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How Realistic Is Saudi Arabia’s $2 Trillion Sovereign Wealth Fund?

How Realistic Is Saudi Arabia’s $2 Trillion Sovereign Wealth Fund?

Though Saudi Arabia’s plan of a $2 trillion fund exudes power and confidence, raising a megafund of that size is practically next to impossible, unless crude oil prices see a significant appreciation or Saudi Arabia plans to sell a higher portion of Aramco.

The Saudi Deputy Crown Prince Mohammed bin Salman has outlined ambitious plans for the future of the Kingdom in his five-hour long interview with Bloomberg. He wants to reduce Saudi Arabia’s dependence on oil; however, there are numerous hiccups to his proposed plans.

Saudi reserves are depleting at a fast pace

From its peak in 2014, the Saudi reserves have depleted by a whopping $150 billion. In 2015 alone, the Kingdom consumed $115 billion in reserves, when the crude oil prices averaged $48.67 per barrel. Even in January 2016, the FX reserves dropped by more than $14 billion, according to the HSBC economists Simon Williams and Razan Nazzer, as reported by the business insider. Related: Is A Permanent Decline Coming For Russia?

(Click to enlarge)

The U.S. Energy Information Administration (EIA) expects crude oil prices to average $34.04/b in 2016 and $40.09/b in 2017. If the crude oil averages below $40 till the end of 2017, the Saudi Kingdom will likely lose another $150 to 200 billion from their reserves in the next two years. A few experts expect the reserves to drop to $200 billion by 2018 if the oil prices don’t recover.

If the reserves drop below a critical level, Saudi Arabia will be unable to maintain the riyal’s peg to the U.S. dollar. Abandoning the peg will usher in a different set of problems, which the Kingdom cannot afford. Related: ExxonMobil’s Secret Weapon Against Low Oil Prices

Aramco might not command a valuation of more than $2.5 trillion

Prince Salman expects to raise large sums from the sale of 5 percent in the flagship Saudi Aramco. There is no doubt that Aramco will be valued astronomically; after all, it pumps 10 million barrels per day, which is the equivalent of what all the companies combined in the U.S. pump each day. However, it is difficult to arrive at a valuation for the crown jewel of Saudi Arabia.

Aramco also has roughly 260 billion barrels of oil reserves. Considering a $10 per barrel valuation of the reserves, Aramco will be worth more than $2.5 trillion. As the Prince plans to divest only a 5 percent stake in the giant, it turns out to be closer to $125 billion, which is roughly equal to the amount of reserves that Saudi Arabia drew from its foreign reserves in 2015 as a result of low oil prices.

Thus a 5 percent stake sale in Aramco will only replenish the foreign reserves used up in a single year. Related: Why Oil Prices Will Rise And Many Pundits Will Be Caught By Surprise

Though a few might argue that a $10/b valuation is too low, a comparative study of the other existing state-run oil companies shows a similar valuation across the board. The Russian Rosneft OAO, which pumps 5 million barrels a day, has a market capitalization of $35 billion. Similarly, Petroleo Brasileiro SA, which controls a large part of the Brazilian oil, is valued at $23 billion. Only the Chinese companies such as PetroChina have higher valuations.

Hence, generating $2 trillion in the next few years by selling only 5 percent in Aramco, especially with oil at such low levels, will be a tall ask.

Though the plans of the Saudi Arabian deputy crown prince seem to be heading in the right direction, oil prices and valuation mathematics don’t seem to be supporting them. If the market values Aramco close to $2.5 trillion, it will dwarf Google and Apple by a huge margin, but this valuation will not fetch the Kingdom sufficient money for it to launch a $2 trillion fund. We will get more clarity when the Kingdom lays down its concrete strategy.

By Rakesh Upadhyay for Oilprice.com

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  • Jim Tomas on April 07 2016 said:
    2.5 trillion valuation is wishful thinking. This is a state company from a dictatorship surrounded by conflict and with huge potential problems in the future. The company will not be run in the interests of shareholders, and there will always be the risk of re-nationalization if an Iranian-like revolution occurs sometime in the future.
  • Hatim Makki Hoho on April 07 2016 said:
    Jim Tomas, you are dreaming
  • Craig W on April 07 2016 said:
    My understanding was that SA has no intention of selling ANY of the reserves. The 5% would come from other Aramco assets. So not much of a start on the $2T.
  • Derek C on April 08 2016 said:
    Well who really knows what is going on in Saudi? My guess is their reserve figure are never true in any climate. Saudi no double would rather sell 60+ oil however they are placing US in big squeeze on production of US oil.

    Us folks only get a fraction of the real news...... There are behind the scenes negotiations going on. What would be great is for Iran to send some F22's in there and blow up the ports of Saudi for some payback and all hell will break lose with oil prices.

    Saudi is not used to this and production will stop when US starts negotiation properly, however as what Trump said we have a bunch of lame ducks running our government and they are probably getting schooled at the negotiation tables. Look at Jim Kerry what a joke, hopefully he is not involved in any of these negotiations.

    LOL
  • Wolff on April 08 2016 said:
    Thank you for your comment Rakesh Upadhyay.
    Saudi Armaco is not a company with a geographical diversification and the main risk is the country. If something bad happens in ghawar or ormuz, no more oil export = no more cash flow.
    Who is enough mad to not integrate this variable in the corporate value?
  • James Rose on April 09 2016 said:
    Petrobras devalued its reserves to tax purposes, not as an expected average future price of oil. $100 per barrel of reserves is a reasonable future price over the coming decades, and $2 trillion in reserves reasonable. This however precludes an IPO for the next few years unless the Saudi Prince knows something we don't.

    And if the Saudis or anybody else stage a pseudo war with somebody who is actually a producer for real, and blow up a few token loading docks, the price of oil could hit $250 without having to diminish supply at all. The market is just that loony.
  • Milo on April 09 2016 said:
    Rakesh,
    thank you for the great article. Please let us know how did you come up with $10/b? Any reference?
  • MT on April 10 2016 said:
    a few points while looking at the calculations: (a) PIF is an existing entity with existing investments - mostly in domestic firims..there are no confirmed reports on its assets but these can be about USD 90 - 100 bn to start with, (b) other than 5% of listed shares, it is possible the entire Aramco Holding (sans the reserves ) are folded into PIF, (c) assets can be financed through debt + equity, taking debt for investments is common practice, (d) the government also has several public enterprises, especially in transports, power, water, ports trade sector - for which they will look at private investments, (e) government is also looking at private and foreign investments in their on-going projects, which I believe they have accounted for on how much of government spending they can reduce by looking at other financing options (the kingdom usually spends USD 400-500 bn/ yr

    There is definitely some science behind the calculation, nevertheless, hypothesis on how this entire thing will work and for how long still remains to be unclear.

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