Talk of windfall taxes tends to have a renaissance in times of crisis. Much like Robin Hood, they promise to rebalance the distribution of wealth, and reinstate the tax system’s social and moral compass.
As such, arguments in favour of them often establish a series of contrasts: businesses versus customers, shareholders versus consumers, profiteering versus poverty. But is this the most useful way to frame the argument? Or are windfalls more slippery than they seem?
'One set of winners, one set of losers'
A windfall tax is a one-off, retrospective tax imposed on companies with profits deemed unexpected or even unearned. They have popped up in various forms over the years, and have usually fuelled controversy – not least because it’s tricky to define what counts as 'unearned' and 'unexpected'. Since Covid took hold, however, calls for such levies have increased, as the dichotomy between success and suffering has become more pronounced.
Given the way in which the pandemic has accelerated the ecommerce boom, online retailers such as Asos (ASC) and Amazon (US:AMZN) have proved popular targets, but no successful sector is immune. In September, the campaign group Tax Justice UK called for a 10 per cent corporation tax surcharge on all “excess profits” made during the pandemic, to ensure “no company was able to profit excessively from a period of immense economic and human suffering”.
This year, however, it is specifically North Sea oil and gas producers that are in the spotlight. It’s easy to see why. Surging commodity prices – made worse by Russia’s invasion of Ukraine – have turned the likes of BP (BP.) and Shell (SHEL) into cash machines. While that's good news for shareholders, public sentiment is sour, particularly in the wake of recent PR missteps (Shell announced a whopping $8.5bn share buyback scheme on the very same day that Ofgem hiked the energy price cap).
Opposition parties want to increase the effective corporation tax on North Sea activities by 10 percentage points, and use the extra money to help households with rising energy bills. The Liberal Democrats have marketed this as a “Robin Hood” tax on oil and gas “barons”, and claim it will raise £5bn to help the most vulnerable.
The populist appeal of such a levy is strong, particularly in wake of news that Shell has paid no tax on its oil and gas production in the North Sea for the fourth year in a row. That was due to tax refunds from the decommissioning of old oil platforms, but made for difficult headlines nonetheless.
The ‘winners and losers’ narrative is powerful and – on the face of it – simple, which typically means it proves very popular with the electorate. While there is always a question of how to impose the tax – should it be levied on turnover, profits, assets, or something complicated like ‘excess profit’? – the basic premise is straightforward and promises an easy source of revenue.
Calls to target oil and gas producers have a prospective advantage on this front. In the UK, North Sea oil and gas has a discrete tax regime, increasing the attraction of tinkering for politicians. Profits are taxed at a higher rate of 40 per cent, consisting of ring-fenced corporation tax and a supplementary charge.
Since the supplementary charge was introduced in 2002, it has yo-yoed from 10 per cent under chancellor Gordon Brown, to 32 per cent under George Osborne, before falling back to 10 per cent. Were current chanceloor Rishi Sunak to bow to pressure, therefore, he would be adding to an already chequered fiscal picture.
So far, the Conservatives have resisted this argument. There was no mention of a windfall tax in Sunak’s Spring Statement, which instead stressed the importance of investment. But those on the other side of the political aisle are again calling for action.
“An exogenous shock has hit the British economy and it has created one set of winners and one set of losers,” says Professor Michael Jacobs, professor of political economy at the University of Sheffield and a former adviser to Gordon Brown.
Fair’s fair – until it isn’t
It is the notion of fairness – as opposed to practicality – that is at the heart of windfall tax proposals. It’s important to note, though, that opponents rely on the very same notion. Would it make sense for the government to single out one type of commodity, when others are doing just as well?
Prices across the commodities complex have all risen sharply in recent months; in sum, energy, agriculture and metals prices are now 19 per cent above their previous peak in July 2008, according to HSBC data. Lithium and cobalt, for instance, are undergoing what many see as a 'supercycle' upswing, along with other platinum group metals, as the world clamours for batteries. Arguably, it is irrational to punish some producers and not others.
There’s also the awkward fact that oil prices go down as well as up – most notably in 2020, when demand collapsed and the US oil price dipped below zero for the first time in history.
“You have to look at what’s driving the profits,” says Andrew Coull, head of renewables at strategic advisory firm Gneiss Energy. “If it’s a market price movement, it seems asymmetric to be taxing the uplift to profits when they come through. Anyone who’s been in the oil sector 20 or 30 years knows that you’ll have a constant cycle of prices.”
This lumpiness is exacerbated by the capital-intensive nature of oil and gas production. Companies invest huge amounts to build oil wells and then face the expense of decommissioning the plant. While there’s usually a lucrative period in between, it is sandwiched between two costly episodes. Profits, therefore, are far from constant.
Investment deterrent
The second argument against retrospective profit raids is about investment – or rather, the lack of it. Speaking at a debate hosted by the Institute for Fiscal Studies and the Chartered Institute for Taxation, Blick Rothenberg partner Heather Self said the impact of retrospective taxes is often dismissed. “But once something has been done once, there is always a fear it will happen again,” she says.
While windfall taxes are always advertised as ‘one-off’, they breed suspicion among investors that is not necessarily limited to one sector.
‘Temporary’ taxes also have a habit of sticking around. “The last time the supplementary charge increased, it took a long time for it to come down, even when the oil price dropped,” says Chris Sanger, global government and risk tax leader at EY.
“The danger is you have a sudden uplift and a slow reduction. If that gets into the psyche of the investor, they will be effectively including a high tax rate even when you have low oil price forecasts. That creates a suboptimal environment for investment, and people saying there’s no point investing in the North Sea.”
Drilling down
The issue of North Sea investment needs unpacking further, however. On the one hand, the war in Ukraine has underlined the importance of a secure domestic energy supply. The government has responded in kind: in April, it announced a new licensing round for North Sea oil and gas projects, as well as plans to boost Britain’s nuclear and renewable output.
Hitting North Sea producers with an extra tax could undermine these efforts to secure more short-term energy production. “If you want to encourage investment in the North Sea, you need fiscal stability, says Julian Small, a UK tax partner at Deloitte.
“If you increase the tax rate you immediately make investment in the UK less attractive relative to other countries which, given the relative maturity of the UK North Sea, is already a challenge."
But the prospect of windfall taxes does not appear to be the main obstacle here. As with mining companies ('Awash with cash', IC, 14 April 2022), big oil and gas players' reticence to start new long-term drilling projects is well-established. Shell, for instance, has sold off its business in the Permian Basin, the biggest oilfield in the US. It returned the cash to shareholders in a bumper buyback programme. The group has also pulled out of the Cambo oil project north-west of the Shetlands following an environmental backlash.
BP, meanwhile, wants to significantly reduce its production by 2030, from over 2mn barrels of oil equivalent per day (boepd) to 1.5mn boepd, largely through divestments.
Even the chief finance officer of Harbour Energy (HBR) – the largest North Sea producer – said in a results call that its extra cash would go towards debt reduction and shareholder returns, as opposed to an immediate increase in expansion or exploration spending.
This is not simply due to worries over a return to boom and bust commodity cycles. Concerns about future returns, both in the US and the UK, are tied up with fears about climate change and our inevitable move away from fossil fuels.
‘Companies are very worried about being left with stranded oil and gas that – if the energy transition accelerates and the demand for oil starts to fall off significantly – could be expensively developed projects that nobody wants,” says Graham Kellas, senior vice-president at Wood Mackenzie.
Renewed interest
“Companies have been turning their attention to projects they can develop as quickly as possible, knowing that there’s a good five to 10 years where the oil demand isn’t going to come down significantly."
In the UK, interest does seem to be reviving in the North Sea. Shell, for instance, has resubmitted plans for approval of a large North Sea gas field off the Aberdeen coast. Meanwhile, Ithaca Energy (IAE) has pledged to develop the controversial Cambo oil field ditched by Shell in 2021. Smaller players' decisions to step in, via a series of acquisitions and other dealmaking activity, have started to reshape the list of the North Sea's largest energy producers (see chart).
“I don’t see oil and gas companies disappearing from being oil and gas companies,” says Jon Fitzpatrick, founder and managing director of Gneiss Energy. “I think there’s been a clever – and, in many cases, real – job of rebranding and changing the balance of portfolios. But I still see them investing in traditional hydrocarbons. I think what will be different is that they need to invest in new technology and tertiary recovery techniques.”
While there is still an abundance of climate concerns, some also argue that producing oil and gas in the North Sea is more environmentally-friendly than importing from the Middle East or North Africa, where carbon taxes and environmental restrictions can’t be insisted upon.
The levying of a windfall tax, therefore – and the message it sends to boardrooms and investors – could still pose a threat to Britain’s future energy supply. Given current incentives, EY’s Chris Sanger suggests a higher tax rate could counteract the impact of high oil prices on marginal field production, increasing the chances that such fields remain undeveloped.
For some, the latest North Sea debate is further confirmation that the UK's energy policy is still playing catch-up. Stop-start taxation rates stand in contrast to the plans on the other side of the water, where Norway's policy of stashing away oil revenues from the 1980s produced what is now the world's largest sovereign wealth fund. And Norwegian oil and gas taxation continues to stand in contrast to the UK's own.
The marginal tax rate for Norwegian oil and gas producers is 78 per cent – more than double the UK's own rate since George Osborne effectively abolished the petroleum revenue tax in 2016. But Norway also offers more attractive exploration incentives: in the UK, the costs of exploration can be offset against future profits, but that often means carrying such losses forward for several years. In Norway, companies receive an immediate cash rebate for those losses. Norwegian policymakers also provided further incentives during the pandemic when the price of oil tumbled.
With North Sea reserves unlikely to last many more years, and sustainable investing considerations becoming increasingly paramount – last August, Norway announced plans to scrap its exploration incentives with a view to focusing on sustainable alternatives – the window of opportunity appears to be closing quickly. But it is not yet fully shut.
Alternative sources
Questions of fairness and investment dominate the windfall debate. A more granular question is: how much money would it actually raise?
Various figures have been bandied about. Labour originally argued that producers would be forced to contribute £1.2bn, while the Lib Dems cited £5bn. Others have suggested the financial impact would be insignificant, not least because there are so many historic tax positions that oil companies can utilise in order to reduce their tax bill.
Nathan Piper, head of oil and gas research at Investec, argues that the amount raised from North Sea energy companies would be minimal.
“Because the UK North Sea has been such a bad investment in terms of returns – for lots of different reasons – [companies] have got huge tax losses,” Piper told the Treasury Committee in March. “The amount of money that would be raised through a windfall tax would be de minimis, but the signal that would give to energy producers would be pretty clear.”
This raises the question as to whether there are other, more efficient ways of easing the energy squeeze. One option, posed by Harvard economist Ricardo Hausmann, is a punitive tax on Russian energy imports. On first reading, it sounds counterintuitive. Would an extra tax not make oil even more expensive for Western consumers? But Hausmann argues that current demand and supply dynamics mean Russia would end up bearing the cost.
“Given very high demand elasticity and very low short-term supply elasticity, a tax on Russian oil would be paid essentially by Russia. Instead of being costly for the world, imposing such a tax would actually be profitable,” he writes.
In other words, because consumers don’t much care where their oil comes from, and because Russian supply cannot easily respond to changes in demand, Russia would be forced to heavily discount its goods in order to stay competitive.
Looking ahead
For now, a North Sea windfall tax looks unlikely, particularly as it is at odds with the government's political philosophy. But those principles have allowed room for such taxes before (see box). And come October – when the energy price cap is due to be raised once again – the levy might seem more appealing to a chancellor under pressure.
Other sectors could also come under scrutiny as the cost of living continues to bite. It’s happening elsewhere. In Australia, a windfall bill was introduced to the Victorian Parliament last year, targeting land that has shot up in value as a result of rezoning. Meanwhile, the European Commission has confirmed that member states can impose temporary windfall taxes on the energy sector and redistribute part of the returns to consumers.
In some sectors, however, prospective changes may end up being more than temporary. In the case of online retailers, for instance, the UK government has published a consultation on a potential online sales tax, which would fund a reduction in business rates for bricks-and-mortar shops. Rather than a windfall tax, as was mooted during the pandemic, the shift to online consumption looks more like a structural issue that requires a permanent reassessment.
Ultimately, every windfall tax debate requires short-term needs to be balanced against long-term ambitions. Does a one-off sugar hit justify certain repercussions? In the North Sea, and the energy sector as a whole, the question is particularly knotty as it is bound up with uncertainties over the energy transition. Russia's war with Ukraine has only further complicated this picture. Environmental concerns are colliding with domestic supply needs, and short-term economic realities are warping long-term aspirations. Companies, campaign groups and policymakers are all juggling competing demands, and the risk of dropping the ball is increasing.
