Why Energy Investing Will Never be the Same
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Why Energy Investing Will Never be the Same

by | published November 6th, 2019

Our plane was still en route from Heathrow to Miami International when the messages began.

One of my six London meetings over the past week had been with principals in The City (London’s financial district) to compare notes on the impending initial placement offer (IPO) for a minority position in giant Saudi Aramco.

What started out as one of the most anticipated offers in memory when it was first unveiled more than two years ago, has been subject to delay and adverse publicity hitting the country, and its young heir apparent Crown Prince Mohammad bin Salman (MbS).

Among my network of contacts, word had been circulating at the end of last week about some significant problems once again surfacing concerning the IPO. Despite the hype about expediting the sale, there had been renewed indications that it would again be delayed.

This development also had a last-minute effect on my earlier meeting in New York City. On October 18, I discussed some main takeaways from the Saudi decision in an Oil & Energy Investor column written while I was flying back to Florida (read it right here).

But there is a deeper factor in all of this, and it cuts to the core of the current Persian Gulf crisis.

In the attempt to attract an acceptable price for the sale of a minority stake in the world’s largest state-owned oil company, Riyadh needs to persuade the global investment community that it can sustain enough security for its fixed oil production and processing assets.

And that, in turn, requires control it no longer has.

The Saudis Are Maintaining a Level of Secrecy – To Their Detriment

According to my estimate published shortly after it was announced in 2016, the Aramco IPO had been expected to generate upward of $600 billion in revenues. This would then be added to an existing Saudi Public Investment Fund (PIF) providing one of the largest sovereign wealth funds in the world.

But ever since the idea to sell a 5% stake in Aramco emerged more than two years ago, problems have surfaced.

I have earlier examined some of the major shortcomings:

  • Unreasonable and unsupportable valuation,
  • The structure of the offer itself,
  • Difficulties in naming primary financial advisors for the sale,
  • Failure to name a primary stock exchange,
  • An insistence that a portion of both the float and the proceeds be run through the Tadawul (the local Riyadh stock exchange) despite its liquidity and transparency problems, and
  • The intensifying crisis heating up the Persian Gulf.

And it’s this last matter that has become a major impediment to the IPO.

As I had noted in a Dark Files analysis reserved for my Energy Inner Circle subscribers (you can read the full briefing right here), the value that investors place on the sales is directly proportional to the value of Saudi oil reserves.

Forgetting for a moment the ongoing fight among Saudi officials over how much data they are prepared to provide and its impact on the information prospective investors want before committing funds, several of my contacts say they are approaching the Aramco sale expecting a discount.

As one source put it, “You must be able to bring the underlying asset to market for it to comprise an acceptable basis for valuation.”

And the attacks on the Saudi pipeline network, the huge Abqaiq processing facility, and the Khurais oil fields left many wondering if the Saudi security umbrella has holes.

Aramco’s value, along with the expected proceeds of the IPO, significantly declines if the production and export of its crude becomes questionable. Put another way: how can a sale be supported if the raw material providing its revenue is itself the target of cross-border conflict?

Against all of this is what may undermine the kind of IPO success required by MbS. Over the past several days, Saudi and regional sources have been telling me something quite interesting.

MbS Is Playing a Politically Dangerous Game

To offset continuing international bad press from the murder of journalist Jamal Khashoggi last year and the ongoing criticism of the human tragedy in Yemen, MbS has been considering reducing the public portion of the Aramco IPO to about 2% of the company’s valuation. The remaining 3% would be reserved for private placements with other sovereign nations and outside state supported banks or institutions.

The idea would be to use such a bifurcated sale structure to generate artificial competition, thereby artificially increasing the value of the offer(s). However, the prospect of foreign governments owning (directly or indirectly) any part of Saudi Arabia’s prized possession has been enough to begin a round of hot disagreements within the rather extended royal family.

Here is the main importance.

The longer the IPO is delayed, the greater the chance that opposition to MbS will grow at home.

In the current regional and geopolitical environment, that could inject troubling domestic political machinations and discord into an already unstable situation. This is precisely what Iran is looking for in its pursuit of leverage against its hated enemy, and hardly what foreign investors in the Aramco IPO or buyers of the company’s oil would find the least bit reassuring.

Unfortunately, what has emerged over the weekend is creating yet another problem for outside investors who may have interest in the IPO.

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Now, I still believe that, given the uniqueness of the issuance, any IPO in Aramco will be oversubscribed, with much of the supposedly independent positions that will be taken ending up effectively controlled by state-supported holdings.

However, word surfaced on Sunday that the prevailing opinion among the inner circle surrounding MbS was toward a floating of the IPO on the Tadawul rather than a more liquid and foreign exchange such as the NYSE in the U.S. or the LSE in the UK.

Two conclusions were then rapidly made in my contact network.

This IPO Could Change the Energy Investment Landscape

First, the decision to float locally allows for less transparency. That means the ongoing disagreement over how much data to release on Aramco’s reserves and sustainable production continues to be a major issue among officials in Riyadh.

Saudi stock exchange Tadawul is a small bourse when compared to the more well-known exchanges in New York, London, Paris, Frankfurt, Tokyo, Singapore, or even Toronto. But it does allow the Saudi government to keep released Aramco data to a minimum.

That diffuses the internal political battle (where the pushback to the IPO comes from those regarding Aramco’s data a national security matter) but keeps what outside investors normally expect before a move below comfort level; how can you analyze an issuance when you do not have access to the “nuts and bolts” of what is being offered?

The last detailed figures on Aramco were provided just before the company was nationalized away from an American consortium.

And that was 1979.

Second, greater reliance on Tadawul will increase an ongoing effective local (i.e., royal family) control over the company’s ownership. The IPO will involve a very small sliver of the company. Additionally, even if it is released on the Saudi exchange, there will be opportunities for foreigners to own stock though the release of depository receipts and depository certificates.

Receipts and certificates allow outsiders to own what remains an internally traded stock. But, unlike receipts, certificates retain share voting rights with the financial house releasing them. That arrangement is still used in Europe (especially surrounding investment affairs entered about Frankfurt) and may be preferred by the House of Saud as another level of maintaining control.

In any event, there will need to be reforms further opening Tadawul to make this work.

And then there is the real target I am emphasizing.

The total PIF resulting will provide the means to allow a unique move for economic diversification.

Saudi Arabia’s domestic economy is tied to the sale of crude oil. PIF will be used to acquire ownership over non-oil assets abroad. The funds are acquired via the valuation of a huge national oil company (NOC) and then sustained at a level based upon the continued operations of that NOC.

But the objects acquired need have nothing to do with oil at all.

At that point, we are introducing a radical departure from what has traditionally been considered an energy investment.

That opens up major new avenues for our interest. Investors will now be able to target non-oil foreign assets subject to Saudi interest.

Things may never be the same again.

Sincerely,

Kent

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