Could a windfall tax work in practice?

By Gavin Stamp Business reporter, BBC News

Campaigners believe firms must put people's welfare before profits

Political support for a windfall tax on the country's leading energy suppliers is growing.

More than 80 MPs are now calling for a one-off tax on the profits of energy firms to be given to people struggling to cope with soaring fuel bills this winter.

Although the Chancellor remains decidedly lukewarm about the idea, the issue - given the sharp rise in household living costs and the government's own political problems - is unlikely to go away.

But how would a windfall tax work in practice and would it really have the desired effect?

'Unearned profits'

Supporters point to the �4.5bn windfall tax levied on the privatised utilities in the wake of Labour's 1997 election victory as a precedent for such a measure.

Oil companies can operate profitably at price levels way way below where we are at the moment Andrew Simms, New Economics Foundation

They draw parallels between what they say were the "excess" profits made by firms such as British Gas and National Power immediately after privatisation and the "unearned" rewards the same firms and oil giants have reaped in recent times from the soaring price of oil and gas

"The spike in oil prices means oil companies are receiving unearned windfall profits that are damaging society, not least because the prices rises are fuelling inflation," various MPs, union leaders and lobby groups - including Friends of the Earth and the Child Poverty Action Group - argued in an open letter earlier this month.

A tax on the profits made by the UK's 'big six' domestic energy suppliers - and the likes of BP and Shell - would be a quick, effective and relatively painless way of alleviating fuel poverty, they believe.

To be effective a windfall tax has to create the expectation that it is not going to be repeated Tim Tutton, Oxera

Others go further and are calling for a permanent tax on oil profits, as is the case in Norway, to fund the UK's move to a low-carbon economy.

"Of course there are costs involved in the extractive infrastructure but oil companies can operate profitably at price levels way way below where we are at the moment," says Andrew Simms, policy director of the New Economic Forum.

"It is unarguable, I believe, that we need this on a recurring basis."

But start to look at how the tax might be calculated and which firms should be liable and the issue gets a little more complicated.

When and where?

In 1997, The Treasury used a complex formula to govern how much more the utilities were worth four years after privatisation compared to when they were sold off.

Critics say defining the UK income of multinational oil firms is problematic

Such a calculation does not apply a decade later and it remains unclear over what period any new windfall tax would apply.

In their recent letter, supporters of the tax highlighted the �2.5bn rise in the combined profits of the big six electricity firms since 2003.

Centrica, the owner of British Gas, made a �2.1bn profit alone last year and made a not inconsiderable �994m in the first half of 2008 as the average price at which gas was sold rose 120%.

But its half-year profit was actually down on the year before while profits at British Gas slumped from �533m to �166m during the period.

Shell made �4bn in the second quarter of 2008 alone, at a time when oil prices were around $140 a barrel, while BP made �3.4bn.

Prices have been rising sharply since the end of 2005, helping the two firms to amass huge profits in each of the past two years.

ENERGY PROFITS: 2007-8 Shell: �13.9bn BP: �9.3bn Centrica: �2.1bn Scottish & Southern Energy: �1.2bn Scottish Power: �1.0bn EDF Energy UK: �957m E.ON UK: �877m Npower: �694m

But that profit has either now been reinvested in its business or paid to shareholders, making retrospective action more difficult.

As with the timing of any tax, identifying the origin of the profits to be taxed could also be fraught with controversy.

Unlike in 1997, the majority of the UK's main electricity and gas suppliers are now foreign-owned.

Although much of Centrica's income from energy production - which rose 50% in the past six months - derives from power stations in the UK and North Sea gas fields, it is less clear cut with foreign owned firms such as NPower, EDF Energy and Powergen.

If these firms are to be taxed purely on activities within the UK, would the same rule apply to the likes of BP and Shell - the vast majority of whose profit comes from production from around the world?

Veiled threats

Multinational firms have often issued veiled threats that a windfall tax may "scare off" investors and make them consider relocating abroad.

Some analysts believe a tax would cause added uncertainty and that efforts to help consumers should be focused on tougher regulation.

They point to already high North Sea taxation and firms having to spend huge sums on developing new and alternative energy sources.

The tax take on North Sea oil production, in particular, has been raised in successive Budgets to extract more for the Chancellor from high oil prices.

"To be effective a windfall tax has to create the expectation that it is not going to be repeated," says Tim Tutton, head of energy policy at consultants Oxera.

"I think that is very difficult.

"For government to do that it would have to cream off profits which have already been earned but not threaten future profits because that is what encourages companies to do things."

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