Despite Tax Break Shale Gas Challenges Remain High

Recent tax breaks unveiled to primarily support shale gas development in the UK highlight the government's commitment to advancing the industry. Although the tax changes are both welcome and necessary, we retain our view that in light of both below and above ground challenges, shale gas production in the UK is unlikely to make a material impact over the course of our current 10-year forecast period to 2022.

Chancellor George Osborne unveiled promised tax incentives for shale gas in his Autumn Statement. Although the incentives would be available to all onshore exploration and production (E&P) work, the plans were specifically designed to incentivise shale gas activity. Under the new fiscal regime, taxes on profits from production would be reduced from 62% to 30%. The lower rate would remain in effect until taxable profits are equal to 75% of the initial costs of development. The new breaks come on top of existing relief that firms can claim for capital expenditure, further reducing their tax bill.

The latest policies reflect what continues to be a robust level of support from the UK government for shale gas since the lifting of a moratorium in December 2012. Despite the political challenges of a coalition government, officials have managed to not only reverse the ban on hydraulic fracking but to push through the most supportive fiscal and regulatory regime for unconventional E&P in Western Europe.

UK Attractive On Prices
UK NBP & US Henry Hub Spot Prices, (US$/mnBTU)

Recent tax breaks unveiled to primarily support shale gas development in the UK highlight the government's commitment to advancing the industry. Although the tax changes are both welcome and necessary, we retain our view that in light of both below and above ground challenges, shale gas production in the UK is unlikely to make a material impact over the course of our current 10-year forecast period to 2022.

Chancellor George Osborne unveiled promised tax incentives for shale gas in his Autumn Statement. Although the incentives would be available to all onshore exploration and production (E&P) work, the plans were specifically designed to incentivise shale gas activity. Under the new fiscal regime, taxes on profits from production would be reduced from 62% to 30%. The lower rate would remain in effect until taxable profits are equal to 75% of the initial costs of development. The new breaks come on top of existing relief that firms can claim for capital expenditure, further reducing their tax bill.

The latest policies reflect what continues to be a robust level of support from the UK government for shale gas since the lifting of a moratorium in December 2012. Despite the political challenges of a coalition government, officials have managed to not only reverse the ban on hydraulic fracking but to push through the most supportive fiscal and regulatory regime for unconventional E&P in Western Europe.

In our view, these incentives are not just a token show of support, but are sorely needed if the UK is to hasten work on proving up its unconventional potential. We expect factors such as an absence of knowledge regarding geology and a lack of supporting service industry will push initial costs of exploration upwards. As a result incentives will be crucial to bringing down these costs as a barrier to investment. This will particularly be the case for attracting the necessary small and midsized players to the UK's unconventional space.

The latest commitment of support from the Chancellor will only add to the UK's attractiveness as a shale gas play. We note the country has a number of strengths beyond its increasingly supportive regulatory environment:

  • Strong Resource Potential: An official British Geological Survey (BGS) estimated central Britain could contain some 36.4trn cubic meters of shale gas resources in place;

  • Infrastructure: Nearly all UK roads are paved, compared to 1/3 unpaved in the US. This should help with initial E&P efforts. Water a key requirement for the fracking process, is not in short supply in the North of England with the Environment Agency categorising water stress as 'low' for the region. Moreover, potential shale gas production sites in the UK are closer to existing transmission networks where there is spare capacity across the existing system.

  • Prices: Higher prices for gas in the UK compared to the US will act as further incentive to production.

UK Attractive On Prices
UK NBP & US Henry Hub Spot Prices, (US$/mnBTU)

That said, we retain a cautious view on shale gas production in the UK, and do not expect the resource to make it significant contribution within our current 10 year forecast period. Despite the continued efforts to make the UK an attractive destination for shale gas investment, we continue to see a number of obstacles to commercialising the country's potential:

  • Geology: Although the UK's shale gas potential is high, resources and ultimate recovery rates remain uncertain and will depend upon acquiring a better understanding of the country's geology. This learning curve will only be mastered after a lengthy and expensive (drilling/exploration) process.

  • Environmental Opposition : Strong and organised opposition to shale gas efforts remains the most pressing risk to our outlook with protest already having derailed exploration work planned by Cuadrilla Resources for example over much of 2013. Shale gas exploration is set to remain controversial on the back of concerns related to the environmental risks associated with hydraulic fracturing. With the UK's shale gas plays far more densely populated than those of the US and opposition groups already successfully derailing exploration work, we see high risks of further disruptions going forward.

View On Fracking Breaking Down Along Party Lines
UK - Should Britain Start Extracting Shale Gas, Breakdown By Party, %
  • Lack Of Onshore Drilling and Drilling Support Industry: Given that the majority of UK oil and gas investment has been directed toward the North Sea, a complementary onshore services industry has yet to develop of the scale required to support shale gas activity. An absence of rigs, supplies, and skilled labour will constrain the pace of activity in the initial phases of development.

  • Regulatory Process: Notwithstanding the better terms on offer, the regulatory process governing the industry remains complex. Although the government has pledged to streamline the process, at present, it remains cumbersome and is likely to slow the pace of activity. Moreover, despite pledges to ensure local communities benefit from shale gas extraction, revenues will be directed largely to the central government. This provides minimal incentive for local governments, where opposition to fracking is likely to be most strongly felt, to make it easy for shale gas work to advance.

Complicated Process
UK - Process To Acquire Exploration Permit

Considering these challenges, we are not expecting a notable increase in gas production in the UK within our forecast period. Instead our current forecast calls for the UK's dependence on imports to grow.

Import Burden Grows Despite Shale Potential
UK Natural Gas Production, Consumption & Net Exports (bcm)

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Sector: Oil & Gas
Geography: United Kingdom
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