What is Saudi Aramco really worth ?

The Initial Public Offering (IPO) of Saudi Aramco has been presented as the central element of Vision 2030, the ambitious economic diversification strategy unveiled by Prince Mohammed Ben Salmane (MBS) in January 2016, when oil prices reached a historical low of $ 29 per barrel. The prospects had suddenly darkened for Saudi Arabia and it was necessary to react quickly. The Crown Prince’s goal was to float 5% of the largest NOC (National Oil Company) in the world, and incidentally the sixth largest company by turnover in 2019, according to the Fortune Global 500 ranking. By selling up to 5% of Saudi Aramco’s equity, based on a skyrocketing valuation of 2 trillion dollars, the Crown Prince expected to replenish the coffers of the Saudi State with up to 100 billion dollars, providing it with much needed financial resources and allowing it to jump starting its investments in line with Vision 2030.

Since the announcement of the IPO, the debate has been much focused on the market valuation of the gigantic oil behemoth. Some analysts pointed out to the discrepancies between the $ 2 trillion figure conveyed by MBS and the much lower estimations they derived from the company’s operations, especially when comparing it to its international peers. An equally contentious issue, that hampered the IPO process early on, was the potential gap between the company’s value maximisation objectives and the government’s energy policy, which, in the Saudi case, largely overlaps with its foreign policy and with its overall economic development policy. As a matter of fact, the Kingdom is endowed with the second largest proven oil reserves in the world after Venezuela. It is the world’s largest crude oil exporter with a 17% market share. It is the Saudi government that defines the amount of oil that can be produced and exported from the kingdom each year.

Saudi Arabia has also been tied since 1960 by its commitments as a member, and de facto leader, of OPEC, of ​​which it was one of the five founding members. More recently, it fully committed to implement the OPEC + agreement concluded in Algiers in December 2016, between OPEC and other major oil producers such as Russia. Actually, the Algiers agreement could be viewed as a Saudi-Russian “entente cordiale”. It was rolled over at the end of 2018, in a testimony to its success and to the market stabilisation it achieved. In the longer term, there is a growing possibility that this Saudi-Russian tactical rapprochement might turn into a long-term strategic partnership, which could have long lasting effects on global oil governance, as I have mentioned many times since 2016.

In this context, in the absence of detailed financial and non-financial information, it was difficult to draw sound and unbiased conclusions on the strategy pursued by Saudi Aramco, and on its potential market value. The first significant elements of information were disclosed in April 2019, in the wake of a $ 12 billion international debt issuance to finance the acquisition of 70% of SABIC, the flagship Saudi chemical company, for $ 69 billion. The disclosed figures revealed that Saudi Aramco generated a net profit of $ 111.1 billion in 2018, more than any other company in the world. As reported by the Financial Times, it was double the profit made by Apple and five times that achieved by Royal Dutch Shell during that same year.

Based on these figures and on an earnings multiple of 13, calculated as an average for several major international oil companies (Exxon Mobil, Chevron, Royal Dutch Shell, Eni, BP, Total), IG analysts valued Saudi Aramco in a range of $ 1.1 to $ 1.45 trillion. The bottom of the range corresponds to a discount of 17%, which takes into account the geopolitical risk premium and the control exerted by the State on the company. On the other hand, thanks to its low level of indebtedness – with a long-term debt of $ 35 billion after taking into account the aforementioned $ 12 billion debt issuance -, which translates into a gearing ratio of 10%, Saudi Aramco could achieve an earnings multiple of 15, much closer to those displayed by Exxon Mobil and Chevron, than to Shell and BP, whose paltry multiple of 10 reflects much higher debt leverage, in the tune of 30% to 40%. Thus, in the best case scenario, Saudi Aramco’s valuation would be capped at $ 1.7 trillion under current oil market conditions, before applying any haircut related to the political and geopolitical risks premiums. Obviously if oil prices drop, as a result of a bleaker global growth outlook and of the related oil demand, the valuation will have to be revised downwards accordingly.

Against this background, the acquisition of SABIC had several objectives. On the one hand, it allowed the Public Investment Fund (PIF) to increase immediately its cash holdings and to ramp-up its investment strategy, both domestically and abroad, in line with the initial objectives of Vision 2030. On the other hand, it was meant to increase the attractiveness of Saudi Aramco for potential investors, by presenting it as an integrated energy company, with a leading position in the upstream sector and a strong position in the downstream sector, including in high value derivatives such as composite materials and specialty chemicals. Concomitantly, the success of the related Saudi Aramco debt issuance was intended to reassure investors and to raise their appetite for the IPO itself, taking advantage of the company’s low level of indebtedness and of the implicit guarantee it enjoys from the State.

In order to facilitate the IPO and to clarify the responsibilities of all the players in the oil sector, the Saudi government made in 2017 several important amendments to the country’s hydrocarbons law. As in many other countries in the world, oil reserves in Saudi Arabia are the exclusive property of the state. Nevertheless, Saudi Aramco had until 2017 enjoyed an exclusive perpetual concession on the exploitation of these fossil resources. As part of a sweeping reform, the perpetual concession was lifted in favour of a 40-year exclusive concession over the period 2017-2057, completed with a 20-years extension period up till 2077. The rate of the profit tax levied on Saudi Aramco has been lowered from 80% to 50%, and a more progressive royalty system has been enacted, with a marginal rate of 20% when oil prices are below $ 70 per barrel, 40% between $ 70 and $ 100, and 80% above $ 100.

In August 2019, in addition to the financial statements disclosed for the previous financial years (2016, 2017, 2018), the group published for the first time of its history its half-yearly financial results. These figures reveal a dividend of $ 46.39 billion paid to the state in the first half of 2019. To boost the valuation of the company, Saudi Aramco announced that it would pay a total dividend of 75 billion dollars in 2020, and that for the years 2000-2024 the dividend paid to minority investors will be calculated prorata temporis out of a dividend floor of $ 75 billion, even if the company has to reduce the total dividend paid to the state, should the actual dividend be lower than expected. Oil majors from Exxon to BP currently offer a dividend yield – the ratio of dividends paid by the company related to its market capitalization – comprised between 4% and 6%.  Should Saudi Aramco apply the same dividend yield,  its potential valuation would be somewhere between 1.25 and $ 1.87 trillion. However, this does not take into account the risk premium associated with this “systemic NOC”. In view of the latter, foreign investors would probably expect a higher dividend to hold Aramco’s shares than, let’s say, Exxon’s or BP’s shares.

Doubts about the timing and the relevance of the Aramco IPO have resurfaced many times since the announcement made by MBS in January 2016, even within the stifled microcosm of Saudi policy makers and technocrats. The persistence of these doubts and passive resistance to the IPO process could perhaps explain the sudden disgrace of former energy minister, Khalid Al Falih, earlier this year. The latter has been deprived of all his responsibilities, including his position as chairman of Saudi Aramco, which has fallen to Yassir Al-Rumayyan, a 49-year-old investment banker appointed by MBS in 2015 to head the Public Investment Fund. In fact, what looks like an erratic move is part of a well-considered strategy.

With the appointment of Al-Rumayyan at the helm of Saudi Aramco board , the PIF, which was until 2016 a backwater institution, becomes a pivotal player in the Saudi economy. This cannot be said of Saudi Arabian Monetary Authority (SAMA), which although it manages the country’s foreign exchange reserves, plays a minor role, due to the Saudi riyal’s hard peg to the US dollar. As a matter of fact, the Minister of Energy has always been considered as the highest Saudi economic policy official, through his grip on Saudi Aramco, the kingdom’s cash cow and the “delivery unit” for all the major projects impulsed by the state. This is no longer the case. From now on, all economic power is concentrated in the hands of MBS and its closest advisors, among whom Al-Rumayyan is the most visible figure. This strategic shift has gone largest unnoticed by observers who are not familiar with the opaque power struggles within the Saudi establishment. In order to give more consistency to this strategic shift, the PIF should perhaps relinquish some of its international exposure  – especially some of the questionable investments made alongside the Japanese conglomerate Softbank –  and increase its support to Saudi companies and to foreign investors that are willing to develop meaningful projects inside the Kingdom. .

The Khashoggi case, named after the prominent Saudi journalist who has  been kidnapped and murdered in October 2018 inside the Saudi consulate in Istanbul,  damaged the reputation of MBS as a progressive and reform-minded leader. For some time, it dampened the interest of western investors toward the Kingdom. A UN-backed report called the  murder of Jamal Khashoggi an extrajudicial execution. The support given by Donald Trump to the Crown Prince, however, dispelled the fears of a disruption in the relations between these two historical allies. President Trump dismissed calls for sanctions to be imposed on the Saudi political leadership, pointing instead to the aligned interests between the two countries. Subsequently, MBS acknowledged its political responsibility in the tragic end of Jamal Khashoggi, while denying that he had anything to do with it. In any case, the healthy attendance at the third edition of the Future Investment Initiative (FII) – a major investment forum dubbed the “Davos in the Desert”, that was held in Riyadh from 29 to 31 October 2019 – proves that there was a return to “Business as usual” on the part of he global investor community.

Nevertheless, the most serious blow to the kingdom’s ambitions and to its national oil company was the coordinated surprise attack on Saudi Aramco’s facilities by missiles and drones in September 2019. Saudi and US authorities attributed these attacks to Iran, directly or through proxy forces in Iraq and Yemen. But so far, there has been no substantiated evidence to support these claims. These attacks demonstrated the  vulnerability of the kingdom’s oil sector to such malign “acts of war”. They caused a temporary disruption of half of Saudi Aramco’s oil extraction and processing capabilities, impacting oil production to the tune of 5 million barrels a day. However, on this occasion, the company proved to the world that it possessed well honed crisis management capabilities . It was able to implement in a record time a contingency plan , allowing it to honour its foreign contracts – especially the Asian refineries which collectively absorb as much as 50% of the Kingdom’s crude oil production and 70% of its oil exports. According to some industry experts, it will take months before the facilities affected by the attack are fully repaired. In the meantime, Saudi Aramco will have to continue to tap into its oil reserves and to import crude oil in due quantity and quality to meet its obligations toward its customers.

Officially, the Saudi authorities now plan to open the capital of Saudi Aramco in two stages: a first flotation of 1% to 2% to capital is expected to take place on the national stock exchange, Tadawul, followed by a further flotation of 1% to 2 % of its capital on an international stock exchange. Donald Trump repeatedly said – and twitted ! – that he wanted the Saudis to choose New York as the main venue for the international IPO. But this could pose inextricable legal problems, not only because of the transparency obligations that this would entail, but because this could potentially expose the company to a seizure of its assets, in connection with longstanding lawsuits initiated against the Kingdom by certain US NGOs and associations. London would have almost the same kind of disadvantages. But there are other alternatives for the flotation, like Tokyo and Singapore. At the same time, the kingdom’s authorities and their financial agents have been actively soliciting sovereign wealth funds and other State owned holdings in the Middle East and Asia-Pacific, in order to contribute to the success of this high stakes IPO. These negotiations almost certainly go far beyond the financial issues involved in such a transaction. They are political by nature  and they may involve major trade-offs and complex tit-for-tat arrangements purporting to State-to-State relations.

Regarding the first stage of the IPO, beyond the doubts on the effective valuation of Saudi Aramco, the IPO might stumble given the contraction of the liquidity on the national stock exchange, Tadawul, following the oil price collapse in 2014. Most of the adjustment to this shock has already been achieved and its main negative effects on the Saudi economy have been absorbed. However, according to  the IMF, the Saudi Treasury will continue to post fiscal deficits comprised between 5% and 6% of GDP over the 2020-2024 period. The government could therefore continue to capture much of the excess liquidity available in the banking sector for its own financing needs, resulting in a further rise in the cost of liquidity, in a context where Saudi interest rates have been rising in tandem with US interest rates, following the monetary tightening initiated by the US Federal Reserve since January 2016.

To alleviate these problems and to maintain a valuation close to US $ 1.7 trillion in the early days of Saudi Aramco debut on the local stock exchange, the Saudi authorities have mandated a host of international and national financial advisors to approach the local  investors. In a country where the state can, at its discretion, make and break the fortunes, because of the dependence of the Saudi economy on public procurement and because of the existing loopholes in the rule of law. Ultra High Net Worth (UHNW) individuals are urged to be patriotic and to acquire shares of the flagship national oil company Saudi Aramco. The “Ritz case” remained in everyone’s minds. However, many local investors possess mostly illiquid assets, consisting of real estate assets and unlisted company shares. The recent stall in the Saudi market could be explained by the liquidation of stock market portfolios by these investors, in anticipation of the “great patriotic gesture” that will be expected of them.

In the longer term, if Vision 2030 succeeds in diversifying the Saudi economy, the Saudi state will gradually become less dependent on the cash flow generated by Saudi Aramco which still account for 60% of its fiscal revenue. This would reduce the risk premium related to the potential confusion and conflict of interests between the corporate and the sovereign strategic priorities. This should reassure investors, but another risk threatens them: the end of the oil age. In 2003, former Saudi oil minister Zaki Yamani summed up this risk through a stinging formula that more relevant than ever : “It’s not because we were short of stone that the stone age has come to an end, and the oil age should end well before we run out of oil. ” With a rising global awareness about climate change and its dire consequences and with the advent of credible alternatives to fossil fuels, Zaki Yamani might be right much earlier than even he originally expected.

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