Hydraulic Fracking and Insurance

January 9, 2014

Transitioning to Green

For MSO

Agenda

• Welcome, Introductions and Background

• Hydraulic fracking context

• Hydraulic fracking basics

• Hydraulic fracking risks

• Stakeholders and Industry collaboration

• Q & A (5 min)

• Insurance industry response

• Insurance industry precedents and policies

• Insurance Claims and Coverage Issues

• Conclusions, Q & A and next event (10 min)

Welcome

Jan Scites, CEO & President, MSO

• TTG Vendor partner with MSO • Survey on Green and Sustainability 2013 • Webinar terrific response • MSO national footprint • MSO committed to providing education to the

insurance industry

Welcome

• Transitioning to Green, LLC – Help organizations determine where they are, where they want to

go and how they can get there in the green economy

– We do this through, consulting, training and LeaderShip for Sustainability.

• Our promise is simple… by applying “holistic sustainability” business practices, we assist every organization we touch to simultaneously and synergistically:

– Engage your People

– Sustain Our Planet

– Optimize your Profitability 4

Jeana Wirtenberg, President & CEO, Transitioning to Green

Today’s Presenters

• Bill Russell, Principal, Transitioning to Green, LLC – Chemical Engineer, MBA-Finance – Hazardous waste site investigator / engineer – Former US environmental practice leader of

PwC • Expert witness on Superfund and Asbestos

Litigation • Advisor to insurance industry on new

environmental risk products • Advisor to industry on Sustainable Enterprise

practices

– Professor, Green Accounting Columbia University

5

• Linda Kelley, Principal, Transitioning to Green, LLC – Enterprise Ecologist

– Artist and naturalist

– Practitioner of whole systems approach to strategy, innovation, collaboration, and learning

– Consultant to business and government

– Pioneer in virtual technologies for collaborative learning

Transitioning to Green Webinars

• High level perspective of sustainability related to insurance risks

• Highlighting the nexus between traditional insurance interests and the emerging nexus of energy, water and food

• A series of three webinars that address concerns and interests expressed by insurance professionals in the MSO Survey in the Spring of 2013 – Hydraulic Fracking and Insurance

– Insurance Risks and Freshwater Quality

– Issues of Food Security and Insurance

Top Industry Risks Related to Greening, continued

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Important

Critical

4. How important are risks related to water and energy quality and reliability?

12. How important is quantifying economic impacts and financial value of "green" risks?

7. How important are risk issues related to air pollution, smog and indoor air quality?

8. How important are risk issues related to wetlands preservation, biodiversity and ecosystem conservation?

Important + Critical = 39%

Important + Critical = 48%

Important + Critical = 46%

Important + Critical = 40%

Top Industry Risks Related to Greening, continued

Important + Critical = 36%

Important + Critical = 30%

Important + Critical = 26%

Important + Critical = 16%

3. How important are risks related to green vehicles, accidents and repair?

11. How important is green marketing and false advertising liabilities related to "greenwashing"?

1. From your company's perspective, how important is assessing risks related to green buildings certifications and service professionals performance claims (e.g. architect design not able to achieve LEED Gold certification level as originally planned?)

10. How important are Directors and Officers insurance policy implications/riders for green/sustainability business practices?

Hydraulic Fracturing Sustainability Context

• World Economic Forum Business Risks

• Energy, Water, Food Nexus

• Climate change and Energy supplies

• Increasing role of Natural Gas

Serious, strategic, preventable risks. World Economic Forum, 2013

Water-Food-Energy nexus

Water, food and energy are inexorably interconnected

Global energy consumption projections

http://www.eia.gov/forecasts/ieo/world.cfm

US Consumption of Natural Gas

In 2012, the U.S. consumed approximately 25.46 trillion cubic feet (Tcf) of natural gas in seven consumer end-uses.

• Electric power generation: 9.14 Tcf (36%) • Industrial: 7.10 Tcf (28%) • Residential: 4.18 Tcf (16%) • Commercial: 2.90 Tcf (11%) • Lease and plant fuel consumption: 1.39 Tcf (5%) • Pipeline and distribution: 0.71 Tcf (3%) • Vehicle fuel: 0.03 Tcf (<1%)

Note: Total does not equal the sum of consumer end-uses due to rounding.

US Natural Gas production

http://fuelfix.com/blog/2014/01/06/10-things-to-consider-about-the-marcellus-shale/

US Natural Gas production by shale source

Hydraulic Fracturing Basics

• Insertion of a mix of fluid chemistry—including water—into an encased drill hole under extreme pressure

• Result: hydraulic fracturing of deep rock layers

• Rather than a simple drill hole, the process employs vertical drilling that then bends and extends horizontally

http://usatoday30.usatoday.com/news/nation/story/2012-05-29/fracking-environment-gas/55845708/1

Environmental Protection Agency illustration of the water cycle of hydraulic fracturing

Geographic areas with shale gas

• Shale beds http://energyblog.nationalgeographic.com/2011/08/11/shale-panel-better-greenhouse-gas-data-needed/

Mid-Atlantic geographic area with underlying shale gas

Figure 1: • The green area on this map marks

the geographic extent of the Utica Shale. Included in this extent are two laterally equivalent rock units: the Antes Shale of central Pennsylvania and Point Pleasant Formation of Ohio and western Pennsylvania. These rocks extend beneath several U.S. states, part of Lake Erie, part of Lake Ontario and part of Ontario, Canada. If developed throughout this extent, the Utica Shale gas play will be larger than any natural gas field known today.

• Inside the yellow line outline is the higher Marcellus shale bed

• http://geology.com/articles/utica-shale/

Hydraulic Fracturing Risks

• Water – Use in the drilling and production process – Groundwater protection – Wastewater management and disposal

• Air – Methane Gas Emissions contributing to Climate Change

• Lands – Earthquakes – Property rights and leases – Construction site impacts and environmental effects – Abandoned wells and environmental restoration

Competition for Water

This map, produced at www.ceres.org, shows that nearly half of all US shale gas and oil wells are being developed in

regions of the US with high to extremely high water stress. The research is based on well data from FracFocus.org.

http://scienceblogs.com/significantfigures/index.php/2013/06/27/the-growing-evidence-of-the-threat-of-fracking-to-the-nations-groundwater/

Fracturing a single Chesapeake Niobrara deep shale well requires an average of 4 million gallons of water

How much is 4.3 million gallons?

• The 4.3 million gallons of water needed to drill and hydraulically fracture a Niobrara Shale well is equivalent to the amount of water consumed by:

• The City of Denver in approximately 26 minutes

• A 1,000 megawatt coal-fired power plant in approximately 10.5 hours

• Irrigating a typical Colorado golf course for 21.5 days

• Irrigating 6.5 acres of Wyoming wheat for a season

While these represent continuing consumption, the water used to produce oil and natural gas from a deep shale well is a one-time use.

Competition for Water

Water contamination

“Robert Jackson, a chemical engineer at Duke University, found methane in 115 of 141 shallow, residential drinking-water wells. The methane concentration in homes less than one mile from a fracking well was six times higher than the concentration in homes farther away. Isotopes and traces of ethane in the methane indicated that the gas was not created by microorganisms living in groundwater but by heat and pressure thousands of feet down in the Marcellus Shale, which is where companies fracture rock to release gas that rises up a well shaft.” Scientific American, September 12, 2013 http://www.scientificamerican.com/article.cfm?id=groundwater-contamination-may-end-the-gas-fracking-boom

Earthquake

http://www.nbcnews.com/science/fracking-practices-blame-ohio-earthquakes-8C11073601

This map shows the intensity of shaking in the area of a magnitude-3.9 earthquake that struck near Youngstown, Ohio, on Dec. 31, 2011. Research has linked this earthquake to the underground injection of wastewater from fracking.

Global greenhouse gas emissions from natural gas production

• Leaks from natural-gas production and other human activities may be releasing more of the powerful greenhouse gas methane into the atmosphere than the Environmental Protection Agency thinks. (MIT Technology Review)

• Estimated CO2 emissions from energy sources

http://www.technologyreview.com/view/522021/greenhouse-emissions-from-natural-gas-production-and-agriculture-higher-than-expected/?utm_content=buffer1385d&utm_source=buffer&utm_medium=twitter&utm_campaign=Buffer

http://therivardreport.com/wp-content/uploads/2013/01/consumption_emissions_pie.jpeg

Who are the stakeholders?

• Energy related companies

– Energy companies

– Drilling companies

– Component manufacturers

• Farmers and ranchers

• Homeowners and business owners

• Municipalities

• And more…

Industry Collaboration

• CSSD is an independent 501(c)(3) nonprofit organization whose mission is to support continuous improvement and innovative practices through performance standards and third-party certification. [It is focused ]on shale development in the Appalachian Basin

• The Center provides a forum for a diverse group of stakeholders to share expertise with the common objective of developing solutions and serving as a center of excellence for shale gas development.

https://www.sustainableshale.org/

The Center for Sustainable Shale Development

Center for Sustainable Shale Development Partners • Chevron • Citizens for Pennsylvania’s Future (PennFuture) • Clean Air Task Force • CONSOL Energy • Environmental Defense Fund • EQT Corporation • Group Against Smog and Pollution (GASP) • Heinz Endowments • Pennsylvania Environmental Council • Shell • William Penn Foundation

• No insurance companies???

Industry Collaboration

Precautionary Principle

“The precautionary principle or precautionary approach states that if an action or policy has a suspected risk of causing harm to the public or to the environment, in the absence of scientific consensus that the action or policy is harmful, the burden of proof that it is not harmful falls on those taking an action.”

http://en.wikipedia.org/wiki/Precautionary_principle

Q & A

5 minutes

Insurance Industry Implications

• Insurance industry precedents and awareness

• Insured policy and claims issues

• Insurance coverage issues

Industry Precedents

• Oil and Gas Drilling

• Underground Storage Tanks

• Hazardous waste sites and Superfund

• Natural Resource Damages

BP oil spill

Fracking Regulation Timeline

• 1996 - EPA concluded that the UIC did not apply to fracking. • 1997 - The United States Court of Appeals for the Eleventh Circuit

overturned this EPA policy. • 2003 - The EPA entered into a Memorandum of Agreement with the

three largest providers of hydraulic fracturing fluids. • 2005 - Congress exempted hydraulic fracturing from the SDWA

under the Energy Policy Act. • 2010 - The EPA began to reassess the effect of hydraulic fracturing

on drinking water. • 2011 - The SEC entered into dialogue and began “asking” oil and gas

companies to provide detailed fracking information, including chemicals.

• 2013 - The U.S. Environmental Protection Agency issued “significant new use rules” under the Toxic Substances Control Act for 15 chemical substances.

Nationwide Underwriting Guidelines

• In July 2012, the Associated Press reported on an internal memo from Nationwide Mutual Insurance Co. “detailing underwriting guidelines” regarding hydraulic fracturing (“fracking”).

• The Associate Press quoted the memo, which said:

Nationwide confirmed the memo was genuine, but not intended for public dissemination.

After months of research and discussion, we have determined that the exposures presented by hydraulic fracturing are too great to ignore. Risks involved with hydraulic fracturing are now prohibited for General Liability, Commercial Auto, Motor Truck Cargo, Auto Physical Damage and Public Auto (insurance) coverage.

Nationwide Underwriting Guidelines Following the Associated Press story, Nationwide Mutual Insurance Company issued a press release regarding its coverage for claims relating to damages from hydraulic fracturing (“fracking”).

• The Columbus, Ohio-based company notes that in “recent years, oil

and gas exploration has come to New York, Pennsylvania and Ohio.” • Nationwide said it had not changed its policies or guidelines for

fracking coverage and was not cancelling policies, but that “[f]racking-related losses have never been a covered loss under personal or commercial lines policies.”

• Noting that risks like “natural gas and oil drilling are not part” of

their insurance contracts, Nationwide said its “personal and commercial lines insurance policies were not designed to provide coverage for any fracking-related risks.”

Energy Companies Insurance and Claims

• Insurance coverage is a paramount concern for those engaged in or entering the fracking industry especially in light of the extensive negative public reaction to same.

• The main issue is whether the policy written by the underwriter will indemnify the insured if an unintended consequence results from the intended act of fracking. – If a plaintiff or a class of plaintiffs alleges that a local drinking water supply

has been contaminated as the result of fracking activity will an insurer defend and indemnify the insured or will the insurer refuse to do so based upon the pollution exclusion contained in most CGL policies.

• While insured will argue that the contamination is an unintended consequence of their intentional activity it remains uncertain whether the courts will agree.

Other Insured Stakeholder Claims

• Homeowners

• Energy Industry Workers

• Business to Business

• Directors and Officers

• First Responders – Liability from fire, police and medical personnel who administer emergency

services following an incident.

• Government Suits – i.e. Attorney General files “citizen suit” seeking injunctive relief and civil penalties for

surface water contamination

Homeowner/Residential Claims

Allegations:

• Initially allegations of contamination of surrounding land, ground and surface water

caused by faulty well-casings, improper drilling and/or the improper disposal of fracking fluids. • Plaintiffs tend to live in rural areas with private water wells that they claim are

being contaminated with fracking chemicals. • Other plaintiffs have alleged that there are now high quantities of non- fluid

substances in their wells, and that the fracking activity caused methane to migrate into their wells.

• Allegations fracking resulted in air pollution and excess noise. • Allegations fracking given rise to earthquakes, resulting in property damage. • Ground subsidence or sinkhole claims.

• Limestone formation may naturally dissolve by the circulation of water. Results in formation of underground caverns and voids. Land collapses.

• Claims also from pipelines required to transport gas extracted from the fracked wells.

Homeowner/Residential Claims Defendants

• Natural gas drilling and exploration company spearheading fracking operations

• Contractors and subcontractors who participated in fracking operations

• Design professionals who assisted in the development of the fracking process

• Chemical companies who prepared components used in fracking fluids

• Property owners who leased land for hydraulic fracturing (particularly if these owners have “deep pockets)

• Manufacturers and installers of pipelines; and • Energy companies that utilized these pipelines.

Homeowner/Residential Claims

Damages

• Common- law theories : Strict liability, negligence, private nuisance, physical trespass, medical monitoring, emotional distress, “inconvenience and discomfort” and negligence per se. • Trespass alleges contaminated materials generated by fracking infiltrated the

plaintiff’s property • Strict liability alleges drilling is an “ultra-hazardous” or “abnormally dangerous”

activity.

• Other theories of damage claimed including bodily injury, diminution in property values, breach of quiet enjoyment, loss of business, increased risk of disease and punitive damages.

• In addition to claims for monetary damages (including punitive damages and attorneys’

fees), plaintiffs frequently seek injunctions to stop drilling activity and mandate remediation of alleged contamination.

Homeowner/Residential Claims

Defenses

• Question of whether hydraulic fracturing is an “abnormally dangerous” activity not addressed by court.

• Courts have addressed more general question whether drilling and operation of natural

gas wells may be deemed “abnormally dangerous.” • In Williams v. Amoco Production Co., Kansas Supreme Court reversed a jury verdict

that was based in part upon the determination that strict liability should be imposed for such activity.

• Court accepted contention that “neither the operation of a gas well nor natural gas as a substance presents a high degree of risk of harm.”

• The Court also noted that as the drilling and operation of the wells occurred on “the largest known reservoir of natural gas in the world,” the “drilling and operation of natural gas wells in this area is a common, accepted and natural use of the land.”

Business to Business Claims

• Power company filed suit against engineering firm who constructed fracking fluid treatment plant. – Metal piping and containers corroded forcing six month plant closure.

– Engineering firm suggested treatment technologies that did not work.

– Causes of action for breach of contract, negligence and negligent misrepresentation.

Directors & Officers Liability Claims

• Not unlike the Deepwater Horizon/BP spill, where derivative actions were brought against the directors and officers (D&O)

• Cabot Oil and Gas, a $4.2 billion corporation involved in hydrofracking in Pennsylvania has already been named in several groundwater contamination lawsuits, could potentially face shareholder derivative lawsuits as a result of those litigations and related losses.

• The SEC’s interest in fracking was presented as ensuring that investors were being told about risks a company may face related to its operations, such as potential lawsuits, compliance costs, environmental liabilities, and other uncertainties, including production estimates. Oil and gas companies were “asked” to supply information confidentially to the SEC. It is uncertain what further steps the agency may take.

Directors & Officers Liability Claims

Stranded Assets? • Listed companies face a carbon budget deficit

• Pro-rata allocation of the global carbon budget, this would amount to around 125 - 275GtCO2, or 20 - 40% of the 762GtCO2 currently booked as reserves.

• The scale of this carbon budget deficit poses a major risk for investors.

• They need to understand that 60 - 80% of coal, oil and gas reserves of listed firms are unburnable.

Source: Carbon Tracker and Grantham Research Institute on Climate Change and the Environment, LSE, “Unburnable Carbon 2013: Wasted capital and stranded assets”

D&O Liability Claims

Potential Fracking Claims

• Environmental/pollution claims: Any bodily injury or property damage caused as a result of hydrofracking-related pollution or groundwater contamination.

• Comprehensive general liability claims: Coverage for liability resulting from

bodily injury or property damage that takes place during the policy period and is caused by an occurrence. Unless specifically excluded, CGL policies usually also provide coverage for losses associated with products, completed operations, premises and operations, and contractors. Moreover, those entities involved in the storage, treatment, transportation and disposal of hydrofracking fluids face potential liability under their CGL policies (as well as other possible sources of coverage).

• Operators’ extra expense claims: Hydrofracking wells have occasionally suffered blowouts as a result of the large amounts and highly pressurized water, “proppants” (sand or ceramic beads) and chemicals that are injected into underground shale formations. Should a blowout occur, many of the energy and drilling companies could look to this type of insurance to cover their losses.

First and Third Party Coverage Issues

• Property Damage

• Pollution Exclusions

• Triggers

• Number of Occurrences

• Causation / Concurrent Causation

• Collapse Coverage

• Earth movement exclusions

Pollution Exclusions

• General liability policies that were issued between the early 1970s and mid-1980s usually include the “qualified pollution exclusion.”

• This exclusion bars coverage for pollution related injuries to persons and property.

• The clause appears almost identically in all insurance policies.

This insurance does not apply…to bodily injury or property damage arising out of the discharge, dispersal, release or escape of ... toxic chemicals, liquids or gases, waste materials, or other irritants, contaminants or pollutants into or upon land, the atmosphere or any water course or body of water; but this exclusion does not apply if such discharge, dispersal, release or escape is sudden and accidental.

Pollution Exclusions

• Some courts have interpreted the exception to include coverage for injuries that were “sudden and accidental”

• Other courts have interpreted it as barring coverage for injuries that were “expected or intended.”

• Under either interpretation, the insurer will submit documents that consider the potential risks of the fracking technique as discussed in journals, trade publications, and in regulatory or legislative settings.

Warren Drilling Co. v. ACE American Ins. Co.

• Case involves an insurer’s (ACE American Insurance) refusal to extend coverage to its insured (Warren Drilling Company) for claims arising out of Warren’s fracking operations.

• In 2008, a homeowner claimed water was contaminated by pollutants from Warren’s fracking.

• Warren eventually settled its case with the homeowner but then sought to recover its legal fees from ACE for its refusal to defend and/or indemnify.

• For Warren to obtain a favorable ruling obligating ACE to indemnify it and to pay its legal fees, it had to show:

(1) The fracking resulted in an unexpected and unintended discharge of pollutants; and

(2) The discharge of pollutants was abrupt and instantaneous.

Pollution Exclusions

• Courts faced with coverage issues arising out of fracking operations may base their decisions on whether the claims asserted are barred by the pollution exclusion clause contained in the comprehensive general liability (CGL) policies issued by insurers.

• Many involved in the fracking industry are anxiously awaiting the court’s decision in Warren as guidance regarding the insured’s right to coverage for fracking claims.

• As for now, each individual needs to understand the specific wordings in their own policy in order to understand what to reasonably expect from their insurer.

Triggers

Establishing the trigger rule applicable to a first- party claim can significantly impact claim valuations. • Generally property insurance is not intended to indemnify for

loss that is ongoing and known to the insured. • Courts impose first-party property insurance coverage liability

for actual, but undisclosed, loss or damage that occurred over a prolonged time span, regardless of when that loss or damage became manifest.

• The manifestation rule affords insurers a strongly supportable argument to avoid liability when a latent, gradual loss first manifests prior to (or after) an insurer’s effective policy period.

Duty to Defend

• An insurer’s duty to defend is broader than its duty to indemnify.

• The insurer’s duty to defend arises when a complaint against the insured gives rise to any potential liability covered by the terms of the policy.

• The duty to defend exists even if the alleged claims are false or groundless.

• Additionally, the insured does not need to provide concrete evidence that the injuries were sudden and accidental; instead, the insured need only provide evidence of a reasonable possibility that the injuries were sudden and accidental.

Subrogation Recovery Opportunities

• Fracking has the potential to generate a great deal of troublesome coverage and litigation issues!

• That said, it provides insureds with subrogation and recovery opportunities. • Opportunities may exist when a carrier reimburses its insured for covered

losses, that are not otherwise excluded. • Subrogation targets could include natural resource companies, contractors

engaged in the drilling process and arguably complicit neighboring property owners where the operations are being engaged.

• Carriers should take appropriate steps from the outset to recognize contribution or indemnity claims against other companies or individuals who are arguably more responsible.

• Insurers facing claims against their property owner insureds should consider claims against those more directly involved with the drilling process on and around the property involved.

• Insurers met with claims against insureds that oversee the drilling activity must consider claims against their contractors to the extent clearly irresponsible activities may have given rise to such claims.

Subrogation Recovery Hurdles/Risks

• Factual Support: Plaintiffs have an uphill battle demonstrating a nexus between a particular drilling activity and alleged damages. – If a carrier indemnifies an insured for a covered loss, it then stands in

the shoes of the insured and must eventually demonstrate in any subrogation effort that the reimbursed damages were proximately caused by the negligent conduct of the subrogation targets identified.

• Contractual Limitations: Possibility exists contract contains risk allocation provisions that will limit or eliminate recovery efforts. – Hold harmless clauses.

– Arbitration clauses.

Conclusion

• Claims examples from participants

• Actions going forward

• Follow-up

• Evaluation survey via email

Upcoming MSO Webinars by Transitioning to Green

Insurance risks and fresh water quality Thursday, January 30, 2014

11:50 to 1:30 pm ET

The risk to water supply and quality is increasing along with the rapid growth in both public and private demand for its use. Severe weather events such as storms and flooding combined with aging infrastructure, faulty handling of waste, and inadequate system design among other factors contribute to increased liability exposure for insurers. In this webinar we will use case examples to look at some of the critical issues that insurers are facing as risks to water quality increase.

In between the obvious risks from crop failures and livestock epidemics, and food contamination at the retail level are food security issues and risks that run through the entire food supply chain. Because there are so many interconnected threads in food security, it is important for insurers to have a grasp of the entire picture. In this webinar we will give an overview of food security and safety that includes operational, regulatory and environmental liabilities. We will use actual cases as examples.

Issues of food security and insurance Thursday, February 13, 2014

11:50 to 1:30 pm ET

Thank you for your participation