The plans for the initial public offering of the world’s biggest oil producer Saudi Arabian Oil Co. has been supposed delayed because of disagreements over where to list the firm, the Wall Street Journal reports. Executives at Saudi Aramco, are pushing to list a slice of the enterprise on the London Stock Exchange, while Saudi Arabia’s ruling family prefer the New York Stock Exchange, because of the kingdom’s longstanding political ties to the U.S. and because the American market represents the deepest pool of capital in the world. Meanwhile, Saudi Aramco’s management is concerned that a New York listing would expose the company to greater legal risks, including from potential class-action shareholder lawsuits. A decision on where to list Aramco is expected by some to come before the Islamic month of Ramadan, but is now not expected until the end of July or longer. As a massive team of consultants, accountants, lawyers and strategists frantically scramble to prepare Saudi Aramco for what could possibly be the largest IPO ever, the shape of the company’s future is beginning to emerge. Only 5% of the company will be floated, but even that is enough to be valued at US$2 trillion for the world’s largest crude oil producer.
The future of Saudi Aramco, however, looks to lie further down the supply chain, in the downstream. It may be sitting on at least 250 billion barrels of proven crude reserves – with another 100 billion barrels more expected to be added – and it still holds mighty sway over crude oil prices, but the prize is in diversification. Because as a publicly-traded company, Aramco will be subject to vagaries of market movements in a way that it never used to be, so risk has to be spread. The government of Saudi Arabia has already announced that it would retain sole control over upstream production – ‘production is sovereign’ – so the only way to counterbalance unexpected swings is to strengthen its other areas.
And that’s exactly what Saudi Aramco has been doing since late last year. Crude will always be its cash cow, but since October 2016, it has announced a series of giant projects that offers a hint of what its operational future will look like. In October last year, it announced a partnership with SABIC to create a massive oil-to-chemicals project in Saudi Arabia. Then in February 2017, it confirmed its participation in the US$27 billion RAPID project by Petronas in Malaysia. In May, it teamed up with China’s NORINCO, a defence manufacturer, to build a 300 kb/d refinery in Liaoning. Talks with Indian state refiners are ongoing, which is expected to yield yet another mega-refinery. In the USA, Aramco completed its divorce from Shell, now wielding sole control of Motiva – and the largest refinery in the Americas in Port Arthur – announcing plans to invest up to US$30 billion to expand the site and create additional downstream operations.
This would give Aramco silos in the most important energy markets in the world – USA, China, India and Southeast Asia (through Malaysia), as well as back home. Together with its existing tie-ups in China, this ensures that Saudi crude can continue to flow to a captive refining base without having to battle with the likes of Iran and Iraq. All the projects also have massive petrochemicals components, where demand growth is the strongest and the margins highest. This massive expansion of downstream will balance out the currently overweighted presence that upstream has in Aramco, creating a more balanced structure. Traditionally, Aramco is not a major natural gas or LNG producer, but it has already signalled that gas will receive significant investment post-IPO, aiming to build a global portfolio that can be traded and sold.
In essence, Aramco is aiming to become the vertically-integrated behemoth that Standard Oil once was, and what ExxonMobil currently is. Except Aramco will be supersized. With the supermajors adapting to the current environment by retreating to specialised areas and excising fat, Aramco is doing the opposite. It certainly is a compelling proposition to consider, and one that will produce a blockbuster IPO.
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Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.
A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.
Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.
Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.
And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.
That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.
Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.
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