The Guggenheim Foundation has taken another step towards becoming a global modern art franchise by announcing plans to build its largest museum yet in Abu Dhabi, to join the existing collections in New York, Venice, Bilbao, Berlin and Las Vegas.

The new building, which will be designed by the Canadian-born architect Frank Gehry, is due to open in 2012, and budgeted to cost $200m (£108m). It will go up on a specially built extension to Saadiyat Island, next door to Abu Dhabi, one of the seven city states that make up the United Arab Emirates. The museum will cover an area of 30,000 sq m, a quarter as large again as the Guggenheim in Bilbao.

The deal, signed at the weekend by Thomas Krens, the Guggenheim's director, and Abu Dhabi's Crown Prince, Sheik Mohammed bin Zayed al-Nahyan, will be Abu Dhabi's first major venture into the world of arts. It underlines the ambitions of a state best known for oil, upmarket tourism and sun-drenched winter homes for celebrities, to turn itself into a multi-national cultural beacon for the entire region.

"Today's signing represents the determination of the Abu Dhabi government to create a world-class cultural destination for its residents and visitors," Sheik Mohammed bin Zayed said.

This weekend's announcement also seals victory for the museum's director Thomas Krens in the argument over the future of the Guggenheim brand. The philanthropist Peter Lewis stepped down in January 2005 as chairman of the museum, complaining that it should focus its efforts on its home city of New York, "instead of being scattered all over the world". With gifts of $77m Mr Lewis had been Guggenheim's largest single benefactor during his seven years as chairman, and the impact of his departure was unclear. But now an even wealthier donor, a Gulf sheikdom flush with oil money, has stepped into the breach, removing any lingering financial doubts.

Cultural ones, however, remain - not least the complaint that Guggenheim museums are more notable for the buildings themselves than the works of art they house. The Crown Prince says merely that GAD, as Guggenheim Abu Dhabi is to be known, will be a prime attraction in a new $27bn "upscale cultural district" and will be endowed with a "prestige" collection of exhibits. The total cost of the venture is said to be at least $400m.

The deal has several other intriguing aspects. For one thing, it links a foundation created in 1937 by Solomon R Guggenheim, one of the most prominent Jewish-Americans of his era, with an Arab kingdom that still refuses diplomatic ties with Israel. The new museum will also be designed by a Jewish architect.

Mr Gehry's concept for the Bilbao Guggenheim, with its gleaming, jagged swirls, has been acclaimed as the most spectacular example of the Deconstructivist school of architecture. But the Abu Dhabi site, on an artificial spit jutting out into the waters of the Persian Gulf would require him "to invent a different kind of architecture". It would, he told the Associated Press, have to "play off the blue water and the colour of the sky and sea and sun".

A separate question is whether the museum will contain nude works, which could upset Muslim traditionalists. But that was "a minor issue," Mr Krens said. "Our objective is not to be confrontational, but to engage in a dialogue." Abu Dhabi is unlikely to mark the end of the Guggenheim's expansion.

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