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It has been almost five years since the giant Khafji field shared between Saudi Arabia and Kuwait was shut down. Ostensibly on environmental concerns, this precipitated a halt of all activities in the so-called Neutral Zone – a colonial-era border relic that holds a significant amount of oil and gas. After years of stop-start negotiations, reports are now suggesting that the OPEC allies are close to a breakthrough on the matter, which could return up to 500,000 b/d of oil to the market at a crucial time for the global oil supply/demand balance.
Left undefined by the Uqair Convention of 1922 that otherwise established concrete borders for Saudi Arabia and Kuwait, the dry piece of land that is 8 times the size of Singapore was mostly ignored until 1938, when the Burgan oil field was discovered within Kuwait’s borders. A race for exploration began, with Saudi Arabia and Kuwait both awarding overlapping concessions to private companies and Getty Oil finally striking oil in 1948. The Wafra field was discovered in 1953, and in 1960, Japan’s Arabian Oil Company (which held an offshore concession awarded by Saudi Arabia in 1957 and another awarded by Kuwait in 1958) discovered the giant Khafji offshore field. Overlapping claims of sovereignty did not prevent exploitation of the resources, but opaque rights eventually led to a formal partition in 1970 where it was agreed that Saudi Arabia and Kuwait would split production equally under a joint operating agreement. The unique status of the Neutral Zone is exemplified by its structure – its largest onshore oil field (Wafra) is operated by Chevron, the only remaining place in Saudi Arabia and Kuwait where a major asset is held by an international firm.
And it was this arrangement that caused the current quandary. Chevron inherited the Neutral Zone assets through its merger with Texaco in 2001, which itself bought Getty Oil in 1984. In 2009, Saudi Arabia renewed Chevron’s concession for Wafra independently, angering Kuwait as the negotiations were performing without its consultation. Kuwait responded by attempting to evict Chevron from its offices in the Neutral Zone, claiming that the land was planned for the giant Ras al Zour refinery. More tit-for-tat moves escalated and eventually Saudi Arabia shut down Khafji in October 2014 and the entire Neutral Zone in May 2015, removing 500,000 b/d of crude oil from the market in one fell swoop.
That may be coming back now, with Saudi Energy Minister Khalid al-Falih stating that he hopes to reach a deal to resume production by the end of this year. It’ll be a boon not only to both countries, but also Chevron, which was in the midst of a full-field steam flood injection EOR project to boost production of heavy oil when the shutdown hit. Given that much time has elapsed, restoration of full production will take a while. If it does happen, however, those additional volumes could complicate mathematics as OPEC faces a scenario of managing global oil supply through its supply deal to account for lost volumes from Iran, Venezuela and Libya, but also surging American shale production. With total production capacity at a maximum of 600,000 b/d, Neutral Zone output is not small drop in the barrel.
But there is more than just restarting fields at stake. While Khafji and Wafra both have a long life left ahead of them (Wafra is estimated to have 4.9 billion recoverable barrels), the Neutral Zone also contains the offshore Dorra field – a politically-sensitive gas field shared with Iran. Plans to exploit Dorra have been shelved since 2013, but Dorra gas is badly needed to power domestic electricity demand in both Kuwait and Saudi Arabia. A restart will help in that matter, certainly in the long term. And it is the long term that is underpinning the renewed negotiations between Saudi Arabia and Kuwait, even if the short-term impact might be negative on global oil fundamentals.
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On Saturday, September 14, 2019, an attack damaged the Saudi Aramco Abqaiq oil processing facility and the Khurais oil field in eastern Saudi Arabia. The Abqaiq oil processing facility is the world’s largest crude oil processing and stabilization plant with a capacity of 7 million barrels per day (b/d), equivalent to about 7% of global crude oil production capacity. On Monday, September 16, 2019, the first full day of trading after the attack, Brent and West Texas Intermediate (WTI) crude oil prices experienced the largest single-day price increase since August 21, 2008 and June 29, 2012, respectively.
On Tuesday, September 17, Saudi Aramco reported that Abqaiq was producing 2 million b/d and that its entire output capacity was expected to be fully restored by the end of September. Additionally, Saudi Aramco stated that crude oil exports to customers will continue by drawing on existing inventories and offering additional crude oil production from other fields. Tanker loading estimates from third-party data sources indicate that loadings at two Saudi Arabian export facilities were restored to the pre-attack levels. Likely driven by news of the expected return of the lost production capacity both Brent and WTI crude oil prices fell on Tuesday, September 17.
Crude oil markets will certainly continue to react to new information as it becomes available in the days and weeks ahead, but this disruption and the resulting changes in global crude oil prices will influence U.S. retail gasoline prices.
The U.S. Energy Information Administration (EIA) estimates that Saudi Arabia was producing 9.9 million b/d of crude oil in August, and estimates from the Joint Organizations Data Initiative (JODI) indicate the country exported 6.9 million b/d during July, the latest month for which data are available (Figure 1). Estimates from a third-party tanker tracking data service, ClipperData, indicate Saudi Arabian crude oil exports in August remained at 6.7 million b/d. These crude oil production and export levels are each 0.5 million b/d lower than their respective 2018 annual averages. JODI data indicate that Saudi Arabia held nearly 180 million barrels of crude oil in inventory at the end of July 2019. Saudi Arabia can use these inventories to maintain a similar level of crude oil exports as before the strike, assuming the production outage is short in duration, as indicated by Saudi Aramco’s update on September 17.
Saudi Arabia is rare among oil producing countries, in that it regularly maintains spare crude oil production capacity as a matter of its oil production policy. EIA defines spare capacity as the volume of production that can be brought online within 30 days and sustained for at least 90 days using sound business practices. In the September Short-Term Energy Outlook (STEO) EIA estimated that the Organization of the Petroleum Exporting Countries (OPEC) spare capacity was 2.2 million b/d in August 2019, nearly all of which was in Saudi Arabia. Outside of OPEC, EIA does not include any unused capacity in its spare capacity total, even when countries periodically hold such capacity (as is the case with Russia). During previous periods of significant oil supply disruptions, Saudi Arabia generally increased production to offset the loss of supplies and stabilize markets (Figure 2).
Following the September 14 attack and an ensuing outage at the Abqaiq facility, the amount of available spare capacity that can be brought online within 30 days in Saudi Arabia is unknown. In addition, because Saudi Arabia holds most of OPEC’s spare capacity, there is likely little spare production capacity elsewhere to offset the loss. Russia may be able to increase production in response to disruption and higher prices, but the amount of time needed for these volumes to become available is uncertain. The United States would also likely be able to increase production, but it would take longer than 30 days. Therefore, without Saudi Arabian spare capacity, the global crude oil market is vulnerable to production outages, as events would be more disruptive than normal.
The most readily available alternative source of supply during a supply outage is stocks of crude oil. As of September 1, commercial inventories of crude oil and other liquids for Organization for Economic Cooperation and Development (OECD) members were estimated at 2.9 billion barrels, enough to cover 61 days of its members’ liquid fuels consumption. On a days-of-supply basis, OECD commercial inventories are 2% lower than the five-year (2014-18) average (Figure 3).
The United States has two types of crude oil inventories: those that private firms hold for commercial purposes, and those the federal government holds in the Strategic Petroleum Reserve (SPR) for use during periods of major supply interruption. Weekly data for September 13 indicate total U.S. commercial inventories were equivalent to 24 days of current U.S. refinery crude oil inputs, with the SPR holding additional volumes equal to slightly more than 37 additional days of current refinery inputs, for a total of 62 days. The supply coverage provided by oil inventories can also be measured by days of net crude oil imports (imports minus exports). By this metric, as of June 2019 the United States could meet its net import needs by drawing down the SPR for 162 days. The Energy Policy and Conservation Act states the President may make the decision to withdraw crude oil from the SPR should they find that there is a severe petroleum supply disruption. The SPR has been used in this capacity three times since its creation: first, in 1991 at the beginning of Operation Desert Storm; second, in the wake of Hurricane Katrina in September 2005; and third, in June 2011 to help offset crude oil supply disruptions in Libya.
Although U.S. imports of crude oil from Saudi Arabia have declined during the past three years—and recently hit a four-week average record low of 380,000 b/d in the week ending September 6—the United States still imports about 7 million b/d of crude oil (Figure 4). As a result, a tighter global crude oil market and increased global crude oil prices will ultimately increase the price of crude oil and transportation fuels in the United States.
Crude oil prices are the largest determinant of the retail price for gasoline, the most widely consumed transportation fuel in the United States. In general, because gasoline taxes and retail distribution costs are generally stable, movements in U.S. gasoline prices are primarily the result of changes in crude oil prices and wholesale margins. Each dollar per barrel of sustained price change in crude oil translates to an average change of about 2.4 cents/gal in petroleum product prices. About 50% of a crude oil price change passes through to retail gasoline prices within two weeks and 80% within four weeks. However, this price pass-through tends to be more rapid when crude oil prices increase than when they decrease. Brent crude oil prices are more relevant than WTI prices in determining U.S. retail gasoline prices.
EIA is closely monitoring the developments related to the oil supply disruption in Saudi Arabia and the effects that they have on oil markets. EIA’s findings will be reflected in the October STEO, which is scheduled for release on October 8.
U.S. average regular gasoline and diesel prices increase
The U.S. average regular gasoline retail price rose less than 1 cent from the previous week to remain at $2.55 per gallon on September 16, 29 cents lower than the same time last year. The Rocky Mountain and Midwest prices each rose 2 cents to $2.65 per gallon and $2.46 per gallon, respectively. The East Coast price fell nearly 1 cent to $2.45 per gallon, and the Gulf Coast price fell less than 1 cent to $2.23 per gallon. The West Coast price remained unchanged at $3.25 per gallon.
The U.S. average diesel fuel price rose nearly 2 cents to $2.99 per gallon on September 16, 28 cents lower than a year ago. The West Coast and Rocky Mountain prices each rose nearly 3 cents to $3.57 per gallon and $2.96 per gallon respectively, the Midwest and Gulf Coast prices each rose nearly 2 cents to $2.88 per gallon and $2.76 per gallon, respectively, and the East Coast price rose nearly 1 cent to $3.00 per gallon.
Propane/propylene inventories rise
U.S. propane/propylene stocks increased by 2.9 million barrels last week to 100.7 million barrels as of September 13, 2019, 14.3 million barrels (16.6%) greater than the five-year (2014-18) average inventory levels for this time of year. Gulf Coast inventories increased by 1.2 million barrels, and East Coast and Midwest inventories each increased by 0.9 million barrels. Rocky Mountain/West Coast inventories decreased slightly, remaining virtually unchanged. Propylene non-fuel-use inventories represented 4.1% of total propane/propylene inventories.
Crude oil prices have been on a rollercoaster ride as tensions heat up in the Middle East. Drone strikes on the heart of the Saudi Arabian production complex – the Abqaiq processing plant (called the most important crude site in the world) and the 1.5 mmb/d Khurais oil field – took out 5.7 mmb/d of crude output. That’s the single largest outage of crude output ever – more than 1973 Middle East oil embargo, more than the Iraqi invasion of Kuwait, more than the 1978 Iranian Revolution. The fires it caused affected more than half of Saudi Arabia’s current crude production output and essentially wipes a large part of the country’s spare capacity. Fortunately, I have not read of any casualty reports from this massive incident.
Yemeni Houthi rebels have claimed responsibility for the attacks. There is some logic to this, given that the Houthi rebel have waged an extended campaign on Saudi oil facilities over the past few years, including a recent attack on the East-West Pipeline – part of a proxy war between Saudi Arabia and Iran backing different factions in Yemen’s civil war. But this incident is different. The Abqaiq crude facilities are near Bahrain, over 700km from closest Yemeni border, and over 400km further than the farthest attack into Saudi territory by the Houthis. For the Houthis to suddenly gain a tremendous amount of range in their attacks – especially given that the suspected drones involved in the attack only have a range of up to about 200km – seems implausible. Which is why the US has publicly blamed Iran for the attacks, releasing data and photos that claim the attacks came from a north-westerly direction. Iran, predictably, has claimed that it is not responsible. Other countries, including Saudi Arabia and the UK, have struck a more cautious approach, promising ‘investigations’.
Because the attacks occurred over the weekend, there was no immediate effect on traded prices. But when markets opened in Asia on Monday, crude oil prices soared by up to 20% at the highest point – with Brent jumping past the US$70/b mark – before settling back to a daily gain of 15%. Because the attacks were on such an important processing plant, market players worried about global supply disruptions that could last for months. President Donald Trump’s move to release US strategic petroleum reserves calmed the market slightly, while subsequent reports from Saudi Aramco that up to 70% of the affected 5.7 mmb/d capacity at Abqaiq had been brought back online provided even more reassurance. Initial fears that the attack would take months to fully restore Saudi Arabian output were downgraded to weeks; still a severe shock, but nowhere near the catastrophe that was suspected.
What is chilling, though, is where this will lead us next. This is the single largest attack in the simmering tensions of the Persian Gulf. With the US so eager to blame Iran, claiming that it was ‘locked and loaded’ for any possible conflict, the risk of military conflict in the region has risen to new heights. Iran has replied that it is also ‘always been ready for a full-fledged war’. We live in chilling times because of this. The supply disruption caused by the drone attack may have already be mitigated by quick action by Saudi Aramco, but the long-term implications are dangerous. War is always triggered by a series of escalating actions, and fears are that the attack on Abqaiq might be the straw that broke the camel’s back. And if that happens, the supply disruptions that will be spinning out of this war will be considerably more severe.
Recent attacks on Saudi Arabian oil infrastructure:
Fossil fuels continue to account for the largest share of energy consumption in the United States. In 2018, about 79% of domestic energy production was from fossil fuels, and 80% of domestic energy consumption originated from fossil fuels.
The U.S. Energy Information Administration (EIA) publishes the U.S. total energy flow diagram to visualize U.S. energy from primary energy supply (production, imports, and stock withdrawals) to disposition (consumption and exports). In this diagram, losses that take place when energy is converted to the secondary forms that are delivered to customers—primarily electricity and gasoline—are allocated to those customers. The result is a visualization that associates the primary energy with customers, even though the amount of energy they purchase is much less.
Source: U.S. Energy Information Administration, Monthly Energy Review
Note: Natural gas plant liquids (NGPL) denoted at top of left panel in brown.
The share of U.S. total energy production from fossil fuels peaked in 1966 at 93%. Total fossil fuel production has continued to rise, but so have non-fossil fuel sources, mainly renewables like wind and solar energy. As a result, fossil fuels have accounted for close to 80% of U.S. energy production over the past decade. Since 2008, production of crude oil, dry natural gas, and natural gas plant liquids (NGPL) has increased by 12 quadrillion British thermal units (quads), 11 quads, and 3 quads, respectively. These increases have more than offset decreasing coal production, which has fallen 9 quads since its peak in 2008.
Source: U.S. Energy Information Administration, Monthly Energy Review
Petroleum has the largest share of U.S. energy trade, accounting for 67% of energy exports and 86% of energy imports in 2018. Much of the imported crude oil goes to U.S. refineries and is then exported as petroleum products. Petroleum products accounted for 71% of total U.S. energy exports in 2018.
In 2018, net energy imports reached the lowest level since 1963. U.S. net energy imports as a share of consumption peaked in 2005 when it reached 30%; in 2018, energy net imports fell to only 4% of consumption.
Source: U.S. Energy Information Administration, Monthly Energy Review
The share of U.S. total energy consumption that originated from fossil fuels has fallen from its peak of 94% in 1966 to 80% in 2018. The total amount of fossil fuels consumed in the United States has also fallen from its peak of 86 quads in 2007. Since then, coal consumption decreased by 10 quads and petroleum by 2 quads, more than offsetting a 7 quad increase in natural gas consumption.
EIA previously published articles detailing the energy flows of petroleum, natural gas, coal, and electricity. More information about total energy consumption, production, trade, and emissions is available in EIA’s Monthly Energy Review.