The Biggest Flags in the Saudi Aramco IPO Prospectus

For Saudi Aramco and its army of bankers, the clock is ticking.

They have under a month to convince investors that Saudi Aramco’s almost boundless reserves of cheap-to-produce oil make it an attractive buying opportunity, even at a time when the global IPO market has all but stalled. Oh, and never mind that the Aramco business faces fundamental risks from terrorism, government interference and climate change campaigners and scientists.

The world’s biggest oil producer acknowledged many of these challenges when it issued around midnight Saudi time on Saturday its 658-page IPO prospectus. It also laid out (in far more detail) what it sees as a unique selling point: its low production cost and decades worth of supply that will meet energy demands even if the world eventually gets more serious about abandoning fossil fuels.

The brochure’s release moves the world’s most profitable company a step closer to selling a small stake of itself to the public. What it failed to include in that same document was pretty giant too: it omitted the number of shares to be sold and the price range, leaving observers unable to properly value the company.

That probably won’t sway individual Saudi investors either way, for whom one-half of a percent of Aramco shares has been set aside. The government is expecting high demand from this group. It’s pressing wealthy Saudis to invest, and it’s encouraging banks to lend money to the rest to buy shares in the state-run company, cinching up the local market.

But a question mark hangs over the appetite from international investment funds when Aramco shares list, as expected, on the Saudi stock exchange, the Tadawul, next month.

‘Monster Oil’

The company has a tough job on its hands convincing international investors that Saudi Aramco is worth anywhere near the $2 trillion price tag that Crown Prince Mohammed bin Salman is aiming for, as many analysts value it well below that level. Initially the plans called for 5% of shares to be sold and an international listing, but for now the shares will only be sold on the Saudi exchange and the offer is expected to be far smaller.

The offer opens on Nov. 17 and book-building will close on Dec. 4, with the final offer price to be set the next day.

Analysts at brokerage Bernstein, in a note last week on the company it nicknames “Monster Oil”, concluded that a fair value range for Saudi Aramco was closer to $1.2 trillion to $1.5 trillion.

The offer prospectus reveals that the Saudi government has agreed not to sell any more of its shares in the year after shares start trading on the Riyadh exchange, except possibly to a foreign government or foreign strategic investor. That could be significant because China’s sovereign wealth fund and Chinese state-owned oil companies PetroChina and Sinopec have been reported to be interested in taking a stake in Aramco.

The supply side of the business is impressive. Aramco, which produces one in every eight barrels of oil pumped globally, is sitting on massive reserves of 257 billion barrels of oil equivalent which it says should last another 52 years. Its proven liquid reserves are about five times bigger than the combined reserves of the five major international oil companies—ExxonMobil, Chevron, BP, Shell and Total—it said. Aramco’s reservoirs are favorably located, giving the company a low production cost of just $2.80 per barrel.

The demand side is not quite as rosy in the longterm. Global demand for oil is expected to continue to grow for the next decade, levelling off around 2035, the prospectus said. Based on that scenario, Saudi Arabia’s oil supply volumes are expected to grow at a compound annual rate of 0.9% between 2015 and 2050. Even if the world moves away from fossil fuels earlier than that, Saudi Arabia’s sales are still expected to rise at an annual rate of 0.7% through 2050 because of its low-cost advantage, it said.

Analysts at Bernstein estimated in a note on Monday that Saudi oil production could peak at 13 million barrels per day in the 2040s, up from 10 million bpd of crude production in the first half of this year.

While Aramco will remain the lowest cost producer for the foreseeable future, the easy oil has been extracted and the company’s costs will surely rise, Bernstein said shared with Fortune.

“Saudi may also have significant unconventional resources, but with this much conventional remaining – who needs more?” it said.

No matter what happens between now and mid-December, Aramco will be facing strong opposition from environmentalists.

“It’s clear that with the planet racing towards catastrophic climate change, with increasingly frequent extreme water events like flooding and wildfires, we need to rapidly pull the plug on dirty fossil fuels – not burn more of them,” said Friends of the Earth climate campaigner Muna Suleiman.

“Energy firms should plan to be part of a cleaner, safer future by investing in carbon-free energy sources—and leave climate-wrecking coal, gas and oil in the ground,” she said in emailed comments to Fortune.

Set against its plentiful reserves, Saudi Aramco also set out a long list of potential risks to its business in the prospectus, as it is legally required to do.

These included the risks that climate change concerns could reduce global demand for oil or that the company’s operations could be affected by social instability, war or terrorism.

Building stadiums for the kingdom

That risk was driven home in September when Yemen’s Houthi group apparently to attack two Saudi Aramco oil processing plants, cutting Saudi oil output by half and briefly sending oil prices through the roof. By early October, oil production had returned to normal, but the incident impacted the company’s bottom line. Third quarter profits topped $21.2 billion, down from $30.3 billion in the year-earlier quarter, Aramco reported.

The prospectus also noted that the Saudi government decides the kingdom’s maximum oil production level and it highlighted the risk that the Saudi government may direct Aramco “to undertake projects or provide assistance for initiatives outside the company’s core business, which may not be consistent with the company’s immediate commercial objectives or profit maximization.”

This has happened before, for example in 2009, when Aramco was given the job of building of a stadium and sports city in Jeddah, and it raises questions about how much of a say minority outside shareholders will have in such key decisions.

Looking at the broader picture, Saudi Aramco is going public at a difficult time in the market. Oil prices have been in the doldrums for five years as the U.S. has massively expanded shale oil and gas production while trade wars and weak economic growth in Europe have undermined demand for oil.

The auto market is shrinking as buyers begin switching to electric vehicles or foregoing ownership altogether. Renewable energy output is expanding as people grow more concerned about global warming while activist groups like Extinction Rebellion are putting pressure on governments to take more decisive action to reduce use of fossil fuels.

The Saudi Aramco IPO is partly a recognition of these mega societal trends as it is the centerpiece of government reforms aimed at weaning the Saudi economy off its reliance on oil. Crown Prince Mohammed promises in his “Vision 2030” blueprint for modernizing the Saudi economy to transform Aramco into “a global industrial conglomerate”.

Jitters in the IPO market

In addition to the uncertain economic environment, the IPO market is jittery with several companies abandoning planned flotations after office-space company WeWork scrapped its IPO in September.

A number of high-profile IPOs have gone badly, with ride-hailing companies Uber Technologies’ and Lyft’s shares both down by around 40% since they made their market debuts earlier this year.

With its proven record of big profits and a promise of a promised to pay a hefty $75 billion dividend, Saudi Aramco is a very different animal, of course. Aramco’s $111 billion net profit in 2018 was more than Apple and Microsoft’s annual profits combined.

Bernstein analysts note that buying Aramco shares would essentially be a ‘yield play’ for income investors.

But if Saudi Aramco achieved a $2 trillion valuation, that would only represent a dividend yield of 3.75%, lower than all of the five oil majors that Saudi Aramco likes to compare itself with – ExxonMobil, Chevron, BP, Shell and Total – whose shares yield between 3.9% and 6.2%.