The global energy markets, so preoccupied on when and where the planned Aramco IPO might take place, was caught off-guard by the news that the Saudi Arabia’s state oil company is building an oil-refining empire, and is in preliminary talks with SABIC to acquire that company’s seventy per cent share owned by the government.
This represents a major shift for the world’s No. 1 crude producer as it tries to shore up its balance sheet ahead of the world’s biggest-ever IPO and make up for income lost to OPEC production cuts.
However, the news should not have come as a surprise to those who have followed the company and its evolving energy strategy closely and makes for fundamental political, economic and financial reasons.
Over the past five years Aramco, has boosted its global refining capacity by more than a third to 5.4 million barrels a day, helped by new facilities along the kingdom’s Red Sea and Arabian Gulf coasts, underpinned not only by the older generation of wholly-owned refineries, a legacy from the PETROMIN days, but also by the new “ crown jewels “ such as the mega joint ventures with Dow Chemical of the US in SADARA and with France’s Total in SATORP.
To put this in perspective, the SADARA project has cost over $20 billion and is the largest and most modern petro chemical facility in the world producing multiple high value speciality chemicals. The SATORP facility is also slated for expansion.
These moves and others including taking full control of the biggest U.S. refinery, in Port Arthur, Texas, have vaulted Aramco’s global refining capacity beyond Western rivals such as Shell , Exxon Mobil and BP.
Going the SABIC acquisition route through international bond borrowing at competitive terms helps to achieve many goals of the Aramco IPODr. Mohamed Ramady
But unlike Aramco, the international oil majors already had strong downstream businesses to bolster their earnings when crude prices plummeted just over three years ago.
This is where the economic logic comes in and Saudi Arabia has publicly stated that it cannot be held hostage to erratic oil prices that have fluctuated between $148 a barrel to a low of $28 a barrel putting strain on fiscal and economic development plans.
Saudi Arabia is now one of the top three exporters of diesel to Europe – the world’s largest diesel market for passenger vehicles – grabbing market share from the continent’s two long-time suppliers, Russia and the US.
Rising Saudi shipments of fuel products have helped soften the financial blow of slashing crude-oil production and exports with the Organization of the Petroleum Exporting Countries (OPEC) and the recent Non-OPEC producer agreement.
The refining investments were years in the making but were accelerated by 2014’s historic oil-price collapse and the kingdom’s subsequent plans to become a more diversified economy for revenue.
The expansion into the petro chemical and refined sector is not a surprise as last April, in remarks at Columbia University, Aramco Chief Executive Amin Nasser said the company aims to increase its refining capacity to between 8 million and 10 million barrels a day in an effort to better balance the company’s business.
Doing this by expanding Aramco’s refining capabilities will help it to be more of an integrated global energy company like the publicly listed Western oil giants, and make for a more valuable IPO when this takes place.
Current and planned operations
But it is not only in the Kingdom that Aramco has expanded in the refined energy business, as Aramco’s refining current and planned operations span the world, with joint ventures in India, South Korea, Malaysia, Japan and China, in addition to the giant Motiva refinery in Port Arthur, Texas.
These facilities give the company a guaranteed outlet for its crude oil in its most important markets and also dispel the notion that Saudi Arabia is not willing or interested to increase its oil production capacity.
Existing ventures and planned acquisitions abroad will have their crude oil needs be met, and the Kingdom must either meet this from expanding its own spare capacity or purchase oil from third parties, thus exposing it to geo-political and supply risk in the future.
This is where the planned SABIC acquisition makes economic sense. According to SABIC, the company operates in more than 50 countries of the world with extensive manufacturing plants, specializing in polymers, specialties, agri-nutrients, and metals.
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The extensive SABIC petrochemical manufacture base, over 34 operations with SABIC having ownership stakes ranging from 100 percent to 25 percent, dwarfing Saudi Aramco’s own manufacturing capacity in the same sector, and had raised some fundamental questions on why the two Saudi companies do not merge their petrochemical operations to ensure synergy in raw material sourcing, marketing, and core research and development, without duplicating efforts.
Further questions had been raised, at least by this author, on whether Saudi Aramco should be involved in petro- chemicals in Saudi Arabia given the dominance of SABIC in this market, or can the two companies form a separate joint venture to hold Saudi Arabia-based assets and ensure a fair access to raw material for both parties, especially gas?
As Saudi Aramco is the sole producer of this raw material, and given the company’s stated objectives to expand further into the petrochemical sector, the alternative for SABIC was either to cooperate with Saudi Aramco on domestic gas supplies, to establish joint production, or to make acquisitions and expand abroad. The news of Aramco’s potential acquisition of SABIC majority stake has answered the question.
Joining forces and merging their existing domestic refineries and petrochemical facilities will ensure better feedstock rationing domestically to the most efficient operations, while at the same time avoiding competitive bidding internationally.
Already both Aramco and SABIC are pursuing this cooperative path with joint investments in India’s refineries and advanced research in oil- to- chemicals production in Saudi Arabia.
According to reports, Aramco’s acquisition of SABIC’s PIF Government 70 percent share will be financed through international and domestic sukuk borrowing, as Aramco has already tested the domestic market appetite by an earlier successful sukuk issue.
Given that many of the assets of both Aramco and SABIC are abroad, the pricing of an international bond should reflect this and reduce a higher geo political risk pricing premium being applied. In all probability the likelihood is that it will be met with a large investor appetite, with the possibility of a portion of the international bond floated as a petro yuan bond given Chinese interest to participate in both any eventual Saudi IPO and to open the door for more Saudi refinery investment in China.
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Other benefits accrue to the Kingdom. The proceeds from such an acquisition will provide the Saudi Sovereign Wealth Fund the PIF, with the means to carry out a more comprehensive domestic and international investment program to earn higher financial returns and help in diversifying the Saudi economy’s revenue base, while Aramco’s much larger international bond borrowing for the SABIC acquisition will also lead to more corporate transparency and release of new information that would help in any future IPO investor prospectus if the State decides to proceed.
One of the principal aims of the planned IPO is to raise funds for the PIF to carry out the above objectives. Going the SABIC acquisition route through international bond borrowing at competitive terms helps to achieve many of the goals of the Aramco IPO.
Of course , no merger is guaranteed to succeed given different organization’s management styles, work ethics, oversight and corporate governance structure, and by necessity there could be some job losses and functional departments merged to save costs.
In the longer term, a mega merger of firms in the same line if business should succeed, given that the final goal of Aramco is to become a global refinery and petrochemical producer, complementing SABIC’s core business.
Dr. Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia and co-author of ‘OPEC in a Post Shale world – where to next ?’. His latest book is on ‘Saudi Aramco 2030: Post IPO challenges’.