Taxes on oil and gas companies are in the news again because the new Labour government plans to increase the Energy Profits Levy (EPL) later this year.
The news comes amid an anticpated 9% rise in energy bills as energy regulator Ofgem adjusts its price cap upwards to accommodate higher demand in autumn and winter. In Whitehall, meanwhile, the Autumn Budget is expected to include an announcement that the EPL will rise to 38% from November 1 2024, from its current level of 35%.
While North Sea oil is a useful source of revenue for the UK government, annual oil production peaked in 1999. As well as being an ESG issue, how to manage the decline of the North Sea – a cash cow and a source of jobs – is a political one because the Scottish National Party supports greater investment in the region to fund economic independence.
What is The Energy Profits Levy?
The EPL isn’t a Labour policy. It was brought in by then-chancellor Rishi Sunak in May 2022 with the aim of raising £5 billion a year from a 25% tax on oil and gas company profits. The move came in response to a backlash against oil and gas companies, whose profits had soared in the wake of the Russian invasion of Ukraine, which caused supply disruptions and a rethink of energy policy by governments west of Moscow.
Conservative chancellor Jeremy Hunt then hiked the rate to 35% for oil and gas companies and introduced a 40% levy on electricity generators in the November Autumn Statement.
These measures were designed to be phased out when profits reached “more normal levels.” Still, the levy has been extended to March 2028 so the government will effectively be taking a chunk of BP and Shell’s profits for six years (from May 2022 to March 2028).
How Much Have Oil Majors Paid Already?
Shell (SHEL) said it paid $802 million (£611.1 million) towards the EPL in the 2023 financial year, according to its annual report. This is in the context of a near $13 billion global tax bill last year, down from nearly $22 billion in 2022.
In the same period, BP (BP.) paid $626 million under the EPL. That’s in addition to the hundreds of millions of dollars paid in the 2022 financial year, when the EPL first started.
Is This a UK-Only Tax?
The European Union also has its own windfall regime, so Shell and BP have to pay that too. Companies must pay a temporary minimum rate of 33%, depending on profit averages over four years. This “solidarity contribution” cost Shell $1.38 billion in the last financial year.
What About Other Taxes?
As well as paying corporation tax and the EPL, oil companies also pay a “ring fence” tax of 30% in the UK. It’s called a “ring fence” because it stops taxable profits from oil and gas extraction being reduced or offset by losses from other activities.
This means the headline tax rate for oil producers is much higher than in other industries. Offshore Energies UK expects these companies to pay an effective tax rate of 78%, against the current standard corporation tax rate of 25%.
What Does the Oil Industry Say?
Perhaps predictably, trade body Offshore Energy UK (OEUK), which represents the British offshore oil and gas industry, has warned of the economic impact of the EPL increase.
It expects the proposed increase to lead to a sharp drop in investments in UK projects by oil and gas producers — from an expected £14.1 billion to £2.3 billion between 2025 and 2029. It also forecasts a loss of 35,000 jobs and drop in tax revenue.
OEUK chief executive David Whitehouse said: “this is a government that has made economic growth its main priority and yet our analysis shows that its policy will ultimately reduce this sector’s contribution to the UK economy.”
Will The Energy Price Levy Affect Investors?
Retail investors who own oil and gas stocks have benefited from share buybacks and dividends in recent years. Shell’s share price has gained £10 a share since 2022, and now trades at £26.84. Still, Morningstar analysts thinks the company’s stock is undervalued.
“New Shell CEO Wael Sawan is sending the right message—that returns will take priority over growth—as he seeks to close the valuation gap with US peers,” says Morningstar director of equity research Allen Good in his latest 1 August assessment of the company.
“While it might not be enough, we believe the key actions accompanying the message, including reduced spending and increased distributions, are positive and crucial steps.”
However, it may not be that simple. A bumper period of oil earnings tends to ignite controversy and increase pressure on governments to rake back profits for the exchequer.
Oil company profits have fallen back significantly since the initial shock of 2022 as prices for crude oil and natural gas have weakened – Brent crude is around $76 a barrel, around $13 lower than at the same point last year.
Listed companies must also deal with the costs of the energy transition and the perception that the industry is high risk from an ESG perspective. Professional investors have been under pressure from investors in recent years to divest away from oil and gas stocks, and this has weighed on share prices.
In Good’s view, Shell displays a degree of weakness here, and so much so it fails to qualify for a Narrow Economic Moat.
“Like peers, it is investing to move away from its legacy hydrocarbon business toward a low-carbon business. However, its transition is less dramatic than some and still leverages lower-carbon legacy businesses to do so,” Good says.
“It is also not focused on becoming a large-scale renewable power generator, a strategy we fear could result in lower returns, given the amount of competition for such projects. Shell’s strategy should help it achieve its carbon-reduction goals and insulate it from a potential decline in oil demand in the long term.
“However, we find it is difficult to carve out durable competitive advantages in businesses such as renewable power supply and trading and electric vehicle charging while strong competition could weigh on returns.”
A version of this article was originally published in February 2023
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