The industrial logic behind Saudi Aramco’s ‘chemical attraction’

Flames are seen at the production facility of Saudi Aramco's Shaybah oilfield in the Empty Quarter, Saudi Arabia, on May 22, 2018. (REUTERS/Ahmed Jadallah/File Photo)
Updated 27 July 2018
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The industrial logic behind Saudi Aramco’s ‘chemical attraction’

  • Aramco wants to become more than just a producer of crude oil.
  • SABIC was first conceived in 1976, and began production in 1981

DUBAI: News that Saudi Aramco, the world’s biggest oil company and the mainstay of the Kingdom’s economy, was in talks to buy a controlling stake in Saudi Basic Industries Corporation (SABIC), the diversified chemicals giant, caused some surprise.

Not only was the move, which could cost Aramco about $70 billion if it acquires the whole stake held by the Public Investment Fund, an apparent step outside the traditional energy business; it looks like a further distraction from the initial public offering (IPO) of shares in Aramco, the flagship project of the economic transformation of the Kingdom set in train by the Vision 2030 strategy.

One prestigious commentator talked of Aramco’s “strange chemical attraction” for a deal some said had been dreamt up by the armies of investment bankers hired by Aramco for the history-setting IPO but now underemployed as the deadline for the flotation has slipped.

Aramco chief executive Amin Nasser confirmed that a deal with SABIC could push the IPO, already delayed until next year, back further.

But experts on Saudi business have told Arab News that there is  a sound industrial logic to a potential move for SABIC, and that the effect on the IPO plans would not necessarily be negative. Long term, a deal with SABIC could make Aramco a more attractive proposition for global investors.

The move, which has been mulled over for some time by advisers at American investment banks JP Morgan and Morgan Stanley, which have reportedly been retained to see it through to transaction, should be viewed against the backdrop of Aramco’s long-term strategic goal: It wants to become more than just a pumper of crude oil for burning in car engines, but instead a high-value-added developer of advanced petrochemical products.

“Demand in the petrochemicals sector is twice as much as the transport sector, so for us it is very important as a strategy to look at other sectors and maximize the value of our resources such as converting crude directly into chemicals,” Nasser said recently.

Industry experts agreed that the move  fitted well into that long-term strategy. Ellen Wald, author of recently published “Saudi, Inc.” and president of US-based Transversal Consulting, told Arab News: “There is a business logic to explain the potential Aramco-SABIC deal.”

“From the SABIC perspective the deal could mean it would benefit from Aramco managerial expertise and maybe even Aramco talent and financing. Also, SABIC could benefit from Aramco’s experience and connections in international expansion. There is also a possibility that a strategic investment from Aramco could mean the return of preferential and cheaper feedstock for Sabic.

“From the Aramco perspective, the benefits are that it would help solve any questions about when or if Aramco’s own chemicals business is competing with SABIC. Also, acquiring a strategic interest in SABIC would immediately increase Aramco’s downstream business, bringing it closer to the profile of a typical independent oil company (IOC),” she said. 

That was echoed by Jean Francois Seznec, a political scientist specializing in Middle East business based in Washington DC.

“Aramco would buy a very extensive research portfolio and excellent chemical management, eventually allowing Saudi Aramco to ‘Saudize’ its chemical division. There could be rationalization of certain basic chemical production lines, which duplicate with Aramco’s and also within SABIC. Aramco would acquire an excellent marketing organization worldwide for its new and future products,” he said.

On the downside, Seznec said that “rationalization (in the form of an Aramco-SABIC merger) means job duplication, perhaps among expats, but also among Saudis.”

Jim Krane, author and fellow for Energy Studies at Rice University’s Baker Institute in Houston Texas, pointed to synergies from the deal. “Currently, Aramco provides SABIC’s feedstock at a cut-rate price and allows SABIC to export products made from that feedstock at the full international price. It reaps the profit, but with Aramco now in the petrochemical business itself, it no longer makes sense. Saudi Aramco is essentially subsidizing a competitor.

“The number-crunchers at Aramco probably figured it makes more sense to combine with SABIC and work together, so that both companies would see the benefits of Saudi Arabia’s cheap supply of natural gas.” 

But what of the financial implications of the deal, both for the Saudi economy and for the Aramco IPO?

Wald said: “It means that the IPO is at the very least delayed.”


Oil markets jittery over lower demand forecasts

Updated 8 sec ago
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Oil markets jittery over lower demand forecasts

WEEKLY ENERGY RECAP

Oil prices continued to nosedive last week over demand concerns amid an outlook of a slowing global economy. The strong US dollar weighed on both oil prices and the global demand outlook. Currencies weakened against the dollar, eroding their purchasing power.

Brent was down to $66.76 per barrel and WTI dropped to $56.46 per barrel by Friday. The former came close to its one-year low as both the International Energy Agency (IEA) and OPEC released monthly reports that articulated a darkening demand outlook in the short term. This increased fears of an oil demand slowdown. Market fundamentals also suggest that price volatility is likely to remain high in the near-term, although the oil market reached a balance in early October.

OPEC’s Monthly Oil Market Report (MOMR) arrived with bearish sentiments, revising downward its oil-demand forecast for this year and next, for the fourth month in a row. It forecast that global oil demand will rise by 1.29 million barrels per day (bpd) in 2019, 70,000 less than what OPEC expected last month. The MOMR also forecast increasing non-OPEC supply growth for 2019, with higher volumes outpacing the annual growth in world oil demand, leading to an excess in supply. The report was welcomed with open arms by the IEA, which had been at least in part responsible for driving sentiment toward a bear market. Surprisingly, OPEC warned that oil demand is falling faster than expected. Necessary action is a must.

Saudi Arabia is not sitting idly by while oil markets look as if they are heading toward instability. Markets were expecting severe US sanctions on Iran, which could have resulted in supply shortages once Iran’s crude exports went to zero. The unexpected introduction of waivers to allow eight countries to continue importing Iranian oil, was however an eye-opener. Now, as the world’s only swing producer, Saudi Arabia will have to take other measures to balance oil markets and drain excess oil from global stockpiles.

Despite what some analysts are claiming, there is currently no strategy to send less oil to the US to help reduce US stockpiles. Yes, some have claimed that Saudi crude shipments to the US are at about 600,000 barrels per day this month, which is a little more than half of what was being shipped in the summer months. But the reasons for this are related to seasonally low demand, the surge in US inventories and refineries heading into their winter maintenance season. Remember that November crude oil shipments were allocated to the US refiners last month before the US waivers on the Iranian sanctions were revealed. Also, keep in mind that Saudi Arabia owns the largest refinery in the US, which has a refining capacity that exceeds 600,000 bpd.

It must be noted that there is a degree of financial manipulation underway in the oil futures markets. At the moment, there are few places where quick profits can be made, so some investors moved from stocks to commodities. Now, there are downward pressures on oil prices as some commodities market traders went long on oil futures, thinking that crude prices would rise. Then these same traders shorted natural gas, assuming that with a warmer winter, prices of that fuel would fall. Unfortunately for the traders, Trump’s sanction waivers on Iranian crude oil exports and cold weather on the US East Coast, caused exactly the reverse to take place. Oil prices fell and natural gas prices rose. Traders were therefore forced to sell their assets to cover margins, pushing oil prices lower. It is expected that some hedge funds and investment funds will also be moving away from going long on oil futures and this will cause further selling.

Lurking on the horizon is the massive US budget deficit and increasing rumbling that the US economic boom is over. The US federal budget deficit rose 17 percent in the 2018 fiscal year. It is now larger than in any year since 2012. Federal spending is up and amidst US President Donald Trump’s tax cuts, and federal revenue is not keeping pace. To make matters worse, the strong US economy and interest rate hikes by the US Federal Reserve have boosted the dollar.

A strong dollar makes commodities such as crude oil more expensive in international markets and reduces demand. Trump wants oil to be priced as low as possible to help bolster the US economy, which is clearly under strain, and to facilitate sales of crude abroad. But with a looming global oil shortage just a few years away due to a lack of upstream investment, it is incumbent on global oil producers to consider the long term in their output decisions.

* Faisal Mrza is an energy and oil market adviser. He was formerly with OPEC and Saudi Aramco. Reach him on Twitter: @faisalmrza