Thawed relations hit strange times: inside the Saudi-Kuwait Neutral Zone

Heidi Vella 30 April 2020 (Last Updated April 29th, 2020 15:07)

After five years of shutdown, Kuwait and Saudi Arabia have decided to resume oil production from their shared fields in the ‘Neutral Zone’. Offshore Technology Focus considers the region’s history and what restarting production could mean for the market at this tumultuous time.

Thawed relations hit strange times: inside the Saudi-Kuwait Neutral Zone
OPEC will decide how oil production should be cut amid the ongoing oil price plunge. Credit: Dalibri

Bordered by Saudi Arabia, Kuwait, and the Persian Gulf, the Neutral Zone is a 2,230 square mile patch of land that was left undistributed after the Uqair Convention in 1922, which divided land between the two countries.

The region was largely ignored until the 1938 discovery of oil in the Burgan region of Kuwait excited the possibility of oil discovery in the Zone. By the mid-1960s, the two  nations agreed to partition the area and exploit its reserves under a joint operating agreement.

That was until relations between the two countries disintegrated in 2015, after Kuwait accused Saudi Arabia of renewing Chevron Corp.’s Wafra oil field concession licence in the area without consultation. All production was subsequently halted.

Amidst a backdrop of rising oil prices, leaders of the two countries decided to put the dispute to bed last December, with both agreeing to restart production at Wafra and the offshore al-Khafji oil field, as well as to develop a large offshore gas field.

At the time, oil ministers from both countries said the resumption of production would not impact their commitments to cuts agreed by OPEC. However, since then, the oil market, and indeed the entire global economy, has changed dramatically due to the ongoing Covid-19pandemic, putting the development in a very different context.

Why now?

Shortly after production in the Neutral Zone was shut down, the global oil price crashed, disincentivising the resumption of talks to end the disagreement.

“At this point, both countries were looking more inwards, trying to make sure the domestic market was intact. There wasn’t enough catalyst in the market to reach an agreement because it was already over supplied with booming US shale,” explains Aditya Saraswat, senior analyst at Rystad Energy.

In 2018-19 however, a stable oil price environment, rising from lows of $30 during the crash to hit $60-70 a barrel, coupled with an increase in demand, changed the mood.

“They [Kuwait and Saudi Arabia] saw the additional oil [from the Neutral Zone] could be easily digested by the increasing global demand, making it the perfect market and price conditions to incentivize an agreement,” says Saraswat.

Furthermore, Ian Thom, principal analyst, Middle East upstream at Wood Mackenzie says, fundamentally, both sides will benefit from the restart.

“It is likely that several factors were behind the partitioned zone agreement: for both Kuwait and Saudi Arabia it is much lower cost to restart the existing assets than to develop new resources. And there are also important gas resources that could only be developed after a political agreement was reached,” he says.

Developing the Dorra Gas Field

After reaching the new agreement, in January Saudi Arabia and Kuwait issued contracts to study the development plan for the Dorra offshore gas field, which has an estimated 10-11 trillion cubic feet of gas and around 300 million barrels of oil. Development of the field was originally supposed to start in 2012 -2014.

The offshore project is particularly attractive to both countries. Saudi Arabia has ambitions to ramp up its expansion into natural gas as a key growth driver, while Kuwait is starting to import LNG as its domestic demand is rising. In January the country signed a 15-year agreement with state-run Qatar Petroleum for three million tonnes of LNG per year.

Rystad expects development of Dorra to start in 2024, with the field coming online in the second half of this decade

“It’s a long journey because, while it’s a proven discovery, both countries have to jointly assess what sort of development requirement it needs for them to increase gas production from the field,” explains Saraswat.

Oil over supply

While the development of Dorra is further down the line, production from the two oilfields, Wafra and the offshore al-Khafji, is expected to reach 550,000 b/d by the end of the year.

However, at the time of writing, global fuel demand has plunged by around 30% and benchmark crude is trading around $30 a barrel, half the level at the end of 2019.

This is largely due to a fall in global demand as a result of Covid-19 lockdowns. The country has been locked into a dispute with fellow OPEC member Russia over further cuts to support prices. Saudi Arabia has been reducing its production and wants others to do the same. It’s that expected Russia and Saudi Arabia will soon agree to mutually cut production

There’s also speculation that Saudi Arabia wants to claw back some sway from the US shale producers as an active leader in balancing the oil market, which is also likely part of its motivation for restarting production in the Neutral Zone.

The two oil fields in the zone, Wafra and Khafji, were collectively producing about 500,000 barrels or more per day before they were shut down. Now they are slowly starting back up again, producing 20,000 – 30,000 barrels per day, according to Saraswat.

Both nations were aiming for the fields to reach more than half of their full capacity by the end of this year, and full capacity by the end of next year. The International Energy Agency recently estimated that Saudi Arabia and Kuwait could potentially pump 320,000 b/d from the Neutral Zone a year.

“Now, however, everyone is trying to increase production after the fallout between Saudi and Russia, and so storage is getting full because demand has dropped; at some point, it will reach a peak,” says Saraswat

“This is where the fields will hit a plateau of development because you can only produce how much you can transport and store; so then ramp up of the fields will be affected,” he adds.

Rystad believes that instead of one-and-a-half to two-years to reach maximum capacity, it will be three to four years: around 2023/24.

“In the long term, we see prices getting balanced in 2023. On top of that, when there is enough appetite in the market, the initial assessment will be completed; then it would be well suited for the fields to increase production, which would give both Saudi Arabia and Kuwait enough share to book the export market,” says Saraswat.

Future production

Although the oil price crash will have a significant effect on the market overall, Saudi Arabia and Kuwait can manage with low prices for longer than other oil-dependent countries, says Thom.

“The Middle East is hugely advantaged relative to other oil and gas producing regions with its low-cost base,” he says. “But government revenues are heavily dependent on oil and gas, while their economies are characterised by extensive subsidies, limited personal taxation and a lack of diversification, but countries in the Middle East, such as Saudi Arabia, have large sovereign wealth funds or investments they can draw on.”

But certainly, Saraswat says, for the other oil projects in the Neutral Zone, the negative revision in global demand amid the coronavirus disease outbreak could adversely affect the development schedule and long-term oil production targets.

“It will depend on when the global oil demand reinstates and oil price recovers,” he says.

However, as both Kuwait and Saudi Arabia have ambitious LNG targets, the gas projects, such as Dorra, may bebetter suited to development.