What Are Windfall Profits?

Windfall profits are large, unexpected gains resulting from lucky circumstances. Such profits are generally well above historical norms and may occur due to factors such as a price spike or supply shortage that are either temporary in nature or longer lasting. Windfall profits are generally reaped by an entire industry sector, but can also find their way to an individual company.

In terms of an individual, a windfall profit could be a spike in income as a result of a specific, one-time event, such as winning the lottery, inheriting money or suddenly being able to sell that rare piece of music memorabilia you own for a large amount of money after the singer passes away.

There was previously a tax on corporate windfall profits, however, it was unpopular and there are currently no such taxes in the United States; although reintroducing the tax has drawn much debate on Wall Street and in Washington.

How Windfall Profits Work

Among the reasons that windfall profits can arise are a sudden change in market structure, an executive order from the government, a court ruling, or a dramatic shift in trade policy. Companies that are beneficiaries of windfall profits had not planned for them, but they would be naturally pleased to receive them.

These profits would have a variety of uses: dividend increases or a special one-time dividend, share buybacks, reinvestments in the business for future growth, or debt reduction. Windfall profits are presently not taxed in the U.S., though there have been tepid efforts to reintroduce the tax.

For an individual, a windfall profit might result in a sudden boost in their income, beyond what they could have reasonably expected. Unlike a corporation, an individual is not expected to pass the profits on to others.

Example of Windfall Profits

From time to time, surging prices for crude oil and natural gas have generated windfall profits for many energy companies. In this industry where supply and demand is the main force determining price levels for the commodities, unexpected supply shortages have led to sharp and quick price rises.

In 2008, a barrel of WTI crude oil climbed above $140 from $60 per barrel just one year earlier. Several factors on both the supply and demand sides conspired to spike the price. Turmoil in the Middle East, lingering effects of Hurricane Katrina, supply disruptions in Venezuela and Nigeria, strong demand from developing nations, and speculative fervor by traders were all believed to be causes of the steep ascent of oil prices. Windfall profits for oil and gas producers followed, but they proved short-lived because a mere five months after the price peaked, a barrel of oil was trading at only $40 per barrel.

Key Takeaways

  • Windfall profits are a sudden and unexpected spike in earnings, often caused by a one-time event that is out of the norm.
  • A business reaps windfall profits when there is a sudden industrywide change, such as a drop or spike in prices or a spike in demand for a certain product.
  • Businesses typically use these profits in part to increase dividends, buyback shares, reinvest in the business for future growth or reduce debt.