By Clara Denina , Sinead Cruise, Rania El Gamal and SimonJessop
LONDON/DUBAI, Aug 20 (Reuters) - Saudi Aramco's biggestasset could also be a liability.
The state energy giant's vast oil reserves – it can sustaincurrent production levels for the next 50 years – make it moreexposed than any other company to a rising tide of environmentalactivism and shift away from fossil fuels.
In the three years since Saudi Crown Prince Mohammed BinSalman first proposed a stock market listing, climate change andnew green technologies are putting some investors, particularlyin Europe and the United States, off the oil and gas sector.
Sustainable investments account for more than a quarter ofall assets under management globally, by some estimates.
Aramco, for its part, argues oil and gas will remain at theheart of the energy mix for decades, saying renewables andnuclear cannot meet rising global demand, and that its crudeproduction has lower greenhouse gas emissions than its rivals.
But with the company talking again to banks about an initialpublic offering (IPO), some investors and lawyers say the windowto execute a sale at a juicy price is shrinking and Aramco willneed to explain to prospective shareholders how it plans toprofit in a lower-carbon world.
"Saudi Aramco is a really interesting test as to whether themarket is getting serious about pricing in energy transitionrisk," said Natasha Landell-Mills, in charge of integratingenvironment, social and governance (ESG) considerations intoinvesting at London-based asset manager Sarasin & Partners.
"The longer that (the IPO) gets delayed, the less willingthe market will be to price it favourably because graduallyinvestors are going to need to ask questions about how valuablethose reserves are in a world that is trying to get down to netzero emissions by 2050."
Reuters reported on Aug. 8 that Prince Mohammed wasinsisting on a $2 trillion valuation even though some bankersand company insiders say the kingdom should trim its target toaround $1.5 trillion.
A valuation gap could hinder any share sale. The IPO waspreviously slated for 2017 or 2018 and, when that deadlineslipped, to 2020-2021.
Aramco told Reuters it was ready for a listing and thetiming would be decided by the government.
The company also said it was investing in research to makecars more efficient, and working on new technologies to usehydrogen in cars, convert more crude to chemicals and captureCO2 which can be injected in its reservoirs to improveextraction of oil.
SELLING THE STORY
Some would argue this is not enough.
A growing number of investors across the world are factoringESG risk into their decision-making, although the degree towhich that would stop them investing in Aramco varies wildly.
Some would exclude the company on principle because of itscarbon output, while others would be prepared to buy if theprice was cheap enough to outweigh the perceived ESG risk -especially given oil companies often pay healthy dividends.
For an interactive version of the graphic, click here https://tmsnrt.rs/2MS62mf.
At a $1.5 trillion valuation, Aramco would be the world'slargest public company. If it were included in major equityindices it would automatically be bought by passive investmentfunds that track them, regardless of their ESG credentials.
And as the world's most profitable company, Aramco shareswould be snapped up by many active investors.
Talks about a share sale were revived this year after Aramcoattracted huge investor demand for its first international bondissue. In its bond prospectus, it said climate change couldpotentially have a "material adverse effect" on its business.
When it comes to an IPO, equity investors require moreinformation about potential risks and how companies plan to dealwith them, as they are more exposed than bondholders if abusiness runs into trouble.
"Companies need to lead with the answers in the prospectus,rather than have two or three paragraphs describing potentialrisks from environmental issues," said Nick O'Donnell, partnerin the corporate department at law firm Baker McKenzie.
"An oil and gas company needs to be thinking about how toexplain the story over the next 20 years and bring it out into aseparate section rather than hiding it away in the prospectus,it needs to use it as a selling tool. And also, once the IPO isdone, every annual report should have a standalone ESG section."
Unlike other major oil companies, Aramco doesn't have aseparate report laying out how it addresses ESG issues such aslabour practices and resource scarcity, while it does notpublish the carbon emissions from products it sells. Until thisyear's bond issue, it also kept its finances under wraps.
The company does however have an Environmental ProtectionDepartment, sponsors sustainability initiatives and is afounding member of the Oil and Gas Climate Initiative, which isled by 13 top energy companies and aims to cut emissions ofmethane, a potent greenhouse gas.
On Aug. 12 Aramco published information on the intensity ofits hydrocarbon mix for the first time. It disclosed the amountof greenhouse gases from each barrel it produces.
Aramco's senior vice president of finance Khalid al-Dabbaghsaid during an earnings call this month that its carbonemissions from "upstream" exploration and production were thelowest among its peers.
A study published by Science magazine last year found carbonemissions from Saudi Arabia's crude production were the world'ssecond lowest after Denmark, as a result of having a smallnumber of highly productive oilfields.
THE OIL PRICE
Aramco says that, with the global economy forecast to doublein size by 2050, oil and gas will remain essential.
"Saudi Aramco is determined to not only meet the world'sgrowing demand for ample, reliable and affordable energy but tomeet the world's growing demand for much cleaner fuel," it toldReuters.
"Alternatives are still facing significant technological,economic and infrastructure hurdles, and the history of pastenergy transitions shows that these developments take time."
The company has also moved to diversify into gas andchemicals and is using renewable energy in its facilities.
But Aramco still, ultimately, represents a bet on the priceof oil.
It generated net income of $111 billion in 2018, over athird more than the combined total of the five "super-majors"ExxonMobil, Royal Dutch Shell, BP,Chevron and Total.
In 2016, when the oil price hit 13-year lows, Aramco's netincome was only $13 billion, according to its bond prospectuswhere it unveiled its finances for the first time, based oncurrent exchange rates. Its earnings fell 12% in the first halfof 2019, mainly on lower oil prices.
Concerns about future demand for fossil fuels have weighedon the sector. Since 2016, when Prince Mohammed first flagged anIPO, the 12-months forward price to earnings ratio of five ofthe world's top listed oil companies has fallen to 12 from 21 onaverage, according to Reuters calculations, lagging the FTSE 100and the STOXX Europe 600 Oil & Gas index averages.
For an interactive version of the graphic, click here https://tmsnrt.rs/2YCvfYY.
By comparison, UK-listed funds investing in renewable energyinfrastructure such as wind farms are trading at one of thebiggest average premiums to net asset value.
For an interactive version of the graphic, click here https://tmsnrt.rs/2YD6n3y.
AN INFLUX OF CAPITAL
Using a broad measure, there was global sustainableinvestment of $30.1 trillion across the world's five majormarkets at the end of 2018, according to the Global SustainableInvestment Review http://www.gsi-alliance.org/wp-content/uploads/2019/06/GSIR_Review2018F.pdf,more than a quarter of all assets under management globally.That compares with $22.8 trillion in 2016.
For an interactive version of the graphic, click here https://tmsnrt.rs/2MKcZGa.
For an interactive version of the graphic, click here https://tmsnrt.rs/2YCZTl0.
"Given the influx of capital into the ESG space, Aramco'sIPO would have been better off going public 5-10 years ago,"said Joseph di Virgilio, global equities portfolio manager atNew York-based Romulus Asset Management, which has $900 millionin assets under management.
"An IPO today would still be the largest of its kind, butmany asset managers focusing solely on ESG may not participate."
The world's top listed oil and gas companies have come underheavy pressure from investors and climate groups in recent yearsto outline strategies to reduce their carbon footprint.
Shell, BP and others have agreed, together withshareholders, on carbon reduction targets for some of operationsand to increase spending on renewable energies. U.S. majorExxonMobil, the world's top publicly traded oil and gas company,has resisted adopting targets.
Britain's biggest asset manager LGIM removed Exxon from its5 billion pounds ($6.3 billion) Future World funds for what itsaid was a failure to confront threats posed by climate change.LGIM did not respond to a request for comment on whether itwould buy shares in Aramco's potential IPO.
Sarasin & Partners said in July it had sold nearly 20% ofits holdings in Shell, saying its spending plans were out ofsync with international targets to battle climate change. Therest of the stake is under review.
The asset manager, which has nearly 14 billion pounds inassets under management, didn't participate in Aramco's bondoffering and Landell-Mills said they would be unlikely to investin any IPO.
(Additional reporting by Ron Bousso in London and VictoriaKlesty in Oslo; Editing by Carmel Crimmins and Pravin Char)
