Two trillion dollars: this was the price tag Riyadh put on the jewel in its crown, state oil and gas giant Aramco.
This is how much the company was worth, officials said, if you multiplied its proven reserves by a factor of US$8, which is the figure used to value oil and gas reserves.
There were doubts about that valuation from the start, and now these are deepening as the company crawls closer to the initial public offering.
For starters Aramco’s opacity was very likely to make potential investors suspicious.
Aramco has never published financial reports. Although there were assurances that it will start doing so ahead of the IPO, to date the latest entry on Aramco’s Corporate Reports page is from July 20 last year, and includes production figures for 2016. Last year, sources had told Reuters the company was planning to start publishing financial reports early this year, but this has not happened yet.
Leaving these concerns aside, there is the bigger problem of the valuation methodology itself. In a blunt but very informative story for Bloomberg Gadfly, Liam Denning suggests that Aramco may need crude oil at US$80 a barrel to get the US$2-trillion valuation it claims it has. That’s in addition to making several wild assumptions along the way.
The oil world today is different from what it was just five years ago. The oil price collapse taught oil producers to be more economical and to pick their projects more carefully to keep cash flows coming in and sharing them with shareholders. Yes, they had to sell additional stock, and some suspended dividends, but the lesson was learned, and the moment prices started perking up, dividends returned, and stock was bought back.
Yields are what investors want when they consider whether to invest in a company, Denning says. They don’t care about proven reserves and production costs as such. Instead, they care about how these can turn into dividends. It’s as simple as that, but this is where it stops being simple.
The average free cash flow yield of the global oil supermajors is between 5 and 7 percent. Russia’s Rosneft, while not a supermajor per se, sports the highest one, at 12.950 percent, while Exxon has the lowest at 5.194 percent. Based on these actual figures, Denning makes an entertaining set of calculations involving major assumptions about the price of oil, Aramco’s production and costs, and profit margins.
The result is that to lure investors with a 5-percent cash flow yield (the minimum that would make it competitive), Aramco needs oil to sell for US$80 a barrel. This is the only scenario where it can be valued at US$2 trillion: the only scenario out of 35, all based on favorable assumptions.
Oil is not going up to US$80 anytime soon unless something cataclysmic happens. Denning is also generously – and deliberately—not factoring in the inherent regional risk in the Middle East that is likely to act as a deterrent to potential investors. The publicity machine around the IPO has begun to creak already. Recently all those suspecting Aramco won’t make its own deadline for the IPO had to pleasure to be proved right: Saudi officials said it will be delayed until next year.
Now, Bloomberg is reporting that U.S. investors have misgivings about the IPO. Citing sources wishing to remain unnamed, Bloomberg had this to say:
“Among the issues raised were the $2 trillion valuation Saudi Arabia wants for the world’s largest oil producer, the scale of dividends Aramco’s prepared to pay and the impact of the shale boom on oil prices over the next few years.”
Investors want cash, not massive reserves. Maybe this would prove a lesson Aramco has to learn the hard way.