Windfall Taxes Sweep Through The Global Energy Sector

Authored by Alex Kimani via OilPrice.com,

Over the past two years, global energy companies have enjoyed record profits amid high commodity prices, with the International Energy Agency estimating that net income by oil and gas companies doubled from 2021 to 2022. Those high oil and gas prices have translated into high fuel prices for consumers, drawing the ire of the public and governments everywhere and sparking populist moves in response. 

The European Union, the UK and India have already introduced windfall taxes on oil and gas companies. 

On September 30, 2022, the Council of the European Union agreed to impose a “temporary solidarity contribution” on energy companies that realize “above a 20% increase of the average yearly taxable profits since 2018”. This tax will be levied on top of whatever taxes these companies already owe in their individual countries. 

A windfall tax is a one-time surtax levied on a company or industry when unusual economic conditions result in large and unexpected profits. 

Others, such as the Netherlands, Norway and the United States are currently considering them. 

According to a recent Wood Mackenzie report, while 2022 was the year in which the idea of the windfall tax and the villainization of Big Oil reached a new peak, this year will likely see more momentum if oil prices remain high. If prices drop, windfall taxes could be eliminated; however, Wood Mackenzie views this as “unlikely”, noting at the same time that some windfall taxes have expiration dates and clauses for modification based on oil prices.

Overall, WoodMac warns that windfall taxes will distort the market and even risk prolonging–or delaying–the energy transition. How? If fossil fuel prices are lower, demand will increase and render renewables less attractive. 

In the meantime, governments have found another way to benefit from soaring oil and gas company profitability–taxing share buybacks, such as has been done in the U.S. and proposed in Canada. Dividends could also be taxes more heavily. Both methods, suggests Wood Mackenzie, would actually “incentivize reinvestment, thus promoting jobs and additional energy supply”.

“A tangle of long-term ambitions will drive upstream regulators and investors toward the big fiscal themes to look for in 2023, from windfall taxes to renewed interest in gas policy terms,” according to WoodMac’s 2023 outlook.

The Windfall Tax Report Card–So Far

United States

Back in October, President Biden threatened to slap a windfall profits tax on American oil and gas companies if they fail to use their “outrageous” bonanza to expand oil supplies in a bid to lower fuel prices. However, he is yet to follow through on his threat but instead American companies have to face a different beast: buyback tax.

As part of the new Inflation Reduction Act that President Biden signed in August is a new 1% tax on corporate share buybacks. Oil and gas companies will bear the brunt of the new tax because they have dramatically increased buybacks as a favored way to return excess cash to shareholders.

“My message to the American energy companies is this: You should not be using your profits to buy back stock or for dividends. Not now, not while a war is raging,” Biden said in October. Biden has scolded U.S. oil producers saying they fail to appreciate the free-market capitalism windfall made possible by American democracy nor sympathy for their retail customers.

In 2022, U.S. oil company share buybacks increased 1,043%, dwarfing the 64% increase for S&P 500 while dividends were up 33%, more than three times the rise for all the companies in the index. Total free cash flow of the 23 companies in the S&P 500 Energy Index increased 2.3 times to $201 billion, with free cash for Exxon Corp. (NYSE: XOM) and Chevron Corp. (NYSE: CVX) increasing 150% to $60 billion and $36 billion. Meanwhile, Valero Energy Corp.’s (NYSE: VAL) free cash flow grew five-fold to $9 billion from the previous four quarters.

United Kingdom

Back in November, the UK government announced plans to increase a windfall tax on oil and gas producers’ profits to 35% from the previous rate of 25%. The new rate, which will apply from 1 January 2023 until March 2028, is part of a raft of budgetary measures aimed at tackling the cost of living crisis and shoring up the UK’s finances.

Normally, UK oil and gas companies operating on its continental shelf are subject to a 40% tax rate, much higher than the 19% rate on corporate profits for companies in other sectors. The new levy now means that companies like BP Plc.(NYSE: BP) and Shell Plc.(NYSE: SHEL) will now fork over 75% in taxes, up from 65% in 2022.

Germany

Starting December 1 2022, the German government introduced a 33% windfall profit tax that will potentially generate a revenue of between one and three billion euros. Dubbed the “EU energy crisis contribution”, the tax is likely to affect dozens of energy companies and will target their 2022 and 2023 profits.  

The new levy will affect oil, gas and coal companies whose profits for 2022 and 2023 exceed by 20% or more than their 2018-2021 average. However, the tax has a major drawback: according to Katharina Beck, spokeswoman on financial matters for the Greens, the planned levy can be circumvented on a large scale by companies moving profits abroad.

“The draft of the finance ministry for windfall profit levy for oil and gas companies falls well short of what is necessary,” Beck said in a statement carried by Reuters. 

Finland

In December, the Finnish government proposed a temporary windfall tax on profits from the country’s electricity companies as part of a European Union response to soaring power costs. The proposed 30% tax would apply to any profits exceeding a 10% return on capital in 2023, with the government estimating it could bring in between 500 million and 1.3 billion euros ($533 million-$1.9 billion).

If the Finnish government goes ahead with its plans, it will join Germany and the UK as the other EU members that have introduced a windfall tax to energy and power companies. 

India

A few weeks ago, India raised its windfall tax on crude oil, petroleum and aviation turbine fuel. Windfall tax on crude oil was increased to 2,100 rupees ($25.38) per tonne from 1,700 rupees ($20.55). The federal government also raised export tax on diesel to 6.50 rupees per liter from 5 rupees, while raising the windfall tax on ATF to 4.5 rupees per liter from 1.5 rupees, the document showed.

India is a major consumer and importer of crude, and has been buying Russian crude barrels at well below a $60 price cap. The Indian government first introduced a windfall tax on crude oil producers and levies on exports of gasoline, diesel and aviation fuel in July after private refiners posted robust refining margins, instead of selling at lower-than-market rates