How Sunak’s windfall tax undermines the fight to ditch foreign fossil fuels
The Government is hitting UK oil and gas producers with a shock levy just as it needs them to invest in production, says Rachel Millard
Linda Cook, chief executive of Harbour Energy, gave a clear warning to the Chancellor this week amid rising calls for a windfall tax on oil and gas producers enjoying record profits.
Higher taxes would knock producers’ finances, leading to fewer developments being approved and harming the UK’S attractiveness as a place to invest, she told peers at trade group Offshore Energies UK’S annual conference in Aberdeen.
“There can be no doubt that imposition of additional taxes would be detrimental to energy sector investment, to our domestic energy security and to our sector’s ability to further the country’s energy transition ambitions,” added Cook, whose company is the largest producer in the North Sea.
Her warnings took a step closer to becoming reality yesterday, as oil and gas producers reacted to Rishi Sunak’s decision to slap them with the windfall tax. BP, which accounts for about 8pc of UK production, declared it would review the impact of the new regime on its North Sea investment plans, while Shell said a “stable” environment was “fundamental to our aim to invest between £20bn-£25bn in the UK in the next decade.”
BP’S boss Bernard Looney had previously said its plans to invest £18bn this decade would be unaffected by the windfall tax, a comment seized on by its proponents amid months of debate.
Despite many Tories expressing their ideological opposition, a windfall tax started to look inevitable this week after Ofgem, the energy regulator, warned energy bills could rise to £2,800 in October in what appeared to be a choreographed move setting the stage for the Chancellor to act.
On top of a 54pc bill increase that came into force in April, it would mean UK households’ bills will have risen by £1,523 in less than a year, with warnings that 40pc of them could end up in fuel poverty.
Petrol and diesel prices rose to record highs on Wednesday on the back of higher crude prices and limited refining capacity. Petrol hit 170.62p per litre and diesel 181.52p, meaning it now costs almost £94 to fill up a tank of the former and almost £100 to fill up one of the latter, the RAC said.
The Government’s new Energy Profits Levy aims to raise an extra £5bn from North Sea oil and gas producers this year by upping the overall tax rate from 40pc to 65pc. It will help towards giving £400 for each household’s energy bills and £650 to about 8m households receiving benefits – a move
‘There can be no doubt imposition of additional taxes would be detrimental to energy sector investment’
generally welcomed. What it means for long-term energy production, however, and therefore long-term energy security and prices, is less clear.
The current surge in gas prices at the heart of the problem has been heightened by market disruption due to Russia’s invasion of Ukraine, on top of longer term under-investment globally. The Government has been pushing the industry to ramp up production in recent weeks to ease supply pressures, even as it works to reduce reliance on oil and gas in the long term.
The new tax policy includes incentives through an investment allowance rate that means producers will save about 91p in tax for every pound they invest in oil and gas.
It is not clear what effect that will have. Trade group Offshore Energies UK warned the introduction of a new tax without any formal consultation “undermined trust and created long-lasting uncertainty over future investment” and could “undermine investments for years ahead”.
The levy would discourage “offshore energy investments, meaning declines in oil and gas exploration and production, and so force an increase in imports,” it added.
Biraj Borkhataria, at RBC Capital Markets, noted that the basin is now dominated by smaller, private companies following a wave of divestment among majors. “These smaller companies typically have higher cost of equity and debt financing, which means higher hurdle rates for future investment,” he said.
Borkhataria said the tax exposure was “relatively small and manageable” for companies such as Shell and BP. UK oil and gas production accounts for about 1.3pc of earnings and 4.3pc of their earnings, respectively. The tax is not being applied retrospectively, meaning that the bumper international profits made by Shell and BP over the latest quarter, of £7bn and £5bn, which fuelled the calls for a windfall tax, will not be affected.
Energy consultancy Wood Mackenzie predicts the windfall tax will cost Harbour nearly £800m in 2022. It argued that companies in the heavier investment or growth phase will be less impacted than those in “harvest mode”.
The levy will apply from now until December 2025 unless oil and gas prices return to “historically more normal levels” , creating a degree of uncertainty which could also prove a further barrier to investment.
It follows a turbulent period for relations between the Government and industry. Shell pulled out of the Cambo oil field last year amid concern about lack of political support due to climate change concerns.
The Chancellor has also raised the prospect of further windfall taxes on electricity generators, saying some have been enjoying “extraordinary profits” and the Government will “urgently evaluate” what steps to take.
It comes despite the Government’s recent energy security strategy which hinges on a huge increase in electricity generation and investment.
Martyn Young, at Investec, said there would be a “cloud over the sector” pending further clarity. Ahead of his statement, trade groups including Renewable UK and the Nuclear Industry Association wrote to Sunak on Wednesday to push back against the move, arguing a “predictable and attractive investment environment” was crucial.
The introduction of a windfall tax has taken some heat off the Government for now. Yet if industry concerns are to be heeded, it may not be off for long.