Oil stocks are staring down the barrel – of more taxes

While North Sea oil is a useful source of revenue for the UK government, annual oil production peaked in 1999. As well as being an ESG issue, how to manage the decline of the North Sea – a cash cow and a source of jobs – is a political one, as the Scottish National Party supports greater investment in the region to fund economic independence.

What is the energy profit tax?

The EPL is not a labor policy. It was introduced by the then chancellor Rishi Sunak in May 2022 with the aim of raising £5bn a year from a 25% tax on oil and gas company profits. The move came in response to a backlash against oil and gas companies, whose profits have soared after Russia’s invasion of Ukraine caused supply disruptions and a rethink of energy policy by governments west of Moscow.

Conservative Chancellor Jeremy Hunt then raised the rate to 35% for oil and gas companies and introduced a 40% levy on electricity generators in November’s Autumn Statement.

These measures were designed to be phased out when profits reached “more normal levels”. However, the levy has been extended until March 2028, so the government will effectively take a share of BP and Shell’s profits for six years (from May 2022 to March 2028).

How much have the oil majors already paid?

Shell ( SHEL ) said it paid $802 million (£611.1 million) to EPL in the 2023 financial year, according to its annual report. This comes against the backdrop of a global tax bill of nearly $13 billion last year, down from nearly $22 billion in 2022.

During the same period, BP (BP.) paid $626 million under the EPL. That’s on top of the hundreds of millions of dollars paid out in the 2022 financial year, when the EPL began.

Is this a UK only charge?

The European Union also has its own exceptional regime, so Shell and BP have to pay that too. Companies must pay a temporary minimum rate of 33%, based on four-year profit averages. This “solidarity contribution” cost Shell $1.38 billion in the last financial year.

What about other fees?

As well as paying corporation tax and EPL, oil companies also pay a 30% ‘ring fence’ tax in the UK. It’s called a ring fence because it stops taxable profits from oil and gas extraction being reduced or offset by losses from other activities.

This means that the overall tax rate for oil producers is much higher than in other industries. Offshore Energies UK expects these companies to pay an effective rate of tax of 78%, compared to the current standard corporation tax rate of 25%.

What does the oil industry say?

Perhaps predictably, trade body Offshore Energy UK (OEUK), which represents the British offshore oil and gas industry, warned of the economic impact of the rise in EPL.

The proposed increase is expected to lead to a sharp drop in investment in UK projects by oil and gas producers. — from an estimated £14.1bn to £2.3bn between 2025 and 2029. It also forecasts a loss of 35,000 jobs and a fall in tax revenue.

OEUK chief executive David Whitehouse said: “This is a government that has made economic growth its top priority and yet our analysis shows that its policy will ultimately reduce the sector’s contribution to the UK economy.”

Will the energy price tax affect investors?

Retail investors holding oil and gas stocks have benefited from share buybacks and dividends in recent years. Shell’s share price has gained £10 per share since 2022 and now trades at £26.84. However, Morningstar analysts believe that the company’s shares are undervalued.

“Shell’s new CEO, Wael Sawan, is sending the right message – that yields will take precedence over growth – as he seeks to close the valuation gap with US peers,” says Morningstar’s director of equity research, Allen Good, in the latest company valuation as of August 1. .

“While it may not be enough, we believe the key actions accompanying the message, including reduced spending and increased distributions, are positive and crucial steps.”

However, it might not be that simple. A bumper period of oil earnings tends to ignite controversy and increase pressure on governments to recoup profits for treasuries.

Oil company profits have fallen significantly since the initial shock in 2022 as crude oil and natural gas prices weakened — Brent crude is around $76 a barrel, about $13 lower than at the same time last year.

Listed companies also have to deal with the costs of the energy transition and the perception that the industry is high risk from an ESG perspective. Professional investors have come under pressure from investors in recent years to divest from oil and gas stocks, and that has hurt stock prices.

Shell’s difficult energy transition

In Good’s view, Shell exhibits a degree of weakness here, and so it fails to qualify for a narrow economic moat.

“Like colleagues, it is investing to transition from the legacy hydrocarbon business to a low-carbon business. However, its transition is less dramatic than some and it still uses low-carbon legacy businesses to do so,” says Good.

“It is also not focused on becoming a large-scale renewable energy generator, a strategy we fear could lead to lower profits given the amount of competition for such projects. Shell’s strategy should help it meet its carbon reduction goals and insulate it from a potential long-term drop in oil demand.

“However, we believe it is difficult to achieve sustainable competitive advantages in businesses such as renewable energy supply and electric vehicle trading and charging, while strong competition could impact profits.”

A version of this article was originally published in February 2023