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    Untitled Document

    Part 1 of 2 Parts: Insurance coverage disputes arising from well blowouts

    EDITOR’S NOTE: In this first of a two-part series, Edward O’Gorman, who handles trials and appeals of insurance coverage and construction cases, examines disputes involving well blowouts. The views expressed are his and are not necessarily those of his firm, its clients, or Oil & Gas Financial Journal.

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    Advances in drilling operations have made possible exploration and extraction of oil and gas from remote areas and severe climates. However, well blowouts with potentially catastrophic damages remain a risk.

    Edward J. O’Gorman Wilson, Elser, Moskowitz, Edelman & Dicker White Plains, NY

    The Mississippi driller, employed by a daywork contract, was working the Smackover formation, known for its high pressure concentrations of hydrogen sulfide, a toxic gas. Approaching the well’s target depth, the driller recognized “several indicators of a kick.” Following standard procedures, he immediately turned off the mud pumps. Confirmation of a kick occurred when the well continued to flow with the mud pumps turned off. Instead of immediately closing the well’s blowout preventer (BOP), which was standard procedure upon detection of a kick, the well operator’s supervisor ordered the driller to turn the mud pumps back on.

    Well blowout in Iraq.
    Photo courtesy of Boots & Coots International Well Control Inc.
    Click here to enlarge image

    While the driller could not believe the order, under the terms of the daywork contract, he followed it. Thirty minutes later, the supervisor, finally realizing a kick had occurred, attempted to shut in the well using the annular BOP. However, the annular BOP failed and began leaking gas. The upper rams on the double BOP were then closed to further encase the well and drilling mud was pumped into the well to try and stabilize pressure. Shutting the BOP’s lower rams failed because handwheels used to lock the rams were missing. A few hours later, the upper arms of the BOP failed, resulting in a “violent eruption of wellbore product.” The operator filed for bankruptcy (Rebel Drilling Co. v. Nabors Drilling, 2004 Tex. App. Lexis 8320).

    While advances in drilling operations have made possible exploration and extraction of oil and gas from remote areas and severe climates, well blowouts with potentially catastrophic damages, remain a risk of drilling operations. Where operators are reluctant to publicize blowouts, and where not all blowouts become known, the frequency of blowouts occurring in many drilling regions is unknown.

    The US Minerals Management Service listed 42 well blowouts occurring on the US outer continental shelf between 1992 and 2005. Exploratory wells encountered the highest rate of blowouts. As was illustrated in the Rebel Drilling action, blowouts result from high pressure formations, operator error, and equipment failure.

    Blowouts cause wells to become abandoned or re-drilled. Other damages are pollution cleanups, repair or replacement of well platforms/drilling equipment, damaged mineral reserves, and lost income from producing wells’ suspended operations. Where drilling occurs near residential or commercial areas, such as Dallas and Fort Worth, both lying above the Barnett shale, a natural gas field, damage to homes and businesses, including evacuations, is an additional risk.

    Risk of catastrophic damages requires most, if not all, energy companies to pass the risk or a portion of it, to insurance companies. Operator’s extra expense insurance and energy exploration and development insurance are two coverages for owners and operators for well control expenses. The policies usually provide coverage for pollution cleanups, re-drilling wells, and damaged third-party equipment. Commercial general liability (CGL) insurance provides contractors with coverage for third-party damage from faulty workmanship or defective products. Some courts have extended CGL coverage to contractors’ repair and replacement costs.

    Insurance coverage is limited, or as insureds sometimes complain, made illusory, by policy exclusions and insurers’ interpretations/definitions of policy terms. Damages from blowouts may be excluded where oil or gas production can be diverted through a relief well following a blowout, or where blowouts are confined to a single geological formation.

    Some insurers contend a blowout does not occur unless the uncontrolled gas or oil exits the surface of the well. Coverage may also be excluded for damage to well equipment located underground or beneath the surface of the water. The challenge for risk managers is to identify potential damages of their company’s drilling operations and be aware of policy definitions or exclusions that may create a gap in insurance coverage.

    Ambiguous/unambiguous language – crux of coverage disputes

    Insurance coverage disputes often hinge on whether insureds’ definitions or interpretations of disputed policy language are reasonable. Insurance policies are contracts and many policies are adhesion contracts, where policy terms are drafted by the insurance company and offered on a take it or leave it basis. (Companies paying substantial premiums may have an input.)

    When an insured’s interpretation of policy language differs from the insurer’s interpretation, and is a reasonable interpretation, disputed language is deemed ambiguous. When ambiguity exists, courts in most states (Maryland is an exception), apply the insured’s interpretation or allow evidence supporting that interpretation. Where disputed policy language is held to be unambiguous, the insurer’s definition usually applies and coverage is likely denied.

    The CGL’s absolute pollution exclusion is an example of judicial division as to whether policy language is ambiguous. Is the exclusion limited to pollution discharges from industrial activity or are non-industrial pollution discharges also excluded? A finding that exclusionary language is ambiguous results in coverage for non-industrial discharges.

    Where the exclusion’s language is held to be unambiguous, analysis is limited to whether a pollutant was discharged, and the context of the discharge is not relevant. A finding of unambiguous policy language resulted in denial of coverage for claims of infants ingesting peeling lead paint in apartments and office workers’ exposure to fumes from building cleaning products.

    Well control coverage

    A well blowout is as an uncontrolled release of oil, gas, or water during drilling operations caused by pressure in the well. A gusher of oil spewing above a derrick is a type of blowout. Blowout was defined in one policy as “when pressure of oil, gas or water entering the well at some depth below the surface is greater than the pressure exerted by the column of drilling fluid in the well …” (Rosamond Drilling v. St. Paul Fire, 305 So. 2d 630).

    Drilling fluid or drilling mud is used to cool drill bits and bring rock cuttings to the well’s surface where they are filtered from the well. Drilling fluid is also used to prevent blowouts as different densities of fluids are used to maintain proper pressure in a well. If the “density is too light, gas may be able to push past the fluid and blow out the top of the well.” (“Oil Well Blowouts: Disastrous, Frightening and Preventable,” by Brian Krause, Risk Management, May, 2007.)

    Where decreasing amounts of drilling fluid reach the well surface, a “kick” may be occurring, which is what occurred in the Rebel Drilling case prior to the blowout. A kick is a “loss of normal fluid circulation when pressure from below is in excess of that exerted by the drilling fluid being pumped into the well.” (Howard R. Williams & Charles J. Meyers, “Manual Of Oil And Gas Terms 559.)

    While the policy in the Rosamond Drilling decision defined “blowout,” not all policies have defined “blowout.” Where a policy provided no definition, insurers argued no blowout occurred unless gas or oil was discharged from the well. Insureds countered that a discharge from the well was not required. Rather, a blowout: occurred where upward well pressure existed. The presence of upward pressure in a well prevents drilling operations because drilling fluid cannot be pumped down to the wellbore, and thus, rock cuttings cannot be removed from a well.

    Courts have held that uncontrolled flows of oil and gas were not required to exit the surface opening of the well for a “blowout” to occur. Rather, where such flows prevented drilling operations, a blowout occurred.

    Well blowout in Iraq.
    Photo courtesy of Boots & Coots International Well Control Inc.
    Click here to enlarge image

    In the Rosamond Drilling case, a “sudden expulsion” of drilling fluid through a fracture in underground strata resulted in an uncontrolled flow of gas to a creek bed. It was held the well was “completely out of control” when “adverse pressure and flow of gas or liquid from the well could not be corrected by injection of drilling mud or otherwise to allow the operator to continue normal drilling operations.”

    The Louisiana Supreme Court in Creole Explorations v. Underwriters at Lloyd’s, 161 So. 2d 768 (1964), similarly held:

    … [T]he well was under control when the column of mud was balanced so that whatever operations were necessary could be performed in the well bore hole, and that it was out of control when the mud column became so imbalanced from gas and saltwater penetrations that operations had to be stopped while the mud was conditioned or weighted up and control regained.

    The time period or length of blowouts has arisen in policy disputes. In Atlantic Richfield v. Underwriters at Lloyd’s, 398 F.Supp. 708, the blowout prevented a well from being reached for nine days because of “intense heat generated by the fire on the platform and in and around the wellhead.” Two weeks after the blowout, mud was pumped into the well hole and pumping continued for three weeks in an attempt to bring the well under control.

    Where the policy did not define “control” or “bringing the well under control,” the insurer contended the well was under control after a fire was extinguished. The court disagreed and held the blowout continued until normal drilling operations could be resumed. Responding to the insurer’s argument, the court wrote, extinguishing fires did “not relieve a drilling operator of the responsibility to continue to counteract potential hazards which may flare at any time and does not permit the operator to resume normal activities immediately.”

    The insurer in Atlantic Richfield also argued control was achieved when the well’s BOP closed because it prevented immediate expulsion of fluids from the well “and kept continuous surface hydrostatic pressure on the drill pipe to counteract down-hole pressure.” (BOP “is a large valve that encases a well… During drilling or well interventions, the valve may be closed if overpressure from an oil reservoir causes formation fluids such as oil and natural gas to back up within the wellbore and threaten the rig.” — Wikipedia).

    However, where drilling activity cannot occur with the BOP closed, it was held a blowout continues until pressure exerted by drilling fluids forces gas or oil below the well bore, allowing resumption of drilling operations.

    Well control exclusions

    Policy exclusions and insurer’s interpretations of policy terms may limit or deny coverage for well blowouts. Exclusions may apply to specific instances where insureds may not readily suspect insurers are assuming less of the risk: blowouts confined to a single formation; where relief wells (drilled to intersect a well that is blowing out) are able to be drilled following a blowout; and damage to the portion of a well below the ground or water surface.

    In Mescalero Energy v. Underwriters Indemnity, 56 S.W.3d 313 (2001), an uncontrolled flow of oil, gas, or water caused a “loss of normal fluid circulation” in the well bore, trapping leased drilling equipment. A claim was made when the well and drilling equipment were abandoned. The policy defined “blowout” as “a sudden, accidental, uncontrollable, and continuous flow of oil, gas, or water simultaneously between two or more separate formations via the well bore under the surface of the earth or water bottom.”

    The insurer denied coverage, claiming the “uncontrolled flow” was confined to a single formation referred to as the Austin chalk. The insurer relied upon the definition of “formation” contained in “Manual Of Oil And Gas Terms” (Williams & Meyers), and cited by the Texas Supreme Court in Amarillo Oil v. Energy-Agri, 794 S.W.2d 20:

    A succession of sedimentary beds that were deposited continuously and under the same general conditions. It may consist of one type of rock or of alterations of types. An individual bed or group of beds distinct in character from the rest of the formation and persisting over a large area is called a member of the formation.

    The insurer’s expert concluded gas and fluid movement through a “fractured, unstable portion of a single formation caused the formation to cave in on the drill pipe.” Where such movement was confined to a single formation, no “blowout” occurred. The insured offered an alternative definition of “formation.” The insured’s expert, a petroleum engineer, defined “formation” as “any mappable, separate, self-contained pressure unit within a geologic interval.”

    Pursuant to this definition, the expert concluded “numerous” formations existed within the Austin chalk and the flow of gas and liquid was not confined to a single formation. In order to determine whether there was coverage, the court had to assess whether the insured’s definition was reasonable. Unlike the insurer’s definition of “formation,” the insured’s definition was not from a publication. It was derived from the expert’s experience in the oil and gas industry.

    When assessing whether the insured’s expert was qualified to provide such a definition, the court noted the engineer’s “extensive work and educational experience (doctorate) in the oil and gas industry…” Finding “experience alone may provide a sufficient basis for an expert’s testimony in some cases,” the court held the engineer’s definition of “formation” was reasonable.

    Where the insured offered an alternative and reasonable definition of “formation,” it was an ambiguous term, and ambiguity dictated use of the insured’s definition. Applying this definition of “formation,” the court found a blowout had occurred. The decision illustrates reasonable definitions are not confined to textbooks and publications and instead, may be derived from one’s education and experience in an industry.

    Where coverage was excluded for blowouts confined to a single “formation,” coverage was also excluded for costs of well restoration or redrilling a well where sufficient drill stem remained or a relief well could be drilled following a blowout:

    There shall be no coverage … for restoration or redrilling of any well whose flow can be safely diverted into production, including by completing through drill stem left in the well insured hereunder, or which can be completed through relief wells drilled for the purpose of controlling a well.

    In Goodrich Operating v. Burnett, 2006 U.S. Dist. Lexis 27672, after drilling a well to a depth of over 14,000 feet, the drill’s perforating guns (device perforating oil and gas wells in preparation for production – Schlumberger’s Oilfield Glossary) “encountered an obstruction preventing the guns from being lowered to the appropriate point.” A tubing unit was “engaged to remove the obstruction and clean out the well.” During the course of the clean out, a blowout occurred, “likely as a result of an inadvertent hole being milled in the liner.”

    Several months later, the insured performed workover operations to restore the well to production and sought $865,300 for the cost of drilling a “sidetrack” well to complete production.

    Coverage was denied by the insurer where the well flow was safely diverted into production following the blowout, according to deposition testimony of an insured’s employee: “it was easy to divert to product;” “I don’t think it created any greater risk;” and “it was not an unsafe operation to divert the well to production.”

    The insured disputed whether the policy condition of “safely diverted into production” was met where “high pressure down hole combined with damage to the on-site rig and surface equipment created an ongoing danger to both the individuals working on the well and to the environment.” The insured argued this method of production was the “only feasible method of decreasing the dangerous downhole pressure.”

    The insured also argued where the flow came from an “open hole” and “not exclusively through the production casing,” it was an unsafe drilling practice because blowout preventers and other well control mechanisms could not be used. The court held the statements of the insured’s employee and the insured’s arguments raised a question of fact as to the exclusion’s applicability, thus denying the insurer’s summary judgment motion.

    Whether oil or gas is able to be “safely diverted into production” following a blowout is dependent upon fact witnesses (as in Goodrich Operating) or use of an expert witness. An expert witness may provide evidence as to the meaning of “safely diverted” in a particular instance and whether the post blowout condition of the well and drilling equipment would allow a flow to be safely diverted into production.

    While the condition of the well following a blowout was at issue in the Goodrich Operating case, the location of the damage to the well was at issue where the exclusion for underground resources and equipment hazard was interpreted. The exclusion applied to damages to well equipment located “beneath the surface of the earth” or the “surface of any body of water.”

    While the exclusion was not addressed in the context of a well blowout, a Texas court recently interpreted a portion of the exclusion. The case, General Star Indemnity v. Gulf Coast Marine, 2008 Tex. App. Lexis 1056, arose where equipment attached to an offshore well, located beneath the surface of the water was damaged. The disputed policy language was:

    C. Any casing, pipe, bit, tool, pump, or other drilling or well servicing machinery or equipment located beneath the surface of the earth in any such well or hole or beneath the surface of any body of water.

    The insurer cited the exclusion when a drilling rig being towed to a well came into contact with the well’s stub and net protector. The insured argued the exclusion did not apply because the stub, which marks the well’s location and the net protector, which protects the well, were not part of the well.

    While the court recognized the stub and net protector as devices which “undoubtedly serve a vital function in the oil industry,” where such devices were not “well servicing or drilling equipment,” the exclusion did not apply.

    “Insurance coverage disputes arising from well blowouts” will conclude in the October 2008 issue of Oil & Gas Financial Journal.

    About the author

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    Edward J. O’Gorman [edward.ogorman@wilsonelser.com] is a partner with the law firm, Wilson, Elser, Moskowitz, Edelman & Dicker. He has written numerous articles on the subject of risk management and insurance coverage and is the author of two books, Intellectual Property Insurance Coverage Disputes, a three-volume 50-state analysis, and Pollution Coverage Issues, a two-volume 50-state analysis, the latter published by the International Risk Management Institute.

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