One of the best kept secrets in oil over the past decades has been how much money Saudi oil giant Aramco has been making from extracting what’s probably the lowest-cost oil in the world.
Aramco has never reported such figures, and as an entirely state-owned enterprise, it was not obliged to do so. But now that it aims to list 5 percent of its shares—more likely in 2019 than in H2 2018 as initially targeted—it will have to report numbers, at the very least in its IPO prospectus.
While speculation as to when and where Saudi Aramco will list ranges from the Saudi stock market only in 2019 to “we’re ready for an IPO, we’re just waiting for the right time”, Bloomberg News has the scoop—Aramco generated US$33.8 billion in net income for the first half of 2017.
This figure—in absolute terms—is mind-blowing—it shows that Aramco is not only the world’s most profitable oil company; it means that Saudi Aramco is more profitable that the most profitable listed company in the world, Apple. Aramco’s US$33.8-billion net profit is also higher than the combined net incomes for H1 2017 of ALL of Big Oil’s five—Exxon, Shell, Chevron, Total, and BP.
The stunning net income in the Saudi oil giant’s figures may be impressive, but the other numbers that Bloomberg has reviewed in Aramco’s accounts are not so impressive.
The obvious question from this scoop is: do those numbers justify a US$-2-trillion valuation of Aramco—a figure that Saudi officials have been targeting since they announced that they wanted to list the oil giant to reap billions in proceeds to pay for economic diversification from the Kingdom’s oil reliance.
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The short answer is: no, according to various analysts and institutional investors who have been asked to crunch the Aramco numbers.
According to Bloomberg calculations, Aramco’s production costs imply a rough estimate that it extracts oil at a cost of less and US$4 a barrel, compared to Shell and Exxon’s per-barrel cost of US$20, for example.
In terms of cash flows, however, Aramco’s figures are not so impressive. Its cash from operations was US$52.1 billion in H1 2017, compared to Shell’s US$20.8 billion, and Exxon’s US$16 billion. Yet, Shell for example, pumped just a quarter of the oil volumes that Aramco extracted in H1 2017.
Proportionately to its oil production, Aramco generates lower cash from operations than Shell and Exxon do. The reason: Aramco pays a 50-percent income tax plus a royalty to the state of Saudi Arabia that varies according to the price of oil—the higher the oil prices, the more marginal royalty rate Aramco pays to the Kingdom.
This means that even with higher oil prices, future investors in Aramco will see limited gains because the royalties that the company would have to pay to Saudi Arabia would rise as the price of oil rises.
According to the financial information that Bloomberg News has seen, Saudi Arabia has linked the royalty regime for Aramco to oil prices, replacing a 20-percent fixed royalty, without publicly announcing the change. As of January 1, 2017, Saudi Arabia imposes a marginal rate of 20 percent of revenue for oil prices up to $70 a barrel, 40 percent for the price of oil between $70 and $100, and 50 percent for oil prices above $100. Since January last year, Aramco’s royalties have been “calculated based on a progressive scheme”, say the financials that Bloomberg has seen.
Another change in the royalty payment scheme is that Aramco is now paying royalties on “crude oil and condensate production”—not on the “value of crude oil and refined products sold as exports,” as it was previously worded. The ‘exports-production’ difference is around 3 million bpd—some one-third of all production—according to Bloomberg.
So, can Aramco achieve the US$2-trillion valuation?
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Even at this astonishing net income figure—no, according to analysts, who say that while the cost of production is an important metric for the valuation, the price of oil is the most important one.
Institutional investors crunched the numbers for Bloomberg, and are saying that Aramco could get a valuation of between US$1 trillion and US$1.2 trillion—just half of what the Saudis are hoping for. This valuation is based on oil prices at US$60 in the long term, and valuation models that are similar to those applied to other major companies.
The Financial Times ran the numbers in a model and asked experts about Aramco’s valuation. Most answers were close to US$1 trillion. The FT calculated the reported financials and found that at oil prices of around US$64, Aramco gets a valuation of US$1.1 trillion. With oil prices at US$93, the Saudi giant would achieve a valuation of US$1.5 trillion. A US$2-trillion valuation can only be achieved if oil prices were to rise to around US$120 a barrel by 2023, according to the FT models.
Commenting on the Aramco figures, Robin Mills, at Dubai-based energy consultancy Qamar Energy, told the FT:
“If they are still hung up on the $2tn number, it’s never going to work.”
According to Aswath Damodaran, a finance professor at New York University, Aramco is a source of Saudi wealth, and the Kingdom “wants to have its cake and eat it too. It wants to go public and be treated as a normal entity, but they also need to use it as a cash cow.”
“There is no way it gets to $2tn. It was a fantasy from the beginning,” Damodaran told the FT.
By Tsvetana Paraskova for Oilprice.com
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Saudi Arabia’s valuation of the IPO and its profitability are two different issues: each based on a set of different underpinning factors.
First the valuation of the IPO is academic as I have been arguing for the last four months that Saudi Arabia will eventually withdraw the IPO altogether as they no longer need it financially with the current rise in oil prices.
Still in the eventuality of the IPO going ahead, Saudi Arabia could not fetch $100 bn because the Saudi valuation is based on claimed proven reserves of 266.5 bb and a projection of oil prices exceeding $70 a barrel.
While oil prices could even exceed $70 this year based on positive market fundamentals, no investors are going to buy Saudi valuation without independent auditing of the Saudi reserves.
In a research paper titled “Saudi Proven Crude Oil Reserves: The Myth & the Reality Revisited” I gave at the 10th IAEE European Conference in Vienna, 7-10 September 2009, I argued that Saudi Arabia’s remaining reserves at the end of 2008 actually ranged from 90-125 bb and not 264 bb claimed by Saudi Arabia then and reported by BP Statistical Review of world Energy.
Since 2008, Saudi Arabia has produced a total of 32.46 bb according to the 2017 OPEC Annual Statistical Bulletin. If we deduct this figure from my estimate of Saudi reserves in 2009, Saudi remaining reserves would amount to 58-93 bb and not the claimed 266.5 bb. Therefore, a realistic valuation of Saudi Aramco’s IPO could realistically be around $700 bn-$1 trillion.
Saudi Aramco’s profitability is not in doubt based on a production cost of $4/barrel and average exports of 7 million barrels a day (mbd) in 2017.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
It is also problematic that the royalty scheme is graduated. There is little incremental value left for shareholders when the price of oil rises above $70. Thus, shareholders would likely prefer to see production volume increases when the price is over $70, while the Saudi government would benefit more from higher oil prices. Thus, the interest of shareholder for more market share would be at odds with the interest of the Saudi government for more royalties.
Until Saudi Aramco can prove to the market that its governance is truly in the interest of shareholders and not beholden to the Saudi government, it will be worth no more than $1T. Growing market share and earnings is a must for any valuation above $1T.