The New “F” Word: “Fraccidental” Insurance Headaches

Source: http://www.propertycasualty360.com, July 29, 2011
By: Gina Jones, Ivy Riggs

Fracking: Understanding the opportunities & challenges of the latest environmental liability exposures

As the pace of change continues to increase at an exponential rate, many may find it challenging to keep up with yesterday’s trendy slang, much less that of today or tomorrow. So you might not raise an eyebrow to hear college students across the nation singing lyrics about how their drinking water is totally fracked.

Could mean anything, right?

However, when it’s no longer the hip 20-something talking, but rather your clients’ top executives who are demanding to know “What the frack is going on,” it’s time to arm yourself with the knowledge to answer their concerns.

WHAT IS FRACKING?

If you visit the online glossary of a leading oilfield services firm, you may not find the term “fracking,” despite it being in common use among both industry experts and laymen alike. What you will find is the term from which it derives: hydraulic fracturing.

This process involves both horizontal and vertical drilling into our nation’s shale formations. The wellbore is then injected with specially engineered fluids at sufficiently high pressure to fracture the deposits and release the natural gas they contain.

These deposits are so extensive that they are anticipated to produce 20 percent of our total domestic gas supply by the end of this decade, according to the latest estimates by the U.S. Environmental Protection Agency.

WHY THE CONCERN?

The casual observer might wonder why the EPA is studying a topic some may view as primarily a concern of the Department of Energy (DOE). After all, tapping our domestic energy sources to produce cleaner fuels, to create much-needed jobs and to reduce dependency on foreign imports are all DOE goals that garner broad-based support.

Additionally, the Energy Policy Act of 2005 specifically exempts hydraulic fracturing from certain requirements of the Safe Drinking Water Act, which otherwise would fall under the oversight of the EPA. Exempted from this oversight, natural-gas producers have been allowed to keep the components of their “specially engineered fluids” a trade secret on the grounds that their formulas are proprietary. Although several have since voluntarily disclosed this information to the EPA, at least one leading firm refused until subpoenaed.

Fracking fluids may vary widely depending on specific characteristics or needs at the geologic formation being developed for natural-gas production. The primary component is water, followed by silica or other similar material. The smallest portion, perhaps as little as 0.5 percent, is comprised of a blend of different chemicals, roughly 750 of which were identified in the Energy & Commerce Committee’s report to Congress earlier this year.

Some are highly toxic, some are carcinogenic, and some are known pollutants. None of these are additives one would want to see introduced to water supplies or spilled on their roadways.

Some well operators are selling their waste. Because the waste is so salty, communities are purchasing the waste water to spread on roads as a de-icing substance and for dust suppression during the summer months. When the ice melts or during a summer rain, the waste can run off the roads, ending up in the local drinking supply.

Yet numerous reports of just such contamination have gained regional and national attention. Predictably, dispute has followed it.

• Oil and gas companies insist their processes occur at depths too great to impact aquifers used for drinking water.

• Local residents respond by taking advantage of the Internet to share videos of their new ability to set their tap water on fire.

• Livestock drinking the water have died.

• Lawsuits are increasing.

At the federal-agency level, the EPA has embarked on a multi-year, seven-site study of the relationship between hydraulic fracturing and drinking-water resources. Meanwhile, the U.S. Forest Service has completed a study providing evidence that fracking-fluid disposal methods can cause severe ecological damage, resulting in more than 50 percent mortality to trees and ground vegetation.

In addition, state environmental-regulatory agencies are fining both gas producers and their contractors for spilling drilling liquids into wetlands and waterways, resulting in local fish kills. Such incidents have proliferated so rapidly that at least one legal-defense fund has compiled an interactive map of “fraccidents” that have occurred nationwide.

Additional concerns are the natural-gas operations also produce smog-forming pollutants, which contribute to the air-pollution problem. Some Midwest rural areas are experience air pollution sometimes as bad as Los Angeles. These wells also release methane, which contributes to global warming.

ARE “FRACCIDENTS” INSURABLE?

It is important to keep in mind that hydraulic fracturing has been used in the United States since 1947. Environmental-liability insurance has been available since the late 1970s. Consequently, it is reasonable to ask what all the current fuss is about. Isn’t it easy to address the pollution exposures of both property owners and contractors in our highly competitive soft market?

Well, it depends…

The variety of loss exposures may include contaminated property, bodily injury, clean-up costs, natural-resource damage or transportation-related pollution. Even if liability is not established, policyholders will be looking for defense against third-party claims. Because general-liability, professional-liability, property and auto policies typically exclude pollution, it is important to work with underwriters who understand the significant pollution risks and can package appropriate terms to fill the gaps that may exist with standard lines.

But do the environmental carriers want them?

For some, the answer is an emphatic no. Just as the old truism states that you can’t insure a burning building, many underwriters are unwilling to offer coverage where the drinking water has already caught fire. In fact, a few insurers are contemplating excluding all fracking operations. Their conservatism may also be due to the fact that the regulatory environment itself is very much in a state of flux. The possibility that new legislation could increase claim activity that was neither foreseen nor priced for has made some very cautious. Prior poor loss experience is also a factor.

For other carriers, the answer is a qualified yes. With a long history of successfully tackling the difficult risks associated with very real pollution exposures, the excess-and-surplus markets are well-versed in creative methods for structuring coverage. The following are some items to consider:

• Is environmental liability subject to a sublimit under the policy?

• Are terms provided on an occurrence basis or claims-made only?

• Are fines, penalties and punitive damages covered (where insurable by law)?

• Are emergency-response costs included? If so, are they sublimited?

• Is coverage for natural-resource damage included?

• Is coverage provided for non-owned disposal sites?

• Are defense costs inside or outside the limits of liability?

• Does the applicant have driller blow-out policy or well blow-out coverage?

The potential impacts on the insurance industry from the expansion of hydraulic fracturing are numerous—but so are the opportunities. For those who are new to environmental-liability insurance, or for those who work with it too infrequently to keep up-to-date on the latest developments and jargon, it is more important than ever to seek out the assistance of those with broad environmental expertise to ensure their clients’ exposures are properly assessed and addressed.

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