Now the windfall tax debate gets interesting. Rishi Sunak and his Treasury officials have noticed what should have been obvious from the off. It’s not just North Sea oil and gas producers, the popular bogeymen, that are making bumper profits in current conditions. Some electricity generators are too.
And, possibly awkwardly for a government that says it wants to give renewables a push, windfarms and solar assets are providing unexpectedly lovely returns for some owners.
Cue a report in the FT that Sunak is preparing to extend the scope of a windfall tax to include generators. Cue, also, oil-style corporate cries about a threat to future investment, this time accompanied by tumbling share prices.
Drax, the biomass group with a residual interest (still) in coal, lost 15%. British Gas owner Centrica, with its one-fifth share in the UK’s current nuclear fleet, was down 7%. SSE, heavy with hydro and windfarm assets, fell 8%.
Is the reported proposal really so outrageous? Not really. Sunak’s progress towards a levy has been shambolic, but, if he wants to take the windfall route, one could say it is logical to include generators. The target is supposed to be windfall profits that arise in exceptional market conditions, not just windfalls that come from under the North Sea.
Exhibit A in this context is Drax. Since last autumn, when wholesale prices started to take off, its shares have soared from 420p to 812p (before Tuesday). The stock market can see that booming electricity prices represent splendid news for a company that hasn’t suffered the same rate of inflation in the cost of the wood pellets it ships from the US to burn in Yorkshire.
Since Drax enjoys generous subsidies when market conditions are trickier for it, it’s hard to see why it should escape a windfall net. Its shareholders, contemplating a new share price of 700p, might reflect that they’re still up 66% in a year.
Another example is nuclear, whose overheads are largely fixed: the value of its output has soared without any extra spending on its part. The same applies to windfarms and solar projects operating under old-style “renewables obligation certificates” (ROCs), which set a floor under the prices the companies receive without capping the upside.
There are, though, two critical limits to Sunak’s apparent new approach. Both suggest that the Treasury would be silly to think it can grab £10bn via a more broadly defined windfall tax. The figure looks a stretch too far, never mind the fact that consumers’ average bills will shortly be going to £2,800 a year, so the regulator says.
First, Sunak should forget any idea of chasing profits made by windfarm and solar generators operating under “contracts for difference” (CfDs), the more modern financing setup.
The game there is very different from ROC arrangements. With CfDs, the Treasury is already collecting windfall-style prizes: it gets paid when the generator sells power at prices above the “strike” price.
Second, the Treasury should not make the mistake of thinking that all electricity is sold at “spot” prices. That is not how the energy market works. In practice, much of the output is sold under long-term contracts at lower prices, so the imagined corporate profit bonanza may be smaller in reality.
And the forward-looking nature of the contracts means the biggest chunk will only occur next winter. If the Treasury starts trumpeting the £10bn figure as set in stone, it probably will scare investors.
But the principle of including generators – or, more precisely, nuclear, biomass and those with old-style ROC arrangements – seems reasonable. As long as CfD assets are given a free pass, investment into renewables should keep flowing.
Think of a CfD as a form of state-backed guarantee that removes the volatility from an investor’s returns. If the guarantee remains in place – and it will – pension funds, infrastructure funds and others should still show up for their stable multi-year returns.
Yes, the firms will scream blue murder and say the financing environment has become unstable, but France and Spain have already tapped their generators so the UK would not be an outlier.
The Treasury’s thinking on windfall taxes seems to change by the day, so we are yet to see if Sunak actually goes with his new plan. The politics, one suspects, is largely driven by a perceived need to out-do Labour, but the economic case for including generators is coherent.
Just make a decision: the procrastination is almost the worst part for investor sentiment.
