This article first appeared in Energy Voice on 5 August 2022.

Legislation for the energy profits levy passed through the House of Commons recently to the dismay of many in the industry.

This “windfall” tax has been imposed on the oil and gas industry in light of exceptional profits – most recently illustrated by BP - due to high commodity prices. I use the word “windfall” loosely because, given the tax is proposed for three years, or until prices return to “more normal levels”, it’s not really a one-off.

Critics of this tax have warned that it will make the North Sea less attractive to investors which would place jobs, tax revenues and our domestic energy security at risk, and also, perversely, thwart investment into cleaner, greener energy solutions, constraining our ability to get to net zero within government-set targets which must remain a priority in the medium term.

Aberdeen & Grampian Chamber of Commerce argued that oil and gas companies are already paying tax on profits from production in the UKCS at a rate of 40%, almost double the usual rate of 19%. They estimate that the North Sea tax yield, before any windfall, for 2022/23 may be £10bn – an amount that could have been used to offset the cost of living. Instead, the government has taken the populist route, badly shaken the stability of our fiscal regime and made the oil and gas industry, which supports hundreds of thousands of jobs, one of the most heavily taxed in the country without applying to other energy supply companies who, it could also be argued, are also enjoying exceptional profits. 

The tax rate on "unexpected, extraordinary profits" of oil and gas producers will rise from 40% to 65% until prices return to “historically more normal levels” or the activation of a sunset clause in 2025.

But no-one seems to know what the government estimates the "normal price" to be and at what price, or when, the levy would be removed creating enormous uncertainty in an industry that will remain key to the UK for years to come. In addition to this, we must factor in a new prime minister who may or may not support this tax.

In countering the understandable outcry from industry, the government say it’s possible to tax extraordinary profits fairly while increasing investment. In explaining this, they point to the “super-deduction” relief which aims to encourage firms to invest in new oil and gas production in the UK. The new 80% investment allowance could see businesses getting a 91p tax saving for every £1 they invest.

While it’s too early to predict the overall impact, there’s one thing we can be sure of: we’re suddenly and unexpectedly facing a high degree of uncertainty, something business fears above all.

There are still so many unanswered questions: will the additional tax accelerate expenditure or hinder it? Will it be different for those already in the North Sea as opposed to those looking to come in or even those looking to exit? Will the allowances encourage firms to spend, to push back decommissioning or to invest in cleaner, greener energy?

It’s clear from our conversations with oilfield service companies that they need to fully understand the impact on the operators, their clients, of the changes and how this will impact their businesses in the supply chain.

Before the windfall tax, there were already reports of companies sitting on large profits and excessive levels of cashflow, which wasn’t filtering down to the supply chain, despite the higher profits. An upturn in activity typically follows an increase in commodity prices. But there appear to be conflicting factors at play and whilst certain elements of the sector are seeing increased levels of activity it remains, to some extent, patchy.

While trading has improved since the challenging two years of the pandemic, the energy transition, with its threats and opportunities, has taken front and centre stage and may explain the disconnect we’re seeing in some areas of the supply chain.

In a commodity market that’s out with our control and government accentuating uncertainty with this tax, it’s increasingly challenging for oilfield services companies to plot a way forward in a sector that’s crying out for investment, both to keep the taps on for our energy security and to plan for the future in terms of electrification of the North Sea and the wider energy transition.

The windfall tax is only going to prolong this hiatus at a time when we need stability and certainty to drive investment in the future.

Securing investment is, as a result, only going to get tougher. Attracting new capital to the sector is increasingly difficult with the overhang of energy transition and the negative public sentiment towards the sector more generally. 

M&A activity in oil services has improved since the upturn in commodity prices combined with the urgent need to deal with the UK’s security of energy supply. Those on the acquisition trail have real choice and can afford to be more selective given the increasingly limited number of investors and buyers active in the market. It’s definitely a buyer’s market and sellers have an increasingly high bar to reach to get a deal over the line.

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If you would like to discuss this further, please don't hesitate to get in touch with myself, a member of our Oil & Gas team, or your usual Johnston Carmichael adviser.