Thursday the UK announced plans to introduce a 25% windfall tax, on top of a complex tax and royalty system that already charges producers 62-81% of pre-tax profits. While most major oil companies have limited exposure to the UK North Sea, increased policy interference in other countries could impact energy share prices. An important consideration for energy investors as politicians attempt to navigate record prices at the pump.
Analyzing geopolitical risk in the energy sector is not new. However, the pervasive belief that the world will quickly move away from fossil fuels has changed policy incentives in many countries. Net-zero strategies, paired with historically high inflation and elevated fuel prices, led the UK to make a major pivot on energy policy. And although the political theatre is filled with calls for net zero strategies, windfall taxes and embargoes, each country has a different set of political incentives and is likely to respond differently to the current energy crisis.
The Norwegian oil fund, capitalized through a 56% "special tax" on the oil sector, has been prudently managed over decades, and now holds ~$1.4T in assets, or ~$250k per man, woman and child in Norway. The fund is regulated to spend no more than ~3% of assets per year, but finances 20% of the government budget and funds the State pension program. Despite Norway's own plans to reduce emissions, the population and government are aligned in ensuring the continued success of the oil and gas industry. And despite the 78% overall tax rate, Norway provides cash rebates for exploration losses and provided significant relief to the industry throughout the pandemic-induced commodity price downturn.
Given the already very high government take, and aligned stakeholder interest in the industry's success, it's highly unlikely that capricious policy measures will lead to investment risk in Norway. These incentives are part of the reason the Norwegian North Sea has seen stable production for the past 20yrs, while the UK North Sea has seen production fall by around half over same period. And that despite very little geologic difference between the Norwegian and UK North Seas.
In France, stakeholder interests are not aligned. The industry is very small, relative to the size of the economy, and President Macron was "very proud" to announce the banning of oil exploration in 2017. In China the industry is strategically important, and despite an in-place price cap on gasoline and diesel, shares of Chinese oil companies have dividend yields in-line with US and European peers. In Brazil, simply the threat of a price cap on domestic refined products has left Petrobras (PBR) shares for dead, despite the ~40% dividend yield.
In Canada, companies pay a corporate income tax and royalties on a sliding scale, depending on oil prices. However, the total government take is relatively low. The likely reason for this is that Canadian oil sands projects are wildly expensive, and take nearly a decade to develop. If the government take in Canada compared to the government take in Norway, the country would never have developed many of its energy resources. That said, the industry is not moving forward with plans to build greenfield oil sands mines. If the capital spending window has passed, the government incentive to maintain a low take has also passed. Increasing the likelihood of accelerating political pressure from Ottawa.
In the US, policy risks come from all angles, and the eventual outcomes are likely dependent on vote-counting in Washington. Senator Warren introduced a "big oil windfall profits tax" bill. The President himself promised to end new oil and gas leasing on public lands. And members of the administration have indicated an oil export ban remains on the table. Despite the various investment disincentives proposed, little action has been taken. While Democrats control the White House and Congress, Democrat Joe Manchin represents the swing vote in the Senate. Manchin has consistently pushed for increased energy supplies to resolve the current crisis, and shied away from supply-side restrictions and redistribution schemes thus far.
The oil (USO) and gas (UNG) sector (XLE) has always been fraught with policy risk. Following actions in the UK, it would appear policy risk is greatest 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) trades at over 20x, investors are being at least partially compensated for the increased risk.