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Saudi Aramco

The message from the world’s biggest and


wildest IPO
The oil industry may decline, but it won’t go quietly

The drilling of the first modern well in Pennsylvania in 1859 set oil on a path
that led to the heart of economics and geopolitics. Oil fuelled the rise of the
West’s consumer culture; it helped determine who won the second world war
and prompted a global economic crisis in the 1970s. Over the past 20 years
China has become the second-biggest consumer of crude, while America’s
fracking revolution has meant it is close to being a net energy exporter for
the first time since the 1950s. Now a new chapter in oil’s story is unfolding:
the prospect of stagnating or falling demand as the world shifts to cleaner
energy. As in the past, this era promises startling economic and geopolitical
change.

Consider the imminent stockmarket flotation of Saudi Aramco, which


produces 10m barrels of oil a day, or 11% of the global total. As well as
Arabian super-light, Aramco pumps out superlatives and controversy
(see Briefing). Worth well over $1trn, it could, once listed, be the world’s
most valuable public firm, squeezing past Apple. The initial public offering
has been delayed several times; a big Aramco processing plant was hit by a
missile strike in September and the firm is ultimately controlled by
Muhammad bin Salman, an autocratic royal with blood on his hands. But
take a moment to look beyond this. Aramco’s underlying strategy is to be the
last oilman standing if the industry shrinks, pointing to the upheavals to
come.

The term “peak oil” was coined in 1956 by M. King Hubbert, a geologist
worried about the stuff running out. Today the phrase is back but for the
opposite reason: the prospect of dwindling demand. That may seem odd
given that this has grown by 1.4% a year since 2008. But the people running
energy companies have long horizons, and on that timescale the picture for
oil is darkened by urban pollution and climate change. Oil is responsible for
a third of global energy use and a similar share of carbon emissions.

Many oil firms still say that production will creep up over the next decade,
to slightly above today’s level of 95m barrels per day (b/d), and then plateau.
But output will need to drop to 45m-70m b/d by 2050 if the world is to stop
temperatures rising more than 1.5-2°C above their pre-industrial level. It
would help, too, if there was a shift to cleaner oilfields, whose crude emits a
fifth less than the dirtiest ones. Though oil bosses insist, in public at least,
that oil remains the planet’s indispensable fuel, they can feel the growing
stigma. Public opinion is shifting in the West, heralding tighter rules on
emissions. And, in a sign of jumpiness, some Western firms have favoured
short-term projects rather than sink their capital in decades-long bets on oil’s
future.

If demand does fall, some products and producers are more vulnerable than
others. Over a third of all oil is used in cars and lorries which could
eventually be fitted with electric engines. It is harder to find a substitute for
the oil in petrochemicals and plastics. Common sense suggests that the
highest-cost and dirtiest oil firms will tend to go out of business first. If so,
an industry that has become gargantuan over 160 years will shrink to a core
of producers that fulfil the world’s residual demand at the lowest financial
and environmental cost.

Many environmental activists fear this energy transition will never happen.
But, in fact, it fits with Aramco’s strategy and pitch to investors. The firm
spends just $3 to lift a barrel from beneath the desert, less than almost anyone
else. The emissions from extracting Saudi oil are rock-bottom, too. Aramco
is expanding in petrochemicals and locking in customers in Asia—in August
it bought a $15bn stake in the chemicals arm of Reliance, an Indian giant.
Saudi Arabia has promised investors they will get steady dividends whatever
the weather. Implicit in the kingdom’s approach is that, if and when oil
demand falters, Aramco will be the producer of last resort.

A cleaner planet is in everyone’s interests. But a shrinking oil industry could


mean more, not less, turbulence for energy markets and geopolitics. Take
energy markets first. The optimistic case is that supply and demand will taper
down in tandem, and that the price of oil will fall along with the cost of
producing the last barrel needed to satisfy ebbing demand. But downsizing
an industry with $16trn of capital and at least 10m employees is never going
to be smooth. Because oilfields naturally deplete, a drought in capital
spending could cause a price spike. Each firm and country, including Saudi
Arabia, will face a choice between holding back supply so as to bolster
profits and tax revenues and opening the taps to grab market share and use
up reserves, whatever the price, before it is too late. The OPEC cartel, which
combines high- and low-cost producers, could implode. And as production
focuses on fewer fields, the risk of disruption from terrorism or accidents
will rise.

The political implications are just as big. Twenty-six countries rely on oil
income for 5% or more of their GDP, says the World Bank (the average for
them is 18%). If economic logic prevails, producers with the dearest and
dirtiest oil—including Algeria, Brazil, Canada, Nigeria and Venezuela—
should wind down output, but that would be painful and, for some,
devastating. America, meanwhile, remains wedded to oil, which meets 40%
of its energy needs. Its thirst has been satisfied by the fracking boom,
especially in the Permian basin in Texas. Yet fracking is dirty and new
projects need an oil price of $40-50 a barrel to break-even, at least twice the
level Aramco requires. For the sake of the climate and efficiency, the
fracking industry should eventually shrink. That, though, would make
America more reliant on foreigners, just as its politics have turned inward.

Till kingdom come


And then there is Saudi Arabia itself. Aramco’s pitch to investors will boast
of its abundant, cheap and relatively clean oil. That much is true. But it will
not dwell on the country’s jobless youth or opaque court politics. Perhaps
the proceeds of the IPO will help modernise the Saudi economy; perhaps not.
Investors betting on Aramco as the last oil major standing in 30 years’ time
will have to consider the risk of revolution or invasion. Aramco’s flotation
is a sign that the end of oil could be in sight. But it is also a reminder that the
black stuff’s capacity to cause economic and political havoc will be
undiminished for decades to come.■

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