Is Saudi Arabia selling off Aramco for peanuts?

When it comes to the price of oil, some exporting countries have just one urgent priority: to restore their oil revenues, but Saudi Arabia has two. Indeed, if the price of crude oil does not rise significantly, plans for the partial privatization (IPO) of the state-owned Saudi Arabian Oil Company (ARAMCO), scheduled for 2018, may capsize.

And yet, this is one of the key measures announced by the Deputy Crown-Prince, Mohammad Ben Salman, as part of his Vision 2030 but it suffers from a fundamental flaw. On one hand, the Prince has insisted that this IPO was not designed to raise liquid assets, but on the other, he has said that the operation is meant to contribute to the creation an investment fund, of which Aramco will be a core asset.

The sale has to bring in the highest price possible for the Saudi government and its future fund, whose purpose is to accelerate the diversification of the economy in view of the post-oil era. The Deputy Crown-Prince - the real power behind the throne - has estimated the value of the oil company at US$ 2,000 billion.

The IPO would concern about 5 percent of the capital. If the asking price for Aramco is too high, it may not bring in the anticipated success, especially among foreign investors. If on the contrary the offer is too low, the government will be accused of selling off the company for peanuts.

Saudi Arabia has already started the necessary preparations for an IPO of Aramco, in particular the certification of the country's reserves, and an audit of its accounts. Officially, the proven reserves of Aramco's crude oil are estimated at 261 billion barrels (Gb) and its reserves of natural gas at 8,430 Gm3*.

The sale has to bring in the highest price possible for the Saudi government

CEO of the company, Amin H. Nasser, is confident that these figures will be certified by independent auditors. Ben Salman's estimate of US$ 2,000 billion is said to be based on a price of $8 per barrel of reserve, but specialists across the board agree that the reserves alone are not an adequate indicator.

No oil company's value is based on its reserves alone. And this is even less pertinent in the case of Aramco, as the company does not own its reserves; they belong to the state. It is therefore necessary to calculate how much profit an investor may expect to earn by buying Aramco stock.

How much is Aramco worth?

The provisional calculation of the operational results of the Saudi company, in its simplest form, ought to take into account a hypothetical oil price, a plausible tax-rate, production costs and production volume. Though there is no official confirmation of the figure, it would seem that Aramco pays a royalty of 20 percent per wellhead and a tax of 85 percent on revenues.

US analyst Boslego Risk Services took as a base for its calculations an estimated production cost of US$10 per barrel, and a production of 10 million barrels per day over a period of 70 days. Applying a 10 percent discount rate, they reached a net valuation of only US$251 billion at a price of 70 dollars per barrel - a figure which falls to US$120 billion for the barrel at US$40 (see table).

The sale of five percent of the firm would only bring in between US$6 billion and US$12.55!

If, as was announced recently, the tax rate is lowered to 50 percent - more in line with standard practice in developed countries - the valuation would almost double, but would remain well below US$2,000 billion.

Wood Mackenzie however, claims to have estimated the valuation of Aramco at around US$400 billion, based on a price of 70 dollars per barrel. This is still much lower than the estimated valuation proposed by the Deputy Crown-Prince.

Source: Boslego Risk Services

Future investors will also take into account the political risks involved, notably due to the fact - publicly confirmed by the Saudi Minister for Energy, Khaled Al-Falih, that the government will retain full control over the company's production and investment strategies, even after the IPO.

"Investors will just have to accept that. It's part of the package," Falih declared.

Like any other state, Saudi Arabia will also remain sovereign in fiscal matters. Will it pursue its policy of keeping a part of its production capacity unused (approximately two billion barrels per day) in order to cope with emergency situations, such as a risk of scarcity should another country's supply decrease?

The government will retain full control over the company's production and investment strategies

If so, then the cost of that unused capacity must also be taken into account. And finally, for the moment there is no way of knowing whether the IPO will include only Aramco's upstream operations, or its downstream ones as well. These valuation estimates have for the moment only focused on the upstream operations.

Amin Nasser recently declared that sometime around 2025, his group will become the world's largest refinery. He also has vast holdings in the petrochemical sector, which is growing in leaps and bounds. 

Changing mentalities

Aramco's IPO project has stirred much discussion in Saudi Arabia. The country has one of the world's highest penetration rates on the social media networks that are so popular among its citizens.

The concerns expressed by Saudis on Twitter and Facebook, are of several kinds: Are we going to sell off our chief national resource? Are foreigners going to take control of our oil? What have we to gain by privatizing Aramco if it means taxing the company's revenues less, which will cost the state dearly?

Are we going to sell off our chief national resource? Are foreigners going to take control of our oil? What have we to gain by privatizing Aramco?

Today Aramco is the wealth of the nation, tomorrow, might it belong only to those who can afford to buy shares? The main problem deciding how much Aramco is worth. If its value is low, why privatize it? And if the price of oil suddenly went up, why would it need to be sold?

Some Saudi officials say the Aramco IPO is chiefly meant to create a shock - to send out a signal designed to change business people's way of thinking, encouraging them to introduce transparency into the management of their companies and accounts, and forcing them to be more concerned with profitability.

The operation is therefore an integral part of the effort to change the behaviour of the business class, the key goal of Mohammad Ben Salman's Vision 2030.

Differences of opinion regarding this IPO are also evident within the Saudi royal family, with its approximately 15,000 members. Some are said to be favourable, others firmly against. And then there are those who say nothing, but who are suspected of political manoeuvring - suspicions which none can verify.

The failure of Aramco's IPO project could very well galvanize its unhappy citizens

Some also point out that the Crown Prince and heir to the throne, Mohammad Ben Nayef has made no public statements, either on this, or other thorny issues resulting from initiatives taken by his cousin, Mohammad Ben Salman, such as the war in Yemen.

What would his opinion be on these issues? After all, King Salman Ben Abdelaziz is 81 and isn't getting any younger. 

The drop in oil prices has played havoc with Saudi Arabia's finances. Its currency reserves fell from US$725 billion in mid-2014, to US$528 billion by the end of 2016, according to the International Monetary Fund (IMF).

Its foreign debt rose from zero before the crisis, to US$57 billion in 2016, and according to the predictions of Standard & Poors, will reach US$112.8 billion by the end of 2017 and US$174.3 billion by the end of 2018. It would then represent 25 percent of the country's GNP.

In 2016, the state cut back spending by US$250 billion, plunging the economy into the doldrums. Unemployment, which was already high, soared to new levels, and the deportation of migrants in successive waves is will not be enough to solve this problem. Saudi Arabian society is starting to grumble. The failure of Aramco's IPO project could very well galvanize its unhappy citizens.

Pierre Terzian is Director of the company Petrostratégies