The ambitious expansion plans of BP Amoco, the world's second largest oil company are running into trouble.

BP Amoco, want to take over US oil company Arco for $27bn (£13.8bn).

But it has now admitted that the deal is unlikely to be approved by the US government.

The Federal Trade Commission is worried that if the merger goes through, BP Amoco would control too much of the huge Alaska oil fields, and dominate the West Coast refinery market.

Oil prices are already higher in California than elsewhere in the US, a politically sensitive issue, and the FTC and the State of California fear that, with 40% of the oil to refineries supplied from Alaska, BP Amoco could raise prices and stifle competition.

"When Alaska North Slope oil ... that is, 74% of the oil there, is owned by one company, that's enough to create worries," California Attorney General Bill Lockyer said.

Although the FTC has approved the merger of Exxon and Mobil, creating the world's largest oil company, there is growing concern that just four major oil companies now dominate the US retail market.

"I think, in the past month, BP tried to address the political concerns. The FTC didn't react. Now BP is raising the ante and taking on the FTC to challenge how strong the economic case is," said Michael Young of Deutsche Banc Alex Brown.

BP Amoco presses ahead

BP Amoco has vowed to press ahead with the merger plan, despite the possibility of a lawsuit from the FTC.

It has already reached agreement with the state of Alaska to sell off enough of its assets on the North Slope, the main oil producing region, to satisfy the state regulators.

It has agreed to reduce its share of the North Slope from 34% to 15% and says it will sign 10 year price supply agreements.

"Because of uncertainty over this merger, work on the North Slope ground to a virtual halt last year and future exploration and development stands to be delayed," said Alaska's governor Tony Knowles.

However, after eight months of talks, it has failed to convince the US federal authorities of the desirability of its plans.

The move puts Atlantic Richfield (Arco) in a difficult position. It has sought the merger as it believed itself to be too small to survive independently.

Shares in BP tumbled another 8.5p to 562p on the news. BP's market value has dropped by some £12bn in the past two weeks, more than the future value of any savings from the Arco deal.

BP Amoco overtook its longstanding Anglo-Dutch rival Shell last year as Europe's biggest oil company.

The shares in many other oil companies have risen as a result of the high oil price.