The Treasury's diesel dividend

Of every £2 a driver pays at a diesel forecourt, 86p goes to the government. The fuel itself (refining margin, distribution and the forecourt's cut) accounts for the other 114p. Two components make up the government's share: fuel duty, currently fixed at 52.95p per litre regardless of the pump price, and VAT at 20% of the total. Because the VAT is calculated on the full pump price including the duty, a rising market lifts Treasury receipts without any decision being required.

VAT is charged not just on the fuel but on the duty itself, as it is with alcohol and tobacco. At £2 a litre, the VAT levied on the 52.95p duty alone comes to 10.59p. On a 55-litre tank that is £5.82: tax charged on a tax.

Fuel duty is flat. Parliament sets a rate, the rate stays fixed between budgets, and every litre pays it regardless of price. VAT works differently. At 20% of the pump price, it rises and falls with the market. When a supply shock pushes diesel to £2, the Treasury does not need to announce anything; its receipts go up automatically.

In March 2022, with pump prices already above £1.85 and rising fast after Russia's invasion of Ukraine, the government cut fuel duty by 5p, from 57.95p to 52.95p. Prices continued rising anyway, reaching 199p in July that year. At 199p, the combined duty and VAT take came to 86p per litre. Before the crisis, when diesel was 149p and duty was 57.95p, the government was collecting 83p. The duty cut did not prevent the Treasury from collecting more as prices went up. The VAT component, rising with every penny added at the pump, more than compensated for the 5p reduction in the flat charge.

The mechanism is straightforward: an ad valorem tax always delivers more revenue when the taxed thing gets more expensive. The 5p duty cut was worth roughly 6p to drivers; at the peak, prices had risen by 50p.

The duty is the same pence per litre regardless of who fills the tank. What differs is how many litres each household must buy, and what that represents as a share of income.

Rural households drive around 40% more miles annually than urban residents, according to DfT National Travel Survey data. They do not drive more by choice: outside major cities, a car is the only practical connection to work, school and healthcare. A rural household covering 14,000 miles a year in a diesel car at 40mpg, paying 86p per litre in combined tax, pays roughly £1,370 in duty and VAT. A comparable urban household at 10,000 miles pays around £980. The rate is equal per litre; the annual bill is not.

Trades workers face the same constraint more acutely. Of the 4.5 million vans on UK roads, 96% run on diesel. For a plumber or electrician, fuel is not a consumption choice; it is a fixed input that determines whether the job gets done. The two-step duty rise from January 2027 does not distinguish between a discretionary car journey and a van that has to be somewhere at eight in the morning.

Among car-owning households, those who most need to reduce their fuel bill have the fewest tools to do so. An electric vehicle eliminates fuel duty entirely, but EV ownership is concentrated at the top of the income distribution. Among drivers earning more than £83,000 a year, 21% own an EV; among those earning under £21,000, the figure is 7%. The transition period (the decade during which duty rises while EVs remain unaffordable for most of the market) falls hardest on the drivers with no alternative.

Fuel is priced globally. Crude oil trades in dollars on world markets; refining margins move with regional supply; transport and retail add broadly similar costs across northwest Europe. Tax policy is the main reason the UK pump price sits higher than most of its neighbours. In April Spain's diesel ran at around £1.57 per litre. On 20 March Madrid had cut its diesel excise to the EU minimum of €0.330 a litre and VAT on fuel from 21% to 10%. At April's price, the Spanish government collected roughly 43p per litre in combined duty and VAT. The UK, at 191p, collected 85p.

The pre-tax retail cost of diesel (wholesale crude, refining margin, distribution and forecourt margin) is broadly similar across northwest Europe. UK fuel duty is 52.95p, roughly €0.61 at April's exchange rate, nearly double Spain's €0.330. A Spanish driver filling a 55-litre tank paid around £19 less than a British one, and the difference in tax more than accounts for the gap.

The immediate cause of the current price surge is disruption in and around the Strait of Hormuz following the Iran conflict of March 2026. Roughly 20% of globally traded oil passes through that chokepoint. France, Germany and Italy, which all retain significant domestic refining capacity, are somewhat buffered from that disruption; the UK, following the permanent closure of the Grangemouth refinery in Scotland in 2025, is not. The UK now imports around a third of its diesel, with the Netherlands the single largest source country, supplying 24% of all petroleum product imports in 2025, according to DESNZ Energy Trends.

The closure was a commercial decision by Petroineos, driven by operating losses and the long-term shift away from fossil fuels, with government support for the site's transition to an import terminal. No alternative Scottish refining capacity was commissioned or planned. The practical consequence is that any disruption to Middle Eastern crude supply transmits more directly into UK pump prices than it otherwise would.

A refinery is not a fuel factory. It is a chemical plant that processes crude oil into dozens of outputs simultaneously, the most visible of which happen to be petrol and diesel. Around 15% of every barrel (roughly 24 litres) does not become fuel at all. It becomes bitumen for road surfaces, lubricants for industrial machinery, wax for food-packaging coatings, and petrochemical feedstocks for plastics, synthetic rubber and synthetic fibres. These by-products feed into nearly every manufactured good. Petrochemical derivatives run through a large share of modern packaging, transport and consumer goods.

The pump price is visible because it changes daily and is displayed on forecourt signs. The rest of the barrel's inflation travels invisibly through supply chains on lags of months to years. Plastic packaging contracts are typically repriced quarterly; bitumen for road resurfacing is bought on annual local authority tenders; synthetic fibres move through four or five manufacturing stages before they reach a clothing rail. When this file was published in April, the disruption was six weeks old and the secondary waves had not arrived. CPI inflation has since risen from 2.6% in June to 3.5% in September (ONS).

Grangemouth supplied not just fuel but 1.4 million tonnes of petrochemicals per year to UK manufacturers: feedstocks for plastics, solvents and industrial chemicals. Its closure means those feedstocks now arrive by ship from continental refineries. When those same refineries are constrained by Middle Eastern crude supply, UK manufacturers compete for allocation against larger domestic markets. That can leave UK manufacturers paying more in tight markets.

Fuel duty has been frozen at 52.95p since March 2022. The first step back up was due on 1 September 2026; on 20 May the government cancelled it and extended the 5p cut to 31 December 2026. Under the schedule now in law, duty rises by 3p on 1 January 2027 and a further 2p on 1 March. The full rate from spring 2027 will be 57.95p, exactly what it was before the 2022 cut, wiping out every penny of the relief announced at the time. The Budget on 28 October sets the final rates.

If diesel holds at £2 through this period (it was 199.3p in the week of 19 October), the total government take per litre from March 2027 would reach around 91p: the highest since the duty freeze began in 2022.