Fracking: Considerations for risk management and financing

Fracking: Considerations for risk management and financing by Richard Soulsby, Jason Kurtz, Bhavini Kamarshi, June 21, 2012, Insight Expert Thinking from Milliman
The recent MTBE contamination in California, while not fracking-related, offers an example of the difficulties in cleaning up ground water contamination and the potential liabilities when public water supplies are compromised. A common additive to gasoline in the 1990s, MTBE was found to have contaminated Santa Monica’s water supply in 1996, forcing the city to find other sources for half of its water. That incident led to a $120 million settlement. Another high-profile case was settled for a $422 million payment upfront, with additional funds for cleanup costs over the following 30 years. There are differences between MTBE and the chemicals found in fracking fluids, but if fracking operations were to lead to such widespread water contamination, the liabilities could reach similar levels. … The biggest uncertainty surrounds the long-term impacts of fracking on public health (through water pollution and airborne effects) and whether it will result in a wave of latent injury allegations sometime down the road. … Considering the large dollar amounts associated with claims on comparable historical pollution events, there could be several scenarios where the indemnity and defense costs for future fracking-related pollution claims amount to several multiples of the largest pollution liability limits that are currently being purchased. For a company responsible for such an event, if insurance coverage is inadequate then investors are at risk of losing up to the full amount of their investment in the company. If the full net worth of the company (in addition to insurance coverage) is insufficient to cover the costs associated with an event, those costs will be borne by those who have suffered property damage or injuries. With the common practice of using site-specific LLC/LLP corporations that are dissolved after operations are completed, and the hundreds of small companies active in shale gas production with typically minimal pollution liability coverage, this outcome is a very real possibility. … A lack of insurance availability for certain energy companies in a region may be a signal that the likelihood of major pollution losses is too high, either because best practices are not being followed or because of the complexities associated with the use of fracking in that region. [Emphasis added]