Oil prices have fallen to levels not seen since before the onset of the pandemic, a development that has prompted the UK Treasury to reassess its fiscal forecasts. Benchmark Brent crude dropped below $40 a barrel on Tuesday, a decline driven by a confluence of factors including weaker demand from China, increased supply from OPEC+ members, and a strengthening US dollar. The price slide marks a significant reversal from the highs of mid-2022, when Brent exceeded $120 a barrel following Russia's invasion of Ukraine.
For the UK Treasury, the implications are dual-edged. Lower oil prices reduce inflationary pressure and ease the cost of living, which could bolster consumer confidence and economic activity. However, they also threaten a key source of tax revenue. The windfall tax on energy companies, introduced in May 2022, was projected to raise approximately £10 billion over its first two years. With oil prices now below the threshold at which the tax was calibrated, revenues from that levy are expected to fall short.
Treasury officials are understood to be modelling scenarios in which the energy profits levy yields £3-5 billion less than originally anticipated. This gap compounds existing fiscal pressures, following the Chancellor's Autumn Statement which announced £55 billion in spending cuts and tax rises to stabilise public finances. Lower oil prices could also reduce receipts from North Sea oil and gas production, which generated around £4 billion in corporation tax and ring-fence profits in the 2022-23 tax year.
Yet the Treasury may derive some compensation from other areas. Lower fuel costs typically reduce the drag on the wider economy, potentially boosting VAT receipts from higher consumer spending. The Office for Budget Responsibility (OBR) is expected to revise its forecasts for UK GDP growth upwards in its next fiscal outlook, partly due to the easing of energy costs. A Treasury spokesperson said: "We keep all tax forecasts under review and base our fiscal decisions on the most up-to-date economic data. The fall in oil prices is welcome for families and businesses struggling with high energy bills, but it does not change our commitment to fiscal discipline."
The decline in oil prices also carries geopolitical dimensions. It weakens the revenue streams of Russia and Iran, both of which are subject to Western sanctions. Lower prices could reduce Iran's ability to fund militant proxies, and may constrain Russia's war effort in Ukraine. Western officials have expressed cautious optimism that the oil price drop could accelerate diplomatic pressure on Moscow. A senior diplomat in the Foreign Office said: "Every dollar decrease in the price of oil is a dollar less for President Putin's war chest. The market is sending a clear signal that the era of high energy rents for authoritarian regimes is over."
However, the fall is not without risks for energy security. Some analysts warn that sustained low prices could reduce investment in new oil and gas fields, potentially creating supply constraints in the medium term. The International Energy Agency (IEA) has noted that global upstream investment is already 25% below pre-pandemic levels. The UK's North Sea Transition Authority has expressed concern that lower prices could accelerate the decline of domestic production, leaving the UK more dependent on imports.
For consumers, the immediate effect is welcome. Asda reported that the average price of petrol fell below 145p per litre on Monday, the lowest level since February 2022. The RAC said that a typical family car could be filled for £10 less than in the summer peak. But the broader economic picture remains uncertain, with the Bank of England likely to maintain its restrictive monetary policy to curb inflation, even as the oil price drop provides a deflationary impulse.
The Treasury's focus now shifts to the Spring Budget, due in March. The Chancellor faces a difficult balance: resisting pressure for tax cuts, as the fiscal headroom from lower oil prices may prove temporary. The OBR is likely to caution against counting on windfall gains from an unpredictable commodity market. As one Treasury insider put it: "The oil price is a volatile friend. We will not base long-term spending plans on its current trajectory."
