By Mark Finley
Well, it’s done. Saudi Aramco (formally, the Saudi Arabian Oil Company) has gone through its IPO. Its shares are now trading on the Saudi stock exchange (the Tadawul) and today (Thursday) its valuation reached $2 trillion—making it by far the world’s largest company by market capitalization.
This is a good time to reflect on what the IPO has accomplished, and what it might mean for Saudi policy (including oil policy) going forward.
The roughly 1.5% offering of Aramco shares on the Tadawul (the actual figure could be slightly higher if options are exercised to sell additional shares in the face of an over-subscribed offering) is the largest IPO ever. And raising just under $30 billion, it provides much-needed funds for Saudi national transformation efforts, a key part of Crown Prince Muhammad bin Salman’s plan to reform the Saudi economy to make it more competitive in the global economy and less dependent on oil revenues.
But while successful, the IPO is a watered-down version of the original plan. Ultimately the Kingdom decided not to offer shares on international exchanges, partly out of concern for the ultimate valuation of Aramco. International investment banks retained by the Saudis generally valued the company well below the target figure of $2 trillion which had long been cited by Saudi officials, including comments by the Saudi oil minister (the Crown Prince’s brother) at last week’s OPEC meeting. The IPO price came in at about $1.7 trillion, and today’s trading brings the valuation to the $2 trillion target. (With the important caveat that confidence in the valuation is colored by the tiny share of the company that has been IPO’d, for trading only on the domestic market.)
The enduring focus on a $2 trillion valuation suggests Saudi leaders will take steps to achieve and defend this target. As with any company, share prices are the result of buyer perceptions and company performance.
Press reports indicate that to boost demand for Aramco shares the Saudi government has been pressing Saudi businesses and wealthy families, as well as neighboring governments, to invest in the company. The government also encouraged Saudi banks to make loans more readily available for buyers of Aramco shares, and advertised the offering heavily within the Kingdom, highlighting the alignment of the IPO with the country’s transformation efforts. Saudi government institutions also bought shares in the IPO. However, efforts to broaden the potential pool of buyers by listing Aramco shares on foreign stock exchanges stumbled on global investor questions about the valuation discussed above.
In addition, Aramco’s valuation would obviously be boosted if the company were more profitable. The recent OPEC meeting illustrates this strategy at work. By agreeing to even larger production cuts, Saudi officials hope to support oil prices and therefore Aramco’s profitability (as well as boost Saudi government revenues via Aramco transfers). At the meeting, Saudi Arabia offered to cut production by 400,000 b/d below its official quota if other members (including some participating non-OPEC producers like Russia) obeyed their quotas.
Saudi Arabia & the broader OPEC/non-OPEC group can make money by cutting production and supporting prices, because it takes time for oil producers & consumers to respond to price changes (economists say that short-term supply and demand are inelastic). However, this strategy becomes unsustainable over time because other producers and consumers will eventually react. On the supply side the reaction time has become much shorter due to the rise of US shale production—additional shale supplies can reach the market in a matter of months rather than the several years needed to bring on the new deepwater supplies that had previously been the market’s marginal source of supply.
All this indicates that we could be heading into a very interesting time for the oil market. Will Saudi Arabia continue seeking to support Aramco’s valuation by boosting oil prices, even if it means cutting production? That would result in a lower global market share for the Kingdom. Higher prices would not only incentivize new oil production elsewhere but would speed the transition to electric cars, permanently reducing oil demand.
Also, inevitably, a time will come when due to market or other factors investment sentiment will weaken: What happens then? Will the Aramco share price fall? (Will it be allowed to?) And how would a lower Aramco share price impact the finances and confidence of Saudi investors? And what about the effect on the reputation of the Saudi government, especially after it has invested so much effort and credibility in supporting the $2 trillion valuation?
Since the Aramco IPO is without a precedent, any predictions here are rather futile. Time will have to tell. The next OPEC meeting is March 6th, 2020.
Mark Finley is the Fellow in Energy and Global Oil at Rice University’s Baker Institute for Public Policy.