Saudi Arabia pushes ahead with IPO

The state firm is making the right noises about its privatisation, but the clock is ticking and market fundamentals could still shift

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Lower oil prices have exposed Saudi Arabia's Achilles' heel and, as global environmental legislation tightens, the kingdom must deal with the problem. The 84-page Vision 2030 is designed to do just this, breaking the country's addiction to oil (and especially oil revenue). The part privatisation of Aramco, as anyone who follows global energy now knows, is part of the effort.

A firm that currently provides 90% of government revenue, hope Riyadh's strategists, will evolve into an energy and industrial conglomerate operating under the umbrella of the Public Investment Fund (PIF), generating wealth indefinitely. Aramco will follow the right path in an age-old fork in the road-change, or be changed.

Much remains to be done, especially considering the speedy schedule. It was only in January 2016 that Saudi's deputy crown prince Mohammed bin Salman, the architect of plans to enhance Riyadh's influence beyond oil diplomacy, announced plans for an initial public offering of 5% of Aramco. He wants the flotation complete in the second half of 2018. The clock ticks.

The IPO marks the biggest shift in Aramco's history since 1980, when the Saudi government paid its partners $1.5bn for their 40% holding in the firm, leaving it fully nationalised. The changing dynamic was marked last year too, when Ali al-Naimi, 21 years in the job of oil minister, handed the ministry's reins to Aramco's chairman, Khalid al-Falih.

As it readies itself for the sale, Aramco and Saudi Arabia are having to relearn some international norms. The firm is shedding some secrecy surrounding the true size of its oil and gas reserves—an essential requirement if it aims to raise up to $100bn from the IPO. The cash injection would come as the kingdom rolls out unprecedented energy-subsidy cuts in the face of a $53bn deficit for 2017. It's impossible not to see the IPO plan as part of the broader thrust to transform an economy that has become all too accustomed to old rentier methods of doing business.

Aramco is considering listing on up to three exchanges. Riyadh's Tawadul is likely, and London, New York, Tokyo and Hong Kong are also in the running. It is making efforts to open the books in response to valid criticism from global investors. Aramco will disclose its 2017 annual statements before the listing, while results of the first independent audit of its oil assets earlier this year were in line with internal estimates of 265bn barrels. That added to the company's sheen as a highly efficient group—not a reputation it shares with many other national oil firms—will shave time as it prepares for Wall Street's scrutiny.

Some investors herald the IPO as a new chapter of financial acumen that could trigger opportunities in other state-owned entities in the Gulf. Others fret that a dangerous precedent could be set if an excitable financial market agrees to move ahead without full transparency. Some doubters see an elaborate PR ruse.

Financial relief

But among the rush of bankers seeking a slice of the IPO business, the consensus is that Riyadh's course is set, even if the timing might depend on the oil price. If the market takes the kind of bearish turn seen in January 2016, when Brent futures dropped to a 12-year low, a sale would bring instant financial relief, encouraging Aramco to stick with the 2018 timetable. But that presupposes a derailing of the Opec-non-Opec agreement struck late last year: there's little sign of that happening, yet, and Aramco has a great deal of sway over the deal's success.

In fact, to shore up the deal, Falih has said that Saudi Arabia could cut even more than it signed up to in November. This is no idle threat, given the wealth of supply at its disposal should Riyadh think the Opec agreement is unravelling. Aramco's output peaked at 10.67m barrels a day last July, with the International Energy Agency (IEA) estimating that the company could easily and quickly pump 11m b/d if necessary. Mohammed bin Salman cites capacity of 20m b/d as a realistic long-term goal.

But what if a much firmer rally grips the market before the scheduled 2018 IPO?

The rising oil price would, in theory at least, increase Aramco's valuation. But by generating more oil-export income for the kingdom it could also sap some of the government's enthusiasm to carry out unpopular reforms, such as those to energy subsidies. And the urgency to sell off some family silver would be less acute too.

Educated guestimates

Many believe the 2018 IPO has been a motivator for Saudi Arabia's re-intervention in oil markets—support for Brent would garner more interest in the sale. But if the IPO is interpreted just as a method to recoup money lost by falling oil income, would a new rally kill off the idea?

Even without a sharp recovery (or another fall) in the oil price, valuing the 5% stake is difficult. The $100bn guestimate most commonly cited would make the value of the IPO four times bigger than the $25bn record held by Chinese internet retailer Alibaba's 2014 IPO.

But this view of the Aramco stake depends on Mohammed bin Salman's and some analysts' $2 trillion estimate of market capitalisation of the whole company. Qamar Energy, a UAE consultancy, reckons the value of the 5% up for grabs could slide to around $20bn once a 20% royalty and 85% tax rate are deducted. Aramco's chief executive, Amin Nasser, reassured investors in mid-January that tax will be adjusted to make the deal more attractive. But details are still thin.

Investors will also have to account for Aramco's new growth plans and his ability to steer the firm through choppy politics. Nasser wants to double Aramco's refining capacity, including its stake in foreign operations, to 10m b/d. Aramco's presence in the US through its Motiva joint venture with Shell, established in 1988, should help the company navigate President Trump's "America First" policy and even play on his pro-oil stance to expand the Saudi firm's downstream and distribution in the country. Plans to dissolve Motiva mean Aramco would have full control of the 0.6m-b/d refinery at Port Arthur, Texas, the US' large such facility.

For Aramco, the greater gains are to be had to the east anyway. In Asia, the Saudi firm must safeguard its coveted client list against intensifying competition. The company exports 65% of its oil and a third of its refined products to the continent. The US, able to ship its oil and gas through the recently widened Panama Canal, will only add to the competition—especially while Aramco and other Opec producers limit their output. Russia last year nudged Aramco aside to emerge as China's biggest crude oil supplier, selling it 1.05m b/d (compared with Aramco's 1.02m b/d). Exports to China from Iran, Riyadh's primary rival in the Middle East, climbed by 18% to a record high of 0.63m b/d in 2016.

Closer to home, Aramco ramped up production capacity at the Shaybah oilfield last May by 250,000 b/d to 1m b/d with plans to lift production capacity at Khurais by 300,000 b/d to 1.5m b/d next year. Another 250,000 b/d of capacity could be unlocked relatively quickly in the Neutral Zone that Saudi shares equally with Kuwait, if the political spat stretching back to October 2014 is resolved.

By national-oil firm standards, Aramco's execution of upstream oil projects is exemplary. But Aramco's gas development plans have lagged—a strategic frailty considering Saudi policy does not allow gas imports.

As gas accounts for only half the kingdom's power generation, the rest is met through domestic oil supply, soaking up 1m b/d or so that could otherwise be exported. Aramco's plan to double total production capacity for natural gas, from 12 billion cubic feet a day over the next decade, would help fix this—and reward investors interested primarily in Aramco's ability to sustain oil exports, regardless of rising local power-generation needs.

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