DW: Saudi Aramco IPO – Winning the battle but losing the war

In today’s DW Monday report, Douglas-Westwood comments on a potential initial public offering (IPO) of Saudi Aramco, which may be included as part of Saudi Arabia’s economic reforms.  

Saudi Arabia’s reluctance to cut production to maintain its share of the global crude market has paid off. By not “blinking first,” the Kingdom has succeeded in driving rigs out of the US shale market, with current rotary rig counts down 65% from 2014 highs in September. This has led to significant decreases in production in the Bakken (-10%) and Eagle Ford (-20%) shale plays over the same period. The situation has been compounded by the retraction of the zero interest rate policy, which is expected to limit further investment into small-cap shale. This has caused many analysts (FT, CNBC, etc.) to sound a death knell for the once-heralded tight oil industry, where up to half of US shale players could go bankrupt in 2016.

However, the strategy put forth by Saudi Arabia has come at a cost. Despite a massive $670 billion sovereign wealth fund, the country is slipping into the red. With the government budget based on $106 oil, falling revenue from oil exports coupled with high spending on subsidies and support to foreign allies has led to a national budget deficit of 22% GDP in 2015. According to the International Monetary Fund (IMF), the country may become bankrupt in five years if its expenditure patterns remain unchanged. With oil prices expected to remain suppressed until 2017–2018, the Kingdom needs to assess all of its options.

In addition to spending cuts, Deputy Crown Prince Mohammed bin Salman has recently spoken of the potential IPO of Saudi Aramco, as a part of the wider series of economic reforms. If successful, such a move would dwarf the other “mega-deals” of the current low oil price environment (e.g., Halliburton and Baker Hughes, or Shell and BG Group). Estimated value of Saudi Aramco could reach up to $10 trillion based on its proven reserve at $40 oil price, which is about 12 times that of ExxonMobil ($357 billion), Chevron ($197 billion), Shell ($192 billion), and Total ($118 billion) combined.

Arguably, the timing could not possibly be worse for a listing of an exploration and production (E&P) company, valuations are at a cyclical trough as a function of low oil prices and most major E&P firms are trading at prices not seen since the global crash in late 2008. It is clear, however, that Saudi Arabia is facing huge budget deficits, and desperate times call for desperate measures.

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