Saudi Arabia’s strategy for Aramco IPO and $80 oil

FEATURE: Plans for second Aramco share sale increase oil price pressure on Saudi Arabia

Saudi Arabia’s strategy for Aramco IPO and $80 oil

Aramco must navigate pandemic, energy transition

Capex cuts may hit production capacity expansion

OPEC+ quota decision looms in March

Dubai — Spurred by the accelerating global energy transition, Saudi Arabia may soon sell more shares of its flagship oil company to finance projects aimed diversifying its hydrocarbon-reliant economy.

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The plan underscores Saudi Arabia's urgency to raise crude prices in the short term, analysts say, as uncertainty over the future of oil demand while the world continue to grapple with the coronavirus pandemic could hamper Aramco's valuation in a share listing.

“I do not expect that there will be a rush to offer more shares in Saudi Aramco but selling a bigger stake in the company was always been part of the crown prince's plans and one of his key objectives,” said Neil Quilliam, managing director of consultancy Azure Strategy. “A sustained upswing in oil prices and a pick-up in global demand will certainly be considered more conducive to another IPO.”

Saudi Arabia buoyed the oil market with its surprise announcement in January to unilaterally cut an extra 1 million b/d of crude production beyond its OPEC+ quota, sending prices to a 13-month high in recent days.

Crown Prince Mohammed bin Salman, the country's de facto leader, then told a Riyadh investment conference later in the month that a second tranche of Aramco shares will be offered, though he provided no timeline nor details on how much of the company will be available.

Proceeds from the sale would be directed to Saudi Arabia's Public Investment Fund, the crown prince's main vehicle to transform the economy and wean it off its dependence on oil revenues, which appear increasingly volatile.

Any share sale would be a follow-up to Aramco's history-making initial public offering in December 2019, when 1.5% of the company was listed, earning it an overall valuation of $1.7 trillion, making it the world's most valuable business at the time.

Stabilizing oil prices

But the oil market looks much different now.

Prospects of global oil demand peaking sooner, rather than later, due to the pandemic, may have increased the imperative for Saudi Arabia to monetize its cash cow. In 2020, Saudi Arabia, the world's largest crude exporter, saw its oil revenues decrease 30.7% year on year to $109.81 billion due to the market crash and production cuts per its commitments to the OPEC+ agreement.

Aramco stock, which trades only on the Saudi domestic exchange, closed Feb. 16 at Riyal 34.85/share ($9.29), up 9% from the IPO price of Riyal 32/share ($8.53).

Further destabilization of the oil market could imperil that valuation, lessening the proceeds that the Saudi government, Aramco's primary shareholder, could earn from a sale.

“It is reasonable to assume that the energy transition and risks associated with the issue will now be having an increasing impact on valuations across the sector,” said a Middle East-focused analyst, on condition of anonymity.

To fund Crown Prince Mohammed's Vision 2030 economic plan, which includes hydrogen projects, futuristic cities and a swath of technology investments, Saudi Arabia is in need of cash.

It has been the ringleader of the OPEC+ alliance, with sometimes reluctant partner Russia, shepherding the producer group through a series of output cuts. But even before the recent rise in prices, many OPEC+ members have been eager to roll back their quotas, in direct opposition to Saudi Arabia's more cautious stance.

The coalition next meets March 4 to decide on production levels for April and possibly beyond, and Saudi officials have been mum on what course of action they will push.

Financial strain

Aramco, meanwhile, has embarked on a series of cost-cutting measures.

It slashed its 2020 capex budget in half, to around $25 billion, and has signaled its yearly capex budget will remain at this level until at least 2023. Aramco is expected to announce its Q4 2020 earnings in the coming weeks.

To make up for any budget shortfall, Aramco may have to take on significant amounts of debt to fund any expansion projects, sources said.

“Aramco is targeting a maximum production capacity of 15 million b/d by 2025; it is gearing up to get a bigger global market share,” said a Gulf-based industry source close to the company. “They need to be prepared for the day when dependence on low-cost oil production increases. They believe that day is coming.”

Additionally, Aramco has increasingly focused production at cheap onshore assets and moved away from pricier offshore projects, sources said.

But its onerous dividend, while a potential attraction to investors, could hamstring growth.

As part of its pitch to investors during the 2019 IPO, Aramco pledged to issue a $75 billion dividend annually for five years. The Saudi government, which owns 98.5% of the company, is the primary benefactor.

Saudi Arabia will have to maintain Aramco's appeal to investors, which may include continuing to prop up crude prices, as it banks its future on its low cost of production in what could be a decades-long global transition away from oil.

'Saudi Arabia will remain the dominant oil market participant as it soaks up an increasing share of demand in a shrinking market, as higher cost producers are edged out,” Quilliam said. “And that would bode well for the valuation, but it will all come down to timing.”


Here’s what investors need to know about the long-awaited Saudi Aramco IPO

Saudi Arabia’s strategy for Aramco IPO and $80 oil

The IPO has been delayed several times in parallel to big swings in the oil price this year. Investors were rattled in September by drone attacks on two of Aramco’s oil facilities temporarily in September halved Aramco’s output. More recently, Saudi has struggled to find anchor investors for its IPO which are crucial to securing demand.

Aramco is looking to sell just 1% to 2% of itself on Riyadh’s exchange, but this would still make it the world’s largest ever flotation worth more than $20 billion. An additional overseas listing may follow, with New York, London and Singapore all vying for the lucrative mandate.

The IPO is a central pillar of the reform program of Crown Prince Mohammed bin Salman (MBS). He believes Aramco is valued at $2 trillion, although several analysts and bankers have placed its value at closer to between $1.3 trillion and $1.5 trillion.

These are some of the key points investors need to know:

The players

Saudi Arabia announced a series of government changes in August in preparation of the planned IPO of Aramco.

Yasir Al-Rumayyan: Chairman of Aramco. He is also head of the Public Investment Fund (PIF), Saudi’s powerful $320 billion sovereign-wealth fund. A close confidante of MBS, Al-Rumayyan is also chairman of Ma’aden 1211, +0.

38%, the state mining company which is 65% owned by PIF. Mining is one of the key sectors MBS wants to develop as part of its economic reforms. In addition, Al-Rumayyan sits on the board of ride-hailing app Uber Technologies UBER, +2.

51%  and Japanese multinational SoftBank Group 9984, +1.80%.

Prince Abdulaziz bin Salman: Energy Minister. The crown prince’s older half-brother was appointed to the role, replacing Khalid Al-Falih who had previously overseen a $427 billion 10-year plan for Saudi’s industrial sector.

Bandar Al-Khorayef: Head of the Ministry of Industry and Mineral Resources.

The Saudi government placed Al-Khorayef, a member of the board of directors of Saudi conglomerate Al-Khorayef Group, in the newly created role after the new ministry of industry and mineral resources was separated from the vast energy ministry. It will operate as an independent entity from 1 January 2020.

Fahd bin Mohammed Al-Essa: Head of the royal court, a powerful gatekeeper position in the absolute monarchy. He previously served in the Defense Ministry.

Amin Nasser: Chief Executive of Aramco. He has worked for the oil group for 30 years.

The numbers

Saudi Aramco is the most valuable company in the world, having generated $111 billion in net income in 2018 — nearly twice that of Apple, the world’s most profitable listed company, and more than that of the five biggest oil groups — ExxonMobil, XOM, -0.28%, Royal Dutch Shell XOM, -0.28% RDSA, +1.96%  BP BP, +2.93%  , Total TTA, +2.56%  and Chevron CVX, +0.35%  — combined.

Aramco published its first ever-half year earnings in August. It reported net income of $46.9 billion, a 12% fall from the $53 billion for the same period a year ago because of lower oil prices. It also said it would pay a special dividend of $20 billion to its biggest shareholder, the Saudi kingdom.

Aramco has huge reserves of 263 billion barrels of oil and 320 trillion cubic feet of natural gas, according to an independent audit which was commissioned to address the group’s lack of transparency.

The company has very low debt levels. It was the largest cash holder of all non-financial companies in the Europe, Middle East and Africa region in 2018, with €43 billion on its balance sheet, according to credit-ratings firm Moody’s. That compares with Apple’s AAPL, +0.42%  cash balance ($245 billion) and Microsoft MSFT, -1.33%  ($128 billion).

The risks

Geopolitical tensions in the Middle East pose a constant risk for investors.

Saudi’s defense vulnerabilities were exposed in September after attacks on Aramco’s largest oil-processing facilities temporarily impacted about half of the oil group’s crude production.

That prompted Fitch Ratings to downgrade Aramco’s credit by one notch to an ‘A’ rating. Riyadh and Washington blamed Iran for the attacks, a charge denied by Tehran.

Oil prices are expected to remain under pressure this year and next, according to a Reuters survey. The poll of 51 economists and analysts forecast Brent crude UK:BRNF20  would average $64.16 a barrel in 2019 and $62.38 next year.

Marshall Steeves, energy markets analyst at IHS Markit said: “For now, the impact on oil prices is ly marginal because the Kingdom may reign in production to support prices (probably without Russia) but in all lihood they would have done this anyway. They have been seeking higher oil prices for three years probably in part to bolster the Aramco IPO price but also to maximize revenue. So that hasn’t changed.”

Investors also need to be aware of any influence the Saudi government may have over Aramco which has dozens of domestic subsidiaries and several joint ventures, including with power generation and petrochemical firms.

Aramco’s tax bill could also rise if the oil price does. Under new measures introduced by Riyadh, the oil group will pay a marginal rate of 15% when Brent crude oil is trading up to $70 a barrel, rising to 45% for an oil price of between $70 and $100 a barrel and 80% above $100.

The oil group has announced plans to increase its dividend payments to at least $75 billion a year starting in 2020 through to 2024. However, any payout is at the discretion of the Aramco board.

The opportunities

Foreign investors can bid for a share allocation in the IPO, but their participation could be limited if local investors subscribe to the IPO.

Foreigners were first allowed to own shares directly in Saudi companies in 2015, but only institutions could invest and they had to apply for a license from the Saudi financial markets regulator to become a Qualified Foreign Investor, or QFI.

QFIs are required to have at least $500 million in assets under management and are also subject to regulation in a jurisdiction with similar standards to the Kingdom such as the U.S. A single QFI isn’t allowed to own more than 10% of a Saudi company’s shares.

Additional reporting by Myra Picache


Can Saudi Arabia really afford to wage an oil price war?

Saudi Arabia’s strategy for Aramco IPO and $80 oil

It was the last thing a slowing global economy needed. 

With the coronavirus pandemic hammering international travel, supply chains and production, Saudi Arabia delivered another shock to the system by declaring an oil price war. 

On March 6, having failed to convince Russia to agree to deep production cuts aimed at shoring up crude prices against the demand destruction unleashed by coronavirus, Saudi Arabia-led OPEC retaliated by announcing it would start pumping crude with abandon.

The next day, the kingdom lowered the price it charges for oil. Come March 9, the markets delivered their verdict. Oil prices crashed 30 percent at one point – the biggest one-day drop since the 1991 Gulf War.

Though some of those losses were pared, announcements of pending production boosts next month by the kingdom and other Gulf producers ensured oil prices had their worst week since the 2008 financial crisis.

The price war is a gamble for the kingdom, one that could either pay off or land it in a deep hole.

Dramatically lower oil prices set up Saudi Arabia, which can produce oil more cheaply than any other country, to steal market share: both from the world’s second-biggest oil producer-Russia-as well as higher-cost United States shale oil producers.

But analysts say it could come at a cost to Saudi Arabia and the ambitious plan of its de facto leader Crown Prince Mohammed bin Salman (MBS), to break the kingdom’s oil-dependence and set it up for a more prosperous future.

A transformation in trouble

Crude accounts for roughly 80 percent of Saudi Arabia’s revenues, and that level of fossil fuel dependence comes with huge drawbacks.

As oil prices rise and fall, so too do the kingdom’s fortunes, which can stall plans and force tough spending choices.

The future is also moving against oil, with the Paris Climate Agreement spurring more governments to reduce emissions and petroleum products plastic raising environmental alarms.

The kingdom needs to diversify its economy, and soonest. But that is easier said than done. Overdependence on any commodity for export effectively salts the earth where other productive sectors could take root.

Vision 2030 seeks to spring the kingdom from this trap by reinvesting fossil fuel wealth into sustainable industries of the future, shrinking a bloated state sector, and creating a thriving, diversified private sector to employ the kingdom’s youthful workforce.

And the government does not see itself doing all of this alone. A successful transformation also hinges on convincing investors, both foreign and domestic, to buy into MBS’s vision.

On many counts though, the blueprint for transformation was struggling even before Riyadh fell out with Moscow.

“Vision 2030 was already lagging on most of its interim targets for 2020,” Laura James, senior Middle East analyst at Oxford Analytica, told Al Jazeera.

A cornerstone of raising cash to reinvest into other sectors was the much-hyped initial public offering (IPO) of Saudi state oil giant Aramco.

As it neared its delayed debut late last year on Riyadh’s Tadawul stock exchange, an attack on Aramco’s facilities in September reminded investors of the geopolitical risk festooning the company and its operations.

After failing to attract sufficient international interest, MBS pressured wealthy Saudis to step up and buy a piece of the company. The IPO raised a record $29.4bn, effectively valuing the firm at $1.7 trillion- well shy of the $2 trillion MBS had originally sought.

Now, the oil price war is hammering shares of Saudi Arabian Oil Co -as Aramco is officially known.

The stock fell 12 percent last week and continued to slide on Sunday, after Aramco announced it is cutting capital spending this year in response to coronavirus, and reported a 21 percent decline in 2019 net profits due to lower oil prices.

On Monday, Aramco is due to hold a webcast to discuss its full-year results.  Company executives could be grilled over whether pumping crude full-throttle is in the best interests shareholders. 

Another Vision 2030 metric – foreign direct investment (FDI) in the kingdom- has also been lacklustre. Though it recovered to $3.2bn in 2018 having not even cracked $2bn the previous year, FDI was still way down from the $8.1bn achieved in 2015 and a mere fraction of the $29.2bn the kingdom attracted in 2010, according to the United Nations Conference on Trade and Development.

Growth in the kingdom’s non-oil private sector is another benchmark.  It was looking promising, until it started slowing in December and continued to decelerate in January. February saw the slowest growth in two years, as output and new orders fell, thanks to disruptions spawned by the coronavirus.

Now, the fiscal stress of an oil price war could make non-oil sector growth even harder to achieve.

Austerity on tap

The kingdom has healthy foreign exchange reserves, roughly $500bn, to ride out a price war, and it does enjoy the lowest production costs among all oil producers.

The Saudis “can still turn-out a profit at these low oil prices, at least for a time,” Tarik Yousef, director at Brookings Doha Center, a nonprofit public policy organization, told Al Jazeera.

Balancing its budget, however, is another story. 

The International Monetary Fund reckons the kingdom needs oil to fetch around $83 a barrel to balance its state budget.

Global benchmark Brent crude last traded at $33.84 a barrel on Friday.

Goldman Sachs reckons that should oil prices average $30 a barrel over the next two quarters and the kingdom boosts output by 10 percent, its budget deficit could swell to 12 percent of gross domestic product (GDP) this year -nearly double its fiscal deficit target.

That would increase the government’s financing requirement by $36bn.

There could be a silver lining. Goldman estimates that if oil prices recover to $60 a barrel by the end of 2021, the kingdom’s budget deficit could narrow to less than 2 percent of GDP by 2022.

But if oil prices only recover to $50 a barrel by the end of next year, Goldman sees the budget deficit remaining “wider for longer, implying an additional $63bn in funding requirements” over the next two years.

More drama

Austerity measures may have been in the cards before the kingdom declared a price war, as Riyadh prepared for slowing oil demand in the face of coronavirus.

State agencies were asked to submit proposals for slashing 20 to 30 percent from their 2020 budgets before the kingdom fell out with Russia, Reuters News Agency reported, citing sources. One source said salaries would not be touched, but projects and the awarding of new contracts could be delayed.

“With salaries largely protected, the impact could be on capital expenditure, which will have a knock-on impact on the private sector and ly hinder diversification efforts,” said James.

Shielding salaries helps maintain loyalty, which is important for any ruler, especially one surrounded by intrigue.

The price war was not the only Saudi drama unfolding while the alliance between OPEC and Russia was collapsing.

Two of the royal family’s most influential members, Prince Ahmed bin Abdul Aziz, the youngest brother of King Salman, and Mohammed bin Nayef, the former crown prince and interior minister, were reportedly being detained in Riyadh. Both men are seen as legitimate contenders for the throne, sparking speculation that at the very least, MBS was making a move to consolidate his power.

The price war “threatens stability at a time where MBS is already facing political pressure and possibly threats from within the royal family as evidenced by the recent arrests,” said Yousef.

Which makes pulling off an economic transformation Vision 2030 that much harder, say analysts. 

“It’s tougher for oil-dependent countries that need higher prices to fund their budgets,” Jim Krane, Wallace S Wilson Fellow in Energy Studies at Rice University’s Baker Institute for Public Policy, told Al Jazeera.

“If they cut spending too much, they could have a rebellion on their hands. Saudi Arabia is vulnerable in this respect.”

Source: Al Jazeera


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