Saudi Aramco’s Double-Edged Advantage

(Bloomberg Opinion) -- Saudi Arabian Oil Co. doesn't do “small.”  It wants to raise about $10 billion in the international bond market to buy a majority stake in Saudi Basic Industries Corp., the country's largest listed company, in what effectively shuffles state assets from one pocket to another. So the state-owned oil giant just dropped a prospectus weighing in at almost 500 pages. As my colleagues at Bloomberg News note, the document reveals, among other things, that Saudi Aramco made a net profit last year of $111 billion, more than five times that of Exxon Mobil Corp.

What really sets Aramco apart, though, are the numbers that aren't bigger. Total assets at the end of 2018 were a shade under $359 billion. That makes Aramco's balance sheet only about 4 percent bigger than Exxon's, despite big differences in production, profits and cash flow. Royal Dutch Shell Plc, another listed peer, actually has a slightly bigger balance sheet than Aramco's.

The similarities in the balance sheets speak to a vast disparity in capital intensity. Simply put, Aramco's geographical advantage means it has to put far less into the ground than the likes of Exxon and Shell in order to produce oil and gas. The clue to this lies in the depreciation and amortization numbers for the upstream business.

The differences are even starker when calculated per barrel of oil equivalent of production:

What this all adds up to is that, when it comes to the integrated oil industry's main financial metric, return on capital employed, Aramco is in a league of its own:

A listed oil company with returns like that would be a magnet for investors – all else being equal, that is. In Aramco's case, however, just like those bars in the chart, all else is far from equal – as one risk factor in the prospectus sums up rather neatly:

The Government [of Saudi Arabia] determines the Kingdom's maximum level of crude oil production in the exercise of its sovereign prerogative … The Government's decisions regarding crude oil production and spare capacity, and the Company's costs of complying with such decisions, may not maximise returns for the Company.

While Aramco's below-ground advantages are undeniable, its risks at the surface are equally so. It needs those returns to fund the state that owns it. Just over 44 percent of revenue last year went directly to the government in the form of royalties and taxes. That tight relationship means any investor tempted by that return on capital would also put a higher risk premium on it. Look back at the charts, and you'll see Russia's Rosneft Oil Co. PJSC also screens well on capital intensity and returns. Yet it sports a market cap of just $68 billion, lower than that of (much smaller) ConocoPhillips.

Aramco wouldn't be treated that harshly if it listed. With international peers yielding between 4 to 10 percent on trailing free cash flow, putting a 7 percent yield on Aramco's gargantuan figure of $85.8 billion implies a value of $1.23 trillion. That's almost exactly in line with my estimate from a year ago (see this) and, if it needs to be said, ginormous.

But it is far below the $2 trillion Saudi Arabia's leaders have spoken of in connection withe the (long-delayed) IPO. Aramco's location is the core of its financial power but also its biggest risk. And nothing illustrates that better than a giant bond sale to buy out the state's interest in another big company.

To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net

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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