Ambiguity in Crude Oil Supply Agreement Leads to Pricing Dispute

International Arbitration, North America

Two different interpretations of a long-term crude oil supply agreement led to an international arbitration. The definition of "available alternative crude oil grades" was disputed, with opposing views on the intended breadth of the basket of crude grades for the basis. We testified on the availability of alternative crudes, their production volumes/prices, optimal crude mix during the period, and the differences in refinery margins between actual and alternative cases.

Petroleum refiners often enter into long-term supply agreements with crude oil producers to ensure future availability of feedstock at a competitive price. Such agreements commonly employ formulas that price the specific crude oil relative to the prices of so-called "benchmark" crude oils that are widely traded in the world market. The objective is to try to ensure that the refiner purchases-and the producer sells-at a price that closely reflects fair market value.

A refiner entered into a long-term supply agreement with a supplier of crude oil. Under the contract, the refiner agreed to upgrade and expand the refinery to accommodate the agreed crude oil volumes. In order to ensure that the refiner paid-and the seller received-a competitive price for the crude oil, a complex formula was established and made part of the agreement. The formula, through the use of a linear program computer model, compared the margin that the refinery actually earned versus the margin it could have earned had it processed a slate of comparable alternative crude oils during a specified period. If the latter proved to be more attractive, the refiner was entitled to claim a rebate on the price it had actually paid for that period. During the course of the contract, however, a dispute arose regarding the computer model calculations. This was largely because the calculation was highly dependent on the determination of the alternative crude oils that were potentially available to the refinery, and the agreement was somewhat ambiguous on this issue. The parties went to arbitration over the matter.

In preparation for the arbitration, Baker & O'Brien was engaged to perform the appropriate computer calculations for each of a number of specified periods. In performing these calculations for each period, our consultants: (1) determined which alternative crude oils would potentially have been available to the refiner for that period; (2) the available production volumes and prices of those crude oils; (3) the optimal mixture of such crude oils in the refinery for that period; and (4) the difference in refinery margin, if any, between the actual case and the alternative case. We issued a report which detailed all of our calculations, inputs, and assumptions. An expert for the opposing party issued a similar report, which our consultants were asked to critique. One of our consultants testified before the arbitration panel regarding our findings and conclusions.

John R. Rayne

Senior Consultant, Recruiting Manager

Petroleum Refining
Commercial Contracts / Litigation / Arbitration / Expert Witness Testimony / Pricing / Crude Oil Valuation / Quantum/Damages Assessment
North America