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Economics & Finance - BLOG

Aramco IPO: It’s Not About the Money

Yasser Al-Saleh, Senior Research Fellow at INSEAD |

Is the proposed sell off of Aramco the start of a Thatcherite revolution in Saudi Arabia?

“Welcome to Aramco…the government’s pampered baby”. Those were the exact words I heard from my scholarship manager upon joining the Saudi oil empire twenty years ago. Back then, the prospect of selling any part of the Saudi piggy bank was more science fiction than science fact. But the rationale behind contemplating such a move today is far from an apparent desire to raise money despite twelve-year low oil prices.

Some commentators have pondered whether talk of a sale is an indication that falling oil prices have left Saudi Arabia strapped for cash. That’s unlikely. The Saudi sovereign wealth funds are some of the world’s biggest, and the Saudi Government has substantial holdings in publicly listed companies. The ‘verifiable’ worth of Saudi investments is over $800 billion. This would be enough to cover its fiscal deficits for several years, even if oil prices remained below $30 a barrel.

If the country really needed to raise money, it could also consider selling land and property, the value of which is unknown, but expected to be in the billions of dollars. The government could also consider raising debt on international markets given today’s low interest rate environment, borrow domestically (either directly or through a bond issue). To support its spending in strategic areas like education and healthcare, the government could choose to tighten the purse strings on non-essential lavish spending or introduce additional economic reforms (such as energy subsidy cuts that have been recently implemented).

Nor should we underestimate the strong leverage the country has on global oil markets. While many analysts associate the current decline in oil prices with the ill-timed Saudi desire to drive shale oil producers from the market, it should be remembered that Saudi Arabia could utilise its unmatched power to unilaterally snap oil prices back at its will. Selling off equity in the country’s crown jewel to random investors will erode these powers. It would make Aramco, nevertheless, a more business-oriented entity that operates at arm’s length from the oil ministry.

What is the rationale?

The idea of an Aramco’s IPO, particularly with regard to selling shares in downstream assets, is not a new one. The aim of popularising these intentions is essentially to entice the appetite of foreign investors for the Saudi stock market, which has been plummeting in line with the burgeoning oil slide. This fall has continued despite the market being opened up to foreigners for the first time in June 2015. The Saudi stock market also wishes to upgrade from frontier to emerging market status by 2017. Listing Aramco is not about raising money as such; it is more a bold political message that no sector is immune from privatisation. Announcing these plans – irrespective of whether they bear fruit or not – is part of an unprecedented economic overhaul that has been enthusiastically labelled a ‘Thatcherite revolution’ for Saudi Arabia.

But would it work?

While Saudi Aramco claims to own reserves of over 260 billion barrels of oil, a prevailing culture of secrecy prevents any independent verification of this figure. Outsiders have questioned how Saudi’s reserve estimates could rise by fifty per cent in 1988, while many experts dismissed the figures as ‘political reserves’, the amount claimed to justify demands for higher production allocation within OPEC. Beyond possible political interference, the process of estimating oil reserves remains more a matter of probability and guess-work than certainty. In fact, it is impossible to place any firm confidence in any estimates of oil reserves, especially when they are exclusively controlled by one national oil company. This means that if Aramco’s much-touted initial public offering (IPO) does go through, it will be difficult to put a reliable dollar figure on its value. Back-of-an-envelope calculations of potential market capitalisation, even with current bearish oil prices, suggest this could be as high as $10 trillion, which would make Aramco the most valuable publicly traded company on earth.

Aramco will, of course, never float all of its shares on the stock market. The company’s chairman of the board recently confirmed that while the oil giant is looking into going public in some form, the Saudi Government will always retain a controlling share. Speaking arbitrarily, if Aramco floated just four per cent of its shares it could raise some $400 billion in what would be the largest IPO in financial history. This would have the additional effect of almost doubling the value of the Saudi stock market, which has been underperforming lately. Listing any slice of the business would however require Aramco to become more transparent about its operations and revenues, and exposed to external auditing.

Regardless of its ‘famously’ secretive nature, Saudi Aramco is considered the most efficient and least corrupt Saudi corporation, so it is often tasked with the design and construction of key infrastructural projects outside the energy industry.

History tells us that going public is not a panacea for government-controlled oil companies. For example, privatising Petrobras in Brazil exposed the corporation to the threat of corruption and greedy organisations seeking to exploit the country’s assets for their personal gains. Elsewhere, shares in the Russian oil giant ‘Rosneft’ have behaved irrationally since they were first made public a decade ago. Part of the poor financial performance has been attributed to inferior corporate governance arguably due to Putin’s iron grip on the company’s management which fuelled a wave of negativity against both the corporation and Russia’s ruling regime.

With this in mind, one may wonder why a successful company like Aramco would ever consider exposing itself to the potential risks associated with a public listing.

Greasing the wheels of change

A listing of Aramco could pave the way for a new era. The Saudi leadership should, therefore, pay closer attention to policy success and failure with regard to implementing economic reforms. In fact, it could learn a lot from New Zealand, the south Pacific nation historically dependent on heavily-subsidised agriculture and food exports. Faced with severe fiscal constraints in 1984, the New Zealand government implemented a courageous deregulation programme which included the removal of subsidies, the devaluation and subsequent floating of the currency and liberalisation of capital markets. Productivity levels rose and business performance is now substantially higher than during the period of high subsidies. While it’s true the success of New Zealand’s economy-wide reforms was partly due to factors like transparency and early-involvement of relevant stakeholders, securing a widespread acceptance was largely attributed to the bold leadership and swift execution on the part of the government.

It may be time for the Saudi Government to fast-track the pace of its economic reforms before short-sighted internal resistance rises to a level that hampers the government’s efforts to maintain political, economic and social stability in the oil kingdom.

Yasser Al Saleh is a senior research fellow at INSEAD

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Comment
Jan,

Every time a country decides to take the privatization route, it is about the money. What other reason would trigger privatization?

In the case of Saudi Arabia, my view is a lot less optimistic than that of the article.

First, it is important to recognize that oil price is going to play a huge role in the future of the country (and the region).

There is wide speculation on what the oil price could be in the future, but there are solid arguments to believe that low prices will stay for years:
- Supply will continue increasing in the foreseeable future: shale oil operations are become more efficient, other countries besides the USA are exploring shale oil as well, Iran will start pumping strongly
- Demand going down: China slowdown, world economy softening, no reason to believe demand will increase in the next few years

If we assume a low-oil price for the mid-term, the magnitude of the challenge becomes clear:
- Budget deficit in 2015 was $100Bn with an average price of over $50 per barrel
- 2016 could easily generate a deficit of $150Bn with current prices, cost of war, etc
- Central bank reserves are ~$620 Bn -> so the time left to fix the country with its own money is 4-5 years

And there is a lot to be fixed.
Saudi has high unemployment rates (around 12%) particulary for the youth (higher than 25%), and with a very young population that will enter the market in the next few years.
The public sector is too big, the private sector is inefficient and not competitive (except for oil).

The country as it is today, cannot operate without the huge subsidies from the government in all areas of the economy. And given the demographic patterns, it will require even more subsidies, not less, if employment is to be kept at reasonable levels.

4-5 years before Saudi runs out of money. Probably less.

With this outlook, which I believe is very well possible, Saudi Arabia needs to truly start reforming the country. And it takes much much longer than 5 years to change a country.
Look at Greece. Look at Spain and Portugal... A decade after the reforms 'started', the countries are doing poorly. And the starting point was much better than Saudi Arabia.

In this context, the first thing Saudi Arabia needs to do is buy time. The more it buys, the better.
Issuing debt is one way of buying time, and issuing debt now rather than in 4 years. There have been reports that Saudi was considering that, and they should...

The other way is privatization. For what reason? To raise money of course!
Aramco is one of the stars, but even Aramco will not save Saudi alone. The oil reserves in Saudi might be valued at $10TN, but Aramco (withouth the reseves) is worth $500 Bn.
So, privitizing Aramco, would raise, in the best case, $100-200 Bn extra: another year, maybe two of time. Of course Saudi could sell the reserves as well, sell a piece of the country, it is all possible. Greece could sell its islands, and Saudi its oil reserves. But I believe this would be the last resort.

In summary, Saudi has 4-5 years to change the country completely without extra income, which is not enough time. The country needs all the money they can get now, so that at least they can buy more time, and hope they can fix the country. Huge task ahead, but without time, it is not even possible.

Selling Aramco is the right move, but it needs to come with so many other reforms.
Adding debt, and with other privatizations, Saudi might have 7-8 years, maybe 10. After that, it is game over.
And of course that Aramco is about the money. What else could it be about?

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