Shale gas tax to be halved

The UK government has proposed cutting the tax on some of the income generated from producing shale gas from 62% to just 30%, in a bid to make the UK the "most generous" regime for shale gas in the world.

However, the tax cut will be dependent on companies providing at least £100,000 of community benefits for each well drilled by the industry.

"We want to create the right conditions for industry to explore and unlock that potential in a way that allows communities to share in the benefits," said Chancellor George Osborne. "I want Britain to be a leader of the shale gas revolution because it has the potential to create thousands of jobs and keep energy bills low for millions of people."

Ministers are hoping to follow in the US' footsteps, where "fracking" has produced a glut of natural gas and pushed down the price to the benefit of households and industry.

However, shadow energy minister Tom Greatrex has stated that there was no proof that there would be the same impact on energy prices in Britain. While expressing cautious support for shale gas, Greatrex said: "Suggestions there is going to be cheap gas to extrapolate the US experience doesn't stand up to much scrutiny, given the way gas is traded."

A recent report from the British Geological Survey estimated there may be 1,300 trillion cubic feet (tcf) of shale gas present in the north of England alone - much of it in the Bowland Basin under Lancashire. Drilling companies have previously estimated that they may be able to extract about 10% of this gas - far in excess of the three trillion cubic feet of gas currently consumed in the UK each year.

However, the industry is still in its infancy, with only a handful of companies holding licences for shale gas exploration in the UK, none of which have begun extracting gas.

Another problem facing the extraction of shale gas is the potential harmful environmental impact. Opponents of shale gas argue that the process of fracking can cause earth tremors and pollute water supplies, and that wells could blight the countryside and affect house prices.

Fracking is the process of drilling down before a high-pressure water mixture is directed at the rock to release the gas inside. Water, sand and chemicals are injected into the rock at high pressure which allows the gas to flow out to the head of the well.

While much of the water used in fracking is collected from the well and processed, there are concerns that potentially carcinogenic chemicals could escape and find their way into drinking-water sources.

Analyst view

"While the market had been widely expecting tax breaks for the shale gas industry, we would agree with most consensus that [Friday's] news is a very generous measure by the UK government and possibly better than expected," stated Malcolm Graham-Wood, oil analyst at VSA Capital. "It should therefore be welcomed by the market along with companies who had been unwilling to be first movers until fiscal terms had been clarified. "We would reiterate our prior views over the need to demonstrate appropriate recoveries to prove the commercial viability of UK shale gas, but this can only be tested with the drillbit from this point on."

How investors can play the shale gas game

UK-listed Centrica is one of the companies that has been actively pursuing the UK's shale gas potential.

On 14 June, the energy giant announced it had acquired a 25% interest in the Bowland shale gas exploration licence in Lancashire, paying £40 million cash for the stake as well as exploration and appraisal costs of up to £60 million.

Initial data suggested that there could be 200 tcf of gas within the licence perimeter.

"In essence, Centrica is acquiring an option for a low outlay to participate in any growth in the UK shale industry. This makes sense in terms of its stated business strategy and overall UK energy policy," stated Harold Hutchinson, analyst at Investec.

"This is a wiser use of capital than, for example, the outlays in capital implicit in new nuclear power plants, from which Centrica recently walked away, in our view.

"Moreover, while shale gas evokes differing political sentiments in the EU, within the UK there is a relatively wide consensus that, subject to proper regulatory scrutiny, a potential new source of indigenous gas is to be welcomed."

Hutchinson rated Centrica stock a 'buy'.

IGAS Energy is another company that could be sitting on 170 tcf of gas in the areas it is licensed to explore in northern England.

"For energy providers and investors alike, the risk of not being invested in the few remaining opportunities in this sector is probably the biggest danger," stressed Graham-Wood. "IGas will be the biggest gainer if it works [with a share price target of] 250p," he commented, adding that he was also "mad about Alkane Energy with a [price] target of 48p."