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Why The Saudis Suddenly Agreed To This Mega Oil Deal

Strange, is it not, that an agreement has suddenly been reached between Saudi Arabia and neighbouring Kuwait on the oil and gas fields that they share in the ‘Neutral Zone’ after a bitter dispute that showed no sign of ending after nearly five years? Aside from the pure peculiarity of this sudden announcement, there is the fact that the deal will throw another 500,000-600,000 barrels per day (bpd) of oil into an already saturated market, against a declining demand profile, at a time when Saudi for one needs the oil price around US$84 per barrel just to allow this year’s budget to break even.

Add to this the fact that half of the new output will be added to Saudi Arabia’s production figure (and the other half to Kuwait’s) at a time when Saudi is supposed to be setting the primary example on compliance with the latest OPEC+ oil production deal and we seem to be entering the ‘Alice In Wonderland’ world in which nothing is as it seems. Actually, this is right, it is not what it seems at all, but OilPrice.com knows why.

The first part of the reason (there are two key parts) dates back to 14 September when two of Saudi Arabia’s key oil facilities – the Abqaiq refinery and the Khurais oil field – were attacked by drones fired by rebel Houthis (and/or Iran). This caused both the suspension of 5.7 million bpd of oil production and an unusually brazen bout of lying and/or market ignorance from the Saudis on such a scale that even the usually collusive credit ratings agencies could barely keep up. 

One particularly striking comment in this vein at the time came from Saudi Arabia’s new oil minister, Prince Abdulaziz bin Salman, just after the attacks. He stated that the Kingdom plans to “restore its production capacity to 11 million barrels per day by the end of September (a maximum of two weeks after the attacks, remember) and recover its full capacity of 12 million bpd two months later.” Related: Big Banks Turn Bearish On Oil Next Year

As highlighted to OilPrice.com by global energy consultancy Energy Aspects’ senior energy analyst Richard Mallinson at the time: “It was extremely telling that he [Abdulaziz bin Salman] spoke of ‘capacity’ and later of ‘supply to the market’, as these are terms that Saudi tends to use in order to avoid talking about actual production, as capacity and supply are not the same thing at all as actual production at the wellheads.” He added: “What Saudi is trying to do by not revealing the true picture is to protect its reputation as a reliable oil supplier, especially to its target clientele in Asia, so we have to take all of these comments with a hefty pinch of salt,” he added.

Indeed, not only had Saudi Arabia – in its entire history – never been able to sustain production of over 11 million bpd for more than a fleeting few days, but also a total implied production capacity of 12.0-12.5 million bpd (based around its historical claim to have 2.0-2.5 million bpd of spare capacity) has never been even remotely tested. Even Saudi Arabia has said that it would need at least 90 days to move rigs to drill new wells and raise production to the mythical 12 million bpd or 12.5 million bpd level, whilst the EIA defines spare capacity specifically as production that can be brought online within 30 days and sustained for at least 90 days.

Perhaps even more ludicrous, although at this point the Saudis were working from an extremely high base of ridiculousness, was the Saudi claim that full production would be restored in such a short space of time. Whatever Saudi’s actual capacity (and it is exactly what OilPrice.com just said it was), there is absolutely no way that the country can have made any accurate assessment of how long it would take to get back to any particular capacity level either. “Engineers we have spoken to have said that following an incident like this it would take several weeks just to assess the damage, never mind to begin doing anything about it, rather than the few days that the Saudis have taken and then announced the actual timeline – and a very short timeline at that – to bring back various stages of capacity,” said Energy Aspects’ Mallinson. 

Saudi, therefore, needed to plug the actual gaps created between its lies and the truth, which meant two things. The first was to run every other oil facility at full blast without a break since then, which understandably places enormous strain on the equipment and on the fields involved and to do this for an extended period risks further damage to these facilities and fields as well.

The second, as also highlighted by OilPrice.com at the time, was that Saudi found itself inadvertently, because it does not know anything about how oil markets work, buying oil barrels from the very people that it thought had attacked it in the first place – Iran. Specifically, in order to plug the holes in the supply contracts for its Asian customers, Saudi checked Iraq barrel prices repeatedly and used them where necessary. ‘Rebranding’ Iranian oil to Iraqi oil in the barrels or on the side of trucks or shipping containers, of course, is a long-favoured method for Tehran to dodge U.S. sanctions.

These two methods have allowed the Saudis to at least meet the minimum requirements of most of its longer term contracts and to buy some time to repair the Abqaiq and Khurais installations but, despite what Saudi says, there is still no comfortable leeway in its oil and refining sector. Consequently, it had little choice but to finally sign the deal to end the dispute over the shared fields with Kuwait in the Neutral Zone. This was also demonstrated to be “a workable solution to the Saudis’ ongoing production dilemma” by the U.S., according to highly-placed U.S. political sources in Washington spoken to by OilPrice.com last week. Related: A Bullish End To The Year For Oil Markets

According to them, although it is now the policy of the U.S. to withdraw from fields of conflict in the Middle East and Asia, it is still in Washington’s interest to stand by Saudi (and its ally Kuwait) to protect them from further attacks and/or territorial incursion by Iran and its allies. The fundamental understanding between the U.S. and Saudi dates back to 14 February 1945 when the then-U.S. President Franklin D. Roosevelt and the Saudi King at the time, Abdulaziz had their first face-to-face meeting on board the U.S. Navy cruiser Quincy in the Great Bitter Lake segment of the Suez Canal.

The deal they agreed – analysed in depth in my new book on the oil markets - which persisted completely unchallenged until the Oil Crisis of 1973 but was then resumed, was this: the U.S. would get all of the oil supplies it needed for as long as Saudi had oil in place, in return for which the U.S. would guarantee the security both of the country and of the ruling House of Saud.

What better way of doing this, in the current fractious environment in the Middle East, than via the only one of the original ‘Seven Sisters’ oil companies that still holds a concession in Saudi Arabia and is controlled by the U.S. – Chevron? And it is Chevron that, along with the Kuwait Gulf Oil Company, manages the onshore fields in Wafra (part of Kuwait), through the joint venture Wafra Joint Operations Company. And it is the Kuwait Gulf Oil Company, in close liaison with Chevron, that also operates the onshore fields in Khafji (part of Saudi Arabia), together with the Aramco Gulf Oil Company, through the Khafji Joint Operations Company. Moreover, the two actual reservoirs further allows Chevron (i.e. the U.S.) to assert its authority into both countries as, although geographically the fields are clearly demarcated by the sovereign boundaries of each country, geologically the oil reservoirs bleed underground into the other’s sovereign territory.

This means that any further attacks on Saudi (or indeed Kuwait) by the Houthis (i.e. Iran) can be regarded by the U.S. as an attack on one of its major companies (and personnel) in the shape of Chevron and on land in which the U.S. has ongoing working interests. This should be established virtually immediately in the resumption of around half of the usual output from the Neutral Zone, with the other half to follow within the next six months.

By Simon Watkins for Oilprice.com

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