Saudi Aramco opens its books

Eighty-one years ago, on 4 March 1938, the Damman-7 well in Dhahran discovered the first oil field in Saudi Arabia. In the intervening decades, more – much more – oil would be found. Saudi Aramco rose to become the world’s biggest producer, delivering 10 million b/d today, 10% of the world’s supply.

All this time, the company’s finances have been a mystery to the outside world. That changed with this week’s publication of the company’s accounts.

Why now?

It’s a regulatory requirement of Aramco’s US$10 billion bond issue, the company’s first step to engage with global capital markets. Bond proceeds will augment Aramco’s huge organic cash generation and will help fund the US$69 billion acquisition of a majority stake in SABIC, Saudi Arabia’s premier petrochemical producer. The deal will transform Aramco into a leading global petrochemicals player, and signals its ambition to strengthen growth options along the energy value chain. This aligns with Saudi Arabia’s Vision 2030 to diversify the Kingdom’s economy away from oil production.

Aramco’s financials are enough to turn any CEO green with envy. We estimate upstream cash flow last year was over three times larger than Shell’s, the most cash-generative of the Supermajors (see chart below). Net cash of US$22 billion on Aramco’s balance sheet at year-end 2018 confirms the company as a financial behemoth.

What will it do with its wealth?

Stewart Williams, Vice President, Middle East, and Norman Valentine, Director, Corporate Research, have just completed Wood Mackenzie’s inaugural Saudi Aramco corporate report. It analyses in depth the company’s upstream and downstream portfolio, future financial prospects and strategy, and presents a comprehensive valuation based on future cash flows. I asked their view of the Saudi Aramco’s priorities.

First, dividends to government are at the top of the list

Fiscal changes in 2017 reduced Aramco’s tax bill but mean that government finances are now more dependent on the company’s dividends. Aramco’s ordinary dividend in 2018 was US$52 billion. It’s also set to pay out another US$20 billion this year as a special dividend for 2018 performance. On our calculations, there’s scope, too, for special dividends in 2020 and 2021 without increasing net debt, as long as Brent averages over US$65/bbl over the next three years.

Second, to grow and diversify the business

Aramco is the world’s leading oil producer. Step changes will be needed in refining and marketing, trading, petrochemicals and global gas to achieve the ambition of becoming global number one or two in these segments. SABIC is just a first step and we expect more M&A over a sustained period. Reports link Aramco with a stake in Novatek’s Artic LNG-2 project, potentially the beginnings of an international gas business.

If Aramco has such an unassailable position in upstream oil, why embark on an expansion strategy and risk diluting returns?

We see a number of drivers:

• Growth: oil production capacity is set to remain broadly flat, so growth has to come from other segments.
• Diversification: increased downstream capacity will help place crude production into the market as future global demand growth slows, reducing oil price risk. Targets are higher growth product markets in Asia, the Middle East and Africa.
• Integration: extracting full value from primary oil and gas production elsewhere in the value chain. Aramco aims to increase its already substantial refining capacity to match its oil production and plans to convert 2 to 3 million b/d of oil production to petrochemicals by 2030.

Aramco has the platform to build towards this ambitious goal. Its low-cost, cash-generative oil business gives it huge financial firepower to direct towards new business development. Success could see the proportion of company value in upstream oil move from over 90% to less than 75% through the next decade, implying investment in the hundreds of billions of dollars. We’d expect the cost of expansion to be funded primarily by organic cash flow.

There will be challenges, notably oil price. We estimate annual cash flow falls by US$14 billion for every US$10/bbl fall in Brent, assuming constant capital spend. Expanding beyond core advantaged assets is invariably difficult for any company. Relationships with stakeholders will be critical, including alignment with government.

The public bond issue to fund SABIC sends a clear message that the business is already embracing change. But a conservative culture embedded over decades will need careful nurturing to adapt to a new phase of expansion outside Saudi Arabia. Delays to the blockbuster IPO indicates Aramco’s transformation will take time.

We think the company is right to take a measured approach, focusing initially on the acquisition of SABIC. But with Aramco’s finances laid bare and revealing its huge cash flow strength, many will be asking which companies and assets might be next on Aramco’s shopping list.