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

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.

Keywords: Oil, gas, fracking, liability, insurance

JEL Classification: K10, K19, K20, K22, K30, K32