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Oil Price Fluctuation in Relation to the UAE

Abstract

The United Arab Emirates (UAE) has experienced tremendous growth from its inception. Its growth is largely attributed to the huge oil reserves that it has and the rising oil prices. The United Arab Emirates is among the members of OPEC, which is responsible for regulating the supply and therefore the prices of oil. OPEC was established to govern petroleum exporting countries and ensure stable oil prices and favorable market conditions. However, things have changed for the past years, and oil prices have become very unstable: countries that are not members of OPEC are producing more than those in the organization. It has reached a point when oil prices are low and many petroleum exporting countries have been impacted negatively. However, the UAE continues to rely on oil despite these challenges. The UAE has continuously utilized the income obtained from the sale of petroleum to develop other sectors of its economy so as to achieve a diversified economy.

The GDP and CPI in the UAE remain favorable, making life affordable in this country. However, Bahrain and Oman, the less diversified countries of the GCC, are seriously affected by shocks in the oil prices. The UAE continues to depend on petroleum to acquire capital and develop other sectors of the economy. Additionally, other moves such as increasing the supply of land are also utilized to boost the growth of real estate. As a result, the importance of oil to the whole economy is strategically reduced through diversification, hence the resilience of the economy.

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Oil Price Fluctuation

Introduction

There are seven emirates that comprise the United Arab Emirates, and these are Ras Al-Khaimah, Abu Dhabi, Umm Al-Quwain, Ajman, Shariah, and Dubai. This country is situated in the southeastern part of the Arabian Peninsula and occupies about 84,000 sq km (Fattouh & Oxford Institute for Energy Studies, 2014). The United Arab Emirates is home to more than 8.5 million people, and over one million of this population resides in Abu Dhabi which is the capital. This nation speaks Arabic as its official language, and it trades in dirham as the official currency. Currently, oil and gas output constitutes about 40% of the gross domestic product of the United Arab Emirates.

The United Arab Emirates (UAE) was recognized to be among the least developed states worldwide about 40 years ago (Slater, 2013). The situation has significantly changed over these years, and the country is now much more developed, with its income being in the range of industrialized countries. Additionally, it has approximately 10% of the global crude oil reserves. According to oil experts, 30% of the UAE’s gross domestic product is derived from oil exports (Fattouh & Oxford Institute for Energy Studies, 2014). The country has large oil revenues that have enabled it to develop rapidly as opposed to gradual development seen in some countries with few resources. The interplay of demand and supply on the global market has been very important in price determination. Additionally, supply shocks and global politics have also played a role in determining oil prices. This fluctuation affects oil exporters and importers alike. Oil prices have been fluctuating on the world market for a long time: this has affected many states, especially the oil-producing countries. Oil prices in the United Arab Emirates have dropped by half since 2014: some experts predict that the situation may remain the same for a few years to come (Timilsina & Zilberman, 2014).

In 1960, five countries, namely Saudi Arabia, Iran, Venezuela, Kuwait, and Iran, held a conference at Baghdad and formed an intergovernmental organization meant to govern them as petroleum exporting countries. This organization was referred to as the Organization of the Petroleum Exporting Countries (OPEC). Although it was only formed by the five mentioned countries, other countries joined the organization in the following years; for example, Indonesia joined it in 1962, Nigeria in 1971, Libya in 1962, Qatar in 1961, and the UAE in 1967 (Slater, 2013). Over the years, some of these countries have suspended their membership from OPEC, and a good example is Indonesia which did that in 2009 (Slater, 2013). Geneva, Switzerland, was the headquarters of OPEC for the first five years after OPEC was formed and before Vienna, Austria, took over as the new headquarters in 1965 (Slater, 2013). OPEC was formed with the objective of bringing together its members and letting them enjoy fair and stable prices by creating unified petroleum exporting policies. Therefore, OPEC has influenced the prices of oil in a number of petroleum-producing countries, and this impact has been felt in the United Arab Emirates too. The policies put in place by OPEC have greatly influenced the oil market in the United Arab Emirates. Since this country largely relies on oil for its exports, OPEC is able to indirectly influence the economy, GDP, and CPI of the United Arab Emirates. In 2014, the members of OPEC held a meeting in Vienna in which they decided against reducing the production of oil in order to boost oil prices. The result was a drop in the global price of oil per barrel.

Objective

As it was mentioned earlier, petroleum is an important export for the UAE as it constitutes around 30% of the GDP. Additionally, this country is estimated to have about 10% of the global unexploited oil reserve, which gives a lot of leverage to a small country with a small population. The OPEC umbrella body encompasses a collection of states among the greatest petroleum-producing countries in the world. Despite this, the country as well as OPEC has taken a rather laid-back stance toward oil prices, especially in the recent past, and has agreed to become price takers instead of monopoly sellers in the world. The aim of this paper is to investigate the oil fluctuations in the UAE. The paper will also explore the relationship between OPEC and the UAE on the global oil markets, including the oil shock that affected oil-exporting countries, especially in the Gulf region. The paper will seek to establish why the UAE has been resilient to fluctuations in oil prices as well as why the country has continued to be oil-dependent.

Research Questions

What are the recent trends in global oil prices?

What is the relationship between OPEC and the UAE?

What are the effects of the recent oil shock in GCC countries?

Why is the UAE resilient to external oil shocks?

Why has the UAE agreed on being oil-dependent?

Literature Review

This section of the paper is aimed at exploring the previous research works that have been done concerning the subject of this research. Many researchers, scholars, political and economic analysts have researched and compiled materials concerning various issues relating to fluctuation in the global oil prices, its effects on the UAE and other OPEC countries as well as the resilience of the UAE economy to various oil shocks on the global market. GCC region has also been researched. This paper will analyze these materials to get more information in order to achieve the objectives of this research and respond effectively to the research questions.

Recent Trends in the Global Oil Prices

Global crude oil prices have been fluctuating since the early 20th century when petroleum products were widely utilized to drive internal combustion engines (Timilsina & Zilberman, 2014). During world wars, no appreciable increase in crude oil use was seen, which means that prices remained rather stable. However, wide-scale utilization of petroleum products occasioned the rapid development of the global economy that was seen after 1946 as countries rapidly got industrialized. Adjusted according to inflation, per barrel cost of crude oil was approximately $19 in 1946. However, due to the increased extraction of this resource between the late 1940s and 1970s, the price increased only marginally and fell to $21 (Timilsina & Zilberman, 2014). However, a combination of factors such as wars and other aspects of global politics saw crude oil prices rise close to $110 by 1980 before falling drastically (Timilsina & Zilberman, 2014). At the turn of the century, crude oil prices were about $38 per barrel. This would be followed by subsequent rises in the price. In the second half of the 20th century, oil-producing nations had significant control over price policies formulated by OPEC and had meaningful impacts on the global market. However, things have changed since the beginning of the century when countries, environmentalists, and innovators are looking into renewable energy as the source of energy for future development due to environmental sustainability (Timilsina & Zilberman, 2014). After 2009, the USA, which was the major importer of crude oil, started exploiting its oil resources and rose to be among the leading oil producer in the world. As a result, this eased pressure on global demand, leading to a general fall in the prices of crude oil. From $144 per barrel in July 2008, the price of crude oil in 2015 reduced to $41.60 (Timilsina & Zilberman, 2014). The withdrawal of a major importer that at one point could import over 30% of the global output means that the prices should go down. Additionally, with the current enthusiasm toward the development of renewable energy, the demand, as well as the prices of crude oil, will continue to fall in the future (Timilsina & Zilberman, 2014).

The Relationship between OPEC and the UAE, the Effects of the Recent Oil Shock on GCC Countries

The role of OPEC was to regulate the oil supply so as to stabilize prices (Kapur, 2015). Additionally, it was argued that controlled supply would ensure price stability and even the revenue stream for oil producers. Moreover, the scope of OPEC included ensuring that investors in the oil industry got fair returns which made oil extraction sustainable. During the 1970s, when the sale of crude oil constituted 90% of the UAE’s economy, the relevance of OPEC was paramount (Kapur, 2015). However, this country has greatly diversified its economy so that the sales of crude oil could contribute much less to the GDP. Furthermore, oil production by Russia more than doubled in the first decade of the 21st century, making it the leading crude oil producer in the world in the previous decade (Kapur, 2015). The USA has come to surpass all other countries to become the leading global producer of crude oil globally. The major oil producers of the 21st century are not members of OPEC, which has reduced the overall significance of OPEC globally (Kapur, 2015). The USA on its side is no longer an importer of oil, while China is leading the world in the development of green energy. For this reason, OPEC has very limited control of the global oil supply. Due to the advancement and diversification of the UAE economy, the country no longer values the regulatory efforts of OPEC as it did before (Kapur, 2015). The fall of global crude oil prices has affected the incomes of oil-producing countries. However, the effects have been different to each Gulf Council Country (GCC). The countries with the least diversified economies, such as Oman and Bahrain, have been affected the most. With the reduced prices, some companies in these countries are not able to produce at globally competitive prices and are opting out of the market. This has also reduced exploration and drilling work which has increased unemployment. Additionally, some companies have already begun downsizing their workforce. The more diversified economies, such as Saudi Arabia, Qatar, Kuwait, and the UAE, have been less affected (Kapur, 2015).

Why is the UAE Resilient to External Oil Shocks?

The UAE has the most diversified economy in the GCC region (Louis & Balli, 2014). Additionally, this economy comes fifth globally as to the readiness to external shocks. The strategic importance of oil to this economy has diminished over time as the economy is diversified with growing sectors that have an influence on the whole region. ICT, sports, and entertainment, as well as tourism, are all well-developed sectors of this economy, thus reducing the effects that would be felt if one sector performed less than expected (Louis & Balli, 2014). Moreover, infrastructural development makes the country a major consumer of crude oil. For this reason, a fall in crude oil prices boosts the economy as products such as bitumen, lubricants, and fuels required for the development of modern infrastructure will be acquired cheaply.

The country is the most prepared in the Arab world to handle shocks: it is also the top in the adoption of long-term technologies (Kapur, 2015). The level of the UAE’s preparedness and resilience in the global arena is the same as that of Hong Kong, Switzerland, and others. This explains why the recent fall in global petroleum prices did not have any significant effect on the UAE apart from a marginal reduction in the rate of economic growth for 2015 (Kapur, 2015). KPMG ranked the UAE economy as being more prepared for the interior and exterior shocks than Japan, the UK, and the USA (Kapur, 2015).

Why the United Arab Emirates is Still Dependent on Oil

Petroleum is still a very important resource in the UAE. Extraction, export, processing, and local consumption of petroleum products are key contributors to the economy. The government uses the proceeds obtained from petroleum to develop other sectors and thus diversify the economy. In the 1970s, 90% of the country’s GPD was obtained from the sale of petroleum (In Griffin, In Fantini & Organization of Petroleum Exporting Countries, 2015). There was virtually no other sector in this economy. However, the proceeds obtained from the sale of petroleum have been used to develop the manufacturing industry, tourism, transport, and logistics as well real estate and construction sectors which constituted 16%, 14%, 15%, and 9.5% of the country’s GDP in 2014, respectively (Griffin, Fantini & Organization of Petroleum Exporting Countries, 2015). The energy sector in which the petroleum subsector lays comprised 29% of the country’s GDP. The government plans to boost the relative importance of other sectors of the economy to make the country more resilient to any shock in the future. Additionally, oil exploration and extraction remain important sources of employment for the locals. In 2009/2010, the marginal increase in oil production coupled with the increase in oil prices shielded the economy from the adverse effects of the global financial crisis (Kapur, 2015).

As the country continues to develop its manufacturing sector, the proceeds from the sale of oil are utilized for capital investment as well as research and development. Still, experiences in the energy sector are also utilized in the manufacture of petrochemicals. In steel, aluminum, cement, and power equipment, the guaranteed supply of fuel from local petroleum companies becomes very convenient (Kapur, 2015). Additionally, many of the manufacturing industries use one or several raw materials obtained from the petroleum subsector. For this reason, the petroleum subsector of the UAE economy is a very important driver to other sectors of the economy. The country’s path to development would have been very different if it did not have its petroleum resources (Kapur, 2015).

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As seen in the literature above, the strategic importance of petroleum to the UAE economy has consistently reduced. However, petroleum has been very important for helping this country to diversify its economy to the levels seen today. It has held the key to the development of sectors such as manufacturing, tourism, real estate, and construction. As a result, the economy has become very resilient to external shocks, especially the ones related to fluctuations in the prices of petroleum. A fall in global oil prices may not have any significant impact on the country’s economy. However, the literature shows that the government is keen to utilize the oil resources to further diversify the economy.

Methodology

This section deals with the collection of data in order to answer the research questions and attain the objectives of the research. This paper will rely on secondary sources of data, which means that already published materials will be referred to. The researcher will conduct a literature search to find books, articles and web resources that contain information concerning the subject of this research. Afterward, relevant information that responds to all the research questions will be used to respond to them in the results and discussion section below. The researcher will utilize this information to draw conclusions for this research.

Results and Discussion

Oil prices have decreased by about 50% since 2014: the UAE has been affected too since it is a petroleum exporter (Kapur, 2015). Although policies and regulations have been put in place by OPEC to protect petroleum exporting countries, the UAE does not have any control over oil prices. However, it has continued to be dependent on oil in developing and diversifying its economy which has made it resilient to external oil shocks, especially the fluctuations in global oil prices. The government embarked on this mission during the times when oil prices were high and the country was getting lots of revenue from exporting petroleum. Currently, the UAE gets only about 30% of its GDP from oil; and thus, it is able to largely profit from non-oil revenues. Additionally, each of the other sectors of this economy produces only a small percentage of the GDP, which means that any shock in the output of any of the sectors is likely to have a minimal effect on the overall economy, hence the enhanced resilience. Generally, the bulk of consumer products in the UAE is usually comprised of consumer goods, including food items. However, some percentage incorporates utilities; for example, housing utilities constitute close to 45% of the CPI (Consumer Price Index). The rise in CPI over the years has been minimal, which has kept the rate of inflation low. The UAE government has ensured that its oil production has been at an adequate rate to reduce the effects of the falling oil prices and thus maintain the incomes of the citizenry. Still, incomes in other sectors have been continuously increasing. The highest year-on-year inflation happened in May 2015 and was 4.5% compared to the same month in 2009 (Kapur, 2015). However, it fell in the following month to 4.3%. The average inflation since 2009 has been 2.25% (Griffin, Fantini & Organization of Petroleum Exporting Countries, 2015). This is not very bad for the country that has experienced GDP growth twice as high as this percentage.

Inflation is only undesirable when it outstrips the rate of GDP expansion. The rise in CPI without an accompanying a rise in GDP means that the population will not be able to afford goods and services. GDP growth in itself presupposes the increase in value and volumes of output. The rise in GDP alone is not desirable as there should be a balancing rise in CPI. However, GDP growth should be higher than the rise in CPI to enable the population to save and invest in the economy. For the 14-year period between 2000 and 2014, the UAE’s GDP expansion rate has averaged 4.82%. The highest GDP growth during this period was 9.8% which was achieved in 2006, while the highest contraction occurred in 2009 at -5.2% (Kapur, 2015). As seen earlier, this average rate of GDP expansion has been adequate to match the rise in CPI and thus make life affordable.

The UAE government utilizes the energy sector and more specifically the petroleum subsector as a source of finance for investment in economic development. There are measures that the government has taken to ensure that the country’s economy does not suffer a lot due to fluctuating oil prices. Some of these measures are fiscal in nature. Over the years, the government has been able to accumulate a significant amount of foreign currency reserves as a way of sustaining government spending. This has many benefits, one of which is the control of the value of the local currency. This can also help the country survive some time before the oil prices stabilize on the market. The government is not planning to respond by waiting for oil prices to stabilize; instead, oil exploration, drilling, and extraction remain unrestrained which has helped keep people employed.

As seen earlier, the United Arab Emirates is the fifth country among those equipped to deal with economic and political shocks worldwide. Among the Arab countries, the UAE is the most equipped to survive long-term disruptions. Reduced oil prices will boost the petrochemical industry, which will in the medium run boost the economy. Still, reduced oil prices may come as a boost to companies in infrastructural development and may also ease the production of consumer goods. The reduction in global oil prices is not likely to have far-reaching negative consequences for the economy of the UAE.

Although countries such as Switzerland, Hong Kong, and Singapore are seen as being more prepared to external shocks than the UAE, the latter actually surpassed the United Kingdom, Japan, and the United States despite the fact that these are developed countries. This shows that the UAE can handle low oil prices for a considerable amount of time. This has been made possible by the initiatives that the government has put in place to significantly improve both the governmental and the private sectors through economic liberalization and strategic investment, which has led to the development of different sectors of the economy. The United Arab Emirates government anticipated and prepared for economic occurrences that could adversely affect its economy. The best way to survive that was by developing different sectors, each of which made a small percentage of contribution to the economy so that any shock in any of the sectors can be manageable. As a result, even if 2014 was characterized by fluctuating oil prices, it was the year in which the economy of the UAE was at its highest since the country formation in 1971. The UAE experienced a 4.6% increase in real GDP and a nominal GDP of $400.5 million. In addition to that, the government withdrew subsidies on petroleum products in August 2015 in order to set the prices at the same level as those on the market (Kapur, 2015).

The real estate industry of the UAE has steadily grown over the past few years, and this has attracted a number of international investors. This has also supported the economy and enabled it to thrive despite the fluctuating oil prices. The authorities of the UAE have used measures to support the growth of the real estate industry. For example, they have tightened their requirements on mortgage lending, increased transaction taxes, and improved the supply of land in the UAE to increase the strength and participation of this sector in the economy.

Conclusion

Between the 1950s and 1970s, oil prices increased by 500%: the reason for this was fast industrialization, while the discovered recoverable oil resources remained rather constant, especially using the technology (Kapur, 2015). This was worsened by wars and global politics. The turn of the century also saw an increase in oil prices, but it was not as steady as seen in the 1980s. However, climatic concerns, the development of oil resource by the USA as well as doubling of Russia’s oil output in the last decades has led to an oversupply of oil on the global market, leading to unprecedented fall in oil prices. These events have reduced the relative importance of OPEC and its regulatory policies. The price and the relative importance of petroleum in the world are projected to continue reducing as countries and innovators try to cut their petroleum consumption due to environmental concerns (Griffin, Fantini & Organization of Petroleum Exporting Countries, 2015).

As seen earlier, oil prices have fallen by roughly 50% since 2014 (Griffin, Fantini & Organization of Petroleum Exporting Countries, 2015). This has affected oil-producing countries, especially in the GCC. The less diversified economies of Bahrain and Oman have been most affected. However, the UAE has not been affected in any significant way. Over time, some of the countries producing the largest amounts of oil have not joined OPEC. Due to large oil production by non-OPEC members, the effectiveness of OPEC’s regulatory framework on oil supply and hence prices have reduced. Over this period of time, the UAE has continuously invested in other sectors of the economy so that to reduce the importance of its oil reserves to the economy. The importance of OPEC to the UAE has decreased as the organization has become a price taker as compared to a price setter.

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Between 1970 and 2014, the contribution of petroleum to the economy has reduced from 90% to 30% (Griffin, Fantini & Organization of Petroleum Exporting Countries, 2015). Other sectors such as industry, tourism, real estate, and construction have greatly expanded from non-existence in the 1970s to constitute between 16% and 9.5% of the country’s GDP in 2014 (Griffin, Fantini & Organization of Petroleum Exporting Countries, 2015). Other sectors of the economy are developing too. As a result, any internal or external shock in the petroleum subsector cannot affect the economy in any significant way. As seen earlier, each of the country’s sectors contributes only a small percentage to its GDP; therefore, none can have a significant effect on the economy is adversely affected by an external shock. This has been the major foundation for the UAE’s resilience. During the recent shock in oil prices, the economy performed well and went ahead with a good performance. Some countries in the GCC were adversely affected, and they have not fully recovered from the consequence of reduced global oil prices.

The UAE has been seen to still be dependent on oil; however, its dependence on oil is very strategic. The country utilizes money obtained from oil sales to develop other sectors of the economy. The petroleum subsector in this economy has been a very crucial financier of other short-term and long-term investment programs. This is the reason why the country has been able to develop rapidly without accumulating debt as is the case with some other countries. Currently, the proceeds from oil sales are used to expand other sectors of the economy to ensure that the country is diversified enough to attain sustainable development in a turbulent global arena.

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