A stand-off over insurance between quango Scottish Water and oil giant BP has seen work on a new £2.65 million water pipeline in Angus aborted, raising the risk that the new infrastructure may never become operational.

Scottish Water was last week unable to explain why it had proceeded to lay approximately three miles of an outfall pipeline from Kirriemuir sewage works to the River Dean near Glamis before securing a standard liability agreement against potential damage to a BP pipeline crossing the proposed route.

The dispute arising from the apparent failure of project management has now dragged on for six months, adding to project costs and leading one affected local landowner to call it "a Third World cock-up".

The BP Forties pipeline, dating from the 1970s, carries up to 500,000 barrels of oil a day – half of the entire output of the UK's North Sea rigs – from BP's terminal at Cruden Bay to Grangemouth.

A BP source told the Sunday Herald: "The significance of the Forties pipeline and the value of its cargo means there needs to be a fairly comprehensive agreement in place. In case of a worst-case scenario – say a digger rupturing it – there would potentially be a great deal of damage, which is why our rules about crossings are quite strict."

"This crossing is not complicated in civil engineering terms. Over the years there have been a lot of similar applications."

"We are not seeking money from Scottish Water, but you have to have a satisfactory commercial agreement in place to protect yourself, and that means agreeing a figure for the cap on liability in case of accidents, as on any car insurance policy."

Although Scottish Water declined to rule out abandoning the project if negotiations on the height of the cap break down, observers note that the amount of public money already invested in the pipe severely weakens their bargaining position.

The projected Kirriemuir water pipe also crosses oil and liquified gas pipes owned by National Grid and Shell. A spokeswoman for the former company reports "no outstanding issues", while the latter declined to comment on "constructive discussions".

One local farmer told the Sunday Herald: "After nearly £3m has been spent on an unconnected pipeline that leads nowhere, it looks like the project has been abandoned. Neither [construction company] Balfour Beatty nor Scottish Water will discuss it with locals and nobody is being held accountable for this Third World cock-up."

Asked why the liability question had not been resolved in advance, to reduce the risk of a bad deal for the taxpayer, a spokesman for Scottish Water said: "[We are] very keen to complete the construction of a new outfall pipeline from Kirriemuir Waste Water Treatment Works to the River Dean. This is an important environmental project facilitating the return of treated waste water to the environment. Most of the project has been completed and discussions with BP, Shell and National Grid are progressing".

"We have a significant investment programme to deliver the best possible service and environmental compliance. In all investment projects we work to put any necessary prior agreements in place and in this case further discussions have been needed regarding an aspect of the project. We are hoping to finalise these discussions satisfactorily as soon as possible so our contractor will then be able to complete the project."

Labour infrastructure spokesman and North East Scotland MSP Richard Baker last night demanded an explanation from Scottish Water as to why "something so fundamental was not clarified from the beginning of the project". He said the impasse raised "big question marks about the standard of project management efficiency" at the £1.14 billion-a-year quango.

"While we hope that BP will act reasonably to resolve this, the delay will have an impact in terms of the cost, as we all know that where infrastructure is concerned time is money, and these costs will accrue to the taxpayer. We need an explanation and we need to assure that any additional costs are minimised as well as clearly quantified."

Richard Khaldi, a spokesman for Water Industry Commission for Scotland, the watchdog that monitors the monopoly water provider on behalf of consumers and taxpayers, said that his agency did not plan to investigate the Kirriemuir case.

After consulting with Scottish Water, he said: "It is up to Scottish Water as to how they run their own projects. If [overspending] turns into a trend, we would [intervene] but what we are not able to do is take an individual project and say they should not do this or not do that, but there may be lessons they need to learn.

"This project is not completed and we don't audit individual projects while they are still going on."