On 26 May 2022 the UK Government announced a 25% windfall tax on oil and gas producers' profits, in a bid to raise £5 billion of the £15 billion package of support for households struggling to meet rising energy bills. The tax, while branded a "one off", will remain in place until “normal” conditions in the energy market return or until the end of December 2025. This will have the effect of increasing corporation tax for the oil and gas sector to 65%.
What is a windfall tax?
A windfall tax is a tax levied against companies considered to have made excessively high profits from circumstances they did not create. In this situation, energy companies are considered to have made excessively high profits as a result of the increase in the price of oil and gas which is inextricably linked to the uncertainty and risk to supply caused by the Russian invasion of Ukraine.
Why has it been imposed now?
The cost of living crisis in the UK has forced the government to devise new methods of supporting lower income families and households. The 'cost of living crisis' refers to the fall in 'real' incomes that the UK has experienced since late 2021. It has been caused in part by the increase in energy bills caused by a risk in the energy price cap, and the effect of the Russian invasion of Ukraine on oil and gas prices.
In an attempt to fund a support package for households struggling to make ends meet as a result of the cost of living crisis, the UK Government has turned to the companies that are benefiting from the increase in the oil price.
However, it is important not to look at current circumstances in a vacuum.
What does it mean for oil & gas companies?
In response to this, the oil and gas sector has suggested that some degree of increased taxation may be appropriate, but should be implemented on a tiered basis to ensure that smaller companies are not disproportionately impacted by the levy and re-investment in renewable energy is not halted.
Industry experts have highlighted the sector suffers cyclical commodity prices, and many companies have suffered large losses over the last few years, particularly during COVID-19 when oil prices were very low for an extended period. In addition, many of the larger companies operating in the sector experienced high losses when withdrawing from Russia. For instance, it has been reported that Shell wrote off $3.9 billion in losses when they withdrew from the Sakhalin-2 project and Exxon estimates losses of $3.4 billion as a result of exiting the Sakhalin-1 project.
On the other side of the coin, the larger companies have the financial and technical capabilities to reinvest profits into future projects while still being able to continue operations, meaning that they will be able to make use of the Investment Allowance. However, for smaller players in the UKCS who do not have the same capabilities they may not be able to take similar steps.
The Investment Allowance
To offset the windfall tax, the UK Government has devised an Investment Allowance of 91%. This means that for every £1 of investment, a company will receive 91p of tax deductions.
This gives companies the option of placing their profits that would otherwise be caught by the windfall tax into future oil and gas production, boosting UK supply security and potentially lowering prices, rather than paying them to HMRC.
However, the Institute of Fiscal Studies has been critical of this, stating “A massively lossmaking investment could still be profitable after tax,” and that it was, “hard to see why the government should provide such huge tax subsidies and thereby incentivise even economically unviable projects”. And, even more ironically, the tax relief scheme does not extend to oil and gas companies investing in renewable energy and technologies.
It remains to be seen what impact this will have on the oil and gas sector in the UKCS, the ongoing cost of living crisis, and the net zero target.
Contributor
Partner
