The planned IPO of Saudi Aramco has far-reaching implications for the Kingdom and global oil markets.
One could be forgiven for only taking a cursory glance at the news that Saudi Arabia will privatise Saudi Aramco, the Kingdom’s oil producing company. Countries privatise their assets all the time. However, given the long history in the Middle East of indigenous populations struggling to control and benefit from their natural resources, and the centrality of oil to Saudi Arabia’s economy and strategic weight, such a significant change warrants closer inspection.
The announcement was made on April 1 by Deputy Crown Prince Mohammad bin Salman Al Saud, the Minister of Defence and the favoured son of King Salman. An IPO is to take place in 2018 or sooner. While Saudi Aramco will not be sold in its entirety – less than 5% will initially be made available – its partial privatisation will change the way the company is run, from direct state management to being managed through a sovereign wealth fund. The shift will mean that oil revenues will technically originate from an investment rather than an asset, changing the way Saudi leadership understands its sources of income.
This new sovereign wealth fund – the Public Investment Fund – is expected to be worth $2 trillion, making it the world’s largest. Indeed, it will be rich enough to buy the four largest publically traded companies in the world and still have a few hundred billion dollars in change.
The recent and sustained fall in oil prices has hurt Saudi Arabia’s public purse. Oil is vital to the Saudi state – oil production accounts for some 80% of government revenue, 90% of export revenue, and 46% of its GDP, meaning the Kingdom is acutely exposed to the decline of oil. This decline is twofold: there is the immediate drop in oil prices, and there is the long-term shift away from oil towards other forms of energy production.
The IMF estimates that the Kingdom requires the price of oil to be at least $106 a barrel to balance its budget; currently, oil is trading at around $40. Even with its large cash reserves, the writing is on the wall, thus, Saudi Arabia is making big moves to reduce its reliance on oil.
While the United Arab Emirates has been working hard to attract non-oil business and has had meaningful success, Riyadh is aiming to shift is wealth from one industry to many industries without having to physically move those industries to its territory. This is a unique and revealing approach.
The Saudi state is built around a centralised source of government revenue. The vast wealth that flows from oil exports goes directly to the state, making it incredibly strong relative to its citizens. Rather than ‘tax in return for services’, patronage largely defines the citizen-government relationship in Saudi Arabia. This is why the Kingdom is seeking centralised government revenue sources rather than a more diverse and active economy. The sovereign wealth fund will enable revenue diversification without requiring the state to ‘open up’ in ways it may not wish to.
Once the change has been made the Kingdom’s leaders will see the income from oil production in the ‘sovereign wealth fund’ column, shifting the way they think about the country’s economic power from that of an asset to that of an investment. As oil becomes a less lucrative investment opportunity, Riyadh will be able to sell Saudi Aramco shares and invest in different companies, diversifying its income base.
Of course, the timing is perhaps a little off. One wonders whether the Kingdom would have been better off undertaking this reform when oil was more valuable. However, it must be said that the driver behind this policy – Mohammad bin Salman – represents a new guard of Saudi leadership, one that had little power under the late King Abdullah. After Abdullah’s death in 2015, the much younger King Salman and his inner circle have moved quickly to modernise aspects of the country and adjust to what is a rapidly changing region and world.
THE DEMISE OF OIL
To state the obvious, Riyadh is not undertaking this monumental reform because it expects there to be a boom in oil prices. Changes in the global supply of oil – Iranian oil re-entering the market and America becoming a net exporter of oil thanks to advanced oil production technologies – have dramatically reduced the price of oil.
However, changes unrelated to oil production are just as significant. Not only are consumers, and some states, looking to combat climate change, new technology is challenging oil’s most fundamental market: transportation. That Tesla announced its new mass-production electric car the day before Saudi Arabia announced the IPO offers a powerful illustration of two key, and related, global industries and their future prospects. One technology rises as another fades.
That is to say that the slow decline of oil is linked to many other societal and technological changes taking place.
…AND OF AMERICA’S INTEREST IN THE MIDDLE EAST?
The strategic implications of this announcement are perhaps the most interesting, though.
In many ways, the security architecture of the Middle East has been structured around oil since it was first discovered. Coups have been arranged or averted, dictators supported and wars waged. Saudi Arabia has the unique combination of immense oil reserves and surplus production capacity. This makes Riyadh capable of significantly influencing the price of oil. In return for a stable and cheap supply of oil, the US has provided the Kingdom with security.
The Saudi-U.S. alliance as we know it began with the 1973-oil crisis and the fundamentals have remained the same. After failed negotiations with the large oil companies, OPEC unilaterally raised the price of oil by 70%. Four days later, in response to U.S. military aid to Israel during the Yom Kippur War, Saudi Arabia, Kuwait and the U.A.E. stopped all oil exports to America. The price of oil quadrupled overnight leading to major oil shortages in the U.S. It also had military implications. Naval vessels, tanks and aircraft all use oil, and the middle of the Vietnam War, and during the Cold War, was no time for the U.S. military to run out of gas.
The crisis highlighted U.S. dependence on foreign oil. By 1975, when the dust had settled, the U.S. supplied Saudi Arabia with $2.2 billion in arms. Thus began the oil-for-security relationship.
Selling 5% of Saudi Aramco will not mean that Riyadh no longer controls its oil production. But the demise of oil broadly raises powerful questions about America’s role in the Middle East, and that has extensive implications. America continues to have interests in the region – namely combating terrorism, maintaining the security of Israel and preventing nuclear proliferation – but oil has been a core component of US policy in the Middle East and the slow but certain exit of this policy driver is significant.
Therefore, while the Kingdom of Saudi Arabia is moving to shift the sources of its economic power, it will need a different plan to bolster its strategic weight.