Saudi Aramco's IPO has created a huge dilemma for investors.
The petroleum giant, officially known as the Saudi Arabian Oil Company, is expected to be the world's most valuable listed company with an anticipated market value between US$1600 billion and $1707b. This compares with Apple's US$1170b value, Microsoft's $1140b, Google $900b, Amazon $870b, Facebook $560b and Berkshire Hathaway's $530b.
ExxonMobil, the most valuable listed oil company at present, has a market value of US$290b while the United Kingdom's BP is worth US$130b and Australia's BHP US$120b.
However, Saudi Aramco is based in one of the world's most repressive countries, as highlighted by the killing of journalist Jamal Khashoggi. The oil giant is the world's biggest polluter according to at least one survey, its main facilities were recently attacked by Yemeni rebels and, in the short term at least, it will only list on the Saudi Arabian Tadawul market.
But what about the future? Will KiwiSaver funds invest in Saudi Aramco if the company subsequently lists on a Western stock exchange?
First, the history.
Saudi Arabia was a poor, tribally controlled area in the 1920s when New Zealander Major Frank Holmes decided the area had oil potential.
In 1922 Holmes negotiated an oil exploration concession with Ibn Saud covering a 30,000 square mile area in Eastern Province for an annual fee of £2000. This is a vast area, as New Zealand's North Island is 43,900 square miles.
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The concession lapsed when Holmes and his syndicate ran out of money, but the former Otago Boys' High School student is widely considered to be one of the first to recognise the region's oil potential and he was inducted into the New Zealand Business Hall of Fame in 2003.
In September 1932 the region was formally united into the Kingdom of Saudi Arabia, with Ibn Saud becoming King and the House of Saud the kingdom's ruling royal family.
In 1933 the cash-strapped kingdom signed an agreement with the US-based Standard Oil of California to explore most of the Eastern Province area that had been granted to Holmes.
The rest is history. Standard Oil made its first Saudi oil discovery in 1938 and the giant Ghawar Field, which can produce up to 3.8 million barrels a day, was discovered in 1948. The Saudi Government started buying into the company in 1973, it became fully Saudi owned by 1980 and in 1988 changed its name to Saudi Aramco.
Saudi Arabia has become one of the world's richest countries, but it remains heavily dependent on oil and gas, which represents about 50 per cent of its gross domestic product and 70 per cent of export earnings.
It is only the world's third largest oil producer, after the United States and Russia, but Saudi Aramco is the country's only producer and it has vast reserves and a very low US$2.80 per barrel cost structure.
Saudi oil is low cost because its production wells are onshore, cheap to maintain and it has low labour and transportation costs. In addition, flow rates are high and Saudi Aramco doesn't have to undertake exploration activity because of its massive reserves. This makes it the most profitable oil company by a wide margin, with a 2018-year net profit of US$111.1b. This is greater than the combined net earnings of BP (US$9.4b), Chevron (US$14.8b), ExxonMobil (US$20.8b), Royal Dutch Shell (US$23.4b) and Paris based Total SA (US$11.4b).
The simple economics are that Saudi Aramco has production costs of less than US$3 a barrel, while conventional oil producers in other parts of the world have cost structures between US$30 and US$40 a barrel.
Meanwhile, hydraulic fracturing, or fracking, in the US can cost US$50 or more a barrel.
The Saudi Aramco IPO is an important step in Crown Prince Mohammed bin Salman's ambition to diversify the country from its huge dependence on oil and the Aramco IPO proceeds will be used to develop tourism, entertainment, technology and other sectors.
The original plan was to sell a 5 per cent stake, raising US$100b for the Saudi Government. This would have valued the company at US$2000b and the US$100b raise would have been a world record IPO, well ahead of the US$25b raised in 2014 through China's Alibaba IPO.
However, on Sunday Aramco announced a scaled down IPO, with the Saudi Government selling a 1.5 per cent stake, or 3 billion shares, at between 30 and 32 Saudi riyals (between US$8.00 and $8.52) a share. Based on this price range, the Saudi Government will raise between US$24.0b and $25.6b, valuing the oil giant between US$1600b and $1707b.
The extensive global marketing and media campaign hasn't excited investors as it coincided with Yemen's Houthi rebels' drone attacks on two Aramco facilities that affected the company's production. This had a negative impact on profitability, with the company announcing net earnings of US$21.3b for the latest September quarter compared with $30.3b for the September 2018 quarter.
Aramco reported net earnings of US$68.2b for the first nine months of the December 2019 year compared with US$83.3b for the same period last year. These figures are after Saudi Arabia's 50 per cent company tax rate and additional royalties paid to the Government.
In early October, the Climate Accountability Institute released a press statement — "Carbon Majors: Update of Top Twenty companies 1965-2017" — which was given considerable coverage by The Guardian.
The update concluded that 20 large oil, natural gas and coal companies have contributed 35.45 per cent of all global fossil fuel and cement emissions since 1965. The five largest contributors have been Saudi Aramco, with 4.38 per cent of global emissions, Chevron (3.20 per cent), Gazprom, Russia (3.19 per cent) ExxonMobil (3.09 per cent) and National Iranian Oil (2.63 per cent).
Saudi Aramco's top-spot global polluter status is not surprising as it is the world's largest oil producer.
There has been a great deal of comment about the rights and wrongs of investing in oil exploration and production companies in a climate change environment, with the massive Norwegian Sovereign Wealth Fund often being quoted in this debate.
This year the Norwegian Minister of Finance announced that "exploration and production companies will be phased out from the fund gradually over time" but "the oil industry will be an important and major industry in Norway for many years to come. The state's revenues from the continental shelf are, as a general rule, a consequence of the profitability of exploration and production activities. Therefore, this measure is about diversification".
Accordingly, Norway, like Saudi Arabia, is over-dependent on oil and the sale of oil companies by the Norwegian fund is mainly due to this issue rather than climate change.
Nevertheless, the Norwegian Finance Minister stated that the fund "should review its efforts relating to climate risk, with a view of strengthening efforts in relation to those individual companies accounting for the largest contributions to the climate risk associated with the fund".
Saudi Aramco IPO bids are required by December 4, the final price will be announced on December 5 and the company will list shortly afterwards.
It is highly unlikely that any New Zealand fund, including KiwiSaver funds, will participate in the Saudi Aramco IPO, but Middle Eastern investors are more enthusiastic because they expect the newly listed company to be included in the MSCI Emerging Markets Index and this will attract global passive funds.
In addition, the company offers a dividend yield of around 4.5 per cent at the indicative mid-price IPO range.
The big dilemma for KiwiSaver funds will occur if Saudi Aramco lists on a major Western stock exchange.
In this scenario, should KiwiSaver funds continue to shun the oil giant for ethical, social and governance reasons, or will they take the view that an exposure to Saudi Aramco will help protect members' capital if there is a sharp increase in oil prices that hasn't been caused by political conflict and Saudi Arabian production cuts?
Saudi Aramco will be an interesting company to follow in the years ahead and we shouldn't forget that New Zealand geologist Major Frank Holmes played an important role in the history of Saudi Arabia's oil industry.
- Brian Gaynor is a director of Milford Asset Management.