Navigating the Legal Landscape of Shale Gas Exploration and Development in the United States: Identifying and Managing Environmental Risks

In the United States, continued concerns about global climate change (despite recent failures in Congress to pass comprehensive climate change legislation) and an over dependence on foreign oil have increased interest and demand for reliable sources of domestic energy.  While renewable energy sources continue to garner interest from the investment community, currently the most economic and reliable source of domestic energy (other than coal) appears to be natural gas.  For example, one of the largest "unconventional" on-shore natural gas deposits in the world is in a geologic formation known as the Marcellus Shale located beneath parts of New York, Pennsylvania, Ohio, Maryland, West Virginia and other states.  Significant natural gas deposits are also located in various other shale formations throughout the United States, including in Louisiana, Arkansas, Texas, Oklahoma, Colorado and Utah.  In fact, many believe that the natural gas trapped in shale formations throughout the country can supply approximately 90 years worth of demand for natural gas in the United States.

High-volume horizontal hydraulic fracturing.  In order to access the natural gas trapped in shale formations, oil and gas ("O&G") exploration and development companies are increasingly utilizing a technique known as high-volume horizontal hydraulic fracturing ("fracking").  In general, fracking involves the pressurized injection of millions of gallons of fluids ("frack-water") into deep geologic formations, causing fractures in the formation and enabling the release of oil or natural gas.  Once the formation is fractured, the pressure of the frack-water is reduced, which reverses the direction of the frack-water in the well back toward the surface.  As a result, the frack-water and any naturally occurring substances (e.g., natural gas) released from the underground formations are allowed to "flowback" to the surface.  Hydraulic fracturing has been utilized by O&G companies in the United States for over fifty years, but has only recently been used to extract large quantities of natural gas from shale formations as horizontal drilling technology has advanced.  

Federal exemptions, EPA's study, and the evolving legal framework.  While legislation was introduced in the Congress in 2010 that would have allowed the U.S. Environmental Protection Agency ("EPA") to regulate and oversee fracking operations, fracking operations (that do not use diesel fuel as a component of frack-water) are currently exempt from regulation under the federal Safe Drinking Water Act.  This exemption, which was codified as part of the Energy Policy Act of 2005, was based, in part, on EPA's conclusion in a 2004 study that the potential threat from hydraulic fracturing in coalbed methane wells to underground drinking water supplies was "minimal."  Notably, O&G exploration and production wastes (e.g., frack-water) are also exempt from regulation as hazardous wastes under the federal Resource Conservation and Recovery Act.  As a result of these federal exemptions, fracking is currently regulated on a state-by-state basis.

Given the recent increase in fracking operations, however, Congress has directed EPA to prepare an updated study focusing specifically on high-volume horizontal hydraulic fracturing in shale gas formations.  EPA is expected to release its interim results in 2012 and issue a final report in 2014.  According to EPA's February 2011 draft plan, the study is expected to address, among other issues, the "hydraulic fracturing water lifecycle – from water acquisition to wastewater treatment and disposal," including the potential for frack-water to impact both surface water and groundwater. 

Despite the lack of federal regulation (and oversight) related to hydraulic fracturing, environmental groups and property owners have raised a myriad of concerns (and filed lawsuits) regarding the potential environmental, health and safety risks related to fracking-related activities.  (Notably, as part of EPA's ongoing study, information requests have been issued to various fracking service providers seeking information regarding: (1) types of chemicals used in frack-water; (2) data on impacts of chemicals on human health and the environment; (3) standard operating procedures; and (4) location of sites where fracking activities have been conducted.)  Meanwhile, state legislation and regulation related to fracking is developing around the country.  For example, on July 1, 2011, the New York Department of Environmental Conservation ("NYDEC") issued its long-awaited recommendations on mitigating environmental impacts of fracking.  NYDEC's recommendations are part of a required environmental review being conducted by the agency that ultimately will lead to standards upon which the agency will rely for issuing permits to allow for fracking in New York.  Given the regulatory process that still must occur, however, fracking permits in New York are not likely to be issued until 2012.

Environmental legal and business risks.  In light of the developing regulatory regimes, companies involved in natural gas exploration and development in general, and high-volume horizontal hydraulic fracturing in particular (including investors, joint venture partners, and insurers), need to understand the environmental legal and business risks associated with this evolving area and how best to manage those risks.  High-volume horizontal hydraulic fracturing, like traditional O&G exploration, involves various environmental legal and business risks including, but not limited to: (1) water supply/disposal and well contamination; (2) release of frack-water and chemicals at the surface; (3) impingement of third party property and/or mineral rights; (4) failures of wells and well blowouts; (5) bodily injury and property damage; (6) common law claims (e.g., negligence, trespass, nuisance, and business interruption); and (7) civil and/or criminal enforcement actions pursuant to federal/state environmental, health and safety laws and regulations.  These risks span the entire fracking process – from site preparation, through well construction, development and production, to well plugging and site reclamation. 

Environmental insurance can be an integral tool to help manage risks.  In light of the unique (and evolving risks) associated with fracking, tailored, deal-specific environmental insurance can be useful to effectively "box in" certain environmental legal and business risks.  While environmental insurance is not necessary or even available (nor cost effective) for every matter, the key is to identify environmental risks and evaluate risk management options at the earliest stage possible. 

Environmental insurance policies, if properly structured, can be written to protect numerous parties (e.g., developers, subcontractors, investors) and embrace multiple sites, and can cover a broad spectrum of potential exposures, including: (1) property damage and bodily injury ("toxic torts"); (2) natural resource damages; (3) liability associated with transportation and disposal of hazardous wastes/substances; (4) project delays and business interruption; (5) loss of collateral value; (6) contract liability; and (7) legal defense costs.  An environmental insurance policy is, in its essence, a contract and needs to be negotiated and tailored to the specifics of the transaction and the underlying environmental risks, just like any other negotiated contract. 

What's next?  Responsible development of shale gas resources offers important economic, energy security and environmental benefits.  Currently, states and the federal government are in the process of developing the legal regimes necessary to address public concerns, ensure environmental protection and manage the benefits and risks of shale gas production in general and high-volume horizontal hydraulic fracturing in particular.  As the legal regimes evolve, companies involved in fracking will want to understand not only the environmental legal and business risks involved, but also how to most efficiently and cost effectively manage those risks.

Andrew N. Davis is a partner and Aaron D. Levy an associate in the environmental and energy practice groups of the global law firm Dewey & LeBoeuf LLP.  Their bios can be found at www.dl.com and they can be contacted at:  adavis@dl.com or +1 212 259 8214; alevy@dl.com or +1 212 259 8543.