1/21/2013
Fracking Know-How

Fracking Know-How

Risks and risk allocation in high-volume hydraulic fracturing for shale gas.

By Michael J. Case

 
Depending on one’s point of view, high-volume hydraulic fracturing for shale gas—or “fracking”—is either a windfall promising decades of relatively clean energy (as well as jobs) from a secure, domestic source or a potential environmental disaster in the making. At the core of the fracking debate is risk, real or perceived, to landowners, drilling companies, contractors, and others who stand to gain or lose from the anticipated expansion in fracking activity.

Questions regarding the extent to which fracking increases seismic activity, degrades groundwater quality, burdens local infrastructure, affects surface water, and diminishes air quality may well be resolved in time through scientific study and mitigation advancements.

Legal disputes will surely be litigated over such issues as the lifting of a moratorium on fracking in the Delaware River Basin, municipalities exercising “home rule” powers to prevent fracking operations, and whether state fracking plans meet environmental-impact review requirements, among other issues. For now, the threat of environmental harm and legal uncertainty around fracking expansion is itself a real and tangible factor to be considered by interested parties.

The insurance industry has a major stake in understanding the scope and extent of risks potentially posed by fracking. In a noteworthy example, Chesapeake Energy agreed to pay $1.6 million to settle allegations that its fracking activities contaminated water wells in Bradford County, Pa. In another incident in late 2010, Cabot Oil and Gas Corp. reportedly paid $4.1 million to settle claims by residents of Dimock, Pa., who asserted that methane gas found in drinking water resulted from fracking.

The scope of insurance contributions to these settlements, if any, is not public information. However, they illustrate the potential exposure to companies that may well seek clarification from their insurers as to whether amounts paid in settlement are reimbursable under their liability policies. The once-theoretical possibility of gas development-related liability has morphed into the threat of very real consequences for policyholders and insurers.

Insurers already have issued policies to landowners, contractors, and operators of well sites. Especially in states like New York, Pennsylvania, Ohio, and West Virginia, where the scale of gas development has historically been modest, many of these policies were issued at a time when the exponential expansion of high-volume gas fracking was a mere abstract possibility. The expansion of fracking operations in North American shale gas formations, such as the Marcellus and Utica Shales (underlying New York’s southern tier, much of Pennsylvania, and parts of Ohio and West Virginia), may give rise to increased claims against policyholders. As potential risks ripen into actual claims, insurers need to give careful consideration to the types of policyholders likely to give rise to a fracking-related claim and to how their policies may respond.

Leasing Land for Shale Gas Drilling

Owners of property subject to a natural gas lease may face legal issues arising from those leases or the operations that the leases permit.

A typical oil and gas lease authorizes exploration, development, and production of oil and gas and their constituents underlying the leased property, as well as the following: use and installation of roads and utilities infrastructure; construction and operation of pipelines and appurtenant facilities; storage of gas underground; movement of material and equipment on, to, and from the lease; and use of unlimited amounts of water from sources other than a domestic water well.

The wide range of permitted uses creates a correspondingly broad range of activities that hold the potential for creating actual or perceived risk, which includes the following: the storage of hazardous or toxic substances, such as fracking fluid additives; storage and use of flammable or explosive substances, particularly including methane gas; storage of radioactive materials, including used fracking fluid contaminated with naturally-occurring radioactive materials (NORM); injury to persons or property arising from industrial operations and related transport at the well site; depletion of water sources available on the leased premises; contamination of surface water and drinking water; increased air emissions; claimed fracking-related seismic activity; and noise and visual traffic impacts.

Well Operators and Contractors

Companies operating high-volume hydraulic fracturing wells, as well as the contractors supporting them, also are prominent targets for lawsuits, in part because of their central role in gas exploration and development, as well as the perception that such companies have deep pockets.

Potential claims against well operators may include nearby residents claiming contamination of their drinking water; workers claiming personal injury as a result of accidents attributed to alleged negligent failure to identify flammable vapors released during drilling or hazardous additives in drilling fluid; landowners alleging breach of lease terms or seeking indemnity or contribution; regulators, citizens, or environmental groups alleging emission of hazardous air pollutants in violation of the federal Clean Air Act or applicable state implementation plans; regulators alleging surface water discharges in violation of a State Pollutant Discharge Elimination System (SPDES) permit, such as the general permit for fracking-related stormwater discharges currently under consideration by the New York Department of Environmental Conservation (NYSDEC); and, in New York, strict liability claims based upon releases of petroleum-based products pursuant to New York’s Navigation Law.

Contractor operations on a well lease may include hauling large quantities of water (two-to-eight million gallons per well, by some estimates) to and from the well site; pipe and lumber haulers; and operators of bulldozers, dump trucks, and other vehicles used in site preparation and operation. Claims against contractors would mirror those against well operators and also would include general liability claims typical of those seen in other industrial contexts.

Proposals, including those set forth in the NYSDEC’s draft Supplemental Generic Environmental Impact Statement (dSGEIS) on the oil, gas, and solution mining regulatory program, have been made to mitigate these impacts. Such proposals include well pad setbacks; closed-loop handling of flowback, casing, and cementing standards; flaring standards; and identification of truck routes. The Environmental Protection Agency is developing plans to regulate disposal of flowback water recovered during the fracking process (potentially containing salts, metals, NORM, and fracking fluids). Whether these proposals will be adopted is a threshold issue. The effectiveness of such measures, if implemented, in reducing discharges (and, consequently, claims) will be closely watched by fracking proponents and opponents alike.

Risk Allocation Between Fee Owner and Lease Operator

At common law, a landowner may be held responsible for permitting the existence of an allegedly dangerous condition on their premises. Thus, absent some means of allocating the risk of fracking operations, the landowner upon whose property gas exploration or production activity is conducted may face potential liability for those activities.

Oil and gas leases can, and often do, include provisions indemnifying the landowner for claims arising from the gas company’s operations and requiring the developer to procure liability insurance covering the landowners for claims arising from those operations. However, such provisions are not universally adopted or required, and landowners are advised to carefully review their leases to determine whether they contain such provisions. Especially in jurisdictions overlaying shale plays, such as the Marcellus and Utica Shale formations, landowners may have relatively little experience negotiating oil and gas leases in comparison to landowners in jurisdictions with a longer history of oil and gas development. As local experience in developing gas reserves through high-volume hydraulic fracturing increases, the level of sophistication among landowners (and their counsel) can be expected to increase. As a result, leases with robust indemnity and insurance provisions may become more common.

In occurrences where the oil and gas lease does not contain an indemnity provision, the landowner may be the primary target of a claim. In this instance, a landowner may nevertheless maintain a claim in common-law contribution or indemnity against the lease operator or other party responsible for liability-causing activities on the leasehold. However, the right to relief on such a claim would need to be established through an adjudicatory proceeding, such as a lawsuit or arbitration. Thus, the landowner would be forced to shoulder the burden of litigation expenses and risk of an adverse outcome in an effort to establish their common law contribution and indemnity rights.

Risk Allocation Between Policyholder and Insurer

A landowner or well operator without the benefit of effective indemnity or insurance procurement provisions under their lease may also seek to recover from their insurer for liability arising from gas lease operations. However, the likelihood of payment on such a claim is far from certain.

For example, a recently disclosed internal memorandum authored by an employee of a domestic insurer states that the company’s personal and commercial policies “were not designed to cover” risks incurred by commercial contractors and landowners who lease property to gas companies. The memorandum, cited in an Associated Press article in July 2012, states:

“…[T]he exposures presented by hydraulic fracturing are too great to ignore. Risks involved with hydraulic fracturing are now prohibited for General Liability, Commercial Auto, Motor Truck Cargo, Auto Physical Damage, and Public Auto [insurance] coverage.”

The insurer clarified that classes of non-covered risks would include landowners leasing land for shale gas drilling and contractors involved in fracking operations, including those who haul water to and from drill sites, pipe and lumber haulers, operators of bulldozers and dump trucks, and other vehicles used in drill site preparation.

While insurance coverage determinations are a matter of case-by-case application of specific policy wording to a particular set of claim facts, a review of commonly used general liability policy terms helps to illustrate some of the grounds upon which insurers may evaluate coverage for liability arising from fracking-related activities.

The Occurrence Limitation. Several courts have held that a discharge of pollutants, if expected or intended from the standpoint of the insured, would not fall within the scope of an “occurrence-basis” general liability policy. Thus, a threshold question under such a policy would be whether fracking-related bodily injury or property damage was “expected or intended” by the policyholder. The answer to this crucial question would require evidence regarding what the policyholder did and did not expect or intend regarding the claimed occurrence.

The “As Damages” Limitation. Some, but not all, state and federal courts have held that costs incurred pursuant to a governmental remedial directive may be recovered under a general liability insurance policy, which typically extends coverage for amounts the policyholder incurs “as damages.” Thus, the “as damages” coverage limitation, if it has any applicability in the context of fracking claims, could only apply with respect to claims arising from a government remedial directive. The limitation would have no application to claims for personal injury or property damage by a third party claiming injury arising from fracking activity.

Absolute Pollution Exclusion. Most recently issued general liability insurance policies contain a pollution exclusion that bars coverage for discharge, dispersal, release, or escape of “pollutants,” regardless of whether the discharge is sudden or accidental. New York’s highest court has declared that such exclusions are restricted to environmental claims and may not be relied upon to defeat coverage for bodily injuries involving exposures not deemed by the court to be environmental in nature.

“Personal Injury” Coverage. A typical general liability insurance policy includes a separate coverage grant for personal injury, which includes, “wrongful entry, eviction, or other invasion of the right of private occupancy.” Claims for environmental contamination have been held by many state courts not to fall within the personal injury coverage grant. However, this is not a universal rule, and the principle is relatively untested in the fracking context. Disputes may arise as to whether a particular fracking-related claim alleging trespass, public nuisance, private nuisance, or “ultra-hazardous” activity falls within the personal injury coverage grant.

Thus, even in those instances in which insurance policies have been issued to a landowner, lease operator, or contractor further questions remain as to whether that policy will respond to a given fracking-related claim. Resolution of coverage questions will require case-specific evaluation of potentially applicable insurance policy terms.

The clear and present potential that fracking operations will result in claims alleging environmental harm, bodily injury, or other liability warrants the attention of insurers and claims professionals. A threshold step in evaluating the potential claims arising from high-volume fracking involves clearly comprehending the roles potentially insured persons and entities are likely to play in the gas development process, as well as the legal and liability context in which those roles play out. Ultimately, the facts giving rise to liability coupled with the applicable policy provisions will determine whether and to what extent liability arising from fracking-related risks comes to rest upon the insurance industry.  

 


Michael J. Case is a New York-based partner in LeClairRyan, a CLM member firm since 2007. He can be reached at michael.case@leclairryan.com.



Michael J. Case is a New York-based partner in LeClairRyan, a CLM member firm since 2007. He can be reached at michael.case@leclairryan.com.

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