Executive Summary
The Gulf states have embarked on an ambitious economic diversification, extending their hydrocarbon value chains and venturing into new sectors like finance, logistics, and tourism.
These efforts are driven by a critical need to reduce oil dependency amid a global shift away from fossil fuels; however, continued reliance on crude revenues, intra-Gulf competition in similar sectors, and a significant gap between investment pledges and actual spending pose considerable challenges.
Putting a premium on regional stability as a framework for economic growth, the Gulf states view the Gaza war as undermining their long-term trajectories and seek to diversify their foreign relations away from the Israel-supporting West.
Implications for International Business
The Gulf states present enticing prospects, in sectors ranging from energy to education, for international business, if partnerships are based on mutual respect.
A new generation of technocratic leaders gradually assumes responsibility in the Gulf states, reflecting the zeitgeist of economic change, although important decisions remain centralized and hierarchical.
European businesses will face competition from other parts of the world as the Gulf states seek to diversify their economic and political relations.
State of Play
A region in search of new riches
Over the past years, the six Gulf states Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE) have launched ambitious diversification projects. They announced that they would radically transform their hydrocarbon-dependent economies, with the ultimate objective of creating alternative sources of income in a post-fossil fuels world. Already today, they are no longer mere exporters of crude oil and raw natural gas but have extended the vertical value chain in the hydrocarbon industry, e.g. by establishing robust petrochemical sectors. In addition, they have ventured into new economic sectors, whether in infrastructure, tech or entertainment. Most notably is the $500 billion megacity Neom, which is as ambitious as it is controversial. Likewise, Gulf states have made billion-dollar investments in artificial intelligence, or they have signed global football superstars to play in the Gulf in a bid to bolster their international standing, including with a nod to the non-Western world.
Notably, the Gulf states’ diversification drive not only aims to overcome the reliance on hydrocarbons but also seeks to lessen dependence on Western countries. To this end, the Gulf states are actively developing ties with China and other East Asian countries, such as Indonesia, Japan, or Malaysia, as well as with Russia. The cooperation between the Saudi-led Organization of the Petroleum Exporting Countries (OPEC) and a group of non-OPEC oil producers led by Russia (OPEC+) has become a vital pillar of the Gulf’s geopolitical and geoeconomic strategy. Now, the war in Gaza has further deepened the rift between the Gulf and the West as most Gulf decision-makers see Israel having been given a carte blanche and Western governments disregarding the Palestinians’ suffering – or “genocide” for many Arabs. Anti-Western sentiment is on the rise, including among elite circles, with accusations of hypocrisy regarding human rights and universalist principles. In this context, the stance of some European leaders advocating a rapid transition away from fossil fuels, still the Gulf’s economic lifeline, while simultaneously seeking support to substitute Russian energy amid the war in Ukraine, only serves to amplify this perception.
Key Issues More active diplomacy & geopolitical diversification
The geopolitics of the Gulf states have witnessed a profound transformation, with a newfound emphasis on regional stability as a prerequisite for successful economic diversification and, ultimately, political survival. The 2011 Arab Spring questioned the legitimacy of ruling regimes, while the “shale oil revolution” in the United States and subsequent oil price slump threatened their economic stability. Internally, Mohammad bin Salman’s rise to power in Saudi Arabia brought bold foreign policy actions, including military intervention in Yemen and the economic and transport blockade of Qatar. Anxiety of Tehran remains high, but the lack of US support in response to an Iran-supported attack on Saudi oil facilities in 2019 led to a shift in strategy: instead of confronting Iran, Riyadh and Abu Dhabi decided to seek a modus vivendi with their arch-rival, culminating in the China-brokered resumption of diplomatic ties between Iran and Saudi Arabia in 2023. In parallel, Bahrain, Saudi Arabia, and the UAE negotiated the normalization of relations with Israel under the so-called Abraham Accords.
The emphasis on diplomacy obviously has not resolved the region’s conflicts, but at least provides the groundwork for (relative) regional stability as a precondition for successful economic diversification. Against this backdrop, Israel’s response to the Hamas terror attacks of October 7th is perceived as not only highly disproportionate but also threatening to the countries’ own aspired trajectories. Many fear that Israel may intend to effectively expel Palestinians from Gaza, which would fuel regional tensions further. This puts some Gulf leaders in a difficult domestic position given their collaboration with Tel Aviv, whether overtly (Bahrain, UAE) or covertly (Saudi Arabia). Moreover, the escalation between Israel and Iran jeopardizes the regional stability that the Gulf states are striving to secure. Rather than siding with Washington as they used to do on security issues, Gulf states are strengthening ties with Russia and China, both at diplomatic and economic level.
Squaring the circle – embracing diversification while prioritizing hydrocarbons
The Gulf states’ current efforts at economic diversification differ significantly from earlier endeavors. In the past, overcoming dependency on oil exports and volatile prices was meant to stabilize government income, but momentum for structural diversification typically waned during boom times. Today, there is a much greater sense of urgency: With the world transitioning away from oil, diversification has become a matter of economic and political survival. Both Gulf rulers and citizens are embracing change as the dawn of a new era.
However, several hurdles stand out on the way to success. First, the Gulf states have a different notion of sustainability from many non-oil exporting countries: They see it as reducing the fossil fuel industry’s carbon footprint, not ending it. For them, a “Circular Carbon Economy”, as promoted by Saudi Arabia during its G20 presidency in 2020, that relies on technological solutions such as carbon capture and storage (CCS) is preferable. Their diversification efforts, meanwhile, remain heavily reliant on financing and subsidies from oil revenue. At a fundamental level, the question therefore remains: Outside the oil sector, where does the Gulf states’ combination of resources and human capital have a competitive advantage in the global division of labor? In this regard, a second hurdle is that the Gulf states largely tend to diversify into the same sectors, such as air and maritime logistics, education, finance, and tourism, effectively competing with one another. A notable example is Saudi Arabia’s introduction of the “Regional Headquarters Program” in 2023, which – in a direct challenge to Qatar and the UAE – forces international companies operating in the kingdom to move their regional headquarters there. Third, the process of diversification is only partial, as efforts at economic integration are accompanied by limited societal but not by political liberalization. In many ways, the Gulf states follow the Chinese model of authoritarian-led modernization, but – so far – without the growth rates and opportunities to compensate for the lack of political freedoms. Finally, there is a significant gap between investment pledges and actual spending among the Gulf states. For instance, as of June last year, Saudi Arabia had only spent $50 out of $879 billion on mega-projects announced under its Vision 2030. All told, firms are advised to tread carefully in pursuing the opportunities on offer, mindful both of the inherent risks of regional or domestic political instability and of the changing business environment that is less welcoming of Western companies.
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