Can Shell and BP emerge from the energy crisis unscathed by windfall taxes?
The last few weeks of news has been dominated by the unedifying spectacle of a highly unpopular PM trying to save his political skin. Mostly, the method seems to have been mainly to confuse everyone by wheeling out Nadine Dorries, or otherwise divert attention away from the whole mess with a series of apparent giveaways from his team of ministerial acolytes. Most of them – not least the levelling up plan, a story for another time - look like they’ve been put together by rehashing existing policies on the backs of various fag packets and which only seem to be cranking up the opprobrium to eleven. The Thick of It meets Spinal Tap if you like.
The main difficulty the PM and his government face apart from working out whether he was or wasn't at a party in his own house is deciding what to do about the savage cost of living crisis that’s hitting many households as bills of all kinds rise faster than wages.
Energy bills are a particular pain point, exacerbated - as we speculated may happen when we discussed on the podcast last year when the gas crisis was still in its infancy – by Ofgem increasing the energy price cap from £1,277 to £1,971 a year to cover the soaring costs of wholesale natural gas, the price of which has quadrupled in the last year.
That will raise average household bills by 54%, far higher than the £200 rebate offered by the Chancellor – essentially a loan (or as money saving expert Martin Lewis described it “a loan-not-loan”) that will have to be taken whether you want it or not and paid back anyway over four years. It barely even warrants the definition of sticking plaster, and anger is building at rising fuel poverty – eat or heat - especially as a portion of the rising bills will be used to cover the cost of the winding up the 27 domestic gas suppliers and counting that have gone bust this year. Once again, privatised profits and losses for the taxpayer.
Anger is also building at the lack of a windfall tax on the profits of the energy companies that have been on the winning side of the gas price rise, such as Shell – no longer royal or Dutch – which saw its adjusted earnings hit $6.4bn in its last quarter thanks largely to a 15% jump in average liquid gas prices. Along with BP, which also reported this week and whose chief executive rather insensitively described it November as “a cash machine at these types of prices”, the two UK oil majors have generated operating cash flow of $70bn this year.
With those numbers in mind it’s now wonder that many seem to think a windfall tax makes sense, but remember that no one was suggesting that we help the oil majors and their embattled shareholders out when their profits slumped as the world locked down for Covid, or in the years running up to the pandemic when few wanted to touch their ESG-unfriendly shares. Between them, Shell and BP reported post-tax losses of over $40bn in 2020, and the sacrosanct dividends were slashed. Both companies have seen their shares rocket in the last year but look back further and shareholders had previously seen the value of their investments plummet, in Shell’s case dropping from a peak of around £28 a share in mid-2018 to less than £10 a share at the height of the pandemic in late 2020. Politicians have short memories, it seems – or maybe they just want to have their populist cake and eat it.
The current energy crisis reveals that they also appear to lack any clear understanding of how the very necessary transition to cleaner energy will actually work in the real world, still so dependent on fossil fuels which accounted for 83% of global energy consumption in 2020. The latest update from SSE highlights one reason behind this - renewables output in the first 9 months of its financial year had achieved only 81% of its targeted 7,304-gigawatt hours, with most of the shortfall the result of a lack of wind throughout the summer.
Its profits are nevertheless still going to be ahead of previous expectations, but that’s only thanks to its gas generating capabilities, which still account for nearly two-thirds of its generating mix. SSE is building more wind farms than any other company in the world, and with £12.5bn of capital expenditure planned up to 2026, the direction of travel is towards a fully renewable portfolio. But it won’t happen overnight - and in the meantime, without gas – and in my case kerosene – we’d all be freezing to death and reading by candlelight.
Indeed, whether politicians like it or not, big energy companies are going to be doing what they’ve always done for a while yet, and taxing one year’s profits is, as the oil majors argue, hardly encouragement for them to think longer term and make the investments in green fuels the planet needs, and many consumers want. BP is aiming to increase annual investment in low-carbon energy to between $4 and $6bn by 2030, around half of its capital investment; Shell expects to see what it calls energy transition investment to hit that level by 2025.
Nevertheless, there’s enough political noise that shareholders in big oil would be forgiven for feeling slightly nervous, and producers must be careful not to be hoist by their own green petard and tempt the government into targeting their profits in some other way. Indeed, the argument put forward by the majors that every penny is needed to fund green investments falls flat on its face if excess profits are redistributed to shareholders in the form of buybacks and dividends. Both Shell and BP have accelerated their buyback programmes, surely a red rag to the Labour party bulls.
Besides which, panicking politicians – even those ministers currently dismissing calls for a windfall tax - can always be relied upon to make a mess of things whatever the data in front of them, the energy price cap that has contributed so much to the UK’s current energy market troubles being case in point.
And let’s not forget that curbs on fossil fuel investments in the UK are exactly why we’re feeling the crisis more than any other nation – North sea decommissioning, no fracking, limited gas storage, a stalling nuclear programme, and few new gas turbines to plug the gap when the wind stops blowing. Energy stocks still look cheap, as I’ve previously argued and activist investors have noted, but that increasingly looks like a fair reflection of the political winds starting to howl against the sector.