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Saudi Aramco In A Low Oil Price World

Business, Company Strategy, Economics, Middle East, Naphtha & other feedstocks, Oil & Gas
By John Richardson on 09-Sep-2016

SaudiGlobalPPSept2016By John Richardson

NEWS of plans to list 5% of Saudi Aramco is obviously some four months old. There is thus a danger that in the welter of other later events, the long term significance of this decision ends up being overlooked. That would be a bad mistake in your scenario planning.

Funding from the IPO could be used for more refining and petrochemicals projects over the next few years, with the recent announcement of a Aramco/SABIC project perhaps fitting into this category.

The evolving Aramco story also serves asn important reminder that we are in a world where social and political, as well as economic, factors will increasingly shape the oil and petrochemicals businesses.

Building more refineries and petrochemicals plants, and then going even further  downstream into manufacturing finished goods, is partly about job creation. The Saudi median age is just 26.4 compared with 37.6 in the United States and no less than 40.4 in the UK.

Industrial diversification also seems to reflect the new oil-market realities. As I quoted as the FT as saying as saying back in April:

Any move to proceed with a sell-off could indicate that Saudi Arabia is preparing for a period of low crude oil prices that could last for years, requiring new sources of income and investment.

In July there was the important announcement that Aramco and SABIC are working on a $30bn oil-to-petrochemicals project, which would be located at Yanbu on the kingdom’s west coast. A joint feasibility study is underway with start-up scheduled for 2020.

If this project happens then funding may come from the Aramco IPO. The investment would also dovetail with Saudi’s wider Vision 2030 agenda, which centres on adding more value to hydrocarbon reserves.

Analysts with a too-narrow view of the world will look at this project and conclude that it makes no real cost-per-tonne of production sense to crack naphtha in Saudi Arabia. They will say that it would instead make more sense to continue to put the country’s surplus naphtha on a ship and send it to Asia to crack, as you would then be nearer the big petrochemicals end-users.

But you need to ignore this very narrow logic by again recognising that we are in a low oil-price world. Adding local value to naphtha could in the future therefore make more sense than exporting the naphtha.

Crucially, also – as I said at the beginning – this is about generating jobs through industrial diversification:

  • Ethane crackers only produce ethylene in commercial quantities, but in a liquids cracker you end up with propylene, C4s and aromatics. You can thus add more derivatives plants downstream of liquids cracking – and then a wider range of employment-generating factories downstream of propylene, C4s etc. –e.g. a factory that makes auto components from polypropylene.
  • There is anyway a lack of new ethane supply in Saudi. This leaves a choice of either cracking naphtha or not building many more new petrochemicals plants in the kingdom. (As an aside, SABIC is in parallel pursuing an ethane cracker project in the US with ExxonMobil, where of course ethane is in abundant supply).
  • Bringing Aramco and SABIC together in this way is a clear win/win, if the project goes ahead. Aramco has the oil and refining strength and SABIC the petrochemicals expertise.

Aramco may also work with more foreign investors in petrochemicals. It already has its PetroRabigh joint venture with Sumitomo Chemical and the recently started-up Sadara joint venture with Dow Chemical

What might this man for global petrochemicals supply and demand balances? The chart at the beginning of this post is just one example to get the debate going – our global view on polypropylene in 2025. How might events in Saudi Arabia change this particular outlook?

The Aramco story is also of much more immediate relevance. It will help you put into the right context all the noise around the informal OPEC meeting in Algeria on 26-28 September. Contradictory reports, almost every day, say an agreement by OPEC to freeze production is either more or less likely.

You need to note that:

  • Saudi Arabia knows  that even if it freezes or cuts production this will make no long term difference to the prices because of a.) Increasing US shale-oil efficiency and B.) We have gone beyond, or a close to going beyond, peak demand growth for oil.
  • It thus makes more sense for Saudi to pump as much oil as it can whilst it can rather than run the risk of leaving its most valuable national asset in the ground for good. Other producers are likely to come around to the same thinking, that’s if they haven’t already arrived at this place.

Even if somehow there is deal in Algeria to freeze output for short term reasons, I wouldn’t  as a sign of a change in Saudi strategy. And what are the real chances of a widespread, sustainable accord to freeze production? Very slim, I would argue.