Why Saudi Arabia is selling 5% of Aramco for $2 trln

 
The price of Brent crude oil (the global benchmark) is currently trading at $45.11, up 1.29% or $0.58 on Monday, April 25. The price of WTI crude oil is marginally lower at $43.73 per barrel, up 1.26% or $0.55. According to the latest economic predictions, WTI crude oil has a 1-year forecast of $50 per barrel based on present market conditions. Nonetheless, the kingdom has endured tremendous hardship in 2016 as oil revenues have plummeted and the country’s reserves have declined at an accelerated rate. The Saudi economy features a growing social welfare component that has typically relied on crude oil revenues for its funding. With the oil price plunging from well over $100 a barrel in 2014 to its current trading range of $40 to $45 per barrel, pressures are mounting.
To counter these growing concerns, the sale of 5% of Saudi Aramco via an initial public offering (IPO) will provide a substantial foundation valued at $2 trln for the Saudi economy to branch out with. The Deputy Crown Prince expects that by 2020 it will be possible for the country to sustain itself without any dependence on crude oil. Along with other government ministers and a progressive new leadership, the Saudi Arabian elite are recognising the changing landscape will ultimately lead to a painful decline in the country’s fortunes if it does not look beyond crude oil for its wellbeing.
The sovereign wealth fund forms part and parcel of a strategic economic roadmap in a world dominated by low crude oil prices. Among others, various measures have been adopted including policymaking initiatives, budgetary alterations and regulatory measures. Combined, these initiatives will serve to lessen the country’s reliance on liquid gold. These ambitious plans are showcased in an economic document known as, ‘Saudi Vision 2030’and it is fast gaining traction at the highest levels with the country’s sharpest economic minds. Even the king endorsed Saudi Vision 2030 in comments to the national press.

Saudi Arabia Attempts Economic Diversification Policy

Saudi Arabia finds itself in an unenviable situation now that crude oil prices are trading at weak levels. The vast majority of the kingdom’s revenues are energy related, with crude oil exports comprising the bulk of the country’s income. In 2015, Saudi Arabia recorded a budget shortfall of $98 bln and various measures are currently taking place to replenish the rapidly depleting government coffers. The public fund that is being created will then be utilised as an investment vehicle for other sectors of the Saudi Arabian economy such as gas, oil, tourism, technology and infrastructure development. The eight non-oil sectors in the Saudi economy also include finance, healthcare, manufacturing, mining and tourism. Brief details of the plan were outlined in an interview with Al-Arabiya, and the gist of it centred around weaning the country off its oil addiction. Saudi Aramco is valued at trillions upon trillions of dollars, and even a percentage divestiture is an unmitigated fortune. Previous reports indicated that the Saudi Arabian wealth fund would be sufficient to purchase the biggest tech stocks on the NASDAQ 100 index with hundreds of billions of dollars left over for additional investments.
What it does for Riyadh and the region is to provide massive amounts of capital for investment outside the kingdom. For example, the Saudis will be able to generate large income streams by purchasing foreign-owned companies or large stock holdings of highly successful companies listed elsewhere. This ensures that even if the oil market collapses, the Saudi economy will prosper by dint of its strategic investment agenda. It is estimated that Saudi fiscal assets could be valued as much as $600 bln and industrial regions could be worth as much as $1 trln. In addition to the divestitures, large-scale privatisation and structural reforms will be taking place to help streamline the economy. The vast fiscal resources now available to Saudi Arabia for development are sufficient to create an alternate economy where oil prospects are less and less important. Then of course, there is the other side of the coin – the inefficiency of the Saudi economic engine. Nepotism, a growing social welfare system, and widespread subsidisation of utilities for the 28 million citizens makes it difficult to sustain in a profitable way for a prolonged period of time.

A Blip on the Radar Could Bury Crude Oil Producers

Such is the dire predicament in Saudi Arabia that the Water & Electricity Minister was recently fired by the king for his injudicious comments about people digging their own water wells. Fiscal reserves in the kingdom plunged $120 bln from $732 bln in 2014 to $612 bln in 2015. Viewed in perspective, these reserves are the largest in the world and there is no risk in the short-term.
Ironically, the problems that Saudi Arabia is facing are of its own doing. Recall that the Saudis, in tandem with Iran, are increasing their production levels because they are trying to maintain market share in the world. In fact, the real reason why Saudi Arabia refuses to reduce its crude oil output is because it doesn’t want its reduced capacity to result in increased production by WTI producers from the US. It is really all about an economic war of attrition where OPEC producers spearheaded by Saudi Arabia (and to a lesser degree Iran) want to maximise their output and market share to prevent US shale oil producers from dominating the market.
The net effect of such behaviour is an oversupply of crude coupled with weak demand and concomitant low prices. Meanwhile, crude oil output is increasing, after a strike in Kuwait ended and workers returned to their jobs in the oil-rich nation. This resulted in oil futures declining after they rallied in the previous week. WTI futures for June delivery dropped $1.09 to $42.64 a barrel on the Nymex and Brent crude for June delivery dropped 1.4% to $44.48 a barrel.
The absence of a production freeze agreement means that there are no measures in place to restrain oil rich countries from supplying the global markets. This is precisely what Iran is doing now that western sanctions have been removed. Although it remains a minor blip on the radar, there is a growing sense of concern that crude oil demand will not be sustainable over the long term with major motor manufacturers like GMC, Tesla Motors, VW and others now preparing to roll out massive quantities of electric vehicles. This has clearly got oil-producing countries concerned, and rightly so.

Please note that this column does not constitute financial advice.