Figures published by the Financial Times suggest that windfall tax revenue will be as low as £16 billion, far lower than the original payday figure of £41.6 billion. Whilst this outcome may seem like a surprise to the Treasury, it’s clear the windfall tax was ill-conceived from the start.
The rationale for a one-off windfall tax on oil and gas companies was that extraordinary profits were more to do with Putin’s invasion of Ukraine than the foresight of savvy executives. But critics at the time were concerned that the levy would threaten investment and make the problem of scarce energy even greater in the future. Today, this great risk seems to have been for little benefit, as potential revenue from the windfall tax disappears down the drain and North Sea investment stalls.
The government has already conceded that the windfall tax is a failed policy and a threat to investment, announcing an ‘Energy Security Investment Mechanism’ earlier this month to “provid[e] certainty to investors to secure the long-term future of domestic energy production”. Under this mechanism, when prices fall to historically normal levels, the rate for oil and gas companies would drop from 75 back to 40 per cent creating an effective floor to the tax. Yet, numerous firms are sceptical of this continued government interference. The French oil and gas firm TotalEnergies said it will cut North Sea investment by 25 per cent due to the tax, and Harbour Energy blamed the tax for the loss of 350 jobs. In the hours following the announcement of the government’s ‘Energy Security Investment Mechanism’ Apache, the North Sea’s ninth largest operator and producer of 50,000 barrels of oil equivalent per day, announced the end to its North Sea drilling operations as well as a number of job losses in Aberdeen.
Meanwhile, the treasury is not raking in the enormous revenues it originally expected. In November, the chancellor predicted the levy would raise as much as £41.6 billion. However, because of the decreasing price of oil and gas, this forecast has now dropped to £26 billion. Whilst still much higher than the £16 billion estimated by industry experts, it is still a disastrous and inevitable product of such a windfall tax. The energy market is defined by extreme cycles of boom and bust, and in some years, the net operating margin of the global listed energy industry is negative. In such volatile markets, the prospect of huge profits in some years plays an essential part in the decisions of oil and gas producers, and the potential revenue for governments can be equally volatile.
While the government is looking in the right direction by limiting the windfall tax, reducing the rate at times of low prices is not enough. Having a high rate when prices are high distorts decision-making, signalling that firms should not seek to secure supplies in times of great need because they cannot expect a big payday. It’s easy to argue that energy companies couldn’t have anticipated the war in Ukraine and that it was a free lunch for them, but geopolitical instability is a huge part of how firms plan their future oil and gas production and if we don’t allow the market to reward firms that plan for this then there will be fewer firms that do so. This will lead to energy insecurity in future and act as a boon to political leaders of energy-rich states that can hold others to ransom with their access to natural resources.
Now that the Labour Party has promised to end new gas and drilling licences in the North Sea if it wins the general election, we should all be worried if the windfall tax debacle has taught us exactly the wrong lessons. Blind resentment towards energy producers who make profits in times of crisis will not solve the problem, but will instead discourage other firms from preparing better for the future. This danger is compounded by the fact that windfall taxes can spill over into other areas of the economy, that perhaps PPE producers will be reluctant to invest due to the threat of a windfall tax on their profits in the next pandemic. To stop this poisonous tendency from taking hold, the chancellor should admit that the windfall tax is more trouble than it is worth and scrap it.
