420 million gallons. That’s how much oil Saudi Aramco produces every single day: 10% of the entire world’s supply. So it’s no surprise that Aramco is the world’s most profitable company, generating $111 billion in 2018. To put that into context, the next five biggest oil producers – ExxonMobil, Royal Dutch Shell, BP, Chevron, and Total – made less money combined.
Ever since 2016, Aramco’s owners – the Saudi Arabian government – have been making noises about publicly selling its shares. A dramatic slump in the price of oil woke Saudi Arabia up to the fact it should probably diversify its economy away from a near-total reliance on oil, and selling just a fraction of Aramco would raise plenty of cash to invest in WeWorks and robot cage-fighting arenas.
That’s where you come in. Following on from its first public financial results back in April, Aramco has now, as of November 2019, announced plans to list around 1.5% of its shares on the Saudi stock market at a price that could value the company at as much as $1.7 trillion. What may well be the world’s largest initial public offering (IPO) will also turn Aramco into the world’s biggest publicly traded company – and you’ve got the option to get involved.
In this Pack, we’ll walk you through why that may or may not be a good idea, as well as explaining just how to go about getting your hands on shares. Like many things in Saudi Arabia, it’s not exactly straightforward…
Even if you don’t choose to invest, you still need to know how the world’s biggest company works: whether it’s in the price you pay at the gas pump or the complexion of the climate, Aramco definitely affects your life. So let’s kick off with the basics: what does it actually do?
The takeaway: Aramco is the most profitable company in the world – and you can invest in it.
The oil industry isn’t a simple one – and as the biggest oil company out there, Aramco’s pretty complicated. Its business is split into two main areas: upstream and downstream.
Upstream is the part where Aramco finds and extracts crude oil. That’s been its bread and butter ever since 1933, when the US oil company now known as Chevron struck a deal to drill in the fledgling Saudi state (the country bought out overseas investors in the business between 1973 and 1980). Today, Aramco claims to be the largest owner of onshore and offshore (i.e. underwater) oil fields in the world – with enough oil reserves to last over 50 years.
The company has to figure out how to extract its existing reserves and, as those fields drain over time, has to regularly scour for new fields too. Aramco also collects and sells another fossil fuel, natural gas; combined, Aramco churned out 13 million “barrels of oil equivalent” each day in the first half of 2019. All this naturally involves complicated geoscience and massive, expensive construction of oil rigs.
Once the oil’s out of the ground, it’s transported “downstream” to a refinery. That’s where the raw crude oil is distilled into a range of compounds that, combined, can form fuels like gasoline and diesel. Some of those compounds are then processed further – ending up as the petrochemicals used in plastics, cosmetics, and even chicken nuggets.
Not all energy companies undertake both upstream and downstream activities. But Aramco is a vertically integrated company, giving it the capacity to control the supply chain from start to finish. And that means it can tailor its downstream business perfectly to refining its different varieties of crude oil.
Despite recent moves to expand its global presence downstream, however, oil production remains the biggest part of Aramco’s business by far. That means its monster profits depend largely on the price of crude oil, which in turn depends on supply and demand. Oil demand is closely linked to economic growth: when times are good, companies are growing and people are spending, and everyone needs more energy. But when the economy slows down, demand drops.
Aramco finds itself in a unique position. As the biggest single producer of oil and de facto leader of the **OPEC **group of major oil-pumping nations, Aramco can respond to falling demand by restricting a large amount of the global supply. That can help keep the oil price steady, insulating Aramco from dramatic profit swings. The company is famous for its ability to quickly adjust production to meet targets low and high, keeping spare production capacity (and more barrels in reserve – you guessed it – than the next five oil giants combined) ready for when demand shoots up again.
That’s just one reason some profit-hungry investors like the look of Aramco, however. Next, we’ll explore what else has them keen to buy.
The takeaway: Aramco both extracts oil (upstream) and refines it (downstream), and its dominance of the global oil market helps it control both price and profit.
When wooing investors, Aramco points to two things. The first is its efficiency: the proximity of Saudi oil to the surface means it can cost Aramco as little as $2.80 to extract a barrel of oil, a fifth of what it costs the likes of ExxonMobil. According to The Economist, as long as the price of oil sticks above $30 a barrel, Aramco can break even on new projects – at 2019’s price of $50-$60, Aramco’s doing okay.
Aramco’s other big selling point is its immense scale – across both upstream and downstream. In recent years it’s made a significant push into the latter, buying Saudi petrochemicals company SABIC in March 2019 and adding a $15 billion investment in India’s Reliance’s refining unit to a worldwide portfolio which also contains Port Arthur, the largest refinery in the US. This has multiple benefits. Controlling both oil’s production and its purification creates efficiencies – SABIC’s profits are expected to increase under Aramco’s control.
What’s more, downstream operations diversify Aramco’s business. The company is aiming to become a lot less reliant on high oil prices – and as long as people keep buying its petrochemicals, it can continue to make money. In fact, as crude oil prices decline, downstream profits actually increase: the refineries don’t need to pay as much to “buy” the raw oil from the upstream business. Aramco’s increasing focus on Asia, where it not only invests but also sends three quarters of its exports, is particularly strategic: petrochemical demand is forecast to grow fast in the region.
Aramco is also more future-proof than many oil companies: it produces less than half the emissions of overseas rivals when extracting oil, and it’s positioning itself to be a big producer of natural gas, widely seen as a less environmentally damaging energy source. As climatic concerns grow, Aramco could end up as the last oil company standing: its market share is forecast to grow even as overall oil demand shrinks. Although for some investors, that’s not reassurance enough…
The takeaway: Aramco’s an efficient, increasingly diversified oil company – which could make it worth more than its peers.
Some investors are steering well clear of Aramco’s stock market listing, concerned that the company's confronting global trends that it simply can’t overcome. Foremost among these is climate change, which may push people to reject all fossil fuels in favor of greener energy sources. Predicting the impact of climate change on global oil demand is very, very difficult: some think oil demand will keep growing indefinitely, others that it’ll peak in 2050, while still more reckon demand could start to drop within a decade. Aramco cites a forecast in its IPO prospectus that oil demand will level off in 2035 – though it warns that peak could arrive as soon as the late 2020s.
A lot depends on geopolitics: if climate targets get more ambitious and petroleum fuels are literally banned in some countries, that could spell disaster for oil demand. While unlikely, that risk is big enough for some to stay away from the sector altogether, even as an increasing number of other investors divest from fossil fuel companies on the basis of ethical concerns. And Aramco is particularly vulnerable – unlike most of its competitors, it doesn’t (yet) have a significant stake in renewable energy businesses.
The other long-term concern is that Saudi Arabia is losing its grip on the oil market: thanks to a revived shale oil boom, the US is now the world’s biggest national producer. And as the US isn’t in OPEC, the Saudi-dominated gang have much less control over the oil price. Their efforts to rein in supply will be futile if the US decides to flood the market with cheap oil (something the US president has actively encouraged). OPEC predicts demand for its members’ oil will drop by 7% over the next four years as a result. And if the organization tells Aramco to produce less in order to drive up demand – and causes it to make less money as a result – it’ll have no choice but to do what it’s told.
The oil market is already pretty weak as things stand. Prices are about a third of the peak they hit in 2008 – and with many expecting a global economic slowdown, they may only get worse. The International Energy Agency thinks demand could outstrip supply in early 2020 by more than a million barrels a day, and the effects of an escalating US-China trade war could fatten that glut. Given the massive inventories already piled up, oil production doesn’t seem like the best game in town.
What’s more, there’s the fact that investing in Aramco involves getting into bed with the Saudi royal family. The rulers of the Sharia state will continue to control as much as 99% of Aramco, and their incentives are most definitely not aligned with Aramco’s other shareholders’. The bulk of Saudi government revenue comes from taxing Aramco – and while the government recently cut those taxes in response to lower oil prices and has promised IPO investors a hefty dividend, if times get tough, there’s nothing stopping it from moving the goalposts.
Indeed, Saudi unemployment remains near record highs, corruption remains rife, and the government continues to control over 80% of the economy. The country’s de facto leader has also shown a heightened interest in Aramco’s affairs of late, sacking previous company chiefs at a whim: something hardly conducive to a stable investment environment. And if tensions between Saudi and neighboring Iran worsen, Aramco could get caught in the crossfire – as happened, literally, when an allegedly Iranian drone attacked oil production facilities in September 2019. Add in journalists getting murdered on government orders, and it’s no surprise overseas investment in the country is less than half what it was three years ago…
But that looks set to change. Despite all Saudi Arabia and the oil market’s travails, Aramco’s still thought to be worth over $1 trillion. Some even say $2 trillion. So who’s right?
The takeaway:The potential for a dip in oil demand and the perils of doing business in Saudia Arabia have some investors worried about Aramco.
It’s really hard to value Aramco. When professional investment analysts tried to do so, their estimates varied from $1.2 trillion to $2.3 trillion – a margin greater than the entire value of Apple. But we’ll take a stab at it anyway.
The easiest way is to compare it to its rivals: oil “supermajors” like Chevron, Royal Dutch Shell, BP, ExxonMobil, and Total. A common metric to look at is free cash flow yield: how much money the company generates from its operations relative to its stock market value. Taking 2018’s cash flows as a percentage of November 2019’s market capitalizations, the yield for those companies varied from 7% (BP) to 14.7% (Shell). Considering the risks attached to Aramco, most investors would probably want a yield of 7% – and on 2018’s $86 billion free cash flow, that implies a valuation of $1.2 trillion.
According to more complicated valuations from Bloomberg, if oil prices stay at $55 per barrel then Aramco’s valuation should look more like $990 billion at a 7% yield – they’d need to get to $65 to justify a $1.2 trillion valuation. At $80, $1.5 trillion is feasible; but Aramco would only be worth $2 trillion if investors could stomach a 5% yield. And that’s unlikely, considering its bonds offer a 5.85% return and are less risky than shares.
You could alternatively value Aramco based on its dividends. It’s promised to pay its investors a $75 billion dividend in 2020, which will reportedly increase by 10% a year. What’s more, it’s said that even if it has to reduce the overall total then new public investors’ proportional share will stay the same, with the Saudi government taking the hit instead. Exxon’s stock currently trades at a dividend yield of 5% – based on that, Aramco’s worth $1.5 trillion.
So that’s what foreign investors were willing to pay. But Aramco’s decided to aim for a $1.6 to $1.7 trillion valuation, and not to bother even trying to persuade them to buy its shares. Instead, it’ll rely on local Saudi investors. Demand from them isn’t just driven by whether they like the look of the company: it’s also driven by a strong sense of patriotic duty, easy access to loans tailored for stock-buying, and perhaps even something more sinister.
That’s something to bear in mind if you do decide to invest. And you might unknowingly do so, whether you like it or not: if you’ve got money in an emerging markets exchange-traded fund (an EM ETF, if you will), you’ll automatically invest in Aramco soon enough: the Saudi stock market makes up 2.8% of the prominent MSCI EM index, which many such ETFs track.
Gaining more direct exposure to the company isn’t easy, however. For now, Aramco will only be listed on the Saudi stock market, the Tadawul. While this opened up to foreign financial “institutions” in 2015, it remains off limits to foreign retail investors: you’ll just have to hope someone creates a global depository receipt, a product backed by company shares held, typically, by a bank. In the meantime, you could also invest in an oil ETF or a Saudi-specific ETF – though that’ll expose you to the whole market, not just Aramco.
If none of that appeals, patience is also a virtue. Aramco may float on international stock markets in 2020 or 2021, which will make buying its shares much easier. And hey – maybe by then we’ll have a clearer idea of whether oil’s going the way of the dinosaurs that formed it.
🔹 Saudi Aramco is the most profitable company in the world, and when it lists its shares you’ll be able to benefit.
🔹 Aramco both extracts oil and refines it, diversifying its business in the event of an oil price collapse (which shouldn’t happen because Saudi Arabia can control the world’s oil supply).
🔹 Investors like its efficiency and scale – one case for investing is that it’ll be the last oil company standing.
🔹 But others worry about the impact of climate change on oil demand, the medium-term prospects for the global economy – and the state of Saudi corporate (and civil) governance.
🔹 It’s very hard to value Aramco: you can use its free cash flow yield, or its dividend yield. But the value it ends up trading for might be higher than its actual value, thanks to friends in high places…
Now test your knowledge on this Pack with our quiz.
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.