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As the investment world prepares for what is becoming the most sought-after IPO in history, problems may be forming on the horizon.
The IPO is for a 5% position in the largest oil producer in the world - Saudi Aramco, Saudi Arabia's national oil company.
When the dust clears from this one, a new sovereign wealth fund will be set up with as much as $2 trillion in purchasing power. Instantly, this will be the largest ever established.
This will usher in one of the most interesting diversification programs ever attempted.
While other "rentier" states - ones that depend on revenue from the extraction of raw materials - desperately attempt to diversify their internal economies by developing industrial production and service sectors, the Saudis are instead acquiring all manner of non-oil assets abroad.
Some of these may, of course, end up having subsidiaries or even headquarters in Saudi Arabia.
There are also signs that some of these investments will be to allow a major diversification of energy provision inside the country.
That will move the country from relying on oil to emphasizing solar, wave power, and even spin-offs from a number of desalinization plants.
Nonetheless, a novel idea is emerging: For the first time, a country will change the nature of its domestic economy by controlling a range of activities outside its own borders.
This makes virtually any publicly traded company anywhere in the world suddenly a potential target for Saudi investment money (and possible control).
Which makes the Aramco IPO uniquely important in the history of stock markets.
But as the world gears up for this hotly anticipated investment roadshow, three complications are setting in that may create some problems for Riyadh...
And opportunities for us...
Saudi Arabia Just Can't Get Away from Oil
First, regardless of what the proceeds are to be used for, the IPO will still be based on the assessed valuation of Aramco itself.
That translates into a double concern. Aramco will need a detailed evaluation to determine its actual market value. For the first time since 1979 (and the company's nationalization by the Saudis), that will require some detailed oil reserve figures.
Some analysts (myself included) have often questioned Saudi Aramco's field operations that appear to emphasize early extraction at the expense of reservoir integrity.
In short, guaranteeing anywhere from 10 million to 12.5 million barrels a day of production now may put Saudi Arabia's longer-term production in jeopardy.
I recall on one of my visits being taken out to a satellite drilling location just opened for production. The Saudis have always enjoyed showing me they have many more fields available than they need.
Well, I enticed the young engineer to drive the Land Rover much closer to the actual facilities than his bosses had intended.
It turns out that 22 wells were operating, but 18 of them were injection wells!
That means that from the very outset, the Saudis were using secondary recovery techniques in this brand-new drilling location. That's likely to do some appreciable damage to reservoir integrity from the outset.
However, given the "on paper" largess of their potential oil reserves, the Saudis can probably put enough spin on what is available to satisfy drooling investors.
But the other half of the Aramco valuation "dance" is now becoming a major concern in Riyadh...
The Saudis Can't Agree on Where to Have This IPO
The proceeds from the IPO will ultimately be decided by the price of oil.
If the current OPEC-Russian attempt to cap global production (a move frustrated by stubbornly resistant U.S. shale volume not included in the agreement) succeeds and prices move back toward $55 to $60 a barrel, Aramco is far more valuable than if the price remains at lower levels.
After all, the worldwide need for crude oil will continue for decades whether or not Saudi Arabia continues to pump as much as it does now.
In short, even as Saudi Arabia weans itself from oil, its national revenue, investment, and financing future still require oil prices to be higher.
Second, there has been an ongoing disagreement within both the government and the leadership at Aramco over where the IPO should be issued.
Those led by royal heir Crown Prince Mohammed bin Salman have favored New York City, while Aramco administrators have been pushing for London.
New York has the advantage of giving access to more liquidity. But the New York Stock Exchange (NYSE) also comes with more regulation and transparency requirements.
For some time, London had been the target of choice for financing international energy deals. It did so with more leverage provided than New York.
Yet after the Brexit vote, the London Stock Exchange's (LSE) attractiveness as the doorway to Europe has ended. And with it, London has almost overnight become a less advantageous place to raise capital.
Of course, more than a few Saudi officials (at Aramco and elsewhere) have used both the UK and the LSE as a conduit for their own financial dealings.
This adds even more intrigue to the choice for where to list the Aramco shares...
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.