Saudi oil policy risks creating perfect storm for Aramco flotation

Oil markets

SHARE THIS STORY

Good business strategies generally create good investments over the longer term. And so Aramco needs to ensure it has the best possible strategies, if it wants to maximise the outcome from its planned $2tn flotation. Unfortunately, the current oil price strategy seems more likely to damage its valuation, by being based on 3 questionable assumptions:

  • Oil demand will always grow at levels seen in the past – if transport demand slows, plastics will take over
  • Saudi will always be able to control the oil market – Russian/US production growth is irrelevant
  • The rise of sustainability concerns, and alternative energy sources such as solar and wind, can be ignored

These are dangerous assumptions to make today, with the BabyBoomer-led SuperCycle fast receding into history.

After all, even in the SuperCycle, OPEC’s attempt in the early 1980s to hold the oil price at around today’s levels (in $2018) was a complete failure.  So the odds on the policy working today are not very high, as Crown Prince Mohammed bin Salman (MbS) himself acknowledged 2 years ago, when launching his ambitious ‘Vision 2030:

“Within 20 years, we will be an economy that doesn’t depend mainly on oil.  We don’t care about oil prices—$30 or $70, they are all the same to us. This battle is not my battle.”

As I noted here at the time, MbS’s bold plan for restructuring the economy included a welcome dose of reality:

“The government’s new Vision statement is based on the assumption of a $30/bbl oil price in 2030 – in line with the long-term historical average. And one key element of this policy is the flotation of 5% of Saudi Aramco, the world’s largest oil company. Estimates suggest it is worth at least $2tn, meaning that 5% will be worth $100bn. And as I suggested to the Wall Street Journal:

“The process of listing will completely change the character of the company and demand a new openness from its senior management“.

MbS is still making good progress with his domestic policy reforms.  Women, for example, are finally due to be allowed to drive in June and modern entertainment facilities such as cinemas are now being allowed again after a 35 year ban.  But unfortunately, over the past 2 years, Saudi oil policy has gone backwards.

SUSTAINABILITY/RENEWABLES ARE ALREADY REDUCING OIL MARKET DEMAND

Restructuring the Saudi economy away from oil-dependence was always going to be a tough challenge.  And the pace of the required change is increasing, as the world’s consumers focus on sustainability and pollution.

It is, of course, easy to miss this trend if your advisers only listen to bonus-hungry investment bankers, or OPEC leaders.  But when brand-owners such as Coca-Cola talk, you can’t afford to ignore what they are saying – and doing.

Coke uses 120bn bottles a year and as its CEO noted when introducing their new policy:

“If left unchecked, plastic waste will slowly choke our oceans and waterways.  We’re using up our earth as if there’s another one on the shelf just waiting to be opened . . . companies have to do their part by making sure their packaging is actually recyclable.”

Similarly, MbS’s advisers seem to be completely ignoring the likely implications of China’s ‘War on Pollution’ for oil demand – and China is its largest customer for oil/plastics exports.

Already the European Union has set out plans to ensureAll plastic packaging is reusable or recyclable in a cost-effective manner by 2030”.

And in China, the city of Shenzhen has converted all of its 16359 buses to run on electric power, and is now converting its 17000 taxis.

Whilst the city of Jinan is planning a network of “intelligent highways” as the video in this Bloomberg report shows, which will use solar panels to charge the batteries of autonomous vehicles as they drive along.

ALIENATING CONSUMERS IS THE WRONG POLICY TO PURSUE
As the chart at the top confirms, oil’s period of energy dominance was already coming to an end, even before the issues of sustainability and pollution really began to emerge as constraints on demand.

This is why MbS was right to aim to move the Saudi economy away from its dependence on oil within 20 years.

By going back on this strategy, Saudi is storing up major problems for the planned Aramco flotation:

  • Of course it is easy to force through price rises in the short-term via production cuts
  • But in the medium term, they upset consumers and so hasten the decline in oil demand and Saudi’s market share
  • It is much easier to fund the development of new technologies such as solar and wind when oil prices are high
  • It is also much easier for rival oil producers, such as US frackers, to fund the growth of new low-cost production

Aramco is making major strides towards becoming a more open company.  But when it comes to the flotation, investors are going to look carefully at the real outlook for oil demand in the critical transport sector.  And they are rightly going to be nervous over the medium/longer-term prospects.

They are also going to be very sceptical about the idea that plastics can replace lost demand in the transport sector.  Already 11 major brands, including Coke, Unilever, Wal-Mart  and Pepsi – responsible for 6 million tonnes of plastic packaging – are committed to using “100% reusable, recyclable or compostable packaging by 2025“.

We can be sure that these numbers will grow dramatically over the next few years.  Recycled plastic, not virgin product, is set to be the growth product of the future.

ITS NOT TOO LATE FOR A RETURN TO MBS’s ORIGINAL POLICY
Saudi already has a major challenge ahead in transforming its economy away from oil.  In the short-term:

  • Higher oil prices may allow the Kingdom to continue with generous handouts to the population
  • But they will reduce Aramco’s value to investors over the medium and longer-term
  • The planned $100bn windfall from the proposed $2tn valuation will become more difficult to achieve

3 years ago, Saudi’s then Oil Minister was very clear about the need to adopt a market share-based pricing policy:

“Saudi Arabia cut output in 1980s to support prices. I was responsible for production at Aramco at that time, and I saw how prices fell, so we lost on output and on prices at the same time. We learned from that mistake.”

As philosopher George Santayana wisely noted, “Those who cannot remember the past are condemned to repeat it.”

PREVIOUS POST

Trump's trade war should set warning bells ringing for every company and investor

08/04/2018

There should be no surprise that President Trump has launched his trade war with...

Learn more
NEXT POST

The tide of global debt has peaked: 8 charts suggest what may happen next, as the tide retreats

22/04/2018

The results of the central bankers’ great experiment with money printing a...

Learn more
More posts
Oil markets hold their ‘flag shape’ for the moment, as recession risks mount
17/11/2019

Oil markets can’t quite make up their mind as to what they want to do, as the chart confirms. ...

Read
Oil market weakness suggests recession now more likely than Middle East war
11/08/2019

Oil markets remain poised between fear of recession and fear of a US attack on Iran. But gradually i...

Read
Recession risk rises as Iran tensions and US-China trade war build
26/05/2019

Oil markets are once again uneasily balanced between two completely different outcomes – and o...

Read
Déjà vu all over again for oil markets as recession risks rise
03/03/2019

Back in 2015, veteran Saudi Oil Minister Ali  Naimi was very clear about Saudi’s need to adop...

Read
Oil prices flag recession risk as Iranian geopolitical tensions rise
20/05/2018

Today, we have “lies, fake news and statistics” rather than the old phrase “lies, ...

Read
Economy faces slowdown as oil/commodity prices slide
12/02/2018

Oil and commodity markets long ago lost contact with the real world of supply and demand. Instead, t...

Read
Saudi Arabia’s ‘Vision 2030’ is looking a lot less clear
30/10/2017

Saudi Arabia’s U-turn to revive oil output quotas is not working and fails to address the chan...

Read
Oil market supply/demand finally begins to matter again as commodity funds withdraw
11/09/2017

Its been a long time since oil market supply/demand was based on physical barrels rather than financ...

Read

Market Intelligence

ICIS provides market intelligence that help businesses in the energy, petrochemical and fertilizer industries.

Learn more

Analytics

Across the globe, ICIS consultants provide detailed analysis and forecasting for the petrochemical, energy and fertilizer markets.

Learn more

Specialist Services

Find out more about how our specialist consulting services, events, conferences and training courses can help your teams.

Learn more

ICIS Insight

From our news service to our thought-leadership content, ICIS experts bring you the latest news and insight, when you need it.

Learn more