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What the Saudi Aramco sale says about the state of the oil industry

Business

As the oil and gas industry gathers in Houston for CERAWeek, a major annual event, geopolitical drivers to oil prices will be a focus.

U.S. shale producers will be particularly attuned to backroom discussions about how Saudi Arabia and Russia are viewing new indications of restored momentum in drilling in the U.S. tight oil patch. The bullish reports on U.S. drilling rates come against the backdrop of statements from close advisers to President Donald Trump that the Organization of Petroleum Exporting Countries (OPEC) will make room for U.S. shale.

Chances are OPEC will not abandon attempts to shore up the global oil market, regardless of the newfound staying power of U.S. production. That’s because Saudi Arabia has bigger fish to fry when it comes to oil prices. Saudi Arabia’s leaders are betting the farm that the sale of 5 percent of Saudi Aramco, the country’s national oil company (NOC), in an initial public offering (IPO) can jumpstart a new era of economic reform that will transform the country and create new jobs for a restive and younger population.

To get the sale of Aramco shares on better footing, Saudi Arabia hopes to get oil prices back to the $60 to $70 a barrel range, analysts say. That’s one reason the kingdom was willing to broker a deal between OPEC and Russia to cut production.

But the issuance of the IPO is not necessarily all good news for the U.S. oil industry. The first cracks in the plan appeared last week and might be more significant than the industry realizes.

At issue is how to value Aramco, the world’s largest oil reserves holder. Recent reports that respected upstream consultant Wood MacKensie Ltd. was valuing Aramco’s core business at $400 billion, far below the $2 trillion assessment suggested by the kingdom’s dynamic deputy Crown Prince Muhammed Bin Salman, highlights the dangers now inherent at issuing an IPO for a giant NOC reserve holder. Saudi Arabia has stated proven reserves of 261 billion barrels, some of which scientific modelers say are likely to be stranded — that is, unable to be monetized due to shrinking market opportunities beyond 2040.

The outcome of an offering of shares in Saudi Aramco could speak volumes about whether the market is ready to discount prolific reserves based on an eventual peaking of demand — or at least what investors believe is the long term price of oil.

The Saudi idea to capture the future value of reserves in the present and use the money to supplement the national budget and develop new directions for the Saudi economy is not a new one. In the 2000s, as oil prices were climbing, many countries, including China, Russia, Norway, Brazil and India offered equity shares in their NOCs on domestic and international financial markets. Investors, believing oil would continue to appreciate, were enthusiastic to pay a healthy price for the shares that reflected the present discounted value of future revenue streams. Indeed, early buyers of Statoil and Petrobras shares did well.

But times have changed. The notion that oil reserves outside the Middle East and former Soviet Union are rapidly depleting has been turned on its head. Now, with transformational technology breakthroughs and the prospects that shale and other source rock can be produced not only in North America but eventually across the globe, the prospect of reserve depletion seems increasingly more distant.

This new reality has unglued the longstanding guiding principle of the oil industry that depletion in non-OPEC would create an appreciation in value for remaining reserves that would mainly be left in strong NOC hands.

'Massive writedowns' of Canadian oil sands reserves, as in Alberta, are having a ripple effect throughout OPEC and the largest multinational oil companies. Photo: Ben Nelms, Bloomberg

Photo: Ben Nelms, Bloomberg

‘Massive writedowns’ of Canadian oil sands reserves, as in Alberta, are having a ripple effect throughout OPEC and the largest multinational oil companies.

Confidence in the premise that oil under the ground will appreciate over time is also starting to lose its sheen in light of massive writedowns of Canadian oil sands reserves. In other words, players within OPEC and the largest multinational oil companies might no longer feel that they can afford to “warehouse” prolific reserves or reserves that are very expensive to extract and wait to produce them at a later time when they will be more valuable.

Adding to anxiety about long-run reserve valuation are new studies suggesting global oil demand could peak sooner than expected. Some investors now fear that reserve values might even depreciate, meaning that the context for the Saudi IPO might be more difficult than IPOs in the past. 

The stakes, analysts say, are high. The possibility of ill fate for Aramco in foreign markets is already prompting criticism at home, opening the possibility that a failed IPO could open up the Saudi government to increased domestic political pressures. Saudi oil reserves are considered the patrimony of the entire country.

But there is also a lot more on the line that how much the kingdom might net from the deal. Internationally, a negative response to an offering of Aramco shares could prompt investors to wonder whether other large oil firms are valuated too high, producing a cascading effect. And what if markets estimate the value of Aramco’s reserves based on a number that implies some percentage of reserves will not be produced? ExxonMobil shares have already been losing value lately in the wake of the de-booking of 3.5 billion barrels of high-cost Canadian oil sands reserves. The rejection by the market of lofty Saudi valuations for its large reserve base could cause investors to recalculate the value of other large NOCs with public shares and bring the question of stranded asset risk more front and center.

So as oil industry leaders gather in Houston this week to discuss the future of the industry, optimism about this year’s oil prices may be front and center. But cheerfulness about how the Saudi IPO will tie the kingdom’s hands to support continued production cuts may be misplaced, if the rest of the financial world doesn’t go along with Riyadh’s bullish estimate for the net present value of its oil company.

 

Amy Myers Jaffe is Executive Director, Energy and Sustainability, at the Institute of Transportation Studies (ITS) at University of California Davis and a global fellow at the Woodrow Wilson International Center for Scholars in Washington D.C.

Chron



19 Comments on "What the Saudi Aramco sale says about the state of the oil industry"

  1. Dorian on Tue, 7th Mar 2017 12:25 pm 

    The dominoes begin to tumble.

  2. rockman on Tue, 7th Mar 2017 1:08 pm 

    Since the market hasn’t been given any details on the specifics of the stock that MIGHT be offered in a POTENTIAL IPO of Aramco there’s no point in discussing hypotheticals here IMHO.

    But a couple of points. With the NG rig rate hitting 1,600 in 2008 but now at 146 while the oil rig rate hit 1,600 in 2014 but now at 609 I don’t think I would characterize the current status as “bullish”…perhaps just improved from a year ago.

    And on the radio this morning the comment about expectations of President Trump’s potential changes in federal frac’ng regs that could boost US oil production. I’m not sure how many here have a totally fictional view of how oil field activity (including frac’ng) is carried out in Texas and Louisiana. I’ll let someone else discuses N Dakota.

    In the 4 decades that the Rockman has drilled, frac’d and produced wells in Texas not once has he every gotten approval from the federal govt to do so. So I can’t imagine what some folks envision for changes in shale activity here that could come about from anything the POTUS might do. In fact the Rockman has no requirement to even inform the federal govt that he’s frac’ng a well. But you might ask what the Rockman might say to a federal inspector that shows up on one of his well sites while frac’ng? In 41 years the Rockman has never seen (yes, not even once) anyone from the federal govt on any well he’s drilled in Texas or Louisiana. Nor has he heard of any federal regulator showing up on anyone else’s well site. Again, not once. But we do have regulators and well site inspectors who have the authority to come onto our well sites without notice and immediately shut down ops if they see something they don’t like. And those are the inspectors with the Texas Rail Road Commission. The same folks we have to file detailed plans of all activities, including frac’ng, in order to get legal permission to conduct those activities.

    Apparently both the pro and anti President Trump camps have their own reasons for hyping the nonexistent potential of the POTUS to have any meaningful impact on operations in Texas and Louisiana. Just silly headlines to stir up the sheeple on both sides of the debate IMHO.

    BTW the Rockman has drilled shale wells (the New Albany Shale) in Kentucky. And unlike Texas that state has given all environmental regulation authority regarding oil/NG development to the federal govt via the EPA. And of course the EPA has very detailed rules and restrictions covering those ops. And the EPA knew the Rockman was following those rules exactly as they are written: every week the Rockman would send the EPA office in Atlanta, Georgia, a form indicating the in KY he was following their rules. Of course he had to do that because here were no EPA inspectors on the Rockman’s drill sites to confirm he wasn’t dumping millions of gallons of toxic sh*t on the ground. And since the state gave that responsibility to the feds they never sent anyone out to check either. BTW the Rcokman knew the names of every member of the KY oil/NG commission…all 8 of them, counting the receptionist. LOL.

    So basically as long as some landowner didn’t catch him the Rockman was free to do whatever the f*ck he wanted to with little concern of getting caught. Maybe the big change President Trump might cause is instead of sending that weekly form to the EPA claiming he was in compliance perhaps it might be required to do it just once a month. LOL.

  3. shortonoil on Tue, 7th Mar 2017 1:59 pm 

    Same crock, different day. The Saudi are willing to sell 261 Gb of oil for $2 trillion, or 0.77¢ per barrel. Sure that sounds reasonable?? What are they charging for fresh camel pea, a nickel a gallon, and are they giving away vodka at Mecca! These Saudi stories are getting stupider by day!

  4. Baptized on Tue, 7th Mar 2017 2:42 pm 

    Rockman you just explained why the USA is going to be a toxic waste land. You may do the right thing. But I assure you 1000’s, will not.

  5. Cloggie on Tue, 7th Mar 2017 3:38 pm 

    Amazing how the perspective on the oil business can change in a matter of a few years.

    A few years ago many of us were fantasizing here about long lines before petrol stations in the hope to score a gallon or two in an oil depletion world. That could be 2016.

    Now the reserves of KSA are depreciated because of fear that demand for, not supply of, oil could evaporate, because of new sources of energy, including energy saving.

    Same crock, different day. The Saudi are willing to sell 261 Gb of oil for $2 trillion, or 0.77¢ per barrel. Sure that sounds reasonable?? What are they charging for fresh camel pea, a nickel a gallon, and are they giving away vodka at Mecca! These Saudi stories are getting stupider by day!

    @ShortOnOil/ShortOnBrains, are you and your HillBilly Group even beginning to understand what this article says? These Saudi’s have understood the future far better than you and your obsolete peak oil superstition. There is not going to be an oil shortage; there is going to be a shortage of customers for the greasy sludge.

  6. rockman on Tue, 7th Mar 2017 3:49 pm 

    B – I wish I could say you’re exaggerating. But even when regs are followed there’s going to be some degradation. There’s very little that anyone does, even the greenest amongst us, that doesn’t do some environmental damage. So it comes down to the cost/benefit relationship. And that will always be relative to each person’s circumstance. Folks in NY are all for banning frac’ng in their state. And at the same time they buy as much NG from frac’d wells in PA. So frac’ng would only harm the NY environment and not that in PA? So is it just another case of NIMBYism or sound environmental stewardship?

  7. HARM on Tue, 7th Mar 2017 4:06 pm 

    There is not going to be an oil shortage; there is going to be a shortage of customers for the greasy sludge.

    Only when you can we can figure out how to run billions of cars, trucks, ships, aircraft, etc. on hopium. Not to mention produce enough fertilizer, plastics, and a billion other industrial goods for which there’s no good substitute for oil –at least not at an EROEI that can sustain industrial activity and the current population.

    Yes, shale/unconventional oil pushed out the Hubbert curve a good decade or two, but the end result and underlying problems (inevitable decline of a finite resource + overpopulation) are not likely to change anytime soon, barring some miracle breakthrough in fusion. “Demand destruction” basically means “a bunch of poor people priced out of the market” and “more refugees pouring into Europe and elsewhere”.

    But keep trolling the good word!

  8. Boat on Tue, 7th Mar 2017 4:09 pm 

    Rock,

    There is a possible Trump effect bigger than regulations. It is reported he would open up high percentages of ocean and on land government controlled areas for drilling.

  9. rockman on Tue, 7th Mar 2017 4:15 pm 

    Cloggie – “The Saudi are willing to sell 261 Gb of oil for $2 trillion, or 0.77¢ per barrel.” Of course shorty is wrong: the KSA isn’t selling any oil. They are just swapping stock certificates for cash. Those stock certificates carry no guarantee the buyer will ever see a single $ delivered to them as a result of buying the stock nor any promise the buyers will ever be able to sell the stock for as much as they paid for it.

    All the oil in the ground remains the property of the KSA and no one else. No different then the private equity law in Mexico.

    For instance many here know how the Snapchat IPO foundered a bit after the first few days. No problamo: the board of directors will make adjustments to get the value up, right? Hmm, wait a second, there is no board of directors: Snap was the first US company to list shares with nonvoting rights.

    So you could own 100% of the Snapchat stock and have no say in how the company is run, the salaries of the executives, the amount of dividends paid (or not paid), etc.

    I wonder how that would compare to the KSA govt owning 98% of the Aramco stock? We all have heard the line about the tail wagging the dog. Have you heard the one about the little dog turd laying on the ground trying to wag the dog? LOL.

  10. rockman on Tue, 7th Mar 2017 4:25 pm 

    Boat – “he would open up high percentages of ocean and on land government controlled areas for drilling.” That’s true. But much of the onshore fed lands have been available to lease for decades. The offshore areas hold some undetermined potential for sure. But even if he pumped up the next 5 year leasing schedule nearly all the new leases will require drill permits from his predecessors. And even if he can get a few exploration wells drilled during his term(s) any production permits will have to come from a future POTUS…who ever that might be. And that’s assuming there’s something significant to produce.

    Bottom line: IMHO there’s little to nothing President Trump can do to actually increase oil/NG production from federal lands in the next 4 to 8 years.

  11. Apneaman on Tue, 7th Mar 2017 4:27 pm 

    Hair clog, congratulations on finally finding a new Fuhrer for the third Reich 2.0

    ‘Black Hitler’ to stand for election for far-right party in Finland

    http://talkradio.co.uk/news/black-hitler-stand-election-far-right-party-finland-17030610898

    Y’all are going to have to change the Nazi salute to a high 5……..lay some skin on me brother blood…..sieg heil!

  12. Jerome Purtzer on Tue, 7th Mar 2017 6:47 pm 

    If The Saudi’s stay true to form they will, over the next 10 years or so, sell all of the shares of the company to “investors” and then turn around and nationalize the company, repatriating the cash. History repeats the Ponzi. Almost as much fun as flying a jet into a building. Then they ban Americans from entering their country.

  13. twocats on Tue, 7th Mar 2017 8:54 pm 

    this article sucks. I want to be a direcktor energy and sustainment in transportation and things at University of Davis. i bet that gig pays over $150k a year. boy do I wish I could live in this fantasy world. life would be so much better.

    http://gsm.ucdavis.edu/distinguished-speaker/amy-myers-jaffe-executive-director-energy-and-sustainability-uc-davis-graduate

  14. James boags on Tue, 7th Mar 2017 10:37 pm 

    Anyone notice Kenz 300 bot hasn’t been around for awhile mabey it’s batteries have finally packed in and the energy returned on investment wasn’t worth it and was sold for scrap

  15. GregT on Tue, 7th Mar 2017 10:48 pm 

    I’m sure it’s been programmed to randomly spam multiple forums and news groups. Have patience James, it’ll be back soon enough.

  16. Cloggie on Wed, 8th Mar 2017 4:09 am 

    apneaman opines Y’all are going to have to change the Nazi salute to a high 5…

    I’m happy that Anonymouse landed himself a nice job in Finland. Now he can elaborate all day long about the “Jew-knighted States” with his True Finns brothers.

    http://talkradio.co.uk/news/black-hitler-stand-election-far-right-party-finland-17030610898

    So you are scanning right-wing sites all day with trembling knees in the hope these stupid goyim still haven’t figured you out yet, right Friedman-Friday?

    But you have to admit that things aren’t exactly going your way, now is it, despite this “black Hitler” you could dig up?

    Still no response to this beating you got yesterday, at the bottom of this thread:

    http://peakoil.com/publicpolicy/should-israel-fear-the-peak-oil-crisis/comment-page-1#comment-316491

    Deafening silence from apnea-thug. Completely cornered. Your order and empire are breaking down faster than you can say mazzeltov.

  17. zleo99 on Wed, 8th Mar 2017 8:39 am 

    “There is not going to be an oil shortage; there is going to be a shortage of customers for the greasy sludge.”

    Who is going to be able to tell, as the exergy-starved economy winds down, whether it is cash-strapped consumers who are unable to demand at the price that Oil Co’s need, or cash-strapped Oil Co’s who are unable to supply at exergy at any price? The answer will robably never be clear except to people who can understand, or accept, Etp. Oil co’s and politicians anxious to avoid dire fall-out for them “on their watch” will probably ignorantly or deliberately obscure the true answer. So history, if ever it is written and preserved by people who will eventually have to back to the skills of the Stone Age to survive, will probably never know.

  18. zleo99 on Wed, 8th Mar 2017 8:44 am 

    Also, the awakening which may take place as a result of the required scrutiny and evaluation of Saudi oil reserves may bring on the financial fallout from recognition of the Maximum Affordable Price curve.

  19. Baptized on Wed, 8th Mar 2017 2:06 pm 

    I cannot understand why people get in a rage when we want to pump oil in remote area’s? Then pump it behind a k-mart, etc. in California and pump & store
    beside schools in New Orleans

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