Shaking Things Up

Some view it as a source of jobs, energy, and foreign independence; others view it purely as a menace. Whichever side you are on, fracking is percolating through contemporary media and culture as its use explodes across the globe.

Most recently, fracking has become associated with earthquakes, as several states are reporting frequent, small tremors surrounding fracked wells and water disposal wells. Some geologists are now claiming that fracking and water disposal wells are even shifting the tectonic plates. Could they really be responsible? And how does this affect your company’s risk exposure?

First, a quick primer on fracking, which refers to two different drilling technologies—horizontal drilling and hydraulic fracturing. Horizontal drilling is just what it sounds like—a well is drilled horizontally rather than vertically through an oil and gas producing formation. This can have great benefit for productivity because most productive formations in nature are oriented horizontally. The amount of oil and gas flowing into a well is determined by rock permeability (the ability of the rock to transmit oil and gas) multiplied by the height of the rock exposed to the wellbore. Horizontal drilling greatly increases this height, and hydraulic fracturing increases the permeability.

To increase permeability, a proppant (usually sand) is suspended in water plus a small amount of other chemicals, and the mixture is pumped at a high pressure down the well and into the productive formation to create small cracks or fissures in the rock and prop the fissures open. Typically, approximately 20 percent of the water used in the frack is recovered; the rest remains in the formation. This recovered water, or flowback water, typically is very salty because it has been mixed with natural formation water and contaminated with petroleum products. Flowback water is often disposed of by pumping it into deep disposal wells at a high pressure (sometimes up to 9,000 psi).

Where Fracking and Water Disposal Are Performed

The use of fracking has grown across the world exponentially but nowhere as fast as in the United States. In fact, it is easier to discuss where fracking is not occurring rather than where it is. Fracking is currently banned in three states—Massachusetts, New York, and Vermont. Fracking is not currently commercially feasible in 16 states— Arizona, Connecticut, Delaware, Georgia, Idaho, Iowa, Minnesota, Montana, New Hampshire, New Jersey, Oregon, Rhode Island, South Carolina, South Dakota, Washington, and Wisconsin—due to the lack of reserves, unusually difficult formations, or both. But thanks to constantly improving technology, fracking likely will be coming to many of these states in the future. Everywhere else in the United States there currently is fracking or preparation to begin fracking operations.

Most states have only a couple of hundred wells statewide. However, the top five states engaging in fracking as measured by the number of wells are: (1) Texas, with 33,753 wells; (2) Colorado, with 18,168 wells; (3) Pennsylvania, with 6,651 wells; (4) North Dakota, with 5,166 wells; and (5) Arkansas, with 4,910 wells.

While fracking and horizontal drilling have been expanding, the need for flowback water disposal also has been growing exponentially. The dramatic oil price increase beginning in 2004 and ending in 2014 stimulated fracking (which increased flowback water production) and also stimulated conventional oil production (which concurrently greatly increased flowback water production). In oil-producing regions, the number of water disposal wells has increased dramatically, as have injected water volumes. For obvious economic reasons, like transportation costs, water disposal wells are typically located very near oil and gas producing wells.

Is Fracking Causing Earthquakes?

Earthquakes have recently been associated, spatially and temporally, with water disposal wells and, to a lesser degree, fracked wells. The theory is that the flowback water, which is injected at high pressures, disturbs the existing subsurface stress field, triggers movement on a pre-existing fault, and causes an earthquake.

Over the past five years, parts of Oklahoma have experienced a marked increase in the number of small- to moderate-sized earthquakes. These increases in seismicity correlate with a fivefold to tenfold increase in the rates of water disposal in the affected areas. Studies by the Oklahoma Geological Survey (OGS) also note recent dramatic increases in seismic activity, stating that “the daily rate of magnitude 3.0 or greater earthquakes is roughly equivalent to that of the annual average from 1980 to 2008.” So, Oklahoma is having about the same number of 3.0 or greater earthquakes per day as they were having per year prior to 2008—a 365-fold increase.

The OGS further comments, “Nowhere else in the world sees the concentration [of earthquakes] that Oklahoma is seeing… We at the Oklahoma Geological Survey believe the rates and trends of seismicity are very unlikely to represent a naturally occurring process… Most likely, wastewater injection wells are the cause of the increase.”

Similarly, in the small town of Azle, Texas, northwest of Fort Worth, residents began experiencing numerous earthquakes between late 2013 and spring of 2014. Residents first went to the Texas Railroad Commission, the governing body that regulates the energy industry in Texas, for a solution, but they were continually told that no link was found.

So residents turned to the scientific community for help. Finally, researchers with Southern Methodist University (SMU), the University of Texas, and the U.S. Geological Survey issued a report in April 2015 concluding that “a combination of brine [and oil and gas] production and wastewater injection near the fault generated subsurface pressures sufficient to induce earthquakes on near critically stressed faults…” and that “brine production combined with wastewater disposal represent the most likely cause of recent seismicity near Azle.” The key takeaway here is that these recent earthquakes probably will be proven to be man-made sooner rather than later.

What Fracking Earthquakes Mean for Insurance Policies

If you are feeling safe because your company’s policy covers earthquakes, you may be on shaky ground. Specifically, if your company insures well operators, landowners, manufacturers of well equipment, or transportation companies involved in the oil and gas industry, it is time to take stock of the specific language of your liability policy, as you may not be covering what you think. Similarly, property policies historically have excluded earth movement and environmental-related losses unless specific earthquake or environmental policies are obtained. But these exclusions may not be sufficient now.

What’s changed? Science. Now that science appears to be coming to the conclusion that man-made wastewater injection is causing earthquakes, these exclusions may no longer be sufficient to exclude coverage from a typical property policy. Is the exclusion just referring to natural earth movement or also movement caused by man-made injection and removal of water from deep within the earth? This may seem like a trivial distinction until you consider that if the causal link between a company’s wastewater injection and earthquakes is established, then it is only a matter of time before experts can establish the causal link between wastewater injection by an insured and a claimant’s damages.

The time is now to look at your policies to keep up with the science. Especially for companies with commercial general lability policies, environmental policies, and first-party property policies, you should act now and not wait for the dust to settle. So here are some issues to consider.

Commercial General Liability Policies. With commercial general liability (CGL) policies, there are two main concerns. First, the scope of coverage in your CGLs typically includes protection against third-party bodily injury, property damage, and potentially nuisance and trespass damages. Claims have already been brought around the United States for bodily injury caused by earthquakes, property damage ranging from foundation cracks to rendering homes uninhabitable, nuisance from constant tremors, and subsurface trespassing due to tremors and earthquakes from nearby wells on adjacent properties.

Second, CGLs generally pay for the cost of defense if the policyholder should be brought into a lawsuit, and this cost of defense is relatively unlimited in most policies. Further, as the initial fracking-related lawsuits have shown, the area allegedly affected by fracking activities can be extensive. With science catching up to claims, this could result in expansive class action lawsuits for your company that test the limits of your policy. But even with single plaintiffs, the recent $2.9 million jury award in Parr V. Aruba Petroleum Inc. demonstrates that the recoverable noneconomic damages can be staggering. It is best to determine now what your CGL policies say about fracking earthquakes and how your company can protect itself from unintended coverage.

Environmental Policies. With environmental liability policies, the biggest source of expense that insurance companies should be guarding against is government-mandated investigation, enforcement, and remediation requirements following an allegation of pollution. Fracking-specific environmental pollution concerns have been well documented by the media in recent years: air pollution, surface and subsurface water contamination, chemical exposure, and transportation-related pollution, for example. Now, fracking earthquakes appear to be another viable pollution claim that needs to be defined specifically in your environmental insurance policies. Companies operating in fracking-hostile states need to be particularly aware of the evolving regulations, because many states—like Colorado, Ohio, Oklahoma, and Pennsylvania—are substantially increasing regulation following findings in Oklahoma and Texas that fracking may be causing earthquakes.

However, if you are concerned that your existing environmental policy might not protect insureds against seismic and fracking environmental claims, consider an environmental impairment liability (EIL) insurance policy. EILs provide protection against pollution and related property, bodily, environmental cleanup, and associated legal and business interruption expenses. Most EILs are written on a claims-made basis so that the claim must both occur and be reported during the policy period. Coverage also can be extended to gradual or aggregate pollution that may be excluded under some CGL policies due to the policy’s time limitations, but EILs generally do not provide coverage for “long-term gradual” pollution claims, appropriately limiting potential claims.

First-Party Property Insurance Policies. First-party property insurance policies (FPP) typically provide coverage for physical damages, or loss to the property owner’s own property, as well as economic damages that a policyholder incurs on account of business interruption due to property damage. In the oil and gas context, this could be a well blowout or a well shutdown/suspension due to earthquakes caused by wastewater injection activities. The earthquakes themselves also could cause property collapse, cracking, shifting, or sinkholes, which are covered under most FPPs. The business interruption provisions of the FPP can reimburse a policyholder for lost profits resulting from actual damage to his property. Additionally, FPPs sometimes contain contingent business interruption coverage, which provides protection for lost profits due instead to the policyholder’s supply chain.

The biggest difficulty for insurance companies with fracking and FPPs is determining when the loss or damage occurred. Fracking earthquakes can be causing latent, progressive, and continuance losses to the insured’s property over years without detection. Because of this, many policies include a “manifestation trigger” for FPPs, which dictates that the damage occurs for policy purposes when it becomes manifest or apparent to the policyholder. Therefore, insurance companies should be exceedingly careful that they do not unintentionally grant coverage outside the policy period by utilizing this language.

Exclusions. Of course, the golden rule of insurance policies applies here: for every inclusion, there is an equal and expansive exclusion. More and more insurance companies are adding hydraulic fracturing exclusion endorsements to their policies, which better limits the insurance company’s liability for any fracking activities or injuries caused by fracking. These exclusions are effective for limiting the exposure resulting from fracking activities specifically, as well as related property and environmental losses generally.

If your company is insuring clients that are involved around fracking activities or wastewater injection wells or have property around these activities, verify that this exclusion is in effect and updated to protect against unnecessary exposure.

Insurance companies should get shaking now and figure out if their policies protect against potential claims caused by fracking earthquakes. Because as science moves forward in understanding, companies’ coverages must follow. Use this information to reevaluate the policies your company currently provides and whether further definitions and exclusions will help limit future exposure to the impending fracking claims wave.