Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

That strange and rather unappetizing sound you just heard was the world’s energy bankers simultaneously salivating over the prospect of the oil deal of the century.

In an interview published Thursday by The Economist, Saudi Arabia’s deputy crown prince Muhammad bin Salman said his country is considering privatizing Saudi Aramco.

A quick back-of-the-envelope calculation for a company whose oil reserves dwarf those of Exxon Mobil yields a potential market capitalization of: gajillions. Apart from anything else, Aramco’s role in supplying roughly a tenth of the world’s oil would make its earnings guidance required reading not merely for sell-side analysts, but central bankers, government leaders and generals, too.

There are many caveats here, beginning with the fact that the privatization is "something that is being reviewed." And if privatization were to proceed, it might well involve listing shares in some downstream part of Aramco such as petrochemicals, rather than the core upstream business or parent company.

The bigger issue, though, is the idea appearing to have any traction at all and being spoken of publicly by no less a figure than the deputy crown prince. It adds a further twist to a narrative emanating from Saudi Arabia that suggests the global oil market is undergoing epochal change.

The interview was wide-ranging, touching on relations with Iran and the U.S., women in the workforce, tax reform and possible privatization in many sectors, not just energy. And the deputy crown prince was in expansive mode, agreeing with his interviewer’s supposition that the autocratic kingdom is undergoing a "Thatcher revolution" and answering one question on attracting foreign investors with an almost Trumpian "I’m only giving out opportunities."

The context for this sweeping vision, though, is the OPEC benchmark oil price having just slipped below $30 a barrel. The rational time to sell shares in Aramco would have been, let’s see, about 18 months ago, when oil was still trading in triple digits and the MSCI Emerging Markets Index was nudging 1100 rather than languishing below 750.

Timing Is Everything
The OPEC benchmark oil price is down 73 percent since July 2014.
Source: Bloomberg

 

More Retreating Than Emerging
MSCI Emerging Markets Index
Source: Bloomberg

Of course, other things play a part in deciding to privatize any state jewel of this scale -- such as, in the words of the deputy crown prince, fostering transparency and strengthening the domestic stock market. Such factors were there, for example, in the privatization of China’s oil majors at the start of this century.

Yet it’s hard not to see talk of floating Aramco as a defensive move forced on a kingdom that is under pressure on the financial, political and military fronts.

Saudi Arabia still sits on sizable foreign reserves. But the increases in (heavily subsidized) domestic fuel prices announced recently, as part of the country’s annual budget, indicate Riyadh’s desire to hunker down for a prolonged period of low oil prices. Indeed, it is possible that raising money from an Aramco IPO would be designed to show that the state is making its own sacrifices.

Ill FX
Saudi Arabia's foreign exchange reserves, while still high, are crumbling in the face of low oil prices.
Source: Bloomberg
Note: Reserves excluding gold

And Barclays pointed out in a recent report that the rigid nature of Saudi Arabia’s public budget means belt-tightening will likely fall disproportionately on capital spending projects -- hardly in keeping with the deputy crown prince’s grand vision. An injection of liquidity from an IPO could potentially help on that front.

Change is clearly in the air. Riyadh is due later this month to unveil a medium-term "National Transformation Plan" aimed at, among other things, streamlining a public sector where wages swallow up nearly a fifth of GDP and diversifying the country’s tax base. This comes soon after a decision to open the country’s stock market to foreign investors.

And, of course, it is happening amid an ongoing policy to maximize oil production in a suddenly much more competitive global oil market.

In one unnerving respect, this is bullish for oil: Ossified political structures are highly vulnerable precisely when they seek even partial reform. Any destabilization in Saudi Arabia could provide the supply shock that clears the glut in oil and raises oil prices.

But don’t forget the warnings given by Saudi Arabia’s petroleum minister just over a year ago that global oil demand growth may face a "black swan" in the next few decades. Viewed through that lens, the policy of pumping more barrels out now looks like not merely a strategy to maintain market share but also to simply monetize reserves that might otherwise be left to mire underground. 

Take it one step further, and you might say the same of Riyadh suddenly deciding it’s time to cash in on Saudi Aramco now, oil price be damned.

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

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net