by Jasper Gilley
Well this is unexpected. Being a regular reader of this site, you expected this post to philosophize about the future of technology or something about that. Au contraire – what follows is a good old-fashioned quasi-clickbait-y article about finance!
If you haven’t been keeping up with the latest in Saudi Arabian geopolitics, word is on the street that Saudi Aramco (the state-owned oil producer and the world’s most valuable oil company) is going to list 5% of its business on the New York Stock Exchange in an IPO* in the near future.¹ Though we don’t yet know what its ticker will be, I’ve decided to pretend it will be $ARAM because it would be a good one and it isn’t taken on the NYSE. If it ends up being $ARAM and someone makes money from reading this article, please send me some.
Now, for the investment advice: short $ARAM.** There are two inextricably intertwined reasons for this, but both amount to a catch-22 ensuring Aramco’s profits will never be better than they are now.
The First Dilemma
Almost exactly three years ago, oil prices began a long descent from their previous equilibrium north of $100/barrel to a new equilibrium hovering in the vicinity of $50/barrel.² This was largely due to Saudi policymakers’ desire to keep the price of oil low so as to slow the rise of burgeoning shale and tar-sands producers in the US and Canada, who generally couldn’t extract oil nearly as cheaply as the Saudis. Unfortunately for the Saudis, shale producers proved able to scale production down quickly in response to lower oil prices, thus averting the bankruptcy Aramco was hoping for.
Of course, low oil prices mean less money for Saudi Arabia and other petro-states***, which most other petro-states weren’t thrilled about. Thus, OPEC (the international body through which petro-states set prices) recently agreed to cut back production, which should theoretically raise prices.³ However, when OPEC cuts back production, shale producers (who aren’t bound by cut-production agreements) gain market share and in so doing, help negate price increases.
It’s a dilemma of the first order for Saudi Arabia and Aramco that essentially ensures oil prices (and profits) will stay low indefinitely. This dilemma alone, however, might not be enough to justify shorting the stock of what is almost certainly the world’s most valuable company (including privately held parts of Aramco.)
The Second Dilemma
Saudi Aramco in 2017 is essentially analogous to Kodak in 1990 – a very valuable business, the days of which are numbered. As Elon Musk has said, “We are going to exit the fossil fuels era. It is inevitable.” [4] Someone will inevitably complain that I quoted the CEO of an electric-vehicle company on fossil fuels, so further: oil drilling is an old business, the efficiency gains in which have been almost entirely squeezed out. Solar power, for instance, is a relatively new business. Even relatively small, incremental reduction in the cost of solar panels compounded over a number of years will eventually be enough to make it significantly cheaper than oil energy. This is really just due to the fundamentals of the businesses: solar power is somewhat capital-intensive but comes with virtually no labor or shipping costs, whereas oil has incumbent capital but comes with high labor and shipping costs. Not to mention that a clean energy company recently pulled off the biggest product launch of all time.
This may not seem like a dilemma so much as a pronouncement of doom, except that Saudi Aramco still has to decide how much oil to produce in the short term, and none of the options are conducive to much profit on Aramco’s part. They could:
- Produce little, driving prices (and possibly profits) up for a short period of time but further accelerating the transition to clean energy.
- Produce a lot, keeping prices low and delaying the transition to clean energy, but minimizing profits.
Given those options, I’d guess Aramco will choose the latter, but either way, the company is generally headed for an era of stagnating profits.
Oiler’s Method
“But wait,” you might say, upon reading this post. “If Saudi Aramco’s prospects are so dim, wouldn’t they be recognized as such by investors during the IPO, making $ARAM undervalued and shorts therefore less profitable?” You would be correct, O diligent investor, except for the fact that Aramco’s financials are excellent and that, by purely quantitative comparison, it blows many Western oil companies out of the water, as it were.¹ In today’s era of quantitative investing, that is likely enough for Wall Street to give it a juicy valuation at the IPO.
Being the informed investor you are, from reading this blog, you will thus be able to make a tidy sum when in 10 years, $ARAM trades at half its IPO price.
Since this was a financial post, the obligatory disclaimer: the author of this post does not have an interest in any of the aforementioned securities (duh). All risk is assumed by the investor when taking financial advice from an 18-year-old. Consult with a real financial advisor before trading securities.
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*IPO stands for Initial Public Offering, and refers to the process by which a company (or part of a company) first becomes publicly held.
1 – The Economist
**Shorting a stock is the opposite of buying it: you sell it on credit, and buy the stock back at a later time. Thus, you make money if the price of the stock goes down.
***Informal term for a state that receives the majority of its revenue from oil.
2 – Bloomberg Energy
3 – Bloomberg
4 – Reuters