Saudi Arabia’s national oil company Aramco has again outperformed forecasts. The world’s largest oil company, and 2nd largest listed company, reported a free cash flow of $18.3 billion in Q1 2021, a 30% increase from Q1 2020.
At the same time, Aramco stated that it will maintain its dividend, with $18.8 billion due to be paid out in both the first and second quarter. The comparison with 2020 is, of course, a bit lopsided, as the oil market was suffering massive global demand destruction during that time period due to COVID and a major oil storage shortage. Aramco also reported a net income of $21.7 billion in the first three months of the year, an increase of $5.1 billion in comparison to 2020. These numbers are higher than even the most optimistic analysts had hoped for. At present, the Saudi giant is close to the same level of net income as it saw in 2019 when it brought in $22.2 billion.
The company’s main underlying financial indicators have been substantially boosted by an improved global oil market, higher oil prices, and lower storage levels. The impact of COVID, however, is still being felt, with Saudi Arabia unilaterally cutting production and exports in order to stabilize markets. The company’s report indicated that 2020 was “the most challenging year” in its history, but also claimed that there is now light at the end of the tunnel. The demand for OPEC oil is picking up while global prices, demand, and economic growth all appear to be improving. Aramco also indicated that its refining and chemicals margins are improving.
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Amin Nasser, Aramco’s CEO and President stated that “the momentum provided by the global economic recovery has strengthened energy markets”. However, he also reiterated that “some headwinds still remain”. Some of the current optimism is under threat as COVID is still wreaking havoc on global markets, while new virus variations are threatening prolonged lockdowns again. Major OECD markets are still struggling to bring COVID under control while emerging markets such as India are suffering from major outbreaks.
For Aramco’s results to continue to improve in the future, the company will need oil market fundamentals to improve. Overall global oil demand is projected to grow in the coming years, while and demand for OPEC crudes looks certain to increase. The negative repercussions of the EU’s Green Deal, Biden’s Green Deal, and energy transition strategies will undoubtedly impact the oil market, but emerging markets and the continued popularity of SUVs will help demand growth in the coming decade. The main source of instability in oil markets is to be expected to come from within OPEC+. Two of the major producers within this new oil cartel (Russia, UAE) are vying for increased market share, while others are suffering from the burden of production cuts.
Aramco’s owner, Saudi Arabia’s PIF and government, could be very soon discussing a potential relaxation of its own export cuts formula. The need for increased revenues and higher government budgets is undeniable when you consider Saudi Vision 2030 strategies. Current net profits will not be enough to keep the MBS dream afloat. Aramco’s future production and exploration will also need significant investment if it is going to maintain its dominance in the region. While revenues have increased, investment is needed in the E&P sectors of the company to ensure long-term growth. In its latest FY2020 report, Aramco reported record-high overall debt levels, with debts almost quadrupling from 2019 levels. The current monetization of assets, as shown by asset sales in recent months, is a very positive move, but in the long-term will mean a reduction in revenue. The main aim for Aramco management at the moment will be to increase overall revenues (likely via increasing oil prices) in a way that will not destabilize the global markets or undermine the power position of Saudi Arabia and Aramco.
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A variable that should be taken into account alongside the companies Q1 report is Saudi Arabia’s geopolitical decisions. Saudi Arabia’s decision to sell 1% of Aramco to a “leading global energy company” is going to rock the markets. It is believed that this sale will be to Chinese entities, a move that suggests a tightening of relations between the two major powers. If the sale is contingent on other conditions, such as giving China priority when it comes to bidding on new projects, the geopolitical consequences could be major. When talking about portfolio optimization, such as the Aramco $12.4 billion pipeline infrastructure deal, the geopolitical risks of such moves cannot be ignored.
Geopolitical risks aren’t the only government-related issues for Aramco, the oil giant must also deal with the financial burden of the state. MBS is currently promoting the new Shareek initiative, enabling Aramco (and SABIC) to pay lower dividends to the government when they invest locally. This will mean paying more to the government as it will be financing economic diversification projects, a development that will lead to increased debt for the oil company. The company’s debt soared in 2020 when revenues collapsed, but the company kept to its dividend payments of $75 billion annually. In 2020 overall gearing (debt/equity) increased from minus 5% in early 2020 to 23% by the end of 2020. Debt has remained steady in Q1, but analysts expect it to decrease due to the $12.4 billion oil pipeline deal, and a potential natural gas pipeline deal in the offing.
Analysts should pay close attention to Aramco’s internal decision making process and its investment choices in the coming months, as well as any changes within the Saudi government. In a surprise move, MBS has already appointed Faisal Alibrahim, former Aramco deal maker and vice minister of economy and planning, as the economy and planning minister. It is clear that Aramco’s primary role is as the economic heart of Saudi Arabia. The former M&A head of Aramco, will now be a full-fledged minister. His main targets will likely be to revamp the Saudi economy, which has been slumping due to COVID. MBS optimistically stated last week that he expects a V-shape recovery. The Saudi King Salman bin Abdulaziz has removed his son Prince Sultan bin Salman as the head of the space agency and appointed him as an adviser to the king. Sultan bin Salman is the elder half-brother of MBS. While earnings were undoubtedly positive for Saudi Aramco, the company’s financials are only half the story as Saudi Arabia continues to transform.
By Cyril Widdershoven for Oilprice.com
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Yet, the Achilles’ heel of Saudi Aramco is low oil prices and the dividend payment to the Saudi government amounting to $73.5 bn or 98% of total dividends. The Saudi government uses this dividend to support the budget.
And without higher oil prices of around $80 a barrel, the Saudi government can neither balance the budget nor pay for the diversification of the economy and therein lies the problem. That is why Saudi Aramco’s debts have been on the rise. Selling some of Aramco’s assets is a short-term policy but in the final analysis it amounts to selling off the family silver leading to a reduction in revenue.
Aramco’s offering to sell China 1% stake reportedly for $19 trillion will never go through if it doesn’t involve production assets. Moreover, neither China nor any buyer in the world will be willing to pay $19 trillion for 1% stake without a fully independent audit of Saudi proven oil reserves. Paying $19 trillion for assets like refineries, petrochemical plants and pipelines might be too excessive even for China. Question marks about the actual size of Saudi proven oil reserves was a major reason why Saudi Aramco’s foreign IPO failed. The other major reason is the risk of US litigation relating to the 9/11 bombing of the World Trade Centre in New York.
On the other hand, Saudi Arabia could help finance the diversification of its economy by replacing oil with renewables and nuclear energy for electricity generation and water desalination with some help from natural gas. This could release an estimated 1.5-2.0 million barrels a day (mbd) of crude oil for export thus earning Saudi Arabia an estimated additional $38-$51 bn a year.
Furthermore, Saudi Arabia should end subsidies for gasoline, water and electricity. This could save the country another $70-$80 bn a year. In addition to this, the government should charge Saudi utilities the full international price for crude. There could be additional savings estimated at $20 bn a year.
Were Saudi Arabia to end its war in Yemen, it can save an estimated $70 bn annually. Reaching some rapprochement with Iran will enable Saudi Arabia to reduce its arms purchases from the United States by an estimated $200 bn a year. All in all, Saudi Arabia could end up saving an estimated $398- $421 bn annually.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London