Saudi Arabia is pushing ahead with the much-watched IPO of the mainstay of its economy, Aramco, although with somewhat diminished aspirations.
The initial plan calling for a stake in Aramco to be sold off, sketched out in 2016, was intended to find the company valued at $2 trillion. The company called in a number of banks to advise it on how to achieve this target in an IPO but struggled to shore up such a value.
Aramco has now scaled backs its ambitions, and those of Crown Prince Mohammed bin Salman (MBS), accepting a projected value of around $1.7 trillion and the issue of 1.5% of its shares – down from a previously touted plan of 5% – on the domestic Tadawul exchange alone. This should raise around $24-26 billion. It is important for prestige reasons to surpass the previous IPO record, held by China’s Alibaba of around $25bn.
“Aramco’s efforts have not hit the high notes it had hoped for because of the paradox at the heart of the process. To get to the [higher] valuation, it would have needed a higher oil price – and that would only have come through Saudi cutting production levels,” Redburn’s analyst Stuart Joyner told Energy Voice. “The higher the oil price, the higher the valuation.”
Given the current oil price of around $60 per barrel, institutional investors found the higher price too big a leap.
Redburn published a report in September about the energy sector in transition, highlighting the much higher cost of capital for the industry than has previously been assumed. In calculations based on this stage of transition, Redburn has a price for Aramco of “much closer to $1trn”.
A sale to domestic investors taps a different market, than the previous discussion of international partners. Where an institutional investor will be trying to beat an index or benchmark, Joyner noted, retail buyers are more likely to compare the dividend price to the interest paid by a bank.
Aramco plans to pay a dividend of $75 billion in 2020, according to a statement in September, with a yield to investors of just under 5%. “It’s an important component to get buy in from the domestic population,” Joyner continued, “it’s more than just fundraising. It’s part of a broader reform movement to create a share ownership culture, encourage investment and entrepreneurship. It’s part of the broader [MBS] agenda to move Saudi up the economic league.”
There are a number of domestic imperatives at work in the sale of the Aramco stake, though. Falanx Assynt’s managing director Charles Hollis, in comments to journalists a briefing this week, noted that a number of businessmen had been moving money out of the country over the last two or three years, amid scepticism of MBS’ Saudi Vision 2030. Those with cash in the country “are under considerable pressure to invest or be under some form of house arrest”, as is the case with Alwaleed bin Talal, who is not allowed to leave the country.
Further risks come from the encouragement of small retail investors to take out loans in order to acquire shares in Aramco. Should the price decline, Hollis said, this would leave these people with negative equity, “which would tarnish the whole project” and the blame would be laid on MBS.
The Saudi government has played an important role in subsidising the lives of its citizens. While lifting costs per barrel of oil are possibly the lowest in the world, the International Monetary Fund (IMF) has said the fiscal breakeven price is more than $80 per barrel, in order to cover the country’s expenditures.
An effort to reduce benefits in 2015 was very unpopular, leading the government to change its tack and bring them back. “It is important for [MBS] to deal with this economic challenge in order to secure his future.” According to Falanx, Saudi’s reserves have been run down by around $200bn over the last four years.
The 2017 arrests of many leading lights of the Saudi society, infamously held in the Ritz Carlton, was “in part to provide revenue stream, it was not a genuine anti-corruption push – or at least that’s how it is seen in Saudi Arabia. Rather it provided [MBS] with immediate funds for the Saudi concerns.”
While Saudi’s efforts to use the Aramco sale as a trigger for broader change in the country’s outlook have been scaled back as reality sets in, there is continuing interest in privatisation from a number of state-run companies.
“There’s an opacity problem” with oil and gas companies that have been state held, Joyner said. Forecasting that oil demand would decline in 2020, he noted that “with hindsight, these sales would have had much better reception five or 10 years ago.” Such sales would need to take into account the higher cost of capital flagged by Redburn in its Lost in Transition report, he reiterated, although “everything is sellable at a price”.
There is a strong case to be made for diversifying an economy, the analyst continued. The process of selling off a stake in Aramco, even such a small one, begins to chip away at the extent to which the company is aligned with the government. Encouraging competition and entrepreneurship is one of the reasons that the “North Sea has defied gravity for so long”, Joyner said.
Once the sale has been completed, the Saudi government will receive direct feedback from the market about how successful the company is seen as being.
The Russian government also had high hopes for Gazprom, the state-controlled gas company. Gazprom’s head Alexey Miller, in 2008, said the company would be the world’s first trillion-dollar company. From a peak of around $350bn it sank in value to a low of $54 billion, BNE Intelligence’s editor-in-chief Ben Aris, a long-time Russia watcher, noted.
Gazprom generates a substantial amount of cash, Aris continued, but that is largely recycled into the company’s infrastructure projects. Just as the Russian company’s crop of major pipeline projects is nearing completion, another set of investments – this time LNG plants – are planned to begin. “Gazprom is not a company, it is the ministry of energy infrastructure. Aramco is surely in the same boat, as a government vehicle for developing domestic infrastructure.”