The Impacts of the Oil and Gas Windfall Tax

Article by Georgia Watts

On July 11, the British government approved a 25% windfall tax on oil and gas producers in the British North Sea. The levy increases taxation from 40% to 65% and is intended to apply until 31 December 2025. It hopes to collect £5 billion in 2022 alone to help households struggling with soaring inflation and energy bills.

The word ‘windfall’ means ‘a large amount of money that is won or received unexpectedly’. A windfall tax is when a higher tax rate is imposed on profits that ensue from a sudden windfall gain to a particular company or industry. The tax does not reflect profits that result from any direct actions of the company.

Oil and gas producers have benefitted both from the rise in global oil and gas prices in the post-Covid recovery period and the sharp spike in energy prices following Russia’s invasion of Ukraine. BP’s profits more than doubled in the first three months of 2022, while Shell’s profits nearly tripled. Although both companies wrote off a lot of money as a result of exiting from investments in Russian oil firms, they have spent billions on share buybacks, which is what companies do to boost their share price when they have cash on hand.

The levy has proved a divisive political issue over the past months. Those in favour of the move often claim that the tax promotes fairness in our society by alleviating the burden of rising energy prices on struggling households. Economists can also argue that taxing these companies is fair, as windfall profits do not result from any factor of their production or entrepreneurship.

However, there are concerns that the imposition of the tax could reduce future investment spending by oil companies, as it may create uncertainty about the future tax regime. “Extracting for oil and gas and then bringing it to shore is inherently a risky and expensive business,” Offshore Energies UK’s head Deirdre Michie said in a statement. “Our members need the UK’s fiscal rules and other regulations to be stable and predictable before they consider investing the hundreds of millions of pounds needed for such profits.” However, the new 80% Investment Allowance, which offers companies a 91p tax saving for every £1 they invest, means that the more investment a company makes, the less tax they will pay. Simon Clarke, Chief Secretary to the Treasury, believes this allowance will lead to an overall increase in investment.

Climate campaigners have criticised the Investment Allowance for failing to offer tax advantages for renewable power projects. Ami McCarthy, a political campaigner for Greenpeace, has argued that the move gives no incentive for investment in renewable energy. Instead, it gives “huge, potentially windfall-cancelling tax breaks to fossil fuel companies for new investment” that will “turbo-charge climate destruction.” Similarly, some people worry that the tax will deter the pace of investment in renewable energy by reducing the industry’s profits.

How Will the Windfall Tax Affect Oil and Gas Companies?

Not all oil and gas companies will be impacted equally. Smaller-sized companies are more likely to operate most or all of their oil and gas portfolio in the British North Sea. In contrast, medium-sized companies boast greater geographic diversification. As the levy specifically targets oil and gas producers in the British North Sea, smaller-sized companies will be affected more than medium-sized ones.

Blue chips like BP and Shell have even more highly diversified operations, further reducing the impact of the tax. Further, they benefit from stronger credit metrics and a greater variety of income streams beyond oil and gas extraction.