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Saudi Aramco’s IPO valuation and the global crude oil market

The Macro View

Saudi Arabia plans to accelerate the IPO timetable for Saudi Aramco, the kingdom’s flagship state owned oil and gas monopoly that happens to be the world’s most profitable company. Saudi Aramco will be the world’s largest IPO ever if it lists on the London or New York stock exchange in early 2020.

The Saudi Aramco IPO plan, all but shelved in 2018, reappeared on the kingdom’s agenda after the company floated a $12 billion new issue last April in the Eurobond market that was wildly oversubscribed, with $100 billion in bids. Lead managed by J.P. Morgan, the international banking syndicate included the crème de la crème of Wall Street, the City of London and European finance. Why would an oil company with $110 billion in 2018 net profits raise $12 billion in Eurobonds in the global capital markets at spreads even lower than the Saudi sovereign bond issue? The answer is obvious. The kingdom is obviously preparing the world of high finance for an imminent Saudi Aramco IPO.

Saudi Arabia has been the ultimate petro-economy since Chevron geologist struck an oil gusher in a Dammam salt dome in 1937 and changed the history of Arabia forever. If ever there was an ultimate prize in the global provinces of black gold, the kingdom of Saudi Arabia is it. With 260 billion barrels of proven reserves, Saudi Aramco is the only oil company in the world that can produce up to 12 million barrels a day with drilling costs estimated at $9 a barrel, the lowest in the world. Saudi Arabia also anchors the Saudi kingdom’s power and influence in the global energy markets since its 1 million barrels a day spare capacity enables Riyadh to act as the “swing producer” in OPEC.

The oil crashes of 1986, 1999 and 2014-15 were all triggered by Saudi Arabia’s decision to temporarily abandon the role of “swing producer” to punish free riders and quota cheaters in OPEC as well as preempt shale gas exports from the Permian Basin in West Texas. Despite five decades of attempted economic diversification, oil revenues are still 90% of both the Saudi government budget and exports. Saudi Aramco’s petrocurrency bonanza has enabled the kingdom to become the financial superpower of the Middle East, the largest economy in the Arab world, the architect of “riyalpolitik”.

The valuation of Saudi Aramco at is IPO will be set by the world’s fund managers, though the Saudi Crown Prince Mohammed bin Salman has argued it is worth $2 trillion, a figure not accepted by most oil and gas sector analysts in London and New York. The coming IPO means Saudi Arabia will do its best to keep crude oil prices in a bullish uptrend, even if it means bearing a disproportionate share of the OPEC/Russian output cut pact. The price of crude oil has been hugely volatile in the past five years – from $128 Brent in October 2011 when Libyan dictator Colonel Gaddafi was lynched amid a NATO bombing campaign and $110 in June 2014 (the month Daesh terrorist seized the Iraqi city of Mosul) to as low as $28 in early 2016 after an epic oil price crash. Oil prices have been on a rollercoaster range from $43 – 85 since 2018. Brent crude trades at $58 now.

Energy stocks have been the worst performing sector in the S&P 500 index in the past decade and in 2019. Wall Street has derated the valuation of oil and gas stocks as recession fears have hit global petroleum demand estimates. Even Saudi Aramco net profits for the first six months of 2019 fell 12% to $46.9 billion. Depending on the outlook for oil prices and Saudi oil production/exports, the Saudi Aramco IPO could value the company anywhere from $800 billion to well above $1.4 trillion, above the market caps of Microsoft and Apple on Wall Street.

Unlike the bond holders, the buyers of Saudi Aramco IPO must remember the majority shareholder (the kingdom plans to sell only a 5% stake to the public) is a sovereign Arab government that may choose to cut oil production for national security/OPEC “swing producer” role reasons, not a share-holder value maximizing economic enterprise. This will necessitate a valuation discount at a time when Shell, BP and Total offer dividend yields as high as 6.5%.

Saudi Arabia also provides concessional oil exports to key allies in the Middle East, such as governments of Bahrain, Jordan, Morocco, Pakistan and Egypt. US law could also make Saudi asset in New York vulnerable to class action lawsuits. There is no real transparency on corporate governance or capex policy in most state-owned oil and gas companies, the reason Brazil’s Petrobras IPO was such a colossal disaster.

The Macro View

About Matein Khalid

Matein Khalid

Matein Khalid is Chief Investment Officer of Asas Capital in the DIFC; he is responsible for global investment strategy and the development of the multi family office platform. He has worked in Wall Street money centre banks, securities firms and hedge funds in New York, London, Chicago and Geneva. In addition, he has been an advisor for royal investment offices in the Gulf for 8 years. Mr Khalid has four degrees in finance, economics, banking and international relations from the Wharton School, University of Pennsylvania. He is a director at the American College of Dubai and has taught MBA level courses in commercial/investment banking at the American University of Sharjah and British University of Dubai. He writes the Global Investing columns for Khaleej Times, Gulf Business and Oman Economic Review.

Articles by Matein Khalid

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