CryptocurrencyInvestingBanksReal Estate

Saudi Aramco IPO Will Give Global Investors a Big Glimpse into the Kingdom’s Tiny Stock Exchange

November 8, 2019, 11:00 AM UTC

The last company to float on the Saudi stock exchange—local schools operator Ataa Educational Co—raised $93 million in July.

The exchange’s next IPO will be several hundred times bigger. The sale of shares in state-owned oil firm Saudi Aramco could raise up to $40 billion, beating the record $25 billion IPO launched by e-commerce giant Alibaba in 2014.

Aramco, the world’s most profitable company, announced last Sunday it would float on the Saudi exchange, or Tadawul, giving private investors, for the first time, the chance to own shares in the company that controls Saudi Arabia’s immense oil wealth.

While it has so far given few details, Saudi Aramco is thought to be looking to sell around 2% of its shares, which, if Saudi Crown Prince Mohammed bin Salman’s $2 trillion estimate of the company’s value is correct, would put the listing at $40 billion. Investment banks, meanwhile, estimate Aramco’s value in the bewilderingly massive range of $1.2-$2.3 trillion.

What is certain is that the IPO will be on a different scale altogether from anything that the Saudi stock exchange has handled until now. That will put unique challenges on the Tadawul, the biggest stock exchange in the Middle East.

It will also likely transform Tadawul’s turnover and raise foreign investor interest in the market to a whole new level.

Saudi Aramco is the world’s largest integrated oil-and-gas company, producing one in eight barrels of crude oil globally, or 13.6 million barrels per day in 2018. It reported a net profit of $68 billion in the first nine months of this year on revenues of $217 billion and, in a big lure to prospective investors, has promised to pay dividends of at least $75 billion next year.

Floating fossil fuels

In the last two years, index providers MSCI and FTSE Russell have included Saudi stocks in their emerging market indices, which many fund managers around the world follow when deciding how to allocate funds, meaning that your pension fund or insurance company could buy shares in Aramco.

That prospect has alarmed environmental groups, 10 of which have written to the heads of the international banks picked as joint global coordinators for the IPO to protest their role in raising funds for Saudi Aramco, which they called “the world’s largest corporate emitter of carbon dioxide.”

“This IPO is likely to be by far the biggest single infusion of capital into the fossil fuel industry since at least the Paris Agreement (on climate change) in late 2015,” the environmental groups, including the Sierra Club and the Rainforest Action Network, said in the letter to the CEOs of Bank of America, Citigroup, Credit Suisse, Goldman Sachs, HSBC, JPMorgan Chase and Morgan Stanley.

Aramco destined for index funds

In a report last year, FTSE Russell said a Saudi Aramco IPO would significantly raise the kingdom’s presence in emerging market indices. “Each $10 billion of capital raised increases Saudi Arabia’s weight in the FTSE Emerging Index by an estimated 24 basis points,” it said.

The proceeds of Saudi Aramco’s IPO are expected to far exceed the funds raised in all the IPOs on the Saudi stock exchange between 2013 and 2018, which totalled 48.78 billion Saudi riyals ($13 billion). Likewise, Aramco’s value will dwarf the total market capitalization of all the companies listed on the Saudi stock exchange, which is around $487 billion.

The offer is open to citizens of Saudi Arabia and Gulf Cooperation Council states, Saudi residents and institutions. It is also open to foreign banks, brokerages, insurance companies or investment funds with at least $500 million of assets under management. Some non-financial foreign institutions will also be allowed to take part, Aramco said Sunday, without giving details.

“The Tadawul and its regulator are definitely two of the better-run institutions in Saudi Arabia that have matured a great deal over the last few years,” Steffen Hertog, an expert on the Gulf and Saudi Aramco, told Fortune.

“Should there be large, rapid inflows or outflows of foreign capital, that could strain the market as liquidity and free float levels are relatively low. But right now it looks more likely that the majority of buyers will be local. This could still affect other stocks as investors reallocate their money, but the government is trying to prevent too strong fluctuations by pushing banks to lend for the IPO,” said Hertog, who is associate professor in comparative politics at the London School of Economics.

Relaxed listing requirements

Proceeds from the IPO will be used to help finance Crown Prince Mohammed’s “Vision 2030” plan to diversify the Saudi economy and reduce its reliance on oil.

Aramco’s IPO prospectus, due out tomorrow, should include more details of the offer, a timetable, analysis of the company’s performance and financial position and information on the risks that might affect the business, according to the Tadawul’s listing guide. The shares are expected to start trading in December.

In one important respect, Aramco appears to have been granted an exemption from the Tadawul’s standard listing rules, which state that a company must offer at least 30% of its shares to the public to gain a listing on the main market.

The crown prince first floated the idea of selling shares in Saudi Aramco back in 2016. Initially, about 5% of the company’s shares were expected to be sold both locally and internationally. New York, London and Hong Kong were all in the running to host the prestigious international IPO at one point. The U.K. financial regulator even changed rules for state-run companies listing in London in what was seen as a move to entice Saudi Aramco to list there.

Meanwhile, the requirement to disclose sensitive information and the risk of litigation under a U.S. terrorism law dissuaded Aramco from seeking a New York listing, according to news reports.

Aramco put the whole plan on hold, ostensibly as it focused on completing a $69 billion purchase of a majority stake in chemical firm Saudi Basic Industries (SABIC), and it has for now settled for a local listing, although it says an international IPO could come later.

Open to outsiders only recently

The Saudi stock market, formed in 2007, opened its market to large foreign investors in 2015 and has taken a series of steps since then to make it easier for foreigners to buy and sell shares, all part of the kingdom’s drive to attract more foreign investment.

The exchange is dominated by raw materials and financial companies followed by telecoms, consumer staples and utilities.

Foreign investors bought $3.2 billion worth of shares on the Saudi exchange in October, or 19% of the total, and they sold $2 billion of shares, of 12% of the total, the exchange said. Foreign investors owned shares representing 9% of total market capitalization at the end of October.

In its 2019 Global Competitiveness Report, the World Economic Forum ranked Saudi Arabia sixth in the world in corporate governance and second in shareholder governance.

Saudi stock market performance has not been stellar with the Tadawul All-Share Index down 0.6% over the last year and down 20% over the last five years. (In comparison, the S&P is up more than 20% year to date.) That reflects the weakness of the Saudi economy, which has seen low or negative growth in recent years following the plunge in the oil price from 2014.

The Saudi drive to attract foreign investment has met with limited success against a difficult political backdrop. Last year, Saudi agents allegedly killed journalist Jamal Khashoggi at the Saudi consulate in Istanbul, causing international outrage, while in Yemen a Saudi-led military coalition is fighting Houthi rebels aligned with Iran. In September, the Houthis apparently used drones to attack two Saudi oil processing plants, cutting the kingdom’s oil output by half and sending oil prices through the roof. By early October, though, oil production had returned to normal and global prices had stabilized.

More must-read stories from Fortune:

“Secret” recession signs may provide clues to when the next downturn is coming
—The HENRYs—high earners, not rich yet—may finally be having their moment
—Markets are betting that good things come in threes—especially rate cuts
—Why Virgin Galactic sidestepped a traditional IPO, according to its CEO
A.I. vs. the wolves of Wall Street
Don’t miss the daily Term Sheet, Fortune’s newsletter on deals and dealmakers.