BY JOHN FOLEY
As it readies for an initial public offering, the second most important question about Saudi Aramco is whether it is worth $2 trillion, as the Saudi Arabian royal family claims. The most important question is what the world’s biggest oil-producing company and its bankers have to do in order to make it so.
Breakingviews has analysed Aramco using a discounted cash flow model. The big inputs are the price of oil and how much the Gulf-state giant can produce. These together decide its revenue. Assume the oil costs $9 per barrel to extract, as many analysts have estimated, and add $2 per barrel of operating costs. Deduct tax and royalties, and the result is an estimate of the company’s earnings, assuming it carries no debt.
The verdict: if the oil price stays where it is now, at around $50 a barrel, Aramco would be worth less than $1.1 trillion – even if it were pumping oil at its full capacity of around 12.5 million barrels per day, rather than the current output of 10 million barrels per day. Indeed, it would require an average oil price of just above $80 per barrel over the next decade to nudge the market capitalisation close to $2 trillion. All this presupposes that Aramco doesn’t pay for the energy subsidies Saudi Arabia gives its population.
The kingdom hasn’t had much luck in pushing the price of oil up recently. But there are other levers it can crank to make Aramco more valuable. Slashing the tax rate is one. It’s currently 50 percent, but halving that might justify a valuation above $2 trillion, provided the oil price averages $60 over the next decade. If that fails, Aramco’s financial advisers will require other kinds of engineering. One option is to include assets like the downstream business. Cutting royalty payments is another.
Saudi royals have another $200 billion of assets to privatise after Aramco’s IPO, according to vice economy minister Mohammed al-Tuwaijri. If the kingdom is determined that the starting price for Aramco is going to be $2 trillion, it has a few ways to make that a reality – and investment banks have plenty of reasons to make the numbers add up.
First published June 22, 2017