Federal pipeline regulators and ExxonMobil lawyers will spar Wednesday in Houston over a proposed $2.7 million fine and allegations that the company delayed crucial inspections, skewed risk data and ignored warning signs before its Pegasus oil pipeline ruptured in Arkansas last year.

The two sides are presenting evidence for and against the fine and allegations in an "informal" administrative hearing that's closed to the public. It is being heard by a presiding officer from the Pipeline and Hazardous Materials Safety Administration (PHMSA), according to Damon Hill, spokesman for the regulatory agency. A final ruling could take six months or longer.

PHMSA's Pegasus case is being closely watched by pipeline opponents who question the government's ability to stand up to oil company pressure and protect the public from harmful—and sometimes deadly—incidents involving oil pipelines and railroad cars filled with crude.

"What gets everybody really suspicious is that you don't have access to watch it, which raises all kinds of issues about transparency," said Richard Kuprewicz, a pipeline safety consultant who serves on PHMSA's safety standards advisory board for oil pipelines. "The pipeline is owned by the company, but it's running through public assets, so [the closed process] tends to be frustrating."

This kind of hearing "is allowing the company to have due process, to test whether PHMSA's perspective is on track or if they missed something that either the company hasn't given them access to, or that they believe PHMSA may have misinterpreted," said Kuprewicz. "This is where the lawyers kind of go at it."

At issue is the bluntly worded notice PHMSA sent to Exxon in early November. In it, PHMSA laid out a series of "probable" violations of pipeline laws and regulations that it found while investigating the March 2013 Pegasus oil spill in Mayflower, Ark. PHMSA said Exxon underestimated the vulnerability of the Pegasus by "selectively using" risk assessment results and relying on artificially lowered risk scores to sidestep the need for extra inspections or special spill prevention measures.

Exxon's system for assessing pipeline vulnerabilities needs changing to make sure risk scores "are not manipulated," that integrity management plans "are not circumvented," and that "conflicting budget goals" don't affect pipeline safety priorities, PHMSA said.

When the notice became public, a pipeline failure analyst who has oil companies as clients noted: "I would read this as PHMSA basically accusing them of gaming their own risk assessment process." Hill, the PHMSA spokesman, said at the time that PHMSA was "not implying that those things were done."

In December, Exxon denied the allegations and requested a hearing to contest the proposed fine, probable violations notice and the related proposed compliance order—Exxon wants all three withdrawn in their entirety. It called the proposed $2.66 million civil penalty "excessive."

Exxon spokesman Aaron Stryk said the company sought the hearing "to demonstrate our compliance with the laws and regulations applicable to the items called into question by the Notice of Probable Violation. Out of respect to PHMSA, we will address the specifics of each item during the hearing process."

Exxon is also fighting a proposed PHMSA fine of $1.7 million for alleged violations related to a July 2011 break in the company's Silvertip oil pipeline, which fouled the Yellowstone River in Montana with 63,000 gallons of crude.

Together, the two fines amount to $4.36 million, or about 0.013 percent of the company's 2013 profit of $32.6 billion.

Exxon Denies Responsibility

The Arkansas case began when Exxon's 858-mile Pegasus oil pipeline split open along its lengthwise seam, sending 210,000 gallons of Canadian diluted bitumen into a nearby neighborhood and cove. The stench and incursion of the diluted tar-like substance sickened residents, forced evacuations and rendered some houses uninhabitable.

Exxon spokesman Stryk said the company has spent an estimated $75.1 million so far on spill-related expenses, including the purchase of more than 20 homes in the affected neighborhood. That doesn't count costs associated with pending lawsuits or lost revenue from shutting down the pipeline, which carried crude oil from Illinois to the Texas coast.

The burst section of the line will remain closed for at least another year while Exxon conducts more robust tests.

Since the spill, much of the discussion around the Pegasus has centered on the pipeline's age and manufacturing lineage. Most of the pipeline—about 650 miles of it—was made of pipe manufactured in 1947 and 1948 using low frequency electric resistance welds (LF-ERW), a technique known to create hook cracks and other defects that can cause seam welds to fail.

That same part of the Pegasus was vulnerable for another reason, too: It was built using pipe made by Youngstown Sheet & Tube Co., whose pipe from that era is known in the industry to be prone to brittleness and fractures.

Pipe experts stress that proper care and precautions can prevent manufacturing defects from growing and eventually causing a pipeline rupture. Something in the way the pipeline was operated must have caused an existing hook crack to grow, they said. Exxon, however, put the blame entirely on the manufacturing metallurgy, and has never explained what awakened a 65-year-old defect in the Pegasus.

At the core of PHMSA's case is its contention that Exxon did not properly assess the risks inherent in the Pegasus—namely, that it was made from pre-1970 pipe welded using the LF-ERW process, and that pipeline segments had ruptured several times during hydrostatic pressure testing and once while it was in service.

Exxon has said its own analysis led to "the determination that the Pegasus pipeline was not seam-failure susceptible."

Exxon also took issue with PHMSA's allegations that the company:

+ Failed to reassess the seam failure risk on the most vulnerable segment of the pipeline within five years of confirming the threat. Despite having suffered the most seam failures during hydrostatic tests in 1991 and 2006, Exxon did not reassess that stretch of pipe for seam threats until February 2013, a few weeks before the Pegasus broke open.

Exxon countered that a different test designed to find corrosion was conducted within the five-year deadline.

+ Failed to take prompt action when it was notified of pipeline conditions that were classified as needing immediate repair. An inspection company told Exxon about two sites needing repair on Aug. 9, 2010, but the company didn't formally "discover" one threat until 19 days later, and the other one until months later. The discovery date is what starts the clock on response deadlines.

Exxon said it was not informed of the repair conditions on the dates PHMSA asserts, and thus it did not miss the deadlines.

+ Failed to follow its procedures "by selectively using results" from its threat assessment process in 2011. That caused Exxon to downplay the risk of an oil release into Arkansas' Lake Maumelle watershed and other areas along the Pegasus segment subject to manufacturing defects. Exxon then failed to elevate the threat, PHMSA said.

Exxon said it considered the pipeline's history as well as inspection and test results for the pipeline segment in question and properly characterized the threat levels.

+ Failed to reassess risk scores after it changed the way pipeline risks were assigned. Exxon combined four pipeline segments that used to have separate risk scores to create two segments, a move that averaged the risks and lowered the overall risk scores, PHMSA said. Regulators said that action masked higher threat segments within the Lake Maumelle watershed and the city of Mayflower.

Exxon said that merging testable pipeline segments didn't affect the risk and threat assessments for the Pegasus.

Kuprewicz, the pipeline safety expert, said cases like the Pegasus can uncover what seem to be obvious regulatory lapses and risky operations at pipeline companies—but nonetheless result in paltry punishment. That's because some regulations leave wiggle room in the wording—or give operators wide latitude in how to comply—and that allows pipeline operators to violate the law's intent without explicitly breaking the letter of the law.

Pipeline companies have fought hard to make sure PHMSA regulations have broad flexibility and fewer specific compliance edicts, he said.

It's not yet clear how the Pegasus case will unfold within PHMSA, Kuprewicz said. "You just have to let it run its course."