Windfall tax explained — why ONGC, Oil India are spooked by it

On a day the Indian market is making a sort of recovery — the Nifty50 is close to 150 points in the green — Indian oil producers are under pressure and are trading in the red.

Why? Well, the UK government yesterday (May 26) announced a 25 percent windfall tax on profits of oil and gas companies with crude surging over 50 percent in 2022 so far and now there is speculation that similar steps can be taken here too (in India) as the government looks at additional revenue mobilisation measures to offset revenue loss due to recent excise duty cuts, higher fertiliser subsidies etc.

This seems to have made investors nervous and it’s being reflected in the stock movement of all the oil and gas majors like ONGC, Oil India, Reliance and Vedanta.

As seen in the chart above, all major Indian oil producers are in the red on May 27 (2:00 pm) with ONGC being hit the most.

The government will need to weigh several key issues if it considers a windfall tax on oil producers. There are not one but several important critical factors to be considered.

The first consideration will be the production sharing contracts (PSCs). Now, these are long term contracts where the government is also a party and there are a lot of other investors involved. As the government is also party to whatever gains are made under the PSCs, when the prices go up, the government also stands to profit.

The second consideration is the royalties and ad valorem duties and most importantly, in case such changes are made to the taxation policy, the govt will have to consider what signal this will send out to the foreign investors under the FDI policy?

If one looks at the revised estimates of the FY22 budget, most of the public sector units (PSUs) have paid up handsome dividends to the government. ONGC has alone paid over Rs 4000 crore. A windfall tax might mean fewer or no special dividends going forward.

As per analysts, every $10/bbl change in net oil price realization, changes ONGC’s FY23E earnings by Rs 7.10/share (10.9 percent, Oil India's earnings by Rs 7.60/share (7.7 percent).

It is noteworthy that in 2022 so far, crude has seen a gain of over 50 percent (From $78 on December 31, 2021, to $117 on May 26, 2022)