The Dirty Side to Cleaner Energy

November 1, 2011

“Fracking”, once thought of as a source of “cleaner” energy, has become a dirty word. The downside impact of this controversial method of extracting natural gas from shale rock was brought to light in 2010 by the Academy Award nominated documentary “Gasland.”

Hydraulic fracturing, or “fracking”, is the extraction of shale gas by pumping millions of gallons of water containing “proppants” (sand and ceramic beads) and chemical additives deep into the earth at high pressure, cracking the shale apart to release the trapped gas. Around for over 60 years, recent advances in fracking technology have contributed to a boom in natural gas production in the U.S., but it is not without its problems.

The potential hazards

To keep up with demand, extraction methods have shifted from vertical to horizontal drilling, involving a much greater land surface. This has increased productivity significantly. Unfortunately it has also raised a number of concerns over potential hazards. Over 200 chemicals — some of them volatile organic compounds (VOCs) such as diesel, benzene, formaldehyde and esters — are added to the water pumped into the ground increasing the risk of groundwater pollution. As much as 80 to 300 tons of chemicals may be used per frack. One controversial aspect of the practice is that due to a loophole in the Energy Policy Act of 2005, fracking is exempt from regulation by the Environmental Protection Agency and energy companies are currently not obliged to divulge the chemicals used.

The process may also trigger seismic events. In the U.K., two small earthquakes were allegedly triggered earlier this year by fracking at a well near Lancashire. Additional hazards may arise from methane and exposure to naturally occurring radiation leaking from drilling sites, as well as from the treatment and handling of the contaminated fluids that are recovered (10-40% of what is pumped in). Some of this contaminated water has found its way back into rivers or has been used by public entities to spray onto roads to mitigate dust and ice.

All these issues have led to fracking being outlawed in France, but in the U.S., the number of wells has been increasing rapidly — there are nearly half a million shale gas wells in operation, 90% of which are now involved in hydrofracking. Meanwhile, the Environmental Protection Agency is investigating the process, with preliminary results due by the end of 2012.

A number of suits alleging health issues and reduction in the value of property are pending and there have already been some settlements involving millions of dollars. States involved include Pennsylvania, New York, Colorado, Arkansas, Texas and Louisiana and the issue is also attracting attention outside the U.S. in Canada, Australia and Europe. These suits contain many of the characteristics of asbestos and pollution cases in the 90’s, including requests for costly long-term medical monitoring, which affects both the original insurance claims and the reinsurance loss costs. Exposure is not limited to the big energy companies. As with Chinese drywall, multiple entities in the hydrofracking process are vulnerable to suits, ranging from drilling companies to servicing contractors, waste haulers, waste treatment facilities and public entities.

The bigger picture

The issues surrounding hydrofracking are complicated by political considerations. Shale gas was seen to be a cleaner form of fossil fuel and its use makes the U.S. less dependent on foreign supplies of energy. It has also created jobs in economically challenged rural areas such as upstate Pennsylvania. In the face of some strong public opposition, New York is presently wrestling with the decision on whether to allow further hydrofracking in the gas-rich Marcellus shale deposit, located in an area that also supplies virtually all of New York City’s water.

Impact to our industry

Hydrofracking has a broad impact on the insurance industry. There is an extensive list of primary coverages involved, including General Liability, Environmental Liability, Directors & Officers Liability, Errors & Omissions, Workers Compensation, Operators’ Extra Expense (Control of Well) Liability and even Homeowners Insurance. Claims may allege property damage and devaluation, bodily injury, seismic events, polluted wells, contamination of crops and livestock and transportation/handling/storage accidents involving the chemicals and contaminated water.

The potential insurance and reinsurance issues are varied and again include many of the technical coverage issues associated with long-tail pollution and asbestos claims. With respect to reinsurance these include timely notice of the claims from the insurer to the reinsurer, questions of whether claims tied to a single occurrence or event can be aggregated to apply retentions and limits, definitions of “an event”, “an occurrence” and “a common cause”, allocation of losses across multiple insureds and policy periods and whether exclusions (such as pollution) will be effective or subject to judicial invalidation.

Hydrofracking is an issue that has emerged in a relatively short amount of time. The number of wells is expected to increase rapidly, with commensurate growth in risk. Many ceding companies may not yet be aware of the extent of their hydrofracking exposure. Reinsurers can help them recognize the risks and manage them through risk selection, pricing and policy construction as well as risk transfer. On the upside, opportunities will also arise for cedants and reinsurers to develop coverage solutions for insureds who are involved in hydraulic fracturing process but who manage the risks in a responsible way.

Story Highlights

  • A shift from vertical to horizontal drilling has increased productivity but raised a number of concerns over potential hazards.
  • Over 200 chemicals — some of them volatile — are added to the water that is pumped into the ground.
  • As much as 300 tons of chemicals are used per frack.
  • A loophole in the Energy Policy Act of 2005 means that fracking is exempt from regulation.
  • Primary coverages include General Liability, Environmental Liability, D&O, E&O, Workers Compensation and even Homeowners Insurance.
  • Claims allege property damage, devaluation, bodily injury, seismic events, polluted wells and contamination of crops, livestock and water supplies.
  • Re/insurance issues include many of the technical coverage issues associated with long-tail pollution and asbestos claims.

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