A Market Approach to Regulating the Energy Revolution: Assurance Bonds, Insurance, and the Certain and Uncertain Risks of Hydraulic Fracturing

A Market Approach to Regulating the Energy Revolution: Assurance Bonds, Insurance, and the Certain and Uncertain Risks of Hydraulic Fracturing David A. Dana  & Hannah J. Wiseman  ABSTRACT: The United States faces a critical moment in environmental regulation. As tens of thousands of new unconventional, hydraulically fractured oil and gas wells spring up around the United States, we face a long-term threat of significant soil and water contamination. The current patchwork of state “command and control” regulations fails to prevent this contamination. Even in states with updated rules, sloppy operations have caused contamination events. Furthermore, thousands of abandoned wells, which can leak pollutants, already dot our landscape, and these numbers could rise over time as operators—the individuals and companies responsible for well development—drill and eventually abandon thousands of new wells each year. Command and control regulations will be an important first step to prevent contamination but cannot address all risks, particularly those for which industry has more knowledge than agencies. These limitations call for a market-based approach of bonding requirements and mandatory environmental liability insurance. An insurance regime will incentivize the party with the most knowledge of the risks—industry—to produce risk information, and it will spur third-party monitoring of risks by companies with a powerful monetary incentive to reduce claim events. Assurance bonds and insurance will also provide a pool of money to support later clean-up, which will be particularly important for disadvantaged areas that lack financial resources and political clout. This Article proposes a market-based approach and responds to objections, and then explores the bottom-up, localities-as-leaders political economy by which bonding and insurance mandates are most likely to emerge and  Kirkland & Ellis Professor of Law, Northwestern University Law School. B.A., Harvard University; J.D., Harvard University. Our thanks to Dan Faichney for excellent research assistance and to Dan Schwarcz and Tom Merrill for very helpful comments.  Assistant Professor, The Florida State University College of Law. A.B., Dartmouth College; J.D., Yale Law School. 1524 IOWA LAW REVIEW [Vol. 99:1523 ultimately become established as a matter of state law. Without adequate bonding and insurance requirements, we risk creating a new wave of widespread, unaddressed pollution from the current energy revolution. At this critical decision point, this Article proposes a better path forward. INTRODUCTION .................................................................................... 1526 I. WELL CONTAMINATION OVER TIME ..................................................... 1534 A. T HE L IFE OF O IL AND G AS W ELLS AND A SSOCIATED C ONTAMINATION ........................................................................... 1534 B. T HE E XTENT OF L IKELY C ONTAMINATION : W ELL N UMBERS ............. 1541 C. S HORT -, M EDIUM -, AND L ONG -T ERM C ONTAMINATION R ISKS .......... 1542 D. C ERTAIN AND U NCERTAIN R ISKS ..................................................... 1545 II. THE THEORETICAL CASE FOR MANDATORY INSURANCE: FRAMING UNCONVENTIONAL OIL AND GAS REGULATION AND INSURANCE REFORMS IN TERMS OF THREE DICHOTOMIES ..................................... 1546 A. C OMMAND AND C ONTROL R EGULATION V ERSUS M ARKET -B ASED R EGULATION .................................................................................. 1547 B. E XCLUSIVE V ERSUS M ULTIPLE R EGULATORS .................................... 1552 C. R EGULATION BY R EGULATORS V ERSUS R EGULATION BY C OMMON L AW T ORT L IABILITY ..................................................................... 1556 D. P LACING F INANCIAL A SSURANCE B ONDS AND M ANDATORY I NSURANCE W ITHIN T HESE D ICHOTOMIES : C OMMAND AND C ONTROL V ERSUS M ARKET R EGULATION ........................................ 1561 E. S INGLE R EGULATOR V ERSUS M ULTIPLE R EGULATORS ...................... 1568 F. M ANDATORY I NSURANCE AND EX ANTE R EGULATION V ERSUS EX POST L IABILITY ............................................................................. 1569 III. OBJECTIONS TO MANDATORY INSURANCE AND RESPONSES ................. 1571 A. W HETHER I NSURANCE W ILL B E C OMMERCIALLY U NAVAILABLE ....... 1572 B. W HETHER P REMIUMS W ILL B E T OO H IGH AND C HILL E CONOMIC A CTIVITY ....................................................................................... 1575 C. W HETHER THE P REMIUMS W ILL B E T OO L OW AND I NVITE M ORAL H AZARD ........................................................................................ 1579 D. W HETHER I NSURANCE R EQUIREMENTS W ILL U NFAIRLY D ISADVANTAGE S MALL B USINESSES ................................................. 1580 E. W HETHER I NSURANCE I S U NNECESSARY B ECAUSE EX POST I NDUSTRY T AXES W ILL E NCOURAGE EX ANTE S AFETY AND (A LONG WITH T AX R EVENUES ) F UND A NY N ECESSARY C LEANUPS .................. 1582 2014] REGULATING THE ENERGY REVOLUTION 1525 IV. THE POLITICAL ECONOMY OF ENACTING UNCONVENTIONAL OIL AND GAS INSURANCE MANDATES ......................................................... 1586 CONCLUSION ....................................................................................... 1591 1526 IOWA LAW REVIEW [Vol. 99:1523 INTRODUCTION In the Industrial Revolution of the nineteenth century, the United States was transformed from a largely agrarian nation of farmers to a major center of manufacturing. With industrialization came new risks to public welfare and, ultimately, changes in law to address those. The United States is now undergoing another revolution, an energy revolution that has the potential to transform the United States from a net energy importer into the next Saudi Arabia. 1 And like the Industrial Revolution, this energy revolution entails new risks and, by necessity, will produce new legal responses to those risks. It has fomented one of the greatest environmental regulatory challenges of our time, and it calls for an effective solution that must be rapidly implemented. This Article addresses a set of important legal responses that so far have received scant attention from academic commentators and lawmakers—market-based requirements for enhanced bonding and, more importantly, environmental liability insurance for wells. The key to the current energy revolution is innovation in the techniques that allow extraction of natural gas from underground rock formations. Advances in horizontal drilling and hydraulic fracturing— fracing, or, more commonly, fracking—have opened up massive natural gas deposits in several regions of the United States. 2 These technologies have driven this revolution by enabling unconventional well development—the production of oil and gas from formations once deemed inaccessible— which we describe as “unconventional development” or “unconventional oil and gas.” 3 Unconventional development has begun, and will continue, to 1. See INT’L ENERGY AGENCY, WORLD ENERGY OUTLOOK 2012: EXECUTIVE SUMMARY 1 (2012), available at http://www.worldenergyoutlook.org/publications/weo-2012/. 2. See Shale Gas Production , U.S. ENERGY INFO. ADMIN. (Aug. 1, 2013), http://www.eia. gov/dnav/ng/ng_prod_shalegas_s1_a.htm (showing major increases in production in states like Arkansas, Louisiana, Oklahoma, Pennsylvania, and Texas). 3. This Article focuses on unconventional wells and proposes assurance bonds and mandatory environmental liability insurance for these wells for several reasons. First, although all conventional oil and gas wells pose many of the same risks we describe here, such as spills of drilling chemicals at the surface and leaking methane from improperly plugged wells, unconventional wells pose more risks by adding more stages to the well-development process, including the use of fracturing chemicals and increased pressure on wells caused by hydraulic fracturing. Although horizontal drilling of unconventional wells might cause some risks to decline by lowering the surface footprint, on net the risks might be higher. See generally Hannah J. Wiseman, Risk and Response in Fracturing Policy , 84 U. COLO. L. REV. 729 (2013). Second, unconventional well development will be the most common form of well development in the United States moving forward. Shale gas and tight sandstone wells, which will dominate production, are the most prevalent forms of unconventional development; they are unconventional because they require advanced technologies and are expensive to develop compared to conventional wells. See U.S. ENERGY INFO. ADMIN., U.S. DEP’T OF ENERGY, ANNUAL ENERGY OUTLOOK 2013 WITH PROJECTIONS TO 2040 76–79 (2013), available at http://www.eia. gov/forecasts/aeo/pdf/0383(2013).pdf (showing that shale gas and “tight gas”—from tight sandstones—will make up the majority of production). Third, oil and gas regulations, primarily written and administered by states, tend to cover both conventional and unconventional well 2014] REGULATING THE ENERGY REVOLUTION 1527 change the landscape of this country. Wells already dot the surface of many counties 4 and this is only the beginning. This development will continue, with tremendous intensity, very likely for several decades at a minimum. 5 Just as the Industrial Revolution gave rise to new risks, such as risks from industrial air pollution and factory fires, unconventional development has generated new risks to public welfare and will continue to do so. 6 These risks are not, individually, as massive as those seen in the Industrial Revolution; public perceptions and environmental protections have changed. But cumulatively, they are likely to be substantial. Some of these risks are relatively certain: We know from past experiences with drilling and mining that there is a large risk that certain well operators—the individuals and companies responsible for well development—will simply abandon wells when they are...