Is a windfall tax on renewable generation appropriate?

Update after the new Budget announcement on 17.11.2022

In the Autumn Statement, the Chancellor announced that the Energy Profits Levy on Oil & Gas (O&G) companies will be raised from 25% to 35% from 1 January 2023 and extended until March 2028. Additionally, there will be a new, Electricity Generator Levy of 45% on low-carbon electricity generation implemented from 1 January 2023. This levy will be applied to companies generating more than 100 GWh per annum of electricity from nuclear, renewable and biomass sources, although it will not apply to electricity generated under a Contract for Difference. Pumped hydroelectricity and battery storage revenues are also exempt from the levy. A benchmark power price of £75/MWh has been set, with any earnings below this level not subject to the levy. 

Whilst the power prices at which projects sell have clearly increased in the last year, the below blog published by Cornwall Insight on 9 November 2022 takes an analytical look at how and why the levels of windfall profit experienced by O&G companies and renewable generators are not comparable. 

This graph neatly illustrates that treating renewable generation companies and O&G companies as equivalent under a windfall tax regime is not appropriate. Share prices are the best representation of investors’ expectations and measure of the profits experienced by firms. The share price performance we have seen since November 2021 for O&G companies, large electricity generators (GenCos), and Listed Renewable Funds (YieldCos) illustrates that the different classes of company must have witnessed substantially different scales of profit in the last 12 months.

  • O&G shares prices have climbed to 150% of their price in November 2021.
  • Renewable listed funds peaked at 115% of their November 2021 price and have since fallen back to the same level as early March 2022.
  • GenCos shares remained largely constant until the Russian invasion of Ukraine and have since shown a strong correlation with the macroeconomy (R2 of 0.7 compared to the FTSE 100).

Whilst we cannot know for certain what is going on without a forensic examination of each and every project in the market, this broad scale analysis does allow us to pose some educated hypotheses. These trends likely reflect the underlying sensitivities of different business models to interest rates, and to commodity prices for their place in the energy value chain:

  • Renewables listed funds are very sensitive to rising interest rates in the UK as they heavily impact discount rates for component project valuations. Risk free rates have climbed significantly since September’s mini budget, having a material devaluation impact on funds.
  • O&G companies are more internationally diverse, with a wide range of exposure to discount rates. Similarly, GenCos have a more diverse international asset base, and varied sources of cashflow from elsewhere in the value chain and are therefore also less sensitive to project discount rates.
  • Renewable listed funds will ultimately forward trade, or hedge, power to give some certainty of returns to capital investors, many of which dislike too much exposure to power price volatility. One hypothesis could be that large volumes of forward hedging took place early- to mid-summer as prices climbed, missing out on the super peak thereafter. Otherwise, we would have expected to see a steeper climb in share prices beyond August. Instead, we have seen listed fund share prices only slowly climbing in late summer before the September fall.
  • O&G companies trade in the source commodity driving the whole energy value chain – gas – and have therefore been able to forward sell under ever increasing price levels since the end of 2021.
  • GenCos have a diverse suite of routes to market for their power sales, and as a result are likely more exposed to prompt price movements than their listed fund counterparts. This would in part explain the higher share prices during early to mid-summer than listed funds, and then the lower share prices in Autumn as prompt prices have collapsed.

This analysis is also instructive because we can view Renewable Listed Funds as a representative sample of the broader renewable project world, certainly for onshore wind and solar. If this is true, then it would be rash to assume that there are excessive windfalls to tax in this part of the market. And, if so, then the damage that undertaking such measures could have on investor confidence, and ultimately the increased risk premia on future investments, in the medium- to long-term could exceed the benefits that a windfall tax might reap in the short term.

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