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BP and Shell shares face increasing likelihood of windfall taxes

BP and Shell shares are rising on strong demand for oil and gas. But with consumer energy bills going up 54% in April, the political argument for windfall taxes is gaining traction.

BP and Shell shares plunged to historic lows in 2020 as demand for oil collapsed. By October, they were worth as little as 97p and 933p respectively.

However, after recording bumper profits in 2021, BP shares have now recovered to 412p, while Shell shares are at 2,053p. And they could soon recover to their pre-covid 19 pandemic highs.

BP and Shell shares: booming oil demand

BP and Shell are rising on a profit expansion driven by the rising price of oil. BP has reported Q4 profits of $4.1 billion, taking annual profits to an 8-year high of $12.8 billion. But while CEO Bernard Looney calls the company a ‘cash machine,’ it’s worth remembering that the company lost $5.7 billion in 2020. Likewise, Shell has reported annual profits of $19.3 billion, including a final quarter profit of $6.4 billion. But last year, it made just $4.85 billion.

Brent Crude is now at an 8-year high of $93 per barrel. However, the world’s top oil trader, Vitol Group, believes that robust demand combined with shrinking excess production capacity and ‘worrisome’ inventory levels could push oil prices even higher in 2022. Mike Muller, head of Vitol Asia, has highlighted ‘China is at bare-minimum operating level in terms of the prescribed level of mandatory stockholding that state enterprises are meant to hold,’ and predicts the country will soon start increasing its oil holdings.

Meanwhile, cyber-attacks on facilities in Germany, Belgium and the Netherlands are creating disruption. Germany is closing the last of its nuclear plants this year. Tensions on the Russia-Ukraine border could see the opening of Nord Stream 2 delayed indefinitely, and fuel exports from Russia could be stopped completely. And in the US, the Texas deep freeze is interrupting Permian oil production. The Bank of America thinks Brent Crude could even rise to $120 by June.

Windfall tax?

Shell’s bumper results last week were announced on the same day that OFGEM lifted the UK’s annual energy price cap by 54% to £1,971. And now both companies are in the firing line for a windfall tax to protect UK consumers from the escalating cost-of-living crisis.

But while Shadow Chancellor Rachel Reeves believes in ‘a one-off windfall tax on oil & gas producers to cut bills,’ Chancellor Rishi Sunak has called the idea ‘superficially appealing,’ and argues it isn’t ‘the right thing to do most obviously because it will deter investment.’

And Looney agrees, saying ‘2021 shows BP doing what we said we would – performing while transforming.’ He plans to increase BP’s low-carbon spending ten-fold to a third of its budget within 10 years. And Third Bridge analyst Allegra Dawes argues the company has embarked on an ‘aggressive strategy’ to cut oil and gas production by 40% by 2030 but has not yet proved it can generate profit on its renewables business.

Shell CEO Ben van Beurden concurs, saying ‘I’m not sure that windfall taxes, popular though they may seem, [are] going to help us with supply or help us with demand.’ And he has argued in the past that Shell’s transition to net-zero ‘will be funded by the oil and gas business,’ with the company aiming for an ‘absolute emission reduction target of 50% by 2030.’

But BP spent $4.15 billion on share buybacks last year and is planning to spend a further $1.5 billion in 2022. Meanwhile, Shell spent $3.5 billion on buybacks in 2021 and expects to increase the programme by $8.5 billion this year as well. This illustrates the companies’ conflict of interest, as they must balance their legal duty to maximise profits for shareholders with investing in the transition to renewables.

Meanwhile, Shadow Secretary of State for climate and net-zero Ed Miliband thinks Sunak ‘is completely out of step with the mood of the country in rejecting (a windfall tax.)’ And Liberal Democrat leader Ed Davey believes ‘it simply cannot be right these energy companies are making super profits while people are too scared to turn their radiators's about basic fairness.’

But while they argue that both BP and Shell should be taxed more on oil extracted from Britain’s territorial waters, only a fraction of their profits come from the North Sea. Moreover, any windfall tax risks discouraging further investment in the UK.

However, personal taxes, interest rates and inflation all rising. And with the BP and Shell shares expected to explode on a combined $55 billion profit this year, the temptation to go after a politically easy target may become hard to ignore.

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