Saudi Arabia’s Aramco Needs a Goldilocks Moment

Haifa Ahmed AlMaashi

To say that Saudi Aramco’s initial public offering of shares is crucial to Saudi Arabia’s long-term economic plans would be an understatement. The IPO, if successfully implemented, will be the biggest in history. The funds it raises will help pave the way toward diversifying the economy, and the impact of this, again, if successfully implemented, will be massive. But between here and the future, between prospect and reality, lies a lot of hard work, challenges and just plain difficult tasks. And a lot of questions that need answering.

The first order of business is to establish the value of Aramco, in order to extract a hoped-for level of profit in selling off a part of the company. If all goes to plan, it is anticipated that the company would be valued at $2 trillion and raise $100 billion through the listing exercise. Here, there are “easier” (but not necessarily “easy”) things to do, and more difficult things to hope for.

In the former category, Aramco is seeking to enhance the value of the company through fresh investments in downstream capacities. Earlier this year, it agreed with the French oil company Total to build a new petrochemical complex in Saudi Arabia. Another agreement was signed with a consortium representing three Indian state-owned oil companies to build a giant refinery near Mumbai. Also this year, it teamed up with Royal Dutch Shell to look for upstream opportunities in natural gas.

More difficult to do is to place a value on its reserves, which depends on forward views of oil prices. The problem is that recent volatility in prices clouds projection for prices going into the period when Aramco begins to be priced for its IPO. Apart from speculative narratives that drive the market, pricing depends on supply and demand. But despite the best efforts of Opec, it cannot convincingly determine supply. For example, Iran has insisted on raising output despite Opec’s agreement to limit production, hoping to profit from more bullish prices since January. And Russia, which is not an Opec member, has compelling interests – for itself and in support of its allies – in producing more oil than is necessarily supportive of prices. While the United States does not meddle in the market, it is not unhappy that its domestic shale producers have the power to vastly increase production. While Washington isn’t in the business of attempting to influence prices, it is within its powers to offer businesses, like shale oil producers, economic benefits that help them prosper. The upshot is that more shale oil is on tap for when prices rise to make production financially viable. Indeed, the ability of shale oil producers to start and stop production quickly has been a key factor in establishing a relatively low resistance level for prices.

Such a pricing situation does not augur favorably for Aramco’s IPO. Changing the map of alliances to control the stability of oil prices at a favorable level is probably the biggest challenge Saudi Arabia faces at the moment. One approach it could take is to initiate bilateral alliances with independent producers outside Opec, provided that such alliances do not conflict with collective agreements within the group. The main goal here is to secure long-term value for Aramco.

Then, there is another problem, this time with the big picture. The Aramco IPO is just one part in a scenario aimed at reforming the Saudi economy as part of the country’s Vision 2030 plans. Income and profit from oil is meant to allow Saudi Arabia to eventually become less dependent on hydrocarbon. So, Saudi Arabia needs to show that it will become less dependent on its oil income for investors to have greater faith in its overall economy. Indeed, Crown Prince Mohammed bin Salman has asserted that the country is fully committed to Vision 2030. However, at the same time, the country has stressed that oil will remain an important source of income for the long term. While this message strengthens Aramco’s position going into the IPO, it also implies to financial market investors that the Aramco IPO may not necessarily be so integral to the reform plans for the non-oil economy. Consequently, even if the IPO were successful, market confusion over the overall prospects for the economy could dampen the future value of Aramco itself. What Aramco needs is a Goldilocks outlook for its prospects and that of the broad non-oil economy: good for the oil sector, but also good for the non-oil economy. This is no easy thing to achieve.

Meanwhile, it still remains unclear where Aramco will be listed abroad – New York, London, Hong Kong or possibly elsewhere. Or even when the listing will occur. Already postponed from the second half of this year until 2019, it is important to quickly confirm a specific date so as not to have an adverse effect on the value of the offering. Markets don’t like uncertainties, and Aramco isn’t the only company out there pitching for investors’ capital.

For Saudi Arabia and Aramco itself, the IPO is like few other listings of companies around the world. The success of the IPO is crucial for influencing the macro- and microeconomics of Saudi Arabia, with repercussions on the economic ecosystem of the Gulf. To get there, Saudi Arabia has to get the pricing right, and then it has to create a very compelling narrative of how the success of an oil company will jumpstart into higher gear the broader non-oil economy. It has to show how Aramco’s listing will anchor the desired elevation of the local stock market to MSCI emerging market status (and thereby attract more foreign portfolio investment), creating greater liquidity to fund and sustain new economy industries that have nothing to do with oil. In short, it has to convince the world to have confidence in an oil company, so that it will have confidence in the country’s nascent non-oil companies.

Confusing? Such is the challenge for Saudi Arabia, a task that no other country has endeavored to this degree.

Haifa Ahmed AlMaashi is director of geostrategic studies at the Dubai Public Policy Research Centre.

Getty Images/Bill Pugliano