Saudi Arabia has lined up 15 banks to manage new multi-billion dollar bond offerings for its flagship oil and gas company, Aramco, according to a number of domestic and international banking and oil industry sources spoken to by OilPrice.com last week.
The new debt issues will comprise either conventional or Islamic bonds – most likely a combination of both – totalling at least US$5 billion but at least double that if the bidding for the paper allows for more to be issued at a reasonable coupon. The obvious question for those who do not closely follow the global oil markets is ‘why does one of the world’s leading oil producers need to take more debt on to the books of its only true prize asset’? The answer is that Aramco has an obligation to pay its shareholders US$18.75 billion each quarter – US$75 billion every year – for the foreseeable future. And how much did the Aramco IPO raise? US$25.6 billion – in total – or to put it another way only slightly more than the amount that Aramco has to pay back every single quarter of every single year to those who bought shares. How and why could such a terrible deal occur and what will Saudi do next?
It is vital to understanding everything surrounding the Aramco IPO debacle to recall that the announcement – and the drive towards IPO’ing Aramco – came from the then-Deputy Crown Prince Mohammed bin Salman (MbS). MbS had only been appointed to this position in April 2015, whilst it was Mohammed bin Nayef (MbN) who had been named as the Crown Prince in the same month, following the death in January 2015 of King Abdullah and the accession to the throne of King Salman. The switch – involving the official replacement of MbN with MbS as Crown Prince on 21 June 2017 – can be regarded in large part as a function of the extreme domestic rivalry between the King Abdullah powerbase and the powerbase of King Salman and also of the U.S. wanting to have a more aggressively anti-Iran figure in charge in Saudi.
In this respect, it had been MbS who had been minister of defence just after the Houthis took control of northern Yemen in late 2014 and who ordered air strikes against the Houthis and the imposition of a naval blockade. MbS had secured the support required from the majority of senior Saudis by assuring them that under his supervision the war against the Houthis would be won very quickly but this has proven to be incorrect. As a result of this intervention, and of similar actions in MbS’s tenure as minister of defence, the German intelligence service, the Bundesnachrichtendienst (BND), leaked an abridged internal-only assessment report of MbS to various trusted members if the press that stated that: “Saudi Arabia [under MbS] has adopted an impulsive policy of intervention.” It went on to describe MbS in terms of being a political gambler who is destabilising the Arab world through proxy wars in Yemen and Syria. Given this, then, it was vital for MbS back in 2015 to originate a strategy by which he could hold on to his position as deputy crown prince, which essentially required that he take the top position, otherwise it was highly likely that MbN would have had MbS removed from the number two position.
The IPO’ing of Aramco was the centrepiece of MbS’s overall strategy to accomplish this, which explains why he pressed ahead with it despite the increasing lack of sense that it made to go through with the offering, as more and more damaging information came out month after month highlighting how and why the IPO of Aramco was so omni-toxic.
Put simply: if the IPO in Aramco had not gone ahead then MbS could well have been removed from his position as Crown Prince. In theory, the idea of IPO’ing Aramco had a number of positive factors going for it, which would benefit MbS and increase the likelihood of him holding on to his position. First, it would raise a lot of money – exactly how much depended on the size of the stake to be sold – part of which could be used to offset the economically disastrous effect on Saudi Arabia of the 2014-2016 Oil Price War. Second, it would likely to be the biggest ever IPO, thus boosting Saudi Arabia’s reputation and the breadth and depth of its capital markets.
And third, the money coming directly from the sale and from the increased capital pool of Saudi capital markets could be used as part of the ‘National Transformation Program’ (NTP) 2020, in turn part of Saudi’s ‘Vision 2030’ development plan that seeks to diversify the Kingdom’s economy away from its reliance on oil and gas exports. After a few months of further discussion, MbS assured senior Saudis that he could ensure that at least 5 per cent of Aramco could be floated – on both the domestic and international stock markets – at a value of at least US$100 billion, which would give a valuation for the entire company of at least US$2 trillion. Within a very short time from the idea being clarified, though, potential international investors began to ask a lot of very tricky questions about the true nature of the company’s business, its relations to the government, and what Saudi Arabia generally got up to in the world as well.
Nonetheless, given what was at stake personally for MbS, the IPO had to go ahead whatever the cost to Saudi Arabia’s finances and its people, and the cost was a guaranteed annual dividend payout of US$75 billion. The already appalling situation for Saudi was made worse by more decisions taken by MbS to cover up the original mistake. The first of these was taken when it had been made clear to MbS by the advisory banks on the Aramco offering that the IPO was not going to list anywhere near the valuation expectations that the Crown Prince had stoked in the senior Saudis, and it was the extraordinary tie-up between Aramco and the Saudi Basic Industries Corporation (SABIC). The preliminary deal was signed at the end of March 2019 and involved Aramco buying a 70 per cent stake in SABIC from the Saudi state-owned sovereign wealth fund, the Public Investment Fund for US$69.1 billion.
Despite this deal being portrayed by MbS to the senior Saudis and the Saudi people alike as generating new funds for the Kingdom to make up for any shortfall in the Aramco IPO it was, in reality, just a meaningless accounting trick that transferred money from one side of the Saudi balance sheet to another. As a result in large part of this deal, Aramco’s own debt levels have soared, with its debt to equity gearing increasing by 28 per cent from minus 5 per cent in early 2020 to plus 23 per cent in March this year, way above the company’s own debt/equity ratio cap of 15 per cent. The second appalling decision compounding the original terrible mistake, of course, was to launch yet another oil price war in the first quarter of 2020 using the tactics as failed in 2014-2016.
Given the position in which Saudi Arabia and Aramco have been placed by MbS, whether or not the Kingdom can sell another US$5 billion or US$10 billion in bonds is beside the point. For various reasons, the oil price is unlikely to rise on a sustained basis much above US$80 per barrel of Brent, compared to the IMF’s predicted fiscal breakeven price per barrel of Brent oil of US$76.20 this year for Saudi Arabia. Even this breakeven figure, though, is predicated on Saudi Arabia sticking to its plan to cut spending by 7.3 per cent this year and this in turn is required for it to begin to address its budget deficit of 12 per cent of GDP.
These factors have conspired to mean that although Aramco continues to make a significant profit almost all of this goes to the government’s black hole of debt dug for it by MbS’s ‘strategies’, leaving it with insufficient free cashflow to meet the crushing dividend payment schedule with which MbS has lumbered it. There is little doubt that Aramco will be able for the time being to sell more bonds but as it continues to do so the compensation coupon by investors to buy them will rise, its debt will soar, and its credit rating will inexorably decline, along with Saudi Arabia’s as a whole. Moreover, its ability to turn this deteriorating profile around will become more limited as planned projects remain suspended or cancelled, as highlighted by OilPrice.com. It also means that the intention of selling even more shares in Aramco is likely to be focused on Chinese buyers with all that this implies, including a significant rise on the foreign exchange risk factor that will threaten one of the cornerstones of Saudi’s economy – the Saudi riyal’s longstanding peg to the US dollar.