Whether it’s the discovery of oil reserves, the lighting of fibre optic cable or the transmission of mobile data, the future can be relied upon to set today’s taxation regime an awkward challenge.

Fracking, the extraction of natural gas from shale deposits stored underground not only provokes strong environmental opinion, it also represents the latest challenge for the world of rating and valuation.

Fracking to bring valuation uncertainty

The British Geological Survey (BGS) has estimated that the Bowland-Hodder shale gas play, a landmass stretching from Blackpool and Shrewsbury in the west to Scarborough and Grimsby in the east may contain between 800 and 2,200 trillion cubic feet of shale gas. BGS stresses that only a small percentage of the volume is likely to be recoverable as gas reserves, and it cannot yet estimate this to a significant degree of accuracy.

This inability to estimate the level of recoverable reserves represents the problem facing valuers and rating specialists. The first rule of rating is to determine the extent of the property to be valued. By its very nature, the shale gas resource is not contained within a uniquely identifiable and measurable subterranean space, but exists under pressure within shale rock, at varying depths and across vast distances. Importantly, the Bowland-Hodder landmass includes the major conurbations of Manchester, Liverpool, Sheffield and Nottingham as well as other high value urban centres.

Tax breaks and compensation for local authorities

There is clear evidence from fracking activities in the United States that highly remunerative extraction ‘sweetspots’ exist, as do many sites which fail to recover any significant volumes of gas. Anecdotal evidence also suggests that property valuations are likely to be affected, either positively or negatively, by the discovery of shale gas deposits and the commencement of fracking works.

There is no doubt that political will exists to encourage the UK’s shale gas industry. Some fracking businesses, keen to bond with local communities, are offering to compensate local authorities to the tune of £100k per drilling well plus 1% of gas revenues. This generosity is clearly being funded by a government so keen to secure long-term energy supplies that it has cut tax on shale gas profits from the industry standard of 62% to just 30%.

Sting-in-the-tail likely for fracking businesses

Under existing business rates legislation, local authorities would also be entitled to recover a percentage of the increase in business rates generated by attracting new shale gas operations into the local area. Going further, the government may consider amending existing legislation to allow all business rates receipts from fracking explorations to be re-invested locally.

Taking a lead from the government’s largesse, fracking businesses are moving ahead quickly. Yet, in the absence of an agreed approach to the measurement and valuation of a drilling site, the government appears to be holding a trump card. As the industry becomes established and revenues begin to flow, successful fracking businesses may ultimately be faced with a government-sponsored site valuation which recoups much of the largesse being used today to kick-start the industry.

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This article is part of the autumn 2013 edition of Rating in Brief.