Oil & gas’ high profits, diversification offset UK windfall tax
The improved financial performance of Fitch-rated oil and gas companies operating on the UK Continental Shelf, boosted by historically high commodity prices, together with their portfolio diversification, will limit the impact of a new energy profits levy (also known as a windfall tax), Fitch Ratings says. An investment allowance will also help reduce tax costs.
In May 2022, the UK government introduced the energy profits levy – a 25% surcharge on the UK oil and gas sector’s profits. The measure includes an investment allowance of 80%, reducing the tax if companies invest in oil and gas extraction in the UK.
The levy will be phased out once oil and gas prices normalise with a sunset clause effective at end-2025, although significant uncertainty remains as to the level of price moderation that would be required for the phase-out.
The levy aims to collect GBP5 billion in 2022 from oil and gas companies to fund a customer support scheme to alleviate the pressure of increased energy bills.
We anticipate oil and gas companies to post strong earnings and increase their significant cash reserves in 2022 due to high oil and gas prices. This will allow for incremental deleveraging by most Fitch-rated issuers with production in the UK, creating ample leverage headroom to absorb the new levy without pressure on their ratings.
We expect the financial performance of oil and gas producers to remain robust even based on our mid-cycle price assumptions, mitigating the impact of the new windfall tax if it remains in place in line with a sunset clause.
Ithaca Energy will be the most affected by the levy among Fitch-rated companies as its entire oil and gas portfolio operates in the UK North Sea. The proposed levy (on an annualised basis) could equate to 15%-20% of Fitch-adjusted 2022 EBITDA (excluding the mitigating impact of the investment allowance).
Ithaca benefits from its strong cash position and low leverage profile, supported by the high price environment incorporated in our oil and gas price assumptions for 2022 and 2023. This boosts financial headroom, which will help absorb the new tax.
We expect the overall medium-term impact of the levy to be tempered by the investment allowance mechanism, even if the company’s FFO net leverage increased in the medium term if the tax is collected until 2025, in line with the sunset clause, and assuming some moderation in oil and gas prices. This forecast assumes a cash outflow of over USD1 billion related to Ithaca’s announced acquisition of Siccar Point, yet to be finalised.
Medium-sized oil and gas companies will be less affected due to their greater geographic diversification. Harbour Energy is most exposed in this peer group as about 90% of its current production is located in the UK North Sea, but the company has sufficient headroom under its sensitivities to absorb the impact. Other producers in this category have a much lower share of production coming from the UK, including Neptune Energy (12%) and Energean (2%).
The impact of the levy on oil and gas majors will be minimal due to their highly diversified operations, income streams coming from various sectors other than oil and gas extraction and strong credit metrics. About 5% of BP’s consolidated production is based in the UK.
We estimate that the levy will account for less than 2% of its EBITDA in 2022 (as adjusted by Fitch and excluding the mitigating impact of the investment allowance).
Similarly, the UK accounts for 8% and 3% of consolidated production for TotalEnergies and Shell, respectively, with the share of the windfall tax for each estimated at a low-single-digit percentage of EBITDA.
