What does the revival of production from the Neutral Zone mean for oil markets?

Saudi Arabia and Kuwait are expected to restart output from their shared fields this month

A tanker removing industrial waste from the remote Wafra area, which stopped pumping oil in 2014 due to a dispute between Saudi Arabia and Kuwait. Gustavo Ferrari / The National.

Saudi Arabia and Kuwait will begin production from the shared Neutral Zone fields along their border this month, bringing an end to a dispute that lasted nearly six years. The onshore Wafra and offshore Khafji fields will begin production this month, with the full capacity of 500,000 barrels per day expected to be achieved by year-end. Exports are also expected to flow within three months, Hashem Hashem, chief executive of Kuwait Petroleum Corporation, told Bloomberg. The fields are operated alongside US major Chevron. We take a look at why the revival in production is important for the oil markets.

Spare capacity 

The Neutral Zone will bring on-stream additional spare capacity to the markets. Spare capacity refers to the volume of output that can be brought online within 30 days and sustained for a minimum of 90 days, according to the US Energy Information Administration. This will be a boost to Opec, of which Saudi Arabia and Kuwait are both members, in times of shortage. The world's spare capacity remains tight, hovering around 3.21 million bpd in 2019, according to International Energy Agency, with 2.27 million bpd in Saudi Arabia alone.

Why now? 

The attack on two oil facilities run by Saudi Aramco in September last year temporarily halted 5 per cent of global supply in September and left the world without any spare capacity. While Saudi Arabia met its export commitments by drawing on its storage, plans to revive production from the Neutral Zone gathered momentum as the kingdom felt the need to have a buffer against possible future outages.

Implications for the oil markets 

Adding more capacity right now could be problematic, however, as oil markets are awash with oil from the US shale basins as well as other new non-Opec supply from Norway and Brazil. Demand is also waning, with the spread of the coronavirus denting demand growth for crude. The International Energy Agency revised its first-quarter demand growth forecast down by 435,000 bpd. Opec also expects demand growth to be tepid, trimming its projection for the first quarter by 440,000 bpd.

Opec+ 

Saudi Arabia and Kuwait are both parties to a global pact to restrict production from the beginning of the year. The alliance, which also includes non-members led by Russia, has been cutting back 1.7 million bpd from the beginning of the year. The group is expected to extend a pact currently valid until March through to year-end. It is also widely expected to push through a temporary deepening of cuts of 600,000 bpd at its next meeting in March.

Silver lining 

The fields' output of largely heavy, sour crude could be welcome for the markets as a replacement for Iranian and Venezuelan oil, both of which are in short supply due to US sanctions. The supplies from the Neutral Zone would also be welcomed by refiners, particularly those on the US Gulf coast, which have found their refining margins becoming squeezed because of a shortage of Venezuelan heavy oil.