The fiscal regime for UK shale gas: Analysing the impacts of pad allowance on shale gas investments

Abstract

The UK is believed to hold prolific reserves of shale gas; the quality of which has been compared and sometimes branded superior to the much successful US shale plays. Nonetheless, after more than ten years since the 13th Onshore Licensing Round, the fracking industry is said to have benefited from just £400 million - £500 million of estimated investments and only one partially fracked well with yet an uncertain fate of commercial production. This paradox motivated the current research. Based on a discounted cash flow model, the economic feasibility of the tax regime was evaluated with a special interest in the pad allowance [PA], a major incentive of the fiscal regime. We find that the design of the fiscal regime well achieves the Government's financial objectives, but fails to support shale gas investments at lower gas prices. PA introduces further variability in investor cash flows, ultimately defeating the ethos of the incentive. We propose a reduction in the overall tax rate from 40% to no more than 21%; a removal of the additional tax charge (Supplementary Charge) and an amendment of PA rules to; (1) allow an extension of RFES to PA; (2) permit transfer of activated PA across companies in the same group; and (3) redefine capital expenditure to include intermediate well retirement costs necessary to drill new wells to stimulate production. Such a tax strategy would simplify and align the UK fiscal regime with practices across the US, China, Algeria and Canada. Importantly, it would better match the risk of shale gas investments to its rewards and could better attract investments. We recommend the strategy for emerging unconventional oil and gas producing countries for an efficient design of their fiscal regimes.