Should the Government place a windfall tax on energy companies?

With gas and electricity prices at record highs, there has been lots of talk about a windfall tax on energy companies as a way to address the energy crisis. 

And that may be coming closer to reality, as Ireland announced a limit on the revenues of non-gas energy generators at €120 per MWh for wind and solar generation and €180 per MWh for oil-fired and coal-fired generation.

Also, any profit that is 20% over the baseline amount made from 2018-2021 will be taxed at 75% for fossil-fuel producers. 

However it’s not really the easy solution many think it is. Particularly for Ireland.

Some parts of the global energy industry are making big bucks right now. 

But not everyone is. 

So if you want to place a windfall tax on energy companies you need to place it on the right ones. So where in Ireland are the excess profits being made?

Energy supplier versus energy generator

First we need to remember that there's a difference between a supplier of energy and a generator or 'producer' of energy/electricity. Some energy companies do both. But some only supply electricity. And these companies aren't making much money right now.

Think Tesco. It supplies milk. It doesn't produce it (the farm does). So if the price of milk shoots up and Tesco passes on the increase in cost, it's not Tesco making the extra money. It's the producer. 

It's similar in the energy market. It's the 'producers' or generators of electricity that are making the most money at the moment.

Suppliers like Pinergy, Prepaypower and Flogas own no electricity generators or wind farms here. They really just provide a retail service. They buy gas and electricity on the wholesale market and in recent months they've just been passing on the increase in the cost of energy (sometimes even operating at a slight loss). So there's not much excess profit to tax here.

This is borne by the fact four energy suppliers have LEFT Ireland this year: Iberdrola, Glowpower, Bright Energy, and Panda Power because they were all LOSING money.

So what about the generators of electricity? 

SSE Airtricity, Energia, ESB/Electric Ireland and Bord Gais Energy (BGE) all either own wind farms and/or fossil fuel-powered electricity generators. And these parts of these companies have been making decent profits. 

So let's tax them more, right?

Well yes we can, but it's not quite the windfall you'd expect.

BGE recently made a half-year profit of €40m in Ireland which angered many people. 

But the company has around 350,000 electricity customers and 300,000 gas customers. Say it makes a full-year profit of €100mn and everything is given back to customers. That’s a refund of around €150 for each person.

However the average gas and electricity bill has gone up by around €2,200 over the past 18 months. So it still leaves a big gap.

It's similar with Energia and SSE.

Also, to put things into perspective, if all circa 2.5 million households in the State were to be compensated for the increase in prices through a windfall tax on energy companies you'd need to find around €5bn, which isn't remotely achievable.. 

What about the ESB?

Earlier in the year the ESB, which is the generation division of Electric Ireland, announced a record operating profit of almost €700 million for 2021, which was up over 10% on the previous year.

However after the profit was announced, the Irish Government also announced that it was taking a record dividend of €126 million for the tax coffers (a multiple of which was then paid back out in the form of the €200 energy credit to all households). 

And the ESB is owned by us, meaning any remaining profit after the Government has taken its money is largely invested back into Ireland’s electricity grid, which needs massive investment over the coming years to cope with a rising population, a growing economy, and the need to be able to cope with more renewable energy. No ESB profit is paid to foreign shareholders, investment banks or 'vulture' funds.

Yes - the Government could have taken a much bigger dividend of up to €700mn - but it would just have left the ESB €700mn short of the money it needs to invest in the grid in the near future - meaning taxpayers would probably have had to stump up the money eventually anyway…

Wind farms

Wind farms have been doing relatively well out of the crisis.

It's complicated but due to a system of marginal pricing in the electricity market, all generators get paid the same amount for the energy they feed into the grid at a given time (which is set by the last and highest-priced bid that's needed to meet demand).

So as the price of gas-generated electricity has gone up, the price wind farms receive has gone up too. 

It might seem strange but it's a very common system for pricing electricity and is used by many countries and promotes efficiency in the longer run. 

However some of the extra money being made by wind farms has been paid back in the form of the PSO levy - which has gone from a payment of almost €60 a year to a credit of almost €90 a year for every household.

Also, many of the wind farms in the country are owned by the ESB - i.e. the State. And as we discussed, there are consequences to going after this money. That's not to say we shouldn't of course...

Where is the big money being made?

Almost all the ‘obscene’ profits in the energy industry right now are being made by companies like Shell, BP, Russia’s Gazprom, and Saudi Arabia's Aramco. 

These are the companies which actually extract fossil fuels such as oil, gas and coal from the Earth and refine it for use by energy companies to supply gas and electricity to people’s homes. It’s highly complex and skilled work but extremely profitable right now. 

BP recently reported its biggest quarterly profit for 14 years, making £6.9bn in the three months to June. Shell recorded even higher second quarter profits of £9bn. And BGE's parent company Centrica recently announced group profits of £1.34 billion at the same time - more than five times the amount it earned a year ago. Meanwhile Norway and Saudi Arabia are posting record current account surpluses.

However these are not Irish companies. We can't go after another country's money. Besides, they’re making money by extracting gas, oil and coal in other countries' territories making the money more difficult to go after.

The UK has placed a 25% windfall tax on energy companies operating in its territory - but it will only apply to the profits made by companies from extracting UK oil and gas (only around one tenth of BP’s profits come from selling UK oil and gas).

However it still expects the tax to raise around £5bn.

So what the Government could do is look at placing a windfall tax on the profits of the owners of the Corrib gas field off Mayo, which supplies around 25% of Ireland's gas. However our gas reserves are only a fraction of the UK's, so there'll be no huge windfall. But it could help.

According to some estimates, the EU's latest windfall tax proposal (which envisages a 33% levy to apply to excess profits more than 20% above a company’s average profits for the last three years) would raise €200mn to €300mn. 

Can’t we just cap prices?

Yes - but the question is - who ends up paying?

Can you force companies to sell something at a loss?

Capping energy prices would almost certainly put suppliers like Pinergy, Prepaypower and Flogas out of business within weeks and leave hundreds of thousands of customers looking for a new provider. 

In the UK there was a price cap (though it was reviewed every six months). It led to around 30 suppliers going bust, thousands of job losses, and a surcharge of up to €100 on everyone’s bills to help pay for all the carnage. The new cap, is really just a state subsidy and will be funded through huge government borrowing. 

France has capped electricity prices. But that is going to come at a huge cost to the French state. 

France has spent around €12bn alone on buying the remaining 16% of EDF, the country's main electricity provider, that the government did not already own. It did this because the price freeze is going to be hugely expensive for EDF. And the cost of this support may only become clear over time.

The final and most salient point is that we import the vast majority of our fuel from other countries - so we can't cap the price of other countries' goods. We'd still have to buy most of our fuel at market prices. 

See here for more info on why a price cap may not work.

What can the Government do in the short term? 

There are a few things the Government can do to help households this winter.

1. Commit to keeping the 9% Vat rate on gas and electricity indefinitely and even reduce it to 5%. The rate of Vat is due to revert to 13.5% from the end of October. When people talk about the 'winners' from the energy crisis, they forget the Government is one of them. Vat is levied on the net price of goods and services, so as the cost of gas, petrol, diesel, and electricity has gone up, so too has the Government's tax take.  

2. Make plans for another energy credit to be paid to all households this winter.

3. Look at taking a greater dividend from the ESB next year, which would help pay for the energy credit.

4. As mentioned, look at placing a windfall tax on the owners of the Corrib gas field.

What can the Government do in the medium term?

1. Build a Liquified Natural Gas (LNG) import facility to increase our diversity of supply and security. Ireland is the only country in Europe with a coast which has no LNG facility. The lack of an LNG facility leaves Ireland highly exposed to piped gas from the UK. 

2. Continue investment in renewables to leave us less exposed to the rising price of oil and gas. 

3. Investigate why electricity here is so expensive to generate - it's over 50% above the EU average. You can read more here on why that is.