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What Is Saudi Aramco Worth? It's Complicated

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[This is not intended as investment advice, but a stab at illuminating the primary issues involved in the IPO. ]

The Saudi Aramco IPO, as recently announced, suggests a value on the company of $1.7 trillion, compared to valuations by various investment banks falling between $1 and $2 trillion. It if takes a billion dollars to be a ‘unicorn’ in Silicon Valley, perhaps Saudi Aramco is Bigfoot riding on a unicorn. But given the recent track record of IPO’s, some might wonder if the company’s value is a little too chimerical.

The idea that some high-tech companies’ overvalued IPOs would affect Saudi Aramco’s value might appear ludicrous, but investors have been known to be influenced by any number of less-than-completely-rational effects.  Still, many of the questions that have been raised are valid, although some now appear less relevant to the value of the company.

First, there should now be little dispute about its oil and gas reserves, as they have been audited by reliable outsiders. The company has enough oil to cover any likely needs for decades to come. Peak oil advocates who questioned the honesty of the company’s claims have largely gone silent, as subsequent events have shown the company well-blessed with resources. (2005’s Twilight in the Desert argued that the company was facing an imminent collapse in production; a decade and a half later, production remains robust.)

Second, concerns that much of the company’s oil reserves might be stranded by peak oil demand should not be taken seriously, since even if global oil demand peaks in the next couple of decades, as the world’s lowest cost producer (challenged only by Iraq), Saudi Aramco will be the last oilman standing should the industry enter decline. (Saudi Aramco’s IPO put its breakeven cost at less than $10/barrel.)

Concern about risk from political instability in the region is certainly valid, as illustrated by the September attacks on Abqaiq, the giant oil facility in Saudi Arabia.The region, and oil companies operating there, are well used to wars, sabotage and terrorism which is not to say they should be considered normal or background noise. On the other hand, the company demonstrated that it is quite capable of coping with such problems, and the income lost due to the missile and drone attack was fairly minor; the production loss was about 1% of annual supply.

Resource nationalism is always a concern when investing in commodity producers, but Saudi Arabia is not alone in this. Countries like Canada and Norway have sometimes adopted policies that draw protests from the industry, and even the U.S. is not above such. While the current focus in American petroleum politics is on the fracking ban proposed by some Democratic presidential candidates, Republicans have not always been oil industry friendly:  both Jeb Bush and Arnold Schwarzenegger opposed offshore drilling as governors of their respective states.

Indeed, I have often pointed out that the government of Angola, since 1975, has posed much less political risk to its oil operators than the government of, say, Canada since that time, mainly reflecting its reliance on oil revenue. Although there are few similarities between Angola and Saudi Arabia, they both have a heavy reliance on oil revenue, which implies that the Saudi government will generally seek to maintain stable, if not robust, oil prices and sales.

I would expect that Saudi Aramco will draw three types of investors:  Saudi citizens, motivated in part by patriotism; foreign investment funds from countries whose governments want to curry favor with the Saudi government; and those who see the company as a good investment.The precise breakdown among them is impossible to predict at this point. Those who invest for financial reasons are not unlike those who bought shares in BP Royalty Trust, a financial instrument geared to income from BP’s oil production in Alaska. Essentially, it was a bond whose yield depended on the price of oil.

Saudi Aramco shares will, on the other hand, have a yield apparently geared towards the company’s income, which is primarily a function of the price of oil and the volume sold. This means that investing in its stock is to take a position on the oil market outlook over the medium term of three to five years. (Beyond five years, the net present value of any returns is small.) This is not without risk, especially of the possibility that Iran and/or Venezuela might see shifting political winds which result in their production rising sharply, but neither seems imminent, to put it mildly.

Given the importance of oil revenues to the Saudi economy and government, it can be assumed that they will attempt to maximize, as they have done in the past. (‘Attempt’ being the operative word, since the oil market is influenced by Saudi policy but far from controlled by it.) Both the EIA and the IEA expect longer-term markets to be robust, with slight pressure on OPEC’s market share and/or rising prices and that is the dominant factor determining the value of the company.