A few years ago, Saudi Arabia had a change of leadership at the top, and the new guy in charge decided to open up the country in some very positive ways. Major steps were taken to open up society, and clumsily heartwarming human rights gestures were even appearing, like rare flowers blooming in the desert after decades of drought. Women were suddenly acknowledged to be different than dogs, and allowed to, for example, go jogging in public, and attend soccer matches. To the relief of all, no mayhem ensued, and the dream of a female being allowed to one day kick a soccer ball in public remains alive.
On the business front, the new ruler decided, or someone in the ruling clique did, that privatizing Saudi Aramco was a good idea as well. Not selling it all, not yet anyway, but a start, with maybe 5 percent to be floated to the public.
The Initial Public Offering (IPO) caused a lot of speculation about why it was being done, and what the impacts on the market would be. Some viewed it as a non-event, as just another crown corporation being sold off as has happened hundreds of times around the world. This one was different, however, for a number of reasons: the potential size of the valuation; the timing (with oil prices in the toilet – the IPO was announced in 2016); and most importantly, the scrutiny that Saudi Aramco would be exposed to as a public company. For decades, the Saudis have thrown around numbers – spare capacity, reserves, etc. – that were completely unverifiable, and they liked it that way. As a public company, that world would change beyond belief. Stock analysts want to know if something changes to the third decimal point, and why.
Lately however, the prospects of the IPO happening seem to be unraveling. In addition to the factors above, a collateral problem may have appeared to go with the great public showing-of-the-underwear. The problem is so huge that it may in fact be the main cause of the IPO’s possible termination, and it is indirectly important to everyone in the oil business.
The issue facing SA if the IPO does proceed is that the entire country’s foreign policy and economic tool kit gets thrown out the window. SA has, for half a century, jerked the world around by manipulating oil production levels (or, more often, by threatening to do so, which had the same effect due to the sheep-like reporting of any Saudi production announcement). All SA had to do was to mention plans to cut a few hundred thousand barrels, or add similar, and oil markets gyrated wildly on the news. SA could even throw out any crazy statement it wanted about how the world would never be short of oil because of their supply cushion, a magical/mythical number that was always relied on but may have had no basis in reality whatsoever. Take, for example, SA’s Ghawar field, which accounts for more than a third the country’s output (or thereabouts, who knows), which is a massively water-flooded field that has been in production for more than half a century. What is the “maximum” production of this field? Can SA crank it by 5 percent? 10? 20? For how long? At what cost, not just economically but in terms of possible damage/water breakthrough for the reservoir?
What we do know is that as a public company, with shareholders to answer to, it would be extremely difficult to shut in/add production as a means to tinker with global price levels. Activist investors and class action lawyers dream about situations like that, which is probably a very big reason Saudi Aramco wandered away from the idea of listing their shares on a US exchange.
Actually, they appear to be mildly nauseated by the whole idea of going public now. The Saudis have even acquiesced to Donald Trump, promising to raise production to lower prices (though yet again that talk is a lot more feathers than chicken). Lowering global oil prices will hurt Saudi Aramco’s bottom line at the very time they are trying to maximize the value of the company, further indicating that the IPO is becoming more unlikely.
What does this have to do with North American producers? Not a whole lot, directly, but indirectly it is very significant. The oil market has an air of mystique about it, because one of the largest and most key variables – Saudi Arabia – has been a black box. At times when the world appeared short of oil, the Saudis placated everyone by promising as much supply as needed. They may have been lying through their teeth, but we tended to believe them because they look so serious and smart and they are oh-so rich. When the world was awash in oil, the reverse happened – the Saudis were one of the few countries that had the flexibility to shut in material amounts at will (by choice, not because economics forced them to).
Many other industries are transparent, or a lot more so, where commodities have proper “price discovery” – that is, all the variables at play are more or less understood at the moment. The market’s guess may be totally wrong, but it is operating with complete information.
Oil markets might look quite different if the world had a thorough understanding of the realities of Saudi Aramco’s assets. The mystery would be gone. It is hard to say what this would mean for prices, there would likely be more volatility without the Saudi damper. When things got to the margin, such as when an oil shock happened somewhere in the world that removed a sizeable chunk of production, the price reaction might be quite different without the soothing words of Uncle Saudi. If the IPO gets cancelled, we will remain in that state of blissful ignorance, at least until things really blow up, and we find out the hard way whether the Saudis have been accurately portraying reality or not.
Read more insightful analysis from Terry Etam here. To reach Terry, click here