The windfall tax will have a long-term impact on the North Sea oil and gas sector, and could accelerate the decline of the domestic fossil fuel industry, argued Investec.
The wealth manager warned that the new levy could incentivise operators to bring forward decommissioning plans, potentially raising the UK’s dependence on overseas imports to meet its energy needs.
While Downing Street has sought further exploration in a declining sector of the UK’s energy industry, hosting roundtables with industry leaders and including oil and gas in its supply security strategy, Investec believes its latest proposals will undermine its ambitions.
It said: “Implementing this windfall tax may provide some short term benefit to UK government revenues. However, in our view, it is likely to have a long term impact on the future of the UK North Sea where, pre-levy, the Oil and Gas Authority [now called the North Sea Transition Authority] expected output to fall 30 per cent – below one million barrels of oil equivalent per day by 2027.”
Earlier this month, the Chancellor Rishi Sunak unveiled the Energy Profits Levy, a further 25 per cent tax on North Sea oil and gas operators.
The government is looking to fund its £15bn plans to ease household energy bills by as much as £1200 per year partly through the levy, which is expected to raise £5bn in additional revenue this year.
Energy giants such as Shell and BP reported record underlying profits of $9.1bn and $6.2bn respectively in the first three months of trading this year, powered by near-record oil and gas prices.
With North Sea operators already facing an elevated 40 per cent corporation tax, the measure has increased overall taxation on profits to 65 per cent.
The levy has a sunset clause of 2025, with Investec expecting the measure to remain in place over the next three years with high energy prices baked into the market over the medium term.
This would make reducing any levy on upstream producers highly unpopular among voters.
Commenting on the latest tax, Investec said: “Oil and gas investment needs stable fiscal terms, given commodity price volatility, and we anticipate that those companies with global portfolios are now more likely to move investment elsewhere.”
Windfall tax offers ‘carrot and stick’ to energy firms
The windfall tax also includes 80 per cent investment relief – which means businesses will get a 91p tax saving for every £1 they invest.
Investec suggests this could present an opportunity to “buy into quality companies” and take advantage of the companies looking to ramp up production.
BP and Shell have pledged to spend £18bn and £25bn in the UK energy sector respectively over the current decade, with the majority of resources focused on low and zero carbon projects.
While the windfall tax could be potentially damaging to the sector over the long-term, Investec does suggest the measure could provide a clear opportunity for investors to scoop up stocks at lower valuations while energy prices remain high.
Following the announced tax, Investec has lowered its valuation of Harbour Energy from 635p to 580p, and Serica Energy from 515p to 395p, while downgrading smaller operators such as IOG TP from 70p to 50p and IGas from 50p to 45p.
Investec said: “The new levy could provide fresh impetus to combine tax paying portfolios with others where there are (or the corporate appetite exists to make) material reinvestment opportunities. Additionally the levy could increase the attractiveness of undeveloped discoveries (well-defined projects) for those operators with more limited portfolios for reinvestment.”
The wealth manager still believes favourable headwinds such as high commodity prices and the likelihood of further EU sanctions on Russia present investors with the opportunity for a 3-4 per cent dividend yield in the sector.
The UK North Sea oil and gas industry is expected to produce around 1.3m barrels per day of oil equivalent (60 per cent of oil) in 2022 – with Harbour Energy the largest producer, responsible for 15 per cent of the output from the basin.
Together the top six producers (which also includes Total, bp, Shell, Ithaca Energy and NEO Energy) account for 60 per cent of output, with a long tail of other domestic businesses.
The sector has enjoyed a revival in both interest and activity in recent weeks, with Shell winning official approval to develop the Jackdaw natural gas field in the UK’s North Sea, eight months after regulators blocked the project on environmental concerns.
Separately, UK-based Tullow Oil has signed all-stock merger agreement with Capricorn Energy to create an Africa-focused energy company with a market value of more than £1.4bn.
The agreement is valued at approximately £656.9m, according to news agency Reuters.