Saudi Aramco Warns of ‘Climate Change Concerns’ in Its IPO Prospectus. It’s Not What You Think.

November 12, 2019, 8:53 AM UTC

Saudi Aramco is aiming to pull off the world’s biggest public listing next month, no small feat in this IPO market.

As it seeks a trillion-dollar-plus valuation, it also intends to cement its position as the world’s biggest oil extractor, a point it made clear in its IPO prospectus, published on Saturday. In the 658-page document, it gave investors a revealing glimpse into how it will grow: “by balancing production between maturing areas and newer production sources, tapping into new reservoirs when required to optimize the depletion rate of its fields.”

A few days before the prospectus dropped, however, a very different message, no less urgent in tone, came from over 11,000 scientists from around the world. The group warned policymakers that the world has to soon replace fossil fuels with renewable alternatives, if humanity is to have a sustainable future. “We should leave remaining stocks of fossil fuels in the ground,” they said, among other urgent recommendations.

Clearly, leaving oil in the ground to save the planet is incompatible with “tapping into new reservoirs.” So at what point will the clash between oil bulls and climate hawks become a concern for those considering investments into Aramco or, indeed, any of its rivals?

Energy transition

Aramco itself expects to see a compound annual growth rate for global crude oil demand of 0.8% from 2018-2030, with the main driver coming from developing countries, particularly in the Asia Pacific region.

According to the company’s prospectus, the demand from such countries will “help mitigate any reduction in demand for crude oil caused by the increasing availability of alternative energy sources, greater energy efficiency and the emergence of new technologies in energy consumer markets, such as electric vehicles.”

Using forecasts from analysts at IHS Markit, the Aramco prospectus refers to a “leveling off” of demand growth around 2035. This is especially notable because Aramco and the Saudi Arabian government (with which it is closely tied) have until now scoffed at the idea of peak oil demand—just this year, Aramco CEO Amin Nasser claimed the notion was “not based on logic and facts, and [was] formed mostly in response to pressure and hype.”

The IHS Markit forecast is in line with the views of commodity traders such as Vitol, which also see the inflection point taking place around 15 years from now. Some suggest it may appear sooner. Neil Atkinson, the head of the oil industry and markets division at the International Energy Agency, said last week that a step-up in governments’ climate policies could see the peak come as soon as the late 2020s.

In some sectors, we can already see renewable energy overtaking fossil fuels. In countries such as Norway and Costa Rica, power grids already run almost entirely on renewable energy; in the U.K. and Sweden, sources such as wind, solar and biomass have at least overtaken fossil fuels in the generation of electricity.

On the auto front, though, little more than 2% of new cars are electric. The market is growing, though demand is significantly affected by subsidies that are sometimes pulled, as recently seen in China.

However, some industry watchers believe that even this early stage of the energy transition will have a big impact on the bottom line of fossil fuel producers.

‘Last man standing’

“What these guys live on is growth rates. You don’t have to have profound impact in the demand in order to show financial trouble for the industry,” said Tom Sanzillo, director of finance at the Institute for Energy Economics & Financial Analysis (IEEFA), which aims to accelerate the energy transition.

Sanzillo noted that Aramco and others are currently investing a great deal in products such as petrochemicals—Aramco is in the process of buying a controlling stake in Saudi manufacturing giant SABIC—that historically provide lower returns than drilling does. “The industry is passively acknowledging that it’s getting smaller from a financial point of view,” he said.

From a capacity point of view, the industry right now has the opposite problem: oversupply, in part thanks to frenzied output from the U.S. shale industry. Oil prices are depressed and, as BP and Royal Dutch Shell recently warned, now is not the time to count on growth in returns.

Aramco, though, has an advantage in this regard—it is, it claims, the lowest-cost producer out there, thanks to factors including Saudi Arabian geological formations and the environment around its reservoirs.

“Considering Saudi Aramco’s oil reserves are among the cheapest to develop, it will likely be the ‘last man standing’, as other more expensive producers drop out of the market one by one,” said Valérie Marcel, an associate fellow at Chatham House in London. “Aramco will be able to turn a profit longer than others, even as the price (and value) of oil decline.”

“There are little-mentioned risks, however,” Marcel added. “First, that it depletes its cheap, easy oil and has to turn to other reserves that are more expensive and energy intensive to develop. Second, that it will be ‘taxed’ for its carbon footprint and emissions, making the company much less profitable.”

‘Climate change concerns’

Aramco’s own prospectus lists carbon taxes among its risks, warning: “Climate change concerns manifested in public sentiment, government policies, laws and regulations, international agreements and treaties and other actions may reduce global demand for hydrocarbons and propel a shift to lower carbon intensity fossil fuels such as gas or alternative energy sources.”

Although Aramco claims to be a greener producer of oil than its rivals, recent analysis by the Climate Accountability Institute identified the firm as the world’s biggest contributor to rising carbon dioxide emissions—this is based on the contentious idea that fossil fuel firms are largely responsible for the impact of their products’ use.

The view of Aramco as a leading source of pollution is already tainting its looming IPO.

Environmental groups urged banking giants Goldman Sachs, Morgan Stanley, HSBC, JPMorgan Chase, Bank of America, Credit Suisse and Citigroup to stay away from the flotation—to no avail, as all remain involved.

From the investment side, the Singaporean government-owned holding company Temasek reportedly decided not to invest in Aramco due to environmental concerns. While Temasek declined to comment on Aramco and this report specifically, it told Fortune that “environmental, social and governance assessments are a key consideration in our investment decision-making, alongside commercial considerations.”

As for people and companies who invest via asset managers, those wanting to shun the Aramco IPO would need to be aware that they generally hold their clients’ money in passive index products—that is, they track stock market indexes rather than actively deciding whether to invest in this or that company. So investors taking this route would, if they want to put their money into environmentally-friendly firms, consciously need to ask their broker to make it so.

But that said, over time the line between environmentally-friendly and environment-damaging may become less clear.

As noted by Thilo Schaefer, the head of the environment and energy research unit at the German Economic Institute, in the long run motor vehicles and industry will probably need synthetic fuels or hydrogen-based fuels and power, as an alternative to fossil fuels.

“The interesting thing is that the oil and fossil fuel companies of today have a big interest in this development because they might be those who do these kinds of projects in the future,” said Schaefer. “We have to distinguish between investment in fossil fuels or in companies with their business case in fossil fuels right now, because they might have another business case in more environmentally-friendly fuels in the future.”

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