The Long and Winding Saudi Aramco Initial Public Offering Road

The initial public offering (IPO) for up to 5 percent of the Saudi Arabian Oil Co. (Aramco) has been delayed several times recently, ostensibly due to a seeming difference of opinion about the value of Aramco between the House of Saud ($2 trillion) and the larger investment market (substantially less than that). The IPO will answer that question. Perhaps this ex ante dispute about the value of Aramco really does boil down to differences about Saudi oil reserves and future oil prices and sales revenues. Because the current market price of oil captures all available information about such parameters, at a minimum it seems questionable that so large a valuation dispute would be the result of such uncertainties.

Instead, a contrarian hypothesis, seemingly unexamined in the open literature, is reasonable at least for discussion: The investment market may believe there is an asymmetric information problem, in that the Saudi government may have better information about external and internal threats to its rule than available publicly.

A simple conceptual exercise under reasonable assumptions about market conditions examines the production and revenue implications of “low-threat” (100-year time horizon) and “high-threat” (10-year time horizon) predicts that the present value of Saudi oil revenues would fall by almost 60 percent under the latter case.

The official rationale the House of Saud gave for its Aramco IPO is a goal of diversifying the economy by selling off part of Aramco and investing the proceeds in other sectors, through the Saudi Vision 2030 diversification program. That explanation has a surface plausibility, but it does not explain why the Saudi government has chosen to invite foreign investment in its oil sector instead of those other sectors the growth of which would yield the aggregate economic diversification that is the ostensible overall goal. One answer might be that the Saudi government has decided that to a degree others have become the efficient bearers of risk in terms of future oil prices and revenue streams; but why would that suddenly have become the case? Why are foreigners not to a degree the efficient bearers of risk in the non-oil sectors envisioned to grow in the diversification effort? The recent saga of the on-again, off-again Aramco IPO suggests that more than a dispute over the market value of Aramco is the driving force. Instead, it is reasonable to surmise that potential buyers may sense an asymmetric information problem: The Saudi government knows more than it is conceding publicly about external and internal threats to its ownership of the future revenues to be earned from petroleum operations. This hypothesis may be little more than speculation, but it is not inconsistent with recent events.

The Recent History of the Saudi Aramco IPO

After almost four years of delays, Aramco officially launched its IPO on November 3, with the first sale of its shares intended by December.1 The IPO originally had been scheduled for the second half of 2018, as announced by Aramco CEO Amin H. Nasser on March 6, 2017.2 This was to be for 5 percent of the company, with a hoped-for valuation of $2 trillion for the whole firm, making the IPO sale worth a prospective $100 billion, by far the largest IPO ever sold.

Reports of a delay surfaced the following September, ostensibly due to “several issues to be settled ahead of the listing.”3 Such issues included the international location of the listing — that is, outside the Saudi Tadawul Stock Exchange. The London Stock Exchange was mentioned prominently as it had changed its rules to accommodate Aramco’s preferences; but that yielded intense criticism from corporate governance groups and some members of Parliament, in particular because of Aramco’s decided historical secrecy about its finances and other such crucial investor information.4

In October 2017 the trade press reported that the IPO might be “shelved,” that the IPO might not be issued for the 5 percent of the company originally envisioned, and that Aramco was considering a private sale of shares instead of an IPO.5 Aramco denied this in an email to the media, stating that “the IPO process is well underway and Saudi Aramco remains focused on ensuring that all IPO related work is completed to the very highest standards on time.”6 Then in August 2018 reports emerged that the IPO had been called off: “Now, sources close to the matter have said that the plans for listing the IPO were scrapped quite some time ago, but the company line started out with mild disappointment, initially suggesting there may be a delay, and gradually increased to a full-scale cancellation.”7

In November 2018, Nasser stated that the IPO could be expected in 2021 “depending on market conditions at that time.”8 The news reports alluded in passing to such familiar problems as the size of Aramco’s oil reserves “shrouded in secrecy” and the ongoing problem with the arrangement of an international venue for the IPO. But the central problem Nasser cited was Aramco’s intended purchase of the 70 percent of the Sabic petrochemical firm then held by the Saudi Arabia Public Investment Fund: “[Sabic] needs to be completed first before you can list Saudi Aramco, and that will take some time. . . . Then you need to reflect that in your balance sheet for at least a year before you can list Saudi Aramco. And this is where they are talking about 2021 and depending on the market conditions at that time the government will list it.”

Aramco announced the signing of the Sabic deal in March 2019.9 In June Crown Prince Mohammed bin Salman was reported to have said that “the IPO is going ahead as planned and is on track for 2020 or 2021.”10 Reports then emerged that the IPO timeline had been moved up to early 2020.11

October was a busy month. Aramco was reported to be awaiting financial results for the third quarter showing that the September missile strikes on the Saudi oil fields had hurt its net income only minimally.12 Then Aramco announced the start of its long-anticipated public offering as soon as November 3; the Saudi state news channel Al Arabiya reported:

Aramco aims to announce the transaction’s price on Nov. 17 and start taking orders from investors on Dec. 4. Shares are expected to start trading Dec. 11 on the local Saudi stock exchange. . . . Crown Prince Mohammed Bin Salman had hoped for a $2 trillion valuation for Aramco. The kingdom reportedly plans to list 1% of Aramco before the end of this year and another 1% in 2020. It ultimately intends to sell as much as 5%. A 1% float, assuming a $2 trillion valuation, would be worth $20 billion.13

It now is reported that the Saudi government is making some final attempts to increase the Aramco valuation.

Saudi Arabia is reportedly bullying the ultra-rich in the country to invest their money in the offering, a pressure campaign that has echoes in the 2017 Ritz-Carlton shakedown. Aramco is also dangling the possibility of larger-than-advertised dividend payouts to investors. ‘Aramco management has stressed the possibility of additional distributions to shareholders above and beyond the minimum dividend pledge,’ Bank of America Merrill Lynch said in a report for investors seen by the Financial Times. Higher dividends would be made possible by borrowing, while the notion is also hinged on some optimistic assumptions on higher oil prices and steady increases in free cash flow. But major banks are still not coming through for Aramco, putting valuation ranges on the company well below the $2 trillion figure that Crown Prince Mohammed bin Salman wants.14

Some Contrarian Observations

Let me now plagiarize the title of an interesting AEI podcast series: “What (the Hell) Is Going On?” The Aramco IPO is not much more than the sale of some oil, or more accurately, the future revenue stream from oil sales in a market characterized by substantial volatility over time.15 However crucial the issue of the $2 trillion valuation, it is a dispute that only the market can decide when the IPO finally moves forward.16 As discussed below, a dispute over future oil prices in the context of the Aramco IPO must be driven by much more than normal uncertainty about future demand and supply conditions — that is, the future path for prices and the revenues yielded by sales of oil. There also is the asymmetric information issue: Does the House of Saud have better information than the market — in this context “the market” means potential buyers in the IPO — about internal and external threats to its tenure?

That the Middle East is a dangerous neighborhood is no secret, a reality that has afflicted the House of Saud for decades, in terms of threats both internal and external. Only a few recent examples from a chronology of events should suffice to illustrate the point. There was the seizure of the Grand Mosque in Mecca in late 1979, a violent rebellion put down only after almost two weeks and the unofficial aid of French troops.17 The bombings in Riyadh in May and November 2003 exposed the violent rifts between the monarchy and the Wahhabi religious establishment.18 (In this context, bombings directed against Americans clearly were a continuation of domestic politics by other means.) More generally, bombings and shooting incidents aimed at the regime have occurred on a regular basis.19

The central long-term external threat has come from Iran in the wake of the overthrow of the shah of Iran and the establishment of the Iranian theocratic regime.20 One result has been a series of proxy battles in Afghanistan, Bahrain, Iraq, Lebanon, and Yemen.21 The more-recent development of the Iranian nuclear weapons program poses a direct and enormous perceived threat to the House of Saud.22 And the threat posed by the Iranian conventional missile inventory was illustrated by the September missile and drone attacks already noted.23

Of greater interest here are the implications of these threats for Saudi oil production policy and in particular the shift in that policy several years after the overthrow of the shah. From 1973 to 1986, Saudi production was consistent with the goal of protecting the official Organization of the Petroleum Exporting Countries price; the Saudis acted as the “swing producer” increasing or cutting output to maintain that price.24 This led to a steady decline in Saudi output from 9.9 million barrels per day (mmbd) in 1980 to 3.4 mmbd in 1985.25 Saudi production increased more or less monotonically beginning in 1986, a year in which market prices for Brent crude oil fell by almost half, from $27.56 in 1985 to $14.43 (in nominal dollars).26

This shift during the mid- to late-1980s is consistent with a straightforward effort by the Saudis to protect their market share and their sales revenues.27 It is consistent also with a production and pricing strategy that can be described as “market punishment” behavior designed to increase the riskiness of foreign investment in competing crude oil reserves. That objective would suggest an increase in reserves and production capacity, to create a threat to flood the market in the face of increasing potential competition. That indeed is what we find: an increase in proven Saudi crude oil reserves from 173 billion barrels in 1989 to 258 billion barrels in 1990.28 (Investment in the discovery and development of new production capacity would be expected to show up in the data suddenly, as new fields are “proven” in an engineering sense.)

Note, however, that Saudi reserves since 1990 have changed virtually not all, increasing from that 258 billion barrels in 1990 to only 266 billion barrels in 2019, even as Saudi production increased from 5.6 mmbd in 1989 to 12.4 mmbd in 2018.29 The Saudi market share of world crude oil production for 1991–2018 has remained fairly stable at 12–14 percent, as world production has increased from 65.3 mmbd to 100.8 mmbd, or by 54 percent.30 The dynamic profit-maximization argument seems not to answer the obvious question: Why have the Saudis failed to increase capacity to profit from this growing market? Or, why have they failed to punish the market to discourage investment by competitors?

One response might be driven by the growing threats perceived by the House of Saud: If there is an increased risk of an overthrow by hostile forces, the Saudi ruling family might have increased incentives to maximize sales revenue over a shorter time horizon. That can be interpreted as “dynamic profit maximization” with a much higher discount rate. After all, in the extreme case in which the private jets are kept fully fueled and ready for quick departure to Switzerland, the suppression of investment incentives for international competitors becomes far less important.

Accordingly, it may be useful to conduct a rough conceptual exercise to see what change in Saudi production levels might result from increased fears of some sort of coup d’état — that is, an increase in the discount rate used (implicitly) by the House of Saud to evaluate the value of future oil revenues. I assume here that the Saudi maximand is the present value of total sales revenue, and a price elasticity of demand for Saudi oil of three (in absolute value). Obviously, other figures could be substituted, but the qualitative nature of the analysis would not change. Table 1 summarizes these calculations for two cases: time horizons for the House of Saud of 100 years and 10 years, with an assumption that optimal production under the 100-year time horizon is 13 mmbd (about 4.7 billion barrels per year) at $60, with a discount rate of 5 percent applied to the revenue stream. Those assumptions yield annual revenues of about $285 billion, with a present value a bit less than $5.7 trillion.

For the 10-year period, I assume a discount rate of 10 percent, reflecting an increase in the perceived threats to the House of Saud and thus a shortening of its time horizon. That increased fear in this conceptual exercise changes the Saudi maximand to the present value of sales revenues over that 10-year horizon. Under the assumption discussed above that sales revenue is a reasonable proxy for profits, this change in conditions induces a price cut from $60 to $45 per barrel, a production increase to about 23 mmbd (about 8.3 billion barrels per year), and annual revenues of about $374 billion, with a present value of $2.3 trillion. Accordingly, this simple “threat” exercise reduces the present value of the revenue stream by almost 60 percent.

Table 1. House of Saud Oil Production Under 100- and 10-Year Horizons

________________________________________________________________________

100-Year Horizon 10-Year Horizon

(5% Discount Rate) (10% Discount Rate)

________________________________________________________________________

Annual Oil Production (Billion Barrels) 4.7 8.3

Price per Barrel ($) 60 45

Annual Total Revenues ($ Billions) 285 374

Revenues Present Value ($ Billions) 5,657 2,298

________________________________________________________________________

Source: Author’s computations, available upon request.

This conceptual exercise is far from obviously “correct” in the sense that several alternative quantitative assumptions would be equally plausible and might yield different numbers. But neither is it obviously flawed. The interesting observation to be made is that the current production and price implications of a threat or coup d’état assumption appear not very different from those attendant upon a dynamic profit-maximization assumption in which the goal is punishment of overseas competitors. But those alternative hypotheses have different implications for future investment by those competitors: The coup d’état hypothesis at least arguably yields higher long-run prices in the future periods during which the House of Saud no longer is dumping oil on the market. The punishment hypothesis also might yield higher future prices but still preserves the threat to drive prices down after foreign competitors have sunk large investments into new production facilities.31

Note also that a (perhaps pro-Iranian) “Arabian” regime replacing the House of Saud would face threats to its political control of the Arabian government and oil revenues and presumably would need revenues for placating its enemies both internal and external. Other regimes in the region would have the same incentives to disrupt Arabian production to raise market prices. At the same time, it is reasonable to hypothesize that an Arabian regime driven explicitly by Wahhabi ideology might have stronger political preferences to “punish” the West by reducing output and perhaps investment, yielding higher prices over the short run.

But in contrast with a Saudi dynamic profit maximization and punishment of competitors strategy, this Saudi short-run maximization strategy implies a reduction in the importance of Arabian oil production over time and increased incentives for investment in production capacity by overseas competitors. Moreover, such price increases would be predicted to increase rig counts globally, particularly in the US, increasing production over time and moderating global price increases.

Conclusion

One answer might be that the Saudi government has decided that to a degree others have become the efficient bearers of risk in terms of future oil prices and revenue streams; but why would that suddenly have become the case? Why are foreigners not to a degree the efficient bearers of risk in the non-oil sectors envisioned to grow in the diversification effort? The recent saga of the on-again, off-again Aramco IPO suggests that more than a dispute over Aramco’s market value is the driving force. Instead, it is reasonable to surmise that potential buyers may sense that there is an asymmetric information problem: The Saudi government knows more than it is conceding publicly about external and internal threats to its ownership of the future revenues to be earned from petroleum operations. This hypothesis may be little more than speculation, but it is not inconsistent with the recent course of events.

Notes

1. See Rory Jones et al., “Saudi Arabia Launches Long-Awaited IPO, Wall Street Journal, November 3, 2019, https://www.wsj.com/articles/saudi-aramco-launches-long-awaited-ipo-11572764620?mod=djemalertNEWS.

2. See Reuters, “Saudi Aramco to List Locally and Abroad in Second Half of 2018: CEO,” March 6, 2017, https://www.reuters.com/article/us-saudi-aramco/saudi-aramco-to-list-locally-and-abroad-in-second-half-of-2018-ceo-idUSKBN16D1ZO.

3. See Irina Slav, “The Biggest IPO in History to Be Delayed,” Oilprice.com, September 14, 2017, https://oilprice.com/Latest-Energy-News/World-News/The-Biggest-IPO-In-History-To-Be-Delayed.html.

4. Aramco issued a “Preliminary International Offering Circular” (prospectus). See Aramco, “Saudi Arabian Oil Company (Saudi Aramco) Prospectus,” November 9, 2019, https://www.saudiaramco.com/-/media/images/investors/saudi-aramco-prospectus-en.pdf?la=en&hash=8DE2DCD689D6E383BB8F4C393033D8964C9F5585.

5. See Julianne Geiger, “Saudi Arabia Looks to Shelve Aramco IPO,” Oilprice.com, October 13, 2017, https://oilprice.com/Energy/Crude-Oil/Saudi-Arabia-Looks-To-Shelve-Aramco-IPO.html.

6. See Irina Slav, “Aramco IPO Remains on Track, Company Says,” Oilprice.com, September 15, 2017, https://oilprice.com/Latest-Energy-News/World-News/Aramco-IPO-Remains-On-Track-Company-Says.html.

7. See Julianne Geiger, “Saudis Officially Call Off Aramco IPO,” Oilprice.com, August 22, 2018, https://oilprice.com/Energy/Energy-General/Saudis-Officially-Call-Off-Aramco-IPO.html.

8. See Tsvetana Paraskova, “Aramco CEO: Expect IPO in 2021,” Oilprice.com, November 12, 2018, https://oilprice.com/Energy/Energy-General/Aramco-CEO-Expect-IPO-In-2021.html.

9. See Saudiaramco.com, “Saudi Aramco Signs Share Purchase Agreement to Acquire 70% Majority Stake in SABIC from the Public Investment Fund of Saudi Arabia,” March 27, 2019, https://www.saudiaramco.com/en/news-media/news/2019/aramco-sabic.

10. See Tsvetana Paraskova, “Saudi Arabia Speeds Up Aramco IPO Timeline to Early 2020,” Oilprice.com, August 9, 2019, https://oilprice.com/Latest-Energy-News/World-News/Saudi-Arabia-Speeds-Up-Aramco-IPO-Timeline-To-Early-2020.html.

11. See Summer Said, Julie Steinberg, and Ben Dummett, “Saudi Plans for Biggest-Ever IPO Are Back on,” Wall Street Journal, August 9, 2019, https://www.wsj.com/articles/aramco-revs-up-ipo-plans-for-as-soon-as-2020-11565355187.

12. See Summer Said, Rory Jones, and Avantika Chilkoti, “Aramco Bets Post-Attack Earnings Can Boost Delayed IPO’s Valuation,” Wall Street Journal, October 18, 2019, https://www.wsj.com/articles/aramco-bets-post-attack-earnings-can-boost-delayed-ipos-valuation-11571420194.

13. See Evie Liu, “Saudi Aramco’s IPO Is Back on Schedule, Again,” Barron’s, October 29, 2019, https://www.barrons.com/articles/saudi-aramco-ipo-oil-energy-initial-public-offering-51572366746.

14. See Nick Cunningham, “Saudi Arabia’s Final Attempt to Boost Aramco’s Valuation,” Oilprice.com, November 8, 2019, https://oilprice.com/Finance/investing-and-trading-reports/Saudi-Arabias-Final-Attempt-To-Boost-Aramcos-Valuation.html.

15. For reasons to be discussed, the volatility is both less and more important than may appear to be the case. That prices in the world oil market fluctuate, sometimes substantially, is hardly a secret, and it is reasonable to predict that expected shifts in prices driven by both demand and supply conditions are reflected in current market prices (both spot and futures), even if the specifics of the future demand and supply shifts are unknown ex ante, because the consumption of oil is substitutable intertemporally. Accordingly, the current price is an unbiased market evaluation of the future value of a barrel of oil, incorporating all available information about future shifts in demand and supply conditions. At any given point in time, expected prices (or more precisely, the total return to holding oil supplies) can be predicted to rise at the market rate of interest. To some extent the price and revenue effects of such future demand and supply shifts can be predicted to offset each other; but even such large events as substantial supply disruptions due, say, to major wars, can be predicted to occur and be reflected in current market prices, even if the timing and magnitude of such given events cannot be specified in advance. See Benjamin Zycher, “World Oil Prices: Market Expectations, the House of Saud, and the Transient Effects of Supply Disruptions,” American Enterprise Institute, June 2, 2016, https://www.aei.org/wp-content/uploads/2016/06/World-Oil-Prices.pdf.

16. See, for example, Neanda Salvaterra, “Why Aramco Pushed Back Its IPO—Energy Journal,” October 21, 2019, https://blogs.wsj.com/moneybeat/2019/10/21/why-aramco-pushed-back-its-ipo-energy-journal/.

17. See Yaroslav Trofimov, The Siege of Mecca: The 1979 Uprising at Islam’s Holiest Shrine (New York: Anchor Books, 2008); and Lawrence Wright, The Looming Tower: Al-Qaeda and the Road to 9/11 (New York: Vintage Books, 2007).

18. See BBC News, “Saudi Bombing Deaths Rise,” May 13, 2003, http://news.bbc.co.uk/2/hi/middle_east/3022473.stm; and CNN, “Saudi Official Blames Riyadh Attacks on Al Qaeda,” November 9, 2003, http://www.cnn.com/2003/US/11/08/saudi.explosion/.

19. See Matthew Levitt, “Iranian and Hezbollah Threats to Saudi Arabia: Past Precedents,” Washington Institute for Near East Policy, May 19, 2015, http://www.washingtoninstitute.org/policy-analysis/view/iranian-and-hezbollah-threats-to-saudi-arabia-past-precedents.

20. See “Timeline of Iran-Saudi Relations,” Wilson Center, January 5, 2016, https://www.wilsoncenter.org/article/timeline-iran-saudi-relations?gclid=Cj0KEQjwt763BRDZx_Xg3-Pv2cABEiQAoDfeGCmqDAomYKMXBshu2UhQREzqi5s98Y9ua0p-FJTPHScaAt1V8P8HAQ.

21. See Michael Knights, “What Would a Saudi-Iran War Look Like? Don’t Look Now, But It Is Already Here,” Washington Institute for Near East Policy, January 11, 2016, http://www.washingtoninstitute.org/policy-analysis/view/what-would-a-saudi-iran-war-look-like-dont-look-now-but-it-is-already-here; and Henry Johnson, “This Map Explains the Saudi-Iran Proxy War,” Foreign Policy, January 6, 2016, http://foreignpolicy.com/2016/01/06/this-map-explains-the-saudi-iran-proxy-war/.

22. See Anthony H. Cordesman, “Saudi Arabia, Iran, and the ‘Clash Within a Civilization,’” Center for Strategic and International Studies, February 3, 2014, http://csis.org/publication/saudi-arabia-iran-and-clash-within-civilization.

23. See Shawn Snow, “Drone and Missile Attacks Against Saudi Arabia Underscore Need for More Robust Air Defenses,” Military Times, October 25, 2019, https://www.militarytimes.com/flashpoints/2019/10/25/drone-and-missile-attacks-against-saudi-arabia-underscore-need-for-more-robust-air-defenses/.

24. See Benjamin Zycher, “OPEC,” in The Concise Encyclopedia of Economics, ed. David R. Henderson, (Indianapolis, IN: Liberty Fund, 2008), http://www.econlib.org/library/Enc/OPEC.html. For the Saudi historical production data for crude oil, see US Energy Information Administration, “Short-Term Energy Outlook Data Browser, https://www.eia.gov/forecasts/steo/tables/?tableNumber=7#startcode=1997.

25. The older data are reported at Index Mundi, “Saudi Arabia Crude Oil Production by Year,” http://www.indexmundi.com/energy.aspx?country=sa&product=oil&graph=production.

26. See BP Global, BP Statistical Review of World Energy, 2019, https://www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/energy-economics/statistical-review/bp-stats-review-2019-full-report.pdf.

27. See Zycher, “OPEC.” Any individual producer faces elastic demand — price and sales revenues move in opposite directions, other things equal —so that a cut in price and increased production would increase (or protect) sales revenues.

28. See the historical data reported by US Energy Information Administration, “International Energy Statistics: Crude Oil Proved Reserves,” http://www.eia.gov/cfapps/ipdbproject/iedindex3.cfm?tid=5&pid=57&aid=6&cid=regions&syid=1995&eyid=2015&unit=BB.

29. See the historical data reported by US Energy Information Administration, “International Energy Statistics: Production of Crude Oil, NGPL, and Other Liquids,” http://www.eia.gov/cfapps/ipdbproject/iedindex3.cfm?tid=5&pid=55&aid=1&cid=ww,SA,&syid=1980&eyid=2015&unit=TBPD. These data include production of natural gas liquids, lease condensates, and other liquids.

30. See US Energy Information Administration, “Global Liquid Fuels,” https://www.eia.gov/outlooks/steo/report/global_oil.php.

31. The Wahhabi or other “Arabian” regime replacing the House of Saud is likely to face similar incentives: threats to its control of oil revenues and a time horizon shorter rather than longer. This might not be the case if the new regime were to enjoy protection from the Iranians and a (future) nuclear umbrella.

32. See Kingdom of Saudi Arabia, “Vision 2030,” https://vision2030.gov.sa/en/node.