A sharp fall in revenues from North Sea oil has played a leading role in the deterioration in the government's finances as the Treasury caught a glimpse of how the nation's coffers will look when the oil starts to run out.

Money flowing into the exchequer from the North Sea declined last month after a U-turn by the Treasury that reversed a large part of the tax rise implemented in the 2011 budget.

Last year George Osborne said it was fair for oil explorers to bear a greater tax burden as part of his austerity measures. He slapped a £2bn tax rise on producers.

In his most recent budget, the chancellor revealed that the industry responded by cutting production by 18%, leading to a £2.3bn drop in tax revenues. Combined with many fields coming to the end of their life, this has seen output fall. A total of 1.04m barrels a day was pumped in the year to March 2012, down from a peak of 2.7m in 1999, and the lowest since the 1970s.

Critics had warned Osborne that pushing tax rates on North Sea oil and gas beyond 80% would kill investment, but they were dismissed at the time. As predicted, some of the industry's biggest firms threatened to pull out of long-term investments if the high tax policy was maintained, signalling an even greater fall in receipts over the coming years.

Last month the Treasury caved in. Officials agreed to a series of tax breaks that dramatically cut levies on some of the most profitable fields.

Sally Hatch, a spokeswoman for the industry lobby group Oil & Gas UK, said investment in the North Sea was expected to increase from £8.5bn last year to £11.5bn this year. Much of the extra commitment from oil majors and smaller explorers resulted from the cut in tax rates.

Hatch said the Treasury also took into account that much of the North Sea is dotted with ageing rigs that have higher costs of production than modern rivals and suffer shutdowns as a result. She said new investment was badly needed and a punitive tax deterred further exploration.

The turnaround is expected to take several years, leaving the Treasury's figures underwater during a crucial period when it needs all the cash it can get.

BP and Chevron have found oil west of Shetland, but the Clare Ridge field run by BP and Chevron's Rose Bank field are not expected to come on stream until at least 2014.

In the meantime output from the region's second largest crude oil stream is set to fall sharply in September, adding to signs of reduced supply from the home of the Brent oil benchmark, which is used to price about two-thirds of the world's oil.

The Treasury says the July figures are a blip. Harry Tchilinguirian, head of oil research at the investment bank BNP Paribas, says a heavier than usual maintenance programme this summer, especially in the Forties field, gives some credence to this argument. Production in the Forties field will be at its lowest level for 25 years this summer.

However, Tchilinguirian stressed that production has fallen steadily over many years and is expected to continue its long-term decline. The new fields coming into production were unlikely to change the long-term picture, he said.

"The UK offshore production industry is based on mature fields. There may be some discoveries and there may be some scope for smaller firms to extract some of the oil left in older fields. But only a massive investment will reverse the long-term decline of the industry," he said.