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UK Windfall Profit Tax Causing Producers to Re-Evaluate Investments In North Sea

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Even though gas prices in America have fallen significantly from this summer’s record highs, fringe U.S. politicians continue to make the false claim that oil and natural gas companies are price gouging consumers. Some are calling for a windfall profit tax on oil companies, even though history shows that the implementation of a windfall tax during the Carter administration only led to lower domestic production, increased imports, and higher energy prices.

The failure of the Windfall Profit Tax of 1980 is not the only case study that shows weaknesses of the proposal. Other countries, particularly in Europe, have enacted their own versions of a windfall profit tax over the last few months. The tax that is furthest along in its implementation is the United Kingdom’s Energy Profit Levy – and energy companies in the U.K. are already warning the government about the tax’s negative impacts on North Sea oil and natural gas production.

The United Kingdom’s Energy Profit Levy

In a statement laying out the U.K. government’s medium-term budget, Chancellor Jeremy Hunt stated that the Energy Profit Levy on oil and natural gas companies will increase from 25 percent to 35 percent from January 1, 2023, and remain in place until the end of March 2028. There will also be a new, temporary 45 percent levy on the excess profits of electricity generators over the five-year period. The Energy Profit Levy – effectively a windfall profit tax on oil and natural gas producers – was originally imposed in May by now-Prime Minister Rishi Sunak.

The windfall profit tax on oil and natural gas extraction and production also includes a deduction for investment in U.K.-based energy whereby companies can claim tax savings of approximately 90 percent of every £1 invested in oil and natural gas extraction in the country. Chancellor Jeremy Hunt emphasized that he didn’t want the tax to stop oil and natural gas investment in the United Kingdom:

“I have no objection to windfall taxes if they are genuinely about windfall profits caused by unexpected increases in energy prices.

“But any such tax should be temporary, not deter investment and recognise the cyclical nature of energy businesses.”

Industry Revaluates U.K. Energy Investment

But despite the tax deduction for new investment, both large and small oil and natural gas producers operating in the United Kingdom have warned politicians that the increased tax rate may deter energy production in the country.

Following the announcement of the increase in the windfall tax, U.K.-headquartered Shell said it would be reviewing its £25 billion ($30 billion) plan to invest in British oil and natural gas projects, which the company announced just five months ago. Shell’s U.K. Chairman David Bunch, said:

“We are going to have to look at each of those projects on a case-by-case basis and re-evaluate them, based on the current fiscal outlook, and that will determine whether or not we invest to the amount we previously discussed.”

The Shell executive’s primary concern is how the windfall profit tax may be repealed if energy prices moderate before the tax phases out more than five years later, in March 2028. Bunch called for the U.K. government to clarify how the tax would be withdrawn if prices reach historical norms:

“The current design of the windfall tax does not have an off switch. It doesn’t have a price point at which that windfall tax turns off. That is something we would like to talk to the government about.”

Norwegian multinational oil company Equinor also stated that it was evaluating the impact of the windfall tax on its oil and natural gas projects, including its giant Rosebank project in the North Sea. The company plans to make a final investment decision on the Rosebank Project in the first quarter of 2023. Expressing similar concerns as Shell, Equinor said that the increased tax and uncertainty around the phase-out timeline “did not help investor confidence.”

Equinor told Reuters, “Uncertainty makes it harder to take investment decisions, especially the uncertainty around the longevity of the EPL (Energy Profits Levy).”

Well before Chancellor Hunt announced the increased Energy Profits Levy, independent North Sea oil and gas producers warned regulators about the tax’s potential negative impacts on U.K. energy development. Linda Cook, CEO of Harbour Energy, the largest U.K.-listed independent oil and natural gas company, said:

“At a time when oil and gas producers are being asked to invest more to help ensure the UK’s energy security and are considering longer-term, material investments in CCS [carbon capture and storage], additional taxes would run the risk of undermining our ability to do either.”

Serica Energy, another North Sea producer, said that an expanded Energy Profit Levy would make further investment “even more challenging” and said any further tax burden would push the company to consider investment opportunities outside of the UK.

These effects were predictable. In February 2022, months before the government enacted the Energy Profits Levy, the Financial Times editorial board issued a warning:

“However appealing it might seem to force oil companies to fund a form of compensation, windfall taxes are a bad idea. … A good tax system should clearly set out, in advance, how an individual or entity will be taxed. Stability is key to promoting both investment and spending — both of which drive economic growth. Predictable and constant regulations are identifiers of a society governed by the rule of law.” (emphasis added)

Bottom Line: Independent and multinational energy companies are revaluating major investments in North Sea oil and natural gas production as the United Kingdom’s windfall profit tax increases uncertainty and disincentivizes long-term investment in the country’s natural resources. Politicians in the United States and in other countries should watch carefully as the full impacts of the U.K. tax on domestic production and household energy prices become apparent.

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