ANALYSIS: The uncertainty around Aramco deal is a sign of Saudi dysfunction

The apparent delay in the sale of Saudi Arabia's mammoth-sized oil firm Aramco is a symptom of dysfunctional government, analysts say.

It is just one example of bizarreness emanating from the kingdom, which says it wants to unhook its economy from oil dependence.

Earlier this month, a slew of conflicting reports broke claiming that the initial public offering (IPO) of the state-owned oil company was either off or delayed.

The original plan, announced in early 2016, was expected to place a value of $2tn on the firm to raise $100bn in cash for the Saudi coffers from the sale of a 5 percent stake.

A valuation of that level is extraordinary even by the standards of global finance.

Now there are other plans it seems. No matter, the start-stop antics are a great example of sub-optimal leadership.

“They proposed an IPO at the worst possible time to sell an oil company, and then called it off at quite a good time to sell an oil company,” said Marcus Chenevix, analyst for EMEA and global political research at financial firm TS Lombard in London. “Nothing more clearly illustrates the way that this project was never a normal IPO.”

To sell a stake in a large oil company, such as Aramco, two things are needed: the first is a robust oil market; the second is a robust capital market.

We always figured Aramco was worth about $800-900bn, not $2tn

- Marcus Chenevix, analyst

In early 2016, neither was happening. The price of oil hit a multi-year low of less than $30 a barrel, down from over $114 in 2014, according to data from Bloomberg.

At the same time global capital markets were riled by economic problems, primarily in China, exacerbated by worries about the European banking system.

This was evidenced by a jump in the interest rate that investors required in order to lend money to companies with less than stellar credit. In mid-2014, so-called junk-borrowers that had to pay around 3.4 percentage points of interest cost more than would the US government. This is known as the spread.

By early 2016, that spread had more than doubled to over 8 percentage points, according to data from the Federal Reserve Bank of St Louis. More interest cost represents more fear on the part of investors.

In other words, most investors had a case of the jitters and the oil market was weak at exactly the time the Aramco sale plan was unveiled.

Contrast that situation with the current one, which would seem to be close to perfect for selling a stake in a large oil company such as Aramco.

Now the oil prices are trading at around $75 a barrel, a level that is good for both consumers and producers of the energy. The price has bounced between $60 and $80 for months, which is generally seen as a good range for all parties involved.

Meanwhile, the capital markets are robust. The interest spread for junk borrowers was recently around 3.5 percent or just about where it was in mid-2014. In the simplest terms, investors were sanguine.

“We always figured Aramco was worth about $800-900bn, not $2tn,” said Chenevix.

He added that the lower price tag is in part because of a lack of growth prospects for Aramco. Put another way, Aramco has the capacity to pump oil but not grow its business in other ways. Lack of future growth always depresses investor estimates of value for any enterprise.

If the country’s de-facto ruler, Mohammed bin Salman (MBS), wants a $2tn valuation - even for face-saving purposes - then the truth is that the IPO may take a long time to arrive, if ever.

Chenevix also notes that the rebound in oil prices, and hence government revenues, has taken the pressure off Saudi Arabia’s leaders. “The fiscal crisis is over,” he said.

That’s a level of dysfunction in itself because the oil market is well-known to have a boom-bust cycle. In essence, if you are in the energy business, there is always another bust to be faced, so thinking that the current rebound in Brent prices is an end to trouble is shortsighted at best.

Shakedown at the Ritz

Another unconventional episode in the chronicles of dysfunction was the detention late last year of multiple Saudi princes in Riyadh’s Ritz-Carlton hotel.

The three-month-long event involved, among others, the effective imprisonment of Saudi Prince Alwaleed bin Talal, perhaps the kingdom’s most famous global investor.

He owns stakes in American financial services firm Citigroup and social media company Twitter, and numerous other global companies.

It’s widely reported that the princes who were detained got their freedom back only after signing over some portion of their wealth.

“The expropriation of the princes was deeply unusual, both in Saudi and in wider emerging markets,” said David Roberts, a professor of defence studies at King's College London.

“Unusual” is perhaps the way a diplomat would describe such an event. For other non-Saudi investors, the event probably evoked horror, perhaps deterring future investment in the country.

“Detaining a slew of princes at the Ritz, ostensibly for corruption, probably hasn’t helped ease concerns of international investors,” Roberts said.

That less-than-optimal reaction is one that MBS and his advisers should have seen before detaining prominent businessmen along his royal cousins.

Different investment

Saudi is now planning to take out loans from the international banks that had queued up to help sell Aramco. Banks get big fees whenever they assist with an IPO or other capital market transaction. The bigger the deal, the higher the fees.

Such banks will likely want to keep in the good graces of the kingdom’s leaders and officials because in addition to the possible fees from the Aramco sale, if and when it happens, the country is also likely to sell a stake in its chemicals business, Sabic.

In addition, the loans will help any temporary funding problems caused by the delay in the Aramco sale.

It's difficult to ascertain accurately what’s next from the kingdom, but if the past year has been anything to go by, it may not follow logical predictions.