Utility Week

Utility Week 4th October 2013

Utility Week - authoritative, impartial and essential reading for senior people within utilities, regulators and government

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Page 18 of 31

Finance & Investment Investor view Martin Brough fields. The proposals are therefore for the allowances to apply at "pad level", that is, upon each particular drilling site. The new regime is envisaged to operate as follows. A company owns two pads, both of which have yielded a profit of £100,000 in the tax year. Significantly greater expenditure was incurred on pad 1 for geological reasons, so let's say £120,000 was incurred on pad 1 and £50,000 on pad 2. It is expected that all of pad 1's profit would be exempted from the supplementary charge, with the excess of £20,000 being carried forward. Only half of pad 2's profit would be exempted from the supplementary charge, with the remaining £50,000 being subject to the rate of 62 per cent. The excess expenditure from pad 1 could not be applied against pad 2's profits. However, pad allowance is only attractive where there are profits against which to offset allowances, which is likely to be several years away for shale gas. To combat and complement this there are two important proposals: • onventional oil and gas companies may C use the allowance across their existing conventional business income within the "ring-fence", for example, profit from the UK continental shelf. This means that established businesses can benefit their existing business, while planning for future income streams from shale gas. • he extension of the existing regime of T losses. In addition to allowances from the supplementary charge, conventional oil and gas companies benefit from enhancements to pre-trading expenses. Such expenditure is uplifted by 10 per cent and is available to offset against profits for up to six accounting periods, within the ring-fence. The government is proposing that such tax breaks go further for shale gas and companies may carry such losses forward for up to ten accounting periods. The proposed extension of the period within which losses can be utilised reflects the fact that the leadin time for shale gas sites to become profitable may be longer than for conventional sites. However, before businesses rush to jump aboard, they are likely to wish for greater certainty regarding the proposals. In particular, the size of the exemption from the supplementary charge is yet to be announced and given the likely costs involved in starting up, it is likely to take more than a token gesture to convince established businesses that the time is right to invest in shale. Mark Howard, partner, and Martin Griffiths, associate, at Charles Russell LLP THE STORY BY NUMBERS The tax story The severe tax regime for oil and gas exploration and production makes it a big stumbling block for shale gas, which will be expensive to get at 23% Standard Corporation Tax in the UK 62% The rate at which conventional oil and gas production is taxed 81% The effective tax rate under the petroleum revenue tax regime for fields developed before 1993 30% Effective tax rate on shale gas profits "If asked, how many customers would like the option of financing their share of the RAB rather than have utilities do it for them?" T he right to buy your rented council house revolutionised home ownership in the UK in the 1980s. Could a right to buy your local RAB (regulated asset base) do the same to utility finance? Community-based utility finance is gaining popularity in Germany. An ongoing attempt by a Berlin co-operative to acquire the local electricity utility is currently generating a heated debate. While the centre-right CDU has opposed this particular initiative, the concept of community investment was given a specific endorsement in Angela Merkel's CDU manifesto for the recent federal elections. The manifesto argued that community investment helps with local acceptance of infrastructure development, facilitates financing and allows the community to benefit financially from the returns. The solar revolution in Germany has already shown that tens of billions of euros of finance can be raised from households, sidestepping the major utilities. Could similar concepts take root in the UK? While utility bills are becoming less affordable for typical households, many savers might question why they are paying for their RABs to be financed with a 4 per cent+ real return and yet struggle to match inflation with their own savings. With most local utilities now privately owned, and utility bonds offering investors real pre-tax returns of perhaps 1 per cent, household savers appear to be denied a way to participate in the attractive returns they fund through their utility bills. The Green Deal programme for encouraging investment in energy efficiency treats UK households as creditconstrained borrowers. Take-up so far has been low. But what about the savers, and the pensioners being offered ever-falling annuity rates? Could the utility sector offer a reverse Green Deal, where households directly finance local utilities to invest in local infrastructure? Water companies in England and Wales are currently consulting customers, among other stakeholders, on plans through to 2020. If asked, how many customers would like the option of financing their share of the RAB rather than have the companies do it on their behalf? In the energy sector, delivering increased renewables, reduced carbon emissions and preserved security of supply will require hundreds of billions of pounds of finance. Traditional debt and equity funding is not about to disappear, but perhaps creativity around household savings could allow a genuinely co-operative approach to finance in the sector. Martin Brough, utilities equity analyst Deutsche Bank UTILITY WEEK | 4th - 10th October 2013 | 19

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