The Market Precipice Looming: The Saudi Aramco IPO and the Petrodollar

The Saudi Aramco IPO and the Petrodollar
The Market Precipice Looming: The Saudi Aramco IPO and the Petrodollar

Wall Street rallied late last week. But Westpac’s results release this morning might cool things down in Australia before they even have a chance to get hot.

We’d already tabled a dividend reduction for the bank. That’s what we got. We’re also getting a capital raising.

We’ll see Mr Market’s judgement on that when Westpac starts trading again tomorrow. It’s unlikely to be bullish.

We need a bit more time to go over Westpac’s full release. Instead, let’s turn our eyes toward another big money spinner in the world of finance…

It’s the Saudi Aramco IPO.

The IPO of Saudi Aramco

There’s no company that’s more profitable than this one. It’s already made US$68 billion in profit this year.

It’s now due to begin life as a (part) public company on the Saudi stock exchange.

The valuation for this beast could be US$1.5 trillion to US$2 trillion. Even selling just 3–5% of the company means raising an all-time record of US$45 billion.

It’s certainly the end of an era. The Saudis can see the long term demand for fossil fuels is bleak. They need to cash out while the going is relatively good.

One can only wonder how the market dynamic changes now that Aramco is no longer a purely sovereign concern.

Here’s a wildcard to think about. You’ll recall the drone and missile attacks that hit Saudi oil facilities in September.

Somebody hit them. We don’t know who, for certain. It’s easy to blame Iran. But that would mean relying on Western media. That’s not a bet I’m willing to take.

We can reasonably assume one thing: whoever did it has an agenda against the Saudi state.

I believe the Saudi Aramco IPO makes another attack highly probable. There’s no surer way of damaging Saudi Arabia that raising the risk around its oil industry.

This would therefore lower the value investors will pay for Aramco’s assets — and hit the Saudis where it hurts them the most. Their back pocket.

But the implication of all this go beyond mere Middle East intrigue…

Declining days of the global credit system

It also puts the status quo of the US dollar for the last 50 years under threat. It’s no secret that the Saudis brokered US security in exchange for pricing oil in dollars.

US President Richard Nixon dropped the gold backing of the US dollar and replaced it with oil.

The world has been living on this ‘petrodollar’ system ever since.

What happens to this dynamic as oil reduces in importance over the next decades makes for an interesting thought experiment. Such a transition is unlikely to be smooth.

Part of the reason Nixon had to break the Bretton Woods system was because the world was swapping their US dollar holdings into gold. There was a run on the US Treasury.

One also wonders if that might happen again sooner rather than later. Consider that the US federal government needs to refinance 50% — or US$11 trillion — in debt over the next three years.

That may look easy when even Greece can flog off government debt at a pittance. But markets don’t always stay so sanguine. It could become a market precipice.

We have a presidential election next year. It’s astonishing how uncertain this makes the outlook for the economy in a myriad of ways.

Democratic contender Elizabeth Warren, for example, wants to ban fracking on her first day in office.

This thought alone is enough to keep investors from committing to companies that operate these operations across the US.

That will reduce their drilling and widen the US trade deficit as its current energy export strength becomes muted.

That, in turn, would make the trade and government deficits look even worse than they do now — while potentially driving up oil and gas prices (inflation) when the bond markets have no room for error.

This is not something to take lightly. The US is the one oil producer going great guns right now.

Look at the problems elsewhere…

Iraqi government could completely collapse

Geopolitical risks to supply abound. The problem is Australia’s media just doesn’t cover the stories.

Iraq is the second largest producer in OPEC. News just in: Protestors are blocking the main arterial roads into the capital city Baghdad. It’s possible the national government is going to collapse1.

The oil fields in the south could easily be shut down, damaged or reduced in some way as this plays out.

Any hint of a very bullish oil price would make for uneasy bond market just when enormous commitments need to be rolled over.

2020 sure is shaping up to be some sort of a doozy in terms of news. I still think a select punt on energy shares is the best idea right now for the next 12 months.

You’re certainly not going to hit anything out of the park buying Aussie bank stocks. We’ll go over why in a future update.


Callum Newman Signature

Callum Newman,
Editor, Profit Watch

1 ‘Iraq Protests:  Capital Baghdad Blocked…’, BBC News