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Last Updated: Thursday, 31 January 2008, 12:04 GMT
Q&A: Windfall tax on Shell
The Unite union has called for the government to impose a windfall tax on the profits of oil companies after Royal Dutch Shell reported record profits for a UK-listed company.

"Shell shareholders are doing very nicely whilst the rest of us, the stakeholders, are paying the price and struggling," said its joint general secretary Tony Woodley.

Would a windfall tax be a good idea?

What is a windfall tax?

The Labour government imposed a windfall tax on privatised utility companies in its first budget after winning the 1997 election.

Gordon Brown before delivering his first budget
Windfall taxes were the centrepiece of the 1997 budget

It was designed to tax the growth in the value of companies such as regional electricity companies, water and sewerage companies and electricity generators in the four years after they were privatised.

It was meant to raise 5.2bn to fund the welfare-to-work scheme that was the centrepiece of the budget.

The Labour Party said that the companies had received windfall gains from the under-pricing of the share issues and the under-regulation of the companies since then.

In the same way, some people think that the oil companies have received windfall gains from record oil prices.

So when do we get a windfall tax then?

Ah, it's not quite that simple.

Most of the privatised utilities were UK-based companies, the majority of whose profits were made there.

The problem with a company such as Shell is that while one of its listings is indeed at the London Stock Exchange, it also has listings in the Netherlands and the US, while its headquarters are in The Hague.

It operates in 130 countries and territories so it is difficult to claim that enough of its profits have been made in the UK for it to be liable to a UK windfall tax.

Indeed, Shell says that well over 90% of its profits are made outside the UK.

It pays tax to the exchequer for its activities in the UK and there were additional taxes imposed on its North Sea oil and gas extraction in the budgets in 2002 and 2005.

But they're still making record profits from record oil prices aren't they?

Yes, it would be a pretty poor oil company that could not make a decent profit with oil prices at their current levels.

On the other hand, Shell does not control market prices, which are set in a relatively free market.

Many commentators believe that even the oil cartel Opec has little control over oil prices any more.

Even if Shell decided altruistically to sell oil at below market prices it would have very little effect on global prices.

Couldn't they just reduce prices at the petrol pump then?

First of all, the amount charged at the pumps is mostly made up of tax, but some of it still goes to the oil companies.

A Shell petrol pump
Average petrol prices are over 1 a litre

It would seem to make sense that - if Shell is getting its own oil out of the ground, refining it and selling it on its own forecourts - it should not therefore be affected by the "external" global price of oil.

However, it is not that simple, as Shell is involved in what are known as both "upstream" and "downstream" operations.

The upstream activities include exploration, getting the oil out of the ground and refining it.

The downstream activities include selling petrol to members of the public on Shell forecourts.

Shell forecourts have to buy their petrol from the Shell refineries at market prices.

Why couldn't the upstream operations subsidise the downstream ones?

The trouble is that not all petrol retailers also have their own upstream operations.

Some, such as small operators and supermarkets, only sell petrol.

They would be unable to compete with the oil giants if the likes of Shell were allowed to use their profitable upstream operations to subsidise their less profitable downstream ones.

Competition authorities would probably see such subsidisation as an anti-competitive attempt to put smaller operators out of business.

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