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By CYRIL TUOHY, managing editor of Risk & Insurance®

A report issued earlier this month by the U.S. Environmental Protection Agency, which for the first time links hydraulic fracturing with groundwater pollution, is likely to add a layer of complexity and perhaps even limit insurers' underwriting appetites for natural gas drilling.

At the very least, the report is going to give energy underwriters pause the next time they bind a general liability or environmental policy for operators of natural gas wells. For the moment, though, underwriters have options.

They could raise the deductible, said Eric Hathorn, Lee Reynolds and Mark Bush, brokers with Arthur J. Gallagher Risk Management Services Inc., in an emailed response in September to questions about fracking.

A stand-alone pollution and environmental liability policy with a standard deductible of, say, $10,000, could be increased to $50,000, in effect raising the risk retained by the oil and gas company.

Underwriters will be interested in the extent of the oil and gas company's testing, and the company's ability to document testing and the condition of the wells, steams, ponds and soils in the area before the drilling took place, the brokers wrote.

EPA studies of the potential impact that hydraulic fracturing operations have on drinking water supplies "is being monitored closely by insurance markets and does factor into the markets' willingness to write this class of risk," wrote Jeffrey Hanneman, director of Aon Risk Solutions' environmental services practice, in an email.

Other insurance markets may deem natural gas extraction too risky and end up declining coverage altogether, as environmental claims connected to hydraulic fracturing may drag on for decades.

Contractors are often insulated against third-party liability, and it is the well owner or operator that buys specific environmental coverage or relies on sudden and accidental coverage under commercial general liability policies, brokers said.

"The typical occurrence-based commercial general liability policy for an operator can include pollution liability for sudden and accidental events, usually subject to a limited discovery and reporting period of very specific parameters," Hathorn, Reynolds and Bush wrote.

Some natural gas well operators will opt for a claims-made environmental policy, which covers gradually occurring, as well as sudden and accidental incidents. "We believe that the demand for gradual coverage will continue to increase as operators seek options to improve protection of the balance sheet," Hathorn, Reynolds and Bush wrote.

In the EPA's latest findings on polluted groundwater in Wyoming, high concentrations of benzene, xylenes and hydrocarbons were found near pits used for the disposal of drilling cuttings and water contaminated by the drilling process, the EPA report said.

Data from deep monitoring wells also reveals "constituents associated with hydraulic fracturing" in the drinking water aquifer tapped by residents, according to the EPA report.

Encana Oil & Gas, a subsidiary of Calgary-based Encana Corp., which owns the wells around Pavillion, refuted the EPA's findings.

The EPA's conclusions "do not stand up to the rigor of a nonpartisan scientific-based review," said Eric Marsh, an executive vice president in Encana's USA Division, in a statement posted on the company's website.

Discrepancies in the research include the fact that the EPA report ignores the historical realities of the Pavillion, Wyo. oil fields' "unique geology and hydrology," the company said, and pointed to inconsistencies in the methodology and sampling used by the EPA.

Until now, there's been little conclusive evidence that fracking -- a technique in which water and chemicals are injected at extreme pressure to shatter rock -- has led to pollution of drinking water.

But there has been plenty of anecdotal evidence. "Gasland," a documentary released last year, raised questions when it cited dozens of homeowners near wells in Wyoming, Colorado, New York and Pennsylvania who complained that their drinking water had been contaminated by fracking fluids.

The EPA will release a more comprehensive study of hydraulic fracturing next year, and the new research should add to underwriters' understanding of the environmental risks posed by the drilling process.

Fracking has exploded around the United States in the past 10 years as new technology has made the extraction of natural gas economically viable. Gas reserves are plentiful in more than 20 states, particularly New York, Pennsylvania, North Dakota, Wyoming and Texas.

December 19, 2011

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