Redistributive policy

Following UK oil windfall tax, investors should prepare for political headwinds

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On Thursday, the UK announced plans to introduce a one-off 25% levy, on top of a complex system of taxes and levies that already charges producers 62-81% of pre-tax profits. While most major oil companies have limited exposure to the British North Sea, increased political interference in other countries could impact energy stock prices. An important consideration for energy investors as politicians try to navigate record prices at the pump.

The analysis of geopolitical risk in the energy sector is not new. However, the widespread belief that the world will rapidly move away from fossil fuels has changed policy incentives in many countries. Net zero strategies, coupled with historically high inflation and high fuel prices, have led the UK to operate a major pivot in energy policy. And while the political theater is filled with calls for net zero strategies, windfall taxes and embargoes, each country has a different set of policy incentives and is likely to react differently to the current energy crisis.

Norway’s oil fund, capitalized by a 56% ‘special levy’ on the oil sector, has been managed cautiously for decades and now holds around $1.4 billion in assets, or about $250,000 per man , wife and child in Norway. The fund is regulated to spend no more than about 3% of assets per year, but funds 20% of the state budget and funds the state pension program. Despite Norway’s own plans to reduce emissions, people and government agree to ensure the continued success of the oil and gas industry. And despite the 78% headline tax rate, Norway offers cash rebates for exploration losses and has provided significant relief to the industry throughout the pandemic-induced decline in commodity prices. .

Given the already very high government involvement and aligned stakeholder interest in the success of the industry, capricious policy measures are highly unlikely to pose investment risk in Norway. These incentives are part of the reason why the Norwegian North Sea has seen stable production over the past 20 years, while the UK North Sea has seen production drop by about half over the same period. And this despite very few geological differences between the Norwegian and British North Seas.

In France, the interests of stakeholders are not aligned. The industry is very small, relative to the size of the economy, and President Macron was “very proudto announce a ban on oil exploration in 2017. In China, the industry is strategically important, and despite a price cap in place on gasoline and diesel, shares of Chinese oil companies have yields of dividends in line with their US and European peers In Brazil, the mere threat of a cap in domestic refined product prices left Petrobras (PBR) shares for dead, despite the dividend yield of around 40%.

In Canada, companies pay corporate income tax and royalties on a sliding scale based on oil prices. However, the total government share is relatively small. The likely reason for this is that Canadian oil sands projects are extremely expensive and take nearly a decade to develop. If the government took over Canada versus the government took over Norway, the country would never have developed many of its energy resources. That said, the industry is not moving forward with plans to build new oil sands mines. If the capital spending window has passed, the government’s incentive to maintain a low grip has also passed. Increase the likelihood of accelerating political pressure from Ottawa.

In the United States, political risks come from all angles, and the eventual outcome likely hinges on the vote tally in Washington. Senator Warren has introduced a bill on the “windfall oil profits tax”. The president himself has promised to end new oil and gas leases on public lands. And members of the administration have indicated that an oil export ban remains on the table. Despite the various investment disincentives proposed, few measures have been taken. While Democrats control the White House and Congress, Democrat Joe Manchin represents the swing vote in the Senate. Manchin has always insisted on increased energy supplies to resolve the current crisis, and have so far avoided supply-side restrictions and redistributive schemes.

The oil (USO) and gas (UNG) (XLE) sector has always been characterized by political risks. Following the actions in the UK, it would appear that political risk is highest in the US, Canada and Brazil. However, with companies like Pioneer (PXD), Canadian Natural (CNQ) and Petrobras (PBR) trading at 5-8x 2022 earnings, while the S&P 500 (SPY) is trading at over 20x, investors are at least partially compensated for the increased risk.