Saudi Aramco’s biggest asset could also be a liability, as the company moves towards an initial public offering (IPO).
The state energy giant’s vast oil reserves – technically possible at current production levels for the next 50 years – make it more exposed than any other company to a rising tide of environmental activism and an accelerating shift away from fossil fuels.
In the three years since Saudi Crown Prince Mohammed bin Salman first proposed a stock market listing, climate change and new green technologies are putting many investors – particularly in Europe and the United States – off the oil and gas sector.
Sustainable investments – which steer clear of petroleum companies – account for more than a quarter of all assets under management globally, by some estimates.
Aramco, officially the Saudi Arabian Oil Company, argues oil and gas will remain at the heart of the energy mix for decades, saying renewables and nuclear energy cannot meet rising global demand. Aramco also boasts that its own crude production has lower greenhouse gas emissions than its rivals.
But with the company talking again to banks about its IPO, some investors and lawyers say the window to execute a sale at a juicy price is shrinking. They say Aramco will need to explain to prospective shareholders how it plans to profit in a lower-carbon world.
“Saudi Aramco is a really interesting test as to whether the market is getting serious about pricing in energy transition risk,” said Natasha Landell-Mills, who is in charge of integrating environmental, social and governance (ESG) considerations into investing at London-based asset manager Sarasin & Partners.
“The longer that [the IPO] gets delayed,” said Landell-Mills, “the less willing the market will be to price it favourably because gradually investors are going to need to ask questions about how valuable those reserves are in a world that is trying to get down to net zero emissions by 2050.”
The Reuters news agency reported on August 8 that Prince Mohammed was insisting on a $2 trillion valuation – even though some bankers and company insiders say Saudi Arabia should trim its target to around $1.5 trillion.
A valuation gap could hinder any share sale. The IPO was previously slated for 2017 or 2018 and, when that deadline slipped, to 2020-2021.
Aramco told Reuters it was ready for a listing, but the timing would be decided by the government. Meanwhile, the Wall Street Journal reported on Thursday that Aramco plans to split the IPO into two stages.
That proposal would involve debuting shares on the Saudi stock exchange – perhaps later this year – and then a follow-up international portion, likely on the Tokyo exchange.
Meanwhile, the company says it is investing in research on several fronts: improving car efficiency, developing hydrogen fuel-cell technology, and converting more crude to chemicals involved in the capture – and sequestration – of CO2 that can compound global warming.
Yet some climate advocates argue this is not enough. A growing number of investors across the world are factoring environmental, social and governance (ESG) risk into their decision-making, although the degree to which that would stop them from investing in Aramco varies wildly.
Some would exclude the company on principle because of its carbon output, while others would be prepared to buy if the price was cheap enough to outweigh the perceived ESG risk – especially given that oil companies often pay healthy dividends.
At the relatively lower $1.5 trillion valuation, Aramco would be the world’s largest public company. If it were included in major equity indices, it would automatically be bought by passive investment funds that track them, regardless of their ESG credentials.
And as shares in the world’s most profitable company, Aramco shares would certainly be snapped up by many active investors.
Talks about a share sale were revived this year after Aramco attracted huge investor demand for its first international bond issue. In its bond prospectus, it said climate change could potentially have a “material adverse effect” on its business.
When it comes to an IPO, equity investors require more information about potential risks and how companies plan to deal with them, as they are more exposed than bondholders if a business runs into trouble.
“Companies need to lead with the answers in the prospectus, rather than have two or three paragraphs describing potential risks from environmental issues,” said Nick O’Donnell, a partner in the corporate department at law firm Baker McKenzie.
“An oil and gas company needs to be thinking about how to explain the story over the next 20 years and bring it out into a separate section rather than hiding it away in the prospectus,” said O’Donnell. “It needs to use it as a selling tool. And also, once the IPO is done, every annual report should have a stand-alone ESG section.”
Unlike other major oil companies, Aramco doesn’t have a separate report laying out how it addresses ESG issues such as labour practices and resource scarcity. It also does not publish the carbon-emissions levels of the products it sells. Until this year’s bond issue, it also kept its finances under wraps.
The company does, however, have some climate-friendly attributes: it sponsors sustainability initiatives, has an environmental protection department, and is a founding member of the Oil and Gas Climate Initiative, which is led by 13 top energy companies and aims to cut emissions of methane, a potent greenhouse gas.
On August 12, Aramco published information on the intensity of its hydrocarbon mix for the first time. It disclosed the amount of greenhouse gases from each barrel it produces.
Aramco’s senior vice president of finance, Khalid al-Dabbagh, said during an earnings call this month that his company’s carbon emissions from “upstream” exploration and production were the lowest among its peers.
A study published by Science magazine last year found carbon emissions from Saudi Arabia’s crude production were the world’s second-lowest after those of Denmark, as a result of Saudi Arabia having a small number of highly productive oilfields.
Aramco says that with the global economy forecast to double in size by 2050, oil and gas will remain essential.
“Saudi Aramco is determined to not only meet the world’s growing demand for ample, reliable and affordable energy, but to meet the world’s growing demand for much cleaner fuel,” the company told Reuters.
“Alternatives are still facing significant technological, economic and infrastructure hurdles, and the history of past energy transitions shows that these developments take time.”
The company has also moved to diversify into gas and chemicals and is using renewable energy in its facilities. But Aramco still, ultimately, represents a bet on the price of oil.
It generated net income of $111bn in 2018, over a third more than the combined total of the five Western supermajors: ExxonMobil, Royal Dutch Shell, BP, Chevron and Total.
In 2016, when the oil price hit 13-year lows, Aramco’s net income was only $13bn (based on current exchange rates), according to the bond prospectus – where the company unveiled its finances for the first time. Its earnings fell 12 percent in the first half of 2019, mainly because of lower oil prices.
Concerns about future demand for fossil fuels have weighed on the sector. Since 2016 – when Prince Mohammed first flagged an IPO – the 12-months-forward price-to-earnings ratio of five of the world’s top listed oil companies has fallen to 12 from 21, on average, according to Reuters calculations. This lags behind the FTSE 100 and the STOXX Europe 600 Oil & Gas index averages.
By comparison, United Kingdom-listed funds investing in renewable energy infrastructure such as wind farms are trading at one of the biggest average premiums to net asset value.
Using a broad measure, there was global sustainable investment of $30.1 trillion across the world’s five major markets at the end of 2018, according to the Global Sustainable Investment Review. That compares with $22.8 trillion in 2016.
“Given the influx of capital into the ESG space, Aramco’s IPO would have been better off going public five to ten years ago,” said Joseph di Virgilio, global equities portfolio manager at New York City-based Romulus Asset Management.
“An IPO today would still be the largest of its kind, but many asset managers focusing solely on ESG may not participate,” di Virgilio said.
The world’s top-listed oil and gas companies have come under heavy pressure from investors and advocates working to reverse climate change to outline strategies to reduce their carbon footprint.
Shell, BP and others have agreed – together with shareholders – to set carbon-reduction targets for some operations and to increase spending on renewable energies. But US major ExxonMobil, the world’s top publicly traded oil and gas company, has resisted adopting targets.
Britain’s biggest asset manager, Legal and General Investment Management (LGIM), removed Exxon from its Future World funds for what it said was a failure to confront threats posed by climate change. LGIM did not respond to a request for comment on whether it would buy shares in Aramco’s potential IPO.
Sarasin & Partners reported in July that it had sold nearly 20 percent of its holdings in Shell, saying its spending plans were out of sync with international targets to battle climate change. The rest of the stake is under review.
The asset manager did not participate in Aramco’s bond offering, and Landell-Mills said they would be unlikely to invest in any IPO.