Saudi Arabia’s Trillion Dollar Gamble Could Be A Bust

Back in March, Saudi Aramco split from Royal Dutch Shell in a $2.2 billion breakup, leaving the Saudi Arabian government as the sole owner of the largest US oil refinery. Port Arthur, Texas' Motiva Enterprises LLC could be just the beginning of a Saudi conquest of US oil as Aramco's IPO--the largest in history--quickly approaches.

Saudi Aramco's efforts to expand downstream investment and international joint ventures are not news, but the latest developments are a marked acceleration of the company's aggressive strategy to move into foreign markets and evolve into a more integrated, diversified, and powerful company.

In recent years, the company has also been busy acquiring companies in China, Indonesia and Malaysia - a large part of Aramco's core market. According to numbers published by Energy Digital, Aramco intends to double its global refining capacity, increasing from its current 5.32mn barrels per day (mb/d) to 10-12 mb/d, and to increase its global petrochemicals capacity by a huge margin from 12mn tonnes per year to 34mn tonnes.

The escalating efforts by Saudi Aramco to diversify, globalize, and cash in with a record-breaking Initial Public Offering are also making waves on a domestic level. For many investors eyeing next year's IPO, it's extremely unsettling that Aramco practically gifts its oil domestically at $6 a barrel--that's 87 percent less than international prices. The exaggerated subsidy, once a point of pride for the private company, is now raising the eyebrows of discerning interests with deep pockets.

This hasn't always been the controversial issue that it is now, as in the past, Saudi Arabia exported 94 percent of its oil. Now, however, the kingdom only exports two thirds of its supply, and that number is decreasing every year. Practically giving away a third or more of their goods does not chalk up to shrewd business in the eye of potential shareholders.

Despite the fact that domestic subsidies are proving to be a major conflict with private investors, however, the Kingdom has been hesitant to change this policy for fear of upsetting the Saudi public, who have grown up with all-but-free energy and consider it a birthright. In an effort to balance finances, Crown Prince and ambitious businessman Mohammed bin Salman al-Saud cut Aramco's tax rate from 85 percent to 50 percent earlier this year. In an effort to appease potential investors. Bin Salman has also said that the government is considering weaning the energy subsidies--by replacing them with cash.

A lot of things about the massive and groundbreaking IPO (Aramco is valued at around $2 trillion) are still up in the air. First of all, where it is to be listed is still a mystery. Some have asserted that it will be in New York while others are insisting just as assuredly that it will be in London. Even more troubling is the fact that, despite the staggering monetary value of the offering, it only amounts to a 5% stake in the company, with little assurance that the shareholders rights will be upheld when the volatile Saudi government still owns 95% of the company.

During a time of upheaval in the Saudi Monarchy (31-year-old, forward-thinking bin Salman was suddenly declared as Crown Prince in June, ousting the more aged and conservative Mohammed bin Nayef as heir to the throne) the Kingdom's future is more uncertain now than ever. Bin Salman has grand plans for the country that will depend entirely on the cash flow provided by the Aramco IPO, but there is still some doubt whether the offering will actually come to pass. While bin Salman's reputation and position as successor hangs on the success of the listing, Saudi volatility, the unsettlingly small size of the stake, and questionable internal policies (such as staggering domestic subsidies) are putting the IPO at great risk.

Saudi Arabia hasn't given up hope. Their salvation may come from another gas-guzzling giant--China. The nation, already the biggest oil importer in the world, continues to see a steadily growing demand with no peak in sight. Despite an aggressive effort to manufacture and popularize electric cars, China also saw 24 million new gas cars on the road just last year as their own production is declining. For the biggest oil importer in the world, owning a stake in Aramco, the biggest oil producer in the world, is a no-brainer.

If Saudi Arabia toes the line and continues to diversify and expand while reigning in its over-generous domestic subsidies and taxation policies, next year's IPO--already the biggest in history--could be even bigger than expected. It may even be the dawn of a new era, where China reigns over oil markets for the first time as a producer, not just a consumer. However, if bin Salman's innovations for his state prove to be too ambitious too soon, Saudi Arabia's big gamble could be a big bust.