High Dividend Cripples World's Largest Oil Company -- Simon Watkins -- July 12, 2021

Updates

Later, 10:05 p.m. CT: Saudi Arabia foreign change reserves, link here. I think this is an all-time low in modern history.

Original Post 

Regular readers (and almost all others interested in oil and gas) are aware of this story, but it's always enjoyable to re-live a bit of schadenfreude. Simon Watkins, always very good, may add some new details. 

The transformation of Saudi Arabia’s flagship asset, Aramco, from perpetual cash-generation machine into a debt-laden giant is set to pick up pace in the coming weeks with a series of schemes aimed at raising much-needed funding for the now-beleaguered oil and gas company.  

It has not been forgotten by many senior Saudis that the reason for this terrible transformation of the former jewel in the crown of Saudi Arabia’s business sector - and the cornerstone of any power that the Kingdom might have had on the world stage – into a crippled corporate money pit is that Crown Prince Mohammed bin Salman (MbS) did not want to lose face in the initial public offering (IPO) for Aramco upon which he had staked his personal political reputation. 

Having opened up the books of Aramco to the scrutiny of the international investment community in the run-up to the December 2019 IPO, so toxic a proposition was Aramco considered to be by then that a range of increasingly desperate measures were taken to sell even a small proportion of the originally intended stake. The most desperate of these was the pledge to guarantee a dividend payment to shareholders in Aramco of US$18.75 billion every single quarter of every single year – a total of US$75 billion every single year.

In other words, each and every year, Aramco has to pay out around three times the entire amount that it received for the entire IPO. Just like the individual who cannot afford the interest repayments on their maxed-out credit card anymore so decides to take on a second credit card debt to pay the interest on the debt of the first – a deadly debt trap from which there is no exit – Saudi Arabia now has no alternative but to continue to sell off assets (the equivalent of selling the family silver, and this can only be done once), sell more bonds (taking on more debt and the interest on this form of Saudi debt is going up with every such sale), and cancel projects (which are crucial to the long-term success of Aramco). 

Much more at the link. But four more paragraphs because I want to showcase a "new" word.

The entire list of money-raising schemes reads like a business school text book of how a company can destroy itself in less than five years. In this case, the start date was 11 December 2019 when the IPO of Aramco was forced through by MbS, despite all sound business logic dictating that it should be put on ice indefinitely due to the lack of broad-based interest from any serious international institutional investors, especially in the West. Since then there have been multiple bond offerings from Saudi Arabia aimed at plugging the ongoing deficit created by the gargantuan US$75 billion per year guaranteed dividend payment to Aramco shareholders.

 The problem with this strategy is that the global investment market has a limit to how much Saudi debt it wants to hold at any one time or, to put it another way, in the matrix of their global asset portfolios, international institutional investors have a certain percentage of the total allocated to holding Saudi debt, at which level the risk/reward balance is considered acceptable. After that point, the appetite of international institutional investors drops off a proverbial cliff and the only way to entice them into buying into further debt offerings is to pay them more compensation to take it, in the form of the coupon rate on the bonds. Exactly the same risk/reward analysis, albeit across a broader spectrum of a country’s and corporate’s financial assets, is undertaken by revolving credit facilities offered by banks or similar rating debt-raising mechanism, such as syndicated loans. Just like the aforementioned credit card victim that has reached bottom, there comes a point when the options to refinance the ever-growing debt and its ballooning interest payments just run out.

A sign that this is precisely what is already happening to Saudi Arabia was that the most recent bond sale – in June – was confined to a shariah-compliant bond (sukuk) offering and not a conventional international bond offering as had been the two previous bond offerings by the company (a debut US$12 billion sale in 2019 and an US$8 billion offering in November last year). The market for bonds governed by shariah principles – forbidding investing in activities that can be deemed speculative, involve uncertainty, entail the payment of interest, are fundamentally unjust to participants, or are involved in prohibited businesses (such as gambling, alcohol, and the sale of certain foodstuffs) – is a captive one, often characterised by a lack of suitable supply compared to a steady weight of demand.

The ‘suitability factor’ narrowed the sukuk availability list down further after 2008 when a wide-ranging audit by the global shariah finance watchdog - the Accounting Auditing Organisation for Islamic Financial Institutions (AAOIFI), in Bahrain – revealed that the repurchase undertakings found in around 85 percent of apparently shariah-compliant bond- and equity- fund structures that were based on ‘mudaraba’ and ‘musharaka’ actually violated the Islamic duty to share risk. Given this market structure, even the ‘junk-rated’ Oman was able to draw in more than US$11.5 billion in orders for its US$1.75 billion sukuk offering in June. Saudi Aramco’s US$6 billion tri-maturity sukuk offering did only marginally better, attracting just over US$60 billion in total bids for the paper.

Archived.

Sukuk: if one reads the definition of "sukuk" closely, it sounds like "sukuk" is more like an equity share, not a bond.

Memo to self: add a new tag at the bottom of the blog -- schadenfreude.