Case Studies details
How “Frozen” Assets Created a “Cold Cash” Obligation
International Arbitration, London
October 1, 2013
To minimize transportation costs, crude oils of differing quality are often commingled together in the same pipeline to produce a single “common stream.” Shippers on such pipelines do not receive back the same hydrocarbon molecules they deliver—instead, they receive a blend of the molecules from all shippers. Each shipper must at all times maintain inventory in the pipeline (the “line fill”) in proportion to the volumes it ships and the value of inventory may sometimes exceed the original cost of the pipeline itself. Such pipelines often also employ systems (referred to as “quality banks”) through which shippers exchange payments to account for differences in the quality of the crude they inject compared to the common stream quality.
A shipper on a large central Asian pipeline had its line fill “frozen” as the result of an adverse judgment against it in an unrelated dispute. This meant that the cargo representing the line fill could not be withdrawn—and any quality bank obligation calculated—until the unrelated matter was settled. When, after three years, the unrelated matter was finally resolved, and the shipper was allowed to withdraw the frozen crude oil, it was presented with a large quality bank payment obligation—primarily because crude oil prices had risen dramatically in the interim. Under the pipeline tariff agreement, the shipper filed for arbitration to have its quality bank obligation reviewed and reduced.
Baker & O’Brien was engaged as an expert to review the pipeline operator’s quality bank calculations and determine whether they had been performed in accordance with the methodology outlined in the pipeline’s tariff agreement. We concluded that the quality bank calculation methodology—as interpreted by the pipeline operator—improperly incorporated various coefficients that were related to the absolute value of crude oil at the time of withdrawal. Thus, the application of the methodology breached the key principle of the quality bank—to account solely for differences in crude oil quality—not temporal value differences. Our evidence was presented in the arbitration and the shipper was able to have its quality bank obligation reduced substantially.