Fracking tax breaks – how do they add up?

What are the plans?

The Government’s consultation paper – Harnessing the potential of the UK’s natural resources: a fiscal regime for shale gas – outlines a number of proposals designed to unlock early investment.

The consultation paper contains a number of specific questions on which response is sought. A summary of the responses will be published later in the year and where appropriate legislation will be included in the Finance Bill 2014.

The two main proposals are:

• A new allowance for shale gas projects (the pad allowance); and
• The extension of the Ring Fence Expenditure Supplement (“RFES”) for shale gas projects from six to ten accounting periods.

How does the ‘pad allowance’ work?

Unlike conventional oil and gas reserves, which are found in clearly delineated fields or reservoirs, shale gas deposits cover large areas with indistinct boundaries. So the Government is proposing to provide an allowance at the pad level, where “pad” is used to describe a drilling and extraction site.

The proposal is to exempt a portion of production income from the supplementary charge (a charge which is currently set at a rate of 32% on a company’s adjusted ring fence profits).

What will this mean?

The effective tax rate on production income which receives the allowance would be reduced from 62% to 30% at current tax rates. The amount of production income which is exempted from the charge will be set at a proportion of the capital expenditure incurred in relation to the pad. The Government will use the responses from the consultation to fix the proportion of capital expenditure that will set the level of the allowance.

The Government proposes to extend the pad allowance to all onshore unconventional hydrocarbons (i.e. not just shale gas).

Each participant in a pad would receive its own allowance based on the actual capital expenditure it has incurred. Accordingly a participant in a pad who has not incurred any capital expenditure will not receive any allowance. (This is a different approach from that used in relation to existing field allowances, where field allowances are divided according to each company’s share of equity in the field.)

How will the RFES extension work?

RFES at present allows companies to uplift their losses by 10% for up to six accounting periods to maintain the value of these allowances until such time as they are able to be offset against the company’s future profits.

Recognising the slower development rate of shale projects, companies will be permitted to apply this uplifting mechanism for ten accounting periods.

What will this mean?

The extension of RFES will allow investors without existing ring fence profits to maintain the time value of their losses over a longer payback period. It is proposed to extend this increased RFES allowance to all types of onshore unconventional hydrocarbon projects.

Are there any other plans to promote fracking?

Alongside these proposed incentives, new guidance has been published for industry, minerals planning authorities and local communities on how shale gas (and other onshore oil and gas) developments should proceed through the planning system.

Some of the key points arising from this guidance include:

• When determining applications for exploration of shale gas, minerals planning authorities should not take into account hypothetical future activities (extraction and production) for which consent has not yet been sought since they will be the subject of separate planning applications and assessments.
• Minerals planning authorities should not consider demand for, or alternatives to, oil and gas when determining applications as government policy is clear that energy supplies should come from a variety of sources. The guidance stresses that planning authorities should give great weight to the benefits of minerals extraction, including to the economy, which is in line with paragraph 144 of National Planning Policy Framework.
• The minerals planning authority should carry out a screening exercise to determine whether any proposal for onshore oil and gas extraction requires an Environmental Impact Assessment.
• How minerals planning authorities will interact with other bodies involved with the regulatory regime. There exist a number of environmental and health and safety issues relating to shale gas which are covered by other regulatory regimes, including the Environment Agency, the Health and Safety Executive and the Department of Energy and Climate Change and whilst these issues may be put before minerals planning authorities, they should not need to carry out their own assessment as they can rely on the assessment of other regulatory bodies.
• Minerals planning authorities and operators should seriously consider planning performance agreements where they consider the size and complexity of a scheme justify such an agreement being drawn up.
• Minerals planning authorities should ensure the proper restoration and aftercare of a site though the imposition of suitable planning conditions and, where necessary, through Section 106 Agreements.

What do the announcements say about Government attitudes to fracking?

The announcements on 19 July confirm the Government’s clear commitment to encouraging the onshore shale gas industry.

How can I find out more about the subject?

Ward Hadaway is holding a seminar on fracking and shale gas at our offices in Manchester on October 9 where the special guest speaker will be Professor Richard Davies of the Durham Energy Institute.

For more details on the seminar or on any issues raised by this update, please get in touch.