Answering Your Excellent Questions
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Answering Your Excellent Questions

by | published November 13th, 2019

On Monday, Marina and I will be off to Paris.

Over the week that we’re there, we’ll have a chance to see old friends and visit some of our favorite restaurants, but for much of the time I will be in meetings that shape up as the next chapter in a rapidly changing energy investment environment.

As readers of Oil & Energy Investment are aware, those changes have obliged I put on the travel miles over the past several weeks – Dubai, Doha, Fujairah and Sha’am in the Persian Gulf, Canada, New York City, and London.

I’ll fill you in upcoming issues of Oil & Energy Investor on what awaits me in Paris; it is likely that some of the biggest issues I have faced await me in the “City of Light.”

But today I thought we could take a breather from the heavy geopolitics and do something else – answering some of the excellent questions you folks have been sending in.

So, let’s get started…

Opening the Oil & Energy Investor Mailbag

The first two questions today address elements in the upcoming Saudi Aramco IPO, the sale of a minority position in the largest oil company in the world:

D.N. asks, “What is the Saudi Public Investment Fund?

Several years ago, the heir apparent to the Saudi throne Crown Prince Mohammad bin Salman (MbS) moved to use the Saudi Public investment Fund (PIF) as his main tool to diversify the domestic economy. The PIF was actually set up in 1971 and has been the basis of the main Saudi Sovereign Wealth Fund (SWF). It currently has about $400 billion in assets under management.

An SWF is set up to invest a government’s excess revenue. These are usually found in raw material producing countries, especially those basing their economies on the export of crude oil. But they can exist for other reasons. China, for example, has several SWFs in which its balance of trade surplus with other nations worldwide is housed.

SWFs have a number of different uses: To provide central budgetary funding; offset pricing declines in the commodities which form the base of its revenues; fund national pension and other programs (that are expensive but provide very little revenue on their own); and, in some cases even provide direct subsidies to citizens.

However, there is one element that is part of each. An SWF is designed to insulate the local economy from the currency instability attending a rapid injection of proceeds, especially hard currency, from the outside. Most SWFs, therefore, retain all or almost all of revenue generated outside the country and invest it, repatriating profits from investments back home selectively.

The intention is to lessen the likelihood of inflation (usually hitting first in the economic sector closest to the foreign trade) and local currency devaluation. This is often called “The Dutch Disease,” the modern version of which occurred in the 1960s following the discovery and export of hydrocarbons from the Netherlands. Some also point out that the same thing happened centuries earlier in Holland’s tulip trade.

The Saudi PIF has a broad mandate, which essentially means that government leaders can use it for just about anything.

And it is here where things are going to get very interesting, especially for us as we explore ways to turn the Aramco IPO into investment profits.

MbS intends to fold proceeds from the IPO into the PIF with as much of the publicly available shares in the IPO (some also to be disseminated in private placements) as practicable run through the Tadawul, the Saudi stock exchange.

The beefed up PIF will then be used to diversify the Saudi economy, moving it from dependence on the price of crude oil. And the plan to do that involves buying assets and equities abroad. If it works, it will mark the first time a domestic economy is diversified by controlling foreign-sourced revenue flows.

All of this requires that Aramco continue to be valued strongly, since it remains the basis for both the IPO proceeds and the strength of the shares resulting.

For us, it may become the largest expansion of what an energy investment means. The process begins with a major energy driver (the value of Aramco) but may end up with the acquisition of all manner of non-energy holdings. Just about anything could then be considered an energy investment.

Next, Robert J. poses a very astute question: “Is there any link between the Aramco IPO and the recent series of RPO dumps to the investment banks as a prelude?

Oh yes, Robert, and well viewed.

RPO here refers to “recruitment process outsourcing.” In advance of the Aramco IPO, investment banks are jockeying for position. A handful of houses will serve as primary “book runners” for the offering, but literally hundreds of banks will participate as the process “syndicates” to spread out risk.

That means the IPO and what the proceeds will be used to acquire (as outlined above) will be a major new direction of investment banking worldwide. As a result, investment banks are self-staffing in anticipation with the larger ones providing services to a wide network of smaller houses and investment groups, or spinning off standalone firms to provide staffing needs to the market.

This is already underway. It became the subject of my recent meetings in London (where participants were exploring what analysts would need to be acquired based on what I thought would be a possible list of Saudi investment targets) and will almost certainly come up again next week in Paris. There, one of my sessions will be to brief French and Swiss investment groups. One of the primary elements in that discussion will address the Saudi IPO and its impact on broader investment elements.

 

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Moving on to other matters, Bill P. forwarded the following: “Since midstream companies are primarily deriving their revenue from the quantity of product that is conveyed through their pipelines or compressed by their compressors or stored in their storage tanks and the volume of product moving through or utilizing these facilities is at record levels, why are the unit prices of these entities mostly doing so poorly?

Bill has put his finger on one of the main problems currently in evidence throughout the U.S. market. The answer to this is very long, but for the purposes of brevity this time around, let me confine it to the most salient point.

Among other things, the value of a midstream company or master limited partnerships (MLPs) and otherholdings controlling such assets is largely determined by two considerations – (1) the market value for the underlying commodity, and (2) the interconnection between market demand for services and a company’s excess spare capacity to house (store) or transport volume.

On this latter point, it is useful to remember that much of American pipeline capacity is used to store, not transmit, especially when it comes to natural gas production.

Well, both of these elements have been working against midstream (MS) providers. There are basic figures you can use that estimate MS profits from factor analyzing how market pricing relates to service excess capacity, and those coefficients remain below expected levels of profitability.

The situation is beginning to change as new pipeline systems become operational and the range of production tightens. That means that some MS companies will begin moving up, though this will not translate into “a rising tide lifting all boats.”

Finally, George B. allows me to take a more reflective look when he asks, “As an historian watching events unfold and a follower of human patterns, it is not hard to see where the direction things are heading. However, what surprises do you personally see coming?”

Just so happens, when in London a few weeks ago, I was asked a very similar question by a much younger colleague over a pint (or two) downed at what used to be my local when I was living in Kensington.

As I told him, after spending more than four decades at this, I have learned to anticipate the unanticipated. What I always find interesting is that so many do not expect the unexpected and have no way of dealing with it once it arrives.

Instead, too many come to believe that the current environment is distinct from what has occurred in the past. This time it is different, they say.

Not so. Perspective is essential and that come largely only with an ability to bring to bear much of what has been experienced. The key to success is to see where a new tangent is going before it becomes apparent to everybody else.

We will have changes in emphasis, outlying events that alter surroundings, and new developments that will usher in new opportunities and deemphasize older ones.

As for what I see coming, there are three.

First, the accelerating energy picture will provide the background for major revisions in the energy balance. Oil, natural gas, and coal will continue to be the leaders worldwide. But the fulcrum of that balance will be held by the emergence of a more seamless exchange of energy sourcing with non-hydrocarbons holding a more pivotal role.

In short, the continued dominance of the three conventional leaders will become more dependent upon other sources holding down guaranteed percentages of the mix.

Second, there will be a breakthrough in life altering battery technology introducing advances in storage and efficiency that will fundamentally revise the energy landscape. A corollary will be the ability to reach regions of the world now largely cut off from essential energy supplies.

And the third surprise?

I believe the Boston Red Sox will finally acquire some decent starting pitching.

My mailbox is always open, so please don’t hesitate to submit any question you may have in the comment section below. I am looking forward to hearing from you.

Sincerely,

Kent Moors

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