In today’s issue:
- Windfall taxes without the windfall profits
- The ever-changing political landscape
- North Sea oil companies are on the brink
How much do politics and regulation matter to investment?
The answer to that is long debated. (In fact, our own team at The Fleet Street Letter has its own take right now – an important warning about what Labour’s plans could have in store for your investments.)
However, an understudied factor is the volatility, or uncertainty, of regulations and policy.
We can see this in the North Sea, where oil and gas producers don’t seem to trust UK government policy anymore, and the ramifications for the sector are getting extreme.
The post-Covid inflationary burst was closely intertwined with the oil price. With oil such a big factor in global economic growth, looking at the price it fetches can give you a strong clue as to where inflation is heading, as you can see in the chart below (where the annual US inflation rate is in blue and WTI crude oil is in grey):
Source: Koyfin
As you might remember, the high oil prices of 2022 resulted in windfall profits for oil companies across the globe, including in the UK.
But with great profits comes great taxation. Mindful of the anger people felt towards Big Oil reaping in record profits during a climate and a cost-of-living crisis led to the implementation of a windfall tax by the last Conservative government. Its technical name is the Energy Profits Levy, or “EPL”.
This involved whacking a 25% tax on top of the existing 40% rate. This was intended as a temporary measure that would be phased out when oil and gas prices returned to normal.
However, it’s what came next that has caused some more serious angst in the industry.
The policy changed. Not once but twice, and it’s now set for a third adjustment.
Firstly, the Tories doubled down in November 2022, adding another 10% to take it to a 75% tax rate on profits, and extended its life by three years to 2028.
And then, earlier this year, even as inflation had mostly subsided alongside any windfall profits, they extended the lifetime of the tax an extra year to 2029. It had originally been due to run out in December 2025.
No doubt, this constant shifting of the floor beneath you is very tough for the companies in the sector. After all, they are trying to commit to multi-year investments with high upfront capital requirements.
That is much harder, and in some cases impossible, if there is too much uncertainty about the likelihood of making a return on your investment. If that confidence isn’t there, the investment won’t be made.
But now the new Labour government are making another slight adjustment, adding 3% to bring the tax rate level with Norway’s 78% level.
Although this doesn’t feel like a big change in the scheme of things – you might think the damage was already done – it’s another change that forces yet another re-calculation of project economics by all involved.
Not all companies have taken it well.
In fact, one of the North Sea’s biggest gas producers is now threatening to end investment in Britain because the tax regime has become too unstable to support offshore energy producers.
Serica Energy, which produces 5% of the UK’s gas supply and around 600,000 barrels of oil a day, is preparing to shift future investment to Norway instead.
David Latin, the company’s chairman, said the UK was now the worst place in the world to operate as a drilling business after successive raids by politicians pushed taxes on oil and gas profits from 40% to 78% in three years.
“The UK is now fiscally more unstable than almost anywhere else on the planet,” Latin told the Telegraph in an interview.
Serica has built its reputation on short-term wins, buying discarded assets from departing oil majors and squeezing a few extra drops of oil out through intelligent geological work and well investment.
But the company is now thinking about cutting its losses here and moving its net northwards to Norway – a country that also has a 78% tax rate for oil producers but offers tax relief on investments and an accelerated investment decision process, allowing for faster decision making and a lower cost of investment.
After all, the bottom line is the bottom line. If you’re not profitable and don’t have a pathway to getting there, you have to change something.
Serica’s share price fell 11% on the day of the launch of Labour’s manifesto in June that outlined their planned tax hike, confirming that it would hit oil and gas companies. Rival Deltic Energy lost 19% of its share value on the same day.
Over the longer term, Serica’s shares have fallen from £4.50 in August 2022 to around £1.27 now
If Serica leaves the North Sea, it will join a host of oil majors that have already sold up and moved on. None now remain in the North Sea as lead owner-operators.
Other companies are looking to make acquisitions to survive.
Take Harbour Energy, which previously threatened to pivot away from the UK but is now making an acquisition so big it will become the UK’s largest exploration company.
It’s acquiring the non-Russian oil and gas assets of Germany’s Wintershall Dea AG, which will triple Harbour’s annual production capacity.
Increasing scale, it is hoped, will bring synergies, lower centralised costs, and overall economies of scale. What it will also do is push its market capitalisation up a level, putting it in the bracket for inclusion in many more funds and exchange-traded funds (ETFs), maybe even the FTSE 100. It should also lower its cost of capital.
What is clear is that the operating environment in the North Sea is increasingly dire with production looking at irriversible decline towards oblivion. With reserves increasingly tapped out and oil demand expected to begin falling in 2030 as the UK’s green energy capacity grows, you might think this is the natural order of things.
But it still remains true that a stable regulatory regime, even if it is quite onerous, is essential to private investment.
My colleague Nick Hubble thinks the same thing is true outside of the energy markets.
Nick, a colleague and friend who isn’t always in line with my views on the energy transition, is highly alert to hidden dangers in the financial system. His understanding of the plumbing and politics of monetary policy is a valuable asset to any investor.
His latest research over at The Fleet Street Letter focuses on something very similar to what I’ve been talking about in the energy markets – but instead of focusing on oil it relates to money itself.
He’s helped investors across the world protect themselves ahead of key inflection points in market, like his warnings about inflation and his predictions of a bull run for nuclear stocks as fossil fuel markets fell.
His current work is all focused on the UK, the surprise monetary shift that no one else is talking about, and what it means for your savings, your pension and your retirement.
Click here now to find out more from investment director of The Fleet Street Letter, John Butler – and take the first step in protecting your wealth from the same volatility and uncertainty that’s plaguing North Sea oil companies.
Until next time,
James Allen
Contributing Editor, Fortune & Freedom
