Saudi Aramco: Lessons From Oil's School Of Hard NOCs
(Bloomberg Gadfly) -- If you've ever wondered what national oil companies are for, one of the bigger ones offers this pithy take on the cover of its annual report:
This isn't strange; national oil companies, or NOCs in industry parlance, are often their country's biggest corporate entity, employer and source of public revenue. The question is what they offer international investors, especially as we await the IPO of the biggest NOC of all, Saudi Arabian Oil Co., or Saudi Aramco.
The proliferation of listed NOCs is mostly a post-2000 phenomenon. These include Russia's Rosneft Oil Co. PJSC; China's PetroChina Co. Ltd., China Petroleum & Chemical Corp., and CNOOC Ltd.; Petroleo Brasileiro SA of Brazil; and Norway's Statoil ASA. The timing, amid a boom in oil prices and emerging markets, was no accident:
The IPO pitches shared common themes like sheer scale and preferential access to either large, protected resource bases or fast-growing domestic energy markets. Plus, their emergence from state ownership meant an opportunity to reap productivity gains.
But they haven't lived up to the hype. Judging by that chart above, the traditional majors have broadly acted as repositories of value; the emerging NOCs haven't.
As peak oil-supply fears have faded, and peak demand has entered the conversation, so scale and primacy in domestic oilfields are no longer trump cards on their own. Exhibit A for this is Rosneft, which stands out for its giant reserves ...
Investors won't fully value a barrel that isn't due to be produced for decades. Exxon Mobil Corp., for example, boasts of "resources" that are a multiple of its proved reserves but definitely doesn't get anywhere near the same credit for them. Even proved reserves can "disappear" if prices change. This is worth remembering, if you're looking at Saudi Aramco's gargantuan reserves life of roughly 60 years and thinking about just slapping an $8 valuation on every barrel.
What counts, as virtually any oil company will tell you these days, is efficiency. On that score, Rosneft initially looks very competitive versus the international majors:
But much of that competitiveness reflects a collapse in the ruble after June 2014. Moreover, Russia's tax system means Rosneft sees very little of the extra income from oil exports once prices rise above $40 a barrel. Plus, like several of its peers, Rosneft has an enormous payroll. It had almost 296,000 employees at the end of 2016, more than four times Exxon's count -- although positively lean compared to PetroChina's half a million:
What this all comes back to is the central weakness of the NOCs as investments, namely their need to serve two masters: a dominant state sponsor and minority shareholders.
This has led, for example, to Rosneft taking on huge debts as it consolidates Russia's oil industry, expanding its reach, along with that of the Kremlin, both internally and to far-flung places like Venezuela.
Meanwhile, China's majors have largely destroyed value as they have also planted flags overseas (although Neil Beveridge of Bernstein Research notes recently that Cnooc has performed better on this front). And, along with Petrobras, PetroChina has suffered huge losses at times on fuel imports due to domestic price controls.
One result is that leverage at the NOCs shot up:
The whiff of intrigue, be it corruption or geopolitical maneuvering, has never been too far away, either. At Petrobras, for example, a massive bribery scandal inflicted financial and reputational costs but left other scars, too. Speaking with Bloomberg reporters last month, CEO Pedro Parente noted that when he took over in 2016, he found a culture of fear resulting from the investigations, saying "mid-level managers were really scared to take any decision."
With a few notable exceptions, NOCs tend to hail from countries that score poorly in terms of corruption and have weaker credit ratings:
Two interesting companies there are Eni SpA and Statoil. Eni is 30 percent-owned by the Italian state and is the country's industrial jewel. While investors tend to view it as more of a commercial enterprise, its credit rating and provenance appear to weigh on its valuation anyway.
Statoil, meanwhile, is 70 percent-owned by Norway. Yet it benefits from a strong reputation in offshore drilling and Norway's squeaky clean profile. The latter likely owes much to the country having already been a functioning democracy with strong institutions before it developed its oil wealth, unlike many other resource-rich nations.
Bernstein's Beveridge points out that China's oil majors now trade at very wide discounts to their international peers on several metrics, despite offering better free cash flow yields and, until 2016, return on capital employed.
That sums up the challenge faced by Saudi Aramco as it prepares to compete for the incremental investment dollar.
The landscape of energy investing has changed dramatically since those arriviste NOCs first appeared almost two decades ago. Scale is a virtue but not a silver bullet. Even diversification can be a mixed blessing, and the U.S. has re-emerged as a magnet for investment: The market cap of the S&P Composite 1500 Oil & Gas Exploration & Production sub-index is almost $360 billion, versus less than $80 billion back in 2000.
In short, investors' menu of energy options has expanded geographically and across the value chain from logistics to refining and marketing, as well as new technologies. As I wrote here, even Exxon must now contend with the fact that it is relatively easy to construct a synthetic, and more rewarding, version of it:
Aramco has heft, technical expertise and a monopoly on the lowest-cost oil reserves on Earth.
Yet Aramco also bears a heavy burden in supporting the Saudi Arabian state and its new de facto ruler's efforts to overhaul it. As with many of those other NOCs, owning Aramco means also owning a piece of the national drama.
International oil companies aren't risk-free either, of course. But they offset that, more or less, with transparency, shareholder democracy and, don't forget, high dividend yields of about 5 percent on average. In the past decade, the international majors paid out almost $380 billion in cash dividends, or 25 percent of their operating cash flow, according to data compiled by Bloomberg. That's double the payout of the emerging NOCs -- and just 15 percent of cash flow -- and has been more consistent, too (this doesn't count buybacks, either). The Chinese majors' yields look good right now, but mainly because of their beaten-down stocks.
Indeed, a commitment to a big, sustained payout is likely the best IPO pitch Aramco could make. The biggest lesson of these first two decades of listed NOCs is that if you want to win over the world's fund managers, wave dollars, not flags.
-- "Flag Drag" chart by Christopher Cannon
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.
This adjusts the enterprise value of the company in order to factor out its downstream refining, marketing and chemicals operations. I use Bernstein Research's methodology, which calculates the percentage of Ebitda generated by each company's downstream businesses and then removes that proportion of the enterprise value to produce an (admittedly crude) estimate of the standalone value of their upstream businesses.
©2017 Bloomberg L.P.