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10 February 2022

Windfall tax on big oil would not sustainably fix UK energy crisis

Soaring gas prices and bumper annual profits for BP have sparked calls for a windfall tax on oil majors operating in the UK. While the company continues to maintain its slogan of “performing while transforming,” all a windfall tax would do is provide short-term relief for billpayers. In the long-term it would leave them exposed to more fossil fuels and higher prices, if companies like BP are unable to fund increasingly ambitious transition strategies.

For 2021, BP reported a profit of $12.8 billion, with around one-third of this coming from boosted oil and gas production in the final quarter of the year. The figure came in at a higher level than expected, although gains were partially offset by reduced income from oil trading, according to the company.

This year’s profits mark the company’s highest in 8 years, and a sharp turnaround from the $5.7 billion loss it saw through a lockdown-riddled 2020. Through 2021, demand pushed back towards pre-pandemic levels, and production shortages – largely from the OPEC+ cartel – pushed prices for crude oil to their highest since 2014.

BP’s CEO Bernard Looney claimed that this turns the company into a “cash machine.” Likewise, recent weeks have seen Shell also announce a quadrupling of profits to $19.3 billion for 2021, while US majors ExxonMobil and Chevron reported figures of $23 billion and $15.6 billion respectively.

For BP, the surge in profits has meant that investors can expect a $1.5 billion share buyback in Q1 2022.

However, while BP and its fossil fuel compatriots have cashed in on record prices for oil and gas, crushed margins have sent as many as 30 downstream suppliers into collapse, while consumers now face a huge inflation in their energy bills.

The announcement of Shell’s annual results even came the same day that British regulator Ofgem announced plans to raise the price cap on energy bills by 54% from April onwards, and the UK government announced a £9 billion package to offset the resultant financial hardship for billpayers. Prices are set to rise even higher by next winter as the global squeeze on gas supplies continues.

The timing of the oil major’s success, paired with a need to offset the rising bills, has naturally led to calls from the left for a windfall tax on its profits.

On the face of it, this makes sense: why should consumers foot the cost of and oil and gas industry that has failed to protect itself from fossil fuel price volatility through sufficient investment in renewables?

BP’s argument is now not that it is “performing while transforming,” but that this ‘performing’ is a prerequisite for its ‘transformation.’ CEO Bernard Looney told the FT that an additional tax on profits in the UK would divert revenues away from projects to boost gas supply and produce low-carbon energy. “I don’t think a windfall tax is going to incentivize people to invest in the thing that we need right now,” he said.

To bolster this argument, Looney astutely published an update of the company’s long-term strategy along with the annual financials.

The company has set out expectations to keep the same level of earnings flowing in from its oil and gas business through to 2030, while reducing its fossil fuel production by 40%. It intends to add to this with between $9 billion and $10 billion of earnings from its ‘transition growth business’ in the same timeframe.

This section of the business, which spans across biofuels, convenience (forecourts and food), charging, renewables and hydrogen, will account for 40% of the BP’s capital investments by 2025, before rising to more than 50% from 2030 onwards. At this point, nearly a third of BP’s earnings could be coming from renewables.

All of this comes as part of a broader plan to reach net zero emissions across operations, production and now its downstream sales by 2050. The company also plans to install another 50 GW of renewable power by 2030 and has upped its pledge to reduce emissions from its operations by 2030 from 30% to 35% up to 50%.

While BP has been criticized in the past for its lack of detail surrounding these plans, the strategy document has outlined some clear steps throughout the company’s transformation, including how it plans to achieve the same profits from fewer, higher performing, fossil fuel assets. It is, however, worth noting that the company will divest its less efficient assets rather than retiring them from operation completely.

In reality, however, BP can only be considered to be a constructive part of the energy transition when it is investing the majority of its finances in clean energy – by 2030, according to today’s promises. Low-carbon investment as a share of total capital expenditure was below 1% for many of the majors between 2015 and 2021, with Shell and BP sitting between just 5% and 8%.

 

The problem here is that BP is still prioritizing the short-term financial wellbeing of its investors over its long-term transition plans. Based on long term oil price assumptions, the company’s expectations for “surplus” cash flow will see 60% piled into the hands of shareholders with the rest going towards debt reduction.

This aims to do two things. Firstly, it hopes to keep investors sweet as BP starts diversifying into new areas of the energy sector, like offshore wind and green hydrogen, which its investors are less experienced in analyzing. Secondly, it hopes to secure some stability in the company’s balance sheet, hedging against the risk of another collapse in fossil fuel prices.

Realistically, a windfall tax wouldn’t suddenly change BP’s investment strategy. It would simply mean that the rate at which it addresses its finances is slower. As would the company’s shift towards renewables if the company cannot strengthen its position to secure investment in projects that have had a lower margin that those of its heyday.

Neither would a single windfall tax have a sustainable impact on energy bills across the UK, which are likely to remain elevated beyond the end of this year.

The UK needs something that can do three things at once. First and foremost, it needs to reduce the cost of energy for consumers, without hindering any investment prospects from the company’s transition to clean energy, and without increasing demand for fossil fuels.

There are several approaches Chancellor Rishi Sunak could take here. He could decrease the number of carbon allowances that are available in the UK each year, elevating their price, and using that price to offset energy bills. He could also reintroduce subsidies and incentives for rooftop solar and residential batteries that would offset the high prices of gas-based grid power for consumers.