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Aramco IPO May Ultimately Change Saudi Arabia’s Oil Policy

Markets are buzzing about the potential valuation of Saudi Aramco after the state-owned oil giant announced plans to hold an initial public offering (IPO).

How much is the world’s largest oil company worth? It’s an important question given the difficult market for global oil equities these days. But it’s arguably not the most important one. The Aramco IPO should have significant ramifications for global oil markets and energy equities, and these should not be ignored amid the fervor overvaluation.

How the IPO affects Aramco strategically and operationally is critical. Aramco has long been recognized as the best-run oil company in the Middle East. While floating a meager 2 percent of its shares on the Saudi stock exchange, the Tadawul, may not seem like much, it may portend significant shifts in Saudi oil policy down the road.

The point of the IPO is to raise $25 billion to diversify the Saudi economy away from dependence on oil, part of Crown Prince Mohammed bin Salman’s Vision 2030 reform plan. The cash generated by the sale of Aramco equity will go to the Public Investment Fund (PIF), the Saudi sovereign wealth fund, which will invest it in projects and companies unrelated to oil.

That points to more sales of Aramco stock in the future. Indeed, the Crown Prince has suggested that up to 10 percent could be sold in the future to raise $100 billion and has mooted that over the long-term, a majority of Aramco stock could be sold to outside investors. A foreign listing, perhaps in London or Asia, is planned a few years down the road, and Riyadh will undoubtedly need access to bigger capital markets than the Tadawul to realize its ultimate goals.

But as more stock is sold to outside investors, Aramco will find itself under greater pressure to operate differently. Investors will want the company to maximize short-term profits, which means leveraging its access to the world’s largest low-cost conventional oil reserves, which amount to 266 billion barrels to the maximum. Aramco’s current plans to expand in lower-margin businesses like global refining and gas markets may be sidelined in favor of tapping easy to reach domestic oil reserves and pushing up production capacity.

As the global oil market moves toward peak demand in the coming years, it makes sense that the world’s lowest-cost producer will want to secure and expand its market share. Of course, it makes no sense for Aramco to do this if it tanks oil prices in the process.

That’s where Saudi Arabia’s long relationship with OPEC comes into play. In the short-term, Saudi Arabia will continue with business as usual within OPEC, which means staying with price-supportive supply cuts. Indeed, even OPEC’s forecast shows that such cuts could be needed for the next five years to keep oil markets balanced amid booming non-OPEC supply, led by U.S. shale, but also Brazil and Guyana.

That means Saudi oil policy and its approach to OPEC won’t change overnight due to the Aramco IPO. The Saudis’ goal will remain maximizing revenue, not production from Aramco. That goal aligns with what outside investors will want from the company because more significant revenue should equate to bigger dividends.

But it will be interesting to watch how Aramco is managed over the next decade as more shares are floated and non-OPEC supply growth slows. As the oil-demand pie shrinks, it’s only natural for Saudi Arabia to seek a more significant share of the market. Will Saudi Arabia have the same need for OPEC in five or 10 years? It’s already the undisputed king of the cartel whose words can sway markets single-handedly, and its current alliance with non-OPEC Russia is viewed as its most crucial producer relationship today.

The upcoming Aramco IPO will likely draw investment from wealthy Saudis who Riyadh has pressured into buying and holding shares, as well as some sovereign wealth funds from Russia and Asia, who are keen to gain political favor with the kingdom. The idea behind securing these “anchor” investors is to assure a high, stable valuation on the local market for Aramco so the Crown Prince can claim success with his Vision 2030 reform program.

Banks like Goldman Sachs and Bank of America working on the Aramco IPO say it is worth $1.6 trillion to $2.3 trillion, but others unaffiliated with the deal are less enamored. Fund managers and institutional investors have estimated a valuation closer of $1 trillion to $1.5 trillion.

But ultimately, over time, as more Aramco shares are floated, the accurate valuation of Aramco will come to light. That’s when more unbiased institutional investors will have a go at it. These are the real market makers.

And that’s when it would behoove Aramco to demonstrate growth potential to draw investment and support a higher stock price. Should that occur, Aramco may take investment away from leading international oil companies like Exxon Mobil, Royal Dutch Shell, Chevron and BP. So dramatic could this shift be that energy economist Philip Verlerger thinks it could hurt capital spending capacity at these Western majors, which would need to spend more on stock buybacks to make up the loss of investment.

This moment of truth for Aramco may very well coincide with expected declines in non-OPEC supply growth, which could ultimately force Saudi Arabia to rethink its relationship with output curbs and OPEC altogether.
Source: Forbes

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