By Syed Rashid Husain
THE debate is on. Is this the right moment to sell Aramco?
Aramco valuation is under focus. Prince Mohammed Bin Salman mentioned the figure of $2 trillion as the base value of Saudi Aramco. Of course, he, being an insider, was speaking with all the background information.
However, some recent valuations of Saudi Aramco are considerably lower than it.
With Aramco IPO expected next year, the intensity of the debate seems rising. Industry executives, analysts, and investors recently told Bloomberg a figure, considerably lower than anticipated in Riyadh. As per clients quoted by Bloomberg, who attended a private meeting organized by Wood Mackenzie Ltd, Aramco’s core business was valued at $400 billion. Wood Mackenzie’s estimate, however, doesn’t factor in Aramco’s downstream, or refining, operation, while hints have been dropped recently that investments in the US could go up further.
According to two clients, the company reportedly based its calculation on the current tax rate, a cost of capital of 10 percent and an in-house oil-price forecast. It used a so-called discounted cash flow method to value Aramco’s upstream business, which is very sensitive to taxation.
Last year, Foreign Reports, a Washington-based oil industry consultancy, estimated that Aramco could have a market value of $250-460 billion, excluding the value of refining assets and guaranteed access to oil and gas.
There is definitely a lot of guestimates involved in this entire exercise, as until now Aramco figures have been a tightly guarded secret. Only insiders had the complete picture before them. Then there are tax issues too. Many feel that its tax rate, which currently stands at around 80 percent may be reduced considerably before the IPO, so as to make it attractive.
Aramco CEO Amin Nasser hinted in Davos last month that before the IPO, Aramco tax rates would “be aligned with other listed companies.” If this is followed through, Wood Mackenzie’s estimate also stands to rise.
Aramco currently is believed to be paying a royalty and income tax to the Saudi government. Now, this tax is the lifeline of the Saudi economy, none can deny. It helps meet the budgetary requirements of the Kingdom. Any changes in the tax regime could require big policy adjustments – for example, a sharp cut in the amount which Aramco pays to the Saudi government.
Yet there is a positive side of this equation too. Oil is a cyclical business. Revenues from oil could go up and go down – as it went below the $26 a barrel mark last February, reducing the revenues significantly.
Vision 2030 wants to get rid of this. It wants to generate a regular and more stable source of income. A profitable IPO could thus help anchor a sovereign wealth fund that could generate enough investment income, both at home and the abroad to dominate state revenues. That would cushion the state revenues from the cyclical nature of the oil income.
There is another strategic dimension to this entire debate too.
Oil demand would peak, one day or the other. Thus, the Kingdom needs to get out of its addiction to oil revenues – sooner rather than later.
Peter Tertzakian writing for Financial Post, recently painted a dismal picture of the emerging scenario, underlining the variation in forecasts about global oil consumption over the next few years and decades.
He underlines that the steepest consumption forecast assumes that our prevailing consumption habits and government policies are extended out a few more decades, resulting in oil demand touching 120 million bpd – up almost 25 percent from today.
More moderate trajectories made by other forecasters are based on pledges made pursuant to the November 2015 Paris Climate Change Conference.
Tallying up country commitments suggests modest growth in global crude consumption. This group feels the global consumption would be between 100 and 105 million bpd by 2040.
However, Tertzakian points out to weaker forecast outlooks that tilt considerably downward, clustering between 73 and 80 million bpd by 2040. This group of forecasters assumes more aggressive global efforts to limit carbon loading in the atmosphere and the faster adoption of innovations like electric vehicles. The International Energy Agency’s 450 Scenario is the most bearish demand outlook among these peers.
Environmental groups and naysayers’ projections go further down. The most catastrophic scenario appears to come from Greenpeace, which proposes that consumption in 2040 would be in the range of 35 million bpd.
What and whom to believe? On one end is 35 million bpd and on the other is 120 million bpd. And even the top cluster varies by 20 percent.
Stakeholders in the oil business generally have the tendency to adopt the idiom that “the truth lies in the middle.” This method instructs us to believe a midpoint somewhere between denial and exuberance, Tertzakian underlines. Taking the median of all expert opinions and calling it the “consensus” of wisdom, suggests oil demand will drop by 20 percent over the next quarter century.
And there are reasons for the emerging pessimistic scenario. Toyota Motor Corp. now wants to rely on hydrogen and replace traditional-engine models by 2050. Use of gasoline, which accounts for one in four barrels consumed globally, is already peaking according to the International Energy Agency. International Energy Agency forecasts that global gasoline consumption has all but peaked as more efficient cars and the advent of electric vehicles from new players such as Tesla Motors Inc. would halt demand growth in the next 25 years.
“Electric cars are happening,” IEA Executive Director Fatih Birol said in an interview in London, adding that their number will rise from little more than 1 million last year to more than 150 million by 2040.
Electric cars would definitely have a significant impact on global crude consumption. With technology improving – especially for batteries – prices are falling. Tax breaks, particularly in China, are helping sales of electric cars.
The oil landscape is changing. Officials including Bank of England Governor Mark Carney have warned investors it’s a matter of time before reserves are “stranded” in the ground. The Royal Dutch Shell Plc, the world’s second-biggest energy company by market value, shocked the energy world when one of its senior executives said the overall oil demand could peak in as little as five years.
The IEA doesn’t share Shell’s pessimism. While the agency anticipates a gasoline peak, it still forecasts overall oil demand growing for several decades because of higher consumption of diesel, fuel oil and jet fuel by the shipping, trucking, aviation, and petrochemical industries.
While the number of passenger vehicles will double to 2 billion by 2040, “the amount of oil we use for cars will be lower than today,” Birol too conceded recently.
Hence, if the current moment is not opportune for the Aramco IPO, then the question is when?