His behaviour just seems extremely… odd. I know he's insane, but still.
He's extremely cocky and arrogant, proclaiming himself to be a god and basically unkillable. He even insists that you strike the first blow.
At the same time, he's unwilling to risk allying with you or accepting your fealty, even if you would offer him the Tools. He claims this is because he doesn't want to risk a betrayal. And yet in that same conversation he also says he doesn't believe there is anything you would have been able to do to stop him.
If he believes his victory is 100% certain, and there's nothing the Nerevarine can do to stop him, then why is he so afraid of the possibility of being betrayed when he specifically says that won't work?
The answer: he isn't.
I believe that Dagoth Ur ultimately wanted the Nerevarine to oppose him, and win. Think about it. The Nerevarine was destined to unite the Great Houses, cause the Tribunal's downfall, and drive out the Imperials. That is exactly what Dagoth Ur wanted as well. The only difference was the paths you were both taking to get there.
The thing is, your path requires the existence of someone like Dagoth Ur in order to succeed. Without Dagoth Ur, the Tribunal is never weakened, and there's no threat for the Nerevarine to unite Morrowind against. If Voryn Dagoth didn't become Dagoth Ur, then as far as we know there is nothing that could have broken the Tribunal's power or brought justice for Nerevar. The Tribunal probably could have maintained the status quo indefinitely.
On the flip side, what does Dagoth Ur's path require from you? Nothing. All he needs is for you to do nothing. If there is no Nerevarine, then Dagoth Ur wins by default. However, as we all know, Dagoth Ur's victory would have turned Morrowind – and possibly the entire world – into a terrible place, where everyone is diseased, insane, or under his control. Nerevar and the "Good Daedra" would have no place in this world, and it would just be replacing the Tribunal's heresy with Dagoth's heresy.
I believe some part of Dagoth Ur recognized this. He recognized that a Morrowind united by the Nerevarine would be far more preferable and more in line with what both he and Nerevar originally wanted, and would have been far superior to one where everyone was enslaved or twisted into an abomination. The real reason he rejects your aid isn't because he fears betrayal; it's because he can't accept that the reincarnation of his best friend would willingly support something so awful.
So, he played the part of the villain. He weakened the Tribunal for you, ensuring that they couldn't steal your spotlight, and that you could actually face them on even footing. He created a threat dangerous enough that it actually gave the various factions of Morrowind enough pause to reconsider their loyalty to the Tribunal. Vivec himself realized the futility of the situation he was in, and offered to work with you.
All of Dagoth Ur's actions benefit you as much as they benefit him. Then when you finally confront him, he makes it clear that he will not accept your fealty, he will not take the Tools from you before he first defeats you in battle, but at the same time he won't actually fight you until you are ready.
In short, Dagoth Ur has done pretty much everything in his power to ensure you have no choice but to oppose him, but will still have a fighting chance.
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