Last Updated 9/30/2019
Issue: The introduction of new drilling technologies and techniques has led to a significant increase in oil and natural gas production worldwide. The new discoveries include innovations in hydraulic fracturing, or “fracking” for short, and horizontal drilling. Hydraulic fracturing is a method in which large quantities of water, chemicals, and sand are injected into gas-producing shell rock beds, creating fractures in the shale formations and allowing gas to be extracted. When used in wells that have been horizontally drilled, producers can extract significantly greater amounts of shale gas than with other methods, allowing for better economies of scale in commercial production. The resulting improvement in productions costs and well productivity has led to record domestic shale gas production in recent years, bringing both opportunities and risks for the U.S.
Overview: Recent innovations in hydraulic fracturing have had a significant impact on the U.S. oil an gas industries. Shale gas production in particular has the ability to meet much of our domestic energy needs and serve as an exportable product. Indeed, the U.S. Energy Information Administration (EIA) estimates the U.S. has 323 trillion cubic feet of proved natural gas reserves, enough to potentially last a century. According to the EIA's 2018 Annual Energy Outlook (AEO2018), the U.S. becomes a net energy exporter in most of the AEO2018 cases due to strong domestic production and flat energy demand. Natural gas production from shale gas and tight oil plays as a share of total U.S. natural gas production is projected to continue to grow amid the more than 500,000 square miles of natural resources.
The Risks: Despite the economic benefits, hydraulic fracturing remains highly controversial due to its impact on the environment. The release of methane gas during the drilling process poses potential air pollution risks. Additionally, improper disposal of the large volumes of chemically treated water used in hydraulic fracturing operations has caused surface water contamination. Furthermore, the millions of gallons of water required for hydraulic fracturing may place additional strain on water supplies, particularly in drought stricken regions. Other issues include the potential for damage from induced earthquakes, operational failures, and transportation of equipment and resources.
In recent years, there has been an increase in earthquake activity in certain parts of the central and eastern U.S. that are known for oil and gas extracting. The United States Geological Survey (USGS) has linked the increase in earthquake activity in these regions to waste water disposal from hydraulic fracturing operations. The USGS identified 17 areas within eight states in the central and eastern U.S. with increased rates of induced seismic activity. These eight states are: Alabama, Arkansas, Colorado, Kansas, New Mexico, Ohio, Oklahoma and Texas, with Oklahoma showing the sharpest increase in induced seismic activity.
Insurance Coverage Implications: The increase in seismic risk in these areas usually underscores the need for homeowners to consider purchasing earthquake insurance that covers damage from induced earthquakes. However, some earthquake policies carve out coverage for earthquakes not naturally occurring, such as earthquakes attributed to waste water injection from hydraulic fracturing activities. Furthermore, many policies have anti-concurrent causation provisions excluding coverage for damage if both a covered and uncovered peril occur, regardless of whether the predominate cause of the loss was a covered loss. This could mean insurers may deny losses for covered perils, such as a fire, if the fire resulted from an uncovered peril, such as an induced earthquake.
Given the plethora of risks involved with shale gas production, it is also important that drilling companies have the proper insurance coverage. Most drilling companies carry commercial general liability insurance (CGL), which protects them against third-party bodily injury and property damage claims. Many also add on business interruption insurance in order to protect themselves from income disruptions, as might occur with a well closure. Additionally, most oil and gas producers purchase operator’s extra expense (OEE) liability coverage to cover liabilities related to well failures. However, environmental exclusions and other limitations placed on such policies mean other types of coverage will need to be in place to protect fully against environmental and seismic claims. These additional policies could include umbrella policies to cover expenses exceeding what is generally afforded under the CGL, environmental liability insurance to protect against pollution risks, and directors and officers (D&O) insurance to protect key company personnel from legal action losses. It should also be noted that homeowners insurance does not cover damage incurred from seismic activity; therefore, homeowners exposed to this risk will need to purchase earthquake specific coverage.
As the use of hydraulic fracturing to extract shale gas continues to proliferate, the insurance industry will become increasingly exposed to its related risks. Liability policies are likely to be most impacted; given the possibility that covered losses could be triggered under multiple policies for a single incident. Additionally, while hydraulic fracturing poses many of the same risks as other drilling operations, it does have some unique environmental risks that are not yet well understood. As drilling related claims rise, the opaqueness of these unique environmental concerns, and how coverage of such risks will be viewed legally, creates ambiguity on potential claim losses for insurers.
Modeling and Mitigation Implications: During the CIPR All Things Earthquake event, a panel of scientists and modelers addressed the link between waste water disposal from hydraulic fracturing activities and earthquakes. The researchers emphasized that it can be difficult to model for induced seismicity because the rate of events is non-stationary and is influenced by human decisions. In differentiating between natural and induced seismicity, geologists explained that induced earthquakes have different characteristics in a geothermal field and behave differently compared with historic earthquakes and plate boundary earthquakes. For more on this event, please refer to the CIPR Newsletter article Insurance Regulators Discuss Earthquake Insurance Issues and Challenges at Event.
Given the external variables that influence induced seismicity, mitigation efforts for induced and natural earthquakes should be viewed differently. Building code enhancements are typical mitigation measures for earthquake risk, however these are difficult to implement when the hazard from induced earthquakes can change before the building regulations are enacted. Induced seismic activity has been linked to known human activities that are themselves regulated at the state and national levels. As such, reducing induced seismicity at the source is likely to be the best prevention measure.
Status: The USGS One-Year Seismic Hazard Forecast distinguishes between induced and natural occurring earthquakes by using two different models. The one-year seismic hazard model will only be used to forecast short intervals to account for the rapid variation of induced seismicity in space and time. The 2017 One-Year Seismic Hazard map showed, when accounting for induced seismicity, hazard is higher than in the 2014 USGS NHSM in some areas by more than a factor of three. The report also found the chance of having a damaging earthquake in north-central Oklahoma and southern Kansas may reach levels similar to natural earthquakes in parts of California. The USGS' one-year time interval coincides with property insurance contracts. It remains to be seen if this could have implications on the coverage terms offered by insurers. Several catastrophe modeling firms are including man-made activity in their model updates.
Committees Active on This Topic
Fracking: There's Insurance Coverage for That?
2018, Perkins Coie LLP
EPA Releases Final Study on Hydraulic Fracturing
January 2017, National Law Review
All Things Earthquake
August 2015, CIPR Event
Man-made Quakes Shake Up Modeling
June 12, 2018, Business Insurance
Earthquakes Follow Wastewater Disposal Patterns in Southern Kansas
February 20, 2018, Seismological Society of America
Insurance Implications of Hydraulic Fracturing
October 2013, CIPR Newsletter
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Regulatory Research Specialist