There is an urgent need for rigorous scrutiny of any new investments in fossil fuels
Crown Prince Muhammad bin Salman faces the prospect of selling a huge slice of the state owned Saudi Aramco for less than half his asking price if investors challenge the $2 trillion company valuation in light of international climate initiatives and low oil prices, according to a new report.
Greg Muttitt and Hannah McKinnon have authored a report for Oil Change International (OCI) titled Overheated Expectations in which they examine the potential impact of proposed climate mitigation measures - including the Paris agreement - on the initial public offering (IPO) of shares in the Saudi oil behemoth.
The authors state: “The world is rapidly approaching climate limits. There is an urgent need for rigorous scrutiny of any new investments in fossil fuels, not least of the partial listing of the world’s largest oil company.”
Investors are looking at the impact of climate policy on oil company valuations. Michael Bloomberg has helped launch the Taskforce on Climate-Related Financial Disclosures, which in turn has warned investors to consider risk within a range of climate mitigation scenarios.
Dramatic impact on valuations
The sale of Saudi Aramco is set to be the world’s largest IPO. Crown Prince Muhammad bin Salman valuation has been met with scepticism. The Financial Times believes the company is worth up to $1.1 trillion. However, the OCI research suggests it could be as low as $700 billion.
This is still a significant amount of money. If the company is valued at $1 trillion the Saudi state will still raise $50 billion from the IPO, according to the FT.
The OCI study examines three factors that would effect the company valuation. They claim prices could remain low due to a fall in global demand for oil, a result of many factors including the rise of the electric car and other alternatives to fossil fuels. This is the "new normal" that even the bosses of oil companies accept.
Further, if governments around the world are serious about taking action to meet their commitments in the Paris agreement, and to keep the world average temperature below the 2 degrees Celsius target, this will also have a dramatic impact on the valuation.
Reductions in oil quotas
“Compared to the base-case estimate of around $1.5 trillion, the value of Aramco could be between 25 percent to 40 percent lower in the IEA’s [International Energy Agency] safer climate scenarios - which correspond to the absolute minimum ambition within the range of the Paris goals,” the authors state.
If the international community acts in the near future to seriously reduce the burning of fossil fuels, that could reduce the oil price and hence Aramco's valuation. If action is left for later, a significant amount of Aramco’s reserves will remain unexploited and unsold. Reductions in oil quotas would then slash prices on a 15 to 25 year timescale, damaging all oil investments, public and private.
As noted in the report, Aramco “has a monopoly right to extract Saudi Arabia’s vast reserves” - which it does slowly. At the current rate, there is enough oil for a further 59 years of production.
The Saudi reserves would have a “profound impact on the climate” if fully extracted and burned. The emissions would amount to 112 Gt of carbon dioxide, fully one third of the carbon budget the world is estimated to have left if we are to limit global warming to 1.5 degrees Celsius.
The authors conclude that investors could be taking a significant risk if they buy stock at the Saudi valuation. “If the IPO realises a value at the higher end of the likely range (say, above $1 trillion), its investors could face significant risk from climate policy”.
However, the report also notes that if investors force down the price of the Saudi oil company this may have a knock on effect for the valuation of the other big five international oil companies, which have fewer oil reserves and also have a higher cost of production.
If the Saudi crown prince gets his price, this will indicate that investors are not as yet scared off by the prospect of international government-led efforts to control carbon emissions. Aramco declined to comment on the CIO report when contacted by the The Ecologist.
Brendan Montague is the contributing editor to The Ecologist and a columnist for openDemocracy. He tweets at @EcoMontague.