The Fuse

Saudi Aramco IPO Encounters Resistance From Domestic Critics

by Pi Praveen and Paul Ruiz | March 03, 2017

Saudi Arabia’s recent overtures that it will list Aramco, the state-owned national oil company (NOC), in an initial public offering (IPO) is facing domestic criticism as the country embarks on a heated debate over the future of its immense oil reserves. In a Reuters article published last week, Saudi sources expressed discontent over the proposed plan by Deputy Crown Prince Mohammed bin Salman (MbS) to offer a reported five percent stake in Saudi Aramco, the world’s most valuable company.

Sources in Saudi Arabia say listing the oil giant on global investment markets undermines issues of equity for individual Saudi investors and fairness in a country that views its immense oil reserves as the birthright of its citizens.

Sources in Saudi Arabia’s public and business communities say listing the oil giant on global investment markets undermines issues of equity for individual Saudi investors and fairness in a country that views its immense oil reserves as the birthright of its citizens. Plans to open up the Kingdom to outside investors will continue to cause fissures within the country, and may also bring about tensions within the OPEC cartel.

Valuation and timing 

Saudi Arabia anticipates the opening of Aramco to be unprecedented by modern standards. In comments delivered early last year, MbS initially suggested the company could be worth as much as $2 trillion, far exceeding the initial market capitalization of any publicly listed company. This estimate is based on the value of its immense reserves. Independent audits suggest the country has 267 billion barrels of oil, most of which can be profitably extracted for $8 per barrel. These reserves include the massive onshore Ghawar oilfield, which can produce oil at $4 per barrel. U.S. production in shale oil basins, by comparison, are currently producing in a band between $30 and $100 per barrel, giving Aramco enormous leverage in the global oil market.

The initial estimate from MbS is, however, overstated. Applying these back-of-the-napkin calculations, for instance, Russia’s Rosneft would be worth $272 billion rather than $64 billion. Challenges to valuing Aramco are compounded by the government’s high royalty and income tax rates, which limit potential cash flow and make the company a less attractive investment at current rates.

For now, Saudi Arabia is relying on its massive stash of funds to withstand current account deficits brought on by high government spending and relatively low oil prices.

In the short run, the question is about timing. Possible decelerating non-OECD oil demand growth and already high commercial inventories are leading the EIA to suggest 2017 year-end prices of $55 per barrel. This price level reflects the market rebalancing at a slow pace. For its part, the Saudi government appears to have set a $60 per barrel target price for year-end 2017, according to a Reuters exclusive citing unnamed Gulf sources. However, early last year, Aramco Chairman Khalid al-Falih suggested the IPO could go ahead at $30 per barrel. If we do it, it “is not for cash,” al-Falih said, but a “sign of the times” that the kingdom is open for business.

Matthew Reed, Vice President of Foreign Reports, Inc., says “[Saudi] officials won’t really know Aramco’s value for sure until banks are brought in to underwrite the offering. They’re the ones who will decide how many shares can be sold at what price. If the total value falls short of early estimates, the Saudis would be wise to delay and reconsider their options. Why rush?” Reports suggest that Saudi officials may push the offering from 2018 to 2019.

For now, Saudi Arabia is relying on its massive stash of funds to withstand current account deficits brought on by high government spending and relatively low oil prices. In January, the country’s foreign exchange reserves reportedly fell approximately $12 billion month-on-month, despite prices that have risen roughly 19 percent since OPEC’s agreed cuts in late November.

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Saudi Arabia’s rationale for the IPO is premised in part on sustained high oil prices over the long-term. Although the IEA predicts prices reaching $79 to $82 per barrel in 2020 and $124 to $146 per barrel in 2040, the agency acknowledges that breakthrough oil-displacing technologies, such as electric and autonomous vehicles, could substantially reduce global demand. In such a scenario, the value of Aramco’s assets could steeply decline over the next several decades, a situation that the Saudis are keenly aware of. Mohammed al-Sabban, who served as the chief economic adviser to Saudi Oil Minister Ali Naimi, said peak oil demand would be “very serious” for the country. “We cannot stay put and say ‘well, this is something that will happen anyway…[The] world cannot wait for us before we are forced to adapt to the reality of lower and lower oil revenues,” he said.

Unrest and division

The Aramco IPO forms the crux of the “Vision 2030” strategy, which aims to restructure Saudi Arabia’s economy and expand investment in non-oil technologies.

The Aramco IPO forms the crux of MbS’ “Vision 2030” strategy, which aims to restructure Saudi Arabia’s economy and expand investment in non-oil technologies. The plan could help insulate the oil-dependent nation’s economy against low and volatile oil prices, but listing an Aramco IPO also intensifies the specter of domestic and regional conflict as the government implements its ambitious economic development plan. Many sources within the Kingdom are expressing misgivings about the IPO, which they see as handing the Kingdom’s assets away at a discount. Moreover, Saudi elites and citizens, most of whom receive generous subsidies, depend on government-sponsored employment. In 2015, Saudi Arabia dedicated nearly $50 billion to pre-tax consumer fuel subsidies, the highest share in the world.

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In a country where civil discourse and debate about the al-Saud family’s ruling strategy is rare, the pushback against the IPO could set off ripple effects in Saudi Arabia’s generally stable internal political and socioeconomic climate. The government is taking on the questions of shared quotas for citizens and foreign ownership over hydrocarbons assets and operations, two key factors that will shape the public’s shifting views of the IPO. MbS has also revealed that Saudi Arabia has formulated a formal strategy in the event of public opposition from clerics that could galvanize certain segments of the public toward protests or violence.

In a November 2016 report, Securing America’s Future Energy (SAFE) examined the prospects for intra-state and intra-regional conflict under conditions of discontent with the al-Saud regime’s policies. Islamic clerics, including the royally sanctioned Grand Mufti Abdul Aziz Al Sheikh, are often known to propagandize differences between the religious minority Shi’a Muslim populations and the ruling Sunni class to refocus the public’s animosity away from the regime. The Saudi Shi’a population is sometimes viewed as a proxy for the Iranian regime, which many clerics blame both for domestic and regional strife.

Saudis may also express their anger directly at the regime by organizing an uprising, especially when 81-year old King Salman bin Abdulaziz Al Saud dies. MbS, who has advanced Vision 2030 as his ambitious plan for the Kingdom, could challenge his older cousin Crown Prince Mohammed bin Nayef. In such a scenario, Vision 2030 may expose further rifts in an already fractured royal family that could lead to broader instability in Saudi Arabia.

Vision 2030 and OPEC

An Aramco opening would force the Saudi king to be beholden to a fiduciary responsibility to shareholders.

Vision 2030 also imperils Saudi Arabia’s role at OPEC’s helm. An Aramco opening would force the Saudi king to be beholden to a fiduciary responsibility to shareholders. But OPEC’s clout in the global oil market is predicated upon Saudi Arabia’s leadership and spare capacity. Energy Minister al-Falih has said that Saudi Arabia will not allow the IPO to sway its position on spare capacity and size of its reserves, nor weaken its authority over capacity and production decisions. Shareholders, concerned with profitmaking and not Aramco’s ties to domestic and international policymaking, may not accept such a trade-off: Even if their status as minority shareholders dilutes their power to dictate terms, they may still mount legal challenges against Aramco’s role in OPEC.

Aramco already retains a competitive advantage over U.S. producers whose average breakeven costs are substantially higher. Collusion with foreign governments could interfere with markets—or worse, expose the company to legal challenges over the suppression of trade in the United States.  Smaller OPEC members dependent on healthy oil prices, not to mention skeptics within Saudi Arabia, will be reluctant to give up the power to manage the market through manipulating supply levels, especially after having suffered during 2014 to 2016’s slump in prices.

Although Vision 2030 has been widely touted since its April 2016 reveal, the Saudis have barely acted upon it despite their desire to reform many times over the years.

Although Vision 2030 has been widely touted since its April 2016 reveal, the Saudis have barely acted upon it despite their desire to reform many times over the years. Even with the current plan’s veneer of potential, the recent rumblings of opposition within the nation and the plan’s implications for Saudi Arabia and OPEC’s futures show that its ultimate implementation has many challenges yet to overcome.

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