WINDFALL TAX GAIN

ON
OIL COMPANIES

DHANANJAY SHARMA
BUSINESS ANALYST
Dhanraj_recw@yahoo.com

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 INTRODUCTION: WINDFALL TAX

The expression ‘windfall’ is just a euphemistic way of

describing a phenomenon of ‘excess profits’ relative to some

normative notion of profitability.

A
against
Tax levied
governments
by

certain
fell down in their own
property. In
case, they could use
such a

industries when the wood or sell it.

economic conditions Needless to say, there
allow those industries were several such
to experience above- instances of acts of
average profits. God and subjects
Windfall taxes are reaped windfall profits
primarily levied on the by selling such wood.
companies in the So, a windfall profit
targeted industry that presupposes an act of
have benefited the God. It is profit earned
most from the through other than the
economic windfall, ordinary course of
most often commodity- business. Does this
based businesses. The definition fit our oil
term “windfall profit” companies? It appears
was first used in the not. As with all tax
colonial era. Subjects initiatives instituted by
were prohibited from governments, there is
using lumber that was always a divide
more than a foot in between those who are
width except where for and those who are
due to an act of God, against the tax. The
such as a storm, trees benefits of a windfall

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tax include proceeds will always be a
being directly used by contentious issue
governments to bolster debated between the
funding for social shareholders of
programs. However, profitable companies
those against windfall and the rest of society.
taxes claim that they This issue came to a
reduce companies' head in 2005, when oil
initiatives to seek out and gas companies,
profits. They also such as Exxon Mobil
believe that profits who reported profits of
should be reinvested to US$36 billion for the
promote innovation year, experienced
that will in turn benefit unusually large profits
society as a whole. due to rising energy
Windfall taxes prices.

UNFLATTERING HISTORY WITH WINDFALL PROFIT TAX

The US experimented with a windfall profit tax on oil

T he
experimented with
a windfall profit tax on
US controls caused
prices to rise from $14
to $24 a barrel raising
oil

oil companies in the demands from

1980s and the lawmakers for a tax on
experience was the windfall earnings of
anything but oil companies. Unlike
worthwhile. President what its name
Jimmy Carter imposed signifies, the windfall
such a tax in April profit tax imposed by
1980 after dismantling the Carter
price controls on the oil administration was
industry. The freeing of actually an excise tax

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in that it was finance, released in
calculated on the March 2006, the tax
difference between the generated just $80
market price of oil and billion in revenue
a base price set by the between 1980 and
administration. Higher 1988 compared to a
the market price, projection of $383
higher was the tax billion. The net revenue
burden. However, the was even lower at $38
tax failed to serve its billion as the tax could
purpose and, worse, be set off against
worked against the income tax liability.Mr
interests of the Lazzari’s study
government. It failed estimates that the tax
to generate the reduced domestic oil
projected revenues, production from
increased the reliance anywhere between
of the US on oil 1.2 and 8 per cent
imports and turned tax and dependence on
administration into a imported oil grew
nightmare for the from 3 to 13 per
Internal Revenue cent. The tax was
Service. finally repealed by the
Reagan administration
According to a study by
in 1988 as it failed to
the US Congressional
generate projected
Research Service called
revenues, increased
The Crude Oil Windfall
dependence on
Profit Tax of the 1980s:
imported oil. One of
Implications for
the unfortunate fallouts
Current Energy Policy
of WPT (in the US) was
by Salvatore Lazzari, a
that it had the effect of
specialist in public

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reducing domestic
supply of crude oil WPT : POLITICS & ECONOMICS
.
below what the supply
The US experimented with a windfall profit tax on oil
would have been
without the tax.

he steep oil price rise since Samajwadi Party said last

May has rekindled the week that the windfall
debate on the need to profits made by the private
impose a windfall profits oil companies should be
tax on private oil taxed. This tax, the party
companies. The matter has suggests, can be used to
even acquired political partly fund the oil subsidy
overtones in the US bill of the government-
presidential elections, with owned oil marketing
one of the nominees, companies. a windfall
Barak Obama, supporting profit tax of up to 50 per
the imposition of such a cent on both upstream and
tax. This issue has now downstream operators for
reared its head in India as RIL , Singh said the levy
well here too; it has will immediately cover the
unsurprisingly assumed under-recoveries of the oil
political proportions. The marketing companies by
Left and other political Rs 100,000 crore (Rs
parties such as the 1,000 billion). The SP
Samajwadi Party have leader said if the
been pressing for levy of government had banned
such a tax citing examples export of steel and rice;
of countries where the tax there was no justification
has been introduced. The to have this (oil) sector

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"singularly favored .Share
prices of RIL , ESSAR,
Cairn fell on the
proposal of windfall tax on
private oil companies .The
PSC( Production sharing
contracts of these
companies with the
government have such an
in-built mechanism
(sliding scale )that on any
upside (in oil prices or
reserves ),government gets
a higher share and the
similar downside
protection is given to the
contractor .Thus , the PSC
itself has an inbuilt
mechanism which adjusts
for higher or lower oil
prices .Government gets
most of it’s revenues in the
form of taxes like profit
share ,royalty and cess.

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 DIVIDED OPINION

The US experimented with a windfall profit tax on oil companies

PROS:
 It generates more revenue.
 The tax proceeds can be used to support R&D activities.

CONS:
 Difficulty in arriving at the quantum of such windfall profit.
 Normally the governments have tendency to continue this tax under some pret
Even after the company ceases to earn such huge and unexpected profit.

 Such profits are made of the entrepreneurship shown by the company/industry

They are already paying normal tax, extra tax hampers financial aspect thereby
It’s like penalizing for their effective decision making and efficient performance

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 WPT: PRIVATE OIL COMPANIES ( INDIA & OTHER COUNTRIES)

The US experimented with a windfall profit tax on oil

I dea of a windfall tax

on private sector oil
companies is
sense.
thoroughly
investor
It would
dampen
confidence,
preposterous and slash funds for
brazen, given its reinvestment and
political context in New plough back, and quite
Delhi. The proposal needlessly stultify
needs to be nipped in markets, enterprise
the bud, post haste. It and growth. It would
has no merit also be a perverse
whatsoever. And no incentive for mis
credible international -declaring profits,
precedent either. which in turn could
Proposals from some lead to capital flight
quarters in the UK and and affect
elsewhere has come governmental
to levy windfall tax on revenues. Besides, if it
global oil majors like can be kosher to slap
Shell and BP. But these an illogical tax on oil, a
have been dismissed similar levy for steel or
outright as a matter of software solutions or
principle by the banking — indeed any
authorities, and rightly other sector —can also
so. be deemed legitimate!
We might as well do
Singling out industry away with the rule of
sectors and corporates law. This is why the
to pay up arbitrary and windfall tax plan is
wholly questionable plain warped in the
taxes just makes no first place.

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In any case, a windfall no scope for higher
tax on petroleum taxes. The financial
refining would go statements reveal how
against the grain of oil these companies are
economics. The fact of reeling under the
the matter is that burden of subsidy;
gross refinery margins they show how these
(GRM) do tend to once cash-rich
fluctuate on a regular companies are now
basis. Also, when it borrowing heavily to
comes to exporting oil finance their working
products, we surely capital and are heading
ought not to be for losses this fiscal.
exporting taxes. So, where are the
As for private oil “windfall profits” to be
production, which is taxed?
only in our JV fields,
The only oil company
the case for higher
that stands to gain
taxes and increased
from the rising global
revenue share is also
crude oil prices is
not tenable. While it is
ONGC. But ONGC is
true that the UK has of
already suffering a
late raised taxes on
windfall profit tax
new oil wells in the
though not by name.
North Sea, the
Just consider this. The
situation is not really
company contributed
comparable. The fact is
Rs 22,000 crore as its
that the levies there
share of the subsidy
were significantly
burden in 2007-08
reduced in the early
(through discounts to
nineties. And the JVs
the downstream
with ONGC here leave
refining companies).

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This reduced its The downstream
turnover to Rs 59,848 refining and
crore in 2007-08, 27 marketing
per cent lower than companies such as
what it ought to have Indian Oil, Bharat
been. Petroleum and
Hindustan Petroleum
The impact was bigger
also share about 10
on the post-tax
per cent of the
earnings. ONGC parted
subsidy burden of
with almost half its
the government. It is
profits to fill the
really illogical to think
subsidy hole. Its post-
of a windfall profit tax
tax earnings at Rs
on them when they are
16,701 crore were
already reeling from
lower by Rs 13,241
the subsidy burden and
crore thanks to the
heading for losses.
subsidy burden. Why
was ONGC asked to So, if it is not ONGC
bear such a large share and the downstream
of the burden? It was refining companies,
because it stood to who is the windfall
gain the most from the profit tax aimed at
rise in global oil prices. then? Reliance
If this subsidy-sharing Industries and Essar
is not a form of Oil are the only other
windfall profit tax, oil companies in the
what is it? Remember, net apart from Cairn
ONGC pays a 33 per India, which is anyway
cent corporate tax in a marginal player in
addition to this the present scenario. If
subsidy. at all Cairn were to
earn a “windfall profit”

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it would be when its The major E&P
Rajasthan fields go on Company in the public
stream in 2009, until sector space is ONGC.
then tapping the Across the board, this
company for windfall tax will hit
incremental taxes will ONGC the most. The
not solve the fuel National Exploration
subsidy issue in the and Licensing Policy
near-term , more ever and production sharing
Cairn Energy ‘s share agreement signed till
price is trading at a now for all oil and gas
significant discount , blocks will have to be
while Essar Oil has yet changed. NELP & PSA
to stabilize and become are international
a profitable refining contracts. Also, the
company Windfall tax government has a
will have to be imposed profit share in all oil
on exploration and and gas blocks.
production companies.
That leaves us with
There is no major
Reliance Industries
private sector E&P
whose profits surged
Company as all private
by 62 per cent in
E&P companies are in
2007-08. But, then
the preliminary stage
again, it is debatable if
of exploration. Barring
this can be construed
Cairn, no private E&P
as a “windfall profit”.
Company produces
The company runs an
significant oil. Oil from
efficient refining
private E&P firms is
operation and has been
less than 5% of total
intelligent in its crude
requirement.
oil sourcing. That its
refinery can process

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heavy and sour crude heavy & sour crude
that is priced at a that is priced at a
discount to the discount to the
premium Brent is also premium Brent is also
a factor in its better a factor in its better
profitability. Its profitability
refinery can process

INFERENCES:

In case of refining companies ,the high price of

crude oil has already multiplied their cost and
led to an increase in the working capital
.Refinery business profits are determined by
the difference between product and crude
prices .Finished product prices are not moving
in tandem with crude oil prices .It is
determined by the available capacity and the
demand –supply balance of finished products
.The refinery business is cyclical .As a matter of
fact , there is tremendous pressure on refining
companies windfall tax will worsen the
situation .

 India is neither a major oil producer nor Indian

companies have gained much from the rising
global prices of oil.
 The government is bound by the contract of the
production sharing agreement as part of the NELP
(New Exploration Licensing Policy).
 As part of the profit sharing plan, the government
is already a beneficiary of the rise in profits of oil

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 companies, besides 35 per cent corporate tax on
such profits.
 WPT on the basis of revenues in discovered blocks
ignores the huge risks, investments and poor
chances of discoveries.
 WPT will discourage long-term investments in oil
industry.

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