Analysis: Insurers find it tough to price fracking risk

Fri May 11, 2012 3:08pm EDT

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(Reuters) - From water worries to well blowouts, the inherent risks of oil and gas extraction are often played down by those in the business. But another group of profit-seekers has every reason to keep a close eye on dangers for drillers: their insurers.

Underwriters now face a politically charged problem in the perceived threats to water supplies of hydraulic fracturing.

Amid litigation and federal probes, insurance companies are left scratching their heads over how to price the risk of the oil and gas production technique now better known as fracking.

The lawsuits and tests so far provide little help. One much-cited case involved Cabot Oil & Gas Co, which settled in late 2010 for $4.1 million with residents of the small Pennsylvania town of Dimock over methane found in their water.

Then on Friday, the Environmental Protection Agency said it had completed testing water at 61 homes in Dimock and found the drinking water was safe to consume.

Insurers may get more clarity once EPA releases initial findings, due later this year, of its five-state investigation into the risks to drinking water of fracking.

Environmentalists say it can also pollute if fracking fluids seep out of wells. An EPA study showed fracking chemicals were likely present in a Wyoming aquifer near the town of Pavillion, but then it agreed in March to retest the water.

"From an insurance standpoint, it's really hard to underwrite something with a lot of uncertainty," Jeffrey Hanneman, the Texas-based director of environmental practice at insurance broker Aon Risk Solutions, said of fracking, "an area that now preoccupies a lot of my time."

Traditional forms of insurance for the oil and gas industry suddenly appeared inadequate once the shale boom was in full swing and water-contamination lawsuits cropped up, he said.

While some insurers avoid it, others like XL Group, Ironshore, Chartis and Zurich Insurance Group sell products such as those that cover the millions in dollars of costs of defending against pollution claims, even if they end up being dismissed.

FRACKING EXCLUSION

Insurance broker Willis Group said the market was getting tighter for what is known as "environmental impairment liability" - the coverage that would most directly relate to pollution claims from accidents - and so the cost is going up.

"Indeed, some insurers have started to exclude fracking activities from their policies," Willis said in an energy market review last month, which found that those who do cover it often restrict it for firms in the Marcellus shale, where Dimock is.

Willis said policies for blowouts - called Operator's Extra Expense - exclude pollution from an underground blowout, which it saw as unlikely to change given the risks tied to fracking.

Plus, regulation varies between states and against federal standards. "Sometimes they're in conflict with each other," said Hanneman. "How do you decide which way this is going to go?"

But he expects the ultimate EPA findings on drinking water will sharpen up the debate. " That whole study is obviously a game changer as far as how the insurance industry will view these risks going forward."

Fracking involves injecting chemical-laced water into wells to crack open shale rock and release natural gas and oil. While the technology is far from new, it has never been deployed as widely and extensively as in the past few years.

Mark Regier, director of stewardship investing for Everence Financial, said the fracking debate entered a less contentious phase in the past year as firms like EOG and Chesapeake open up about it, though Chesapeake just took a hit to its safety credentials with a blowout in Wyoming.

"We're hopeful that both the industry and the investment community and other related groups like the insurance industry are realizing that we are at the beginning of a boom or a rush, and that with that comes escalated risks," Regier said.

While experts see bigger environmental dangers around other energy assets, from pipelines to refineries, their record of past accidents and damages allows insurers to price those risks.

Andrew Scholz, a special counsel at Goldberg Segalla in New York, saw parallels with long-running disputes like asbestos coverage, in that many complex issues have not yet been decided.

"The underlying litigations concerning fracking are still in their infancy," he said. "There are many suits being filed and many more everyday, but many haven't gone to judgment and you haven't gotten to expert causation issues."

For example, if a trucker hauling fracking wastewater had an accident that led to a spill, a commercial general liability policy would have a pollution exclusion denying coverage; except in some states, the spill would be considered property damage and not environmental, so the exclusions would not apply.

DRILL DOWN FOR DATA

Scholz said the lack of clear legal precedents meant lawyers had to draw analogies from other energy-related cases.

"Some have settled, some have been dismissed," according to Aon's Hanneman. "We just don't have a lot of data to decide what really is a risk from an insurance standpoint."

A recent case about polluted water brought against Range Resources Corp in Texas, and supported by the EPA, was dropped last month after the judge decided it could not go ahead because the state regulator exonerated Range.

An EPA spokesman said the end of that case would allow the agency to shift its focus away from litigation and towards a "joint effort on the science and safety of energy extraction."

But that effort may not be as comprehensive as many hope.

"I actually don't think anything all that helpful is going to come from the federal government any time soon," said Jim Smith, a partner in the environmental section of Houston law firm Porter Hedges.

Smith saw the EPA report as just one part of a process of people growing more comfortable with fracking over time, assuming no evidence of a drinking water threat emerges. He saw a comparison in the decades-old worries about living near power lines and fears about electromagnetic fields, which gradually diminished due to lack of any clear scientific evidence.

(Reporting by Braden Reddall in San Francisco and Ben Berkowitz in Boston, with additional reporting by Tim Gardner in Washington; Editing by Patricia Kranz and Tim Dobbyn)

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