Hydrofracking: Risks involved for all types of businesses

Media coverage of hydrofracking – the use of high-pressure water and chemicals to extract natural gas deposits from shale – has primarily focused on the energy industry in terms of risk management. However, as hydrofracking becomes more common, the risks have spread to other industries and sectors – many quite unrelated to energy or natural gas production. 

Gregory S. Hoffnagle is an attorney with Edwards Wildman Palmer LLP who has studied the legal risks posed by hydrofracking for several years. He initially began tracking the issue for insurance and reinsurance clients, but quickly realized what he was finding had much broader applications. Hoffnagle continues to work with the insurance industry, but also regularly advises energy sector clients, landowners, governments, engineers, financial services companies, and risk managers from broad range of industries. 

Below are some key trends Hoffnagle is seeing with respect to risk management and the practice of hydrofracking, as well as some initial commentary. 

Securities Violations: Did energy companies mislead investors as to the exact benefits and risks of hydrofracking? This question is on the mind of at least one state attorney general – Eric T. Schneiderman in New York – and likely many others. For his part, Schneiderman recently served subpoenas on five of the largest hydrofracking companies in New York seeking information on their research and other knowledge about hydrofracking. 

“This is likely an attempt to figure out what hydrofracking companies know about the technology, and when they knew it,” says Hoffnagle. “To some extent this is about the environmental risks, but it’s likely more to do with the statements these companies have made to shareholders and investors in order to secure financing for hydrofracking projects.” 

Hoffnagle says the New York A.G. might be contemplating legal action against the energy companies for securities law violations. 

“The A.G. might believe that companies were either underselling the risk of hydrofracking, or overselling the benefits – or both – to investors in order to raise funds to finance operations,” says Hoffnagle. “The risks and benefits of hydrofracking are actually more nuanced than the energy companies may have presented, and regulators and lawmakers may be seeing smoke and trying to find the fire.” 

Added Complexity for Banks Involved in Farmland Forclosures: Farmers have been among the hardest hit during the recession and continued economic uncertainty. In particular, land prices plummeted and many are underwater with their mortgages. In a bid to generate revenue, some farmers have granted hydrofracking leases for their properties – likely in violation of their mortgages. 

“This creates a gray area for banks where little legal precedent exists,
 says Hoffnagle. “The issue is further compounded if, as has been happening in greater and greater numbers, the farm property falls into receivership and ownership either reverts to the bank or it is sold in a short sale. In these cases, there is little clarity on the status of the hydrofracking contracts. Does the lease go with the land?” 

Hoffnagle believes we are about to see lawsuits stemming from this issue. 

“This adds an entirely new wrinkle to the wave of bankruptcies we’re already seeing,” says Hoffnagle. “Now as you sort out the rights of landowners and banks, you also have to consider the standing of the hydrofracking contracts. It’s a perfect storm that is only likely to get sorted out in the courts.” 

Energy Company Lawsuits Against Municipalities: As the issue of hydrofracking became part of the public consciousness, many municipalities passed laws either banning the practice or that set tight restrictions on the practice. In response, energy companies, many of which have existing leases that allow hydrofracking, have launched lawsuits against these municipalities, seeking to strike down the legislation. 

“I would tend to think the energy companies believe their claims have merit,” says Hoffnagle. “They are not going to be devoting resources to suits they do not feel are valid. The companies have likely studied the issue, examined their existing contracts, and reviewed issues with respect to jurisdiction and the pre-emption of municipal legislation by state and federal law. If the energy companies did not believe they had a good chance of getting these laws overturned, they would not have filed.”

Hoffnagle is available for interviews on hydrofracking and related risks. [10/24/2011]