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Aramco’s IPO Gives Saudi Arabia Incentive to Pump More Oil, Not Less

Ellen R. Wald

(Bloomberg Opinion) -- Now that Saudi Aramco is finally about to become a public company, it will have to start acting like one. And that means the share price of the state-owned oil giant will be of primary consideration to its executives and its shareholders. The kingdom’s monarchy, which will still control nearly all of Aramco’s shares after the IPO, will have particular interest in the stock price as it seeks to sell additional shares following the lock-up period. But because Aramco is a unique oil company, this could lead to unexpected OPEC oil policies.

The widely held perception is that the Saudi monarchy will seek higher oil prices to bolster the share price for a publicly traded Aramco (the company’s formal name is Saudi Arabian Oil Co). The accepted forecast calls for Saudi Arabia’s Oil Ministry to act to limit OPEC production at this week’s meeting or those in the future, to achieve these higher oil prices — and indeed, there are reports that the kingdom is pushing for a three-month extension of current production cuts, through June 2020. However, the best way for Saudi Arabia to boost Aramco’s share price is actually to increase its own oil production, even if that leads to lower prices for crude. As such, the oil market needs to be prepared for the possibility that Saudi Arabia may employ this strategy prior to any future sales of Aramco shares.

The Aramco IPO is only the beginning of Saudi Arabia’s attempt to monetize its national oil company. Various members of the Saudi government have suggested that more shares of Aramco will be sold in the future, either on the local Saudi stock exchange or possibly on an international bourse. Crown Prince Mohammed bin Salman will likely be eager to sell more shares, especially since he was forced to scale back his original plan of selling 5% of the company at a $2 trillion valuation. The government will be forced to wait at least six months before it engages in most types of sales, though it can sell shares to foreign governments before that. 

In advance of future share sales, Saudi Arabia will want to maximize Aramco’s revenue and profit, just like any public company that wants to increase the attractiveness of its stock. The common view is that share prices for oil companies go up when oil prices rise, and this is generally true for companies such as Exxon Mobil Corp. or Total SA. But even those companies would tend to keep pumping even when oil prices are middling, like they are now, because they need to show revenue strength. Oftentimes, it is expected that Aramco and OPEC partners will be the producers that try to raise or maintain the price of oil  by actively decreasing production. However, for Aramco, the sale of more oil, even at relatively low prices, offers a better opportunity to increase revenue and profit to look good at earnings time.

Aramco has the lowest lifting cost per barrel  of oil (production costs after drilling), at $2.80, and an exceedingly low upstream capital expenditure per barrel of $4.70. As a result, Aramco makes much more money per barrel of crude it sells than any other oil company and can make much more money per barrel at lower prices — though of course it wouldn’t benefit from a slump. As for the opposite scenario of tightened production, Saudi Arabia’s oil policy has been fairly ineffective at raising oil prices in a market that features lagging demand growth and rising supply from non-OPEC producers like the U.S. Thus, it is questionable as to how much OPEC could raise the price of oil if Saudi Arabia wanted it to.

Even if Saudi Arabia was able to push up oil prices, profit growth would diminish. Under the new marginal royalty scheme in Saudi Arabia, the company currently only pays 15% to the kingdom on crude production at current price levels. But if the price rises above $70, the royalty rate hits 45%, and above $100 it hits an enormous 80%. At some point, the rise in oil price helps the Saudi government coffers much more than the company, and potential investors know that. 

One of the reasons Aramco is unique among oil producers is that it can significantly increase its production. In fact, Aramco is currently required, under the Saudi Hydrocarbons Law, to be able to produce 12 million barrels per day with three months’ notice. That would be an increase of 2.2 million barrels per day from its October levels. Most likely, Aramco could produce in excess of 12 million barrels, if the government directed. In addition to increased production, Aramco also maintains significant amounts of stored oil, which it can release to the market to increase its own revenue.

In contrast, other major producers can’t increase their crude oil sales in any significant way. They don’t maintain large amounts of spare capacity, because they are producing to optimize revenue all of the time; after all, they have shareholders to appease. Aramco has left its production far below capacity for good reasons. Traditionally, Aramco and the Saudi government haven’t immediately needed more cash and have prioritized the health and long-term viability of Saudi Arabia’s oil reserves. Moreover, until now, Saudi Arabia hasn’t had to consider Aramco’s share price.

Now, with a focus on share price and optimizing the amount of cash the monarchy can make from future share sales, Aramco has reason to enhance its revenue and profits in the short term. The best way to do this is for the company to increase oil production. As the de facto leader of OPEC, we can expect these new incentives to factor into Saudi Arabia’s preferred oil policies from here on out.

To contact the author of this story: Ellen R. Wald at ewald@tvslconsulting.com

To contact the editor responsible for this story: Beth Williams at bewilliams@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ellen R. Wald is president of Transversal Consulting and a nonresident senior fellow at the Atlantic Council's Global Energy Center.

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