Saudi Arabia is again discussing selling a small share of its national oil company, Aramco, to the public. The announcement has attracted little attention from those who follow oil company shares. From this lack of discussion, I conclude that most analysts think an Aramco IPO will be a non-event.
Those who believe this should think again. The sale of shares could suppress oil equities by up to ten percent if Saudi Arabia raises $100 billion from the sale. The publicly traded oil firms could be forced to curtail their exploration and production programs quickly to repurchase shares to offset the effect of the sale and support stock prices. Non-OPEC production might begin to decline, leading to an increase in Saudi output, a rise in Saudi revenue, and, possibly, higher oil prices.
A sale of Aramco shares could be a big event – and a big disaster for Big Oil, as well as those holding oil company shares. Here is why.
The oil sector today has become a pariah industry for many investors. Its unpopularity is rivaled only by that of the tobacco industry twenty years ago, Non-governmental organizations such as Climate Tracker have pushed large investors to divest shares in oil, gas, and coal companies. Large pension funds, sovereign wealth funds, and college endowments have responded to such pressure by selling shares in many of the firms. The divestitures have contributed to the underperformance of energy shares relative to the major indices. For example, the S&P Energy index is unchanged in 2019, while the S&P 500 is up seventeen percent.
The shunning of energy shares has reduced the market capitalization of the world’s largest publicly held oil companies. These companies (BP, Chevron, ENI, Equinor, ExxonMobil, Shell, Petrobras, and Total) have an aggregate market cap of $1.3 trillion. (Microsoft is worth almost as much standing alone.) The total climbs to $1.6 trillion if one adds in the other oil producers that are part of the S&P Energy index. This is a relatively modest sum.
The sector’s unpopularity with investors means these companies must compete with Aramco for the investment dollars of a limited number of participants. There seems to be no elasticity today in the supply of investor cash for oil industry shares. This means that Aramco’s IPO, should it proceed, would cause the aggregate market capitalization of other firms to decline as their equities are sold to fund purchases of Aramco shares. (While the absence of any elasticity of supply of new funds may seem extreme, the data suggest that money has been flowing out of the nonrenewable sector for more than a year. It is hard to see why fund managers would reallocate back to nonrenewables to buy Aramco shares.)
If investors do sell shares in other “nonrenewable” firms such as ExxonMobil, one should expect the managers of these firms to take steps to offset the price decline. Today, they have only two options: buy back shares or raise dividends.
Choosing either of these options would force oil firms to move cash away from investing in new or existing exploration and production projects. To see the impact, assume that the Aramco IPO raises $75 billion, all of which comes from the sale of shares in the eight largest oil companies. Those sales would cause a six-percent decline on average in these firms’ share prices. The $75 billion reduction would also equal sixty percent of their announced capital expenditures.
There should be little doubt that some and perhaps all these companies would increase share buybacks if the IPO takes place. Again, this would require them to divert capital from exploration and production or issue more debt. In many cases, they would reduce capital expenditures substantially.
That reduction would depress their future oil and gas output. In effect, the Aramco IPO would slow or reverse the oil production increases from non-OPEC countries, particularly those in the United States.
The impact might be particularly severe for Shell and BP should the Aramco shares be listed on the London Stock Exchange. These two firms would need to react quickly if investors sought to maintain balanced portfolios.
Those who invest in oil equities need to focus on the Aramco IPO’s threat to the share prices of other oil firms. Some see the oil industry as a collegial group of companies, all of whom are engaged in profiting by selling more oil. The Aramco IMO will test that proposition. A better model for the industry’s future may be found in California’s Silicon Valley, where the “winner takes all” philosophy dominates.