Through a combination of bribing local retail investors via preferential loans, threatening wealthy Saudis with a re-run of their treatment in the Ritz Carlton in 2017, and inveigling the two principal credit ratings agencies to toe the exact Saudi line on the ‘lack of significance’ of the ‘Houthi’ attacks on Abqaiq and Khurais, the Saudis finally sold off a much smaller part of Aramco to a far narrower group of people for a lot less total value than it wanted. The unequivocal facts remain that the Saudi state’s flagship oil and gas company is an omni-toxic value proposition from a myriad of perspectives even before the risk premium of last week’s execution of Iran’s Qassem Soleimani is fully factored in. Consequently, much of the smart money is now looking to short sell Aramco.
Quite aside from the fact that its position as the key corporate tool of the key member of oil cartel OPEC could well mean that Aramco may no longer exist in its current form this time next year due to anti-trust legislation, from a purely operational perspective the current price per share of just over SAR35.00 (US$9.00) per share looks unjustifiable. A look at the real operating and corollary metrics of the only full set of figures that Aramco released before the pre-offer fictional release is instructive in this regard. The full set of accounts for the first six months of 2017 – prepared to ‘International Financial Reporting Standards’ (IFRS) –highlighted that over the period Aramco generated adjusted cash flow of around USD52.1 billion, when Brent crude averaged nearly US$53 per barrel (pb), with about US$33.8 billion in net income. The cash flow figure reflected the US$21.4 billion or so that the Saudi government owed.
More specifically, though, the cash generation figure reflected the fact that since January 2017 Aramco had been subject to a new tax regime, although this had not been publicly announced. Before the changes, Aramco had only paid a royalty to the government of 20 per cent on crude oil and refined products exported. Since the beginning of 2017, though, Aramco had apparently been subject to a standard 50 per cent income tax plus an additional variable royalty on revenue on all of its oil liquids production. The sliding scale begins at 20 per cent for oil prices up to US$70 pb, 40 per cent between US$70 and US$100 pb, and 50 per cent in excess of US$100 pb. Not only does this mean that future tax increases can just ‘occur’ on shareholdings with no prior warning but it also means right now that if oil holds above the US$70 pb level then the amount that Aramco will take out of the potential profit (and dividend) pot from shareholders will double. When potential foreign investors looked further under the bonnet there were even more nasty surprises, as analysed in greater depth in my new book on the oil markets. The real figures showed that although it is true that Aramco does indeed generate more adjusted cash flow than Royal Dutch Shell, it is also true that Shell still managed to generate nearly half of Aramco’s cash flow from just a quarter of the oil and gas that Aramco pumps. Another question over why there is not even more cashflow and income being generated by Aramco arises from the fact that it costs Aramco an average of less than US$4 pb to pump all of its hydrocarbons, compared to an average of around US$20 pb for Shell. From the perspective of future shareholders as well, the effective dividend (US$13 billion) that Aramco paid its shareholders (the government) that year (2016-2017) is nowhere near as great a percentage as that paid out by Shell its shareholders for the same period (US$7.8 billion).
Part of the reason for these discrepancies is the fact that the Saudi government uses Aramco as a cash cow for shareholder value-destructive social projects. These have included developing a US$5 billion ship repair and building complex on the east coast, working with General Electric on a US$400 million forging and casting venture, and even financing the King Abdullah University of Science and Technology. Another reason for the discrepancies is the bloated bureaucratic infrastructure of Aramco and this is set to become a lot worse, given the duplication of people, offices, technology, equipment, research and development, marketing, and capital employed, amongst others, that will result from its ongoing integration with the previously relatively well-run Saudi Basic Industries Corporation (SABIC) in which Aramco ‘bought’ a 70 per cent stake for US$69.1 billion. In reality, this was another smoke and mirrors operation by the Saudis that involved it just moving money and debt from one side of its balance sheet to another, as the state-owned Aramco bought the stake from the state-run sovereign wealth fund, the Public Investment Fund (PIF).
Over and above the rhetorical nonsense spouted by the various involved participants about value-enhancing ‘synergies’ between the two entities floats the stark fact that there are none at all and, for those who think otherwise, Aramco has history in this regard that makes grim reading. Aramco’s previous foray into the petrochemicals sector – its own former petchems and refining arm, the Rabigh Refining and Petrochemical Company (Petro Rabigh) – was floated via an initial public offering (IPO) in 2008. Its 132 page glossy prospectus sought to show Aramco as being of the ‘cut above the rest’ organisation it likes to portray itself as, characterised by world-class operations, engineering, and employees. The facts that were legally obliged to be in the IPO document – but that were buried in the thousands of extra pages of appendices – painted a very different picture. There were, for example, warnings to would-be investors that showed that PetroRabigh had ‘significant long-term borrowings’ and that its ‘strategy contemplates significant capital expenditures for the development of future expansions’.
Its performance from the beginning of its newly-listed life was disastrous. Its principal petchems complex suffered a huge fire, there were multiple major power failures at the same installation, and the debt burden soared on vast accumulated debts. It lost an accumulated US$428 million from its listing in 2008 to 2016, when it finally turned a tiny profit (of US$9.7 million). By the end of its first listed year, shareholders had lost 80% of the funds they had invested in the stock and for the first 10 years of its being listed investors lost a net 30% of their money. This was not due to a broad-based malaise in the oil industry, incidentally, as over the same period (2008-late 2017) the S&P’s four-member refinery index added 56% in value. Aside from all of this and the additional fact that Aramco does not actually own any of the sites from which it extracts oil and gas and that its oil reserves and spare capacity numbers are absolute nonsense, is the extremely likely possibility that at the very top of the list of possible reprisals that Iran may engineer for the execution of its top general, Qassem Soleimani, by the U.S. is further attacks on key oil and gas sites in Saudi Arabia aimed specifically at disrupting Aramco’s oil and gas production just as it did in September. It should be remembered that prior to the September attacks on Abqaiq and Khurais by the Houthis (Iran) in Saudi, the Saudis had bought and installed the very latest in anti-missile defence systems from the U.S. but they were unable to prevent this relatively low-tech, low-cost but very high-return attack from taking out over half of its oil production capacity in a few minutes.
One happy consequence of the market ignorance of Crown Prince Mohammad bin Salman (MbS) is that no one in Saudi seems to realise that it is theoretically possible within the rules of Saudi Arabia’s benchmark stock market – the Tadawul All Share Index (TASI) – to short sell (borrow stock in order to sell it) Aramco shares. Ironically, as part of its Westernisation process ahead of the Aramco IPO and inclusion in the MSCI indices, the Saudi Capital Markets Authority introduced this facility to short sell in 2017. “Once these bank bids [buying orders from the book-runner banks employed by Saudi to prop up prices in the first few weeks of secondary market trading] are out then we’re itching to sell and that’s true for a lot of the hedgies [hedge funds],” the chief executive officer of a major New York-based commodities hedge fund told OilPrice.com last week.
“The only cap on the amount we’ll sell is the amount we can get hold of,” he added. In this context, the very unpopularity of Aramco amongst foreign investors may provide a temporary floor to its share price, although this is likely to be well below its current level, as the bulk of Aramco shares are held by Saudi citizens or entities at the moment (only 0.19 per cent of Aramco’s shares are held by foreign investors, according to the latest data). “The locals – banks and brokers included – don’t want to be seen lending it [Aramco stock] out to sellers right now but that will change over time, and for the moment we can do the usual Saudi short through swaps, options, and futures, which is fine to get most of the risk move down,” he underlined.