George Osborne has undertaken a partial U-turn on his North Sea fiscal regime by unveiling a tax break for oil companies in a bid to halt a major decline in exploration and production which is hitting jobs and investment.

Having introduced a supplementary charge to the petroleum revenue tax in the budget last year to fund a cut in road fuel duty, the chancellor announced on Friday that he was now reducing this for older oil and gas fields.

The new Brown Field Allowance will shield up to £500m of income from the charge when firms are boosting production from established oil or gas fields – potentially cutting their tax bill by £160m.

The move is expected to cost the exchequer £100m per year initially – but officials insist the long-term tax revenues will be significantly higher.

“Today’s tax allowance is more good news for the North Sea, good news for jobs and good news for the broader economy. It will give companies the incentive to get the most out of older fields, creating jobs and delivering more revenue for taxpayers,” said Osborne.

“This government has signalled its absolute determination to get more investment in the North Sea, a huge national asset. Just last week, I saw the benefits at a supply chain factory creating many hundreds of jobs in the north-east thanks to government support for North Sea gas which made a major project possible,” he added.

The U-turn comes amid a 19% downturn in UK hydrocarbon production. Half as many exploration wells were drilled last year, compared to 2010, by an industry that is estimated to pay a quarter of all the UK’s corporation tax.

The offshore industry’s lobby group, Oil & Gas UK, welcomed the chancellor’s announcement of the new tax relief to encourage investment in older oil and gas fields.

“This is a strong signal of the government’s commitment to make the most of the UK’s oil and gas resources to the benefit of our energy security, the public purse and jobs,” said Mike Tholen, the organisation’s economics and commercial director.

“Oil & Gas UK is encouraged by the support announced for oil and gas ‘brown fields’ in the UK which typically have high running costs and are subject to up to 81% tax on production. This initiative will have an immediate impact in that it will help to promote investment and sustain production from many mature fields, enabling more oil and gas to be recovered from them and postponing decommissioning by a number of years.”

Oil & Gas UK believes the move could rapidly lead to a number of new investments amounting to £2bn.

John Walker, national chairman of the Federation of Small Businesses, is worried that the tax cut could mean an increase in fuel duty in future.

“The Treasury increased tax on the North Sea oil and gas industry 18 months ago to pay for a cut in fuel duty. Now the chancellor has announced a tax break for the industry,” Walker said.

The environmental movement reacted angrily to the new tax rates.

Friends of the Earth’s head of campaigns Andrew Pendleton said:

“The chancellor should be urgently trying to wean the economy off fossil fuels, not subsidising its addiction.

“Cash-strapped households and businesses have been struggling with the soaring cost of gas and oil for years – and with experts predicting future price hikes, a long-term approach is needed.

“It’s time to stop scraping the bottom of the barrel on energy policy – we should invest in clean British energy from the wind, waves and sun as well as cutting waste to create jobs and give us power we can all afford.”

Tom Pering, an energy analyst at Inenco, described Osborne’s move as “a very small step”.

“Suggestions that this will allow activity to continue for 50 years are mis-placed, as the cost of extracting from almost depleted reservoirs will have long since ceased to be economically viable,” he said

“Increased extraction and the creation of jobs in the short term will just use up our own reserves at a faster pace, leading to a bigger energy crunch further down the road.”