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What is a windfall tax and how will it affect my shares?

The Government has performed a screeching U-turn on a windfall tax on oil and gas companies in a bid to ease the cost of living crisis.

Debate has raged over whether the government should introduce a on energy companies if they refuse to reinvest their bumper profits.

This afternoon the Chancellor announced plans for a temporary surcharge on oil and gas company profits at a rate of 25 per cent raising around £5billion. 

But with many considering a windfall tax had some time ago become a case of ‘when’ not ‘if’, how much of an impact will this have on share prices and dividends for the army of British small investors who hold FTSE oil and gas giants’ stocks? 

Oil majors Shell and BP reported bumper quarterly profits intensifying calls for a windfall tax to ease the cost of living crisis 

Critics have argued a windfall tax would have a significant impact on investment in renewable projects. 

In a bid to keep investment in the UK, Rishi Sunak has doubled the relief for energy companies that invest their profits here. 

And in a sign that the announcement of a windfall tax was expected and is not being seen as highly detrimental to companies, the share prices of three FTSE 100 oil and energy giants, BP, Shell and Centrica remained broadly flat today.

We look at what the windfall tax will mean for the oil and energy sectors and the knock-on effect on investments.

How will the windfall tax affect the oil majors?

The oil sector has recovered well from the pandemic. BP more than doubled its underlying profit, having made £4.9billion in the first three months of the year.

Meanwhile, Shell posted its highest ever quarterly profit of £7.3billion in the same period, despite taking a £3.1billion hit from pulling out of Russia.

Despite making investment pledges, both companies have come under pressure from proponents of the windfall tax as inflation nears double digits and the energy price cap is due to soar to £2,800 in October.

Despite the political backlash, their share prices have been resilient: BP and Shell have jumped 23 per cent and 39.3 per cent respectively since the start of the year.

And it has had a knock on effect on the wider market. The FTSE 100’s high exposure to oil means it is up 0.16 per cent this year. By comparison the S&P 500 is down a staggering 18 per cent.

‘At a time when equity markets across the globe have moved lower, the UK has been a relatively resilient performer in comparison,’ says Jason Holland, managing director of Bestinvest. 

‘That’s in part due to its high exposure to energy and also its reputation as a key market for income seekers, so there are some risks of applying too punitive a tax on energy companies who will, anyway, end up paying more tax as profits rise.’ 

The key question is whether the impact of a windfall tax will significantly affect the share prices of the oil majors.

The 25 per cent levy is significantly higher than the 10 per cent proposed by the Labour Party but the new investment allowance is likely to calm nerves. 

The allowance, which is similar to the super deduction, will incentivise companies to invest by saving them 91p for every £1 they invest. 

This nearly doubles the current tax relief available.  

The National Audit Office has said that in some years the government has paid more to these companies in tax relief than they have paid in taxes.

Hollands thinks the companies have taken prospects of a tax in their stride: ‘We also should not forget that the oil and gas companies have effectively written off their exposure to Russia and been able to move on.’

While the investment allowance is generous, shareholders will be eyeing the effect of the levy on payouts. 

Dividends in the oil sector were slashed during the pandemic when crude prices crashed but they have staged a significant recovery as cash flow increased.

Payouts from the sector are up 29 per cent to £505million already, according to Link’s Dividend Monitor, and are expected to hit £9.5billion this year.

Given the exposure of the oil sector in the FTSE, a significant drop in their value could see UK income funds suffer.

Top income funds like Liontrust Income and Artemis Income include either BP or Shell among their top holdings so income-focused investors could well be hit.

Ryan Lightfoot Aminoff, senior research analyst at Chelsea Financial Services says: ‘These companies are big contributors to dividends for the UK market and are widely held in UK income funds, which will represent a not insignificant weight for pension pots.’

Will energy companies feel the effect?

One of the key questions beyond the day to day share price is whether the companies will want to reinvest what remains of their profits into renewable projects.

‘The likes of BP and Shell are using a large chunk of these profits on development capital for renewables – which will help the UK in the long-term as our peak renewable generation will outstrip UK demand. If these profits are taken away, there is less money to spend on these renewable projects,’ says Lightfoot Aminoff.

Kasim Zafar, chief investment strategist at EQ Investors adds: ‘How can we expect these large fossil fuel companies to shift their businesses into generating more sustainable energy if we tax the profits that would allow them to invest in the transition?’

BP boss Bernard Looney told shareholders at their annual meeting that the company plans to invest £18billion in the UK by the end of 2030, representing 15 to 20 per cent of total capital expenditure. Shell has committed to investing up to £25billion this decade.

Lightfoot Aminoff says: ‘A windfall tax could also make companies think twice about reinvesting in their future, if this is the outcome when they make a profit. It is difficult to assess how they would react, or what knock-on effect it will have on companies willing to base themselves in the UK.

‘It would certainly go against the Conservative ideology to do this and would go against their ‘business friendly’ post-Brexit mantra.’

Sunak had reportedly been mulling an extension of the levy to include electricity companies but has ruled this out for now. 

It would have seen the likes of SSE, Scottish Power, EDF Energy and RWE having to cough up more tax largely because higher gas prices have had a knock-on effect in the electricity market.

While the levy does not apply to the electricity generation sector, the Treasury will ‘urgently evaluate the scale of these extraordinary profits and the appropriate steps to take.’ 

Shares in SSE and British Gas owner Centrica were down 1.9 per cent and 0.4 per cent respectively. 

It suggests that while investors in BP and Shell have priced in the windfall tax, the possible inclusion of utility and energy-focused stocks has taken the markets by surprise.

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