Why has the UAE left Opec and what impact will its departure have?

The United Arab Emirates said on Tuesday that it was quitting Opec, dealing a heavy blow to the oil-exporting cartel and its de facto leader, Saudi Arabia, at a time when the Iran war has caused a historic energy shock and rattled the global economy.

But what is Opec, and how does it impact consumers?

What is Opec?

Founded in 1960, the Organisation of the Petroleum Exporting Countries (Opec) is a bloc of oil-exporting nations that coordinate their oil and gas policies as a means of managing the oil market.

The founding members were Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela, but in 2016 the group expanded into OPEC+, which now comprises 23 countries.

The bloc controls slightly over 50 per cent of global crude production, Jorge León, head of geopolitical analysis at Rystad Energy, told Reuters.

What is the purpose of Opec?

Opec’s main purpose is to reduce volatility in oil markets, León said. He used the example of the Covid-19 pandemic, when oil demand dropped by 20 million barrels a day.

The group reduced supply by 10m barrels to stabilise the market.

“These are historical examples that show how Opec and Opec+ have managed to manage the market, moving supply from one period to another,” he said.

Why is the UAE leaving?

The loss of the UAE, a longstanding Opec member, could weaken the group, which has usually sought to show a united front despite internal disagreements over geopolitics and production quotas.

So why has the UAE left? León said it comes down to incentives. Being part of a bloc that exists within a growing market is one thing, but when that market shrinks, the incentives shrink as well.

“If you’re part of a cartel that operates in a shrinking market, then the incentives to remain in the group are less and less,” he said.

“It’s more about who moves first. And right now, it seems like the UAE has taken that step.”

The UAE has not attributed its departure to the war, according to CNBC.

Energy Minister Suhail Al Mazrouei told CNBC in an interview on Tuesday that the UAE’s exit was timed to “limit the disruption” to fellow producers in the group.

According to the minister, it wanted more freedom to make production decisions without Opec constraints, and to reach its goal of 5m bpd of capacity by 2027.

The UAE has “chafed” under years of oil production cuts led by the Saudis to support prices, said Andy Lipow, president of Lipow Oil Associates, according to CNBC.

What impact will it have?

In the short term, León said the impact would be minimal.

“Because of the Strait of Hormuz being closed, any additional supply coming from the UAE is quite restrictive at the moment,” León explained.

Once the strait reopens, however, the UAE will likely rush to increase oil production and make use of its spare capacity.

“They will start pumping as much as they can to reach those five million barrels per day. So in reality, what it means is that there’s more supply to the market in the medium term,” he elaborated.

The market may miss Saudi Arabia’s ability to put a floor under prices if oil demand is weak and there’s a big surplus in the future, David Goldwyn, the US State Department’s former special envoy and coordinator for international energy affairs, told CNBC.

“There’s a significant risk of higher oil price volatility as a result of this decision,” he said. “But in the end, when market conditions require cooperation, the UAE leaving Opec doesn’t prevent it from cooperating with Opec.”

While oil futures prices did not react strongly to the announcement on Tuesday, the move could prove bearish later, John Kilduff, founder of Again Capital, said, according to CNBC.

“It undermines the cohesion needed among producers to keep prices from falling too much during supply gluts,” he said.

What happens to Opec now?

“It really puts a question mark on the future of Opec and Opec+ as a cohesive organisation,” León said, adding that all eyes will now be on Saudi Arabia.

As the “central banker” of the oil market, will they continue to take the reins and manage the market? Or will the market become more of a free-for-all?

“That is the big question at the moment,” León said.

According to CNBC, the UAE was the most influential member of Opec behind Saudi Arabia, as they were among the few members with meaningful spare production capacity — idle production that can be brought online quickly during crises — to influence prices and respond to supply shocks.

“Saudi Arabia and the UAE together control a majority of the world’s total spare capacity of more than 4m barrels per day, making them particularly influential during periods of distress,” CNBC said.

The UAE’s departure, therefore, removes “one of the core pillars underpinning Opec’s ability to manage the market”, León noted. As a result, Opec will become “structurally weaker”.

Goldwyn said that the move would also undermine the Saudis’ ability to manage Opec as an organisation.

“Riyadh will still have a significant ability to discipline the market with its own spare capacity, but it will have a weaker hand now that the UAE is no longer a member,” Goldwyn told CNBC.

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