The Kingdom of Saudi Arabia made history on November 17, 2019. Its state-owned oil giant Aramco—the world’s most profitable company—made an initial public offering (IPO) of its shares to individual and institutional investors, setting a new record for the world’s biggest stock market launch.
An IPO allows a private company to publicly sell its stocks to the general public through one or more stock exchanges, where they must be listed. Aramco, which stands for the Arabia American Oil Company (the name coined by its founder, the Standard Oil Co. of California, in 1949), has been wholly owned by the Saudi government since 1981. Its official name is the Saudi Arabian Oil Company.
Aramco’s IPO became part of Saudi Crown Prince Mohammed bin Salman’s (MbS) Vision 2030 goals to diversify and boost the competitiveness of the non-oil sectors of KSA’s economy, reduce its dependence on oil, and attract more foreign investment to the kingdom. Saudi Minister of Energy and Chairman of Aramco’s Board of Directors Khalid al-Falih, said recently that the company would play a major role in implementing Vision 2030.
Aramco will transition from a purely hydrocarbon development company to a “much more technology- and knowledge-driven organization . . . . Saudi Aramco will develop a stronger downstream business, double refining capacity, expanding into chemicals, do more with renewables, create new technologies through its research and development efforts, and develop new business lines through investments and acquisitions,” according to al-Falih.
MbS hopes that the new version of Aramco will help modernize the Saudi economy in step with a changing global economy.
MbS hopes that the new version of Aramco will help modernize the Saudi economy in step with a changing global economy. Leading up to the IPO, Aramco aimed to sell up to 5 percent of its equity with a valuation of 2 trillion USD. The offering having ended to individual investors, institutional investors had a deadline to make their offers by December 4, 2019.
While the Saudi authorities have been preparing Aramco’s IPO for several years, the November launch has faced more challenges than they anticipated. So far, the company has fallen short of drawing much interest from Western investors. It has reduced its offering from 5 percent to 1.5 percent. Many Western finance observers insist that MbS’s goal of a 2 trillion USD valuation for Aramco is too ambitious and may even be too high so as to be unattractive to most institutional investors. In fact, analysts argue that the Saudi government overvalued the IPO by almost 35 percent, which means that investors are paying nearly 35 percent more for the company’s shares than they are worth. Investors are skeptical about the unreasonably inflated IPO prices. The more realistic valuation could be below 1.5 trillion USD. This is higher than Microsoft’s market capitalization, but it may be lower than what MbS had expected from Aramco’s public offering.
Failing to raise the planned 100 billion USD after the launch, Saudi officials are grappling with the bruised global prestige of Aramco and an inability to push forward the ambitious domestic economic reforms tied to its desired profitability. However, it was not all bad news for the company. It raised about 44 billion USD from Saudi and institutional investors.
The challenges and uncertainty are not just limited to Aramco. Saudi Arabia’s relationship with the Organization for the Petroleum Exporting Countries (OPEC) is bound to get more difficult. In fact, Aramco’s partial privatization will have a major impact on KSA and OPEC. The oil cartel’s power to dictate global oil prices has been diminishing over the past five years as the U.S. shale oil industry has risen to challenge it. Since 2014, KSA has been trying to partner with non-OPEC oil producers, such as Russia, to coordinate oil output cuts, boost oil prices, and galvanize enough pushback against American shale producers. But such cooperation has not prevented Russia from violating production cut agreements with the cartel. Just this November Moscow increased (again) its oil production level more than it was agreed on with OPEC.
As Aramco goes public, KSA’s ability to be a swing producer in OPEC and a leading decision-maker over oil production levels will diminish.
As Aramco goes public, KSA’s ability to be a swing producer in OPEC and a leading decision-maker over oil production levels will diminish. Aramco has always been the Saudi state’s instrument of influence over the cartel’s policies. As a publicly traded company, Aramco will need to care about interests of private investors, which may not be in line with those of OPEC. The company would have to justify its moves to cut or increase oil production to investors. At the same time, its non-compliance with OPEC’s production requirements would render the oil cartel meaningless and weak.
Because the Saudi state remains the majority shareholder in Aramco with a stake of around 98 percent, private shareholders will have little influence on either the company or the Saudi government. Nothing will stop Saudi officials from taking money from Aramco if the state is running low on cash. Because of the volatility of oil prices, geopolitical risks (i.e. numerous wars and conflicts in the Middle East and North Africa), and the government’s continued overwhelming influence over the company, private investors would likely seek a risk premium in the form of higher dividend payouts than desired by Aramco. Another problem for investors is MbS’s goal to channel the money earned from Aramco’s public offering not back to the company, but to his National Transformation Program to start reforming the oil-based Saudi economy. These factors perhaps explain the tepid response from Western investors to the world’s biggest IPO.
A new Aramco potentially exposes itself to more risks than it has before as a purely state-run company.
Going forward, a new Aramco potentially exposes itself to more risks than it has before as a purely state-run company. Aramco could face potential lawsuits through a 2016 U.S. law that allows legal action against Saudi Arabia for the September 11, 2001, terrorist attacks and a 2019 NOPEC legislation (yet to be enacted) targeting OPEC. Such suits could have damaging effects on the company and spook investors.
An emerging big risk to Aramco will be from environmental groups as the global threat of climate change has been putting a particularly negative spotlight on oil and gas companies. Aramco’s profitability in the West could be further diminished and its image tarnished if climate change activists file a lawsuit against the company in Western countries.
The Saudi government has been planning the Aramco IPO for a long time with the goal of having it serve as its tool to help reform the oil-dependent economy of the kingdom. But MbS cannot have his cake and eat it too: once a publicly-traded company has other moneyed interests that can make or break its profitability, it can no longer be a state’s tool without facing financial and reputational losses. Investor skepticism will grow if the Saudi government abuses its majority shareholder role in Aramco.
At this juncture, MbS is unlikely to reach his minimum of 2 trillion USD valuation of Aramco because he is unable to control the market and the existential risks faced by the company. The company cannot keep inflating its share prices. Eventually, the market catches up with that.
But he can make up his mind whether the company should be fully transparent and realistic with respect to its financials for its long-term health, and whether it should operate in the interests of private investors or the state. The latter concerns are mutually exclusive.
KSA’s inability to appreciate the serious import of these issues will prevent it from realizing its Vision 2030 dream.