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Saudi Aramco's light in the desert

A partial sale of the state-owned firm is just part of the plan for a world-beating company that also wants to find more gas, refine more oil and produce even more crude

KHALID al-Falih, Saudi Arabia’s new oil minister and already chairman of Saudi Aramco, oversees a company about to embark on its biggest change since nationalisation was completed in 1980. The new Saudi economic plan calls for the kingdom to shift away from oil as its paramount revenue source, while selling a minority share in Aramco to public investors. But the world’s largest oil company was already in the middle of transformation to meet new realities: low oil prices, soaring domestic gas demand, a shift to downstream projects, the shale revolution and the eastward drift of its main customers.

Aramco is the descendant of the Arabian American Oil Company, a consortium of the forerunners of Exxon, Chevron, Texaco and Mobil, which first discovered oil at Dammam in eastern Saudi Arabia in 1938. The core of its business remains its monopoly on upstream operations in the kingdom, where it produced about 10.12m barrels a day of crude oil (in March 2016), 1.8m b/d of natural gas liquids and 12bn cubic feet a day of gas. In June 2015, it set a record high of 10.564m b/d, and claims 12.5m b/d of crude oil production capacity. This makes it by far the world’s largest oil-producing company, ahead of Russia’s Rosneft and Iran’s Nioc, each with about 3.8m b/d at full capacity.

Since the end of 2015, a political dispute has shut down output in the Neutral Zone, which was producing about 0.52m b/d, shared equally between Saudi Arabia and Kuwait. But Aramco, unlike Kuwait, has largely been able to make this up from other fields.

The company also enjoys the world’s largest conventional oil reserves, officially 267bn barrels at the end of 2014. These reserves, hosted in the world’s largest field, the onshore Ghawar, the largest offshore field, Safaniya, and a number of other giants, are cheap to produce, with all-in costs for new developments estimated at around $10 a barrel. The kingdom needs just 3,400 or so wells to keep output flowing – a measure of its prolific geology. By contrast, the US relies on 300,000 wells for a similar level of output.

But technical difficulties have grown over the years, with rising water production, and attempts to maximise recovery factors via enormous computer simulation models, multilateral wells and a variety of other technologies, some developed at its research centres in Saudi Arabia, the US, Europe, South Korea and China. But even if reserves are significantly overstated, as a number of mostly fringe analysts like to propose, the company’s conservative production policy still leaves plenty of room to sustain and expand output.

Siphoning off oil

Although deputy crown prince Mohammed bin Salman claimed in an interview in April that Aramco could go to 20m b/d with increased investment, the company’s current programme only aims at maintaining capacity. The Shaybah field, in the Rub al-Khali (Empty Quarter) near the border with Abu Dhabi, will be expanded from 0.75m to 1m b/d by the end of May. By 2018, the Khurais field will be expanded from 1.2m to 1.5m b/d. But these projects are intended only to sustain the capacity level, not increase it, as other fields age.

Supplies to foreign buyers are another matter. To maintain exports at present levels while feeding domestic demand growing by 100,000-200,000 b/d each year, Aramco will need to bring on new production. Plans outlined just before the global financial crisis, to reach 15m b/d capacity, could be dusted off. That extra headroom may be needed if Saudi Arabia’s price war against its Opec and non-Opec rivals, particularly tight oil producers, continues for an extended period. Aramco, of course, executes Saudi Arabia’s Opec policy – cutting or lifting output in the past when directed to – and so plays a key strategic role in global oil markets.

Even if reserves are significantly overstated, as a number of mostly fringe analysts like to propose, the company’s conservative production policy still leaves plenty of room to sustain and expand output

Having inherited the practices and many of the staff of its American parents, Aramco’s nationalisation was relatively smooth and it remains probably the most respected national oil company for professionalism and capability. Falih, elevated to health minister in April 2015, was replaced as chief executive by another experienced technocrat, Amin Nasser. The company attracts the cream of Saudi talent, with a workforce now 83% local, but it is hard to judge its efficiency when it does not operate head-to-head against any peers.

The foundation of Aramco’s gas business was laid from the early 1980s, with the construction of the Master Gas System to use associated gas instead of flaring it. In the early 2000s, after another episode of low oil prices, and with associated gas mostly utilised, the country’s leadership realised the need to expand gas production. Falih was a prominent negotiator with international companies, among them ExxonMobil and Shell, for ambitious ventures combining gas production and industrial facilities. But these talks led nowhere, other than to some disappointing gas exploration ventures in the Rub al-Khali.

Saudi gas production still meets only about half its electricity-generation needs. So up to 1m b/d of crude oil, as well as fuel oil and diesel, are burnt to meet summer air-conditioning loads. The kingdom also needs gas and ethane for new petrochemical and industrial ventures. Saudi Arabia’s policy is not to import gas, so Aramco has responded by developing tight gasfields around Ghawar, and more recently with its first offshore non-associated gasfields: Karan, Hasbah and Arabiya. Expanding the Master Gas System with projects in Fadhili, Midyan and Wasit has also added more than 5bn cf/d of capacity. Aramco plans to lift gas output to 23bn cf/d, although it is not clear which other fields will contribute.

Tight and shale gas appraisal is underway. Services firm Baker Hughes estimates that Saudi Arabia holds 645 trillion cf of shale gas resources. The System B contract, recently awarded, will install facilities for 200m cf/d of shale gas production in the Turaif region, in the northwest of the country, a new area for Aramco’s production, and feed a phosphate mine. Although domestic gas prices were recently raised from $0.75 to $1.25 per million British thermal units, this will still be too low to make shale and tight gas fields economically viable. Aramco will have to absorb a loss to support domestic power and industry.

Diversity ahead

Aramco has also increasingly expanded downstream in recent years. It aims to become the world’s largest refining company, via a number of mega-refineries in joint ventures at home, as well as strategic refineries overseas to cement a share of key markets. It recently agreed to divide its Motiva joint venture with Shell in the US to improve operational performance and give it full control of the Port Arthur refinery, North America’s largest and a major user of Saudi crude. Alongside jointly owned refineries in China, Japan and South Korea is one planned for Indonesia.

Aramco Trading was formed in 2012 to trade oil products, supporting this downstream strategy. Though Saudi Aramco has lately been more aggressive on pricing in Asia and Eastern Europe, and has even offered some spot sales, a wholesale change to its conservative crude oil-marketing approach does not appear in the offing.

To capture more of the value of its low-priced gas, instead of sending it to rival Sabic, the Saudi petrochemicals firm, Aramco is also investing in integrated refining and petrochemical complexes.

The company’s value was stated at $2 trillion, but taking into account the tax it pays to the government, and the slow rate of producing its reserves, a value of around $400bn appears more likely, unless its fiscal arrangements are completely re-jigged

But, with substantial debt loads, and the jaws of lower oil prices and increased domestic gas prices closing, it is doubtful whether ventures such as Petro Rabigh, listed on the Saudi Tadawul stock exchange, or the $20bn Sadara, will be very profitable. It has also been expanding in power generation and planning renewable-energy projects.

Prince Mohammed bin Salman’s announcement in January that an IPO of Aramco was planned grabbed headlines. The ownership of the company is to be transferred to the Public Investment Fund, an existing sovereign wealth fund which would be greatly expanded. Some more details have emerged but the shape of a listing remains unclear – 5% could be sold to investors, but this would be too large for the Tadawul alone. However, a dual listing including New York or, more likely, London, raises issues of exposure to law-suits, and requirements for detailed disclosure of reserves and financial performance.

The company’s value was stated at $2 trillion, but taking into account the tax it pays to the government, and the slow rate of producing its reserves, a value of around $400bn appears more likely, unless its fiscal arrangements are completely re-jigged.

While playing its part in the fundamental re-engineering of the national economy, supporting a less predictable and bolder Opec policy, and adapting to the huge changes playing out in the global energy business, Aramco needs to keep its focus on efficient delivery of its pivotal upstream activities.

The company has long protected its turf determinedly, and Falih brings deep understanding of the company to his role as minister. The balance between welcoming innovation while retaining core strengths may not be an easy one to find.

Robin M Mills is chief executive of Qamar Energy, and author of The Myth of the Oil Crisis

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