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

• Author: David A. Dana & Hannah J. Wiseman
• Position: Kirkland & Ellis Professor of Law, Northwestern University Law School/Assistant Professor, The Florida State University College of Law
• Pages: 1523-1593

1523

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. THE LIFE OF OIL AND GAS WELLS AND ASSOCIATED

CONTAMINATION ........................................................................... 1534

B. THE EXTENT OF LIKELY CONTAMINATION: WELL NUMBERS ............. 1541

C. SHORT-, MEDIUM-, AND LONG-TERM CONTAMINATION RISKS .......... 1542

D. CERTAIN AND UNCERTAIN RISKS ..................................................... 1545

II. THE THEORETICAL CASE FOR MANDATORY INSURANCE: FRAMING

UNCONVENTIONAL OIL AND GAS REGULATION AND INSURANCE

REFORMS IN TERMS OF THREE DICHOTOMIES ..................................... 1546

A. COMMAND AND CONTROL REGULATION VERSUS MARKET-BASED

REGULATION .................................................................................. 1547

B. EXCLUSIVE VERSUS MULTIPLE REGULATORS .................................... 1552

C. REGULATION BY REGULATORS VERSUS REGULATION BY COMMON

LAW TORT LIABILITY ..................................................................... 1556

D. PLACING FINANCIAL ASSURANCE BONDS AND MANDATORY

INSURANCE WITHIN THESE DICHOTOMIES: COMMAND AND

CONTROL VERSUS MARKET REGULATION ........................................ 1561

E. SINGLE REGULATOR VERSUS MULTIPLE REGULATORS ...................... 1568

F. MANDATORY INSURANCE AND EX ANTE REGULATION VERSUS EX

POST LIABILITY ............................................................................. 1569

III. OBJECTIONS TO MANDATORY INSURANCE AND RESPONSES ................. 1571

A. WHETHER INSURANCE WILL BE COMMERCIALLY UNAVAILABLE ....... 1572

B. WHETHER PREMIUMS WILL BE TOO HIGH AND CHILL ECONOMIC

ACTIVITY ....................................................................................... 1575

C. WHETHER THE PREMIUMS WILL BE TOO LOW AND INVITE MORAL

HAZARD ........................................................................................ 1579

D. WHETHER INSURANCE REQUIREMENTS WILL UNFAIRLY

DISADVANTAGE SMALL BUSINESSES ................................................. 1580

E. WHETHER INSURANCE IS UNNECESSARY BECAUSE EX POST

INDUSTRY TAXES WILL ENCOURAGE EX ANTE SAFETY AND (ALONG

WITH TAX REVENUES) FUND ANY NECESSARY CLEANUPS .................. 1582

2014] REGULATING THE ENERGY REVOLUTION 1525

IV. THE POLITICAL ECONOMY OF ENACTING UNCONVENTIONAL OIL

AND GAS INSURANCE MANDATES ......................................................... 1586

CONCLUSION ....................................................................................... 1591