Hydrofracking: A rising star, but uncertainties exist

Surging energy needs

Modern lifestyles are leading to greater demand for energy. The U.S. Energy Information Administration (the “IEA”) predicts that world energy consumption will rise nearly 60% in the next three decades. Whilst renewable energy use is growing, fossil fuels still dominate and are expected to make up around 80% of total energy use through to 2040. Natural gas is the fastest growing traditional energy source, which has been bolstered by shale gas extraction as technologies for hydraulic fracturing (also known as “hydrofracking”) evolve.

What is hydrofracking?

Hydrofracking is a technique to fracture shale rock by pumping in a hydro fluid (water, sand, and chemicals) and extracting natural gas. The technique has been around for over half a century, although its usage has exploded recently. Hydrofracking is different from conventional natural gas drilling in several ways:

  1. Hydrofracking uses significantly more water, which is mixed with chemicals to form the hydro fluid;
  2. Most hydro fluids in use have high toxicity potential, which could have a lasting impact on ecosystems; and
  3. Drilling deep into the earth is likely to have a significant impact on the surrounding environment, causing damage beneath the ground and to the land surface and contaminating ground and surface water.

Risks associated with hydrofracking

There are a number of scientific and political disputes over the risks associated with hydrofracking. The greatest of these is groundwater contamination, caused by (a) hydro fluids, (b) natural constituents such as radium released in the process, (c) disposal of used water (backflow) and (d) methane accumulation in drilling wells.

Many hydrofracking operations are alleged to have links with small earthquakes experienced near some drilling wells. The operation injects water, sand, and chemicals into the ground at extremely high pressure, cracking shale deposits to free up trapped natural gas. When rock splits and moves, the vibrations generated can cause a seismic event.

Due to their lasting impacts, other areas of concern are air pollution, greenhouse gas emissions, drilling noise, deforestation and loss of agricultural land, aggressive expansion of drilling activities and accidents during the transport of toxic chemicals and waste.

Potential impacts on insurance business

Dozens of U.S. lawsuits have been filed against hydrofracking business owners, operators and contractors, with plaintiffs including municipalities, environmental citizen groups and individuals. Hydrofracking is an emerging liability segment, with some experts calling it “the next asbestos.”

A likely claim scenario is that groundwater contamination could trigger coverage of an environmental/pollution liability policy, providing indemnity for bodily injury, property damage, and remediation costs. Commercial entities involved with hydrofracking usually have Comprehensive General Liability (CGL) insurance, which covers third-party liabilities arising out of covered premises/operations and products/completed operations. CGL may also cover a sudden and accidental pollution incident, unless such risk is explicitly excluded.

Workers’ compensation and employers’ liability also deserve attention. Potential exposures are not limited to death/permanent disability or injury caused by an accident. Occupational diseases, whether acute or chronic, could also have a prolonged impact.

In addition, a catastrophic accident may damage the value of any business involved. Directors and officers may rely on Directors & Officers coverage, which provides defense and indemnity for any alleged errors, omissions or misstatements.  

Given the potential risks, issues originating from such claims could be similar to those seen in respect of (a) asbestos, pollution, toxic tort and other types of long-tail claims and (b) catastrophic incidents like the Deepwater Horizon Oil Spill. Resolutions of these issues would be driven by the facts of a given claim, the relevant policy language and applicable laws and regulations.

The future for hydrofracking in Asia Pacific

In June 2013, the IEA released an updated assessment of shale gas resources in 41 non-U.S. countries. It found that China possesses the largest potentially recoverable shale gas resources, while Australia, Pakistan and India also rank among the world's top 20 countries for shale gas reserves. Although shale gas extraction in the Asia Pacific region is still at an early stage, rising energy demand will accelerate hydrofracking activities.

While hydrofracking looks promising, the technique brings with it a variety of potential risks, liabilities and exposures. The insurance/reinsurance industry is unlikely to eliminate all of the uncertainties and will have to monitor the evolving risk landscape. In doing so, it will need to steer these risks within manageable boundaries.  

Published June 2014

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