By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
One, the $2 trillion valuation sought by the Royal Court in the kingdom since 2016 was rejected by global fund managers in Wall Street, the City of London and Hong Kong/Singapore, the main reason a $100 billion global IPO on an international stock exchange like the LSE or NYSE morphed into a $25.6 billion flotation on the kingdom’s stock exchange in Riyadh. Even on the Tadawul, Saudi Aramco was not able to sustain its brief $2 trillion valuation and has fallen more than 10% from its 38.70 SAR high to 34.50 SAR as I write, just 2.50 SAR above its IPO offer price.
Two, 5 million Saudi citizens now own the shares in the Saudi Aramco IPO, thanks to high octane leverage from the banking system as high as two for one loan to value metrics. This makes the shares vulnerable to steep downside risks though most of my Saudi friends, admittedly professional investors, do not intend to sell as they want to receive the bonus shares. They also expect a de facto “kingdom put” protects them as they expect Saudi sovereign wealth funds will be mobilized to prevent any falls in the shares below the 32 SAR IPO price.
As an equity investor neurologically programmed to position against conventional wisdom, mass complacency or any King Canute style state intervention to short circuit market forces, I am worried that the shares could trade below 32 SAR and trigger a tsunami of margin calls for retail investors who remember the trauma of the 2006 crash on Tadawul when the Saudi stock index plunged from 20,000 to below 6000. The Wuhan coronavirus epidemic is a disaster for Chinese petroleum demand, the reason Brent has fallen to $61 despite Iran, Libya and the Vienna output cuts. What happens to Saudi Aramco shares if Brent falls below $55?
Three, the Trump White House’s killing of the Iranian regime’s most revered military commander and Iran’s ballistic missile launches against US air bases in Iraq and earlier, precision targeting of the Saudi oil processing hubs in the Eastern Province could not prevent a steep fall in Brent crude prices from $70 to the current $61. Even the Prince Abdelaziz bin Salman/Sasha Novok brokered OPEC plus agreement to increase its cut from 1.2 to 1.7 MBD was not enough to sustain the oil price above $70 Brent. The oil market has concluded too existential factors from the recent US-Iran crisis – the Great Satan in Washington and the Axil of Evil in Tehran do not want to escalate into a full scale war and so a steep geopolitical risk premium in black gold/Texas tea is unwarranted.
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Moreover, in a world where US shale oil output exceeds 12 MBD, the oil market’s obsession is with a supply glut, not supply shock. The historic reality of the oil business since the time of John D. Rockefeller’s Standard Oil trust and the Seven Sisters remain as valid today as it did a century ago in the Jazz Age – the real problem of crude oil is excess supply, not excess demand. This problem will only be exacerbated by the Digital Age, electric cars, robotics and artificial intelligence. What happens in a world where the US produces 17 MBD and Argentina’s Vaca Muerte shale basin emerges as the next Permian Basin or Kuwait, a 2.5 MBD elephant gusher even as fossil fuel demand crumbles due to EV technologies? This world is all too real to me in 2024. What happens to Brent in such a world, to Russia, Iran, Iraq, and the Gulf oil exporters? What happens to Saudi Aramco’s promised dividend?
Four, the US-China trade deal will force China to buy $40 billion from US energy exporters (the Cheniere Energy LNG deal with Petro-China is only the tip of the iceberg), force Chinese refineries to process American crude for local use in the Middle Kingdom and export to other industrialized, gas guzzling Asian tiger economies. This is a double whammy for Saudi Aramco that is not remotely priced into the share’s stratospheric valuation at 19 times earnings. But it will in time. The valuation multiple of the entire Tadawul, at 22 times earnings, will compress dramatically in a post China deal world.
Mr. Market is merciless, inhuman and Darwinian, as any survivor of the oil price crashes of 1999, 2008 and 2014-15 (moi!) can attest. Mr. Market discounts the future, not extrapolates the recent past like human beings – and frankly, does not know or cares who owns Saudi Aramco at what price. This is another existential reality of financial markets and not a matter for debate or opinion.
Five, I doubt if institutions and fund managers will be attracted by Saudi Aramco’s sub 4% dividend yield alone if the shares fall another 10%, though its low drilling costs and long life reserves are unique. Exxon Mobile offers me a 5.2% dividend that will only increase in May 2020 – with a resumption of the share buyback program suspended when oil price crashed in June 2014. BP offers a 6.5% dividend yield on the precipice of a $10 billion asset sales program. Royal Dutch Shell’s dividend yield and a share buyback program can easily offer a 15% total return in 2020. True, five million Saudis do not have an Interactive Brokers account or read investment strategists who call a spade a spade, not mouth the idiotic platitudes of a cheerleading corporate media. As Keynes said, markets can remain irrational a lot longer than I can remain solvent. Still, will 5 million retail Saudi investors retain their enthusiasm for Saudi Aramco shares at a 19X valuation multiple via the herd instincts/mass psychology alone and sustain it via “irrational exuberance” recycled as patriotism? Oh please.
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Six, the economics of Saudi Aramco becomes fascinating in the extremes of the oil price cycle. At Brent $100, the Saudi government’s progressive royalties will rise to a draconian 75% of revenues. Yet at Brent $20, Saudi Aramco’s breakeven drilling cost is $10 while BP’s, breakeven is $20, Exxon and Chevron are closer to $40. At $20 Brent, there will be a bloodbath in Wall Street oil and gas supermajor shares – but where will Saudi Aramco trade? Will Saudi Arabia broker the mother of all oil price output cuts pacts to prevent Brent $20, akin to its 4 MBD OPEC cut after Lehman/global recession in 2009? So what happens to Saudi Aramco earnings if the kingdom plays the role of swing producer and orders a 2 MBD output cut? Will the 1.6% free float mean shareholders will have any say in a decision that could profoundly affect the value of their shares? No way José!
Seven, as the swing producer and powerbroker of OPEC, Saudi Arabia could be forced to reduce its oil output, as it did in the 2016 and 2019 Vienna output cut deals. This is a sword of Damocles for Saudi Aramco shareholders that I do not face as an investor if I buy BP, Exxon or Shell. Will the kingdom be able to fulfill the Aramco dividend guarantee that no Seven Sisters/Big Oil CEO can match – if oil prices collapse? I have no idea but I will not pay a stratospheric valuation multiple of 19X to assume a state policy/geopolitical risk I cannot possibly calculate. What was the exact cost of the Abqaiq and Khurais drone missile attacks? – the unknown unknowns of oil and gas investing. What will be Saudi Aramco’s dividend growth in 2021-22? No clue, except that it will be a state decision, based not just on the economics of the business but the national security/political imperatives of the Saudi kingdom. Can I incorporate this into a DCF/DDM model? Absolutely not.
Eight, what are the governance norms of Saudi Aramco? Do independent directors have any real power or voice in decision making? Is shareholder value optimization a sole priority? The answer is no – not if private ownership is barely 1.6% and a government owns the rest. Should this command a valuation premium? You decide.