Wood Mackenzie looks at the impact of the latest government windfall tax policy and how this could affect the direction of the energy industry over the coming year with a full review of the sector’s fiscal system set to be undertaken.
The coming 12 months will see a full review of the energy sector’s fiscal system beyond 2028 following the government’s decision in November to extend the Energy Profits Levy (EPL) by three years from 2025 and raised the rate from 25% to 35%. This presents an opportunity for a smart and modern system to be put in place.
Many countries have discussed or implemented policies to deal with high gas and power prices, notably in Europe. Different approaches are being undertaken, with the focus on either prices, revenues or profits and targeting oil and gas producers, power generators, or energy companies in general.
Ben van Beurden, the former Shell CEO, has publicly acknowledged that some form of government response is inevitable, and anti-fossil fuel sentiments will influence the discussion, but energy price intervention and /or windfall taxes create an environment that could discourage investment and threaten future supply when it is most needed.
In recent weeks, some prominent UKCS producers have announced reductions in their planned investments and participation in future licensing opportunities. They cite fiscal instability – the EPL – as the main cause. Governments that are still eager for upstream investment must proceed with caution.
Two main options exist for governments. They can either intervene in the market and regulate natural gas and power prices received by producers and/or paid by customers or allow market prices to prevail but extract the windfall revenue or profits being generated by producing and supply companies and use these additional tax revenues to alleviate the energy bills of the poorest consumers.
Windfall taxes must be smart. One size does not fit all and existing fiscal terms are hugely significant, but for governments planning a new windfall policy, some principles could be established that would result in bespoke outcomes for the spectrum of energy producers.
A windfall should be defined by significant increases in a company’s actual revenue per unit of energy produced (R/Eu), factoring in hedging and other pricing arrangements other than spot market sales;
A high price royalty, enabling both the high price trigger and the royalty rate to rise and fall automatically based on changes in the R/Eu, would create fiscal predictability;
Investment credits should be included to incentivise producers to reinvest in new energy projects, with high applicable to preferable projects, such as renewable energy.
A radical reform of the UK’s petroleum tax system needs to emerge from the 2023 review. The process should address the fundamental flaws in the current system and replace it with a progressive, predictable one that would automatically adjust the government share of revenues as market conditions change. It would also remove the need for constant tinkering with the terms which frustrates investors.
About the author: Graham Kellas has over 35 years’ experience as a petroleum economist, analysing global fiscal systems. In that time, he has advised governments and IOCs on the full range of petroleum taxation matters and has supported industry associations in negotiating appropriate fiscal terms. Graham leads Wood Mackenzie’s fiscal information gathering, modelling and reporting and leads its global fiscal systems multi client reports.