Oil and Copper – Separate Ways Part 2

Geopolitical drivers of the UAE-Saudi fight, which in turn affects the supply imbalance

In our last newsletter we highlighted how and why oil supply may continue to outstrip demand in the near-term. But let’s go deeper on that point and look into UAE-Saudi Arabia relations and how they are shaping OPEC+ decisions, which recently resulted in an increase in baseline quotas, which in turn could continue to result in excess supply on the market.

As we noted above, the recent OPEC+ stalemate was on account of UAE voicing their unhappiness with the then baseline production level figures, especially in relation to Saudi Arabia. But the reason was quite deep rooted.

First, there are the economic drivers of the fight. Compared to Saudi Arabia, the UAE has diversified its economy at a faster clip and oil and gas account for just a third UAE’s national revenues, compared to over 65% for other oil producing nations. This has been achieved in part through creating avenues to attract foreign investment, particularly as relates to green energy, real estate, and finance. Their approach has been strategic as the nation has made deals with both domestic and foreign investors for the explicit purpose of diversifying the UAE’s economy.

In contrast, Saudi Arabia remains heavily dependent on oil and gas and requires more time to diversify away from the sector. They have taken some steps, such as the IPO of Saudi Aramco as well as proposed economic reforms, but still rely on the stability provided by OPEC+ and their ability to influence market decisions, especially in regard to maintaining higher prices. Furthermore, Saudi Arabia is nowhere close to reforming its massive welfare program, which is an immense fiscal drain, making it all the more dependent on oil revenue.?

With that said, despite the UAE’s transition from oil, it has made significant investments in the sector and wants to reap the benefits while it can - before it transitions even further away from oil. In other words, they are tied to the fiscal and economic benefits of oil, while concurrently changing the trajectory of the economy. Accordingly, UAE authorities are aiming to produce 5 million barrels of oil per day by 2030 as compared to the 3.5 million produced in 2018. From their perspective, emerging economies will be the largest source of oil demand growth over time while the U.S. and European markets shrink. So, in the short-to-medium term, the UAE seeks to capitalize on its oil resources as much as they can until the transition to green energy is complete. In their long-term view, they envision themselves as one of a few global oil producers that is relied upon by the rest of the world, but with less geopolitical baggage (e.g. Saudi Arabia and its ongoing tensions with Iran).?

For the UAE, it is a long-term plan. They are endearing themselves to new markets that are poised to become economic powerhouses by providing consistent oil (like India and China), using the money they earn to further invest in their country and diversify their economy. Then they will incentivize their new partners in the emerging markets to invest even more in the UAE. Thus, higher baselines help UAE’s national economic strategy because not receiving those higher baselines due to Saudi Arabia was a thorn in their side.

Second, there’s the security/geopolitical angle. Saudi Arabia and Iran see themselves as the dominant power of the Middle East. Some of this historical, and some of it is due to the Shia-Sunni divisions between the two nations. However, until recently, it has also meant that the Middle East was largely carved between Saudi Arabia and its friends on one side, and Iran and its friends on the other.

In recent years, the fault lines have become increasingly blurred. Turkey is starting to project itself as a major power in the region. While Turkey for many years saw itself as a potential European state and member of NATO (to which it still belongs), it is actively trying to play a dominant role in Middle East affairs; and it is not on the same side of either Saudi Arabia or Iran.

Granted the UAE and Iran do not share close relations, neither does the UAE with Turkey, but this does not automatically mean the UAE will serve as a satellite state of Saudi Arabia. A lot of investments flow to Iran through the UAE, thus the UAE and Iran have a natural incentive to keep their relations cordial at a minimum. Furthermore, with the rise of new power centers in the Middle East, the UAE no longer believes that it needs to be in one of two camps (Saudi Arabia or Iran).

Instead, many believe that the UAE is seeking to create a foothold for itself with its own independent foreign and national security policy and not just depend on Saudi Arabia. This is partially why the UAE has spent so much money in recent years buying American defense equipment, like the recent order for fifty F-35, which American leadership generally only provides to its closest allies. This is also likely why the UAE formally recognized Israel last year. Thus, the evolution in the UAE’s position in the region, and its policy making, signal that the UAE and Saudi Arabia may not be as close as they once were.

Why did Saudi Arabia concede to increase baselines?

?Mainly to ensure that the value of OPEC+ holds. The UAE benefits from the lowest fiscal breakeven cost of any OPEC member in 2021 at USD 65/bbl and this is projected to decline further.?This is a point of leverage for the UAE within OPEC+ because they can weaponize their increased production capabilities, compete for market share at lower prices, and not adversely affect their economy given the level of diversification the UAE enjoys. This would effectively decrease OPEC+’s role in managing the global markets.

Saudi Arabia knows it cannot compete for market share at low prices and requires a longer runway to reduce its dependence on oil and gas as a share of their overall economy. This was a small giveaway by Saudi Arabia to the UAE, while enabling Saudi Arabia to remain the more dominant oil producer in the cartel. The same holds true for giving Russia a higher baseline. Recall last year Saudi Arabia and Russia had a disagreement over production, with Russia opting to increase its supply to hurt Saudi Arabia. Russia’s baseline will be more than its production capabilities but giving it more headroom in this arrangement helps keep Moscow on side their too. It’s better to keep OPEC+ members happy, for now, until new non-OPEC+ markets, like Iran, start to provide supply.

Please stay tuned for part three, which will look at copper.