Explained | Taxing windfall profits of oil companies

The story so far: On February 3, the Union government hiked the windfall profit tax levied on domestically-produced crude oil as well as on the export of diesel and aviation turbine fuel (ATF). Just three days before this, the Chairman of the Central Board of Indirect Taxes & Customs Vivek Johri, told PTI that prices of crude were on the rise again and thus, “for the time being windfall tax will continue.” He added that it would be difficult to predict for how long the taxation will continue.

Why tax windfall profits?

‘Windfall profits’ refer to an unanticipated spike in earnings of an entity resulting from an exogenous event (which could be one-off and/or prolonged) and not resulting from a business decision. The B.K. Chaturvedi committee’s report on the Financial Position of Oil Companies (2008) had stated that taxing of these windfall gains has been seen as a prerogative of governments, in part to meet fiscal needs and in part to pursue redistributive justice. The central idea here is for sovereigns to capitalise on the lofty profits made by the entities and use it for specific domestic pursuits, for example, spur collections (of taxes) to guard against the consequences of a larger geopolitical event or redistribute them for it to be used for domestic social service schemes, among other reasons. As per the government, the collection of Special Additional Excise Duty (SAED) for the ongoing financial year is estimated to be ₹25,000 crore from production of crude oil, export of petrol, diesel and ATF. Windfall taxes are reviewed on a fortnightly basis and are subject to factors such as international oil prices, exchange rate and quantity of exports. India had first imposed SAED in July 2022.

What led to windfall gains?

Russia’s actions in Ukraine were central to the volatility observed in the oil market in the previous calendar year. For perspective, Russia was among the major players in the global oil market and among the largest producers alongside Saudi Arabia and U.S. As a response to Russia’s actions, several Western countries, moved to stop or curtail their energy imports from Russia. This led to sharp increases in fossil fuel prices as sovereigns went to look for other suppliers for its energy needs, culminating in major profits for oil companies. This was a total reversal of fortunes compared to the onset of the pandemic when oil had struggled to even attain fiscal breakeven. According to Reuters, all ‘Big Oil’ companies (including BP, Chevron, Equinor, ExxonMobil, Shell and Total Energies) combined, more than doubled their profits to $219 billion in 2022. In fact, Chevron commenced a share buyback programme amounting to $75 billion alongside a 6% increase in its quarterly dividend — both indicative of its financial strength.

In India, ONGC’s profit-after-tax (PAT) until September end in the ongoing financial year stood at ₹28,032 crore, compared to the ₹40,306 crore in the complete fiscal ending March 31, 2022. The turn of events has led to oil companies prioritising investments in conventional sources to provide for energy security than transitioning towards cleaner energy to meet energy requirements. Industry participants have particularly argued about the need for investments to facilitate decarbonisation. In an interview to CNBC, Saudi Aramco’s CEO Amin Nasser said that windfall taxes would not be helpful (for oil companies) to acquire additional investment. “There’s no doubt, transition needs to (happen),” he stated, adding, “At the same time, we need to build oil and gas, while at the same time decarbonise oil and gas. We need support for alternatives. But at the same time, we need the support or the conventional sources of energy by building carbon capture and storage and giving incentives and support by policymakers.”

What potentially lies ahead?

Nearly a year since the geopolitical conflict erupted, the International Energy Agency (IEA) notes that global oil markets are trading in “relative calm”.

Oil prices are back to pre-war levels, exception being diesel, though it has also drifted much lower than last summer’s historical highs. “World oil supply looks set to exceed demand through the first half of 2023, but the balance could shift quickly to deficit as demand recovers and some Russian output is shut in,” read IEA’s Oil Market Report for February 2023. It added that Russian oil production and exports have held up relatively well notwithstanding the sanctions. It has managed to reroute shipments of crude to Asia and the G7 price cap on crude “appears to be helping to keep the barrels flowing.”

IEA estimates that global oil demand is set to rise by 2 mb/d in 2023 to 101.9 mb/d. The Asia-Pacific region, fuelled by China which resumed economic activities following a prolonged period of lockdowns, dominates the outlook. The supply side has been largely steady in January at around 100.8 mb/d.

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