ARAMCO: The awakening of a sleeping giant

This year crude oil markets are going through a turbulent process. Nobody seems to be willing to reduce their market share, no matter how low prices get nor how many supports are broken in the charts. In addition, a slow-growing and relatively flat global demand (around 96m barrels per day) is being outgrown by an oversupplied market. For years now there has been an increasing investment in new productive capacity, which meant non-OPEC production has risen between 2-3 mbpd above demand growth. The new fracking techniques carried out in the US resulted in a huge decrease in American oil imports which has come to produce even more than Saudi Arabia by the beginning of 2016. In turn, OPEC surplus capacity rose from 2.6% in 2011 to 6.3% in 2015. Although global economy keeps growing (2.5% GDP), the energy mix is gradually changing and the energy efficiency is growing, meaning less energy is required throughout the value chain. As energy efficiency continues to improve, less will be needed to produce more.

The “Peak Oil theory” from the 90’s has been discredited by several analysts and sector experts, especially right after the “discovery” all over the world of shale oil and gas reserves. Even the former U.S. President Jimmy Carter (1978) said in a TV speech that the world was running out of oil. Years later, global oil output increased by more than 35% and known reserves are way higher than they were back then. What now keeps oil producers awake at night is precisely the possibility of an “Oil Demand Peak”. According to The Telegraph in this article (http://www.telegraph.co.uk/business/2016/06/06/oil-demand-to-peak-in-2030-as-energy-experts-slash-forecasts/) , forecasts and research from consulting firm McKinsey point towards a possible peak of 100 million barrels a day around 2030. This is very subjective nevertheless, as many unexpected things can draw a new pattern in the markets from here on out.

After the failed attempt last April 17th (Doha) to reach an agreement in terms of freezing or setting a limit to global oil production (mainly due to a disagreement between Iran, that did not assist, and Saudi Arabia), OPEC and Russia will try again to strike a deal in Algiers soon. Nevertheless, a lot has happened since then, and a success now will not mean as much as it would have meant couple months ago. Oil has rallied since its 30$ low few months ago (now being around the 50$ Brent conversion), and now producers start seeing the silver lining again. Thus, more oil is being pumped since then, ergo the effects of an agreement would be less effective. That being said, many analysts believe major producers are reaching their maximum output levels, so a freeze would not suppose a great sacrifice to them (Iran restored most of the crude output from pre-sanction levels). It is assured though, that Iran will participate in the talks this time, said Iranian Oil Minister Bijan Namdar Zanganeh (Wsj.com). The negative output situations of Nigeria and Venezuela might also be a setback to meet an agreement.

Aramco might be one of the early movers

In this scenario, a behemoth of the oil industry is preparing an unprecedented move. Saudi Aramco (ARAMCO) is preparing a likely IPO by 2017-18. This information was disclosed in January early this year by Deputy Crown Prince Muhammad bin Salman, in an interview with Al Arabiya News Channel.

But how big is Saudi Aramco to begin with? The state-owned enterprise produces more oil than any other company in the world and manages all of the reserves of Saudi Arabia (top 1 crude oil exporter in the world). We are talking about more than 310 billion barrels, as you can see in the chart below. Though pumping oil from the ground and selling it to market is their main activity, they also develop tasks concerning crude oil exploration, refine crude into oil products such as gasoline and chemicals, and acts as an independent petroleum trader buying and selling other companies’ crude.

Several analyses have valued the enterprise between 2 to 3 trillion$ (taking into account its oil reserves of 260 billion barrels at a conservative valuation of 10$/barrel, 10 times those of Exxon Mobil Corp.). This is currently under hot debate, as the estimations are not exactly accurate and there are many defending a lower or higher valuation amount. For instance, Mohamad al-Sabban (an independent oil analyst and former senior adviser to the Saudi oil ministry) gives ARAMCO’s value an estimate of 10 trillion$ dollars.

To make ourselves a clearer idea, it would be interesting to analyze the case of Sadara Chemical Co. complex in the city of Jubail. This petrochemicals project will be fully operative in 2017, and it has been built in partnership with Dow Chemical Co. It is due for an IPO this year, that some say would debut at a value of around 20 billion dollars. We can also take a look at SATORP massive refinery project with TOTAL at Jubail.

Another “precedent” to compare to, is that of one of its domestic downstream facilities, PetroRabigh (refining and petrochemical company). It held an initial public offering of a 25% of its shares in 2008. The complex is co-owned between Saudi Aramco and Sumitomo Chemical Co. (JAP), each holding a 37.5% share. Hence, as it can be seen, Aramco is not new to the business.

The public offering would be compounded of a 5% of the total value, not determined if shares in Aramco and/or some downstream assets. A partial privatization of a 5% of its total value would mean a listing of around 100-150 billion $. This would dwarf all previous massive IPO’s we can remember.

One problem for data accuracy is the lack of transparency, as specific internal economic details of the company are kept secret to investors. Saudi Arabia never published an audit of the actual reserves, nor were any details unveiled about the size of its giant fields. However, there is no wonder Aramco takes the lead among its state-owned peers. With 10.5m barrels per day, it holds over 10% of pumped oil every day, more than double of Rosneft output, its Russian counterpart.

This aggressive, yet conservative (only a 5%), likely privatization brings back some memories from the late 70’s. We are referring to British Prime Minister Margaret Thatcher who in 1979 led the privatization of many Gov-run enterprises. More than 50 companies were sold or privatized – including the dozens from the power and water industries – raising more than £50bn for the Exchequer.

Saudi Arabia is not new to privatizations though. Besides the Joint Ventures we have reviewed above, we can go back to several partial sales of Saudi Telecom Company in 2003, the Saudi Arabian Mining Company in 2008 and the recent National Commercial Bank’s privatization through an IPO listed 6 billion dollars in 2014. This last IPO was heavily oversubscribed (around 20 times more the shares offered for sale, worth 80 billion dollars). Such IPO was limited to Saudi citizens, though.

But why precisely now?

But what triggers this reaction on behalf of the Saudi state-owned company? Why now? There are several takes on this.

The first and most obvious now, is the current situation of the crude oil market. As the main exporter of crude oil on the planet, Saudi’s economy relies heavily on their income that stems from the selling of crude and derivatives. In the low-priced current scenario for that commodity, they are seeing their income dramatically reduced- Not only that, but also the national debt of the Kingdom is at record levels at around a 15% deficit over GDP (98 billion dollars’ deficit). This IPO might add some valuable funds to mitigate this.

To this we must add the “Saudi Vision 2030” program of economic reforms they plan to implement in order to untie their economy from their oil production. Cut expenses and look for further investment opportunities are some of the main guidelines to follow. And to attract investors, privatization must take place. The Prince also believes this IPO will be important to make Aramco more efficient and cost effective, as well as to add a better structure, organization, more transparency and a higher degree of competitiveness.

Another reason might be to actually increase their productivity. As some studies we mentioned above, Aramco is certain Demand will slowly decrease as other technologies and energetic alternatives take over. Before the demand is close to being inexistent in the future, they would want to make sure they sell as much oil as possible, now that it does have a monetary value.

Aramco’s listing could be the spearhead to future and further privatizations through the program implementation process. Lead by example, they say.

What remains certain for now, is that this move will not go unnoticed for the crude oil markets, and prices will play an important role here. OPEC’s main producer and influencer will do what it takes to calm the seas before the IPO is launched, and it is likely they will force stability in the markets (to avoid “up & downs” scenarios like the one we just witnessed couple months ago) with all means at their disposal. Or why not, push towards a raise in the prices to increase their value. But at certain levels, since Saudi Arabia might not be interested in a huge rally in oil prices as this would mean a closer approach to the break-even point of production costs of American shale gas and oil operations. In any case, strap yourselves in!

Javier Palazón Nadal | Energy Consultant