the Saudi Aramco ipo

A while ago Saudi Arabia decided to list its government-owned oil and gas company, Aramco, both on its own national stock exchange as well on at least one foreign bourse.  The potential listing date is thought to be some time next year.  The Saudis are rumored to be thinking of selling 5% of the company for $100 billion–implying a $2 trillion valuation for the company as a whole.

Why the long delay?

It’s to whip a government bureaucracy into palatable enough shape for foreign investors, as well as local citizens, to want to buy shares.  It’s also to find a foreign stock exchange big enough, and willing enough, to act as host.  “Willing,” in this case, means among other considerations, being able to accept the corporate opacity that the Saudi government would surely like to surround the operations of its national treasure.

While world interest centers on trying to figure out what stock exchange is the most eager to compromise its governing principles in order to achieve a huge payday for its domestic brokerage firms (my answer:  all of them), I don’t think this is the most interesting question.

My query is why the offering.  I see two possibilities:

–the Saudi government hopes to achieve greater efficiency of operations by opening Aramco management to the scrutiny of the investing public

–the Saudi government wants/needs the $100 billion proceeds to fund its government spending.

I’m sure the reality is that both are key objectives.  The question, however, is which of the two is uppermost in Riyadh’s mind.


If it’s the former, then the stock is likely, I think, to be a perennial laggard.   And it will give a black eye to whatever foreign listing venue it chooses (London and New York are understood to be the frontrunners, although Hong Kong is also big enough to handle an offering of Aramco’s intended mammoth size).

If the latter, the stock may be worth taking a chance on.  After all, it does have a massive amount of extremely low-cost oil and gas reserves.  However, whatever the case, Aramco appears destined to miss the current market, in which companies like Snap and Blue Apron floated successfully,  and which would have been the ideal time for any issuer to come public.

BP Energy Outlook 2016

BP just released its annual Energy Outlook.  

The company is projecting faster development of shale oil, coming mostly over the next few years from the US, than it previously thought.  Renewable energy supply will rise more quickly; (heavily polluting) coal usage will fall faster.  Most of the action will be in developing nations like China and India.  The US will attain energy self-sufficiency in a handful of years, oil self-sufficiency shortly after that.


To me, the most interesting topic the release brings up is not actually contained in the report.  It comes from comments by Spencer Dale, BP’s chief economist, during a press conference promoting the new Outlook.

According to the Financial Times, Mr. Dale said that there’s twice as much technically recoverable oil available as the world is expected to need between now and 2050.”

First, “technically recoverable” means only that all of this oil can be extracted from the ground using current oilfield methods.  It does not mean it can be done profitably.  In fact, the choice of the word “technically” suggests BP believes that a significant portion is uneconomical at today’s prices.

Second, according to BP, much of this oil is unlikely to see the light of day…ever.    That’s because global demand for energy is likely to grow by less than 2% yearly.  Most of that will be supplied by renewables and natural gas; oil demand increases by less than 1% annually.

At some point, as the price of renewable energy continues to fall, and absent a decline in the oil price, demand for oil begins to shrink.   Since one might imagine that this drop might not take place thirty years, it may be of little practical concern to you and me.  However, for OPEC countries like Saudi Arabia, which holds perhaps 100 years worth of economically viable oil, and whose economy is radically dependent on petroleum, this is a significant worry.

Investment implications (assuming BP is correct):

–the oil price is unlikely to go up

–OPEC + shale oil will squeeze out higher cost oil production from the rest of the world

–future shale oil company profits will come as much from lowering production costs as from new finds

–big oil firms probably still have plenty of stranded assets (meaning oilfield investments that have become uneconomical and where recovery of the money already spent is unlikely) on their balance sheets.





new oil and gas finds in mature areas

a lesson from base metals

A decade of intensive exploration for base metals during the 1970s, on what proved to be the mistaken idea that their consumption must rise in lockstep with global GDP, resulted in a substantial glut of copper, zinc, lead…by the end of that decade.

Miners responded by redirecting their exploration and development efforts in two ways:

— they started looking for gold, for its high value in a small package, and

–they concentrated on areas near existing infrastructure.

This cut costs and almost immediately began to generate much-needed cash flow. In some cases, miners even went back to the tailings (dump heaps) of nineteenth-century mines to extract now-economical gold.  Yes, this effort created a glut of gold within a decade, but that’s another story.

the oil industry today

Something similar seems to be going on now in the oil industry in the US.  A few months ago, Apache announced a major discovery (3 billion barrels of oil, 75 trillion cubic feet of gas) in an overlooked area near the Permian Basin in Texas.  Two days ago, Caelus Energy, a privately-held firm, announced a potentially large find (2.4 billion barrels of light crude) in shallow water in Smith Bay in northern Alaska–close, at least in Alaska terms, to delivery systems from earlier finds by oil majors.

That exploration effort should have shifted in this direction isn’t surprising.  The large amounts of oil and gas being uncovered are.  Although no one would want to generalize from this small sample, the discoveries do seem to me to call for demands for greater evidence for any claim that oil and gas prices will rise a lot from current levels.



the investigation of Exxon’s (XOM) oil and gas reserves

The Wall Street Journal has recently reported that the New York attorney general and the SEC are investigating whether the accounting XOM gives of its oil and gas reserves in its annual 10k filing is accurate.

There appear to be two points to the probes:

–the SEC wants to know if/how XOM has factored the cost of increasing environmental regulations into its evaluations

–the NY attorney general observes that other publicly traded oil and gas companies have written off $200+ billion from the balance sheet carrying value of their exploration and development assets.  XOM has done none.  He wants to know how that’s possible.

oil and gas balance sheets

These are very murky waters, for a number of reasons:

–there probably isn’t any “right” way to account for future environmental regulations.  It’s possible the SEC just wants to send a message to the industry to do something

–balance sheet writedowns aren’t required when assets become less profitable, which they obviously have as oil prices have plunged, but only when they become unprofitable.  For oil and gas fields that may have decades of future life, this requires some judgment about what future selling prices and costs will likely be

–the unprofitability test isn’t done well by well or even field by field.  It can be done for pools of assets that are as big as a given country.  For a mature company like XOM this will mean a pool can contain not only fields put into production two years ago but also ones from the 1960s, when crude went for $1 a barrel.  It’s possible that XOM has simply not been as aggressive (read: reckless) as its peers in chasing discoveries that are only viable with oil selling for over $100 a barrel.

supplementary present value disclosure

There is also another–more significant, in my view– set of calculations of the present value of oil and gas reserves that each company is required to include in its 10k.  This is a standardized measure with fixed assumptions.  The most important are that selling prices are assumed to be constant at those of the time of the report, and the discount factor to be used is a whopping 10%.

On this measure, XOM has already written down the present value of its oil and gas holdings by a gigantic amount.  From December 2012 on, the figures are as follows:

2012          $225 billion

2013          $220 billion

2014          $208 billion

2015          $71 billion.

Based on the 2015 figure it’s hard to make an argument that XOM is somehow covering up the loss in value it has experienced with the fall in oil prices.


crude oil: from shortage to surplus

Until very recently, petroleum industry thinking about crude oil supplies has been dominated by what has been called “peak oil theory.”  Developed by geologist and Shell Oil researcher M. King Hubbert in the 1950s, the simplest statement of the theory is that world production of crude oil would peak shortly after the year 2000, and then begin an inevitable decline.  The reason?   …all the world’s oilfields would have been discovered and fully exploited by that time.

We now know that Dr. Hubbert’s hypothesis is incorrect.  In fact, it’s wildly–even directionally–wrong, done in by the incentive of high prices and the development of hydraulic fracturing.


Peak oil is of more than academic interest, since strong belief that the world is facing an inevitable decline in oil production has informed the capital spending budgets of all the major oil companies for the past generation.  For them, the present situation of abundant supply at around $50 – $60 a barrel was unthinkable.  As a result, the majors have poured billions and billions of dollars into locating very high-cost hazardous-environment oil prospects that may now be not economically viable.

What happens now?


My mind keeps going back to the late 1990s and the mad rush to lay fiber optic cable around the world to support the internet.  Corning and a few Asian suppliers made the highest-quality glass cable.  Global Crossing and others spent immense amounts of money as they raced to complete undersea cables to connect the US to the rest of the world.  Internet traffic was expanding at such a fantastic rate that, in these firms’ minds, the fact that a whole bunch of firms were all doing so made no difference.

In hindsight, a key assumption these companies all made was that each optic fiber in a cable would be able to handle only one transmission at a time.

Then came dense wavelength division multiplexing.   DWDM amounted to putting a prism at each end of a fiber, breaking the light into a number of different wavelengths and sending a separate communication over each wavelength.   First it was two wavelengths, then four, then 256…

Suddenly the looming fiber optic shortage was an actual fiber optic glut.

What happened beak then?    The fiber optic cable business fell apart.  So too equipment suppliers like JDS Uniphase.  The most aggressive fiber optic cable layers went into bankruptcy.


I’ve been thinking that it’s time to poke around in the wreckage of smaller US oil exploration firms, although I suspect we may not see oil price lows until the end of the winter heating season (assuming there is one) next February.  But I also continue to think that the DWDM analogy is a reasonable one.  It suggests that there’s still lots of trouble ahead for the biggest and best-known names in the oil industry.



the proposed Aramco IPO: why?

Aramco and an IPO

Over the past few days, as a new, younger generation prepares to take over leadership of Saudi Arabia, the kingdom has been announcing plans to overhaul the structure of its radically oil-dependent economy.

The most concrete of these is a proposed IPO for the Saudi national oil company, Aramco (the Arabian American Oil Company before it was nationalized in the 1970s).  The idea would be to sell roughly a 5% interest in Aramco to the investing public, with a dual listing in Saudi Arabia and somewhere else.  The leading “somewhere else” contender is the US.

It’s not clear yet exactly what the future shareholders would have an ownership interest in.  Aramco contains all sorts of oil-related operations, from exploration and production to refining to petrochemical production.  The Saudis intend to restructure Aramco into a holding company with subsidiaries–structured presumably by type of business–before offering equity.  To me, it sounds as if the offering will be of stock in a subsidiary, not the holding company.



The obvious answer is that the kingdom wants to raise money to fund its budget deficit.  It figures the proposed IPO will raise $100 billion – $150 billion, a figure that already has investment bankers around the world salivating.  This, by the way, implies a total value for Aramco of $2 trillion – $3 trillion.

deeper motivation

But there’s almost invariably a deeper motivation when a country takes action like this.  It wants to focus and streamline operations of the to-be-IPOed company, either because current service is terrible and/or to generate more funds from operations to fill government coffers.  The IPO offers potential wealth and prestige to the management of the government-owned company if they run it well.  That substitutes for pre-IPO motivation, which may simply be to do the least work possible, and make the fewest waves, without getting fired.

better than they look

In my experience, such IPOs, however dreary the prospectus may sound, often do quite well for at least the first couple of years.  Two reasons:

–their scope for change becomes much wider when public scrutiny protects the manager from interference by politically-connected sluggards who like the status quo, and

–managers tend to, in a sense, stop working once they find out an IPO is in the offing.  Why make improvements today that will only make post-IPO earnings comparisons harder?  Better to save them for the time when the stock is publicly traded and holders of stock, stock options and management incentive plans will cash in on them.

in sum

The IPO itself is evidence that the Saudis are serious about a reorientation of their economic priorities.  Human nature argues that 2016 will be like wading through molasses for Aramco but that it will break very quickly from the gate after the IPO.

latest news on oil

Three developments in the last week or so:

Saudi Arabia has clarified for reporters the significance of its recent agreement with Russia, Venezuela and Qatar to refrain from increasing oil production.  The Saudis have no intention of decreasing production, as the media had speculated, but will not pump out more than it is doing at present.

This makes it resoundingly clear, as if it weren’t already, that Saudi Arabia is taking a page out of J D Rockefeller’s nineteenth-century playbook.  It intends to maintain oversupply until weaker, higher-cost competitors are driven out of business.

the International Energy Agency has revised up its estimate of how long it will take for steadily increasing world demand for petroleum to catch up to the current level of supply.  The breakeven date is being pushed back into 2017.

This breaking even consists of two separate elements:  the point when daily usage rises to/above the level of current oil production, and the subsequent–possible quite extended–period during which accumulated excess inventories will be run off.

My first guess is that the prices of oil equities will begin to readjust when the first of the two comes into sight.

J P Morgan announced with its latest earnings report that it is tripling the reserves it is providing on its balance sheet for potential oil company loan losses.

This is “old” news, in the sense that this is accounting recognition of economic damage that has already occurred.  Two reasons for the lag:

—bank loans are typically secured by the oil and gas reserves that the borrower owns.  Their value can change either because the selling price of output rises/falls, or because the quantity of output that can be brought to the surface at a profit changes with price.   It’s conceivable that a small firm that had a million barrels of reserves a year ago only has 500,000 today–because 100,000 have been produced and 400,000 are not economically viable at today’s selling price. Because of this, in an extreme case a halving of the oil price could conceivably wipe out 90% of the value of reserves.  Figuring this out depends on getting a report from petroleum engineers who “audit” reserves annually.  Many such reports have presumably been just rolling in since yearend.

—accounting theory and tax law both argue against a bank making a good-faith guess at what the potential liability will be.  The more prudent course is to wait for reserve reports (required in the loan covenants) from borrowers.

My bottom line:  the only surprise here is the IEA surmise that supply and demand won’t be back into balance before next year.  Otherwise, the oil market adjustment process appears to me to be playing out as one might have expected six or more months ago.  On the good news front, we’re passing the seasonal low point for oil demand.  On the bad news side of the ledger, there’s no evidence that the successful, if economically crazy, stock market trading linkage between equities and oil is being broken.  If I were a trader, though, I’d keep working the trade despite the lack of economic underpinnings until I stopped making money with it.