The Risks of Hydrofracking

Huhnsik Chung , Gregory Hoffnagle


June 1, 2011

The process of high-volume horizontal hydraulic fracturing, or "hydrofracking," was first used commercially by Halliburton in 1949. It involves injecting millions of gallons of water, mixed with sand and chemicals, deep into the ground at high pressure in order to break up dense shale rock formations and release trapped natural gas to the surface.

Recently, hydrofracking has received considerable media and congressional attention as the method has become more widespread and the prospects for large-scale natural gas production from shale formations have become a reality. The scrutiny has largely focused on three areas of risk: legal liabilities emanating from negative environmental and health impacts, regulatory risk from new state and federal laws that would impose new costs or restrict hydrofracking operations, and reputation risk from the growing public and political concern paid to this issue -- something exemplified by New York City Mayor Michael Bloomberg's vocal opposition alleging that hydrofracking poses an unacceptable threat to the water supply of nine million New Yorkers.

At present, allegations abound that hydrofracking has resulted in the contamination of the environment -- specifically to the detriment of aquifers, surface water and air quality. Some people have claimed that they have sustained illness and injury as the result of drinking water drawn from fresh-water aquifers contaminated by hydrofracking operations.

Further claims allege that vibrations and subterranean pressure changes associated with hydrofracking have negatively altered underground and surface geology -- and even increased the risk for seismic events such as earthquakes. Other risks include well blowouts, nearby property devaluation, damage to crops or livestock, improper transportation, handling or storage of toxic chemicals and waste, and the migration of gases or naturally forming radioactive materials to the earth's surface. It remains unclear whether any of these will prove to be significant threats, but the practice is currently proliferating in many regions and many locals are becoming increasingly concerned.

Given all its uncertainty, one may logically ask why such an apparently risky enterprise is growing at such a rapid pace in the United States. There is no simple single answer. Instead, a confluence of political, technological and, perhaps most of all, economic factors are the driving force behind the recent hydrofracking renaissance.

For one, technical improvements to high-volume horizontal hydrofracking have allowed for easier exploration and discovery. Today, energy companies can explore greater areas of shale gas reservoirs per single well. In the past, older vertical hydrofracking wells covered less area and produced much less shale gas per well. Higher prices for crude oil and natural gas imports have also made hydrofracking -- a relatively costly operation per well -- more attractive. The market has turned something formerly considered a cost-prohibitive method for extracting sellable products into a financially viable venture for energy companies.

Along with the financial incentive for companies, hydrofracking has been able to rapidly expand because there are very few federal, and in some cases state, laws or regulations governing the industry. The infamous "Halliburton Loophole" has made headlines recently and been featured in the Oscar-nominated documentary Gasland. Simply put, this exempts hydrofracking operations from the Safe Drinking Water Act and exempts energy companies from having to disclose the ingredients included in the water, sand and (often toxic) chemical "fracking cocktail" used in the extraction process.

This loophole in the Energy Policy Act of 2005, legislation designed to combat growing energy problems by providing tax incentives and loan guarantees for energy production, took the Environmental Protection Agency off the job of regulating hydrofracking. As such, there are very few, if any, federal regulations that govern the industry, hence the frequent comparisons to the 19th century Gold Rush in the fledgling nation's western frontier.

Additional political support for hydrofracking was recently displayed in President Barrack Obama's "Blueprint for a Secure Energy Future," which set a goal of cutting oil imports by one-third by 2025. This plans to accomplish the lofty goal by focusing on greater production and use of natural gas. Related to this goal, and in light of the recent events in the Middle East and in particular Libya (which has the ninth-largest oil reserves in the world with 41.5 billion barrels) is the ongoing national security concern. By focusing its energy policy on the approximately 6,600 trillion cubic feet of shale gas in the United States, the argument is that the country could greatly relieve its dependence on, and the associated need for military intervention in, the Middle East.

On a macroeconomic level, hydrofracking also has the potential to be a huge job generator. Many hydrofracking wells are located in otherwise depressed regions of the country where new employment opportunities could greatly buoy the local economy. Consequently, states are already jockeying to be the next "hydrofracking capital," with Pennsylvania  being the current frontrunner.

Hydrofracking Claims
The allegations of hydrofracking-related injuries and damage have caught the attention of the media, the federal government, the usual environmental groups and, predictably, a number of the same plaintiffs' law firms that spearheaded the wave of TCE, MTBE and asbestos-related litigation that has flooded the courts in recent decades.

Lawsuit hotbeds have also emerged. In Pennsylvania, Texas, West Virginia and New York, for example, hydrofracking-related lawsuits have sought to force environmental remediation by hydrofracking operators and recover damages to compensate for bodily injuries and property damage allegedly caused by hydrofracking. At present, energy companies that sponsor or conduct hydrofracking operations are the primary targets of these lawsuits. As more claims and lawsuits develop, associated companies will undoubtedly turn to their insurers for third party liability insurance coverage in defending against the various types of claims and for indemnity of any resulting liabilities. (For more on hydrofracking insurance, see "Insurance for Hydrofracking".)

There are at least 13 states (Arkansas, Colorado, Indiana, New Mexico, New York, North Dakota, Ohio, Oklahoma, Pennsylvania, Texas, Virginia, West Virginia and Wyoming) whose body of law will probably come into play regarding related claims and lawsuits. And it is safe to assume that many more jurisdictions will become involved as claims and litigation continue to mount wherever hydrofracking is taking place.

While the hydrofracking claims landscape is in flux and various types of allegations continue to blossom, one thing is clear: efforts will be made to consign as much of the costs for the losses as possible under various types of insurance. Insurers are equipped to handle these types of claims, but given their volume, certain uniqueness and variety, along with the significant amounts of money at play, it seems inevitable that not all parties will be in agreement as to which losses are covered and which are not under a particular type of insurance coverage.

Thus, the emerging risk of hydrofracking will be yet another test for underwriters as they continue to navigate the emerging risk landscape.

Huhnsik Chung is a partner in the insurance and reinsurance department at Edwards Angell Palmer & Dodge LLP.
Gregory Hoffnagle is an associate in the insurance and reinsurance department at Edwards Angell Palmer & Dodge LLP.