Analysis - Economic Trends

Future Options

A smooth post-oil transition for the UAE
Thursday، February 18، 2016
Future Options

The developments which hit the global oil markets in mid-2014 raised questions about the impacts of the significant slump in oil prices on the economic conditions of major oil exporting countries, including the UAE. These questions include whether persistent low prices would cause financial problems, affect plans for economic development and the creation of employment opportunities for the youth, among other economic and social issues in affected states. The UAE seeks to transform into a model state that succeeds in shifting its economy from dependence on natural resources to dependence on advanced industries and scientific research, based on the minds and skills of its citizens.

This vision was stressed by Crown Prince of Abu Dhabi and Deputy Supreme Commander of the Armed Forces, His Highness Sheikh Mohamed Bin Zayed Al-Nahyan, during his participation in the Cabinet Retreat on the Post Oil Phase in late January. Because it is at the forefront of acquiring innovative solutions and creative ideas to counter various challenges, the UAE took measures to allow for a smooth shift to the post-oil era.

What is the Reason for the Drop in Global Oil Prices?

Several factors and variables have significantly  impacted the global supply and demand in the past one and a half years, driving prices to plunge from US$105 a barrel in 2014 to as low as the current US$30 a barrel, a  decline of approximately 75 percent. As far as supply is concerned, major oil producing countries increased their production significantly, driven by technological advances which made the production of shale oil in the United States and shale sands in Canada economically feasible due to the high oil prices. This in turn, for instance, led to the increase in the United States' oil production by one million barrels a day during the past three years of the oil price collapse.

In addition, several non-OPEC producing countries, like Russia, which produce oil at high prices, were scrambling to compete with OPEC members, including the members of the Gulf Cooperation Council (GCC), which enjoy very low production costs. This led to an oversupply in global markets and weakened coordination between OPEC members and several major non-OPEC producers.

It should be noted that OPEC, whose influence on the market receded significantly because its share of world output fell to a third today, is witnessing increasingly sharp differences between its members. This made it difficult for them to reach an agreement to cut production in order to stop the collapse of crude oil prices. Finally, expected outputs of major oil exporters like Iran and Iraq, which suffered from problems in production and export, would soon return to normal levels. These expectations have led to predictions of a significant increase in future supplies and consequently have held global oil prices under continuous pressure in the recent period.

On the demand side, the persistent global economic slowdown, which followed the 2008 global financial crisis, has weakened demand for oil. Similarly, declining growth rates and recent weak outlooks for emerging economies, China, in particular, led to increased pressure on its crude oil prices. However, one could not ignore the impacts of technological advances, which helped increase energy efficiency and increased use of sustainable and new energies for environmental reasons. That is, even if these two factors do not contribute to a significant fall in oil demand, they, at least, helped prevent demand growth from keeping pace with an already lagging global economy. Given the aforementioned factors, global oil prices are projected to continue to maintain significantly lower prices than those prior to mid-2014, at least in the medium term, with prices not exceeding US$60 a barrel.

The UAE: Two Pillars to Counter Oil Price Fluctuations

The UAE took early preemptive measures to counter the potential consequences of fluctuating oil revenues, including the recent deep slide in global oil prices, and the expected depletion of oil in the distant future. These measures revolve around two major pivots: economic diversification and increased fiscal efficiency. The country is working on developing its economy and educational systems, qualifying workers for the labor market. The approach takes into consideration the potential impacts of oil price fluctuations and even transforms them from sources of concern to sources of economic progress based on diversification, modernization, and technological advancement.

Within this context, the UAE adopted a number of strategies for economic diversification to reduce the share of the oil sector in its economic activity and expand the role of competitive sectors like tourism, travel and financial services, foreign trade, IT, and aircraft components manufacturing. The Emirates also worked to provide a favorable investment environment to attract more investments from the private sector, other Gulf countries as well as countries beyond the region through eased and modernized legislation, adoption of smart government, and constructing transportation and communications networks, airports, seaports and free zones.

The UAE also used financial surpluses generated from the oil sector to avoid the impacts of falling oil prices and achieve just distribution of revenues between the generations through sovereign wealth funds, that are among the world’s biggest, to diversify sources of income, safeguard the country against oil price fluctuations, and preserve and grow the wealth for the benefit of future generations. The UAE also made substantial and pioneering efforts towards developing alternative energy sources for domestic use so as to prevent facing a shortage of supplies driven by the country's growing economy. At the same time, the efforts would take the country to the forefront of environmental protection. In addition, the UAE is pursuing a strategy for peaceful use of nuclear energy based on the world's highest safety standards, and is investing in the development of renewable and clean energy resources through "Masdar City", and "Shams 1", one of the world's biggest solar power plants.

As for public finance, the UAE has made significant efforts, both federally and at the level of individual emirates, to increase the efficiency of revenues and expenditure. It also deregulated fuel to shift to a system of adjusting prices monthly in response to global trends to increase fuel efficiency, reduce environmental impact and road traffic congestion.

Within the same context, the UAE is working towards a better pricing system for water and electricity so as to reduce waste, rationalize consumption and reduce pressures on the energy sector heavily used by the desalination sector. The UAE also enhanced sources of government revenues, provided sufficient resources for the development and maintenance of infrastructure through modern systems. This is in order to levy fees for basic government services, such as toll gates and parking lots, in addition to developing a distinct public transportation and railway network.

Future Outlook

The UAE is expected to continue to stay in the lead of the race to diversify its economy away from the oil sector and work towards encouraging and attracting local, Gulf and foreign private investments. Within this context, the UAE is expected to work on enhancing competitive advantages that attract these investments by using the best ICT technologies and improving the country's road network, airports, seaports and railways to sustain its growth and pioneering efforts. The UAE is also expected to enhance its financial markets to transform itself into a global financial center and provide advanced financial tools like Islamic finance for example.It is also likely that the leading private sector would be supported in the future, even in the government services' sector, through increased reliance on the principle of "public-private partnerships" to construct large-scale projects.

Additionally, the government would also intensify its efforts to develop small and medium-sized enterprises (SMEs). As they are a major source of new economic opportunities for the innovative youth, so as to assist them in finding new jobs and provide the youth with constructive economic opportunities. This vision goes in line with the current trend of developing the education system using modern technologies and developing technical and vocational education and training to meet future demands for labor in the post-oil era.

In the area of public finance, the UAE can seek to introduce more development to diversify sources of revenue to support its efforts in providing basic services for nationals and expats. This would be carried out by introducing modern tax systems, perhaps starting with the value added tax, which can be enforced in coordination between all members of the Gulf Cooperation Council.

The UAE is also expected to develop its government securities market and provide favorable financial tools to curb risks in financial investment portfolios and provide effective low-cost means to fund government policies and manage the state's economic policies. Furthermore, the UAE is expected to work with other members of the Gulf Cooperation Council to develop a common Gulf market to achieve goals like free movement of people, capitals, and goods and achieve further intra-Gulf coordination and cooperation to form newly aligned strategies for the region in the post-oil era.

In conclusion, in light of the expected continuous efforts to develop and modernize basic services provided by the UAE, the ongoing work to introduce ambitious and advanced thoughts through giving  more responsibilities to the national youth, dealing with economic challenges as a source of inspiration for developing the UAE economy and taking it to the lead, the current stage of fluctuating oil prices is expected to be a major source of support for the economic vision embraced by the country before the recent collapse of oil prices. This would positively impact the UAE economy over the medium and long terms.

Keywords: oilPolitical EconomyUAEtradediversificationSovereign Wealth Funds