With Saudi Arabia poised to open a portion of state-owned national oil company Saudi Aramco to outside investors in an effort to diversify its economy, the current state of the initial public offering raises more questions than answers. Critics inside the Kingdom, the timing and valuation of the IPO, where shares will be listed, and the impact of transparency efforts highlight some of the major uncertainties surrounding the initiative.
Key among these concerns is how an IPO will affect oil prices and Saudi Arabia’s relationship with the OPEC cartel. Speakers on a panel at the Atlantic Council in Washington, DC this week disagreed on the ultimate market impact of Saudi Arabia opening up a portion of Aramco to outside investors.
Phillip Cornell, a nonresident fellow at the Atlantic Council’s Global Energy Center, said that the Saudis, after the IPO, will return to a strategy of pumping all out in order to satisfy shareholders. He argued that even though production decisions will still reside with the government, pressure from investors will push officials to shoot for maximizing output. Saudi Energy Minister Khalid Al-Falih, previously the Aramco CEO, supported the market share strategy in 2014-15 as prices fell, and he will likely give approval to a return to that approach after an IPO.
“The reality of shifting to a new revenue stream that’s based on dividends means that the country will move to a production strategy that is based on pumping full out.”
“The reality of shifting to a new revenue stream that’s based on dividends means that the country will move to a production strategy that is based on pumping full out,” Cornell said. “Over the long run, that will put downward pressure on oil prices. It has been made clear that the production decisions will still lie with the government, but there will be pressure on moving to a profit-maximizing model. That would mean not holding back and would put pressure on an OPEC deal continuing beyond an IPO.”
The other two panelists disagreed, reflecting the lack of consensus and overall uncertainty surrounding the direction of oil markets later this decade and in the early 2020s. Jean-Francois Seznec, also a nonresident fellow at the Atlantic Council, said that the management of Aramco may in fact side with holding back supply in order to support prices, similar to what the Kingdom and OPEC are doing now. Pointing out that petroleum is still an inelastic commodity (since it has a monopoly in the transportation and petchem sectors), Seznec highlighted that OPEC’s five percent production cut in 1998 brought about a 40 percent increase in prices. Market dynamics have changed since then because of shale, but it’s not clear if fundamentals have been altered enough to make output cuts completely ineffective.
Strategic investors will ultimately want a policy that brings about the highest returns possible over the long run. “I don’t think we’ll see a significant change in how Saudi Arabia makes oil policy.”
Ayham Kamel, the director of Middle East and North Africa at the Eurasia Group, stressed that Saudi officials will still dominate production decisions and policy won’t change. However, decisions post-IPO will largely depend on Russia’s role in production cuts, how flexible U.S. shale is beyond 2019, and where the oil price is. Kamel argued that the “spirit of conversation” of the Aramco board will guide the relationship with OPEC and the Saudis’ output strategy, which will be based on long-term economic motives. Strategic investors will ultimately want a policy that brings about the highest returns possible over the long run. “I don’t think we’ll see a significant change in how Saudi Arabia makes oil policy,” said Kamel.
While the panelists were split over production policy, they expressed confidence that the IPO will indeed go ahead despite internal disputes and logistical difficulties. A lot of political capital has been spent on “Vision 2030” and relatively young, Western-educated Saudis close to Deputy Crown Prince Muhammed Bin Salman, along with civil servants and technocrats, are determined to move forward despite inherent risks. Panelists were clear that the IPO opening is solely about economic diversification and transparency rather than a statement on the durability of oil for the longer term and the outlook for demand growth. Civil servants inside the Kingdom have for decades called for weaning the country off of its economic dependence on just oil revenues.
Even though the low oil price over the last several years has hurt the Saudi economy, Seznec argued that it has been “a blessing.” Without the crash in the oil markets, the Kingdom wouldn’t be taking necessary economic reforms.
Despite the expected reforms should the IPO go forward, Aramco will be only 5 percent publicly owned, prompting questions about how much transparency the IPO will bring to the company and the royal family.
It’s important to note that despite the expected reforms should the IPO go forward, Aramco will be only 5 percent publicly owned, prompting questions about how much transparency the IPO will bring to the company and the royal family. There hasn’t been any guidance on who will control the other 95 percent. If it is run by the Saudi royal family, expected increases in transparency may be limited. “Who gets what and when? That is a key question,” said Seznec. “Once you’ve sold 5 percent, that leaves 95 percent. Who owns that? That hasn’t been clarified. Will it be the public investment funds? Will it be the Ministry of Finance? Will a portion go to the Royal family?” The answers to these questions will go a long way in determining the likelihood of increased transparency.