Should we levy a windfall tax on Big Oil's big profits?

Oil rig worker — Oil infrastructure is a big commitment, so companies need certainty

(Image credit: © Simon Dawson/Bloomberg via Getty Images)

EU leaders met this week to discuss measures to tackle the energy crisis and soaring prices of gas and oil, including a proposal from the European Commission of a bloc-wide windfall tax on energy companies’ soaring profits. In recent months four EU countries – Spain, Italy, Romania and Bulgaria – have already introduced their own windfall taxes.

In the US, Democrats have introduced legislation that would dramatically increase taxes on the “war-fuelled profits” of the largest oil companies (those producing or importing at least 300,000 barrels of oil per day). If the legislation is passed (which is far from certain), the oil majors would pay a per-barrel tax equal to half the difference between the current price of a barrel and the average price from the years 2015 to 2019.

Try 6 free issues of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

What’s the case in favour of a windfall tax?

Windfall taxes have a “bad name for good reasons”, says Chris Giles in the FT. For businesses to flourish, a country needs a predictable tax regime. However, the oil-price spike driven by Russia’s invasion of Ukraine is one of those rare occasions when a one-off windfall tax on North Sea oil and gas extraction would be both “efficient and fair”.

Under the current tax regime governing North Sea oil and gas – set in 2016 in an era of persistently low energy prices – profits are taxed at 40%. In practice though, as the National Audit Office has pointed out, the government often gives more to oil and gas companies in tax relief (on things like decommissioning North Sea oil platforms) than it gets in taxes. BP, for example, got overall refunds every year from 2015-2020 – the same BP whose boss Bernard Looney recently hailed the market conditions that had made his firm into “literally a cash machine”.

Given the exceptional times, the Conservatives should go beyond Labour’s demand for a ten point rise, says Giles, and return to the 62% level imposed by George Osborne when prices were last this high, back in 2011.

What’s the argument against?

The core argument against windfall taxes on energy firms – that they deter future investment and compound uncertainty – has lost a bit of potency given that the world is trying to phase out the burning of fossil fuels and capital investment has already slumped, says The Economist. But they are still wrong-headed for lots of reasons.

The energy industry buys and sells power using long-term contracts, making the link between current prices and tomorrow’s profits “fuzzy” and taxing them complex. Meanwhile, prices can fall as quickly as they rise – as in 2015, 2016 and 2020, for example, when globally listed energy firms posted operating losses. If oil producers are obliged to bear the burden of low prices on their own, but “find chunks of their profits seized when prices rise”, they become unviable.

That’s bad for everyone, because it means the certainty and vast investments needed to fund future innovation – in all forms of energy generation, not just hydrocarbons – disappear. In a nutshell, “hiving off the rewards that are on offer for supplying energy during today’s shortage will only make the next supply crunch – even a predictable one – all the worse”.

So windfall taxes are wrong in principle?

Some interesting voices think not. This week, John Browne, chief executive of BP for 12 years until 2007, argued that a windfall tax was “justifiable” given prolonged high prices – and highlighted that natural resources are typically extracted under conditional licences granted by nation states.

“Most nations want to keep people interested in what they’re doing, so they can’t just say we’ll tax 100% because they’ll stop working,” says Browne. “But it’s always a fine balance between how much do you let the rent owner have and how much do you take for the nation.”

When the price level becomes “outrageous and stays there, I think it’s not unreasonable to expect the nation to take a bigger portion of the rent”, Browne argues. And last week, the former Tory minister David Willetts urged that the policy option of windfall taxes on energy “should not belong to Labour alone”.

What are the politics?

Rishi Sunak remains opposed to such a levy. Instead, North Sea energy companies reportedly believe they have a “tacit agreement” with the government that if they step up investment in oil and gas fields they will be spared a windfall tax.

In the UK, the best known windfall tax in recent fiscal history was New Labour’s 1997 one-off tax (raising £5.2bn, and trailed in their landslide-winning manifesto) on privatised utilities that had been sold too cheaply (they argued) under the Conservatives. The rationale was the state sell-off had underpriced the businesses and left them too loosely regulated, allowing them to rake in undeserved and excessive profits.

What about a Tory precedent?

There’s another, more surprising precedent for a “moralistic” windfall tax, says Jon Yeomans in The Sunday Times. In the depths of recession and high unemployment in 1981, Margaret Thatcher’s first administration imposed a 2.5% levy on bank deposits to raise about £400m from the giant profits banks were making from high interest rates (of up to 15%).

“Naturally, the banks strongly opposed this”, Thatcher wrote later. “But the fact remained that they had made their large profits as a result of our policy of high interest rates, rather than because of increased efficiency or better service.”

It was acceptable in the 1980s. But in the 2020s, a Tory windfall tax is still looking unlikely.

Explore More