BY GEORGE HAY

Aramco’s debt is both cheap and overpriced. That’s the takeaway from the Saudi oil giant’s maiden $12 billion bond sale to international investors. While a success, it’s also contradictory.

The $100 billion-plus of orders that Aramco’s intended $10 billion sale amassed partly reflects fund managers inflating their demands in an attempt to secure a decent allocation. But it’s also clearly indicative of strong appetite. That’s reflected in Aramco’s decision to bump up the proceeds by $2 billion, and the tight pricing. Entities linked to Gulf states can borrow at rates close to their sovereigns: Mubadala’s bond maturing in 2024 has yielded around 20 basis points more than Abu Dhabi government debt. But Aramco’s borrowing costs are actually lower than Saudi government debt of the same maturity.

The oil group’s $111 billion of earnings in 2018 certainly warrants special treatment. That’s more than five times Exxon Mobil’s $21 billion. Yet the U.S. oil giant’s bonds maturing in 2026 cost it 39 basis points a year over U.S. Treasuries, according to CreditSights research, compared with 75 basis points for Aramco’s five-year debt.

The obvious difference is Saudi, and its crown prince, Mohammed bin Salman. As its prospectus makes clear, Aramco’s sole shareholder can choose to tweak royalty or tax rates should it face a budget shortfall. With 63 percent of the government’s revenues coming from the oil sector in 2017, the state’s embrace of Aramco was a potential problem even before Riyadh sparked international condemnation after it admitted that Saudi agents had killed Washington Post columnist Jamal Khashoggi.

All of which implies a more rational price for Aramco debt would be at a premium of 5-10 basis points above sovereign bonds, according to one credit analyst. There are long-term risks to oil prices from peak demand, and the company’s earnings – which slumped as low as $13 billion in 2016 – are volatile. Right now, investors are implying that an entity in many ways superior to Exxon should pay higher borrowing costs to reflect the risk of state meddling, while simultaneously underplaying that risk. That’s a weird combination.

First published April 10, 2019