16 February 2022
By Dr Paul Jourdan
The Labour Party has called for a windfall tax to be levied on Oil and Gas companies. This comes against a backdrop of both BP and Shell posting a significant increase in profits, and rising energy costs.
For Dr Paul Jourdan, Founder CEO and Fund Manager at Amati Global Investors, the arguments are not so clear cut. He says:
Many of the interviews that I have heard with proponents of a windfall tax are frustratingly confused. Yesterday we had the suggestion that the UK Government should take a share of BP’s total profits. But Labour’s proposal was for a UK North Sea windfall tax, and that would barely touch BP as only a tiny fraction of their profit emanates from the UK. BP don’t even split the UK out in their segmental income, classifying it under ‘Europe’, which in 2021 was 14% of oil production, and 16% of gas production. Were the UK Government to impose a tax on the global profits of the oil majors they could simply leave the jurisdiction of the UK.
In terms of Labour’s proposal for a UK North Sea windfall tax, it is not yet clear whether they are proposing this to be retrospective. If they are, what they are asking for is to upend a key principle of tax legislation that the Government won’t impose taxes retrospectively. To change this would be to diminish the UK’s legal standing in the world significantly and to devalue UK businesses which rely on principles of fairness in tax legislation.
If the proposal is to introduce the tax on profits after April 2022 (which we must assume it is) then results for 2021 are clearly not relevant. A supertax of this type being imposed would have clear implications for capital expenditure plans in the North Sea however. Such a tax would reduce the incentive to invest, and would create further advantages for companies to develop fields in Norway and Holland to export to the UK, instead of UK fields. This would be completely counter-productive in terms of actual tax revenues achieved in the medium term.
Politicians get away with blaming high gas prices in the UK on the global market for gas but this is fundamentally flawed. Oil prices are international because the movement of oil is relatively cheap. Gas prices are regional because moving it long distances requires fixed pipelines or the very expensive process of moving it as a liquid."
In the US gas prices are $4 per thousand cubic feet (mcf), higher than the long run, but massively below Europe, where they are currently around $27 per mcf (or 200p per therm). In Israel gas prices range from $4-6 per mcf because the Government there has supported the creation of local gas supply in big quantities. UK policy has failed to stimulate and protect UK gas supplies over recent years, so we have net imports to meet 50% of our demand, and this number is forecast to rise through the 2020s.
The UK Climate Change Committee (‘CCC’) produced a Balanced Net Zero Pathway, which estimates that the UK will consume 18.3 billion barrels of oil equivalent (boe) of oil and gas over the next three decades, with around 8.5 billion boe of this demand coming from the UK North Sea. This is a very weak starting point for energy security and throws the UK open to the kind of energy price spikes we are now seeing, particularly given the fact that the big surpluses of oil and gas supplies come from nations which are in many cases not friendly to the UK’s interests. To say that the correct response to this is to tax local production more so that it falls further as a percentage of demand looks like strategic folly unless very carefully handled.
Public discussion of North Sea oil and gas production during 2021 was dangerously wrong-headed. Politicians seemed to be convinced by the idea that shutting down North Sea production would reduce the UK’s carbon footprint. This is a huge mistake because instead it just makes the UK more vulnerable to an increased price of gas in the UK and increases the carbon footprint of getting both oil and gas here. It fails to recognise that UK demand for oil and gas cannot currently be substituted for other energy sources rapidly and at scale. The reduction of the UK’s carbon footprint needs to be focused on reducing demand for oil and gas over time by facilitating this substitution. To cut supply ahead of demand, as we did in making any new North Sea developments next to impossible last year, simply creates the likelihood of price spikes. This results in great potential suffering because consumers just have to pay the higher prices or go without power. Politicians want a scapegoat, but the price spikes represent policy failings and are not the fault of the producers. Policy should focus on creating increased investment in oil and gas locally to meet UK the demand profile projected by the CCC, so that lower prices can be protected on the pathway to net zero.
The marginal tax rate on UK North Sea production is already around 40%, so much higher than standard UK corporation tax. This rate has fluctuated a good deal over the past 20 years. But we already have a long-term windfall tax in the North Sea.
All this said, there may be a sensible way to introduce some additional taxes on North Sea producers by taking the overall tax rate back up to its previous peak of around 50%, when the commodity prices were at exceptional levels (say oil prices above $90 and gas prices above 110p per therm) and with full reliefs given against new capital investment. This would distinguish between gas and oil production, and could be applied on an annualised basis based on the average achieved commodity prices over that time. It would however be very important that hedging losses could be offset against earnings; otherwise the policy would be making it impossible for operators to hedge their positions, which could have serious negative consequences, and would also limit the ability of energy buyers to fix prices ahead. However, the likely additional taxes raised by this kind of measure are not going to offset the costs to UK consumers of current high energy prices as Labour are suggesting. However, more punitive tax measures are likely to make the problem of price spikes worse by reducing supply further.
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