Saudi Arabia Inc.?

March 16, 2016 03:00 PM

In a recent interview with The Economist, the Deputy Crown Prince of Saudi Arabia (second in line for the crown), Muhammad bin Salman, mentioned that Saudi Aramco is considering selling shares of the company on Tadawul, the Saudi stock market. His exact words when asked about this were: “This is something that is being reviewed, and we believe a decision will be made over the next few months. I’m enthusiastic about this step. It is in the interest of the Saudi market, and it is in the interest of Aramco, and it is for the interest of more transparency, and to counter corruption, if any, that may be circling around Aramco.” 

Shortly thereafter, Saudi Aramco issued a press release that confirmed that the company, “has been studying various options to allow broad public participation in its equity through the listing in the capital markets of an appropriate percentage of the Company’s shares and/or the listing of a bundle of its downstream subsidies.” 

Suddenly, the most pressing question for market analysts went from “When will OPEC cut production?” to “How much is Saudi Aramco worth?” 

We do know that if Saudi Aramco were to make a public offering as is, it would clearly have the largest market capitalization in the world. A better question for investors to consider is, “If Saudi Aramco does make some sort of public offering, will it be a good investment?” The answer depends largely on the following conditions: 

1 will it happen anytime soon? 

The Saudis are well known for their careful and deliberate decision-making. The royal family rarely makes swift or abrupt changes, other than in the case of Saudi Arabia’s physical safety. Since this is not an issue of immediate survival we can expect that the Saudis will very deliberately consider whether to IPO Saudi Aramco or some portion of the company. Even if the company’s directors, the oil minister and the royal family decide that a stock offering is in their best interests, they will likely gradually implement it over an even longer period. 

As an illustrative comparison, Saudi Arabia first began the process of taking ownership of the American-owned Aramco in 1951, when it requested that a Saudi national be named to the board of directors. In 1959, two Saudis were elected to the board, and in 1973, Saudi Arabia began to purchase shares in the company from its American owners. Finally, in 1980, Saudi Arabia completed the process and purchased the rest of the company for $5 billion (see “Good timing,” below). Saudi Arabia waited 29 years to acquire the company it wanted. For a country that prizes stability and incremental change, it is unlikely that any changes  to Saudi Aramco’s ownership will happen quickly.  Quickly or over a longer period, Saudi Arabia is likely  to choose a time that would maximize the value of any public offering. 

2 if Saudi Arabia sells shares in saudi aramco, what kind of offering would it be? 

Many analysts believe that Saudi Arabia can dig holes in the ground and pump out oil but little else. Nothing could be farther from the truth. Saudi Aramco is seen as another national oil company, albeit a very big one. However, while Aramco is a national company owned by the royal family, the Saudis operate it more along the lines of public multinational energy companies like ExxonMobil, Chevron, BP and Royal Dutch Shell. Saudi Aramco is a dynamic and diversified enterprise that includes extensive research and development enterprises, venture capital arms, massive petrochemical complexes and domestic and foreign refineries with a global shipping and distribution network and the most high-tech crude oil extraction facilities in the world. All of these diversified energy interests are in addition to Saudi Arabia’s crude oil and natural gas reserves. 

It is extremely unlikely that Saudi Arabia will IPO the Aramco parent company, although CEO Khalid al-Falih has mentioned this as a potential avenue. Such a move, even on the Saudi stock exchange (Tadawul), would entail a degree of financial disclosure that the Saudi royal family would not permit. Saudi Arabia is far more likely to offer shares in some of its subsidiaries or in a bundle of its downstream subsidiaries. That list is large with components constituting significant capital (see “Sum of its parts,” below). 

Even if Saudi Arabia does offer shares in some or all of these companies, the initial offering would likely be small, perhaps 10%, and would not dilute Saudi Aramco’s leadership in any significant way. 

3 why is Saudi Arabia considering selling shares of aramco subsidiaries? 

Despite the media hype, Saudi Arabia is not considering an IPO because the royal family is looking to cash out. There is no evidence that the Saudi royal family is in financial or political trouble. Even if the royal family thought it was in trouble, its best move would be to convert the wealth that is tied up in its energy industry to other assets, like real estate. We also would see Saudi royal family members moving out of the country in large numbers and acquiring permanent residency and citizenship in other countries, if this were true. 

Similarly, Saudi Aramco is not looking to raise cash to offset financial problems. Failing shale oil companies in the United States tend to put more shares up for sale to raise cash right before banks review their credit lines in order to make their balance sheets more presentable,  but the evidence does not indicate that Aramco is looking for cash. In March 2015, Saudi Aramco signed an agreement with a group of regional and international banks for $10 billion of revolving credit. Even though the price of crude oil is at a 12-year low, Saudi Aramco is selling more oil than ever before, and its refineries are profiting greatly from the low oil prices. The company has vast reserves of foreign currency and does not need more liquid assets at this point in time. 

Most probably, Aramco is considering an IPO because the move might benefit the Saudi economy and Saudi Aramco’s relationship with its customers, in the long term. Any IPO would take place on the Saudi stock exchange, which opened last year and has not done well. Putting up shares from the Kingdom’s most profitable enterprise (even if just from less prestigious subsidiaries) would help lift the value and the popularity of the Saudi stock market. 

An IPO on the Saudi exchange also would enable Saudi citizens to share in the Kingdom’s wealth, an approach that fits the Saudi family’s ruling philosophy. Bedouin tradition calls on the leader of the tribe to demonstrate his power and strength by providing for the needs of the people and the people expect the leader to provide for them. After Abdul Aziz ibn Saud united the different regions of Saudi Arabia under his control, the revenues he later received from Aramco enabled him to provide material benefits like healthcare, education, electricity and clean water for his people. Even today, the King provides benefits such as global education and occasional financial stipends to his subjects. A modern extension of this Bedouin practice might be to make shares available to the King’s subjects, perhaps even with some favorable options for Saudi citizens. This practice is not unique to Bedouins in the oil industry; in 2010, it was reported that 8% of all British pension income came from ownership of BP shares. 

It also would benefit Saudi Arabia to offer shares in Aramco subsidiaries to foreign investors. Saudi Aramco’s primary customers are in the United States, Europe, China and India. Stock offerings, even those for less prestigious subsidiaries and perhaps at prices prohibitive for the casual investor, would benefit the company by providing an avenue for its best customers to have a stake in the company and the country’s success. Many of the subsidiaries under consideration for public offering are joint ventures with China, one of Saudi Aramco’s largest crude oil purchasers. If Saudi Aramco’s top customers also own shares in the refineries located in their countries and in the trading unit they purchase products from, these customers will see Saudi Aramco’s success as their own success. 

4 is Saudi Arabia politically stable? 

The Middle East is one of the most politically volatile regions in the world. However, Saudi Arabia is one of the most stable countries in the Middle East. Since its establishment in 1932, the Saudi family has never faced a succession crisis or a coup. Over the years, the country has dealt with internal terrorist activities — as have most Western nations — but largely has been immune to the political instability of the Arab Spring. Much has been made of the generational transition between the current King, who is the last of Abdul Aziz ibn Saud’s sons to rule the country, and the Crown Prince, who will be the first of Abdul Aziz’s grandson’s to rule. However, the family’s political structure is such that the “next generation” has been participating in the country’s governance for years. This ensures that the generational transition will likely be as seamless as previous transitions. 

Saudi society is undeniably foreign and brutal to the outsider’s eye. The Saudi justice system includes punishments — beheadings, lashings and amputations — that the Western world considers barbaric. The strictures governing the separation of men and women are misogynistic and Islamic devotion is ever-present. However, the heavy handed totalitarianism coupled with the barren geography, the small and largely homogenous population and the traditional material generosity of the leaders to the subjects are all reasons a coup is unlikely. Moreover, regardless of the religious fundamentalism, Saudis have always run Aramco outside of these traditional dictates. Saudi Aramco’s headquarters in Dhahran look and feel like any other modern, Western company. In short, the Kingdom of Saudi Arabia and Aramco are as stable as any other investment. 

Conclusion 

Ultimately, whether or not Saudi Arabia offers shares in its most important asset, and in what form, will be a decision the monarchy and the company make for their best interests. Will investing in Saudi Aramco be a good decision? Saudi Aramco’s vision is to become the world’s leading energy and chemical enterprise. In its 35 years of Saudi ownership the company has pursued this dream with relentless success. If the past is any indication of the future, Saudi Aramco’s future looks promising.  

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