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Legal Fight Between Rowan and BP Amoco Will Set a Precedent

The battle will decide who calls the shots with contract cancellations.

A legal battle between

Rowan

(RDC)

and oil behemoth

BP Amoco

(BPA)

could change the way oil companies and drilling contractors do business.

In January, BP Amoco

canceled a one-year, $65 million drilling contract with Rowan to use its Gorilla V drilling rig. BP Amoco then filed a breach-of-contract suit in London. The same day, Rowan filed a suit in Houston against BP Amoco for damages it says it sustained when BP Amoco canceled the contract. In addition, Rowan filed counterclaims in London.

The London case could set precedents for when and how oil companies can terminate contracts, possibly making it much easier for them. Meanwhile, if Rowan wins a large award in Houston, other oil-service companies could feel emboldened to proceed with similar suits.

The BP Amoco/Rowan battle is part of a burgeoning war between the oil companies and oil-service providers. Through mergers, big oil companies are getting even bigger and wielding more

purchasing power over oil-service and drilling companies. Rowan, for instance, is just one of a half dozen drilling contractors that have had drilling contracts canceled since December. And the cancellations may continue.

Marine Drilling

was warned earlier this month by a unit of

Exxon

(XON) - Get Intrexon Corporation Report

that its contract for a rig in the final phases of construction may be canned.

For investors, the ramifications could be significant. After all, the first thing an oil-service investor wants to know is how solid a company's contracts are, especially if the driller is putting up money for a shipyard to refurbish a rig, says Wes Maat, who follows Rowan at

Deutsche Banc Alex. Brown

in New York.

"Investors are less likely to put capital up" if the contracts are in doubt, Maat says. He rates Rowan hold, and his firm hasn't performed underwriting for Rowan.

The situation "is one of the most interesting things that's happened to the drilling industry in years," says Bryan Dutt, founder and principal of

Ironman Energy Capital

, a Houston-based hedge fund and Rowan shareholder. "This is the first time that I can recall a service company actually taking a major oil company to task. If they don't settle and it goes all the way and BP Amoco wins, it will give oil companies even greater incentive to renege on contracts. If Rowan wins, the oil companies will have to think twice about reneging on long-term contracts."

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Bob Palmer, Rowan's chairman, chief executive and president, declined to comment on specifics but says, "I think there is no question this case is going to have an impact. The open question is, Is a deal a deal and is a signed contract a signed contract? That will depend on the outcome of this litigation."

BP Amoco declined to comment.

A Contract Signed in the Good Old Days

In September 1997,

Amoco (U.K.) Exploration

, formerly a division of

Amoco

and now part of BP Amoco, contracted with

British American Offshore

, Rowan's London subsidiary, for the use of the Gorilla V, a heavy-duty rig designed to withstand the North Sea's harsh waters. The rig was to drill off a platform controlled by Amoco,

Amerada Hess

(AHC) - Get A.H. Belo Corporation Class A Report

and

Enterprise Oil

(ETP)

. At the time, oil was selling for $19 per barrel.

By January, oil prices were at $11 a barrel thanks to Asia's economic crisis, and Amoco was no longer independent, having completed its merger with

British Petroleum

. With the cancellation, the legal battle followed.

As a result of these lawsuits, drilling contracts will be written with increasing specificity, says Robert Trace, an analyst at

SouthCoast Capital

in Houston. Oil companies will try to increase the number of issues they can call on to get out of contracts, while oil-service firms will try to close those loopholes, he says. Trace has a strong buy rating on Rowan, and his firm hasn't performed underwriting for Rowan.

The situation could even affect mergers, says Trace. Only companies with very deep pockets typically have the wherewithal to fight big oil producers in court, so smaller drilling firms may look to partner up with larger, better-capitalized companies to ensure they will have the balance sheets to withstand contract cancellations and possible lawsuits.

A Deal Is a Deal Is a Deal

At issue in the London cases are the actual contractual details and the readiness of the rig. BP Amoco says the rig was delivered three months late, and in an inoperable condition. Rowan says the rig was delivered within an acceptable time frame. Under the original contract between Amoco and Rowan, any disagreements arising from the contract would be litigated under British law.

It may be months before trial dates are set. Right now, attorneys are duking it out on both sides of the Atlantic over what Rowan calls "procedural issues." Both sides have challenged the jurisdiction of the other's case.

These preliminary issues are sure to drag the saga out as the companies bicker across the Atlantic. For now, only one thing is clear: The precedent-setting judgments will be a long time coming.