A surprise move

Earlier this month, in somewhat of a surprise move, the United Arab Emirates (UAE) left OPEC, the oil cartel to which it had belonged since 1967. OPEC nations produce about 40% of the world’s oil and hold about 80% of proven reserves and have held sway over the global oil price for generations. The UAE’s May 1 move reflects changes in regional politics and geopolitics, the energy markets themselves, and the country’s own ambitions. It also indicates longer-term shifts in the composition of the energy supply.

Why did the UAE leave? Explanations abound. Geopolitics and competition with its regional neighbors, particularly Saudi Arabia, likely played a role. With Iran shooting missiles at its once-idyllic oasis, the UAE may be looking for even greater help from the US either economically – think swap lines – or militarily.  The larger issue, however, is likely financial. The UAE can produce far more oil than OPEC will currently permit.

In essence, OPEC allocates production quotas to member countries, dictating just how much oil each can produce at a given time. OPEC quotas call for the UAE to pump about three million barrels a day. For its part, the UAE wants to produce five million barrels a day as soon as next year. They have invested billions on infrastructure to allow them to increase production.

While many commentators have prematurely called for the end of oil, the Emiratis are in a race against time.  The overarching motive driving the UAE’s action may be this: they want to sell all the oil they can now while prices remain elevated and demand for oil remains strong. The energy transition will likely take many years, but eventually other sources of power could impact the demand for petroleum. OPEC’s own World Oil Outlook indicates that growth in renewable energy is set to far outstrip growth in oil production in the years ahead. Many other oil-producing nations face the same quandary – Norway and Saudi Arabia come to mind. The UAE’s ambassador to the United States described the withdrawal from OPEC as a matter of funding the energy transition with revenue from oil, as part of a long-term strategy to transform the country from “an oil state” to “a diversified economy.”

What happens next?

We see several implications arising from the UAE’s withdrawal from OPEC membership. For one thing, oil prices should likely drop once hostilities end and the Strait of Hormuz reopens to traffic – unless other producers curb production. And even then, demand growth is bound to slow over time in spite of increasing global economic activity due to innovations in fuel efficiency and the slow but steady rise of nuclear and renewables.  We’re not calling for the end of oil and believe that it will remain a major source of energy for decades to come, but its relative importance will continue to decrease. Also, OPEC is likely to see its power decline as result, particularly if other countries are willing to leave OPEC too. For instance, Iraq is another player whose oil-production capacity is being capped by what OPEC quotas currently allow.

The war in Iran has upended global energy supply chains. The US is now the world’s largest swing producer.  Actions such as the UAE’s will definitely place pressure on oil prices once the war with Iran is behind us, whenever that may be. Once production is fully restored and reserves are built up, it’s hard to see how this action could fail to drive prices lower unless others decrease production. The reverse is likely, as there’s a lot of new capacity coming online around the world, from Africa and Venezuela among other sources. The UAE’s departure may also make energy prices even more volatile than they already are. One thing OPEC has brought in recent years is a degree of stability, something that looks like a casualty of the current war. Time will tell what other long-term effects the UAE’s decision will have.