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.

In her quest to help Britain "embrace the world," U.K. Prime Minister Theresa May has been glad-handing in Saudi Arabia this week. One thing she likely hopes to do is lure Saudi Arabian Oil Co., or Saudi Aramco, to London for its hotly anticipated IPO. The presence of the London Stock Exchange's CEO in her delegation at least suggests the thought has crossed her mind.

With valuation estimates ranging upward of $400 billion, floating even a sliver of Aramco could smash records. What better way to demonstrate to the world that Britannia still rules than landing the biggest-ever IPO?

Having Aramco list in London would also bolster the U.K. government's line that Britain will emerge from the EU as some sort of global business and trading hub. Indeed, on that score, it would enhance an existing peculiarity of London -- if "enhance" is the right word.

London's stock market tilts heavily toward commodities already. A little more than 21 percent of the FTSE 100's capitalization of about $2.5 trillion  relates to oil majors and metals and mining companies. In this respect, London's benchmark index bears more resemblance to those of Toronto or Sydney (or São Paulo) than New York or Hong Kong:

London Underground
The FTSE's weighting toward commodity-producing sectors marks it out from indices in other large, global markets such as New York or Hong Kong
Source: Bloomberg, Deutsche Boerse
Note: Weightings in benchmark indices as of April 5th, 2017

The addition of Aramco would push London's commodities weighting higher. There is, of course, no guarantee Aramco would be added to the index. In general, foreign companies are required to have a free float of at least 50 percent in order to be considered for inclusion in the FTSE 100, and Saudi Arabia is thought to be selling only 5 percent of Aramco initially. Still, exceptions can be made, especially if a company is large enough that liquidity wouldn't be a problem. And London's chances of hosting Aramco's IPO would likely be greatly diminished if inclusion in the benchmark wasn't on offer.

Aramco's impact would, of course, depend on its valuation. At $400 billion and a 5 percent free float, the $20 billion listing would give Aramco a weighting of 0.8 percent in the FTSE 100, based on current pricing. Nothing game-changing there. Royal Dutch Shell Plc, for example, weighs in at more than $220 billion of float, almost 10 percent of the index.

At a $1 trillion valuation -- half the figure Saudi Arabia has touted -- things get more interesting. A $50 billion float would put Aramco in the FTSE 100's top 15 companies by value, with a weighting of 2 percent. I'm guessing FTSE would find it hard to say no to a trillion-dollar company.

This would, all else equal, take the FTSE 100's commodities weighting to almost a quarter. But all else probably wouldn't be equal. It's worth remembering the index is already heavily weighted to the sector despite the fact that energy prices have crashed and most metals are well below their peaks. That weighting has been much higher in the past.

Heavy Metal (And Oil)
At the peak of the supercycle, energy, metals and mining accounted for more than a third of the FTSE 100's value
Source: Bloomberg

If Aramco is to be listed, Saudi Arabia is pretty much compelled to do what it can to push oil prices higher over the next year or so (as I argued here). So the run-up to the IPO ought to raise the value of Shell and BP Plc, too, especially if passive money reinforces a push back into energy.

Moreover, Aramco's valuation and float aren't fixed in stone. Over time, both could rise, pushing the FTSE 100's weighting to commodities back toward 30 percent (especially if, as Bloomberg News reported on Thursday, Russian billionaire Oleg Deripaska decides to list his energy and mining conglomerate En+ Group Ltd. in London by June).

On one hand, this isn't a problem. London's been peculiar like this for a long time. Some fund managers may even welcome the chance to diversify some of their energy weighting into another company. As recently as the end of 2013, the FTSE 100 hosted six of them. Attrition and Shell's acquisition of BG Group Plc took that down to two.

Then again, not everyone will necessarily be comfortable about having to hold shares in an entity that would effectively be a privatized arm of the Saudi Arabian state. Aramco brings exposure to the vicissitudes of Middle Eastern politics and a very ambitious reform program, not just the swings of the oil market.

Aramco's debut also would boost London's weighting to oil just as large fund managers there, along with the governor of the Bank of England, are raising concerns about the financial risks around climate change. In particular, they worry that at least some of the wealth tied up in fossil-fuel reserves could be stranded as things like vehicle electrification and climate-focused legislation eat into demand.

The irony? The very fact that Saudi Arabia is finally pitching an Aramco IPO suggests they may be onto something.

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

  1. All the figures in this column are as of April 5, 2017, and taken from the Bloomberg Terminal.

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

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