A Crude Awakening

This week OPEC has lost another member state, but before discussing the reasons behind the UAE’s withdrawal and its implications, it is worth providing a bit of background. The Organisation of Petroleum Exporting Countries was set up in the 1960s to shift the balance of power in energy markets towards oil producing states and away from British and American oil companies. By limiting production using quotas for each of the member states, elevated oil prices could be maintained to maximise revenues through time. Saudi Arabia is by far the largest producer in the group and is the de-facto leader, but OPEC and OPEC+ includes countries right across the Middle East, Latin America, Africa and Asia.

The most notable omissions from the club are the USA and Canada, who rank as the world’s number 1 and number 4 oil producers. The increase in North American oil production since the shale oil boom of the 2010s has understandably reduced OPEC’s influence, and the cartel’s effectiveness is sometimes further called into question given members regularly ‘cheat’ and pump more oil than they should do. But despite these shortcomings, OPEC is still kind of a big deal. Breakaways from the group aren’t unheard of (Qatar and Angola both withdrew in recent years), but the UAE is more significant as it makes up a greater share of the cartel’s production capacity - around 14%.

In the near term, this news will have little impact on the oil price as the factor limiting supply and pushing oil prices above $120/bbl isn’t how much oil the Emiratis are pumping, it’s whether any of it can get through the Strait of Hormuz without being attacked or seized by Iran. That blockage isn’t showing much sign of easing and the latest tweets from both President Trump and Iran don’t give the impression a deal is imminent. Given who we are dealing with, it is probably reasonable to assume this is mainly posturing. Lots of public disagreement and threats doesn’t necessarily mean all is lost, but who knows?

The economic argument for withdrawing from OPEC is that a yawning gap has opened up between the amount of oil the UAE could produce and the amount its quota allows it to produce, unnecessarily limiting oil revenues. Meanwhile, the transition away from fossil fuels limits how much time there is left to monetise oil reserves. Renewed concerns regarding energy security in Europe and Asia may well accelerate the energy transition, so time is of the essence for any country that derives a large portion of its wealth from oil exports. Sitting around in a cartel and underproducing for the good of the team feels like a less and less of an attractive option, particularly when another member of the team is bombing your oil infrastructure.

Geopolitically, this can be seen as a move to align more with the US. One motivation will be defence guarantees, but there is also a link to the currency swap line arranged last week between the Central Bank of the UAE and the Federal Reserve. A currency swap is exactly what it sounds like, in this case the UAE will give the Fed some dihrams and the Fed will swap these for US dollars. It’s not like the Emiratis don’t have access to dollars though – the Central Bank holds around $100bn of US Treasury bonds – but at a time when there is already upwards pressure on bond yields due to the inflationary impact of the war with Iran, the US is keen to avoid any forced selling that would add fuel to the fire. In this regard the arrangement is mutually beneficial rather than being a charitable contribution by the US to the UAE.

Time will tell whether leaving OPEC proves to be a good move. Revenues depend on both volume and price. If OPEC doesn’t respond to the additional supply of oil from the UAE by reducing its own supply, then the oil price should fall, potentially eliminating any gains the UAE hoped to make. Everyone knows this, so it seems reasonable to frame this more as a broader strategic shift rather than being about oil policy per se. What this now means for relations with its neighbours in the Gulf will be interesting to observe; and at a time when it is popular to berate the US, it is notable that this is the side the UAE has picked. So, perhaps all is not lost for the US, even if the current president may not be the best advertisement for the land of the free and the home of the brave.