By Doug McLeod
The boom in shale gas hydrofracking may be creating another growth industry: environmental liability litigation that, in turn, will trigger coverage disputes between oil and gas companies and their insurers.
At least three dozen fracking-related lawsuits have been filed to date against well operators and drillers, most of them alleging contamination of groundwater with methane or other pollutants, according to a tally by law firm Edwards Wildman Palmer LLP. About 20 more suits have been brought by environmental groups, property owners and energy companies seeking to enforce federal or state statutes either to block or to allow drilling.
While these numbers are minuscule by mass tort standards, the rate of new filings is growing at "a decent-sized clip," expanding by one-third over the last six months, said Gregory Hoffnagle, a lawyer with Edwards Wildman in New York.
"Now that we're drilling literally under people's back yards, the general awareness of fracking as, at least, a potential issue is much higher, said Charles Dewhurst, a partner and leader of the natural resources practice at BDO USA LLP in Houston.
And while few coverage cases have emerged so far, their numbers are also certain to grow as the number of underlying liability suits expands, lawyers predicted.
"I absolutely think it's coming," said Carl Pernicone, a partner with Wilson, Elser, Moskowitz, Edelman & Dicker in New York.
The issues in fracking coverage disputes in some ways will mirror those in previous environmental and asbestos litigation, lawyers said. They include the applicability of pollution exclusions in general liability policies, the scope of "sudden and accidental" pollution coverage added to some policies, the number of occurrences triggered by an incident, and allocation of losses among defendants and their insurers.
"None of these things we're talking about is new," Pernicone noted. "It's just a novel application of the same types of issues."
Oil and gas drillers have used hydraulic fracturing since the late 1940s, but technological advances in horizontal drilling have opened vast shale deposits to production in the last decade. In a hydraulically fractured gas well, a rig may drill down more than a mile through layers of rock, then turn horizontally and drill out through a shale layer several thousand feet from the wellhead.
Up to seven million gallons of water, mixed with sand and various chemicals -- some of them hazardous -- are pumped into the well at high pressure to fracture the shale and release trapped gas. Much of the fracking fluid comes back up the well -- sometimes mixed with naturally occurring benzene, a carcinogen, and radioactive radium -- and is disposed of either in large evaporation pits, by injecting it into disposal wells, or by recycling it for use at other drill sites.
The shale "plays" attracting the most attention from oil and gas companies are the Marcellus, running from southern New York through Pennsylvania, West Virginia and Ohio; the Barnett and Eagle Ford in Texas; the Fayetteville in Arkansas; and the Bakken in North Dakota.
Pennsylvania, an epicenter of hydrofracking controversy, has seen at least 1,873 new fracked oil and gas wells drilled since the beginning of 2011, according to FracFocus, a registry of well sites and fracking chemicals that collects data from 320 energy companies. Texas has seen 10,973 new fracked wells in the same period; Arkansas, 1,243; and North Dakota, 1,158, FracFocus reported.
POTENTIAL LIABILITY RISKS
The drilling presents a variety of environmental liability risks, including contamination of groundwater with methane leaked from faulty well casings. A Duke University study of 60 drinking water wells in Pennsylvania and New York last year found that wells within one kilometer of active gas drilling operations contained average levels of shale methane above the federal level for hazard mitigation; in some cases, levels were high enough to present an explosion risk.
Other hazards include air pollution from methane released at wellheads during drilling or from well blowouts; pollution from disposal of fracking fluid in evaporation ponds that may leak or overflow in heavy rains; and seismic activity potentially triggered either by fracking or by the high-pressure injection of fracking waste into disposal wells. The U.S. Geological Survey concluded earlier this year that an increase in the rate of small quakes in Arkansas and Oklahoma in recent years is "almost certainly" related to oil and gas production, while Ohio officials have linked small quakes there to waste injection wells.
Apart from drilling operations themselves, fracking presents such ancillary hazards as commercial auto risk arising from the hundreds of truck trips required to haul equipment, fracking fluid and waste to and from drill sites.
"You're sending a significant amount of industrial activity into areas that are not built for it," said Michael Conley, a principal with law firm Offit Kurman in Philadelphia.
Of the few dozen liability suits filed so far, most involve allegations of groundwater contaminations and most have been brought in Pennsylvania, New York and Texas, according to Edwards Wildman. None of the cases has led to a jury verdict yet, Hoffnagle said, though energy companies and drillers -- often under pressure from state regulators -- have settled a handful of suits.
As of the end of 2011, for example, Houston-based Cabot Oil & Gas Corp., had paid or escrowed $5.5 million to settle drinking water contamination claims in Dimock, Pa., including $1.3 million in fines and settlements paid to the state and $4.2 million for affected property owners, according to Cabot's 2011 Form 10-K report.
Well owners and operators such as Cabot are not the only likely targets of liability litigation, experts said. Other targets can include drilling contractors that perform the actual drilling and fracking operations; subcontractors handling various other roles at the sites, including transportation of equipment, fracking fluid and waste; and the manufacturers of well equipment and the constituent chemicals in fracking fluid.
Fracking risks have caused at least one insurer to back away from the exposure: In a leaked internal memo, Nationwide Mutual Insurance Co. officials earlier this year called the risk "too great to ignore" and said that the insurer would not write general liability, auto liability or truck motor cargo coverage for companies with fracking exposure. Nationwide later clarified that it has never insured the oil and gas industry, and that its policies "were not designed to provide coverage for any fracking-related risks."
Other commercial insurers, however, have embraced the risk, offering general liability policies with an exception to the standard pollution exclusion that provides "sudden and accidental" pollution coverage as long as an event is discovered and reported to the insurer within specified time limits -- discovery within 30 days and reporting within 60 days, for example. Bermuda-based Oil Insurance Ltd. offers stand-alone "non-gradual" pollution coverage, with a 40-day discovery/120-day reporting requirement.
Along with general liability coverage, energy companies typically have operators extra expense policies, which will cover liabilities for bodily injury, property damage and above-ground pollution cleanup in case of a well blowout, said Bernard C. Thibeaux Jr., senior vice president at HUB International Gulf South Ltd. in Lafayette, La.
Large oil and gas companies and drilling contractors may also have manuscripted, stand-alone environmental impairment liability policies. Environmental impairment liability limits of up to $200 million are available, though the coverage can be pricey and underwriters have grown selective about which risks they assume, according to a 2012 energy market review by Willis Ltd. Some environmental impairment liability insurers have started to exclude fracking activities, while others have placed coverage restrictions specifically on Marcellus Shale drilling, Willis reported.
Whatever the policy in question, coverage disputes are sure to follow any increase in fracking liability litigation, legal and insurance sources agreed.
In one of the few coverage fights to emerge in court so far, ACE American Insurance Co. is contesting coverage of a drilling contractor on grounds that the driller didn't follow the notice provisions of an ACE commercial general liability policy's pollution extension endorsement.
Warren Drilling Co. of Dexter City, Ohio, was named in a West Virginia property owner's 2010 lawsuit charging contamination of drinking water with fracking fluid. The suit was filed two years after the property owner first contacted the wells' owner and operator -- a unit of Pittsburgh-based EQT Corp., which had hired Warren -- about the water problem, according to court records.
Warren said it was not notified at the time and did not learn of the alleged contamination until it was sued, after which it notified ACE. ACE, however, denied liability, saying that Warren's pollution coverage endorsement required that Warren discover the contamination within 30 days of the initial discharge and that it notify ACE within 60 days.
That case is pending in U.S. District Court in Columbus, Ohio.
The pollution exclusion in standard CGL policies and the terms of pollution coverage extensions such as Warren's are likely to be a primary focus of coverage disputes, lawyers said. "Tapping current GL policies will be complicated by the specter of pollution associated with fracking and the application of any pollution exclusion," said John Nevius, a partner at Anderson, Kill & Olick in New York.
In cases involving fracking fluid leaks, policyholders may argue that fracking fluid is a "product" under the terms of commercial general liability policies -- and that products and completed operations coverage therefore applies -- rather than pollution excluded by policies' absolute pollution exclusions, Pernicone observed.
Insurers, meanwhile, will argue that the fluid is only a "product" when used for its intended purpose, and that leaks are instead "pollution."
The "absolute" pollution exclusion is also not necessarily absolute, Hoffnagle added, noting that its scope varies from one court jurisdiction to another depending on specific policy terms and the other individual case facts.
Where commercial general liability policies include a pollution coverage extension, the terms of those extensions will also likely be disputed. The extensions generally cover "sudden and accidental" or "abrupt and instantaneous" discharges and may define these -- as Warren's policy did -- as happening at a specifically identifiable time and date.
Nevertheless, the exact meaning of "sudden and accidental" will probably be litigated, along with the applicability of notice provisions such as Warren's, experts said.
Policyholders losing on "sudden and accidental" claims may argue alternatively that liabilities arising from public nuisance or trespass claims -- often included in underlying liability lawsuits -- are covered under personal injury provisions of commercial general liability policies, Pernicone said.
The number of occurrences will likely also become an issue in cases where pollution is covered: Drilling sites often have multiple wells, and if more than one well is involved in an event, policyholders may argue that there have been multiple occurrences to maximize per occurrence limits, Pernicone said.
Similar battles will develop over allocating liability in cases where -- for instance -- pollution lawsuits target multiple wells in the same vicinity, owned by different companies, covered by different insurers and possibly involving more than one policy year for each well.
"You are going to have messy allocation issues," Hoffnagle observed.
Many parties in oil and gas development also include indemnification and contribution clauses in their contracts: Drilling and other subcontractors, for example, might agree to indemnify a well operator for liabilities arising from their work. These provisions will likewise create thorny allocation problems in the event of a loss, he added. "You have a lot of players out there doing different things on the same site, so there will be a lot of finger-pointing," Hoffnagle said.
Many fracking liability lawsuits, meanwhile, include demands for medical monitoring for those whose drinking water is contaminated. Policyholders and insurers will be fighting over these liabilities, too, with insurers maintaining that without actual bodily injury to claimants, no coverage for medical monitoring is triggered, Pernicone said.
State laws and regulations will also affect energy companies' insurance recoveries in contamination cases, Conley said. In June, for example, Ohio enacted a bill that requires well operators to maintain liability insurance with at least $5 million in limits, including a "reasonable level" of environmental liability coverage. The $5 million limit applies whether an operator owns one well or 50 wells, though, and there is no explanation of what level of pollution coverage is "reasonable," he said.
The law also requires an operator to maintain the coverage until all of its wells are capped and abandoned. If groundwater contamination is discovered two or three years later, Conley pointed out, there is no guarantee that that coverage will still be in force.
DOUG MCLEOD writes about risk management and insurance. He can be reached at firstname.lastname@example.org.
October 1, 2012
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