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Due to insufficient error handling in the StAX API, the actual error is not being propagated. Hence, it only throws a generic error message "Unable to create StAX reader or writer" to the web service client.
As such, the actual error that causes the failure in the web service client will remain unknown.
Due to insufficient error handling in StAX, in which the actual cause of error is not propagated to calling clients, you can consider using other XML streaming implementation, like Woodstox.
Thanks a lot for your suggestion Kal, I managed to narrow the problem...
We were using oracle service bus (OSB) as proxy for our services. When we are accessing problematic service directly, without OSB, everything is working fine.
OSB doesn't transform message received from the webservice client in any way, it just acts as a single access point, but somehow it causes problem.