Oil Over Troubled Waters?

“When a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully,” said Dr Samuel Johnson. The same is true of a major oil producer when the price falls below $28 per barrel, as happened on Friday. Saudi Arabia’s economic reform plans, revealed in an Economist interview with the Saudi king’s influential son, Mohammed bin Salman, are certainly concentrated. And nothing seems more wonderful to global investors than the suggestion that the kingdom could sell a stake in its crown jewel national oil company, Aramco. The idea of an initial public offering of Aramco raises some striking questions. What is Aramco worth? How would such an IPO be structured? And what do the Saudis hope to achieve?

First, it’s worth appreciating the sheer scale of the Saudi state oil company. With a domestic monopoly, it produces just above 10 million barrels of oil per day—more than a tenth of global output, and twice the next largest, Russia’s Rosneft. It holds the world’s largest conventional oil reserves, officially 265 billion barrels, which are also amongst the cheapest to produce, at less than $10 per barrel. The world’s fourth largest refiner, its joint ventures in the U.S., China, Japan and South Korea cement its access to world markets.

Aramco is also a strategic national and global asset. Originally a consortium of the four largest U.S. oil majors, it was nationalized by 1980, in a gradual process, which retained technical and managerial competence. Respected as professional and effective—in comparison to many other mismanaged state oil firms—it generated 77 percent of the Saudi government budget in 2015, and oil is 45 percent of the country’s GDP. Most importantly, 2 million barrels per day of spare production capacity allows Riyadh to influence global oil prices—disciplining recalcitrant colleagues in the Organization of Petroleum Exporting Countries (OPEC), or trying to drive high-cost competitors, such as American shale oil, out of the market.

So what is such a behemoth worth? This is an exercise in making up large numbers: $781 billion, as McKinsey proposed in 2005, $2.5 trillion according to Bloomberg, or more than $10 trillion, in the view of former Saudi petroleum adviser Mohammed Al Sabban. Compare this to the $350 billion enterprise value of ExxonMobil, the world’s largest listed petroleum company.

Such estimates are meaningless without clarity on two things: Aramco’s oil reserves and production; and the way it is taxed.
Some observers have suggested Saudi reserves are heavily overstated. One consultancy estimates reserves at 204 billion barrels, some way below the official figure. But such debates miss the point: even this lower figure is equivalent to almost 50 years of production at current levels. Compare this to a public company such as Shell, whose ‘reserves life’ is about 11 years.

Amin Al Nasser, Aramco CEO since last September, said in 2008 that the company planned to increase proved reserves to 450 billion barrels by 2020. This sounds exaggerated, but undoubtedly the Saudis can sustain and increase production for decades, boosting recovery from known fields as well as discovering new resources. Oil to be produced in 2050—even assuming there is a market for it—barely counts in today’s valuation. This slow rate of depletion means that simple rules of thumb for valuing an oil company based on its reserves make little sense for Aramco.

Precisely how Aramco is taxed today is not widely known, nor does it matter much when the state owns the entire company. A part-private Aramco would need a tax scheme calibrated to pay the bulk of profits to the Saudi state, while allowing it enough funds to re-invest. Mexico’s Pemex, for instance, has long been choked by rules that transferred some 60 percent of revenues—not profits—to the government.

A sale of 5 percent of the company could easily raise $50 billion or more, the largest ever IPO, and too large for the $350 billion Tadawul exchange to absorb—requiring a listing in London or New York. But again that would require full disclosure of financial statements and oil reserves, matters considered state secrets, and open it to shareholder lawsuits, anti-corruption laws and other unwelcome attention.

Listing only part of the company could sidestep such difficult issues. Smaller and so more digestible to the market, this approach still retains the option to sell more later. Aramco could offer shares in its ‘downstream’ unit—refining, petrochemicals and fuel retail. Already 25 percent of its Petro Rabigh refinery is traded on the Tadawul. Or, the company could float a select ‘upstream’ subsidiary—containing some lesser oil and gas fields. Non-petroleum assets, such as its social services, would remain with the parent. That would give investors access to the coveted Saudi upstream sector, but without giving away much information about the country’s overall reserves. It would also ease any nationalist objections to selling off the country’s birthright. This is the approach followed by Chinese state oil companies, with subsidiaries such as PetroChina traded in Hong Kong.

So why are the Saudis contemplating such a drastic move now? Although running a large budget deficit, forecast at $87 billion this year, net foreign assets still total $628 billion and debt is only 5.8 percent of GDP. There is no urgent need for cash.

Listing any part of Aramco will be a lengthy process, so it’s as well to start now. But more than money, the proposal of an IPO should be seen as part of Prince Mohammed’s ambitious economic restructuring plan. To the outside world—and particularly oil-producing competitors—a stronger Aramco signals that Saudi Arabia is prepared to keep production high, and weather a lengthy period of low oil prices. A shareholding by, for instance, a Chinese state fund would provide some political insurance for the House of Saud.

Domestically, the impact could be even greater. Greater transparency has been mentioned as a benefit. Aramco is certainly effective but, as a state monopoly, it may not be efficient. Mentions of eliminating corruption may be a warning to prominent Saudis with access to company cash flows. And for such a bold statement to come from Prince Mohammed—rather than the king, crown prince, oil minister or Aramco CEO—further emphasizes his prominence.

The prince extolled Margaret Thatcher, but perhaps modern China is the model—privatization intended not to eliminate state companies but to strengthen them, and economic reform intended not to accompany political reform but to forestall it.

Robin M. Mills is Non-Resident Fellow for Energy at the Brookings Doha Center, and author of The Myth of the Oil Crisis