Eberhart: Saudi Purge Adds to Aramco’s Challenges on Public Offering

Saudi Arabia's Crown Prince Mohammed bin Salman, shown here on October 24, 2017, has denounced Iran's supreme leader Ayatollah Ali Khamenei as the "new Hitler of the Middle East"

The arrests of scores of Saudi royals, ministers, and businessmen in an anti-corruption sweep that started November 3, and the resulting swap of assets for freedom, may have silenced potential rivals of Crown Prince Mohammed bin Salman. But the roundup has also cast doubt on the outcome of plans to offer a public stake in the state-owned oil giant, Saudi Aramco.

The arrests have chilled opposition to the crown prince’s ambitious cultural and financial reforms. They have also increased concern among wary foreign investors about the kingdom’s stability and respect for the rule of law.

Investors were already viewing the public offering of up to 5 percent of Saudi Inc. with trepidation given the kingdom’s mixed record on human rights. Now it appears they have cause to worry. One of those arrested on November 4 was Prince al-Waleed bin Talal, a billionaire investor in several western companies, including Apple and Twitter.

The crackdown is the latest sign of growing turmoil in the region and certainly not good news for what’s been billed as the biggest IPO of all time. According to some, this changes the “risk perception” of the country quite a bit. The arrests make an initial sale to China more likely, even while oil prices finally broke through the $60 ceiling.

In declaring a $2 trillion valuation target for the initial public offering of Saudi Aramco, Prince Mohammed has been betting on an oversupplied oil market and falling prices to hobble U.S. shale producers and provide him with the necessary funds to carry out his reform plan.

With America out of the picture, the heir to the Saudi throne assumed OPEC, which controls 42 percent of world production, would be able to resume turning off the oil spigots at will to manipulate prices.

To make the $2 trillion target pencil out, Prince Mohammed needs oil prices above $60 a barrel. The European benchmark hit that magic number Monday morning, registering a two-year high at $62.54 a barrel. The question is whether prices will remain there or slip back to the mid-$50s where it’s been stuck for most of the year.

Bedeviling the crown prince has been good-old American innovation and resourcefulness. Rather than shutdown production, America’s shale industry used the low-price environment to recalibrate their operations and become more efficient. Many shale plays can now produce at prices as low as $35 a barrel.

That spells long-term trouble for Crown Prince Mohammed as prices for much of the past three years have not come close to justifying the audacious valuation he seeks. Skeptical investment banks looking at the public offering have pegged the value of Saudi Aramco at half or less of Prince Mohammed’s asking price.

Failure to knockout U.S. shale has exposed Saudi vulnerability to a functioning free market and stamped a large question mark on whether the public offering will go forward. Sending around the Black Marias for his political enemies has also thrown cold water on the crown prince’s reputation as a reformer.

The crown prince, having overplayed his hand, is now signaling a potential postponement of the Aramco listing until 2019, or the possibility of a private sale to the Chinese, which would align the world’s biggest oil reserves with the world’s fastest growing economy.

A private sale would also sidestep the pesky disclosure requirements of international exchanges and avoid potential legal questions, including the risk of lawsuits from survivors of the 9/11 terrorist attacks or environmental activists.

A mixed private sale and domestic listing would also be a boost to Riyadh’s fledgling Tadawul, though it would likely bring in less revenue than a listing in New York or London. President Trump, for his part, took to Twitter over the weekend to encourage the Saudis to use the New York Stock Exchange for the IPO.

Far from abandoning their strategy of attrition against America’s shale industry, the Saudis have doubled down with their OPEC partners with plans to extend production cuts through the end of 2018. The cartel, with the addition of Russia, has gone so far as to encourage American producers to join them in slowing output to winnow stockpiles – an unlikely scenario given the shale industry’s new found ability to capture market share as OPEC cuts production.

Far from hanging up their drill bits, most American shale companies have shown themselves far more resilient than the Saudis anticipated. Since the 2016 price crash, when the U.S. rig count fell 83 percent, shale producers have cleaned up their balance sheets and improved the efficiency of their operations. Production costs in shale plays have dropped by roughly half since 2014.

Shale, which accounts for roughly half of all domestic output, helped push total U.S. production in September to 9.5 million barrels a day, the highest output for that month since 1970, and the highest for any month since April 2015, according to the Energy Information Administration (EIA).

U.S. production is expected to jump even higher in 2018 to 9.9 million barrels, surpassing the previous high of 9.6 million barrels a day set in 1970, and closing rapidly on Saudi Arabia’s own 10.2 million barrels of daily production.

The era of affordable oil may complicate Prince Mohammed’s dreams of reforming the kingdom, but they are good news for U.S. consumers, especially since domestic shale production is projected to continue to grow as a share of total U.S. output.

The nearly two-year-old decision by Congress to lift the ban on oil exports has contributed to shale’s success by opening new markets. The U.S. exported a record 2.13 million barrels of oil a day in the week ending Oct. 27, helping rebalance America’s trade deficit and handing the Trump Administration a new source of soft power.

Beyond the geopolitical benefits, a resurgent American energy juggernaut has spurred economic growth and job creation here at home. With U.S. production forecast to continue to rise, America can expect to reap the benefits of greater energy independence, increased trade, and growing prestige for the foreseeable future – even if it doesn’t fit the script Crown Prince Mohammed had in mind.

Dan K. Eberhart is the CEO of Canary, LLC and a board member of the Los Angeles World Affairs Council who previously resided in Singapore. 


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