Saudi Aramco Is Coming Out to Play

(Bloomberg Opinion) -- According to Khalid Al-Falih, Saudi Arabia’s energy and industry minister and chairman of Saudi Arabian Oil Co., “the world is going to be Saudi Aramco’s playground.” If it is, then that will be partly because some others have ceded ground.

In an interview with the Financial Times published this week, Al-Falih sketched out plans for Saudi Aramco to build an international exploration and production business for the first time. Traditionally, Aramco refrained from making direct investments in upstream projects elsewhere (as opposed to downstream projects such as refineries, where it remains quite active). 

The timing is interesting, as Aramco plans to take flight just as many of the listed oil majors have had their wings clipped. Oil investors demand more in the way of payouts these days. That’s partly because returns on the mega-projects built during the oil boom have been poor. It also reflects creeping concern about whether large-scale projects now risk being stranded to some degree by political or economic effects related to climate change. Shorter-cycle assets, such as U.S. shale, are in vogue, and Exxon Mobil Corp.’s higher spending – predicated in part on developing a major new field offshore Guyana – now weighs on its valuation.

The drop in upstream spending by the majors has provoked warnings of a supply gap; although, with Saudi Arabia now entering year three of what was originally a six-month supply cut, this has yet to materialize. Still, if Aramco foresees that gap still emerging, then the oil world would effectively be on sale right now due to a lack of buyers.

Barring that, however, it is tough to see the upside from a strictly commercial perspective.

Any argument for the benefits of geographic diversification runs into the problem that Aramco sits on roughly 270 billion of what are regarded as among the lowest-cost barrels on the planet. Diversifying from that into higher-cost assets would (a) require an enormous outlay in order to be meaningful and (b) probably be dilutive.

As I wrote here, hopes for Aramco’s valuation –  assuming that is still a consideration – rest to a large degree on its prodigious free cash flow being priced with a relatively low risk premium. Big spending in foreign climes is likely to crimp the cash flow while doing nothing for that risk premium (Aramco will still be viewed as the Saudi Arabian national oil company, regardless).

Al-Falih says initial plans focus on building a global natural gas business. This has been a fairly mainstream strategy for the listed oil majors for years, but Saudi Arabia has lagged in this regard. Yet as the country seeks to build up its industrial base and stop burning valuable (and more polluting) oil for power generation, using more natural gas is a no-brainer.

Contracting for foreign natural-gas supply would seem a fairly straightforward (and less capital-intensive) way to address this. However, despite Riyadh’s reform plans, Aramco is, if anything, cementing its position still further at the heart of the economy. It is poised to absorb Saudi Basic Industries Corp., the country’s largest listed company. And despite Aramco’s relative lack of experience in foreign upstream ventures, Al-Falih says, “We can stand shoulder to shoulder with anyone and outdo them.” All in all, I’m guessing Aramco would prefer to produce and own natural gas rather than just buy it from someone else.

With the biggest nearby gas giants, Qatar and Iran, unlikely to partner with Aramco any time soon, Saudi Arabia has been considering involvement in projects in Russia and the U.S. – its chief OPEC+ partner and chief defense partner, respectively. Both have a vested interest in expanding their natural-gas export capabilities, and that may give Saudi Arabia a chance to deploy its checkbook in the national interest (funnily enough, you could say Qatar already did much the same thing).

Amid the long-running talk of that IPO, it is all too easy to forget that Aramco is far from being a strictly commercial venture.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

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