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Saudi Aramco’s Disappointing Earnings Are the Least of Its Problems

Published 05/17/2023, 03:03 AM
  • Saudi Aramco saw its Q1 2023 net profit decline by 19% year-on-year.
  • Many Western investors are concerned that Saudi Arabia uses Aramco as a cash–cow for non-hydrocarbon-related projects.
  • Aramco’s huge dividend commitment could start to weigh on the company’s financial health.

It might appear counter-intuitive to characterize Saudi Aramco's (TADAWUL:2222) first-quarter net income of SAR119.54 billion (US$31.88 billion) as bad but in the context of what the company is, it is. It is not so much the 19 percent drop in net income that will be troubling to savvy oil market watchers.

The drop in oil prices over the quarter can explain some of that. It is troubling that the result came from the flagship oil and gas company of the world's third largest crude oil producer with a near monopoly on its oil fields. These fields have an average ‘lifting cost’ (the price of extracting one barrel of oil from the ground, not including capital expenditure) of US$1-2 per barrel.

This is the lowest in the world, alongside the oil fields of Iran and Iraq. The reasons why there is such a discrepancy between this cheap extraction cost and Saudi Aramco’s net income figures raise significant questions that make the future of Saudi Aramco potentially even more troubling.

These questions were key reasons why no major Western stock exchange would allow Saudi Aramco to list on them. This was despite such a high-profile listing being one of Crown Prince Mohammed bin Salman’s (MbS) key selling points to senior Saudis when he first pitched them the idea of floating part of Saudi Aramco.

In the mid-2010s, the then-Deputy Crown Prince MbS saw Saudi Aramco's initial public offering (IPO) as a core part of his strategy to usurp the position of Crown Prince from Muhammed bin Nayef. In theory, the idea had several positive factors going for it that would benefit MbS.

First, it could raise a lot of money, part of which might be used to offset the economically disastrous effect on Saudi Arabia of the 2014-2016 Oil Price War. Second, it could boost Saudi Arabia’s reputation and the breadth and depth of its capital markets. And third, the money coming directly from the sale and the increased capital pool of Saudi capital markets could be used as part of the ‘National Transformation Program’ 2020 - part of Saudi’s ‘Vision 2030’ development plan.

This sought to diversify the Kingdom’s economy away from its reliance on oil and gas exports. After a few months of further discussion, MbS assured senior Saudis that he could ensure the flotation of 5 percent of the company, which he believed would raise at least US$100 billion in much-needed funds for Saudi Arabia. It would also make the Saudi Aramco offering the biggest IPO in history. This, in turn, would place a valuation on the entire company of at least US$2 trillion. In addition, MbS said, Saudi Aramco would be listed on one of the world’s major stock exchanges, with the New York Stock Exchange and the London Stock Exchange being the two preferred options.

However, looking at Saudi Aramco in more depth, including in the mammoth pre-IPO prospectus, raised more questions than answers for Western investors. For a start, the crude oil production figures that Saudi Arabia had long bandied around as being fact were no such thing. Far from being able to produce 10, 11, or 12 more million barrels per day (bpd), Saudi Arabia struggled to produce anything over 9 million bpd. To be accurate: from 1 January 1973 to Monday 15 May 2023, Saudi Arabia’s average crude oil production was 8.252 million bpd. This meant that the country’s equally much-vaunted spare capacity of around 2 million bpd was also not true, founded as it was on a false baseline crude oil production capability.

Additionally concerning then and now are Saudi Arabia’s equally fantastical claims about its oil reserves. Specifically, at the beginning of 1989, the country claimed proven oil reserves of 170 billion barrels. Just one year later, and without discovering any major new oil fields, it claimed proven reserves of 257 billion barrels, an increase of 51.2 percent. Shortly afterward, Saudi Arabia’s proven oil reserves miraculously increased again, this time to just over 266 billion barrels, without discovering any major new oil fields.

Proven oil reserves increased once more in 2017 to 268.5 billion barrels, again with no new major oil finds being discovered. At the same time as these increases were announced, the country was extracting an average of 8.162 million bpd. Therefore, from 1990 (the year in which Saudi Arabia’s claimed proven oil reserves jumped from 170 billion barrels to 257 billion barrels) to 2017 (the year when Saudi Arabia claimed proven oil reserves of 268.5 billion barrels), Saudi Arabia had physically removed from the ground forever an average of just over 2.979 billion barrels of crude oil every year.

The total amount of crude oil permanently removed from the beginning of 1990 to the beginning of 2017 was 80.43 billion barrels. In short, from 1990 to 2017, Saudi Arabia’s official crude oil reserves number had gone up to 98.5 billion barrels, despite there being no new oil finds and it physically removing 80.43 barrels forever. Western investors were also profoundly concerned that Saudi Aramco was being used as a cash cow for various other non-hydrocarbon projects dreamt up by the senior Saudis, MbS, and their advisers. There was funding for multiple socio-economic projects, including the creation of the King Abdullah University of Science and Technology.

There were also broader sovereign concerns over Saudi Arabia that fed through into a negative risk backdrop for the Saudi Aramco IPO. Crucially in this context, 28 September 2017 saw the U.S. Congress override former President Barack Obama’s veto of the Justice Against Sponsors of Terrorism Act, making it possible for victims’ families to sue the government of Saudi Arabia. Within weeks, there were seven major lawsuits in federal courts alleging Saudi government support and funding for the ‘9/11’ terrorist attack on the U.S. Although Saudi Arabia has denied longstanding suspicions of involvement in the attack, 15 of the 19 hijackers were Saudi nationals.

In 2010, various news media published documents highlighting such potential links between Saudi Arabia and various terrorist organizations. One of these was a leaked classified memo from then-U.S. Secretary of State Hilary Clinton, in which she warned that donors in Saudi Arabia were:

“The most significant source of funding to Sunni terrorist groups worldwide.”

Given these and many other negative factors, MbS could not engage any significant Western investor interest in the Saudi Aramco IPO. So, the stage was set for a series of events that partly defined the new global oil market order. One of these was a face-saving offer for MbS from China that he has never forgotten, underpinning Saudi Arabia’s drift towards China since then. Another was the expediting of Saudi Arabia’s move away from the U.S. and toward Russia, which had been gathering pace since the Second Oil Price War ended in 2016.

Even more specifically for Saudi Aramco, it meant that MbS had to offer massive incentives to investors to buy any of the IPO. One of these was a guarantee by the Saudi government that, whatever happened, it would pay a US$75 billion dividend payment in 2020, split equally into payments of US$18.75 billion every quarter. Making matters worse now is that along with the Q1 2023 results, Saudi Aramco’s chief executive officer Amin Nasser said that the company is looking to introduce additional performance-linked dividends. He said these would target 50-70 percent of annual free cash flow, net of the base dividend and other amounts, including external investments.

It may be that counting such numbers ultimately equates to trying to work out how many angels can dance on the head of a pin. Given the increasing antagonism between the U.S. and Saudi Arabia that also partly defines the new global oil market order, as analyzed in my new book on that subject, the possibility of the final introduction of the ‘No Oil Producing and Exporting Cartels Act’ (NOPEC) might be the end of Saudi Aramco in its current form. NOPEC would open the way for sovereign governments to sue for predatory pricing and failure to comply with the U.S.’s antitrust laws.

OPEC is a de facto cartel, Saudi Arabia is its de facto leader, and Saudi Aramco is Saudi Arabia’s key oil company. The enactment of NOPEC would mean that trading in all Saudi Aramco’s products – including oil – would be subject to the antitrust legislation, meaning the prohibition of sales in U.S. dollars. It could further mean the eventual break-up of Aramco into smaller constituent companies that cannot influence the oil price.

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