The announcement of a 35% price hike in gas prices and the mammoth profits posted by energy companies have increased calls from a variety of stakeholders for the government to introduce a windfall tax. This week’s Knowledgeshop examines the potential impacts of such a policy.

Pressure

Worries over energy provision are again top of the UK government’s agenda due to conflict in South Ossetia. BP has closed the Western Route Export Pipeline (WREP) and the South Caucasus gas pipeline and in doing so has caused uncertainty over the ability of EU countries to source oil and gas from the Caucasus.

The government is also feeling the pressure politically - it is 20 points behind the Conservatives in the polls (according to a recent Yougov poll) and, as yet, shows no sign of closing the gap.

Consumers are also experiencing a sense of pressure as they feel the effects of the current economic downturn. CPI annual inflation – the government’s target measure – was 4.4 per cent in July, up from 3.8 per cent in June with predictions of a further increase in the coming months. Last month, consumers were dealt a further blow by British Gas’s announcement of 35% price hikes. The average British family now faces annual energy bills of £1200. 

Energy Policy

The day after the announcement of 35% price rises for consumers, Centrica, the parent company of British Gas, announced first-half pre-tax profits of £1 billion. Unsurprisingly this generated outrage from consumer groups because Centrica’s profits and the increase in energy prices comes at a time when one in six British households is living in fuel poverty – defined as when a household spends more than a tenth of its income on utility bills.

Centrica have defended their position by claiming that the energy price increase was needed to offset higher costs. It is the secondary market for oil and gas that has caused an increase in price while demand has remained fairly constant. The secondary market is the transfer of securities between one investor and another - it is hugely speculative and prone to hyperbole. A recent Radio 4 special report quoted David Kelly, chief market strategist for the investment bank JP Morgan as one of the analysts who believe it’s this speculation that has caused the surge in prices. He said

“Over the last year we are seeing a speculative bubble in oil… this has really been the decade of the bubble. There has been a tech bubble, a real estate bubble and now we are seeing a commodity bubble and oil is at the vanguard of this bubble”

The profits generated by Centrica caused immediate demands by some of Labour’s leftwing backbenchers for a windfall tax on energy companies. They see a windfall tax as an opportunity for the Government to help those who are struggling to stay above the fuel poverty line, gain the political initiative and revive Labour’s dismal poll ratings. Aside from the political boost they think a windfall tax would generate for Labour, advocates of the initiative argue that part of the funding generated could also be used to invest in renewable energy.

MPs on the left of the Labour party are not the only ones who support a windfall tax. Geoffrey Robinson MP, a very close ally of Brown and former Treasury Minister has added his name to the list of supporters, as has Blairite former Minister and MP and safe-seat candidate Stephen Twigg . Earlier this year a Sunday Times poll showed that 84% of people believe energy companies should suffer from a windfall tax. This is cited by supporters as showing how much political capital would be generated if such a move was implemented. Furthermore, in a joint letter to the Guardian newspaper, influential members of organisations including the soft left faction Compass and unions Unite and Unison, stated: “We believe the moment is right for a one-off windfall tax to guarantee social and environmental justice”. 

It should be noted that Labour previously successfully generated £4.5bn through a windfall tax on the unearned profits of privatised utilities in 1997.

Lib Dem Leader Nick Clegg has stated that “Ministers should be clawing back the money from the energy companies’ £9bn European windfall to help protect struggling households from the effects of fuel poverty”. Interestingly, the Conservatives have kept relatively quite on the issue. This could be because the idea of a windfall tax does not appeal to them but they don’t want to explicitly argue against one in case it proves popular.

The Prime Minister has suffered politically from policy leaks over the last few weeks because a number of options that Brown and Darling are reportedly considering have reached the media. These include a £150 bonus to meet fuel payments for families who receive child benefit and ‘green tax’ on utility companies. Unfortunately for Brown, this has added to his reputation as a ‘ditherer’ who is indecisive with regard to policy decisions.

Potential Problems

Although the impact of the 1997 windfall tax was arguably positive, some commentators believe that if the concept of a windfall tax is unravelled, it can be seen as contradictory. A simple explanation of this is given by blogger Tim Worstall. He states that:

‘In order to get fuel prices down we’d like to have a greater supply of fuel and lower demand for it. These people are insisting that we should take the money away from those who would go and find more fuel and give it to the people who want to buy fuel. That is, their plan for reducing prices is to reduce supply and increase demand’.

The logic behind Tim Worstall’s argument is slightly skewed. However, it does emphasise the speculative nature of predicting the economic effects of a windfall tax. 

A windfall tax on energy companies could damage the prospect of future investment in the UK’s energy industry, particularly an expensive new generation of nuclear power stations, by foreign energy companies. At a time when the government is trying to encourage buyers for British Energy, the possibility of a windfall tax on energy companies is unlikely to encourage a high selling price. The collapse of the sale of British Energy to EDF (the French utility company) could leave a massive hole in the government’s energy policy as it wonders how to provide for the planned expansion in nuclear power.

David Hunter, energy analyst at McKinnon & Clarke, commented: “EDF’s purchase of British Energy was the government’s ‘get out of jail free card’ which hasn’t materialised.

“There are tough decisions to be made as the reality is Britain will run short of power. Our crumbling infrastructure and lack of political will to sort has left assets ripe for picking off by larger European energy companies.”

However, two weeks after the collapse of talks, Bill Coley, Chief Executive of British Energy announced: “We continue discussions in respect of a potential transaction”, as the nuclear energy firm reports a 66% fall in profits this year. The government will be hoping a deal is completed as soon as possible.

The energy companies have a key ally in John Hutton, the Secretary of State for Business, Enterprise and Regulatory Reform (BERR). He is one of the most Blairite members of the cabinet and he expressed his views by saying:

‘We have got to have a fiscal and regulatory climate that encourages all of that [power generation] investment because, quite simply, it will go elsewhere if there is not the confidence in the UK market’. 

The pressure the government are facing on this issue and the financial hardship currently being felt by the City plays directly into the hands of Alex Salmond and the SNP. At a time when the government is expected to earn £16 billion through taxes on North Sea oil, the potential of a windfall tax increases calls from the SNP for Scotland to be given a percentage of this tax to generate an oil fund. Mr Salmond stated that:

“Right across government and local government, there won’t be a public service that’s not affected by high energy bills and the Chancellor can do something about it if he uses the windfall to ease the pressure. And secondly, from a Scottish point of view, this is the moment when we must start an oil fund”.

At a time when Labour is under intense pressure from the SNP in Scotland, a further tax on energy generating companies would give Alex Salmond even more ammunition to use against the UK government.

The re-launch

To escape from the windfall tax label, a report in the Sunday Times claimed Brown was planning a £500 million “green tax” where utilities must buy the right to produce carbon dioxide. Although this may sound like it avoids a windfall tax, the potential of being taxed through a ‘green tax’ is not exactly any more appealing to potential energy generating investors.

Whatever the Prime Minister decides, energy policy will certainly contribute to the government’s re-launch in the autumn. If the Labour left-wingers get their way and a windfall tax is implemented, the government would have implemented a policy for short-term popularity with their own activists not long-term sustainability in energy production or their own reputation as a business-friendly Party. 

Additional reporting by Liam O’Keefe