Aramco’s IPO and Investors’ Discontent

“First you say you do, and then you don’t, and then you say you will, and then you won’t, … Now you want to play.” This Ella Fitzgerald golden oldie best describes Saudi/Aramco policy now that Crown Prince Mohammed bin Salman, MBS to friends and columnists short of space, announced early this summer, “We are committed to the initial public offering [IPO] of Saudi Aramco … I expect that it will happen between 2020 and beginning of 2021.” Earlier plans were postponed when it was discovered that the company had never kept proper books; their publication might have revealed just how much the royal family had skimmed off the oil giant’s revenues before sharing them with its subjects. After years of getting Aramco’s books in shape MBS “wants to play,” as Ella put it in “Undecided”, and has retained respected auditors to attest to its oil reserve estimates and to prepare a more orthodox set of books.

The importance of this public sale of some of the company’s shares extends beyond the sheer size of the state-owned company, which is impressive. Its net income in the first half of this year was $46.9 billion, just short of ten times that of Exxon Mobil, the largest publicly traded oil company and well above that of Apple, with $31.5 billion in earnings the world’s second-most profitable publicly traded company. The proceeds of the share issue will be used, so MBS says, to fund his “Vision 2030”, a plan to wean the Kingdom off its heavy dependence on oil and gas, which account for about 50% of its GDP and 70% of its export earnings.

Perhaps most important of all to the world’s economies is the Kingdom’s control not only of the 297.7 billion barrels of proved reserves it sits astride, but its influence over its OPEC partners and the cartel’s fellow traveler, Russia, which together account for 77.9% of world oil reserves and 53.6% of world oil production. By comparison, the US accounts for 3.6% and 16.6% of global reserves and production, respectively. Equally important, the US government’s Energy Information Administration (EIA) reports that OPEC production plans “can produce strong reactions in oil prices.” Saudi energy minister Khalid al Falih says independent auditors put the cost of producing his country’s oil at $4 per barrel, the lowest in the world.

Because America exports more oil than it imports, President Trump claims the US is now “energy independent”. But the large market share of Saudi Arabia and its partners, and its low production cost give it substantial power over prices, making the US far from “independent”. In moments of inadvertent candor, when gasoline prices are on the upswing, Trump boasts that he “called up OPEC, I said you’ve got to bring them down.” (They didn’t.) How America can be completely independent of foreign suppliers who can “produce strong reactions in oil prices” remains unexplained.

That is not to say that the technological revolution dubbed “fracking” is irrelevant. It has enabled American oil companies to step up production quickly and massively to record levels, according to the EIA, perhaps ending the days of $100 oil, constraining but not eliminating OPEC’s once-unrivalled power.

In short, OPEC cannot completely shield Aramco from price volatility. Profits and share prices will not be the same when oil sells for less than $30, as is did early in 2016, or when a barrel fetches $54, as it does now after a recent drop, and hits the $74 level that prevailed less than a year ago. Nor will they be unaffected when OPEC lowers its forecasts of expected demand as it has recently done.

Sheard, Paul Even more important for long-term investors is the prospect for oil in the age of environmental activism, with politicians and major shareholders calling for the end of the era of fossil fuels. A call ignored by outrider Exxon Mobil, which increased capital spending by 10% to increase oil production “while our competitors are leaning back. You do it when everybody else is at home” says CEO Darrren Woods. If Mr. Woods is right, and oil has a brighter future than the greens would have us believe, Aramco shares might be under-valued by the market when they become available, and prove a winner for investors who add them to their portfolios.

It is even more difficult to predict the future political environment in which Aramco will be operating. It is one thing to possess some 300 billion barrels of (heavy, high-cost) oil, and quite another to profit from that asset. As Venezuela has shown, mismanagement and poor maintenance of oil fields, and contempt for the rule of law can impoverish a nation blessed with massive oil reserves. Like Venezuela’s Nicolás Maduro, Saudi Arabia’s rulers consider the rule of law an inapplicable foreign construct. Investors might take Venezuela’s experience as a warning as MBS trolls the world for capital. They are aware of the regime’s imprisonment of women’s rights activists without charges or trial, and will recall the sojourn of leading Saudi businessmen in the Riyadh Ritz-Carlton while they re-examined earlier estimates of their obligations to MBS’s treasury. And Khashoggi.

Investors will have to weigh at least four additional risks. Some Saudi oil facilities are within reach of Yemen’s Iran-allied Houthi rebels, who earlier this month used ten drones to set fire to an Aramco gas processing plant in the Shaybah field, about 600 miles from the Houthi controlled parts of Yemen. “More and wider attacks” are promised by Houthi army spokesman Yahya Sarea.

Second, the country’s reserves might pass into hands of domestic or foreign opponents who do not view confiscation an inappropriate response to the royal family’s years of plundering the nation’s oil reserves to finance yachts, works of art, palaces, and other necessities of the royal lifestyle. And who might open the valves to generate much-needed cash.

Third, should the Saudis make another mistake on the order of the murder of Khashoggi, crucial American support for MBS & Co., including the military hardware the Kingdom needs if it is to hold off Iran, would be further eroded. Finally, should MBS’s grandiose projects threaten the financial stability of the Kingdom or Aramco, investors might take a dim view of the oil giant’s value.

Impossible? The late Jamal Khashoggi warned on Al Jazeera on March 24, 2018 that MBS’s planned futuristic city, Neom, “could bankrupt the country.” Seven months later he was dead.