The commodity crash over the past two years has claimed a wide range of victims. Both oil and gas companies, as well as nations that depend on oil revenue, are suffering. There is perhaps no country with more to lose now that Brent crude has fallen from $110 per barrel at its peak, to its current level near $30 per barrel, than Saudi Arabia. As the biggest oil exporting nation in the world, Saudi Arabia depends on oil to an overwhelming degree.

With its budget getting squeezed from falling oil revenue, Saudi Arabia is rumored to be considering selling shares in Aramco, its state-owned oil company. This would be a landmark decision that is a significant break away from the country’s previous policy, which was not to share the wealth with public investors. This is a decision that could move the markets, simply because of Aramco’s sheer size. The big question facing energy investors is what the impact on the oil market will be.

Saudi Arabia faces a cash crunch

Saudi Arabia reported a record $98 billion budget deficit for 2015, according to the Council of Economic and Development Affairs. The reason is simple: Saudi Arabia generates the vast majority of its government revenue from oil. The country maintains significant entitlement programs for its citizens, which has exacerbated its deficit.

In response, rather than risk ceding market share to rivals such as Iran and the United States, Saudi Arabia is turning to massive budget cuts to shore up its finances. Next year’s budget calls for 840 billion riyals (approximately $224 billion) in spending, down from 975 billion riyals ($260 billion) spent in 2015. But spending cuts alone won’t fix the budget. Saudi Arabia is still projected to see a 326 billion-riyal ($87 billion) deficit in 2016.

As the price of oil keeps falling, Saudi Arabia’s budget continues to contract. Many economists have stated that meaningful cuts in oil production is the only way to restore higher oil prices, but so far Saudi Arabia has signaled no intention of keeping its foot off the production pedal. Investors can easily see that in the past two years, Saudi Arabia’s oil production has soared, even under the stress of lower prices.

 

Thousands of barrels per day. Source: BP Statistical Review of World Energy

Consequently, the country must find an alternative way to raise cash in this environment. It believes it has found a solution, by potentially offering shares to the public in Aramco. There is good reason to think the IPO will indeed take place. In an interview with the Economist, Crown Prince Mohammad bin Salman Al Saud, son of the Saudi king, said the IPO is “something that is being reviewed”, and that “a decision will be made over the next few months”.

Why an Aramco IPO would be a landmark event

Aramco is actually the world’s biggest oil company, far bigger than even ExxonMobil Corporation (NYSE: XOM), the largest publicly-traded company in the world right now. Aramco has crude oil reserves estimated at approximately 265 billion barrels, which itself amounts to 15 percent of all global reserves. Because of this, if Aramco did go public, it could very well be the first publicly-traded company with a $1 trillion market capitalization.

But the implication for the price of oil is far from certain. Investors might instinctively feel that an IPO would help increase the price of oil, as that is the over-arching goal of all Saudi policy. However, there is reason to believe an Aramco IPO would actually be bearish for oil. That is because, an IPO represents the Saudi government giving up equity in its state-owned oil company at a disadvantageous time. The proceeds received from such a sale would likely be far less than the long-term, or intrinsic, value of the company, with Brent stuck at $30 per barrel.

As a result, while buyers would potentially be getting a steal of a price, the Saudi government would be negatively affected. That could hurt the Saudi currency on the global stage. The U.S. dollar could continue to strengthen on the move, which is very bearish for oil prices. The analyst community remains fairly bearish on Big Oil. For example, Exxon Mobil carries an average ‘sell’ rating; analysts forecast Exxon Mobil’s earnings to decline another 15 percent in 2016. For example, in November, Raymond James downgraded the stock to ‘underperform’ from ‘market perform’. Analyst Pavel Molchanov said the downgrade is not a short-term trading call but a 6-12 month time horizon.

Can investors expect greater disclosure?

One of the positive impacts of Saudi Arabia potentially offering shares of Aramco to the public would be the greater reporting requirements that go hand-in-hand with being a publicly traded entity. As such, investors would normally expect a higher level of public disclosure about financial data, but also non-financial information such as environmental impacts of its oil production and consumption. However, there are certain factors investors should keep in mind.

Saudi Arabia has been notoriously withholding of its environmental and social information as it pertains to oil production. The Carbon Disclosure Project is an organization that seeks to obtain disclosures from cities and corporations regarding their emissions and general environmental data. But so far, the CDP has not received reports from Saudi Arabia, or Aramco. But there is data available that speaks to Saudi Arabia’s poor environmental track record, namely its unimpeded rise in carbon emissions over the past several decades.

Millions of metric tons per year. Source: BP Statistical Review of World Energy

Therefore, investors should not hold their breath that further disclosures will be forthcoming, if and when Saudi Arabia IPOs its state-owned oil giant. 

Companies to Watch

Exxon Mobil: Exxon has a business relationship with Aramco, and as a result would be a company to watch if and when Aramco files for an IPO. Exxon and Aramco have a joint venture in Yanbu known as SAMREF. Exxon Mobil may see higher competition for oil acreage if Aramco goes public and decides to invest proceeds back into upstream production growth.

Royal Dutch Shell (NYSE: RDS.B): Like Exxon, Royal Dutch Shell has a joint venture with Aramco, in a Jubail refinery known as SASREF. Also, similarly as Exxon, Royal Dutch Shell stands to lose if Aramco goes public because Aramco would likely be an aggressive bidder for downstream assets and cheap upstream assets.

Sinopec (NYSE: SHI): China Petrochemical Corp has a partnership with Aramco through their YASREF refinery. Sinopec would not likely be materially affected by Aramco, as Sinopec is not as actively pursuing production growth as Exxon and Shell in downstream.

Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.