Investors evaluating Aramco IPO

Investors evaluating Aramco IPO

Saudi Arabia – the world’s oil market maker – is gearing up for the historic initial public offering (IPO) of state oil giant Saudi Aramco. Given that Aramco is the most profitable company in existence, earning $68 billion between January and September of 2019, expectations are high for the largest IPO to date. But headwinds exist. Oil prices are middling, oil demand is tepid, and Middle East oil supplies are under constant threat of attack or seizure.

As Forbes reports, attempting to put a further damper on the IPO deal, Iranian President Hassan Rouhani announced on Sunday the discovery of a new oil field, purported to contain between 20-50 billion barrels of oil – a value of $1 - $2.5 trillion at a global oil price of $50 per barrel.

Yet, under the current sanctions regime, Iran lacks the financial and technological resources to exploit such a find. China, one of Iran’s few remaining global partners, is capable of developing the field, but Beijing is likely refrain from doing that given the enormous political risk.

But the Iranian discovery isn’t slowing the Saudis down.

Approval of the Aramco IPO by the Crown Prince Mohammed bin Salman is part of a larger initiative to reform and fundamentally improve the Kingdom’s economy – which has long been reliant on oil for revenue. Saudi Arabia needs a systemic reform package to bootstrap itself to the 21st century.

The Saudi oil giant is responsible for 10% of global oil production and published its prospectus last week. This provided a first glimpse into the company’s financial and business strategies – including the economic, political and business risks Aramco faces.

While Prince Mohammed priced Aramco at $2 trillion, bankers have estimated it to be valued closer to $1.5 trillion, with bidding to purchase shares beginning November 17 and final pricing set for December 5. Shares would be sold on the Tadawul, the Saudi stock exchange.

As the most profitable company in the world and the largest oil producer, Saudi Aramco is seen by many as an attractive investment option. Aramco also boasts some of the lowest production costs of oil in the world, able to extract a barrel of oil for under $9, while U.S. shale operators average closer to $20 – a significant advantage over rivals.

Consistent with their Belt and Road strategy, the Chinese Silk Road Fund, state-owned oil producer Sinopec Corp (NYSE: HKSE), and China Investment Corp are among the first big players to express interest in the Aramco IPO.

CONCERNS OF PEAK OIL DEMAND AND CLIMATE CHANGE

Despite its overwhelming size and yield - $111 billion in profits in 2018 (see above graph) – certain geopolitical and economic risks may deter major investors from buying shares in the Saudi oil giant. Peak oil demand forecasts, a global push to reduce emissions, and geopolitical unrest all pose as significant risks the prospectus outlined to potential investors.

Amid growing concern over climate change, there has been an overall trend by investors to diversify away from fossil fuels and shift investment to clean energy sources. Earlier this year, the world’s largest sovereign investor, the Norwegian oil fund, announced it would move away from fossil fuels – removing roughly $7.5 billion of oil and gas companies whose business operations focus on exploration and production.

Consequently, this push towards renewable energy has forced some of the world’s largest oil producing members, specifically OPEC, to decrease its production forecast to 32.8 million barrels per day (bpd) by 2024 – citing an increase in alternative energy and climate change as factors.

As the recent Iranian attacks on the Saudi oil facilities and fields demonstrated, geopolitical conflicts in the Middle East and Africa threaten Saudi Aramco’s oil production and important transportation routes. In September, Saudi oil facilities were struck by drones and cruise missiles – removing 5.7 million bpd of oil form production and causing oil prices to spike, albeit briefly. Escalating tensions, a rash of attacks and seizures of oil tankers, and threats by Iran have jeopardized the Strait of Hormuz, a vital transit route to oil reaching other markets. In 2018, oil transportation via the Strait averaged 21 million bpd.

Perhaps most notable in the Saudi Aramco prospectus was the assessment conducted by IHS Markit Ltd., forecasting that peak oil demand may occur in the next 20 years. The Kingdom has previously downplayed any such notion of a slowdown in oil demand – signaling that Riyadh is positioning itself for a low-carbon future.   

The Aramco IPO comes at a time of ambiguity in the global oil market – with low oil prices, an abundance of global oil reserves, and heightened geopolitical risk triggered by Iran. While market and geopolitical forces will make this IPO more challenging than they had hoped, Saudi Arabia has pledged to do whatever is necessary to ensure the success of the IPO.

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