Will 'beyond our control' argument have legal merit?

Posted: Wednesday, August 16, 2006

DALLAS - Exxon Mobil Corp. and ConocoPhillips Co. are notifying customers they cannot meet contract obligations to supply crude oil from Alaska's Prudhoe Bay oil field because of unavoidable events beyond their control.

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This leads some to question whether the underlying reason - pipeline corrosion that went undetected after years of lax maintenance - really fits the standard for invoking that legal escape clause.

The clause is called force majeure, a contractual get out of jail free card excusing a company from fulfilling its obligation because performance failure could not be avoided.

Exercising this option usually happens during war or following a natural disaster such as a hurricane, often lumped under the category of "acts of God." Neither was the case when both invoked the clause last week after field operator BP announced it was partially shutting down the nation's largest oil field. As a result, some questions may linger, legal and industry analysts say.

If BP was negligent - the British oil giant has accepted responsibility for the lack of upkeep that led to shutdown - does this really qualify as an unforeseen circumstance? As huge interest holders, do Exxon Mobil and ConocoPhillips still have some oversight responsibility? If so, do Exxon Mobil and ConocoPhillips really have a legitimate claim to use the legal clause?

"Someone could very easily bring that claim and have it be a valid one," said Houston attorney Tom Kruse, of Baker & Hostetler LLP, who has tried force majeure cases.

"It will come down question of law that if you have ownership in pipeline, whether or not you have responsibility to monitor BP's operations," he said. "They are trying to get ahead of the curve and get declaration from the court that they are not responsible."

Still, industry lawyers, analysts and engineers say the Exxon Mobil and ConocoPhillips did the right thing protecting their interests as well as those of the shareholders.

"They are implicitly distancing themselves from potential liability," said Brian Hicks, a natural resources fund manager for U.S. Global Investors Inc.

"In doing so they are protecting themselves," he said. "It's what they should be doing. It's not a good situation for the companies involved the way it looks now."

While each company has slightly more than 36 percent interest in the nation's largest producing oil field, minority owner BP (26 percent share) operates the field and is responsible for maintenance.

About 150,000 barrels of crude and natural gas were flowing Tuesday from one half of the field and the company hopes to eventually produce about 200,000 barrels, or half of the field's normal production.

University of Houston petroleum engineering professor Michael J. Economides said BP's practices should have been questioned by its partners given its previous troubles such as the Texas City refinery explosion last year that killed 15 and another North Slope leak in March, when up to 267,000 gallons of oil spilled on the tundra.

"Yes, they had no choice but to invoke force majeure, but they depend on BP's due diligence, which in my estimation has been questionable," said Economides, who spent four years at the University of Alaska Fairbanks.

"I don't like the statement that BP was surprised by the corrosion," he said. "A company that size should have first-rate engineers and managers. We don't like surprises in my business, and good due diligence precludes all of these things."

Houston oil and gas attorney J. Lanier Yeates said energy companies typically account for problems such as corrosion in contracts with clients, suppliers and royalty owners, in this case the state of Alaska.

The clause, he said, is designed to protect numerous interests and often carries broad criteria.

"I expect the provisions in the contracts that apply here are broad enough to include these kinds of problems from the wear and tear and corrosions and deterioration of the pipes," he said. "I would be greatly surprised if there weren't contractual provisions that relate to damages to the pipeline."

Although instances aren't readily tracked, Yeates and colleague Pat Martin, law professor at Louisiana State University, say the legal clause received a great deal of attention after hurricanes Katrina and Rita slammed the Gulf Coast last year.

The hurricanes temporarily shut down 28 percent of the country's refining capacity, moved pipelines miles away from their original position and turned oil production platforms on their side. It was a natural case for the clause.

Time will tell whether Prudhoe Bay is viewed the same way.

"There are often questions raised as to whether one could have taken steps to avoid circumstances they claim to be force majeure," Martin said.

"But my guess is you won't see it out of this," he said. "I don't think ConocoPhillips or Exxon Mobil could be tagged with breach of contract if the oil is not available to them."

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