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Geopolitical Analysis: Mirage or Watershed? The reasons for and geopolitical implications of Saudi Aramco’s possible IPO

 

The Saudi Announcement of a possible Aramco IPO was designed to test the waters and probably motivated by internal political considerations; but an actual IPO, even partial, could have a tremendous world-wide geopolitical impact.

 

Introduction

The unexpected has become the norm in the topsy-turvy Middle East that greets the new year. Saudi Aramco, the world’s largest company and financial guarantor of the Kingdom, seems to be heading towards an Initial Public Offering, or IPO.  Oil and gas market owners, stakeholders, and analysts are shocked by Saudi Deputy Crown Prince and Defense Minister Mohammed bin Salman’s latest announcement that the Kingdom is considering selling a stake in its its national oil reserves.

The Aramco IPO – what does it mean?

To be sure, Saudi Arabia is becoming adept at sending shock waves around the region and the world.   In these past weeks, we’ve witnessed the sudden re-emergence of the Saudi-Iran conflict sparked by the execution of the Shi’ite cleric Sheikh Nimr Al Nimr, followed by Saudi Arabia and Iran’s escalating responses to each other’s provocations.  Then came the announcement of a possible Aramco IPO.

After the initial shock of the announcement, caught the immediate attention of investors, we need to ask what exactly we should expect next.  If Aramco is truly going to the stock-market, the oil market will be witness to a redistribution of geopolitical and economic power with significant second and third order effects.

Saudi Transparency Rocks the Markets?

An Aramco IPO could be a watershed moment.  Until now, no Arab national oil company world (or OPEC) has been willing to give a clear view of their known and proven reserve estimates. Arab oil producers treat such data as a national security issue.  Confidentiality is the first casualty of an IPO.

Real numbers matter in the wake of the Saudi announcement on Aramco’s possible IPO.  Oil and gas markets are dependent on the reserve and production figures divulged by OPEC on a yearly basis.  We do not know how accurate these figures are. Reserve basins influence not just national economics, but also measure an oil producer’s geopolitical significance and strategic weight. 

Assuming that Aramco has not been providing accurate figures, a possible opening of Aramco’s reserve books could have one of two effects. Either reserves booked until now, on which the underlying structure (demand-supply) of the oil market is based, could be substantially lower than recorded.  The result:  Peak Oil analysts and OPEC critics will have a field day, but energy markets will be devastated. Or, the Aramco data on reserves may be proven accurate or too low. In this case, the Saudi figures would be projected onto other cartel member states, resulting in a higher than previous estimate of OPEC reserves.

Let’s be realistic: Saudi Arabia is unlikely to risk such scrutiny of its main national asset. Simultaneously, any reference to an opening up of the books will put all other OPEC countries on an anti-Saudi war-path.  Honesty is not always the best oil policy.  All OPEC countries, Venezuela and Iran included, will be threatened. Their reserves are currently not open; with data unilaterally decided by national governments and not by external consultants or international technical experts. If Aramco opens its books, the rest will under great pressure to do the same.  Immediately, Iran and Qatar will find themselves under the microscope, as both are suspected to have serious field and production issues, and assessments of Doha’s fields have been impeded due to a lack of reserve and field data.

What if Aramco’s IPO is only for its downstream joint ventures?

Some analysts have suggested that if Aramco continues with an IPO the main assets on offer will not be upstream assets but Aramco’s national and international oil and gas downstream projects.  Indeed, privately Aramco officials are indicating that this route might be preferable.  It also would mean that we will not see a real IPO of Aramco itself (the parent company) but of its vast range of joint ventures (JV). Investor interest would in this case be much lower than if the oil colossus itself would open up its oil fields for foreign investments and ownership, but appetite from investors is still expected to be extremely high.

Aramco JVs currently are processing worldwide more than 5.3 million bpd, of which Aramco owns 3.1 million bpd directly. The downstream offering would bring an enormous amount of liquidity to Saudi Arabia without giving up its national treasures.  Aramco’s current position on the global downstream market is fourth, behind Exxon, Shell and CPCC.

Investor prospects

Overall most investors will be very interested to have a share in the world’s largest integrated oil company, whether upstream or downstream. If Aramco CEO Khalid Al Falih’s plans to increase the company’s downstream capacity to 10 million bpd materialize (difficult but not impossible in this world of $30 oil), the attractiveness to investors would greatly increase. Aramco would in this case become the largest downstream producer, with the capacity to refine and supply all petroleum product demand to, for example, China.

A partial-IPO, resulting in a share sale of around 5%, which has been mooted, could generate enough liquidity to finance Al Falih’s plans.  We believe that a sale of shares, especially from the downstream side, would be the easiest means to generate the cash needed to make Falih’s dream a reality; especially since going to the market to borrow money to invest in oil is not realistic, Saudi oil is simply not generating revenues sufficient to support such an investment at this point in time.

Aramco’s current market value is unknown. Some American asset managers have indicated that the NOC could be worth 20 times the value of ExxonMobil, which is currently valued around US$400 billion.  So, at present prices, this could mean Aramco is worth between US$7-US$10 trillion. The main Aramco assets are its claimed hydrocarbon reserves of 261 billion barrels. To understand the enormity of that claim, note that ExxonMobil holds less than 14 billion barrels. The Saudi giant pumps more than the entire United States’ oil industry, including shale oil.  At the same time, Saudi Aramco also holds the very attractive advantage of being, along with Kuwait, the cheapest oil producer in the world.

Still, the market could be less receptive if the share sale was only of downstream assets. Saudi Aramco’s downstream assets are valued at around US$100-150 billion, much less than Exxon’s which stand at around US$313 billion. Note, a listing of downstream assets is not new for Aramco. In 2008, Aramco sold shares in the Rabigh Refinery JV to Sumitomo; and Aramco has talked several times of floating stakes in domestic JVs such as Satorp or Yasref.

When looking at an IPO, investors should first ask themselves where be the company will be listed. We believe it would be difficult for the Saudis to comply with the European or US transparency, anti-corruption and share-holder activist environment.  For this reason and also reasons of national pride, the only likely option for Aramco’s IPO will be on the Saudi bourse, which could lead to a drastic revaluation of the Saudi Stock Exchange (with a current market value of US$400 billion).

China’s interests

Investors and analysts should ask themselves what kind of international shareholders Saudi Aramco or Saudi Arabia are seeking.  The natural linkage between energy and geopolitics leads us to believe that Asian investors, especially China, will be in pole position.  China is showing a greater interest in the Middle East, as we’ve documented elsewhere, and an investment in Aramco would be irresistible.  This will serve to link China more to Saudi Arabia’s overall strategic development plans. With Chinese government-linked entities as shareholders, a geopolitical and economic link between China and the House of Saud would be forged that will shift the strategic balance in the Middle East for the foreseeable future.

Internal political factors

But let’s pause and look inwards, and ask what role internal Saudi politics may have played in the announcement.  It’s useful to ask: “Why is Aramco (Saudi Arabia) coming to the market with this proposal at the same time that it is under increasing international scrutiny with regard to its conflict with Iran, war with Yemen and involvement in Syria?"

Why did the Aramco statement come from the Deputy Crown Prince Mohammed bin Salman, who is also Defense Minister, the driving force behind the Saudi-led coalition in Yemen and support to anti-Assad forces in Syria? Bin Salman also is very vocal about his opposition to the P5+1 agreement. In a normal situation, an Aramco IPO would have been first made public by either Aramco’s CEO Al Falih or Saudi Minister of Petroleum Ali Al Naimi.

Deputy Crown Prince Mohammed bin Salman’s action makes more sense if it is actually designed to divert attention inside Saudi Arabia away from the geopolitical situation in which the kingdom finds itself.  It also clearly demonstrates his power as the key decision-maker in the kingdom. If this was his aim, the policy announcement succeeded.  It also served to address growing concern about the kingdom’s ability to weather the continuing long term low oil prices.

Moreover, noting that Saudi Aramco is still very liquid, the need for an IPO is not pressing, so is this just all hot air? As one analyst stated “Either the Aramco IPO will be the biggest IPO ever or it will be a mirage!”

Saudi futures

The future of the House of Saud is intertwined with the future of Aramco and its subsidiaries.  Whatever the kingdom decides to do with Aramco, the world’s largest company, will affect Saudi Arabia’s geopolitical relations and also the international strategic balance.  Chances are this will aid the rise of China and help cement its steadily growing foothold in the Middle East.

Alternative Reality - Saudi expansion?

We also wonder why Saudi Arabia is not, instead, considering a take-over or acquisition of an IOC, such as Shell, BP or ENI. Current market conditions are conducive for such as move, and it would help to satiate the Kingdom’s intent to increase its market share. IOCs are currently very vulnerable, due to the falling oil and gas prices, lack of long-term reserves, share-price declines, and a domestic EU-US environment in which investors are becoming generally warier of long term investment in oil and gas companies.  Aramco could acquire an IOC at a very attractive price.  Perhaps most attractive would be an acquisition of a European IOC. This would remove many of the constraints holding back increased Saudi involvement in the EU, as Aramco would control European assets, a retail network and vast refining base. Such an acquisition would be in accord with Aramco’s internationalization aims, and also in line with those of some its GCC neighbor companies (especially Qatar Petroleum and the UAE’s ADNOC).  If agreement could be reached between the Kingdom and an EU energy company, a purchase would not only guarantee additional downstream sales, but also bring leverage for Saudi Arabia in its dealings with European governments.

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