Fracking: Frack to the future
With the government pushing hydraulic fracturing in the UK, how will developments in this market affect insurers and what risks does it entail? Shale gas drilling in the UK is gathering momentum as political leaders and drilling operators ramp up efforts to increase support for exploratory drilling in Britain. Prime Minister David Cameron has promised those local authorities that back hydraulic fracturing – or fracking – operations in their regions will keep more money in tax revenue. Meanwhile, fracking operators have pledged to create thousands of jobs through increased drilling.
So how will these developments affect insurers? They are already involved in insuring fracking risk – the majority of commentators contacted by Post were quick to emphasise fracking has been covered globally for many years in areas such as the North Sea, South Africa, Poland and the US. On the flipside, concerns have been raised in the press – and by anti-fracking groups – about the way fracking is conducted in the US, with apprehensions that potential UK drilling operations could result in similar water contamination and seismic issues. But there appears to be little cause for concern. A 2011 Energy and Climate Change select committee inquiry found that shale gas was unlikely to be as much of a “game changer” in the UK as it has been in the US, due to less land being available to drill on and landowners not owning the rights to the hydrocarbons beneath the land.
Joe McMahon, chief executive of specialist energy loss adjuster Lloyd Warwick, agrees with the inquiry wholeheartedly. “The fracking business in the US has operated for many, many years and it is only recently that there has been a huge increase in activity. Ownership for mineral rights is different in the US and, of course, they are not having to carry out these operations on our small and overcrowded island,” McMahon says.
Indeed, KPMG insurance director Robert Andrews considers population density to be a key risk factor for UK fracking operators and insurers – meaning that the densely-packed nature of the UK could prevent fracking from developing here at all. He says: “If you look at where this is done in the US, there are just not as many people living in some of these places. It means there is more potential damage [in the UK] if things do go wrong,” Andrews says.
“I find it hard to imagine that [fracking] will develop as [quickly] as in the US, because we are much more densely populated and there is much more potential for local opposition,” he adds.
Regulatory requirements will also be a lot more stringent in the UK, according to Zurich global energy offshore energy head Frank Streidl: “In the UK, [fracking] is heavily regulated and there is a lot of press and political interest in it.”
Questgates environmental division head Alan Dobson agrees US fracking regulations appear significantly more relaxed than in the UK. “They seem to be much more reliant on the landowner and the fracking companies, with the regulators having less involvement,” Dobson explains.
The way the US is regulated is another reason its fracking experience might differ from the UK’s. Andrews adds: “There is quite a lot of difference between states [in the US] in terms of how much fracking is allowed and what the legal third party liabilities could be.”
For example, the state of Vermont has banned fracking, with Massachusetts tipped to follow suit. Several cities, such as Dallas, have even placed moratoriums on fracking operations.
One US insurer, Nationwide Mutual Insurance Company, also got in on the banning action, confirming in 2012 that it would not cover damage related to fracking.
The UK takes a blanket approach to insuring fracking, and utilises existing oil and gas exploration regulations. Operators are required to obtain a UK Petroleum Exploration and Development license, as well as obtaining planning permission, access rights from landowners, permits from Environment Agencies, must meet health and safety regulations from the Health and Safety Executive, and get consent to drill and frack from the Department of Energy and Climate Change.
The DECC also monitors fracking operators’ insurance coverage. A spokeswoman told Post that, as part of its licensing process, the government body checks that all operators have the appropriate insurance to cover risks.
“Companies that explore or drill for shale gas have to take out insurance and would be liable for any damage or pollution caused by their operations,” she said.
In terms of insurance, fracking risks are largely covered by existing policies for other oil and gas drilling and exploration. Matt Yeldham, Aegis London casualty head and executive director, says there has been no need to develop a separate product for fracking.
“Most standard general liability covers have been judged to be appropriate for our client requirements for third-party liability exposures,” Yeldham says – and this does not include longer-term damage.
“While there has been a lot of talk about environmental pollution and associated liabilities, it is important to note there is only cover for pollution on a sudden and accidental or named peril basis only. The general liability market will not cover the longer term and more latent pollution issues,” he explains.
Streidl, whose remit is to insure drilling operations, oil rigs and production, says Zurich has a similar stance. “We insure [fracking] under our control of well packages and we insure sudden and accidental occurrences. On the liability side they might cover risks that have a gradual process of a loss coming through,” he explains.
The costs can vary, too. John Hopper, AIG senior underwriter, oil rig, explains that the cost of covering onshore fracking is likely to be lower than offshore exploration and drilling.
“Sub-surface pressures and temperatures are such that, unlike conventional offshore exploration drilling, there is reduced concern of a well suffering a loss. Drilling costs are relatively low compared with offshore wells and, therefore, limit of coverage purchased tends to be low,” Hopper says.
But in the event of damage, the cost to insurers could skyrocket. Streidl counts pollution of water supplies as one of the most prevalent fracking risks.
“I am afraid of [fracking] chemicals getting into the water we drink and the uncontrolled flow of these [chemicals] through the soil,” he says. Events such as contamination can prove costly.
However, according to Associated Press research in the US, although hundreds of pollution lawsuits and complaints have been brought forward – only a minority of cases have confirmed water well contamination.
In a high-profile 2012 example, the US Environmental Protection Agency overturned its earlier decision that water supplies of 19 families in Dimock, Pennsylvania had been contaminated by fracking activity from operator Cabot Oil & Gas Corp.
Indeed, for Hopper, the risk of water contamination caused by fracking remains low. “The studies conducted around potential contamination of drinking water concluded that the probabilities were very low risk, but will always remain a concern for some elements of the public,” he says.
McMahon adds despite his long-term involvement in the industry, he has not witnessed a dramatic increase in pollution or environmental claims.
“Parts of the industry are still new and developing and there is always some concern about any long-term issues. However, there is nothing to date that has emerged which should really cause underwriters to be any more cautious than they would with normal drilling operations,” he says.
Fracking’s relation to earth tremors has also garnered attention. In 2011, drilling company Cuadrilla suspended its shale exploration activity in Lancashire, admitting several months later that its activities probably caused two seismic events in Blackpool. Andrews says he has a personal interest in the seismic subsidence side of fracking after his property began subsiding following nearby fracking activity.
“In 2011 my neighbours had subsidence, and they claimed it [from their insurer]. Fracking started in 2012, and then in 2013 I have subsidence – but is it because of fracking or is it because of the general instability of the earth under my house anyway?” he asks, questioning whether such a claim would be covered by a general household insurance policy.
“You would worry about whether it would affect the ratings your household insurer starts to put on houses that are allegedly in fracking areas. But if there is a good price and clear coverage I don’t see why that would stop the insurer from [setting good ratings].”
The Association of British Insurers is reportedly working with the industry as fracking becomes more prevalent in the UK. The organisation’s spokesman, Stephen Sobey, says unless it is specifically requested by an insurer, homeowners do not currently need to disclose their proximity to fracking sites.
“There is, at present, little evidence to show a link between fracking and seismic activity that could cause damage to a well-maintained property. However, insurers will continue to monitor the potential for fracking, or similar explorations, to cause damage,” Sobey says.
For Yeldham, one risk that does not get as much attention is the potential increase in auto liability exposure.
“Fracking requires considerable volumes of water and other pieces of equipment to be moved. Often this needs to be transported to the drilling site – mainly by truck.
This increase in transportation activity has led to more auto liability claims, and this exposure needs to be underwritten and charged for,” he says.
McMahon also highlights an operational risk that has resulted in large claims.
“The largest claims in fracking have arisen through the high value of equipment required on the surface which, if a fire occurs, can prove very expensive to replace. The value of equipment from pumping trucks would be more expensive than would be required for normal drilling operations,” he says.
With exploration well underway, fracking is firmly implanted on UK insurers’ minds. And as the government pushes for more sites to be drilled, insurers’ involvement in fracking is only likely to increase.
Streidl concludes he is not against fracking and prefers it to other more “inappropriate” drilling methods. “From an insurance perspective, as long as it is done carefully and geologists have had a look at it and they contain all of the potential risks, there is nothing wrong with it,” he says.
McMahon agrees adding: “There is no reason why the UK could not enjoy a lot of the benefits, with little downside, as long as the work is carried out in accordance with proper regulations and best practice.”
What can UK insurers learn from the US experience of fracking?
Robert Andrews, KPMG insurance director, says: “There is a fairly entrepreneurial legal culture in the US so I would take a lot of comfort from seeing the kinds of claims that have been created there, and [regard them as] insight into the kinds of claims that could occur in the UK.”
Frank Streidl, Zurich global energy offshore energy head, says: “I would see learning from US in terms of corporate responsibility. We don’t want to back ruthless operators. What we want to do is make sure that they are sticking to the rules and that the population is not exposed.”
John Hopper, AIG senior underwriter, says: “There will be many lessons to be learned from the experience gained in the US but these will be more associated with handling the public relations rather than the physical operation.”
An article by Katie Marriner, 18 Feb 2014