Oil and gas prices soared when consumer demand surged with the lifting of COVID-19 restrictions. Then Russia invaded Ukraine, wielding Gazprom and its control of fuel prices against EU and British sanctions. This squeeze on supply allowed oil and gas companies to post record profits in 2022. And after a dip in 2023, energy giants are posting record breaking profits again.
In response to the first surge in prices, then British Prime Minister Rishi Sunak introduced the Energy Profits Levy (EPL) in May 2022 to tax the windfalls that oil and gas companies were seeing. And in March of this year, U.K. finance minister Jeremy Hunt lengthened the EPL’s duration to the end of the decade after raising the initial 25% tax to 35%.
This rapid policy implementation raises the question of what were the EPL’s effects on firms? The Walton College’s Chair in Professional Accounting Kristian Allee researched the impact of the EPL on effected firms and measured the spillover effect that impacted the wider energy industry. His research, “Market-based Oil Spill(overs): Market Reactions to the Energy Windfall Tax Announcements and Disclosures in the United Kingdom,” was published recently in Economics Letters.
With his coauthors Raffael Speitmann (European Commission, Joint Research Centre), Arthur Stenzel (NHH Norwegian School of Economics), and Yuchen Wu (University of St. Gallen), Allee found significant negative abnormal price effects and returns following the U.K.’s announcement of the EPL. The international team of researchers says their data also suggests that larger, more profitable firms were particularly impacted.
The impact was not limited, however, just to the firms that the U.K. targeted. Due to the uncertainty the EPL injected into the market, other energy producers also suffered negative, abnormal price effects due to the potential “spillover effects” of this legislation.
There is appetite both in the U.S. and abroad to implement more or similar windfall tax schemes, so the researchers hope their data can help regulators make well-informed policy decisions and be more aware of the threat of potential spillovers.
What Is the Energy Profits Levy?
The EPL is a windfall tax, so it imposes an extra tax upon what regulators define as excessive profits. The British government has imposed various windfall taxes since the 1980s, and the US passed a crude oil windfall tax in 1979. In more recent memory, the 2008 Financial Crisis stirred some talk of windfall taxes on corporations, but those never materialized.
In this most recent spate of windfall taxes, the U.K. targeted firms that extract oil and gas in the U.K. and on the U.K. continental shelf. The British government describes the tax as kept separate from other taxes by a “ring fence,” which blocks firms from importing losses from other economic activities into the tax scheme, preventing the firm from reducing the levy.
The tax scheme also has two investment allowance rates to continue to encourage firms to invest their earnings. The lower rate is a 29% allowance and reflects a desire to ensure that investments of all kinds still have value for the firm. And in an effort to support the British energy industry’s transition to Net Zero, decarbonization investments have an 80% allowance. In early June 2024, the U.N. Secretary General Antonio Guterres called on nations around the globe to implement similar policies.
How Firms Responded to the EPL
Allee, Speitmann, Stenzel, and Wu constructed a dataset of 27 public firms that were targeted by the EPL. The researchers said their analysis naturally evolved since 17 of the 27 firms voluntarily disclosed information about how the EPL impacted their taxes during their analysis window. Seven of those firms disclosed precise information, specifically how much they expected the levy to increase their taxes, whereas the other ten only released narrative information.
The researchers’ analysis showed that the firms, which voluntarily disclosed information, had on average more sales, higher net earnings, higher tax expenses, and higher effective tax rates. So, the more likely the EPL was to affect the firm, the more likely they were to disclose financial data.
Targeted firms had negative, average abnormal returns between 6.0 and 7.3% lower than non-targeted firms. Firms that disclosed information during the researchers’ study had even lower, abnormal returns, between 7.7 and 10.6% on average. Allee and his colleagues estimate that firms lost between $2.16 and $3.18 billion in value due to the EPL. (The researchers conducted their tax analysis in British pounds, so the US dollar amounts represent the exchange rate in early June 2024).
Further analysis revealed that also non-targeted firms across the energy industry saw negative abnormal returns after the U.K. announced the EPL. Allee and his coauthors suggest “lower demand by investors and an expected negative valuation impact given the policy uncertainty around the announcement” as a possible explanation. That is, the researchers found support for a spillover effect by the EPL.
The researchers did not find evidence for tax avoidance among EPL-impacted firms, nor did they find that larger firms were using their size or supply chain to foist the cost of the windfall tax upon other stakeholders and customers – a known tactic in other circumstances. Rather, it would appear the EPL had the unintended consequence of impacting the whole energy sector in the U.K. rather than just the targeted firms.
Allee says, “These findings contribute to the understanding of how the stock market responds to tax policy changes.” And considering regulator and global voter interest in these taxes, he and his colleagues hope that “our tests alert regulators to a spillover effect associated with windfall tax regulation.”
Kris Allee
