SCENESETTER FOR VISIT OF UNDER SECRETARY REUBEN JEFFERY III

UNCLAS SECTION 01 OF 03 ABU DHABI 000372

SIPDIS

SIPDIS
SENSITIVE

DEPT FOR E, NEA/ARP, EB/IFD/OMA

********* C O R R E C T E D C O P Y *********

E.O. 12958: DECL: NA
TAGS: ECON EFIN ETRD EINV AE
SUBJECT: SCENESETTER FOR VISIT OF UNDER SECRETARY REUBEN JEFFERY III

Ref: A) Abu Dhabi 299, B) Abu Dhabi 145, C) Abu Dhabi 45, D) Dubai
101, E) 07 Abu Dhabi 1021, E) Abu Dhabi 320, F) Abu Dhabi 319

ABU DHABI 00000372 001.6 OF 003


This cable contains Business Proprietary Information.


1. Embassy Abu Dhabi and Consulate General Dubai welcome the April
6-8 visit of Under Secretary for Economic, Energy, and Agricultural
Affairs Reuben Jeffery.

Economic and Financial Growth Strong
--------------


2. (U) UAE economic growth continues to be strong, on the back of
high oil prices, increasing foreign and domestic investment, and a
construction boom. Nominal GDP hit about USD 190 billion in 2007 and
according to initial UAEG estimates, real GDP growth in 2007 was
7.4%. Despite holding nine percent of the world's proven oil
reserves, the UAE has followed an aggressive policy of economic
diversification to the point where only about 35 percent of nominal
GDP comes directly from the production of crude oil and gas. Fixed
investment in 2007 increased by 19 percent to reach USD 39.4 billion
(including about 18 percent into the real estate sector, reflected in
the forest of cranes throughout Dubai and to a lesser extent the rest
of UAE).


3. (U) As strong as these numbers are, the UAE has ambitious growth
plans. The Emirate of Dubai's strategic plan forecasts 11 percent
real growth through 2015. Dubai is building the world's tallest
building, the world's biggest airport and the world's biggest
artificial island. For its part, the Emirate of Abu Dhabi is also
starting to flex its economic muscles. There are between USD 330 and
USD 350 billion in development projects in the pipeline in the
Emirate of Abu Dhabi alone, including a brand new world class port
facility and what may eventually be the world's largest aluminum
plant. In addition, the Emirate of Abu Dhabi has ambitious plans to
increase oil production capacity to four million barrels per day by
the 2014 timeframe.

What are the risks?
--------------


4. (SBU) Although the prognosis for the UAE is generally positive,
there are geopolitical and economic risks. Thus far, the UAE has
benefited from being an oasis of stability in a dangerous
neighborhood. A major terrorist attack or sharp increase in tensions
with Iran would likely cut economic growth, especially in the UAE's
growing tourism and transport business. The UAE is keenly aware of
threats to its economy. The Emirate of Abu Dhabi has established the
Critical National Infrastructure Authority to protect the Emirate's
vital facilities, including oil and gas installations, power
plants/desalination facilities, and airports/sea ports.


5. (SBU) Inflation, currently estimated by some analysts at around 11
percent, presents a serious economic risk. The rapid development of
the UAE has put serious pressure on the housing market, causing sharp
increases in rents. It has also put pressure on all types of goods
from foodstuffs to steel and concrete. The vast number of projects
in the UAE, and in the GCC generally, is putting extreme stress on
human and material resources, thus increasing costs. These increased
costs are squeezing the UAE's largely expatriate middle class and
making it more difficult for the UAE to attract necessary human
capital. Business contacts increasingly complain about the costs
involved in attracting both skilled and unskilled workers. In at
least some cases, they have lost workers when salaries and benefits
failed to match rising costs of living. In other cases, lower paid
workers are sending family members home as increasing schooling and
housing costs force expenditure cutbacks. UAE officials have
responded by imposing (or negotiating) price caps on basic household
items, rent caps in Abu Dhabi and Dubai, and by raising federal
salaries by 70 percent.


6. (SBU) Rapid economic growth is also putting serious pressure on
the UAE's infrastructure, particularly on power generation. Abu
Dhabi's water and electricity company's recent demand growth
forecasts are for 6.7 percent average annual growth for the next 23
years. (Note: this figure does not include "off grid" projects such
as the new aluminum plant. End note.) Moody's estimates that the
Emirate of Dubai will need to triple its power generation capacity
over the next ten years. Although the northern emirates are starting
from a much lower base, they also have ambitious development plans
which are already overstressing their power generation capacity. The
mismatch between development and power in the northern emirates has
hurt a U.S. investor, Guardian Industries, which built a USD 150
million float glass plant in the Emirate of Ras Al-Khaimah only to
discover that the Federal Electricity and Water Authority was unable
to provide needed power. The Embassy and Consulate General
intervened on behalf of Guardian, which is now receiving some of its
required power from FEWA, but is required to use expensive generators
for the rest.

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7. (SBU) The sharp increases in projected power and water demand will
require significant investments in power and desalination plants, but
also raise a more fundamental question of feedstock sources.
Although the UAE has the fifth larges proven natural gas reserves in
the world, it is not producing enough natural gas to meet its current
needs (including reservoir management). Oil and gas belong to the
seven individual emirates, not the UAE as a whole, and are unevenly
distributed among the emirates (with Abu Dhabi having around 93-94
percent of the total reserves). Abu Dhabi does not produce enough
gas to meet the demands of all of the other emirates.


8. (SBU) Abu Dhabi has several projects underway to increase gas
production available to power generation projects, including building
a pipeline to connect offshore fields to the UAE mainland and a major
onshore sour gas development project. (Note: Although the deal has
not been publicly announced or signed, U.S. firm ConocoPhillips has
won the sour gas development project. End note.) In addition, the
UAE currently imports two billion cubic feet per day of natural gas
from Qatar via pipeline (the Dolphin Project, with Occidental
Petroleum holding a 24.5 percent stake). Despite these projects, UAE
officials estimate that the planned gas production will still be
insufficient to meet projected demand growth and are examining
alternatives. Abu Dhabi is considering the development of peaceful
nuclear power and has engaged in discussions with the USG about
potential assistance. It has also signed a nuclear cooperation
agreement with the Government of France, though contrary to news
reports, not with French companies.

The Currency Peg
--------------


9. (SBU) There is increasing public pressure on the UAEG to at least
revalue the dirham, if not drop the dollar peg in favor of a peg to a
trade-weighted basket of currencies. There are almost daily articles
calling for a revaluation. Many expatriates, especially from Europe
and India, have complained about the "double hit" from the increasing
local cost of living and the relatively lower income in comparison to
their home currencies. Although the Central Bank has asserted that
domestic capacity constraints rather than dollar weakness are the
main drivers of inflation, several bank economists have argued that
low interest rates have sharply increased liquidity and by extension
higher prices. Although the counter arguments rarely make the
papers, there are those who note that a revaluation would not be cost
free to the UAE. Abu Dhabi holds significant overseas financial
assets, many dollar- denominated. Revaluing the dirham would reduce
the relative value of these assets. It could also harm the UAE's
efforts to diversify its economy by potentially making non-oil
exports less competitive and making the UAE a less attractive
destination for European tourists. Efforts to move to a trade-
weighted peg would be hampered by statistical shortcomings and poor
information flow from the individual emirates (which track trade) to
the federal government.


10. (SBU) So far the UAE has steadfastly maintained its peg to the
dollar and recently cut its rate by 75 basis points to match the
Federal Reserve's cut. UAE officials have also insisted, both
publicly and privately, that they are committed to maintaining the
peg. They also note that as part of the GCC agreement to create a
monetary union by 2010, member states agreed to peg their currencies
to the dollar. Any change would need to be a consensus decision.
Should another GCC country revalue or drop the peg, however, the
pressure on the UAEG would increase sharply.

Investment and Sovereign Wealth Funds
--------------


11. (SBU) UAE institutions are major foreign investors, with the
Emirate of Abu Dhabi's Sovereign Wealth Fund (SWF),the Abu Dhabi
Investment Authority (ADIA),widely regarded as one of the world's
largest SWFs. Since its establishment in 1976, ADIA has followed a
largely passive, diversified, long-term strategy. Since,
constitutionally, natural resources belong to the individual emirates
rather than the UAE as a whole, SWFs and other investment vehicles
are emirate-level rather than federal-level organizations, although
the UAE established the Emirates Investment Authority in November
2007 to invest the assets of the federal government.


12. (SBU) Although ADIA is a largely passive, portfolio investor,
other UAE investment organizations and State-owned enterprises take
larger stakes in overseas investments. DP World's ultimately failed
attempt to purchase P&O's U.S. assets is still a source of local
resentment, although UAE-based government-owned investors have
subsequently made several high-profile acquisitions in the U.S. In
your conversations with UAE officials, you are likely to hear
concerns about "political risk" premiums for foreign investment in
the U.S.


13. (SBU) Abu Dhabi officials have consistently assured us that the

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Abu Dhabi Government would never use its foreign investments as a
foreign policy tool. ADIA and Government of Abu Dhabi officials
worked closely with the Treasury Department and the Government of
Singapore to develop a series of best practice policy principles for
SWFs and for countries receiving SWF investment. Abu Dhabi officials
jointly released these principles with Treasury Secretary Paulson and
officials from Singapore on March 20 as a way to encourage the IMF
and the OECD's work to develop voluntary best practices for both SWFs
and inward investment regimes.


14. (SBU) With regard to investment in the UAE, the investment
climate still favors locals. Outside the UAE's many free zones,
there is still a legal requirement to have local ownership of 51
percent of a company or industrial enterprise. The UAEG has been
considering revisions to the Commercial Companies Law and a new FDI
law, which reportedly would permit greater foreign ownership in
certain sectors, but those laws have not yet been passed. The
inclusion of natural resources became a stumbling block in our
efforts to conclude an FTA with the UAE. That said, the Emirate of
Abu Dhabi has always allowed foreign equity participation in the oil
sector. ExxonMobil has a 9.5 percent stake in the onshore oil
company and a 28 percent stake in the offshore Upper Zakum field.
ADNOC has all but concluded an agreement with ConocoPhilips to
develop an onshore sour gas field, although neither party has
officially announced the deal. This would be the first time that a
foreign company would have access to an upstream gas development
project.

Strengthening the Economic Relationship
--------------


15. (U) The U.S.-UAE economic and trade relationship remains strong
with USD 12.9 billion in two-way trade and the U.S. running almost a
USD 10.3 billion trade surplus. There are over 750 U.S. firms
physically present in the UAE, many serving the wider region.


16. (SBU) Although both parties decided last year that we would not
be able to conclude a Free Trade Agreement in the time permitted
before the lapse of trade promotion authority, FTA negotiations made
progress in a number of areas, including in making revisions to the
UAE's Agency Law that tied the length of an agency agreement to the
length of the contract between the foreign principal and the UAE
agent. The revised Agency Law also required mutual consent to renew
an agreement, where previously the UAE agent could unilaterally
re-register the agreement. Issues related to dispute settlement and
treatment of natural resources in the investment chapter had not been
resolved, nor had issues related to opening up the telecommunications
sector. In addition, the UAE's lack of rights of association and
collective bargaining remained a serious problem.


17. (SBU) The UAE and the U.S. agreed to a TIFA-Plus arrangement to
further promote trade ties. The two sides held the first council
meeting in late June of 2007, but have not held subsequent meetings.
The UAE has agreed to participate in Anti-Counterfeiting Trade
Agreement negotiations with the U.S., but there has been little
visible progress in other areas of TIFA-Plus engagement. UAE
economic engagement continues in other fora, however, for example
through ADIA's cooperation with the Department of Treasury.


18. (SBU) The UAE had expressed interest in exploring a Bilateral
Investment Treaty (BIT). The USG had expressed concern that issues
that had caused problems in the FTA investment chapter would cause
similar problems with the BIT. The UAE has not pushed for BIT
negotiations, but at least some of the UAE's negotiators have
privately said that they see more flexibility in the model BIT text
than in the FTA investment chapter.


19. (SBU) The UAE's February cabinet reshuffle has also changed the
UAE's economic team. Sheikha Lubna Al-Qasimi, who as Minister of
Economy was a co-chair of the UAE negotiating team, is now the head
of a newly created Ministry of Foreign Trade. Minister of State for
Financial and Industrial Affairs, Dr. Mohamed Khalfan bin Kharbash,
the other FTA co-chair, was replaced by Obaid Humaid Al-Tayer, who as
head of the Dubai Chamber of Commerce and Industry had publicly
expressed skepticism about the benefits of the FTA to UAE businesses.
These shake-ups (and changes in USTR) will likely complicate
near-term efforts on the trade front, but could also give us an
opportunity to re-energize our overall economic cooperation. A first
step would be an open discussion with the UAE on core needs and
interests moving forward.

Quinn