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Breaking News:

Drilling Giant Posts $11 Billion Loss

Is Saudi Arabia Showing Signs Of Weakness?

Saudi Arabia

Saudi Arabia is increasingly portrayed as a wayward actor intent on destabilizing everything it can get its hands on, uncomfortable about raising oil production despite U.S. warnings that the Saudi king would not last for two weeks without America’s military support. Riyadh, however, is aspiring to perform a triple balancing act, appeasing U.S. President Trump and adhering firmly to its vision of creating a grand OPEC+ crude oil producers’ alliance with Russia, whilst simultaneously keeping crude prices at a level which is sustainable for its economy. In this, Saudi Arabia will face a plethora of challenges, seen in this week’s sudden Saudi Arabia-Kuwait talks on restarting oil production in the Neutral Zone.

In Mohammad bin Salman’s failure to get a deal done lie many uncomfortable truths about Riyadh’s rather limited options. As details begin to transpite, it turns out the September 30 meeting between Saudi Crown Prince Mohammad bin Salman and Kuwaiti Emir Sheikh Sabah al-Ahmad al-Jaber al-Sabah has sowed more confusion than settled discrepancies between the two nations. Interestingly, the visit was initially intended to be a two-day one, but in the end was reduced to a couple of hours, with no official communication following the leaders’ reportedly tense talks. According to sources from both Saudi Arabia and Kuwait, one of the key points of contention was the resumption of oil production in the Partitioned Neutral Zone which was swiftly fobbed off by the Kuwaiti Emir.

Graph 1. Partitioned Neutral Zone.

Source: EIA.

The Saudi-Kuwaiti Neutral Zone, a quaintly delimited territory of 2230 square miles opening on the Persian Gulf, is a somewhat peculiar case of state boundary demarcation that initially reflected the aversion of desert tribes to delineate countries according to ’modern’ practice. Based on the Uqair Convention of 1922 defining the boundaries between Iraq and what is now Saudi Arabia and Kuwait, the Sultanate of Najd agreed to have equal rights over the given territory. 40 years later, largely spurred by massive oil discoveries in the Neutral Zone and adjacent territories, Kuwait and Saudi Arabia agreed to split the area in half, however large fields transgressing the median line were managed jointly…up until 2014.

The first to halt production was the Khafji field where Saudi Aramco, the operator of the field, unilaterally ceased to produce oil in November 2014, citing environmental concerns (as it stated, due to new government flaring standards). The brusque decision was preceded by years of lingering conflict between the two sides – first when Saudi Arabia renewed the Chevron concession to Wafra in 2009 for another 30 years without asking Kuwait, then again over the gas allocation ratios of the offshore Dorra gas field, which in the end was better left alone.

It did not take a lot of time for onshore Wafra to stop - the 4.7 billion reserves heavy giant field, then operated jointly by Chevron’s Saudi unit (the only field on Saudi territory not to be operated by Saudi Aramco) and KGOC, was discontinued in May 2015 after the American major could not secure work and equipment permits for the project. Since then, there have been several occasions where it seemed highly likely that at least Khafji would be brought onstream again, to no avail so far.

(Click to enlarge)

Rumours circulating around Kuwait City state that Saudi Arabia is intent on bringing the Khafji field back online, despite fierce resistance from the Kuwaiti authorities. Khafji is the northern extension of the largest offshore oil field in the world, Safaniya, and before shutting down was producing roughly 300 000 bpd of oil (although Saudi sources talk of a potential hike to 400 000 bpd). Of course, before the row the produced volumes were split – with the 150 000 bpd allocated to both parties roughly equivalent to 5 percent of Kuwait’s and 1.5 percent of Saudi Arabia’s output. It is interesting that the 250 000 bpd Wafra field, the majority of which lies on Kuwaiti territory, was never a matter of discussion since the halt. If one is to look at the location of the Khafji field – say, draw a direct line, a continuation of the onshore demarcation line, pretty much all of the field would end up in territory that should’ve been purely Saudi.

Rehabilitation works on drilling equipment and facilities have reportedly begun at the Khafji field already in the first days of August. Oddly enough, the decision to grant the Canadian firm SNC-Lavalin a contract to provide engineering services for Khafji was taken by joint Saudi-Kuwaiti operations company, despite Kuwait’s manifest reluctance to resume production. As is conspicuous from the story above, Saudi Arabia is extremely interested in getting Khafji (and potentially Wafra) volumes back to the market – it is willing to do it jointly and is even ready to acquiesce to Kuwait’s traditionally aggressive policy strategy with regard to their common Asian customers as long as additional volumes are pumped. Now that we have examined the Saudi-Kuwaiti relationship, it would be beneficial to take a larger look on Saudi Arabia’s standing.

Judging by the figures Saudi Arabia reported to OPEC, its production in August 2018 stood at 10.42 mbpd. When asked about its prospective output volume in October-November 2018, Saudi Energy Minister Khalid al-Falih stated it would average around 10.7 mbpd. For the sake of information exhaustiveness, it has to be said that Saudi Arabia’s historic record was set in November 2016 with a 10.72 mbpd monthly average. This is not the first time, however, that Riyadh promises radical production ramp-ups, just this June the Wahhabite launched a wave of media hype indicating oil output will radically increase to 10.8 mbpd as early as July 2018. However, instead of hiking Saudi Arabia ended up decreasing its production from 10.5 mbpd to 10.3 mbpd, citing inadequate market demand.

Graph 3. Saudi Arabia Crude Production (mbpd).

(Click to enlarge)

Source: OilPrice data.

With such a backstory, many analysts openly doubt whether Saudi Arabia can actually deliver on the promise and tap into its mythical 2 million barrel per day spare capacity. For much of the 2010s, media outlets have reproduced Khalid al-Falih’s and Amin Nasser’s claim that Saudi Arabia has a peak production capacity of 12.5 mbpd, thus can “meet additional oil demand in case of any interruption in supplies”. However, al-Falih himself explained some years ago that the 12.5 mbpd ceiling is a nominal one and that Saudi Arabia aims for such a production level that would ensure maximum recovery across the nation’s oil sector. Guaranteeing that output plateaus last for as long as possible are oftentimes underpinned by geological conditions – al-Falih claimed that the Khurais field could potentially produce 1.4-1.5 mbpd of oil, however beyond 1.2 mbpd there is water ingress.

Stories like these abound, adding up to a general narrative where the current Saudi production is to a greater or lesser extent the optimal modus operandi, beyond which Saudi Aramco would jeopardize future output. That is the reason why Saudi Arabia wants to invest $20 billion to “maintain spare production capacity”, as stated by Minister al-Falih this week – translated from doubletalk, it means Saudi Arabia will invest the money to increase production from the current 10.4-10.5 mbpd to 11.5 mbpd. On the back of such developments, restarting Khafji could be a crucial part of strategy, it would concurrently placate President Trump and help Saudi Arabia in its aim to take over a part of Iran’s market share.

For Saudi Arabia, it would be a face-saving variant if it could restart both fields jointly with Kuwait. Yes, Kuwait has been a difficult partner to deal with from the Saudi viewpoint – it refused to participate in the Saudi-led bombardment of Yemen and maintains diplomatic relations with Qatar despite Riyadh’s insistence to cut ties. Still, Saudi Arabia needs it to cooperate, which perhaps explains the allegedly aggressive stance Mohammad bin Salman adopted vis-a-vis the Kuwaiti emir. However, if Kuwait recalcitrates, Riyadh has the capabilities and means to tackle the resumption of Khafji production alone, without any Kuwaiti involvement – and it will do so.

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