Finances
Windfall tax could raise less than expected and set back renewable investments
The UK windfall tax could raise less than the expected $5.9bn and the investment loophole may even set back climate efforts, argues Isabeau van Halm.
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fter resisting a windfall tax for several months, on 26 May then-UK Chancellor of the Exchequer Rishi Sunak announced that the government would implement a tax on oil and gas profits, named the Energy Profits Levy.
The levy followed Ofgem’s announcement on 24 May that the energy price cap will rise to around $3,390 (£2,800) in October 2022, which could lead to 12 million UK households experiencing fuel poverty.
The UK is not the first European country to implement a windfall tax. Spain already introduced a tax scheme in September 2021 to protect households against rising energy bills and Italy followed in January. In the US, Democrats are eyeing a similar way to act against rising energy bills with a proposal for a new quarterly tax on oil companies.
“We have the tools and the determination we need to combat and reduce inflation. We will make sure the most vulnerable and the least well off get the support they need at this time of difficulty,” said Sunak in a speech at the House of Commons as he announced the windfall tax. “And we will turn this moment of difficulty into a springboard for economic renewal and growth.”
A new support package
Under the new support package that the windfall tax is part of, every household in the UK gets around $448 (£400) of support for energy bills. This is double the amount of an earlier rebate scheme announced in February and, unlike that proposal, the money doesn’t have to be repaid.
Additionally, around eight million of the lowest income households will get a one-off cost of living payment of $787 (£650); eight million pensioner households who already receive the Winter Fuel Payment will get $363 (£300); and six million people who receive disability benefits will each get $181 (£150).
To cover people who might struggle with energy bills but are not specifically included in the extra payments, the Household Support Fund from local authorities is being extended by $605m (£500m).
The announced measures total $18.2bn (£15bn). Part of the support package will be financed by a 25% tax charged on the profits of oil and gas companies, bringing the total tax on oil and gas profits to 65%. Sunak expects the tax to bring in $6bn (£5bn). The remaining $12bn (£10bn) of support will be covered by extra borrowing, according to the chancellor.
After the windfall tax was announced, BP said that the company would review its North Sea investments, despite the CEO saying in early May that a windfall tax wouldn’t impact the company’s investments in the projects.
BP profits more than doubled to $6.2bn (£5.1bn) in the first quarter of 2022, the company's highest quarterly profits in more than a decade. Shell, which reported nearly tripled quarterly profits of $9.1bn (£7.5bn), said that the levy creates uncertainty about investments for North Sea oil and gas, as well as other future long-term investments.
More investments mean fewer taxes
However, the windfall tax has an investment allowance built-in, meaning that companies will be given an incentive to reinvest the profits. For every $1 a company invests, it will get back $0.91 in tax relief. The more a company invests, the less tax it will pay.
This means that oil and gas companies could use investments to decrease the amount of windfall tax they have to pay, and the government may raise less than the expected £5bn.
“Either the chancellor will raise the [$6bn] he touted, or the oil and gas companies will take advantage of the $0.91 deduction on every $1 invested,” says Chris Hayes, senior data analyst at think tank Common Wealth. “He can't have both.”
It is unclear how the Treasury plans to fill a potential gap in funding, as there is no mention of it in the policy paper. If it’s funded similarly to the $12bn, then it would come out of extra government borrowing.
Common Wealth is critical of the tax loophole, saying that oil and gas companies have “enjoyed handsome state support for long enough”. “Total taxpayer support for fossil fuels amounted to an average of around $14.5bn (£12bn) a year over the last five years, including tax breaks for fossil fuel companies worth about $3.8bn (£3.1bn) in 2019-20, and $3bn (£2.5bn) in 2020.”
Common Wealth calculated the amount of tax relief for both domestic production and consumption of fossil fuels in a special report on fossil fuel support in the UK tax system. They found that despite the UK being part of the Paris Agreement since 2015, the amount of tax relief that fossil fuel receives has not been substantially reduced.
Encouraging fossil fuel investments
Furthermore, the investment allowance was included to encourage companies to invest specifically in oil and gas extraction in the UK, according to the policy paper.
“Instead of recognising the urgent need for large-scale direct public investment in green energy, the chancellor has opted to reaffirm his nonchalance regarding the climate emergency and his apparent belief that public money should only ever be spent securing paltry concessions from big business,” says Hayes. “Energy is too essential to be left out of public hands.”
According to analysts from research company Wood Mackenzie, the new tax is unlikely to render new or existing North Sea projects uneconomic, contrary to what oil and gas companies say, and it could even accelerate the development of projects in late stages, such as the Rosebank and Cambo oil fields.
“The timeframe could be enough for some discoveries, currently awaiting a final investment decision, to be developed with the bulk of costs receiving this tax relief,” said Graham Kellas, senior vice president of Global Fiscal Research at Wood Mackenzie in a news release.
Gas producer Serica already announced that they will ramp up investments to offset tax. The company had already planned to invest around £60m in 2022 and is evaluating investments in additional projects.
Committing to additional gas and oil extraction projects now could have negative consequences for reaching net zero. A special report from the International Energy Agency said that to reach net zero by 2050, there should be no further investments in new fossil fuel supply projects.
Extending to electricity generators
Electricity generators were left out of the initial levy, but Sunak has hinted that the tax could be extended to electricity companies as well due to the “extraordinary profits” that are being made in the sector.
Energy UK, a trade association that represents the energy sector, has warned against an extension of the tax as it could further discourage investments in renewable energy projects. They said that the industry is investing more than $121bn (£100bn) in new energy sources over this decade, but that a windfall tax “could delay and increase the costs of these investments”.
Analysts from market researcher Cornwall Insight similarly warn against including electricity companies and urge instead to look for other ways to help vulnerable households, such as a social tariff or investing in more permanent solutions such as energy efficiency.
“With millions of people in the UK currently in fuel poverty, some may rightly ask, without a windfall tax, how we fund support for vulnerable consumers,” says Dan Atzori, research partner at Cornwall Insight. “Besides giving all consumers small discounts to their energy costs, there are multiple, more sustainable options available that target support at those most in need.”
US and the Gulf of Mexico
The number of active drilling rigs in the lower 48 states of the US, excluding the Gulf of Mexico, stood at 753 in February. This fell to 738 in March, before reaching a four-year low of 572 in April, the lowest since May 2016. As of 8 May 2020, the Lower 48 land rig count reached 355 rigs, according to Baker Hughes’ data.
When it comes to the sought-after oil and gas fields in the Gulf of Mexico, production is estimated to remain relatively flat. The US Energy Information Administration (EIA) forecasts an average of 1.9 million bpd over 2020 and 2021, almost unchanged from its 2019 average.
The administration said that it does not expect any cancellations to Gulf of Mexico projects announced in 2020 and 2021.
Before the oil price crisis in the first half of 2020, Shell had awarded a contract to Sembcorp Marine for construction of the topsides and hull of a floating production unit for the Whale exploration project in the US Gulf of Mexico. Later this year, uncertain economic conditions forced Shell to postpone the project to 2021.
Regarding crude oil production in Alaska, the EIA predicted that it would remain relatively stable, at an average of 460,000 b/d in 2020, and that it will slightly rise in 2021.
Norway
Oil companies operating in Norway, Western Europe’s largest petroleum producer, drilled just 30 exploration wells off the coast of Norway by the end of 2020. This marked the lowest level in 14 years, as announced by the Norwegian Petroleum Directorate (NPD) in October.
The search for new oil and gas reserves has also decreased from 57 drilled wells in 2019 and falls behind previous projections of about 50 wells.
The NPD said in a statement: "The decline in demand for oil and lower prices have led oil companies to reduce their exploration budgets for the year and postpone a number of exploration wells.”
Companies including Equinor, Aker BP, and Lundin Energy announced considerable cost cuts in the early phases of the Covid-19 crisis, attempting to preserve capital and weather the storm.
In response, NPD director of exploration Torgeir Stordal expressed concerns over the near future of the industry: "Without new discoveries, oil and gas production could decline rapidly after 2030."
In the meantime, Norway still believes that there are significant resources to be found beneath its seabed, which are projected at around 3.9 billion cubic meters (bcm), a slight decrease from 4 bcm two years ago, the NPD said.
Brazil
The Brazilian oil and gas industry has been deeply influenced by the unusual events of 2020.
In November 2019, Petrobras announced its 2020–24 investment plan, with a new budget of approximately $75.7bn (84.94% allocated to exploration and production). Despite the challenges, the company has not reported massive obstacles.
It also continued with its divestment programme of some upstream, midstream, and downstream assets, opening new opportunities for foreign investment.
During the Covid-19 outbreak, Petrobras and other oil companies shifted focus from their own projects onto divesting in ancillary projects, which helped reduce their expenses while generating income for the sale of such non-core assets.
November’s bidding rounds by the National Agency of Petroleum, Natural Gas and Biofuels (ANP), showed that the usual interest in Brazil’s offshore upstream rounds has plunged, which led to the suspension of the Brazil Round 17 for exploratory blocks under the concession regime.
Despite the hardships, the ANP managed to keep the First Cycle of the permanent offer, which involves a continuous offer of fields returned and exploratory blocks offered in previous tenders that were not acquired or returned to the agency.
The UK Continental Shelf
British consultancy Westwood Global estimated in September 2020 that the UK Continental Shelf (UKCS) was on course to reach a record low of offshore exploration wells this year, its lowest since companies started exploring the North Sea for oil in the 1960s.
In May 2020, along with the publication of its annual review of global exploration activity and outlook for 2020 and beyond, the consultancy said that while dealing with the immediate Covid-19 crisis, “societal pressure is building for a rapid transition to a low-carbon future”.
In September, Alyson Harding, technical manager at Westwood, said in Energy Voice that the company predicts only five exploration wells will be drilled in 2020, one less than in 2018. By comparison, 14 exploration wells were drilled last year with only one becoming commercial.
According to Westwood’s early estimations from February, the UKCS was predicted to reach 17 wells by the end of the year, but the pandemic hampered these plans. So far, Chrysaor’s and Apache’s Solar well and Total’s Isabella well are commercially viable.
While the Oil and Gas Authority offered 113 licence areas over 259 blocks or part-blocks to 65 companies in early September, it is not certain that operations will take advantage of this opportunity because of current market instability.
Looking ahead, Harding said in a company webinar that the firm has been given indications from companies that 23 exploration and 10 appraisals wells could be drilled in the UKCS next year, depending on the impact of Covid-19 in 2021.
Mozambique
Mozambique’s untapped oil and gas potential was first revealed by initial exploratory drilling in 2007.
Later, natural gas became part of Mozambique’s oil and gas strategy to help industrialise the northern provinces of the country. However, after some recent project cancellations, Mozambique’s Council of Ministers is now planning to transport the north’s oil and gas to the better developed south.
In a tender process run in 2017, Shell was given the right to build a gas-to-liquids plant that would convert gas to synthetic diesel, naphtha, and kerosene; Norwegian chemical company Yara International was allowed to build a fertiliser plant to power the northern town of Palma using domestic market gas; and Kenyan power company Great Lakes Africa Energy was allocated gas to build a 250MW power plant in the north-eastern city of Nacala.
However, whether influenced by the Covid-19 crisis or rising environmental scrutiny in the country, it appears that only the Nacala power plant will take place. Yara has cancelled its fertiliser project and Shell’s CEO has been giving indications that the company does not expect to develop any new greenfield gas-to-liquids projects.