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Saudi finds cheap way to be generous to Aramco
March 28, 2017 / 4:06 PM / 8 months ago

Saudi finds cheap way to be generous to Aramco

LONDON (Reuters Breakingviews) - Saudi Arabia has hit on a cheap way to spruce up the odds for its big oil producer’s initial public offering: cut its taxes. The move should deliver a sizeable uplift on Aramco’s value as it prepares to sell around 5 percent of the state-owned company to outside investors in an IPO. But it need not be a big drain on Saudi’s finances.

A Saudi Aramco employee sits in the area of its stand at the Middle East Petrotech 2016, an exhibition and conference for the refining and petrochemical industries, in Manama, Bahrain, September 27, 2016. REUTERS/Hamad I Mohammed - RTSPMKF

At present, the government takes money out of its biggest cash cow at three separate points: a royalty on revenue, tax on its income and a dividend. After the royal edict on Monday, the income tax payable from the beginning of this year will fall to 50 percent, from a previous rate of 85 percent.

That will have a giant effect on Aramco’s earnings. Assume that the world’s largest single oil producer pumps 3.8 billion barrels this year, which it sells at an average price of $53 per barrel, or just over $200 billion. A further $20 billion or so should come from associated gas and other products. Subtract royalties of 20 percent, and deduct production costs plus operating expenses of a combined $11 per barrel, and Aramco’s pre-tax profit would be $135 billion.

Tax that at the previous 85 percent rate, and it gives earnings of just over $20 billion. But cut the tax rate to 50 percent, and those earnings more than triple to almost $68 billion.

Aramco’s market capitalisation would, in theory, triple too. Place those earnings on a 20 times multiple, comparable with that of Exxon Mobil, and Aramco’s upstream operations could be worth $1.4 trillion. The real IPO valuation could be far higher if it includes Aramco’s downstream and refining businesses, or if the oil price increases.

The beauty of this plan is that it will leave Riyadh barely out of pocket. Since the government will still own 95 percent of the company and control its board, it could get most if not all of the extra earnings back in the form of dividends. Aramco’s tax saving in 2017 could be around $47 billion, based on the above calculation. But if all earnings are paid out to shareholders, Saudi will have effectively given away just 5 percent of that, or $2.4 billion, equivalent to 0.4 percent of GDP. Such generosity has never come so cheap.


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