Few topics have dominated our news cycle in recent months, if not years, as much our country’s dependence on foreign oil. Not only is the cost of filling up at the pump a daily concern for most Americans, but our oil consumption has economic, environmental, national security and political implications that are the subject of heated debate.

Recently, however, a different source of energy has gained increased attention from politicians, media outlets and the general public – natural gas. Viewed by some as a clean, domestically-available alternative to oil or coal, the search for natural gas wells located throughout the United States has been characterized by some as the gold rush of the 21st century. Yet while natural gas has always been part of the alternative energy discussion, the risks associated with a relatively new process being employed by companies to extract the gas – hydraulic fracturing or hydrofracking – has caused some concern.

This article will discuss the basics of hydrofracking, why it is viewed by some as an attractive source of alternative energy, as well as the various risks and dangers that some allege are linked to this process. The article will then provide a broad overview of the potential coverage issues that may arise for insurers and reinsurers that provide coverage for entities involved in hydrofracking operations. Although we are aware of only a few hydrofracking claims and lawsuits, there is no disputing the fact that insureds involved in this area face a variety of diverse risks.

Hydrofracking 101 – The What, Where & Why

Hydrofracking is a technique by which large amounts of water, sand and chemicals are injected into deep underground shale formations at extreme pressures – up to a maximum rate of 15,000 pounds per square inch (psi). The goal is to create fractures in the rock formations, which results in the release of natural gas trapped between the layers of shale.

Between one and eight million gallons of fluid, and eighty to three hundred tons of chemicals, may be used to frack a single well. The fluid consists mostly of sand and water, but the chemical combinations used as part of the fracking process – sometimes referred to as “fracking cocktails” – can consist of up to two hundred different types of chemicals, the specifics of which are sometimes not disclosed to the public (although several states have passed laws mandating some type of disclosure). Indeed, according to the Environmental Protection Agency (EPA), toxic chemicals used in hydrofracking include substances such as polycyclic aromatic hydrocarbons, methanol, formaldehyde, ethylene glycol, glycol ethers, hydrochloric acid, sodium hydroxide, and diesel fuel, which contains benzene, ethylbenzene, xylene, naphthalene and other chemicals. These chemicals have known negative health effects on the respiratory, neurological, central nervous and reproductive systems, and can cause cancer in some situations. Evaporators and condensate tanks are used to prevent the release of volatile organic compounds (VOCs) into the atmosphere, which normally operate twenty-four hours a day, seven days a week.

One well may be fracked up to eighteen times, and a well can produce up to one hundred barrels of natural gas per minute. A significant percentage of the fluids used as part of the fracking process – anywhere between sixty to ninety percent – remain underground after the natural gas has been extracted. The remaining fluid is typically transported to a treatment facility in which certain procedures are employed to remove any toxic, radioactive or otherwise harmful chemicals from the fracking-fluid. That fluid is either used again a part of the fracking process, discharged into natural water sources, or disposed elsewhere (i.e., stored in deep underground wells).

There are currently about 495,000 known hydrofracking wells in the United States. About one-third of these wells are located in two states – Texas and Pennsylvania. One particular area of heightened exploration – named the Marcellus Shale Area – has been called the “Saudi Arabia of Natural Gas.” It stretches from southwestern New York, through northwestern Pennsylvania, and into parts of West Virginia, Ohio, Maryland and Virginia, and is believed to contain enough natural gas to heat buildings, generate electricity and power vehicles for up to a hundred years. The EPA projects that by 2020, shale gas will comprise over 15-20% of the nation’s gas supply.

The availability of natural gas is not the only reason, however, why the hydrofracking industry is a growing one. For one, the technology used as part of the fracking process has improved significantly in recent years, permitting the increased exploration (and related discovery) of shale gas reservoirs for each fracking well. Companies have developed techniques that some argue make hydrofracking safer than in the past. For example, drillers now install a series of protective steel (“casings”) and cement layers that maintain the integrity of the well and protect the surrounding natural formations. In particular, in the upper part of the well, multiple layers of cement and steel casing are installed to create an impermeable barrier between the well and groundwater/aquifer zones. Drillers now also use casing deeper into the well to ensure its integrity and to isolate natural gas formations from the surrounding areas. In addition, most companies employ a series of engineers and technicians to continuously test and monitor each layer of casing and cement to ensure the integrity of the well and the quality of the protective casings.

A second reason for the increased focus on hydrofracking lies in the increasing prices for crude oil and natural gas imports. This has made hydrofracking – a relatively costly operation itself – a financially viable and attractive alternative for energy companies, particularly when combined with tax incentives for companies that develop alternative sources of energy and relaxed regulatory oversight.1

Moreover, there are significant environmental, political, and national security components to hydrofracking that have led to its growth in recent years. Some environmentalists support using natural gas a means of slowing climate change, because it burns more cleanly than coal and oil. The Obama Administration has publicly set a goal of cutting all oil imports by one-third by 2025, which it seeks to accomplish in part by focusing on greater production and use of natural gas. And, of course, there is the continued instability in the Middle East, where we import the majority of our oil. By focusing our energy policy on the roughly 6600 trillion cubic feet of shale gas in the United States, some believe that we can significantly reduce our dependence on, and the associated need for military intervention in, Middle Eastern oil-producing countries.2

Last, hydrofracking has been an economic boon to certain areas of the country that are otherwise struggling. Hydrofracking operations create jobs. They also provide a source of tax revenue, benefit both local businesses and, in certain instances, even homeowners, who lease portions of their land to energy companies for drilling and exploration. As such, certain states have sought to position themselves as the “hydrofracking capital of the world,” with the current frontrunner being Pennsylvania.

Hydrofracking Risks and the Related Insurance-Exposures

It has been alleged in several lawsuits3 that hydrofracking has resulted in the contamination of the environment – specifically to the detriment of aquifers, surface waters and air quality. These lawsuits allege that individuals have sustained certain illnesses and injuries as a result of drinking water drawn from fresh-water aquifers contaminated by hydrofracking operations. Others have claimed that vibrations and subterranean pressure changes associated with hydrofracking have caused permanent damage to the underground and surface geology (i.e., surface subsidence) – and even seismic events such as earthquakes. And still other potential risks include

  1. pressure explosions (i.e., “blowouts”);
  2. private property damage or devaluation;
  3. migration of gases and naturally forming radioactive materials to the earth’s surface;
  4. loss of crops and livestock; and
  5. accidents in the transportation, handling and storage of toxic chemicals and waste.

These suits seek damages to compensate alleged bodily injuries and/or property damage, and, in certain instances, also seek to compel remediation of the conditions purportedly caused by hydrofracking.4 At present, energy companies are the primary targets of these lawsuits, as well as the companies that sponsor or conduct hydrofracking operations.

The hydrofracking-related lawsuits have alleged the following causes of action: violation of certain federal and state environmental statutes (such as the Clean Water Act, Clean Air Act, and Comprehensive Environmental Response Compensation and Liability Act), various negligence-based theories, private/ public nuisance, trespass to land and breach of contract/fraudulent misrepresentation (by certain landowners who leased portions of their property to companies involved in hydrofracking).5

Recently, New York Attorney General Eric Schneiderman also subpoenaed some of the largest companies in the country involved in natural gas drilling.6 The subpoenas seek documents concerning the disclosures made by those companies to investors about the risks related to hydrofracking.

As more claims and lawsuits develop, companies involved in hydrofracking will undoubtedly look to their insurers to provide them with a defense, and ultimately seek indemnity for any resulting liabilities. And those insurers will, in turn, seek recovery from any applicable reinsurance coverage. While it is impossible at this point to predict with complete accuracy, and then analyze, all of the coverage issues that might arise as a result of hydrofracking claims, a brief list of the likely types of exposures and related insurance coverages are, as follows:

  1. Environmental/Pollution Claims

It has been alleged in several cases that the toxic fluids, waste water, and chemicals involved in the hydrofracking process have polluted the water supply of certain municipalities and/ or individuals.7 Any bodily injury or property damage caused as a result of hydrofracking¬related pollution or groundwater contamination could trigger coverage under an environmental/ pollution liability policy, which typically provides defense and/or indemnity for bodily injury, property damage, and remediation costs resulting from a ‘pollution’ incident at a ‘covered’ site.

  1. Claims Arising Under Comprehensive General Liability Coverage

Most commercial entities involved in hydrofracking will likely have Comprehensive General Liability (CGL) insurance, which generally provides coverage for liability resulting from bodily injury or property damage that takes place during the policy period and is caused by an occurrence. Unless specifically excluded, CGL policies usually also provide coverage for losses associated with products, completed operations, premises and operations, and contractors.

As noted above, there have been allegations that the chemicals and waste water involved in the hydrofracking process have leaked into surrounding soil and sources of drinking water, causing bodily injury or property damage. On April 20, 2011, it was reported by several publications that a fracking eruption occurred in rural Pennsylvania, spilling chemically treated fluids into a creek and prompting the evacuation of nearby residents.8 The creek flows into the Susquehanna River, which feeds a number of other bodies of water, including the Chesapeake Bay. The Maryland Attorney General’s Office has already stated that it intends to file a lawsuit against the companies involved in the spill that seeks injunctive relief and civil penalties under the federal Resource Conservation and Recovery Act (RCRA) and the Clean Water Act (CW).9 Accidents of this nature could potentially result in claims under the CGL coverage available to drillers, manufacturers, contractors, sub¬contractors, and others involved in the fracking operation at a particular site.

Moreover, those entities involved in the storage, treatment, transportation and disposal of hydrofracking fluids face potential liability under their CGL policies (as well as other possible sources of coverage). It has been alleged by some that these entities do a less-than-adequate job of ensuring that fracking fluid, which may contains combinations of potentially toxic or radioactive chemicals, does not end up in our water supply or other areas where it can cause environmental or health problems.

  1. Directors and Officers (D&O) Liability Claims

D&O insurance provides financial protection for, among other things, the directors and officers of a company who are sued in connection with the performance of their duties for that company. One need not look any further than the Deepwater Horizon/BP spill – where derivative actions were brought against the directors and officers of the companies involved in that disaster – to see the potential exposure that directors and officers of an entity involved in the hydrofracking process could have if a similar type of catastrophe occurred.10 Indeed, Cabot Oil and Gas (Cabot), a $4.2 billion publicly traded corporation that is deeply involved in hydrofracking in Pennsylvania, and who has already been named in several groundwater contamination lawsuits, could potentially face shareholder derivative lawsuits as a result of those litigations and related losses.11 Further, one media outlet recently predicted that executives of natural gas companies could face risks arising from forecasts provided to investors concerning the productivity of hydrofracking wells, or statements regarding the size of their natural gas reserves.12 Directors and officers of companies involved in hydrofracking might look to their D&O coverage to provide defense and indemnity with respect to any alleged errors, omissions, or misstatements associated with their business decisions and activities.

  1. Workers Compensation Claims

Commercial Workers Compensation liability policies generally provide coverage for losses due to injury or death of the insureds’ employees, including medical and rehabilitation costs and lost wages. Given the potentially volatile nature of hydrofracking operations – sand, water and toxic chemicals injected thousands of feet below the subsurface at extreme pressures – and the various entities involved in the process (drillers, contractors, sub-contractors, engineers), there is certainly a chance this type of coverage will be implicated by future claims.

  1. Operators’ Extra Expense Claims

Operators’ Extra Expense (Control of Well) liability coverage often provides insurance for losses incurred when regaining control of an offshore or onshore well blowout, including re-drilling expenses, costs for seepage and pollution emanating from the blowout, damage to and loss of third-party property, and other related liabilities. Hydrofracking wells have occasionally suffered blowouts as a result of the large amounts and highly pressurized water, “proppants” (sand or ceramic beads) and chemicals that are injected into underground shale formations. Should a blowout occur, similar to the incident in Pennsylvania discussed above in section (B), many of the energy and drilling companies could look to this type of insurance to cover their losses.

Potential Insurance and Reinsurance Issues

Although hydrofracking claims have been presented to insurers and reinsurers, we are not aware of any hydrofracking-related coverage disputes that have resulted in a court decision. Nonetheless, given the potential risks associated with hydrofracking, it is likely that the insurance and reinsurance issues that will originate from such claims are similar to those the industry has seen with respect to (a) asbestos, pollution, toxic tort and other types of long-tail claims and/or (b) catastrophic incidents (i.e., the Deepwater Horizon/BP spill).

For example, several of the lawsuits discussed above allege that the chemicals, sand and water used as part of the fracking process contaminate surrounding water supplies, soil and even our air quality. It is not difficult to imagine a lawsuit that alleges that certain individuals suffered injuries (or owned property that was damaged) due to the prolonged exposure to the allegedly contaminated water, soil or air. These circumstances would likely implicate many (if not all) of the primary (and possibly excess) insurance policies that provided coverage to the insureds involved in operations at the subject well, and raise a host of traditional insurance coverage issues, such as trigger, exhaustion, and allocation of liability. Not only would the resolution of these issues be driven by the facts of a given claim and the relevant policy language, but also the law of the jurisdiction(s) that applied.

Likewise, an incident such as a blowout at a hydrofracking well, or a large-scale fracking spill, could result in a coverage dispute as to whether or not any related claims can be aggregated as a single occurrence or event under any applicable insurance policy (or reinsurance contract), or whether those claims constitute multiple occurrences/events. Given that the limits and any retention/deductible of an insurance policy or reinsurance contract are often linked to the number of occurrences, this could be a potentially significant issue, as it has been for other long-tail or catastrophic claims.

Moreover, because hydrofracking involves the use of certain combinations of toxic or potentially harmful chemicals, it is plausible that insureds and insurers will ultimately litigate the viability of the “pollution exclusion” found in many CGL policies, as well as similar types of exclusions. The pollution exclusion typically states that there is no coverage for “bodily injury” or “property damage” that would not have occurred in whole or in part but for the actual or alleged “discharge, dispersal, seepage, migration, release or escape” of “pollutants,” which is then defined in the policy. The interpretation and enforceability of this exclusion may differ depending upon the governing law, how the term “pollutant” is defined, and what fracking chemicals are alleged to be involved in the incident in question.

Other potential issues that arise commonly in disputes related to long-tail or catastrophic claims are a party’s failure to comply with a policy’s, treaty’s or facultative certificate’s notice of claim requirement, the availability of inuring or other applicable insurance for a loss, the implication of clash coverage (with respect to reinsurance contract’s only), and the various types of disputes that involve the scope of the follow the fortunes or settlements doctrine.

Conclusion

Hydrofracking is clearly an area of potential growth for insureds involved in the energy industry, and thus of interest to insurers and reinsurers who underwrite that business. But associated with hydrofracking are a variety of potential risks, liabilities and exposures that members of the insurance and reinsurance community should be aware of.