Faisal Islam: Why the UAE’s exit from Opec is a big deal

The United Arab Emirates (UAE) has announced its sudden withdrawal from the Organization of the Petroleum Exporting Countries (OPEC), which is a very big deal. Emiratis have been members of the organization since before it became a nation-state in 1971.

OPEC, a group of mostly Gulf oil exporters, has for decades controlled crude prices by reducing or increasing production and allocating quotas among its members. It played a crucial role in the oil crisis of the 1970s, thereby changing global energy policy.

While OPEC production is dominated by Saudi Arabia, the UAE has the second largest amount of spare capacity. In other words, it is the second most important swing producer with the ability to increase production to help ease prices.

In fact, it was this that led to the UAE’s long-term reconsideration of its position. In short, the UAE wants to take advantage of the massive capacity it has invested in.

OPEC quotas limit its output to 3-3.5 million barrels per day. In terms of lost revenue, the UAE has made a disproportionate sacrifice for OPEC membership.

However, the timing of the move hints at the consequences of a war with Iran. The pressure cooker in the Gulf has affected the UAE’s relations with Iran and could affect its already tense relationship with Saudi Arabia.

For OPEC, it is a huge blow at a time when major questions are being raised about its long-term consistency.

That’s not just because the UAE may set a production target of 5 million barrels per day when it is able to fully put oil back on the market by sea or pipeline. Saudi Arabia may respond with an oil price war, which the UAE’s more diversified economy can afford, but other poorer OPEC members may not.

Much depends on the Saudi response.

Key Emirati officials have discussed a new pipeline from the UAE’s Abu Dhabi oil fields, bypassing the Strait of Hormuz and heading to the underutilized port of Fujairah.

There is already one pipeline in heavy use, but more capacity is needed to cope with increased production and permanent changes in the liquidity and costs of tanker shipping in the Gulf.

Of course, this is not currently the main event in the oil market during the double blockade of maritime traffic in the Strait of Hormuz, affecting the prices of oil, natural gas, gasoline, plastics and food.

While it’s understandable that the world is focused on oil at $110 a barrel, that’s why we don’t discount the possibility that oil could approach $50 sometime next year – if the chaos in the Channel is resolved, such as before the US midterm elections later this year.

OPEC’s importance to world oil markets has declined compared with the 1970s, when its share of international oil trade was 85%, compared with about 50% today. Oil has also become less important to the world economy than it was in the 1970s. OPEC now has influence, but not a monopoly. Arguably, it cannot hold the world to ransom.

I remember OPEC puppet and former Saudi Oil Minister Sheikh Yamani once said: “The Stone Age did not end because the world ran out of stone. The Petroleum Age did not end because the world ran out of oil.” This heralded a world in which hydrocarbons will be replaced by other energy sources.

One way to read the UAE’s action is as a sign of the world’s reduced dependence on oil, and there are other clues in the current maelstrom: Chinese investments in electrification are helping to soften the blow to the economy from rising oil and gas prices.

By some calculations, the electrification of China’s cars, trucks and trains has reduced oil demand in the world’s second-largest economy by 1 million barrels a day. As this trend accelerates globally, global oil demand is likely to stabilize.

From this point of view, it makes sense to raise as much money as possible from oil reserves as quickly as possible before demand drops. The UAE has financial strength and a diversified economy partly through financial services and tourism.

Much will depend on what the new normal looks like after hostilities in the Gulf cease.

The UAE’s withdrawal from OPEC could trigger more dominoes to fall, with Saudi Arabia now facing considerable pressure.

When tankers flow through the strait again, or if the UAE redoubles its efforts to build new pipelines, Emirati oil will flow like never before, unbound by OPEC commitments.

This will have little impact on the current lockdown. It might change everything after that.