Will Saudi Aramco’s IPO affect the market meaningfully?
The market focus on the valuation of Saudi Aramco’s initial public offering (IPO) is similar to Bugatti Chiron owners focusing on their vehicles’ top speeds — interesting, but of little relevance.
The $1.7-trillion (R25-trillion) upper value placed on the Saudi state oil company, the world’s largest crude exporter, will no doubt generate speculation about whether it’s too high, and whether it will be viewed as reasonable enough to attract interest beyond the kingdom’s small domestic equity market.
But these discussions are largely irrelevant for the crude oil market.
By far the most important question for crude markets is whether the IPO of Aramco will alter the behaviour of the oil giant in any meaningful way likely to have an effect on market dynamics?
Initial indications are no, and the market expectation is that Aramco will continue to behave in much the same manner as it does now.
In other words, the Saudis will remain the key player in Opec, which is engaged in a long-running effort, in conjunction with allied producers such as Russia, to boost crude prices.
But the crude market’s complacency over Aramco turning into a public company may be slightly misplaced.
The first thing to note is that the company has committed to paying an annual dividend of at least $75bn for the next five years.
This means Aramco will be under some pressure to maintain its existing strong profitability, and this may influence how the company’s executives view their role in global oil markets.
For instance, picture a scenario where US shale output continues to grow, as well as output from other producers outside the Opec-plus-allies agreement.
Will Aramco continue to advocate for output cuts by Opec and its allies, or will it be tempted to run the numbers on once again chasing volume over value, given its inherent advantage of being the lowest-cost major oil producer?
Aramco is also likely to have to become somewhat more transparent in its interactions with the market.
The company has a reputation of being quite secretive in its public dealings. For instance, it doesn’t discuss its pricing or strategies.
However, investors are likely to want more details of Aramco’s inner workings as they try to assess whether the company is worth buying into, and whether it can deliver upon its stated aims.
The nature of Aramco’s very limited IPO may also influence the company's behaviour, given the view of some analysts that the offering may be priced too richly.
The valuation of between 30 riyals and 32 riyals ($8-$8.50) a share for the IPO — a date for which has still to be confirmed —will value Aramco at $1.6-trillion-$1.7-trillion.
This is well below the $2-trillion apparently sought by Saudi Arabia’s de facto ruler, Crown Prince Mohammed bin Salman, but also well above the range of many Western investment banks.
The IPO is only for 1.5% of the company’s shares and is only open to Saudi citizens and those foreigners qualified to invest in the kingdom. That means vast numbers of potential investors won’t be able to participate, even if they wanted to.
Nonetheless, the pressure will be on for the shares to rise in the weeks and months following the IPO to show that it has been successful, and that Aramco justifies a higher market valuation than what many investment banks currently believe.
It also means Aramco will be under pressure to deliver on earnings and dividends — and the best way of achieving that is through higher crude prices.
While the state of the global economy is beyond the control of the Saudis, the current conditions in the crude oil market are somewhat concerning.
Demand growth has been weak in 2019, and if it weren’t for surging Chinese imports there would be hardly any additional crude demand in the year.
Supply growth continues in the US and elsewhere, making a sustained increase in crude oil prices unlikely.
For the crude oil market, much as for supercars in the real world, the important questions are how fast Aramco can accelerate, and how well it handles the road ahead?