Petroleum engineers mostly worry about what goes on underground. At Saudi Aramco, concern extends to the sky overhead. A big aerial attack this past weekend on the national oil company's facilities disrupted over half its production.
A threat of reprisals by an angry Kingdom of Saudi Arabia means the value of oil will rise. The latter factor may pump up the valuation of a promised IPO of Saudi Aramco. But elevated investment risk more than offsets that, ensuring Aramco is worth far less than the mooted $2 trillion (€1.82 trillion).
Oil prices for near-term delivery jumped over 10 per cent on Monday morning, for good reason. Saudi Arabia produces about a tenth of the world’s crude supply.
Some of its curtailed flow may return reasonably quickly. But there are reports that important equipment which separate impurities such as natural gas from the crude oil could need months to repair. That suggests a core of Saudi Aramco’s production is offline for a while. How quickly management reacts will give potential investors a sense of how the national oil company deals with threats to its infrastructure.
Calculations
However, this attack will also force Excel-jockeys to rethink their calculations. Valuing any company using future cash flows necessarily involves some potential for error. Doing so for Saudi Aramco, a state-owned enterprise, only multiplies that margin.
An earlier calculation depended on assuming a cost of equity closer to the likes of ExxonMobil or Royal Dutch Shell of about 9 per cent. Pad that rate up, with a higher premium for country risk, and the IPO valuation for Saudi Aramco declines. It is estimated that every percentage increase in the cost of equity slashes about 12 per cent from Saudi Aramco's valuation, even after adjusting up oil price assumptions. Models, schmodels, some will counter. Aramco has much higher profitability – 36 per cent return on capital employed – than the major listed crude producers. It should deserve a higher rating.
Perhaps, but expecting a blue-sky valuation is fanciful, especially given the threats from above.
Copyright The Financial Times Limited 2019
