Aramco Posts $6.6 Billion Profit Amidst Dismal Oil & Gas Earnings But Dividend Promise Weighs Heavy

Saudi Aramco, the oil company of the Saudi Arabian kingdom, is the world’s most profitable company in a good year. However, this is not a good year for oil. We now know that in the second quarter of 2020, the company’s net income was $6.6 billion, which seems fine given the poor showing of the oil market amidst the coronavirus issues, but it is actually a sign of the imposing burden the Saudi government has become on the company. The second quarter numbers highlight that Aramco itself is a great company that is in a great position with great assets, but that the current iteration of the Saudi government is like a weight around the company’s neck. 

Saudi Monarchy Control

In times past, the Saudi government allowed the company a great deal of autonomy. That autonomy included the ability for the company to control its own finances when revenue came in, which was in stark contrast to most other national oil companies that were less successful. In addition, between 1995 and last year, the government oil ministry was run by former heads of Aramco, so the country’s oil policy was not disruptive to the company’s goals. However, in recent years, under the current king, Salman, and his son Mohammed, the company controls little beyond its own finances. 

SABIC Acquistion

In Q2, Aramco completed the paperwork for a purchase of 70% of SABIC, a local petrochemicals company. Aramco bought the company from the country’s sovereign wealth fund under orders of the Saudi government (ostensibly the crown prince, Mohammed) as a way to infuse cash into the sovereign wealth fund. Notably, Yasir Rumayyan, the head of the Saudi sovereign wealth fund, has been also the chairman of Aramco since last year. That was a role that had traditionally been held by the oil minister and former Aramco CEO. Now, it is held by a man with no oil experience but a very close relationship with the king’s son. In the end, Aramco will pay top dollar for a petrochemicals company that presents many redundancies with Aramco’s own operations. Moreover, SABIC’s value has already dropped since the negotiations—it should be bought for less. But Aramco must do what the monarchy says. 

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Maximum Crude Oil Production

Also in Q2, Aramco was forced to produce oil at its maximum capacity and sell it for cheap, which caused global prices to plummet. Aramco long touted a maximum sustained capacity (MSC) of 12 million barrels production of oil per day, but had never reached that limit in actual production. It chose to keep some spare capacity in case of emergency and as a strategic advantage. However, in early March, the Saudi oil ministry—which is now headed by another of the king’s sons, Abdulaziz—was upset that Russia rejected an OPEC proposal to cut production. As a result, the oil ministry decided unilaterally to increase production to capacity (an average of 12 mmbpd) in April and simultaneously decrease the price it charged to Asian customers.  On April 2, Aramco set a record with 12.1 million barrels produced. The oil ministry’s decision, more than anything, caused the sudden and severe drop in oil prices in early March. It caused the price of Brent to drop 30% in a matter of hours on March 9 before trading even began in the United States. It set the stage for the low prices of the second quarter. Yes, demand collapsed, but oil prices fell on Saudi Arabia’s decision before anyone knew what would happen to demand. 

That early March decision by the Saudi oil ministry—ostensibly a decision by the monarchy—caused low prices which hurt Aramco as well as all of its competitors. It also forced Aramco to overproduce, possibly hurting its oil fields. As a result of the overproduction, Aramco was also tasked with increasing capacity to 13 million bpd, a tough ask that would require a commitment of resources. (Ultimately, Aramco dropped its production in May, but on its August 10 earnings call Aramco confirmed that it still has a goal of 13 mmbpd MSC in the future). In short, when the Saudi oil ministry, under control of the monarchy, reacted impetuously in early March, it both plummeted oil prices hurting profits and hurt Aramco operations. Aramco had no say. 

Quarterly Profit

Aramco did have a net income of $6.6 billion in the quarter, down from the already low number of $16.6 billion the prior quarter. In the entire first half of 2019, net income was $46.9 billion. Compared to competitors, though, Aramco did well. For instance, ExxonMobil XOM and Chevron CVX both saw losses in the second quarter. Aramco has the lowest cost of production, because the oil it pumps is easily accessible, it has built an efficient system and it has the sole concession agreement for the kingdom. Aramco is a well-run business and has many advantages. 

Dividend Promises

Yet, the company will be paying out all of that $6.6 billion plus another $12.15 in dividends for the quarter. This is because the government (through the company) promised a $75 billion dividend before the December IPO, and the government cannot afford to renege on that promise. When the company went public, 20% of all Saudi citizens—men, women and children—bought in. Many companies and wealthy individuals were compelled to buy in by government salesmen, and it’s safe to say that “no” was not an expected answer. Part of the promise of buying into Aramco was the huge dividend. It would be one thing to upset an investor, but a king cannot afford to enrage his population. Furthermore, if the dividend was decreased, the stock price would drop, making the king and his son look even worse in front of the population. Therefore, Aramco is tasked with doling out money it did not make last quarter to satisfy the political needs of a monarchy. 

Aramco has some great things going for it—easily accessed oil, efficient operations and strong management. These characteristics, coupled with a government that stayed out of the way, were what led to its rise in profitability and production between 1988 and 2014. Now, it has a government that is unpredictable and increasingly eager to interfere. Aramco’s Q2 earnings are a mark of uncertainty, and it looks like there is more to come.

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