Aramco sell-off can work as part of broad reforms

The privatisation of Saudi Aramco, Saudi Arabia’s national oil company, has been much discussed in recent months. How realistic are the prospects of its privatisation? Although appealing in principle, privatisations are often derailed by changing market circumstances and domestic political considerations, including resource nationalism.

Governments privatise companies for two reasons – to raise revenue for government coffers or to unload a loss-making enterprise. Sometimes governments also privatise to bring market discipline to a firm, but generally it comes down to national budget constraints.

This past spring, Prince Mohammed bin Salman, the deputy crown prince of Saudi Arabia, announced a plan to list up to 5 per cent of Aramco on public stocks markets. He estimated the value of the oil company at between US$2 trillion and $3tn, implying that the sale could raise as much as $150 billion for the Saudi treasury. While generous, this valuation is by no means outlandish. For example, Exxon produces about 4 million barrels of oil and gas per day, yielding a market capitalisation of about $400bn. Given that Aramco produces two-and-a-half times as much oil at a lower production cost with much lower effective taxation, a $2tn to $3tn market capitalisation is not beyond imagination.

Nevertheless, this valuation appears to assume that Aramco’s oil reserves, which represent the lion’s share of value, will be part of the deal. If they are, the kingdom will be selling 5 per cent of its oil patrimony for perhaps no more than $100bn, if oil prices remain around recent levels.

Moreover, only New York, London and Hong Kong have the liquidity to handle such an offering. In these markets, securities regulations would require Aramco to detail its reserves in the offering prospectus. Saudi reserves are not public today and are handled as something of a state secret. Thus, by including the country’s oil reserves in the deal, Saudi Aramco would have to provide transparency about the true state of the country’s oil resources – and not only at the initial listing, but every quarter thereafter.

Will the kingdom be willing to regularly divulge the data? It would run counter to long-standing Saudi practice.

On the other hand, Aramco could be listed without its oil reserves. These would remain the property of the Saudi government, as they do in places such as Iraq, with the company accessing and purchasing the Saudi crude on some basis. For example, Saudi Aramco might be entitled to buy crude oil from the Saudi government at 60 per cent of the world market price. In this case, the government would retain a fixed source of revenue – the 60 per cent share – but retain Aramco’s ability to create value. This would reduce the potential valuation by a good bit – perhaps by half – but it would avoid the issue of selling out Saudi Arabia’s oil patrimony and circumvent the need to disclose reserves.

Finally, any privatisation could be limited only to Aramco’s downstream – refining and petrochemicals – assets, leaving the upstream segment entirely in government hands. This would be a smaller, cleaner and less politicised privatisation, but again would highlight some of the underlying issues. For example, petrol in the country sells at about half the world market rate. A refinery can make money at this price, but only if it can also purchase crude for refining at half global prices. Establishing a price for the crude to be bought by Saudi refiners would be one task before a privatisation.

Running a public company is a different experience to that of a state-owned enterprise. For example, staffing and compensation levels, unit costs and safety and environmental issues are entirely internal at Aramco today. However, with a public listing, these will become public issues, dissected and discussed in the US and UK press, with activist investors clamouring for “accountability”.

There is nothing wrong with transparency if this is the Saudi leadership’s goal. Nevertheless, it represents a big change from the way things are done today. In my experience as an energy banker, I found that managers, even of private companies, considered the requirements of public reporting and scrutiny to be daunting. For this reason, starting with a more modest pilot project might be advisable.

The deal is also at risk from recovering oil prices. Governments are inevitably keen to privatise when oil prices are low. I made an unforgettable visit to Algeria in 1998 – then still in the throes of civil war – to talk about the experience that the auditor Deloitte, for which I had worked, had undergone in privatising Mol, Hungary’s oil company. As oil prices had fallen to $10 a barrel, there was keen interest from the audience in Algeria. But all good intentions evaporated as soon as oil prices rebounded. The pressure Saudi Arabia faces today will fade when oil prices move up over the next two years.

I may sound sceptical about privatisation. I am most certainly not.

For a national oil company such as Mexico’s Pemex, it could work wonders, not only for the company itself but for the Mexican economy as a whole. But privatisations can also go wrong, as in the case of Petrobras. The Brazilian government was simply unwilling to let Petrobras operate as a truly privatised oil company and its share prices has fallen by nearly 90 per cent as a result.

Privatisation can work in Saudi Arabia if it is part of a broader reform package aimed at materially reducing the role of the state in the economy and private life. Aramco’s privatisation, however, should not be treated as a panacea. It will consume an inordinate amount of effort, time and political capital, all of which may ultimately have been better deployed on less spectacular, but more meaningful and lasting, reforms.

Steven Kopits is the president of Princeton Energy Advisors in New Jersey

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