Bracing for Aftershocks

• Lynna A Goch
• April 2016
• 

Surging earthquake activity in Oklahoma has put a target on the state's hydraulic fracturing sector, specifically the businesses that operate wastewater disposal wells. Lawyers representing residents are filing lawsuits, and regulators are turning their attention to the active but low-profile energy insurance sector. Some worry that a major quake could trigger shock losses large enough to rattle the U.S. insurance sector.

Insurers are particularly worried that a flurry of lawsuits against fracking operators could trigger catastrophic losses. Of added concern, not to mention a bit unexpected, are claims brought by homeowners and business owners allegedly harmed by earthquake shocks.

Earthquakes are risks underwriters involved in oil and gas operations were not traditionally concerned with in the Central United States. Underwriters never signed up for the potential liabilities that could arise from an insured causing an earthquake, said Pascal Ray, USI Insurance Services' senior vice president and marine and energy practice leader.

But a lawsuit filed after a 2011 temblor in Prague, Okla., just might force insurers and others to acknowledge the role played by earthquakes--particularly those that could be attributed to fracking--in the energy insurance game. Resident Sandra Ladra sued Spess Oil Company and New Dominion, charging their fracking operations caused the 5.0-magnitude earthquake that resulted in personal injury and damage to her home. A state court dismissed the case, but in December 2015 a district court denied the defendants' motion to dismiss the matter, which is now pending.

What makes this case noteworthy is that it got this far. According to the Hydraulic Fracturing Tort Summary published online by the University of Dayton School of Law, more than 40 lawsuits have been filed in the United States against fracking operations. Most, however, have been settled quietly or dismissed. Ladra's is one of only six in Oklahoma to survive, and many eyes are watching.

"We don't know what the settlements have been," Ray said. "It's all been kept secret, which is creating uncertainty in the minds of the underwriters. Underwriters can't quantify, in dollars, what this earthquake risk is to them. With all this uncertainty, it's going to be interesting to see what the reactions of the underwriters are if this case goes to trial and there's a verdict. If a substantial verdict is handed down, there will be a significant reaction in the marketplace."

"My experience in watching the energy industry deal with these kinds of suits is that once it becomes clear that it will go to trial, and once it becomes clear that it will be heard, things tend to get settled relatively quickly," said R.J. Briggs, an energy economist at Praedicat, a liability catastrophe modeling company.

"Finding of fact against the company establishes precedent that oftentimes these companies don't want established. If you look at most of the fracking litigation, for instance, a lot of it wound up getting settled in confidential statement settlements. Companies want to contain defense costs, have certainty over losses, and minimize incentives for future suits."

A Surge in Activity

In recent years Oklahoma has experienced a great increase in the number of earthquakes. Last year alone there were more than 3,500 quakes, 907 of which were magnitude 3 or higher. A 5.1-magnitude temblor on Feb. 13, 2016, was the third-largest in the state's history, with impact felt as far away as Chicago. Following that, litigation increased and Oklahoma's chief regulator, the Oklahoma Corporation Commission, announced plans to implement the largest volume reduction plan yet for oil and gas disposal wells in western Oklahoma. The plan encompasses 5,281 square miles and 245 disposal wells injecting wastewater into the western part of the state. (Oklahoma is home to 4,580 wastewater disposal wells, with an estimated 3,800 in operation.)

The action came in response to continued seismicity in the state, said Tim Baker, director of the OCC's Oil and Gas Division. "The wells covered in this plan include those along the western area of the plan's boundaries where there has not yet been major earthquake activity," Baker said. "This plan is aimed not only at taking further action in response to past activity, but also to get out ahead of it and hopefully prevent new areas from being involved."

Ray expects few dramatic changes from the OCC's latest move. "Underwriters are in a wait and see mode," Ray said. "Is that going to fix it, or are disposal well operations going to continue to be associated with earthquakes? From an underwriting point of view I think it's interesting, but I don't think this one measure to mitigate earthquakes due to disposal well operations is going to cause any change in favor of the insured with policy wordings or underwriter behavior."

Maybe It's Not the Fracking

Back in April 2015, the Oklahoma Geological Survey issued a statement saying it is "very likely that the majority of recent earthquakes, particularly those in central and north-central Oklahoma, are triggered by the injection of produced water in disposal wells. The primary source for suspected triggered seismicity is not from hydraulic fracturing, but from the injection/disposal of water associated with oil and gas production."

This goes along with the OCC's 2016 move. Still, fracking is polarizing, particularly when it comes to just how much impact it has on the environment.

Fracking--formally, hydraulic fracturing--directs a mix of pressurized water, sand and chemicals to extract gas and oil trapped between layers of shale. The water is then injected into wastewater disposal wells that are buried deep into the ground. Many companies participate in and are largely insured for fracking-related activity, but perhaps the greatest exposure surrounds those that operate and own saltwater disposal wells, said Bill Helander, executive vice president of JLT Specialty USA's energy practice.

Despite this risk, brokers report that pricing and availability of fracking-related coverage remain stable. "The specter of earthquakes has not had enough impact, ultimately, on the loss experience to date in the energy economy to push pricing or the appetite in one distinct direction or another," Helander said. "We see moments and instances where certain insurers have had tempered interest in a risk. They may have gone so far as to try to write language to preclude them from covering claims. But it's not necessarily something that I would say would be a market-wide event."

For insurers pondering the potential effects of major energy-related claims, they need only remember the Santa Barbara oil spill of 1969. The EPA was formed as a result of this oil spill, Ray said. Today, the EPA is investigating earthquake phenomena and is making recommendations to mitigate this risk to state regulators, he said.

While the 1969 oil spill wasn't caused by an earthquake, it did involve a blowout arising from offshore drilling operations that spewed an estimated three million gallons of oil along the California coast. This was the first major offshore oil spill in U.S. history, Ray said. A cascade of lawsuits and regulations that followed drove most U.S. insurers from writing pollution coverage for offshore oil and gas operations, he added.

"If this Oklahoma earthquake liability lawsuit is won, and a significant verdict is handed down, the reaction may be more similar to the 1969 Santa Barbara oil spill, where underwriters withdrew from the market, or made significant pollution exclusions to their insurance policies. If a lesser verdict is handed down, the reaction may be more similar to the precedent fracking case in Decatur, Texas, that resulted in a verdict of $2.9 million. There were some expectations that the verdict would have been much larger. That lawsuit was filed in 2011, the verdict handed down in 2014, and is now currently on appeal. Because of the relatively small verdict and the case being tied up in appeal, there has not been a dramatic market change due to the 2014 verdict," Ray said.

Another Road to Compensation

Insurance losses also could come from homeowners' claims made to first party insurers.

"Because of the evidence that earthquakes are generated by commercial activity, we expect that you would see successful subrogation to the wastewater injection well operators and their commercial general liability insurers," said Briggs, the energy economist. "In particular, if you could imagine some of these low probability scenarios, say an earthquake in Oklahoma City, a metropolitan area that has a relatively high population density, commercial buildings, and so forth that has no earthquake codes. You imagine a 6+-magnitude earthquake in that area, and it can generate tens of billions of dollars in damage. We expect that's underinsured, to say the least, and that the tort system would look for a way to compensate the damaged property owners."

A suit filed after a flurry of minor earthquakes this past January has used a different tactic: Public Justice, on behalf of the Sierra Club, filed a lawsuit under the federal Resource Conservation and Recovery Act, which regulates the disposal of waste. Public Justice and the Sierra Club allege that waste from fracking and production operations is being injected deep into the ground in Oklahoma, causing large and frequent earthquakes. "So what we allege is that the waste handling disposal operations may present an endangerment to the health of the citizens of Oklahoma and the environment of Oklahoma," said Richard Webster, a Public Justice lead attorney. Webster predicts the outcome may not be known for years.

Right now, it seems the best chance of resolving the debate around fracking and earthquakes lies with the Ladra lawsuit. Until then, it's just a guessing game.

"There's no instruction manual," Ray said. "The regulators, litigators, underwriters, oil and gas industry, as well as the general public are all in uncharted waters.

"This is all new,'' he added, "and everybody's reacting to the frequency and intensity of the earthquakes that's occurring. And, reactions by the underwriters to this has only increased uncertainty. This is due to a lack of precedent and the inability to quantify the liabilities that could result should one of their clients be found guilty of causing an earthquake."

By Lynna Goch, editor, Best's Review: Lynna.Goch@ambest.com