Crucial Insights from the Saudi Aramco 2018 Charter

Transcription

1 Crucial Insights from the Saudi Aramco 2018 Charter Ellen R. Wald, PhD Nonresident scholar, Arabia Foundation Translation by Farah Alalami

2 I. Executive Summary At the beginning of 2018, Saudi Aramco released a charter in Arabic that includes components typically associated with articles of incorporation and bylaws. The charter includes information about Aramco s future operations, the direction of the company, control of the board of directors, dividends, and stock classes. Significantly, the charter provides insight into the future Aramco initial public offering and the ways it will benefit the Saudi economy and Saudi people during and after the state-led economic transformation. Although the charter does not directly inform on Aramco s potential valuation, it raises important questions for future valuation. Key points and implications of the charter are as follows: 1. Plans for an initial public offering of the company are progressing and Saudi Arabia intends to list Aramco on domestic and/or foreign exchanges at some point in the future. 2. The Saudi economy and private sector could receive a significant boost through the decentralized investment (i.e., investment from sources other than the central government) and spending through wealth received from Aramco stock. This is indicative of the efforts to diversify the Saudi economy (e.g., Vision 2030). 3. Aramco will continue to be an energy company only and will not expand outside the field of energy and petrochemicals. Aramco will not become an arm of the Saudi government operating in other industries like construction, manufacturing, marketing, or finance. Saudi businesses in other sectors, and investors in those businesses, should not see Aramco as a competitor in the Saudi economy. The charter does not preclude Aramco from pursuing investments overseas in its core business. 4. Although the charter only specifies one class of common stock, Aramco may offer a second class of preferred shares in the future. Preferred shares would limit voting rights but increase dividends, potentially indicating a higher valuation for Aramco while maintaining state control over the Aramco board. 5. The company may grant shares to employees, creating a new opportunity to share wealth with fiftyfive thousand Saudi citizens. Providing Aramco stock to Saudi employees of Aramco could infuse the economy with cash from diffuse sources. This would decentralize wealth, increase commercialism (and private spending), raise real estate values, and perhaps encourage domestic investment in local small businesses. This infusion of wealth into private hands in Saudi Arabia, coupled with private and pension-plan purchases of Aramco stock, would mean that a large portion of Saudi Arabia would acquire a personal stake in the success and future of the largest company in the kingdom. The opportunity for Saudis to own shares in Aramco would be an important contribution to the overall economic transformation of Saudi Arabia, which is currently a primary aim for the Saudi government. The government s economic transformation plans are, in part, designed to incentivize the people to take a larger stake in their own economic futures. 6. The charter establishes various protections of state influence on the company. All owners of common stock can vote in the annual shareholder meeting for the election of board members, but the state retains control over appointment and dismissal of the chairperson and vice chairperson of the board. Even if the state sells a large portion of its stake in the company at a later date, the state will still have overwhelming influence over the board. Safeguards of state control alleviate concerns among some Saudi citizens who have expressed concern that the country could lose control over Aramco upon selling shares. II. Introduction In January 2016, Saudi Arabia first announced plans to take Saudi Aramco, its national oil company, public. Saudi Arabia s intention was to create an initial public offering (IPO), floating approximately 5 percent of the oil giant on several stock exchanges. Since the time the announcement was made, Aramco has been preparing for the IPO in a variety of ways. Financial institutions are preparing the company s financial statements, petroleum-consulting firms have audited the country s oil reserves, and the state and company have been making changes to Aramco s tax structure and organization. At the very beginning of 2018, Saudi Arabia and Saudi Aramco issued several major statements. The government announced that the company, which was established as a Saudi company by decree in 1988, would now become a joint stock company. The details of Saudi Aramco s corporate structure between 1988 and 2018 are not known. Also, at the very start of 2018, Saudi Aramco issued a charter that included some of the types of details typically addressed in articles of incorporation and company bylaws in the United States. The charter is written entirely in Arabic. An Englishlanguage translation of the charter, along with any other relevant documents, was requested from Aramco for this report, but the official response from Aramco was that the company does not have an English translation available. III. Historical Context Beginnings ( ) Standard Oil of California (now Chevron) first secured an oil concession in Saudi Arabia in 1933 through a subsidiary, 2

3 Casoc. Eventually, it was joined by the Texas Company (now Texaco). Oil was discovered in Saudi Arabia in In 1944, two more companies, Standard Oil of New York (later Mobil) and Standard Oil of New Jersey (later Exxon), purchased half of the US oil operation in Saudi Arabia, and the company was renamed the Arabian American Oil Company ( Aramco ). Chevron, Texaco, and Exxon each owned 30 percent of Aramco, and Mobil owned 10 percent. Aramco was incorporated in the state of Delaware with headquarters in San Francisco. Its board members were chosen by its four corporate shareholders until 1959, when Aramco decided to allow the government of Saudi Arabia to appoint two board members. Saudi Purchase ( ) In 1972, Saudi Arabia purchased 25 percent of the company from the American shareholders. It is not known how much Saudi Arabia paid the shareholders, but the most reliable estimate at the time was $500 million. In 1974, Saudi Arabia increased its ownership to 60 percent through a second purchase from the American shareholders. Again, the price was not disclosed. In 1976, the Saudis negotiated to purchase the remaining shares of Aramco, and by 1980, 100 percent of Aramco s shares were owned by Saudi Arabia. Saudi ization ( ) Aramco remained a Delaware-based US corporation until 1988, when the Saudi Council of Ministers approved a decree from the king that established Aramco as a Saudi corporate entity. The company was renamed Saudi Aramco at that time. It is not known what type of corporate structure Aramco had, nor is the content of that decree known. A request was made to Aramco to provide a copy of the 1988 decree, but Aramco reported that it does not have the document in question. Independent Operations ( ) Initially, control of Aramco was unclear and unsettled, with different elements within Saudi Arabia seeking oversight. The Finance Ministry sought to assume control over Aramco by ensuring that the revenue from Aramco went directly to the Finance Ministry instead of to Aramco. Typically, other national oil companies outside of Saudi Arabia sent the revenue directly to state coffers, and the businesses operated with funds provided by the state. Then CEO Ali al-naimi refused to allow the Finance Ministry to control Aramco s cash. Instead, because of Naimi s insistence, a system was established in which Aramco had near complete financial and operational independence. According to Naimi, Aramco received all of its revenue and paid royalties, taxes, and dividends to the Saudi government. 1 In 2017, the rate of tax paid by Aramco to the state was reduced from 85 percent to 50 percent. Corporate Governance and Ownership as a Saudi Company ( ) Even after the Saud ization of Aramco, the company continued to operate with a board of directors that included Saudi nationals as well as foreigners. Initially some of the foreign members of the board were retained from Aramco s former US shareholders. Later, board members were drawn from a variety of Western corporate and financial institutions and were selected by the Supreme Petroleum Council, which also oversaw Aramco s strategic plans. The king of Saudi Arabia appointed members of the Supreme Petroleum Council. In 2015, the Supreme Petroleum Council was replaced by a body called the Saudi Aramco Supreme Council. It is now chaired by the crown prince of the Saudi monarchy and includes former and current ministers from the Saudi government. Ali al-naimi, the former Aramco CEO and former oil minister, and Khalid al-falih, the former CEO and current oil minister, both serve on the council. The Saudi Aramco Supreme Council acts as the shareholder representative, according to current Aramco vice president for strategy and markets, Yasser Mufti. 2 Currently, there is only one Saudi Aramco shareholder. Aramco personnel, including the CEO, Amin Nasser, have been heard talking about the shareholder. Former Aramco employees have said that the shareholder refers to the king, but the company officially says that the shareholder is the government. 3 Throughout the 2018 charter, the word al-dawla is used, which is translated as state in this report. The translation is not exact. In some Arabic-speaking communities, the word can be understood as government or, perhaps, may imply the meaning monarchy. The translation with the most comprehensive and accurate meaning is state. The Saudi Ministry of Energy, Industry, and Mineral Resources (the Oil Ministry) sets oil policy and production rates, but Aramco runs the operations and the business. (Moreover, since 1995, the minister of that department has been a former Aramco CEO, giving some the impression that Aramco influences the ministry as much as or more than the ministry influences Aramco.) The charter maintains the company s independent operations as they were. IV. The Future of Aramco Operations Article 3 The main objective of the Company is to carry out all aspects of activities related to energy. The new Aramco charter lists specific fields in which Saudi Aramco will operate. Of note are all aspects of activities related to energy fields, including hydrocarbon, chemical, related and complementary industries. There are fourteen specific activities listed, all of which are related to the 1. H. E. Ali al-naimi, interview with author, Dhahran, Saudi Arabia. 2. Yasser Mufti, interview with author, Dhahran, Saudi Arabia. 3. Lee Ingham (retired Aramco employee), interview with author, and Yasser Mufti (Aramco vice president), interview with author, Dhahran, Saudi Arabia. 3

4 energy business and are already part of Aramco s portfolio of activities. Some of these include energy trading; transportation and distribution of energy; import and export of all types of hydrocarbon energy and chemicals; and electricity generation, storage, and distribution. The least energy-related activities listed are still vital to Aramco s current operations and include financial services, aviation and freight services, medical services and health care services, and owning and disposing of real estate. Although this list may appear wide-ranging and vague, it is quite specific in comparison to the stated objectives of many other corporations. In contrast, many companies will be vague in their articles of incorporation in order to leave the company s purpose and potential activities open to future possibilities. For example, a typical Delaware, USA, incorporation (Delaware is the most common incorporating jurisdiction in the United States) might read, The nature of business and purpose of the organization is to engage in any lawful act or activity for which corporations may be organized under the Delaware General Corporation Laws. Under this type of incorporation, a Delaware corporation could legally pursue any legal and profitable business. The business purposes of Saudi Aramco, however, are specific. With Article 3 of the charter, Aramco effectively announced that it is an energy business and does not intend to become a conglomerate with operations in various (perhaps entirely unrelated) industries. In some countries, such conglomerates can become exceedingly powerful. In South Korea, for example, recent scandals have exposed potential problems presented by international conglomerates that dominate an economy. 4 The statement of business purposes in Aramco s new charter indicates that Aramco will remain in the energy business and in energyrelated businesses. The implication for other businesses in Saudi Arabia and for investors in Saudi businesses is significant. Saudi Aramco is a national behemoth. A corporation with its capital, talent, and connections could quickly dominate other sectors of the economy. This charter indicates that Saudi businesses in other sectors and investors in those businesses should not see Aramco as a competitor in the Saudi economy. For example, international media reported on February 1, 2018, that Aramco is exploring a partnership with Google for joint ventures, potentially to open data centers around the kingdom. 5 According to Aramco s charter, these data centers would not be used for expansion into unrelated technology services; the data centers would need to be for the use of Aramco and its subsidiaries. Thus, Aramco would not be competing with the data centers that Microsoft and Amazon are looking to open in the kingdom. For international oil companies, this article is also important. It explains that Aramco will continue to be in the energy business. The charter does not preclude Aramco from pursuing upstream oil and gas holdings overseas, in the manner of traditional international oil companies. Article 3 defines the parameters of the company so that potential investors in Aramco, such as potential anchor investors in China or investors buying shares on an exchange post-ipo, know that they will be investing in an energy company and not in a Korean-style conglomerate. It also lets future investors know that Aramco intends to stay within its areas of expertise. V. Share Classes, Dividends, and Impact on Valuation Articles 6 and 8 The Extraordinary General Assembly of the Company may issue or decide to buy ordinary shares. According to Article 6, the charter creates one class of common shares for Saudi Aramco. The company s assets are valued at sixty billion Saudi riyals. (This is not a note to valuation, but an unrelated number for accounting purposes.) The charter creates two hundred billion shares of equal voting power with no par value. The company has not indicated how many shares are outstanding and currently owned by the company s sole current shareholder. According to Article 8, the company may have a special meeting to convert ordinary shares into preferred shares and vice versa. It can also issue new common shares or repurchase (buy back) common shares. Preferred shares do not confer shareholder voting rights to the shareholders, but preferred shares do grant a higher share of the net profit of the company. In other words, preferred shares would offer a higher dividend, if the company creates them. VI. Stock Transfers to Employees Article 11 The Extraordinary General Assembly may decide to increase the number of shares of the Company. According to Article 11, Aramco may provide shares to employees of the company or to employees of any subsidiary company. The charter empowers the company to provide shares to employees, though it is not clear if this comes in the form of payments or stock options, or some other form. Providing Aramco stock to Saudi employees of 4. Iain Marlow, South Korea s Chaebol Problem, Globe and Mail, April 24, Maureen Farrell, Benoit Faucon, and Summer Said, Google Weighs Unusual Bid with Giant Oil Firm Aramco to Rev Up the Saudi Tech Sector, Wall Street Journal, February 1,

5 Aramco would be a major transfer of wealth to the Saudi population and could infuse the economy with cash from diffuse sources. It has the possibility of creating a large number of wealthy Saudis who do not come from typical Saudi sources of wealth. This would assist the greater economy by decentralizing wealth, increasing commercialism (and private spending), raising real estate values, and perhaps encouraging domestic investment in local small businesses. Just as stock options have served to enrich large numbers of nonfounders in Silicon Valley, stock transfers to Aramco employees could have a similar impact. Whereas in the West stock options are useful in lowering the tax liability of individuals, Saudi Arabia does not have a personal income tax, a capital gains tax, or a gift tax. Saudi Arabia uses an Islamic zakat system based on cash generated from earnings and working capital. Therefore, a simple payment of stock from Aramco to the employee is easiest and likely preferable to options. Whether Aramco employees receive stock before or after an IPO, employees can easily liquidate shares for cash wealth if the company is public. This infusion of wealth into private hands in Saudi Arabia, coupled with private and pension-plan purchases of Aramco stock (perhaps on Tadawul), would also give a large portion of Saudi Arabia s citizens a personal stake in the success and future of the largest company in the kingdom. This is somewhat similar to the importance of BP to the people of the United Kingdom, where BP is historically prevalent in many pension plans. However, in Saudi Arabia, transfer of shares to citizens (employees or investors) also has a significant psychological impact, because if individual Saudis own shares in Aramco, they will have a stake in the country s most valuable natural resource. This opportunity for Saudis to own shares in Aramco is in line with the larger push for economic transformation within Saudi Arabia. The government s economic transformation plans are, in part, designed to incentivize the people to take a larger stake in their own economic futures. The transformation efforts are intended, in part, to shift the relationship from a monarchy that bestows wealth on its subjects to a government that creates an environment for healthy economic growth. The charter itself does not limit providing of shares to employees within Saudi Arabia or even to Saudi citizens. In 2016, Saudi employees made up 85 percent of the sixtyfive-thousand-person Saudi Aramco workforce. 6 The charter allows for providing shares even to subsidiary employees, perhaps including employees in subsidiaries outside Saudi Arabia. This could include, for example, employees at the Motiva refinery and innovation hubs across the United States, or employees at downstream operations across Asia. Allotments to employees very well may come prior to any initial public offering. VII. State Majority Ownership and Influence Articles The State directly nominates six candidates to be elected to the Board of Directors. The charter provides some opportunity for nonstate owners of common stock to be involved in the formation of the board of directors, but the state maintains control over the board of directors. Of course, even after an IPO, the state is expected to own 95 percent of the company for the foreseeable future. Additionally, protections for the state s control are also included in the charter: Article 14 indicates that the state nominates six candidates to be elected to the board of directors, and Article 15 reserves for the state the right to vote out members of the board. The charter does allow for any group of shareholders owning more than 0.1 percent of common shares to nominate a candidate for the board of directors. The charter does not specify here the total number of board members. All owners of common stock can vote in the annual shareholder meeting for the election of board members. The state also retains control over appointment and dismissal of the chairperson and vice chairperson of the board. For reference, before the charter, the board members of Saudi Aramco were appointed by the Saudi Aramco Supreme Council, which most recently has been led by Crown Prince Mohammad bin Salman. Prior to the charter, the board was composed of the oil minister, the Saudi Aramco CEO, the managing director of the Saudi Arabian Public Investment Fund, one Saudi academic, two other Saudi advisors, two Western oil industry veterans, and a Western finance industry veteran. 7 Even if Saudi Aramco were to obtain an anchor investment prior to an IPO, the anchor investment (which would likely be more than 0.1 percent of shares) might include preferred shares, which would limit the investors voting ability and influence. The charter ensures that in a future potential situation in which the state has sold large portions of its stake in the company, the state will still have overwhelming influence over the board. In addition to ensuring continued state control of the board, these safeguards for the state may also alleviate concerns among some Saudi citizens who have expressed apprehension that the country could lose control over Aramco upon selling shares. VIII. Conclusions The issuance of this charter is a significant indication that plans for an initial public offering of the company are progressing and that Aramco is preparing for listing on both domestic and foreign exchanges at some point in the future. 6. Saudi Aramco Annual Review 2016, Saudi Aramco, 7. Ibid. 5

6 These listings could occur simultaneously or in multiple phases. Nothing in the charter indicates that a domestic listing would preclude a foreign listing at a later date. As it was before, there is no formal document available to the public explaining Aramco s organization or governance structure. In a country like Saudi Arabia, with a monarchy friendly to the company, this situation was sufficient for many years. But this charter serves the purpose of opening the company to the global investment community. Some media highlighted the news that Aramco became a joint stock company at the start of This provided little meaning or insight. In the United States or Britain, for example, virtually any large industrial company will be a joint stock company. It simply means that the company issues shares for the owner(s). It was a necessity for Aramco to become a joint stock company to privately sell shares to outside investors or go public. Despite inquiries to the company, at this point it is still unknown under what type of structure Aramco operated between 1988 and The charter answers some questions for early estimates of the valuation of Aramco, but even more than that, it helps pinpoint questions to be asked later in the process. Questions still to be answered are as follows: What dividends will be available for common and preferred shares? What is the feasibility for nonstate actors to bring shareholders together to nominate a sufficient number of board members to influence company decisions? If it seems that the limitations on nonstate actors influencing board members are too restrictive, then the valuation could be lowered. On the other hand, investors may see value in preferred shares that offer limited voting influence but higher dividends. In 2017, Saudi Arabia announced that it reduced the tax paid by Aramco from approximately 85 percent to 50 percent. In 2018, Saudi Arabia announced that Aramco would pay an adjustable royalty based on oil prices. Many wondered how Saudi Arabia would continue to fund its budget with significantly reduced revenue from Aramco. One avenue unrelated to Aramco is economic diversification, which would enable the government to obtain revenue from other sources. A second non-aramco avenue is the recently introduced value added tax and other new taxes applied within the kingdom. A third non-aramco avenue is debt, which is common among industrialized nations and which Saudi Arabia has used before to finance its budget during periods of low oil revenue or to pursue national infrastructure improvements. However, we can expect that Saudi Arabia will continue to earn significant revenue from Aramco, even at this lower tax rate. The state can receive dividends, which will supplement tax revenue and also increase the valuation of the company, because the dividends for the state will be the same as dividends for investors in the same class of stock. The state can also sell additional shares to the public to raise additional funds although the state would then own a smaller percentage of the company. Crown Prince Mohammad bin Salman has raised this possibility himself. In the long term, there is also the possibility for Aramco to repurchase shares through a buyback, thus raising the value of all shares and providing cash to the state. A future repurchase of shares (or multiple repurchases) is a significant possibility because Aramco has traditionally been a business with significant cash on hand. The charter should be seen to be in line with the greater government efforts to transform the Saudi economy through Vision 2030, the Public Investment Fund, and other endeavors. The charter ensures that Aramco will remain operating in its core area of business, energy and petrochemicals. It reassures other Saudi businesses and potential business creators or investors that Saudi Aramco will not become a competitor. The charter also specifically raises the possibility of providing stock to Aramco employees, most of whom are Saudis. This, in conjunction with the lack of income taxes, capital gains taxes, and gift taxes in the kingdom, has the potential to infuse cash into the Saudi economy at the worker and manager level. Not only will it benefit the Saudi employees, but also, because of the relaxed tax system, Aramco workers can invest in and gift funds to family, family businesses, etc. The government is the largest employer in Saudi Arabia, but there is a recognition that diverse private businesses are necessary for a healthy economy. Decentralized investment and spending through wealth received from Aramco stock would be a huge boost to the Saudi economy and the financial well-being of nonwealthy Saudis. 6