HYDRAULIC FRACTURING

Insurance issues loom over shale gas development

Insurance providers want a clearer picture of the potential hazards of deep well hydraulic fracturing in U.S. shale plays as they weigh the costs of covering the risks -- or consider whether to provide insurance at all, industry officials and experts say.

Some major global reinsurers, which traditionally pick up substantial parts of insurance exposure, remain unwilling to take on fracking and well drilling risks in shale plays until operating, regulatory and legal liability issues become clearer, said Justin Russo, senior vice president of energy insurance provider Energi Inc., based in Peabody, Mass.

A more consistent, visible and effective set of best operating practices is needed, said Russo. "We think it [drilling for oil and gas] can be done safely," said Russo, who described the dilemma at a meeting of the Environmental Council of the States last month.

"We've developed 'best practices.' But the reinsurance community isn't convinced," he said.

The unique nature of fracking and horizontal drilling operations presents new legal issues that could bear critically on the effectiveness of insurance coverage, said Earl Hagström, an attorney with the Sedgwick law firm's hydraulic fracturing group.

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"The issue that insurance companies and their counsel are wrestling with is: Is this risk covered under existing policies?" he said.

"Environmental risk has been around for a long time. Insurance companies know how to deal with it. But there are a lot of unknowns [in shale gas operations], and a lot of conflicting information. If something goes wrong, how big a problem is it?" Hagström said.

"It is an unresolved issue that will have to play out over the next few years, maybe longer" as a new block of lawsuits moves through state courts, Hagström said.

"The insurers and the reinsurers are reticent to participate if they can't understand the risk. If they can't understand the risk, they can't price it. That's what the insurance industry is wrestling with: 'If we write this policy, is it going to be profitable for us?'" he added.

Several major reinsurers declined to comment on their position on shale gas and oil development for this story.

"The whole business of reinsurance is based on that premise that you can understand and quantify risk and spread it around to an insurance pool," said Andrew Logan, director of insurance program at Ceres, a Boston-based advocacy group for sustainable resources strategies.

"If an insurer can't measure and quantify that, the choice would be to stay out of the business entirely.

"Insurance is one side of the issue. Bank financing is another," he said. "Rabobank, the Dutch financial firm, has declared it won't finance fracking projects at all," he added. "They don't understand the risk, and they don't think it is justified by the returns.

"We've certainly heard other banks are trying to come up with some set of indicators to judge which [drilling] companies to lend to and which not to," Logan said. "Given the tight constraints on gas operations, that's a pretty big deal."

Best practices checklist

Energi's insurance underwriting process includes a compliance audit of a client's operations to ensure that safety and loss-prevention "best practices" are followed, the company says. The audit results are part of decisions on reviewing coverage, Energi said.

For example, the company's best practices checklist includes pre-drilling evaluations of well sites to identify abandoned wells, natural fractures, shallow natural gas zones and other geological features that could increase risks of aquifer or surface contamination. Private wells should be sampled to determine water quality before drilling, the checklist says.

Fracking chemicals should be disclosed and usage should be tracked, Energi said. Waste fluids should be contained in a "closed loop" system if possible, or managed in properly lined pits, it said. The list includes measures to assure proper well construction.

"A common agreement among states on a best practice would certainly make life easier for everybody, and you'd get a better result," Russo said in an interview.

Russo's colleague, Energi Senior Vice President David Tiedgen, noted that the American Petroleum Institute has developed extensive guidelines on best practices for shale gas and oil development. "Now it's a matter of people accepting them on a state regulatory basis and implementing them," he said.

State rules on shale gas and oil development vary widely, and public visibility into state regulation of shale gas and oil production is limited, according to an analysis by Resources for the Future, a Washington think tank.

Drilling operators and state officials generally oppose standardized "top-down" environmental standards in shale plays, saying states know best how to oversee the industry. "Some consistency of regulation would be helpful, but it's so political," Russo said.

Going without coverage

Insurance issues have not kept shale gas and oil development from surging in the past half-dozen years. Traditional liability and environmental damage policies have been available for drilling companies. Shale wells require fleets of trucks transporting water, chemicals and drilling equipment, and standard vehicle liability policies are common, experts said.

"While some environmental insurance markets are being very selective when it comes to underwriting and employing their capacity for fracking risks, we are not seeing carriers universally attaching exclusions or declining fracturing risks across the board," the Willis Environmental Risk Newsletter reported last year. Willis is a major insurance broker.

Russo said his firm is writing policies that cover most exposures up to the "over the hole" operations, when the well pad and materials are in place and drilling is ready to begin. The most common coverage choice is a limited pollution insurance policy, and the major oil companies may add pollution coverage through "captive" self-insurance, Energi said. Also, some states require producers to obtain surety bonds and/or insurance to meet their potential liability obligations.

Some operators or subcontractors may be going without drilling and fracking coverage, said Seth Chandler, a University of Houston law professor. "Standard liability insurance policies don't cover the fracking issues," he said. It is unlikely that policies would cover damage caused by earthquakes related to deep underground injections of fracking waste fluids, he added.

"If you frack and you don't have liability insurance that covers you, you're betting that nothing bad is going to happen," Chandler said. "And if you believe the frackers, nothing does happen."

Lawsuits and 'fortuity'

Lawsuits linked to fracking and deep horizontal well operations are increasing. In the wake of several multimillion-dollar settlements, the insurance industry has "a major stake in understanding the scope and extent of risks potentially posed by fracking," attorney Michael Case of the LeClairRyan law firm wrote this year in Claims Management magazine.

An investigation by EnergyWire found that spills, blowouts and other mishaps at onshore oil and gas well sites increased 17 percent from 2010 to 2012 as shale drilling activity accelerated, according to state and federal data. There were more than 6,000 spills in 2012, an average of more than 16 spills a day, EnergyWire reported last month.

"One of the big issues is the issue of fortuity," Hagström said. If an accident happens and a well goes out of control and spews out oil or gas, and it clearly was unintended or fortuitous, that is the kind of accident that policies are intended to ensure against, he said.

"The problem I see with some of the coverage that's being considered for the fracking issue is that you are intentionally pumping down millions of gallons or water" with chemicals to assist the shale rock fracturing. "If that then results in migration of methane or fracking fluids into unintended zones, is that a fortuitous event or the result of intentional actions?

"This issue has not made its way through the courts," Hagström said.

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