Saudi Aramco is grabbing a lot of headlines this week with its half-year earnings of nearly $50 billion and first ever earnings call. But it’s never been a secret that Aramco, the world’s largest oil company and its lowest-cost producer, is also the biggest cash machine.
State-owned Aramco last year issued public debt for the first time and continues to toy with plans for an initial public stock offering (IPO) – the reason behind this week’s unprecedented public disclosure of earnings.
If Aramco goes ahead with plans to sell up to 5 percent of its shares, investors will undoubtedly bite. The desire – and, in the case of many passive index funds, the need – to own part of the world’s largest energy company that delivers higher profits than any other multinational, will ensure Aramco’s order book is filled.
But what’s the broader investment rationale for an IPO? It’s certainly not growth.
Saudi Arabia’s Aramco sits on some 266 billion barrels of oil reserves, and with production costs of less than $3 a barrel, the Saudis could quickly increase output by 50 percent – from around 10 million barrels a day today to some 15 million barrels a day. That would be a great growth story, boosting Saudi market share in key markets like Asia and putting many rival higher-cost producers, including some in the United States, out of business quickly.
But that’s not going to happen. Such a move would tank the price of oil and wreck the economies of many of Saudi Arabia’s fellow OPEC members. Saudi Arabia is the de facto and undisputed leader of OPEC, and it has no intentions of giving up the political clout that comes with that status.
Aramco Chairman and CEO Khalid al-Falih is also Saudi Arabia’s energy minister. He is the architect of a 1.2 million barrels a day supply cut deal that OPEC forged with Russia and several non-OPEC producers. The agreement has kept a floor under prices since its inception in late-2016.
If anything, participants in this deal need to cut more output moving forward after the price of Brent benchmark oil fell below $60 a barrel last week. Indeed, Saudi officials spent last week reaching out to their partners to discuss additional cuts.
The world doesn’t need more oil right now and that’s unlikely to change anytime soon.
Not with U.S. shale expected to keep growing at a blazing pace in coming years. But it’s not just the United States that is rapidly increasing non-OPEC supply. Considerable investments in Brazil’s offshore are now starting to bring on vast amounts of oil, and Guyana is on its way to becoming a major producer and exporter, too.
That could put OPEC in the supply cut business for at least the next decade.
And that means Saudi Aramco, should it go public, clearly won’t be a growth play for investors. Shareholders might push for a new strategy, but even if the entire 5-percent stake was in the hands of a single investor, that level of ownership wouldn’t get you far on a corporate board. Certainly not one like Aramco, which is responsible for funding the majority of Saudi Arabia’s federal budget.
Unless it establishes a generous dividend program, Aramco might be viewed as a less attractive investment than some listed international oil companies (IOCs). At least leading IOCs like Exxon Mobil, Chevron and Shell can set production growth and other operating targets unconstrained by OPEC politics.
It is these Western major oil companies that are starting to put pressure on Saudi-led OPEC –and thus Aramco’s future – by increasing output. Exxon and Chevron are the largest players in Texas’ Permian Basin, the most important U.S. oil play and the biggest source of non-OPEC production growth in the world.
In other words, they are OPEC’s biggest headache. The shift in control of Permian assets from free-wheeling independents to well-capitalized majors has long-term ramifications for the shale basin’s future. It all but ensures the Permian will remain a significant force in global oil markets for many years to come.
And the majors are performing exceptionally well in the Permian, reporting their strongest well results yet in the second quarter of this year.
Exxon’s production in the Permian shocked analysts, rising by almost 90 percent from 2018 levels to around 275,000 barrels of oil equivalent per day. Those numbers are keeping the company on track to reach its goal of producing 1 million barrels a day from the Permian by 2024.
Chevron boosted its Permian production by 55 percent year on year to 421,000 barrels of oil equivalent per day, putting it well on its way to 900,000 barrels of oil equivalent per day by 2023. Both companies are due to generate healthy profits from the basin, even at lower prices.
The majors’ production costs may not be $3 a barrel like Aramco, but the investment rationale is easier to see – profitable growth and rising dividends.
Even so, the majors continue to struggle in equity markets. It’s tough sledding for all oil companies in the stock market lately – and it has been that way for some time. Investors are no longer enamored with the shale boom. Oil company equities across the board have underperformed major stock market indexes for several years now.
It’s baffling why Aramco would consider going public now. It generates enormous profits, but it’s prospects are constrained by OPEC policy. Furthermore, the Saudi oil company is expanding into businesses like refining, petrochemicals and natural gas that deliver substantially lower returns than its core upstream business. You can bet investors won’t be thrilled about that.
Operating amid seemingly endless Mideast tensions is a turn off to investors, too. So is knowing that you, as an investor, will always take a backseat to Riyadh in Aramco’s decision making.
So my advice to Aramco’s board and the Saudi leadership is to keep the company private. Some splashy headlines aren’t worth all the trouble.