil and gas sector. Companies may need to pause or reassess their investment strategies in light of the reduced financial incentives.
• A reduction in capital allowance claims: Limiting the ability to offset capital expenditures against taxable profits could significantly impact cash flow and increase tax liabilities. This may worsen existing tax issues, such as high EPL rates for companies with substantial decommissioning costs, even if they are loss-making.

Companies should prepare for increased uncertainty and potential financial impacts until the specifics of the new restrictions are clarified in the upcoming Budget. This uncertainty could also affect current and future M&A activity, which often relies heavily on tax considerations. Businesses need to evaluate potential risks and plan for various scenarios to mitigate adverse effects on their operations and financial health.

Unintended consequences 

Offshore Energies UK (OEUK), representing over 400 companies in the sector, stated these EPL changes could jeopardise thousands of jobs and harm companies vital to the UK’s industrial strategy and net zero targets. The uncertain duration of the levy complicates long-term financial planning and investment decisions. Companies should prepare for sustained elevated taxation and consider strategies to mitigate its impact, especially since early removal of the levy remains unlikely under current price forecasts.

In an open letter, an industry consortium – including manufacturing, engineering, and technology companies dependent on oil, gas, wind, hydrogen, and carbon capture projects –warned that the EPL changes risk damaging the sector’s supply chain. “For our companies, this surprise risks operators – big and small – further scaling back or postponing their investment plans in response,” the letter reads. “The ramifications will be felt throughout the supply chain, affecting jobs and the communities this industry supports, both directly and indirectly.” The EPL was originally introduced by Rishi Sunak in May 2022 in response to soaring profits by energy providers, driven by rising demand after Covid-19 restrictions were lifted and wholesale energy price spikes following the invasion of Ukraine.

The consortium’s letter further stated: “We view the proposals to increase the EPL, extend its term, and reduce the rate of capital allowances with grave concern that these would be a blunt response which could undermine the levers to long-term solutions and jeopardise jobs in communities across the UK. Companies investing in nascent opportunities like floating offshore wind and CCS will require the cash flow from a stable and predictable oil and gas business to fund these opportunities.”

Managing competing priorities

Britain’s oil and gas companies, along with their supply chain partners, must transform their business models to focus on sustainable energy production methods while balancing multiple, often conflicting, financial, political, and environmental priorities. This creates a range of complex trade-offs for energy providers and their suppliers, with no straightforward solutions.

Companies throughout the energy sector need to carefully consider how to position themselves in light of the following challenges:

• Balancing profitability and investment: Demonstrating a commitment to sustainability while maintaining shareholder returns requires strategic capital expenditure and investment in clean energy technologies. This delicate balance is complicated by the substantial costs associated with the energy transition. To maintain investor confidence, companies need clear strategies and transparent communication. The volatile economic environment and evolving regulations further complicate budget planning and timelines.
• Safeguarding jobs: As the industry shifts away from fossil fuels, companies must mitigate potential job losses by investing in reskilling and retraining programmes to help workers transition to new roles, such as renewable energy technicians or hydrogen plant operators. The UK government has recognised this need with the launch of Skills England to develop a more skilled workforce for the future.
• Aligning with net zero targets: Companies must align their strategies with government net zero targets, often requiring the adoption of new technologies, emissions reductions, and possibly operational restructuring. However, misalignment between corporate and political timelines can create tension, especially when government-imposed deadlines outpace the industry’s ability to adapt, posing risks to shareholder returns.
• Navigating regulatory and tax changes: The sector faces increased financial pressure from windfall taxes and changing regulations. Companies must carefully plan to adapt to these changes while maintaining operational stability and investment capacity.
   

The transition from oil and gas to renewables will be challenging. BTG Advisory can assist your company in making informed decisions for the long-term growth of your business. For a confidential discussion about your specific corporate circumstances, please contact our team today.