Why the case for a windfall tax on oil company profits is growing stronger

Calls for a windfall tax on oil and gas company profits are growing after BP reported that its underlying earnings had jumped to £5bn in the latest quarter.

Like all oil giants, the London-based multinational is riding a wave of high oil prices, fuelled by Russia’s invasion of Ukraine.

Shell reported record profits on the day that Ofgem announced that the average household would see their energy bills rise by almost £700 a year.

Sanctions on Russian oil exports have pushed up prices by putting pressure on supplies at a time when demand is rising as the global economy recovers from the pandemic.

Tougher measures being mooted by European governments would continue to push prices higher. That means more pain for consumers and businesses.

Labour and the Liberal Democrats are pushing for a one-off tax on the profits UK-based oil and gas companies have received due to higher prices.

Labour estimates it would bring in around £1.2bn which could be used to help families struggling with higher bills.

All of this might sound very simple. However, matters are complicated by the fact that oil companies also face hefty costs from exiting Russia after its invasion of Ukraine.

BP reckons it faces a £25bn bill from selling its stake in Rosneft, the Kremlin-backed oil company. When this one-off cost is taken into account, BP technically suffered a big loss during its latest quarter.

Of course, the costs of exiting Russia are actually borne over many years, even if they are accounted for in one go. A couple of years of higher oil prices could more than make up for that £25bn cost to BP.

More importantly, BP has already reaped huge profits from its Russian investment. It was among the firms that benefited from a gold rush in Russian energy after the Soviet Union’s collapse.

The ties in Russia that a number of energy companies have profited from have left Europe arguably reliant on Vladimir Putin’s government. Those energy firms that have benefited from investments in what was always a high-risk region will struggle to make the case that they are being hard done by when those risks result in large one-off costs.

Where oil companies might feel that they have a stronger argument against a windfall tax is that their profits are always cyclical – rising when the oil price is high and falling when it is low.

Indeed, BP reported its worst ever loss in 2020 when the Covid-19 pandemic grounded planes and shut down industries across the world, pushing oil to below $30 (£24) a barrel.

While that’s true, the fact that oil companies’ fortunes are so inextricable tied to market prices (not, say, innovative new products or technology) is symptomatic of an industry where profits stem from the capture of revenues from natural resources.

It’s an industry that has huge barriers to entry and delivers outsized rewards to a small number of strategically important companies.

In the UK, BP was sold off by the Margaret Thatcher government between 1979 and 1987. But to ensure that the UK exchequer still benefits from oil extraction, North Sea profits are taxed at a higher rate than the profits of most other companies.

In practice, however, UK oil companies can lower their bills through a range of subsidies and tax credits, including for the decommissioning of platforms in the North Sea.

In recent years, BP has at points received more money from the government in tax relief than it has paid in UK taxes.

So are there any legitimate arguments against a one-off windfall tax? Kwasi Kwarteng, the business secretary, claims that it might discourage investment in the UK.

This line of attack is weakened significantly by the fact that BP plans to spend a big chunk of its windfall not on lowering energy prices for consumers, or investment in green energy, but on buying back its own shares to boost the share price.

The company’s CEO, Bernard Looney, has even reportedly said that a windfall tax would not deter him from going ahead with any of the £18bn investment BP has planned for the UK.