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Rodd Zolkos

Fracking risks evolve while changing legal landscape complicates regulation

Variety of state rules complicate efforts to manage environmental liabilities

March 2, 2014 - 6:00am



While increased hydraulic fracturing by the oil and gas industry has raised concerns about environmental and seismic risks, differing state laws and a changing legal landscape have created challenges in managing and transferring those exposures.

Hydraulic fracturing, commonly known as fracking, has been used to improve access to oil and gas in shale rock formations for decades, experts say. But recent improvements in technology have made it feasible to drill in previously marginal production areas, driving a dramatic increase in the technique's use.

With the increased use of fracking have come claims that it is causing groundwater contamination in some areas and seismic activity in others.

Meanwhile, the regulation of fracking activity has been left largely to the states, a development some experts see as a positive but others see as complicating the process of managing and insuring related risks.

“It's a really complex mosaic of laws and issues and requirements that companies have to look at when they're working in this industry,” said Pamela D. Hans, managing shareholder at Anderson Kill P.C. in Philadelphia.

From an indemnity risk transfer perspective, “it's very hard to negotiate because the landscape is changing so frequently and it varies so much from state to state,” Ms. Hans said.

Though the state-by-state regulatory landscape may add complications for companies using fracking in multiple states, state regulation that is done well is a good thing for the energy business and the insurance industry, said Brian K. McCarthy, president and CEO at Energi Insurance Services Inc., a Peabody, Mass., provider of specialized energy industry insurance programs in the United States and Canada.

“States like Pennsylvania and Ohio, North Dakota, Oklahoma have really taken the lead on regulation,” Mr. McCarthy said. “The regulation is no different than the regulation on other energy sectors where the regulation is really good for insurance.”

“The American Petroleum Institute has put together some general best practices, but what we're seeing is the states are taking the best practices to the next level,” said Justin Russo, senior vice president of safety and loss prevention at Energi. “That's really what has to be done when there are such differences in geology.”

Solid regulation including inspection of drilling facilities reduces exposures, Mr. McCarthy said. “Today the state of Pennsylvania has hundreds of inspectors on staff,” he said. “They have resources in place.”

The current insurance market for fracking is limited, Mr. McCarthy said, but those that are doing it well emphasize inspections.

“The insurers out there that are doing it right are really making sure there's stability in the market for the long haul,” he said. “They have boots on the ground. They have their own inspectors.”

“In casualty lines that have significant loss exposures, you absolutely have to have significant investment in loss control and engineering,” Mr. McCarthy said. “Otherwise, you're going to get hit with the losses, the reinsurers are going to get hit with the losses and you'll have disruptions to the market.”

“There's a lot of insurers that have gone into the market, haven't done particularly well, then pulled out of the market,” said Mr. Russo, agreeing that those that have done well have done so because of their risk engineering arrangements.

“Just like with anything, there are good actors and bad actors” among energy companies engaged in fracking, Mr. Russo said. “The good actors embrace the safety and loss management and invite insurers to come out and view their business operations and ask for help.”

While litigation around hydraulic fracturing has increased in the past several years and publicity surrounding it, the amount of litigation remains limited, said Carl J. Pernicone, partner at Wilson Elser Moskowitz Edelman & Dicker L.L.P. in New York.

“There's not a huge number of pending cases,” Mr. Pernicone said. There are, however, common causes of action in almost every case that include nuisance, trespass and negligence, he said.

In addition, “Virtually every complaint has a medical monitoring count. If you look at all the complaints, typically a common count is to set up a medical monitoring fund,” he said.

Mr. Pernicone said he thinks the limited number of fracking-related suits might be due to a lack of injuries definitively connected to the practice.

“I think it probably has something to do with the fact that there isn't really any present injury,” he said. “I can't think of anybody that's claiming they have an immediate injury.”

As an example of similar litigation, he said suits in the recent West Virginia chemical spill are seeking medical monitoring funds. “Water contamination claims are well-suited to these kinds of funds, but it remains to be seen at the end of the day whether these things will be upheld,” he said.

Jason B. Kurtz, a consulting actuary at Milliman Inc. in New York, said past water contamination cases in other industries, such as those that involve gasoline additive MTBE, demonstrate how costly such events can be.

“If these types of things do manifest themselves, some of the companies involved (in fracking) may not be big enough to fully absorb the financial hit,” he said. “Regulators should be aware of that.”

Regulators overseeing fracking might want to look to insurer solvency requirements as a guide to requirements that could be imposed on companies involved in hydraulic fracturing that would ensure they have sufficient resources, either through their own funds or insurance, to cover groundwater contamination claims, Mr. Kurtz said.

As they look to secure insurance to cover fracking activities, companies need to be aware of the differences in regulation and the language defining some causes of action from state to state, said Ms. Hans. They should try to keep insurance and indemnification contracts “all encompassing” with language that's “plain old English as opposed to legal lingo,” she said. At the same time, she said, ”companies should take care to avoid recycling the same contract forms or language without paying close attention to variations in state law.”

Concerning claims of fracking-caused seismic activity, Ms. Hans said some insurance policies “actually exclude liability arising from earth movement and collapse.”

“You want to make sure that your insurance policy doesn't have an earth movement exclusion, a collapse exclusion if those are the risks of your activity,” she said. If it's not possible to remove the exclusion or find coverage elsewhere, companies might consider forming a captive or risk retention group, Ms. Hans said.

Companies looking to address potential water contamination exposures also have to be aware of differing state laws when watersheds cross state lines, she said.

And it's necessary to understand the insurance coverage and financial wherewithal of partner companies providing indemnity agreements, she said, while companies that provide the indemnification should consider limiting the scope of the indemnity obligation by dollar amount or duration.

 



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