From the July 2012 issue of Investment Advisor • Subscribe!

June 26, 2012

Earth, Water and Fire

Fracking is raising a variety of insurance issues--not just for the companies that are doing it, but for landowners as well

This is an extended version of the article that appeared in the July 2012 issue of Investment Advisor.

The search for natural gas and oil found through the process known as hydraulic fracturing, or fracking, is fraught with controversy. Eager proponents of the process tout the supply of gas to be found in areas like the Marcellus Shale in Pennsylvaniaand upstate New Yorkas a means to become less dependent on imported energy sources, and property owners in areas with few opportunities for income are delighted with the financial boon that gas royalties can bring.

Meanwhile, environmentalists and property owners (some disillusioned after wells have been drilled on their land) point to drawbacks like polluted groundwater, illness, poisoned livestock, earthquakes and explosions.

With so many areas of contention, insurers are finding that fracking presents numerous areas of risk. How (and whether) that filters down to any of your clients depends on many factors, and since all the data isn’t in yet, you should consider keeping an eye on the situation—particularly if you have clients who live or invest in areas where fracking is ongoing.

The Marcellus Shale isn’t the only area in which fracking is carried out. Arkansas, California, Colorado, Delaware, Louisiana, Maryland, New Jersey, New Mexico, Ohio, Texas, West Virginia and Wyoming have seen the eager (and sometimes not so eager) embrace of the search for gas deposits via fracking.Vermontbanned the practice in May. There are fracking sites inCanadaas well.

The hydrofracturing process brings to the surface deposits that can only be extracted from surrounding rock by the injection of vast quantities of water to which a “cocktail” of chemicals has been added. The chemicals themselves are regarded as proprietary, and outside the industry, little is known about which chemicals are used and in what concentrations.

According to U.K.-based insurance broker Willis Group, insurers should be wary of the risks associated with fracking, since neither regulatory nor environmental standards have yet solidified, and the potential for high costs could be great. In its April “Energy Market Review,” the company said, “[Insurance] buyers will have to differentiate their risk by proving adherence to best practice if cover is to be provided at an economic price. This is especially the case in the environmental impairment liability arena, which can offer the critical protection for the ‘gradual’ pollution liability risk associated with the hydraulic fracturing (or ‘fracking’) process.”

Citing the rising public awareness of the practice and the Oscar nomination of the documentary “Gasland,” which had critical things to say about fracking and its environmental effects, Willis said that fracking is “an industry that is here to stay, with risks that will need to be managed [or] insured in the usual manner.” The firm pointed out that fracking operations take place not just in North America, but also in Australia, China, Africa, Europe and South America.

A New York Times report at the end of May said that increasingly, U.S. state and international governments are moving toward enacting laws requiring disclosure of the chemicals used in the fracking cocktail and that environmentalists are pressing for disclosure of the chemicals used not just for fracking but throughout the drilling process. The final version of an Ohio law passed in May did not contain the latter measure, but future actions may be more exacting.

Willis broke down the hazard categories involved with fracking into three general groups: contamination or disruption of the drill site and surrounding area (which would include chemical contamination and possible depletion of groundwater, thanks to the millions of gallons of water that are required for the operation); contamination of underground aquifers (New York City residents expressed concern over this possibility because of the drilling operations in the Marcellus Shale, close to the aquifer that supplies Manhattan’s drinking water); and earthquake damage from fracking operations (Bloomberg reported in April that a wave of earthquakes in Arkansas was attributed to the disposal of millions of gallons of wastewater in disposal wells, spurring a shutdown of four disposal wells in the Fayetteville Shale).

While Willis acknowledges that there are risks in fracking, it also points out that the industry is 40 years old and that the use of best practices can minimize those risks. The firm enumerates a number of questions that should be considered when deciding whether coverage is appropriate and says that three areas of the insurance market stand to feel the most impact from fracking operations:

  • Operator’s extra expense (OEE) coverage, which indemnifies the costs of regaining control of a well following a blowout, including redrilling and the cost of cleaning up seepage and pollution. These costs can be high in the case of gas wells, since multiple wells are often drilled on the same pad, and in the case of a blowout it is likely that all the wells on that pad would be affected.
  • Comprehensive general liability (CGL) and excess umbrella liability cover (umbrella), which cover damage to third-party property and bodily injury. One of the complaints that has surfaced regarding gas wells is the heavy traffic into and out of areas that causes excess wear and tear on roads. There is also the potential for damage and injury to neighboring properties and individuals, as well as crews, when wells are drilled in more populated areas.
  • Environmental impairment liability (EIL), which covers legal liabilities arising out of the pollution conditions from operations or general pollution conditions at the site itself. The two chief coverages in this area are the expected pollution liability, purchased by the owner of the drilling site (or the mining company leasing the site from the property owner), and contractors’ pollution liability, purchased by those actually doing the drilling – often a subcontractor to the mining company.

Clients who buy property in areas with gas wells may need to consider their own insurance needs, lest the presence of gas wells leads to gaps in coverage for everything from earthquake damage to contamination of drinking water or damage done by vehicles or equipment. As examples of some of the more unusual hazards being laid at the door of fracking operations are the case of a water well in Dimock, Penn.that exploded in 2009 due to high concentrations of methane in the water (other wells in the area are said to be contaminated as well) and cases of farmers whose livestock died after allegedly being poisoned by drinking contaminated water in Louisiana and Wyoming.

If clients are interested in the potential rewards of hosting a gas well or wells on land that they own, they should investigate before they sign on the dotted line to be sure that the companies they sign with have insurance against potential dangers. Not only the mining company but its contractors should be covered for the hazards mentioned above. 

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