UK slaps windfall tax on North Sea [Gas In Transition]

The ruling Conservative party in the UK has made a dramatic departure from its traditional North Sea policy, announcing on May 26 that it would impose a windfall tax on the offshore oil and gas sector in an attempt to address soaring energy costs for consumers.

Faced with dwindling poll numbers over the so-called Partygate scandal and its handling of the cost-of-living crisis, the government said the one-off surcharge would raise around £5bn ($6.3bn) over the next year, helping to pay for a £15bn support package for UK households coping with soaring energy costs. This package will provide each UK household with a £400 discount on their annual energy bills, with more available for low-income energy users.

The government has avoided calling it a windfall tax, and has stressed that the levy contains provisions designed to encourage investment.

“We will introduce a temporary and targeted energy profits levy but we have built into the new levy a new investment allowance that means companies will have a new and significant incentive to reinvest their profits,” UK chancellor of the exchequer Rishi Sunak said in an address to parliament. “The more a company invests, the less tax they will pay.”

Specifically, the government is introducing a 80% Investment Allowance, which it says will mean that businesses make a £0.91 tax saving for every £1 they invest. 

“A disappointing and worrying development”

This provision was not enough to get the industry on side, however. Industry body OEUK described the tax as a “backward step by a government which, just weeks ago, pledged to build a greener and more energy-independent nation.” This was a reference to the British Energy Security Strategy that the government announced in early April. The strategy called for significant expansions in wind, solar and nuclear power generation, but also increased support for domestic oil and gas supply.

“The Energy Profits Levy, announced today, will discourage UK offshore energy investments, meaning declines in oil and gas exploration and production, and so force an increase in imports,” OEUK CEO Deidre Michie said. “This is the exact opposite of what was promised in the British Energy Security Strategy.”

The levy is on top of the 40% headline tax rate that the industry already pays from its profits, as well as a 30% ringfenced corporation tax and a 10% supplementary charge. Michie said that without the new levy the industry was already on track to pay £7.8bn in tax this year, marking a 20-fold increase from the tax that operators paid two years ago. Investor confidence hinges on predictable taxation, and so the introduction of a new levy without formal consultation will undermine investment, she said.

“This is a disappointing and worrying development for industry, the shockwaves of which will be felt in offshore energy jobs and communities, and by consumers, for years to come,” she said.

This sentiment was shared by analysts. Moody’s agreed that tax would lead to greater uncertainty over investment decisions, noting that junior developers would be harder hit, as it will take a comparatively greater toll on their cash flow generation and hamper their ability to invest.

“The announcement of the windfall took some of the wind from the sails of companies that have been riding the crest of a wave of high prices and some easing of public opposition to the sector,” Craig Stevens, director at corporate finance advisory Gneiss Energy, said in an emailed statement to Gneiss Energy.

However, he noted that the investment allowance could allow investments to proceed largely as planned.

In an open letter to the government prior to the announcement of the tax, 31 oilfield services firms warned that the sector was only beginning to recover after the downturn caused by the coronavirus pandemic.

“A one-off windfall tax on energy producers will not sustainably help consumers and will only further reduce investor confidence in the UK, the ripple effect of which we will feel for many years to come,” the letter read. “And it will do nothing to address the cyclical nature of an energy system linked to global supply and demand, with the UK becoming much less attractive to investors who will look elsewhere for the long-term stability they require to progress major energy projects.”

Stock hit

The share prices of most oil and gas players with significant exposure to the UK North Sea slumped on news of the tax. One player that suffered a particularly severe drop in its stock of 14% on May 26 to £2.72/share, although its price has since recovered to £2.80/share. 

Analysts at Jefferies estimate that Serica, which is responsible for 5% of UK gas production, will have to shell out up to $64mn this year as a result of the new levy, rising to $99mn in 2023.

Seeking to quell investor concerns, Serica issued a statement noting it already had a $75mn investment programme that includes ongoing intervention work at the Bruce M1 well, aimed at replenishing resources and extending production at several wells. It is also set to spud the North Eigg exploration well in the third quarter of this year. As such, the company said it was “well placed” to exploit the new investment incentives, with a cash position and a balance sheet providing the “leverage and resources” to do so.

“Although fiscal instability is unwelcome in an industry with long lead times for capital expenditure, this new levy is part of a package that includes significant investment incentives designed to encourage companies like Serica to continue to reinvest profits,” Serica said.

Larger players including the UK North Sea’s Harbour and EnQuest incurred similar losses. Jefferies analysts estimate that the levy will cost Harbour $107mn in 2022 and $268mn in 2023, while EnQuest will pay out $14mn this year and $73mn next.