How can energy investors navigate the tax and regulatory landscape?

Over recent years, there has been rapid fiscal change in the global energy sector, with the introduction of a complex mix of incentives and windfall taxes.  This has been impacting investor confidence.   

The UK has raised revenues through windfall taxes applicable to renewable generation as well as oil and gas production, with few tax incentives specific to the energy transition. This is a stark contrast to certain other jurisdictions, most notably the US, which is using tax incentives as a tool to try and attract investment and develop green technologies. We have seen that various countries have taken different approaches in a bid to attract investment with varying degrees of success.

The UK has introduced full expensing for certain qualifying capital expenditure and there are R&D tax incentives which may be beneficial for the development of certain green technologies.

However, as well as the ‘fiscal carrots’ mentioned above, there are also some sticks, not least the two temporary windfall taxes - the Energy Profits Levy and the Electricity Generator Levy.  In the Spring Budget 2024 it was announced that the Energy Profits Levy would be extended by an additional year to 31 March 2029.  However, a positive development for renewable energy projects is that draft legislation has been published which (if enacted) will provide an exemption from the Electricity Generator Levy for new investments where a final investment decision is reached on or after 22 November 2022.

The Contract for Difference scheme has been pivotal for the UK’s clean energy strategy, aiming to de-risk investments.

However, Allocation Round 5 saw no new offshore wind projects awarded. In contrast to previous rounds, the lack of a ringfenced budget for offshore wind meant fixed-bottom offshore projects had to compete against much cheaper technologies, like onshore wind and ground-mounted solar.

The next Contract for Difference allocation round (AR6) is due to take place in summer 2024 and the government has announced a budget of £1.025bn in the Spring Budget 2024, showing the government’s appetite to kick start new offshore wind developments.

In terms of the UK legal framework, the Energy Act 2023 passed into UK law on 26 October 2023 with the aim of increasing energy reliability and supporting the UK’s climate change targets. There are a raft of provisions for various energy sub-sectors, including the introduction of a framework for economic and licensing regulation for both carbon capture and storage, and hydrogen projects; and the establishment of an Independent System Operator and Planner, which should provide some much-needed long term planning capability. 

In Spring Budget 2024, the Chancellor announced a £120m increase to the Green Industries Growth Accelerator budget, increasing the total funding available to over £1bn. 

Therefore, the more significant developments to incentivise the energy sector in the UK are arising outside of fiscal measures through improving legal frameworks and funding availability.

The UK government opened applications for the Second Hydrogen Allocation Round (HAR2) in December 2023, hoping to support up to 875MW of capacity.  Applications, together with supporting evidence, must be submitted by 19 April 2024.  Contracts are expected to be awarded from early 2025.    

Revenue support for projects applying for HAR2 will be assessed through the Hydrogen Production Business Model (HPBM), which looks to provide price support using a variable premium model (volume support being provided indirectly using a sliding scale approach). 

The contractual arrangement behind the HPBM is the Low Carbon Hydrogen Agreement (LCHA), a draft of which was published in August 2023.  A LCHA will be signed by a hydrogen production counterparty (expected to be the Low Carbon Contract Company) and an eligible low carbon hydrogen producer.  Applicants should be aware that the form of LCHA is still a draft and may be amended to reflect policy changes affecting HAR2.

On 12 March 2024, the government announced its support for the construction of new gas power stations in the UK.  Once operational, the power stations will generate electricity during periods when the weather is not conducive to powering sources of renewable energy and so increase security of supply. 

Boosting gas power capacity forms part of the second consultation on the Review of the Electricity Market Arrangements (REMA) with proposals to: (i) amend existing legislation so that new gas power plants are built ‘net zero ready’ and can convert to use low carbon alternatives going forward, and (ii) run the new gas power plants less often as the UK begins to rely more and more on low carbon technology. 

The second consultation on REMA was published in March and will close on 7 May 2024.

2024 involves elections covering more than 40% of the world’s population including the UK. 

Labour has announced that they would increase the Energy Profits Levy to 78% and there are concerns that tax relief for capital expenditure would be removed which would further increase the effective tax rate applicable to UK oil and gas Producers. In addition, Labour has announced that the budgeted £28bn per annum on green investment will be reduced, due to the state of the public finances.

The UK needs to be internationally competitive to attract the capital investment required to reach its net zero targets.  Whilst there are positive developments in terms of increased funding becoming available for the energy transition and a developing legal framework, a history of fiscal volatility and lack of targeted fiscal incentives may put the UK at a disadvantage in attracting globally mobile capital.

Our KPMG Tax and Legal experts hosted an event in September 2023 “Unlocking the Energy Transition: How can investors navigate the tax and regulatory landscape?” , you can watch this on-demand  here and find out more about the  Future of Tax and our KPMG Law function.