The Fuse

Key Questions Surrounding a Possible Saudi Aramco IPO

by Matt Piotrowski | January 12, 2016

Saudi Arabia took the oil world by storm last week when Muhammad bin Salman, the Kingdom’s deputy crown prince and the country’s defense minister, told The Economist in an interview that the Kingdom was considering selling shares in state-owned Saudi Aramco, which owns some 260 billion barrels in crude reserves and is the most valuable company in the world. “This is something that is being reviewed, and we believe a decision will be made over the next few months. Personally I’m enthusiastic about this step,” he told The Economist. “I believe it is in the interest of the Saudi market, and it is in the interest of Aramco, and it is for the interest of more transparency, and to counter corruption, if any, that may be circling around Aramco.”

The news a possible Saudi Aramco IPO has sparked a wave of anticipation in the financial and oil market worlds for obvious reasons, given the company’s gigantic size and high value, but there is also a host of questions surrounding any opening of assets to investors.

Aramco followed suit with its own statement, confirming that it is indeed mulling an initial public offering (IPO): “Saudi Aramco confirms that it has been studying various options to allow broad public participation in its equity through the listing in the capital markets of an appropriate percentage of the Company’s shares and/or the listing of a bundle of its downstream subsidiaries.”

It continued: “Once the study of these various options is complete, the findings will be presented to the Company’s Board of Directors which will make its recommendations to the Saudi Aramco Supreme Council. This proposal is consistent with the broad and progressive direction pursued by the Kingdom for reforms, including privatization in various sectors of the Saudi economy and deregulation of markets, which the Company strongly supports.”

The news a possible Saudi Aramco IPO has sparked a wave of anticipation in the financial and oil market worlds for obvious reasons, given the company’s gigantic size and high value. But there is also a host of questions surrounding any opening of assets to investors, since Aramco decisions are highly political and the company is run by an opaque regime.

How much of Aramco would be investor-owned?

It’s clear that everything is on the table, but the most probable assets to be opened to investors would include parts of its refining ventures, since downstream assets are easier to value, hold less geopolitical risk, and are geographically diverse.

The Saudis will take public what is economically and politically viable, and so far, no exact figures or timeline have been given. Reuters reported over the weekend that Aramco would only list shares of its downstream units, with a holding company being the most likely. But Khalid al-Falih, chairman of the Saudi Arabian Oil Co., told The Wall Street Journal that the company is considering upstream assets. It’s clear that everything is on the table, but the most probable assets to be opened to investors would include parts of its refining ventures, since downstream assets are easier to value, hold less geopolitical risk, and are geographically diverse. The Kingdom, for instance, holds downstream joint ventures inside Saudi Arabia, the United States, South Korea, Japan, and China. Opening the upstream sector, while not implausible, would be much harder to execute given the political importance of oil assets to the Kingdom. Aramco would likely open only a small percentage of its downstream and petrochemical assets to investors, in order to keep them from having any veto power in decision-making.

What’s the value of the company?

Aramco is difficult to value, given its large size, the lack of transparency regarding reserves, and political risks inside the Kingdom and in the Middle East in general. Analysts have put the entire value of the company as high as $10 trillion, but without upstream assets, the number is reduced considerably—but still huge.

The company is difficult to value, given its large size, the lack of transparency regarding reserves, and political risks inside the Kingdom and in the Middle East in general. Analysts have put the entire value of the company as high as $10 trillion, but without upstream assets, the number is reduced considerably—but still huge. One investment banker told the FT that without the country’s natural resources included, the value would be around $500 billion. Aramco currently owns 4 mbd of refining capacity, and has plans to more than double its downstream volumes, with the growth coming in Asia and the Middle East. One industry veteran told The Fuse that for the best comparable price to earnings (P/E) ratio (although it is an imperfect comparison) for a company with only downstream asssets, one could look at U.S. independent refiner Valero, which owns almost 3 mbd of refining capacity in North America, the UK and the Caribbean and exports refined products to markets in South America and Europe. Valero’s P/E ratio in 2015 fluctuated between 6 and 8 and is estimated to be just under 9 for 2016. In contrast, Exxon Mobil currently has a P/E ratio of 15. 7 right now, and should average 21 in 2016. If Aramco opened some upstream assets to investors, Exxon would be the most comparable in this respect, even though Aramco owns roughly 12 times the oil and gas reserves as the U.S. major. Exxon and other international oil companies (IOCs), however, would be more attractive to investors that want exposure to the industry and the oil price because IOCs have more diverse portfolios and offer less geopolitical risk.

Why is the Kingdom considering opening assets to foreign investors?

“The privatization of Saudi Aramco and its subsidiaries will, if implemented, help the kingdom join the group of modern countries that have proper governance.”

There are likely multiple reasons Saudi Arabia is mulling an IPO. Some may see it as an act of desperation to raise cash, with the low oil price causing the country to go into debt. The International Monetary Fund (IMF) sees the country running a budget deficit of almost 20 percent this year and running out of financial assets within five years. Besides low oil prices, spending heavily on social programs, generous energy subsidies (which it is trying to rein in), efforts to diversify the economy, and its military operations, particularly current airstrikes in Yemen, have caused the deficit to balloon. The Kingdom has issued debt and can tap foreign reserves, but it’s clear these measures won’t be enough. Inviting new investors is one way of raising cash to help offset rising debt levels. While that may be part of its motivation, there are other key reasons. For one, it would allow Aramco to diversify risk as it moves forward with its lofty ambitions of doubling its refining capacity. More importantly, the Saudis are trying to become more open and transparent as part of its transition from an emerging market to a mature economy. Opening up to investors would be a major signal that the Saudis are serious about advancing the country’s capital markets and financial institutions. “The privatization of Saudi Aramco and its subsidiaries will, if implemented, help the kingdom join the group of modern countries that have proper governance,” wrote Middle East scholar Jean-François Seznec on the Atlantic Council’s blog. “Increased transparency in the ownership of the largest company in the kingdom, as well as new forms of funding the state, will push the country away from its dependence on oil revenues towards a modern economy more comparable to the G20 countries to which the kingdom belongs.”

What would such action mean for OPEC and the oil markets?

The main reason Saudi Arabia will probably balk at opening upstream operations to foreign investors is because data on reserves are state secrets.

The improved transparency will likely only go so far. The main reason Saudi Arabia will probably balk at opening upstream operations to foreign investors is because data on reserves are state secrets, and Aramco essentially carries out the policy of the government. As a result, the Kingdom’s oil policy would not likely change, particularly if Aramco sold only part of its downstream operations. If Aramco were an investor-owned company, there would be too many competing interests. Investors would be skeptical as to whether decisions the company made were in the interest of shareholders or Saudi government policy.

 

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