How the Saudi Aramco initial public offering pits foreign investors against Saudi citizens.
Imagine how shareholders would react if ExxonMobil gave away a third of the oil it produced, rather than selling it at market prices. There would be hell to pay, right?
But state-owned Saudi Aramco does something almost as ruinous, selling a third of its oil inside the kingdom for less than $6 a barrel. That’s a discount of 87 percent on the international price.
For would-be subscribers to Saudi Arabia’s forthcoming IPO, the national oil company’s huge subsidy burden is emerging as a major bone of contention.
A few decades ago, providing discount oil and gas to Saudis wasn’t such a big problem. Only 6 percent of Aramco’s oil was consumed domestically in 1980. The other 94 percent was exported.
But the exported share of Saudi Aramco’s production declines every year. Now the kingdom gets full price for only two-thirds of the oil it produces. Next year, it will probably be even less.
What about Aramco’s natural gas exports? There are none. One hundred percent of Saudi Aramco’s natural gas is consumed domestically, which is unsurprising because it is priced under $2 per million British thermal units, which means there is more demand than supply. Countries that border Saudi Arabia, including Kuwait and the United Arab Emirates, import natural gas at international prices about three times as high.
The kingdom’s lavish energy subsidies ought to give pause to investors giddy over the prospect of buying into the world’s largest IPO, and the world’s largest company, period, in revenue terms.
Domestic prices are shaping up as a major sticking point between private investors and Aramco’s management. Ultimately, Aramco shareholders must contend with the Saudi public, which views ultracheap energy as a birthright.
The kingdom’s crown prince, Mohammed bin Salman, understands the stakes. He aims to dismantle some of the more onerous state claims on Aramco. In March, the government cut Aramco’s tax rate from 85 percent to 50 percent. Mohammed has also said the government aims to gradually take away energy subsidies, replacing them with cash.
The kingdom made impressive strides in this direction in 2016, raising prices on energy products across the board. Unfortunately, Saudi prices were so low in 2015 that the new prices are still a fraction of international benchmarks.
It remains to be seen whether the royal family can go all the way — imposing full international prices on citizens already vexed by the doubling of gasoline prices and the near-doubling of residential electricity bills.
Retracting energy subsidies is a well-known trigger for social unrest. Regimes that attempted similar austerity measures in OPEC member states Indonesia and Venezuela found themselves overthrown by angry mobs. Gasoline price riots in Nigeria in 2012 and in Mexico this year provide further warnings. The Saudi government understandably treads with caution.
The values of Aramco’s publicly traded shares are ultimately going to revolve around the giant company’s ability to maximize profits. When share price disappoints, foreign investors are bound to demand that Saudi Aramco start treating domestic consumers the way it treats everyone else.
Of course, foreign investors’ voices might be loud, but their influence won’t be huge. The Saudi state will retain a 95 percent stake in Saudi Aramco.
Investor interests will bump against Aramco’s typical operating strategy in other ways.
A Saudi decision to go along with a production cut by the Organization of the Petroleum Exporting Countries might be irksome to shareholders, particularly if competing producers such as Venezuela or Russia aren’t sharing the load.
Saudi Aramco’s vaunted spare production capacity, a strategic asset that allows the kingdom to balance oil markets during price swings, could be another irritant. Private shareholders might grumble that valuable capital assets are sitting idle, instead of producing oil and profits.
A big attraction of Saudi Aramco stock is the juicy dividend payment expected to flow to shareholders. What if Aramco someday finds it necessary to cut those dividends? You can bet foreign investors won’t sit quietly, especially if Saudi drivers are paying less than $1 a gallon at the pump.
Elsewhere, Aramco officials have pointed out that the company is actively trying to jettison its role in nation-building projects around the kingdom, such as erecting museums, stadiums and universities.
Saudi Aramco’s domestic subsidization problem eclipses these other risks. Subsidies, if left unreformed, pose a major threat to the long-term health of Aramco. Shareholders will soon be a party to those risks.
Saudi domestic oil consumption has increased by an average of 5 percent a year since 1970. In the 2000s, domestic oil demand grew an average of 6 percent per year. In the 2010s, it has slowed, averaging just 4 percent.
Potential investors can take heart that Saudi oil demand grew by just 1 percent last year, due to the increased local prices as well as an increase in natural gas production, which substitutes for oil in electricity generation.
Still, decades of compounding growth has left Saudi oil demand on par with that of Russia, a comparable oil producer that has five times the population and a much larger economy. On a per capita basis, Saudi residents consume 46 barrels per year, vs. eight barrels per capita in Russia. (By contrast, per capita oil demand in the United States is 22 barrels per year.)
What happens if Saudi energy subsidies cannot be reformed? At some point, continued growth in domestic demand could leave only half — or even less — of Aramco’s oil production for export.
There have been rumblings among Saudi citizens who oppose selling off a portion of the company, seeing it as inviting foreign interference in the kingdom’s sovereign affairs.
A lot is at stake. On the one hand, the Aramco IPO could be rocket fuel for the Saudi economy, providing the cash for a longpromised diversification into businesses that can soak up the legions of Saudi unemployed.
On the other hand, the IPO will insert foreign investors into the peculiar internal politics of an absolute monarchy. Many Saudis will resent it, especially if it means the end of cheap gasoline and electricity. Krane is the Wallace S. Wilson Fellow for Energy Studies at Rice University’s Baker Institute.