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How will smaller UK energy companies be affected by the windfall tax?

Offshore oil and gas drilling site

At a time when consumers are feeling the pinch amid a perfect storm of inflationary pressures and rising energy costs, BP [BP] and Shell [SHEL] have been recording bumper profits. It’s no surprise, then, that the UK government has announced a windfall tax to help ease the cost of living crisis.

The two oil giants have shrugged off the potential impact of the levy, with shares in each company rising to 52-week highs during the week ending 3 June. The same cannot be said for smaller players such as Harbour Energy [HBR], EnQuest [ENQ] and Serica Energy [SQZ].

According to research from Jefferies seen by Bloomberg, the three companies will see their profits slashed by a combined $3.3bn through 2025. This is because their revenue streams depend heavily on their UK operations, whereas BP and Shell have international portfolios.

Serica share price could be tested

The upstream producer’s operations are focused on the North Sea. Jefferies analyst Mark Wilson believes it could be the worst affected of the smaller players. In a note to clients seen by Proactive Investors, Wilson explained that a “hypothetical 10% increase in the UK marginal rate” would reduce Serica’s net income and free cash flow by roughly 15%.

Serica reported a net profit of £79.3m for the 12 months to the end of December, up significantly from a net profit of £7.8m in 2020. Its cash flow from operations was £157.6m, up from £44.1m

In its earnings release in April, the company argued that the situation in Ukraine has “underscored the importance of our own domestic resources”. However, the windfall tax could test this.

The Serica share price set an all-time high of 423.5p on 14 April but has slid in recent weeks, closing at 264p on 6 June. The stock is down 22.3% in the past month, but it is up 9.5% since the start of the year.

Harbour Energy likely to absorb the impact

The Edinburgh-based producer swung to a post-tax profit of $101m in the 12 months to the end of January following the completion of the Chrysaor-Premier Oil merger in April last year, from which Harbour Energy was created. The company’s loss after tax in 2020 was $778m.

While medium-sized oil and gas companies tend to be fairly geographically diverse, Fitch Ratings believes Harbour Energy to be the “most exposed in this peer group”, as roughly 90% of its production is in the North Sea.

“The company has sufficient headroom under its sensitivities to absorb the impact,” the credit rating agency noted. Free cash flow in 2021 came in at $678m, up from $562m in 2020. The company paid out its first dividend of 8.4505p per share in May.

When markets opened on Tuesday, the Harbour Energy share price was up 10.5% year-to-date at 384.3p. Having recorded an all-time high of 538.6p on 19 April, the stock has pulled back sharply, dropping 24.9% in the past month.

EnQuest less likely to be affected

At the other end of the spectrum, EnQuest will likely be the least affected by the windfall tax. Jefferies has estimated that it will book charges of $14m this year and $73m in 2023. In comparison, Harbour Energy is expected to be hit by charges of $107m and $268m, respectively.

“EnQuest’s tax losses and investment allowances would see it incur little to no incremental UK cash tax exposure,” Wilson wrote in a recent note.

EnQuest’s net profit for 2021 was $377m, having reported a net loss of $469.9m in 2020. The current fiscal year is expected to see its biggest annual investment in the North Sea since 2014. It produced 50,361 barrels of oil per day in the first four months of 2022, compared with 45,158 a year ago.

The EnQuest share price hasn’t been as adversely affected as those of Serica Energy and Harbour Energy. The stock has risen 44.3% year-to-date to close at 27p on 6 June, having set a 52-week high of 37.35 on 23 May. However, the stock has pulled back 25.2% in the past month.

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