Saudi Arabia’s Big Cash Grab (Before the Music Stops)

The Kingdom of Saudi Arabia (KSA) just threw a $2 trillion Hail Mary pass. Yes, I know that KSA is an Islamic country, so forgive the mixed religious metaphor.

But when Saudi sells even a small piece of its massive, state-owned oil company – long known as Saudi Aramco – it tells me that KSA is desperate for cash.

We’re witnessing a desperate money-grab by a country whose government is on its last legs.

Let me explain…

Outwardly, KSA appears to be wealthy, and a functioning nation. There’s the huge royal family, massive palaces, fancy cars, private jets, big military purchases and all the rest. The place looks flush, right?

But the reality is that KSA is in deep financial distress, for many reasons… And the people are restless. The ruling regime could fall like a house of cards. That’s the heart of the issue here.

So, keep your eye on the main ball that’s in play. KSA is selling off part of Saudi Aramco to raise fast cash.

Why call it a “Hail Mary”? Well… The usual term from the Islamic world – “Insh’Allah” (“God’s will”) – just doesn’t quite fit the picture.

Bottom line is that Saudi needs money, with which to continue subsidizing its lavish ruling class at the top, and buying off people who are ready to burn down the palaces.

Meanwhile, the Saudi sale of oil interest it tells us something about the state of the global energy industry after five years of relatively low prices.

Here’s some quick background.

For three years, KSA has teased the idea of selling off a small part of its state-owned Saudi Arabian Oil Company, aka Aramco. Dangling the bait, so to speak.

Why the long lead time? Saudis were gauging investor interest. That is, determine who wants to buy into Aramco and become a partner – a very junior partner – to KSA in terms of owning a piece of the world’s largest oil play.

Many international players were not keen on buying into Aramco. The company is notoriously opaque in terms of opening its books to outside scrutiny. With Aramco, it’s difficult to perform due diligence. You don’t know what’s inside the black box.

Still, the lure is that Saudi Aramco is a massive energy producer. It’s very profitable. It’s the world’s largest integrated oil and gas company, producing one in every eight barrels of crude oil globally. In 2018, Aramco produced 13.6 million barrels per day of oil equivalent (BOE), including 10.3 million barrels per day of crude oil, including blended condensate.1

Those are big numbers. And cash value from all that oil and gas is impressive.  For example, take 13.6 million BOE, times $50 per barrel; the low end of oil prices. That’s $680 million per day. Times 365 days… $248 billion per year.

What happens when oil prices are higher? Obviously, the daily, monthly and/or annual take moves up as well.

Meanwhile, Saudi costs for producing oil are low; under about $10 per BOE.

Compare Saudi’s $10 production cost with the cost to lift oil from the U.S. shale patch; up around the $30 to $40 range per BOE. Saudi oil is cheap to produce, and hence profitable.

In any commodity business – and oil is a commodity – you want to be the lowest cost producer. Low costs drive profit margins.

I should mention, though, that not all of that Saudi oil is sold internationally and exported. Saudi uses quite a bit at home for generating power, for motor fuel, chemical feedstock and more. That alone is a huge internal energy subsidy that eats up cash.

Still, keep that $248 billion number in mind…

So, if Aramco can generate over $248 billion per year, what’s the company worth? What metrics apply?

In the leadup to IPO, KSA wanted to value Aramco at $2 trillion… about eight times that $248 billion number.

After much delay, a couple weeks ago KSA held an initial public offering (IPO) for a small share – about 1.5% – of Aramco.

More than 80% of the IPO stake was purchased by Saudi buyers. Saudi citizens were encouraged by their government to buy shares as an act of patriotism. KSA officials encouraged the county’s wealthiest families to buy stock, and even offered cheap loans for purchases.

All this while interest from international players was lukewarm.

At the outset, the IPO sale price was 32 Saudi riyals (about $8.53). Then on the first day of trading, shares rose the maximum 10% to 35.2 riyals, giving Aramco a market value of around $1.8 trillion. Later, based on apparent government “encouragement,” Aramco’s market cap hit that magic $2 trillion.

All is well, right? Clearly, Aramco displays significant market value. And KSA raised about $26 billion via IPO. Will KSA eventually offer more shares? Time will tell…

Still, the fact is that current “free float” shares are miniscule, compared with other large companies across the world. Here’s the share structure of Aramco, compared with several other well-known companies and their share structures.

Charts

If you own shares in Aramco, you’re a small fish in a very big pond.

And post-IPO, what does the future hold?

Let’s stick with the Aramco play for another moment, and then get into global-level issues.

First, just like everyone in the oil biz, Aramco’s new investors will face oil-price volatility and geopolitical risks. Oil prices do what they do; up and down. But Saudi offers its own special version of geopolitical risk.

For example, recall a couple of months ago when about half of Saudi crude output was shut off by a series of drone strikes on just one major export point. In other words, Saudi Aramco is big; but it also offers big targets to bad actors.

And who attacked Saudi? Apparently, it was the Houthis of Yemen, against whom Saudi has been waging war for several years. So, if you buy into Aramco you’re buying into a company whose critical assets are targets in the middle of a war zone.

Second, Aramco’s new investors will have no influence on company governance. KSA is the majority shareholder. Sure, KSA will likely give the appearance of respecting what are called “minority rights” under business law. But if and when KSA has to make decisions that squeeze small shareholders, there’s no real recourse.

Third, the government of KSA can always dip into Aramco’s profits. All those royal households, fancy palaces, personal jets and huge military expenses have to be paid for somehow. And Aramco is the only piggy bank in town, so to speak.

Finally, there’s the Aramco dividend. The IPO promise is at least $75 billion per year paid out as dividends. At a market cap of $2 trillion, that’s about 3.75% yield; not bad, but…

If you’re looking for dividend yield from oil shares, you can do better than Aramco. BP pays a dividend of 6.7%. Shell pays 6.5%. Total pays 5.5%. ExxonMobil pays 5%. And Chevron pays 4%; all more than Aramco.

Of course, Aramco or no, the global oil industry has issues… And that’s perhaps the key to Aramco’s recent IPO.

One of these days, we’ll look back and realize that Aramco’s IPO established the high-water mark for extracting large amounts of cash from energy investors. KSA is raking in cash while it’s there to rake.

Or as Saudi Sheik and former Energy Minister Zaki Yamani once said, “The Stone Age didn’t end for lack of stones. And the Oil Age won’t end for lack of oil.” (Note: I heard him say this in a talk at Harvard, back in the 1970s.)

Think about this in terms of Chevron, mentioned above. The California-based company just announced a write-down of $11 billion in assets. According to Chevron CEO Mike Wirth, “We have to make the tough choices to high-grade our portfolio and invest in the highest-return projects in the world we see ahead of us, and that’s a different world than the one that lies behind us.” (Emphasis added.)

About half of Chevron’s write-down is with shale-gas projects in Appalachia, namely Marcellus-Utica plays. Chevron is also writing down a major liquefied natural gas (LNG) effort in British Columbia, called Kitimat.

Chevron is not alone in biting bullets. In October, oil services player Schlumberger took a massive $12.7 billion write-down due to the slowdown in shale drilling. Also in October, BP wrote down $2.6 billion in assets, while Repsol took a $5 billion impairment.

All of this is just the tip of the iceberg. It’s clear that across the world, investors and companies are reassessing the value of their holdings in the face of a global supply glut in oil and gas, as well as growing concerns about the long-term future of fossil fuels.

Indeed, there’s a new term floating around, namely “Peak Demand,” a play on the older concept of “Peak Oil.” Sheik Yamani’s long-ago comment may be playing out.

We’re in early innings for the transition away from Sheik Yamani’s “Oil Age.” There’s much yet to happen, and oil remains a critical, valuable commodity. But the writing is on the wall… The entire industry is transforming, based on new technology and changing social expectations.

KSA has long been a one-commodity nation; a petro-state, dependent on oil income to keep the lights on and population under control. But it’s all changing.

Indeed, as the future unfolds, Aramco is now trying to extract value from its oil and gas assets not by drilling, but by selling them to outside investors.

It’s Saudi’s last grab for cash before the music stops.

There’s your “Hail Mary” play… Insh’Allah.

On that note, I rest my case.

That’s all for now…  Thank you for subscribing and reading.

Best wishes…

Byron King

Byron King
Managing Editor, Whiskey & Gunpowder
WhiskeyAndGunpowderFeedback@StPaulResearch.com

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Byron King

A Harvard-trained geologist and former aide to the United States Chief of Naval Operations, Byron King is our resident gold and mining expert, and we are proud to have him on board as the managing editor of Whiskey & Gunpowder.

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