It's no secret that the engine of Saudi Arabia's massive economy is its energy giant, the Saudi Arabian Oil Co. The company produces nearly all of the kingdom's oil and natural gas, which accounted for 63 percent of the government's revenue last year even amid stubbornly low oil prices and an attempt to diversify away from the energy sector. But a lesser-known (and perhaps more interesting) aspect of the firm is its competence, efficiency and skilled internal management — characteristics that are rarely found in most national oil companies.
The firm may not retain these traits for much longer, though. Crown Prince Mohammed bin Salman has begun driving fundamental changes in the kingdom's leadership and oil industry that could blunt Saudi Aramco's edge over its less effective peers in the long run, especially amid the new challenges arising as the company grows into an integrated multinational firm.
Isolated From Incompetence
With the mid-20th century came a wave of nationalizations in the oil and natural gas industry, which spared few corners of the globe. The movement reached the Middle East in 1951, when the Iranian parliament voted to grant assets of the Anglo-Persian Oil Co. to the state-owned National Iranian Oil Co. Though lawmakers largely overturned the decision two years later, nearly every Middle Eastern country took steps to nationalize their oil industries in some fashion over the three decades that followed.
Saudi Arabia wasn't immune to this trend, but it was able to enact change more gradually than many of its neighbors. For one, the kingdom didn't have to contend with the anti-colonialist sentiments that fueled calls for nationalist policies throughout the rest of the region. For another, the U.S.-based Arabian American Oil Co. — what would later become Saudi Aramco — controlled the Saudi oil industry rather than Petromin, a rival national oil company modeled off its cumbersome, politicized counterparts abroad. Nationalizing the Arabian American Oil Co. would have endangered Riyadh's deep ties with Washington, which the kingdom was eager to protect. Because of these factors, Saudi Aramco did not become fully nationalized until 1988.
Even then, foreign executives remained on the company's board. Moreover, many of the firm's longtime employees maintained that the kingdom hadn't unilaterally taken control of Saudi Aramco, but it had legitimately bought it. In an effort to appease the Saudi officials leading the nationalization charge, the company spearheaded a program to increase employment among Saudi citizens. But to avoid the brain drain that had plagued so many of the kingdom's neighbors, Saudi Aramco trained promising young Saudi workers and sent them overseas to receive their education, hoping to someday move them into leadership positions back home.
This gradual shift toward state control left Saudi Aramco with a strong corporate culture not unlike that of international oil companies — a legacy that lasted well beyond the firm's nationalization. Today the company's budget is separate from the government's finances. Beyond taxes and the dividends it provides to its shareholders (now Riyadh), Saudi Aramco also keeps its revenue. That move is a relic of its past in the private sector and a means of insulating the company from rampant corruption among the kingdom's political officials. By contrast, the nationalizations of most other countries' energy sectors left behind hollowed-out firms with a notorious propensity for graft and inefficiency.
More important, the Saudi state has taken a hands-off approach to the operation and management of the oil sector. Rather than reserving control of the company for a particular branch of the House of Saud, as it has with other ministries and businesses, the government has left the firm in the hands of professional technocrats. (The royal line of former Crown Prince Nayef bin Abdulaziz, for instance, held the Interior Ministry from 1975 to 2017.) Saudi Aramco's isolation from the patronage-based fiefdoms that make up the complex mosaic of the Saudi state has enabled it to remain competent against all odds.
A Source of Princely Power and Patronage
It's unclear how much Salman's recent consolidation of power and plans for reform will undermine the energy behemoth's independence and capabilities. While the crown prince hopes that his push for greater transparency and the impending initial public offering (IPO) of the company will boost Saudi Aramco's efficiency, the firm won't continue to enjoy the same success if it becomes more politicized — as many fear it might.
Concerns about the oil industry's autonomy arose when King Salman ascended to the throne in January 2015. With one of his first decrees, the monarch consolidated the Saudi bureaucracy and placed rising star Mohammed bin Salman at the head of the Council of Economic and Development Affairs. Then in May of that year, the king created the Supreme Council for Saudi Aramco to oversee the company, granting its chairmanship to the crown prince.
In one fell swoop, the king had split off Saudi Aramco from the technocratic Oil Ministry and placed it under the direct control of a single branch of the royal family. (Prior to Salman's decision, the company submitted its plans to the Supreme Council for Petroleum and Minerals, chaired by the king, for approval, but that move was only a formality.) It wasn't long before the crown prince made clear his intention to take an active role in the firm's decision-making by announcing preparations for the IPO.
Salman's new responsibilities further stoked anxiety about the politicization of the energy sector in April 2016. At the beginning of the year, oil prices had bottomed out at about $25 per barrel, and sanctions against Iran had lifted, leaving Saudi Arabia's regional rival poised to double its oil exports. The kingdom's technocrats, led by longtime Oil Minister Ali al-Naimi, began to seriously consider striking a deal to implement production freezes in OPEC in order to stave off a steeper decline in prices. All signs pointed to the bloc reaching an agreement that excluded Iran during its meeting in April.
But at the last minute, Saudi Arabia balked at the deal. The unexpected turn of events signaled that al-Naimi — the most powerful voice in the Saudi oil industry for more than two decades — was no longer calling the shots. Instead the crown prince had intervened, hoping to force the negotiation of an agreement that included Iran. Soon after the incident Khalid al-Falih replaced al-Naimi at the head of the Oil Ministry. (Notably the king chose al-Falih, a technocrat, for the post rather than one of his sons, as many expected.)
Since then, Saudi Aramco's IPO has become the centerpiece of the crown prince's Vision 2030 reform package. On paper, the proceeds of the IPO are intended to fill the kingdom's nascent Public Investment Fund, as will any unsold shares of Saudi Aramco. But because the fund is under the control of the Council of Economic and Development Affairs — and, by extension, Salman — its coffers and the company's earnings could become the lifeblood of the crown prince's patronage networks.
The Risky Business of Reform
Salman's intentions for Saudi Aramco's IPO may be good, and he could still choose to maintain the hands-off approach to corporate management of his predecessors. Nevertheless, the crown prince is taking a risk by removing a technocratic element from the company's leadership — particularly during a transformative period in the kingdom's energy industry.
First, the IPO itself will be a fraught endeavor. Since Saudi Arabia announced the project's aggressive timetable, it has had to negotiate with a number of different stock exchanges, including those of the United States and United Kingdom, to hash out the details of the IPO's international portion. Though Salman has advocated listing the IPO on the New York Stock Exchange, especially as his relationship with the White House deepens, most Saudi officials seem to prefer using the London Stock Exchange because it is one of the largest in the world and it would be able to manage an offering for a company of Saudi Aramco's size. Moreover, the London Stock Exchange would bring less scrutiny of the company's oil reserves than its U.S. counterpart would; in New York, the IPO would raise a litany of questions about Saudi Aramco's corporate strategy, long-term goals and financial obligations to shareholders. Not only would this scrutiny reduce interest among potential investors, but it would also call into question whether the costs of an IPO outweigh the economic benefits. Despite these pressing questions that have yet to be answered, Saudi officials insist that the IPO is on track to take place in 2018. But more and more figures have raised the possibility of delaying the offering's international component and the preliminary private sale of a stake in the company.
Second, Saudi Aramco is undertaking substantial changes to its corporate strategy. The alterations are designed not only to make the company more attractive to investors ahead of the IPO, but also to address specific challenges facing the firm. Even before oil prices plunged in 2014, Saudi Arabia had spent a decade expanding its downstream operations at home and abroad, often partnering with international oil companies in the process. By doing so, Saudi Aramco became a more integrated oil company and climbed the industry's value chain.
Since oil prices dropped, the company has doubled down on that strategy. The firm unveiled a new 10-year investment plan on Dec. 12 that entailed $414 billion in spending — about a quarter more than the previous year's estimate — and just under half of those funds will be devoted to the downstream and petrochemical sectors. Beyond the kingdom's borders, Saudi Aramco is weighing the possibility of investing in upstream assets as well. The company appears to be considering the acquisition of a share in Novatek's Arctic 2 liquefied natural gas (LNG) project, and Saudi officials have said additional purchases of LNG assets could be on the horizon. Riyadh has also explored the option of buying upstream shale assets in the United States.
Both avenues underscore another of Saudi Arabia's enduring problems: Producing natural gas in the kingdom isn't cheap. Although the country's natural gas output is considerable, most of it is merely a byproduct of producing crude oil. Tapping into Saudi Arabia's most plentiful natural gas reserves — which are either sour (tainted with hydrogen sulfide), offshore or trapped in the shale formations of the Rub al-Khali desert — is an expensive proposition. Coupled with the kingdom's price controls on natural gas, these factors have made projects dedicated to natural gas production uneconomic by international standards. That said, those projects (along with LNG imports) would become viable if prices were to rise more than threefold. Investors will therefore expect the kingdom to take steps to normalize prices ahead of any IPO.
A Slippery Slope
The shifts underway within the halls of Saudi Aramco suggest four new changes lie ahead. First, the IPO — should it materialize — will bring greater oversight to the company's balance sheets and performance. Second, Saudi Aramco will increasingly become a multinational firm in its own right that boasts upstream, midstream and downstream investments worldwide. Third, the company will become more involved in downstream and petrochemical projects with massive price tags, such as the $20 billion joint venture with chemical manufacturer Sabic it announced in November 2017. Fourth, Saudi Aramco's new upstream projects won't look like its typical efforts to tap cheap, easy oil reserves, because as the company tries to produce sour and shale natural gas, it will have no choice but to harness more sophisticated technologies.
Saudi Aramco's apolitical and technocratic nature will be critical to its success in managing each of these developments in the years ahead. But given the signs of politicization that have already emerged in its corporate policy under Salman's rule, the company's days as an independent and competent national oil company may be numbered.