Crude or Rude Awakening?
Posted By: Robert Snyder CPCU, CIC Vice President, Environmental Risk Management
Sunday, April 15, 2012
Marcellus and Utica Shale Oil and Gas Drilling -
The Financial Risk to Land Owners
The history of oil and gas exploration in the United States,
specifically in the Ohio and Ohio Valley region, goes back almost
two hundred years. The discovery of oil was made by mistake
at first, while decades later it became an emerging industry.
Interestingly, the first drilling rig over water was in Ohio on
Lake Saint Mary in West Central Ohio. In the mid 1800's,
inefficiencies and waste delayed the commercial potential until
late in the 1800's. [i]
By the late 1800's, efficiencies and market potential had been
recognized, and the startup of the commercial oil industry began in
earnest in Ohio. In 1865, William Rockefeller brother of John
D. Rockefeller, living in Strongsville, Ohio, entered the oil
business by starting a refinery. In 1870, his older brother,
John D., founded the Standard Oil Company, an Ohio partnership,
with brother, William, and four other men. In 1887, the
Marathon Oil Company of Findlay, Ohio, began as The Ohio Oil
Company. Today drilling rights and interest for both
predecessor organizations lay all over the globe.
The popular Marcellus and Utica shale formations are
specifically located in the Appalachian Basin. The Marcellus
formation is in Ohio, Pennsylvania, New York and West
Virginia. Several thousand feet below the formation is the
larger Utica Shale formation under Ohio, Pennsylvania, New York,
West Virginia, Virginia, Maryland, Tennessee and Kentucky.
This land is popular because of the tight deep formations that hold
large amounts of natural gas and oil.
The future estimated production of oil and gas from these shale
formations is difficult to calculate. The economic impact on
the region is a moving target and the information is
adjusted by scientific reports as test data is developed.
This land is rugged remote and hilly. It will take many years
to recover these resources. In the first illustration you
will note the Utica formation in green and the Marcellus outlined
in yellow. [ii]
This illustration showing the relative depths of the two mineral
formations [iii]
Gary Lash, geology professor at State University of New York at
Fredonia, has calculated that more than 490 TCF of natural gas may
be contained in the Marcellus shale. At the present level of
technology, it is believed approximately 10% of this 49 TCF could
be recovered. This is enough to satisfy approximately two
years of total U.S. consumption. Add to that the Utica shale oil
and gas, and it is easy to understand the interest of oil and gas
exploration companies in the rights to our mineral rich land.
This is not developing, however, without serious financial risk for
land owners looking for high rewards.
"With risk comes reward" is a common principle in
business. Thousands of dollars per acre, production rights
that can produce energy for your use, and healthy income streams
for years are quite motivating. Imagine if you could find a
faster, easier formula for instant wealth. The more land you
own, the higher the stakes. Is it really that straight
forward?
What are the various risk factors for consideration in this high
stakes business in this highly litigious society? This paper
is a case study to illustrate the necessary and appropriate means
of identifying and transferring financial risk associated with oil
and gas drilling, fracturing, waste management and transportation
or distribution. Applying due diligence and risk management
tools of industry is a proper exercise for every owner to
consider.
To identify the risk one must first understand the physical
nature of the events of drilling, fracturing, waste management,
distribution and transportation.
Directional drilling can be used to reach targets that can not
be drilled with a vertical well. For example: it may not be
possible to get a drilling permit for a well located within a
populated area or within a park. However, a well could be
drilled just out side of the populated area or park and then
steered directionally to hit the target.
This video illustrates the equipment, materials and procedures
used in the hydraulic fracturing process. It applies to the use of
hydraulic fracturing combined with horizontal drilling in the
development of a natural gas well in organic-rich shale. It was
prepared by Chesapeake Energy.[iv]
Hydraulic fracturing involves the high-pressure injection of
water, sand and chemicals into a shale bed, which causes the rock
to shatter, releasing natural gas. A new study from the
University of Texas at Austin was presented January 26, 2012, at
the American Association for the Advancement of Science in
Vancouver, British Columbia. Hydraulic fracturing of shale
formations to extract natural gas has no direct connection to
reports of groundwater contamination. Researchers found that
many problems ascribed to hydraulic fracturing are related to
processes common to all oil and gas drilling operations, such as
casing failures or poor cement jobs.
"University researchers also concluded that many reports of
contamination can be traced to above-ground spills or other
mishandling of wastewater produced from shale gas drilling, rather
than from hydraulic fracturing per se," said Charles "Chip" Groat,
an Energy Institute associate director who led the project.
"These problems are not unique to hydraulic fracturing,"
Other findings from the Energy Institute study include:
• Natural gas found in water wells within some shale gas
areas (e.g., Marcellus) can be traced to natural sources and
probably was presented before the onset of shale gas
operations.
• Although some states have been proactive in
overseeing shale gas development, most regulations were written
before the widespread use of hydraulic fracturing.
• Media coverage of hydraulic fracturing is decidedly
negative, and few news reports mention scientific research related
to the practice.
• Overall, surface spills of fracturing fluids pose greater
risks to groundwater sources than from hydraulic fracturing
itself.
• The lack of baseline studies in areas of shale gas
development makes it difficult to evaluate the long-term,
cumulative effects and risks associated with hydraulic
fracturing.
These statements confirm the fact that financial risk associated
with releases of pollutants onto the ground, in the air or into
groundwater are real. Additionally, every time materials
including process chemicals are brought to or waste taken from the
site, there is a chance that a release could occur during loading,
unloading or transportation.[v]
Consider too the pipeline that may be installed on your land
used to distribute large quantities of product to market. In
any case, a release may cause an expensive clean-up; damage to
neighbor's property, ground water contamination and or loss of
income. How can these various financial concerns be minimized
and transferred from your finances? Owners that contract
their land for oil and gas exploration must understand how to risk
manage and insure these exposures.
The insurance industry has offered products for problem solving
complex environmental issues for decades. Interestingly, the
availability of capital to take environmental risk has matured
significantly in recent years. This is evidenced by the
increase in carriers that have entered the market in the last four
years. Comprehensive environmental insurance programs assist
owners manage their exposure while providing coverage frequently
left out of standard insurance programs. Coverage can be
designed to include the interest of investors as well.
At The Fedeli Group, our success is based on the strength with
which we serve our clients. The focus of the environmental
practice is in building relationships with our clients, solving
their problems, exchanging information, ideas and resources with
them and providing them with value added services. An owner
of approximately 1,000 acres in the Marcellus and Utica shale
formations in South East Ohio wanted to assess their financial risk
and to design an insurance program that would adequately protect
them from the unexpected catastrophic cost of a
loss.
Initially, a review of the owner's agreements was conducted to
identify and quantify financial risk. Certificates of
insurance were gathered from all contractors, and then reviewed
before work began or equipment was staged at the work site.
Each contractor's certificate of insurance must be maintained
throughout the contract terms as long as production continues as a
precautionary backup.
Various exposures, common to every land owner, where drilling
and production of oil and gas occur, can be protected from in a
comprehensive environmental insurance program. The financial
concerns this client identified in the analysis included:
• Remediation expense due to a spill or release of hazardous
materials or substances
• Bodily injury and property damage including diminution in
value of property
• Defense costs including associated investigation costs of
third party claims and government enforcement actions
• Waste disposal at injection wells, wastewater treatment and
tank farm storage
• Natural disasters including windstorm, hurricanes,
earthquakes and flooding
• Control of well events including evacuation expense
• Loss of production revenue from a loss
Each of these serious risks could be assessed and underwritten
from information at hand. A comprehensive cost effective
multi-year insurance policy was offered with several options
provided. As with most insurance, it is important that there are
several characteristics of the program that an informed buyer can
use to help control the cost of the insurance policy- specifically,
the retention or deductible, liability limits and policy
term. Multi year policy terms should be considered.
Significant premium discounts are offered where policy limits are
not reinstated annually, as with one year policy terms.
Throughout the Appalachian Basin, which includes Ohio and the
Ohio Valley region, land owners are hearing and talking about the
"Crude Awakening", the financial opportunities and incentives that
lie below the surface of their land. The media is talking
about the "Rude Awakening" for families once the drilling and shale
fracturing begins. Environmental insurance that protects
parties from allegations of injury, damage and defense provides
financial protection and a piece of mind to land owners making
significant decisions about allowing oil and gas drilling on their
property.
For more information about how to protect your financial
interest contact The Fedeli Group on the web at
www.thefedeligroup.com or call The Fedeli Group at 800-831-7191 and
ask for Robert Snyder.