Saudi Aramco IPO: Stay Out Of The Sun

(Bloomberg Gadfly) -- IPO prospectuses always come with an invisible set of rose-colored spectacles (even video-enabled ones these days). Now Saudi Aramco, aiming for the biggest IPO ever, also wants to hand out some green-shaded ones.

Bloomberg News reported this weekend that Aramco hopes a mooted $5 billion investment in solar panels will tempt the sort of investor who might otherwise pass on a company that supposedly has more than 10 times the proved oil and gas reserves of Exxon Mobil Corp.

If so, it's a bad idea.

This isn't to say Saudi Arabia, the country, shouldn't be investing in solar power. As my colleague Julian Lee pointed out here, Saudi Arabia burns a lot of oil to produce electricity during its sweltering summers. That oil would be worth much more if exported, promising short payback times on solar farms there (similar to Hawaii, where solar power helps displace high-priced diesel imports).

The question is whether Saudi Aramco should be a big part of that effort.

The arguments in favor of doing so revolve around branding and hedging. A growing number of investors demand companies of all stripes pay more than lip service to environmental issues. For those companies in the business of producing fossil fuels, this has the added dimension of having some sort of hedge against a carbon-constrained world.

Which is fine, but let's be serious. Saudi Aramco produces more than one of every ten barrels of oil consumed on the planet.

It is not unheard-of for oil majors to invest in renewable energy; France's Total SA is a notable example. But oil and power, while they share the common moniker of "energy'," are fundamentally different businesses, with very different risk and return profiles. Oil majors have still to prove they can make big bets on shale pay -- and that at least is more like their traditional business than, say, building a solar farm and selling its power like a utility.

In Aramco's case, a multi-billion-dollar solar program would have an especially muddying effect on the equity story. That's because the biggest impediment to achieving a high valuation is that Aramco will remain 90-percent-plus owned by the Saudi Arabian government.

Consider Rosneft Oil Co., the Russian oil major. This is a company with more than 43 billion barrels of oil equivalent in proved reserves (Exxon's clock in at just less than 20 billion) and favored access to one of the biggest reservoirs of untapped oil outside of the Middle East. Yet, at $105 billion, its enterprise value is just more than a quarter of Exxon's, and it trades on a lower Ebitda multiple than Petroleo Brasileiro SA -- which is famous for, among other things, being at the center of Brazil's biggest-ever corruption scandal:

Valuation is a tricky thing to explain, but I am guessing investors aren't discounting Rosneft because they want it to embrace wind power in a big way. Rather, as with other national oil companies, there are understandable concerns about investing in what is, essentially, a privatized arm of the government.

If Aramco is to avoid a deep discount and net the proceeds Riyadh seeks in the IPO, it will have to convince investors as far as possible that it is a relatively commercial entity. No one buying shares in Aramco will think it stands entirely distinct from the Saudi Arabian state or that they, minority shareholders, are more than mere passengers along for the ride.

Equally, though, the more daylight Aramco can put between itself and its main shareholder, the more new investors may be willing to pay.

This has much bigger ramifications for Aramco's valuation than the idea it is diversifying ahead of the end of the oil age. As I wrote here

On the flip side, it would also be better for Saudi Arabia if it made clear that efforts to diversify its energy sources and develop new industries like solar power were being done under the aegis of national policy, rather than Aramco's corporate activities.

Demonstrating that the country could deploy new business and technologies out from under Aramco's umbrella would offer a counter-argument to commonly held views that the oil giant monopolizes Saudi Arabia's expertise and technological capability. This would, in turn, provide more credibility for the country's wider, very ambitious reform goals.

Plus, in leaving Aramco be, to do what it does best, it may also mean raising more money to realize those goals.

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

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

To contact the author of this story: Liam Denning in New York at ldenning1@bloomberg.net.

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