As usual, these days the media’s focus is overwhelmingly on statistical trivia – mesmerized completely by the slightest wiggle in rig count numbers, or a .0001 percent revision in production estimates or global demand, or whatever nugget reinforces the prevalent theme of the day. It’s too bad, because the fixation with near-random minute fluctuations is missing some really important stories.
As a significant example, Saudi Arabia recently announced plans to take Saudi Aramco public. That did make the news, but only because it was a huge market transaction worth possibly hundreds of billions. Anyone paying attention marvelled at the potential market cap of Saudi Aramco, noted the size of the offering (initial sale of 5 percent) then forgot the topic and got back to shouting about 8 more rigs in the Permian.
The significance of the story is that the world’s petroleum crown jewels – Saudi’s reservoirs – are being put on the market and opened for public inspection. This action is much more than just an attempt to grab some cash (though it certainly is that as well), it is an upending of the world petroleum order.
For decades the Saudis effectively controlled world oil prices, and they let the world know it. No other jurisdiction or company had the ability to add or subtract meaningful production with the sole objective of messing with global prices. They were able to pull it off because there has always been an element of mystery about what exactly they could do. They proved in the 1974 oil supply crunch that they definitely could remove millions of barrels per day of production from markets, which caused enormous problems and proved to the world that they could (and really would) do such things to advance their agenda. From then on they were like an unstable, 6 foot 6, 300 pound ex-con. No one messed with them. No one knew what they were actually capable of and no one would take the risk to find out.
The country showed in 1974 that it could withhold plenty of production, and also threatened the other way – to flood the market if it so desired. Because their data was completely secret, the world had to take the threats seriously no matter how implausible they sounded. The tactics made for a highly effective tool, and It was absolutely remarkable that they were able to manipulate the world’s most valuable and necessary commodity so singlehandedly and effectively. They could act however they wanted, because they didn’t answer to anyone.
Now, with the partial sale of Saudi Aramco, they are abandoning that power and that strategy. SA’s tactics worked because of the mystery of what they really had – they could say anything and no one knew they were bluffing. After the IPO, those games are done.
As a publicly traded entity, Saudi Aramco will answer to someone – the most demanding, nagging, lawsuit-happy, needy partner one would ever fear to meet – the US capital markets. That may sound like an insult to capital markets, and it is, but it is also a compliment – public capital markets demand transparency.
SA will no longer be able to make totally unfounded statements about reserve levels, productive capability, etc. The markets will hold them to their word, or sue the wheels off their Ferraris. And not only will they have to provide full and clear disclosure, they will have to produce in a profit maximizing way, whatever that turns out to be. This is an enormous switch from a company that was in instrument of international policy as much as a profit generator.
The change is not to be underestimated. Saudi Aramco was a tool to implement the Saudi government’s agenda, with no thought to financial discipline because of the sheer size of Saudi Aramco relative to the country. Now they will have to switch mentalities to assimilate with the rest of the profit seeking herd. Profit seekers don’t withhold production or flood markets to manipulate prices (although potash companies come pretty close), they produce what they can to make as much as they can. These production levels are based on prevailing prices, which impact global production because the price sets the level of activity. Countries that farm out their resources to multinationals will have them largely developed as the companies see fit, based on economics. Saudi Arabia is one of the few entities that didn’t march to that drummer, and it is the largest.
But now that’s over, and the impact will be huge for a number of reasons. First, it is now relinquishing the singular power to control output to move global oil prices. As a public entity, it’s obligations now will be to shareholders, and to act against their interests will attract activist investors and one trillion lawyers, salivating at the prospect of settling out of court with the lumbering beast.
The second major impact is full disclosure of Saudi Aramco’s actual reserve base. This will be most fascinating, because they will (or should) be held to international standards. There is plenty of evidence right before our eyes that the public number is somewhat less than scientific. (as shown in this chart) Reserves took a dubious leap in the mid 1980s at the exact time that OPEC decided to allocate production quotas based on reserves. What an amazing coincidence. It’s been just as weird ever since, with reserves remaining at 260 billion barrels, plus or minus a percent or two, for 30 years. During that period, the Saudis produced well over 200 billion barrels. The old system of having barrels miraculously replace themselves every year, in exact amounts, will have to be replaced.
And finally, most importantly, the world’s energy security blanket will be gone. In times of global stress, when it appeared the supply of oil could in some way be constrained such as various middle eastern skirmishes, 9/11, earthquakes, etc., the Saudis always placated markets by assuring that they could bring millions of barrels to market immediately and ensure no one went without. As a public entity, it is very difficult to see how they will be able to keep millions of barrels per day on the sidelines (assuming they ever could).
These factors add up to a tectonic shift in the way global petroleum markets will work after the IPO. No longer will there be a mischievous imp at the helm, able to either flood or starve the world’s oil supplies at a moment’s notice. No longer will there be a country standing ready to top up the world’s requirements at times of global distress. We forget how easy it is to get in one of those states, how easy it can be to knock a million barrels per day off the market through some regional war or disaster. If it happens now, we’ll see a different reaction from markets.
Read more insightful analysis from Terry Etam here