London missing out on Aramco IPO could be a blessing in disguise

Saudi Arabia is getting deadly serious about the stock market flotation of state oil giant Aramco, just not in London.

Once tipped as a potential host for what could be the world’s largest initial public offering, Brexit chaos and the prospect of Jeremy Corbyn seizing power have significantly diminished the City’s chances of becoming the international home for Aramco’s shares. Missing out would be a blow to prestige, but it could also be a blessing in disguise.

Aramco – which the kingdom’s Crown Prince Mohammed bin Salman believes is worth $2 trillion – would tether the overall performance of the London Stock Exchange’s main market dangerously to the unpredictable price of crude along with the decisions of OPEC and its allies. Despite the cartel striking a pact with Russia to restrict output and boost prices, Brent crude trading at around $60/b is still at a level almost 40% lower than it was five years ago.

British oil companies such as BP and Royal Dutch Shell already account for around 15% of the total market capitalization of the FTSE 100, which is a tolerable risk for tracker funds. The addition of Aramco – which pumps four times more crude than both Shell and BP combined – would make oil producers the largest constituents of any sector on the FTSE, effectively turning it into a petrodollar index.

The performance of Saudi Arabia’s domestic stock market, known as the Tadawul, should act as a warning for the LSE. Since 2014, when crude was trading closer to $100 per barrel, the Tadawul All Share Index has lost a third of its value. The performance of the kingdom’s top listed companies is closely linked to the health of its fossil fuel-based economy, which needs oil to trade at around $80/b in order to function properly.

However, after it raises upwards of $100 billion selling a 5% stake in Aramco, the kingdom may decide to change policy and increase production. Such a move could hurt international investors, but they would have no way to stop it. “It is certainly relevant to ask whether the Saudi leadership’s incentive to support oil prices will wane following a successful Aramco listing,” RBC Capital Markets warned in a research note last week.

ESG and investor activism

There is also a moral question for London to consider. The alleged assassination of the Saudi journalist Jamal Khashoggi by agents in the kingdom’s consulate in Istanbul last year cast a dark cloud over the country’s international reputation. Many global CEOs cancelled plans to attend a high-profile economic conference hosted by the crown prince in the wake of the killing.

A listing on the LSE would test the City’s commitment to encourage tougher environmental, social and governance standards (ESG). Oil companies are already facing an investor backlash in the UK, where calls to divest from fossil fuels by pension funds have intensified. National Trust plans to divest its portfolio from oil companies, while the Church of England hopes to use its investment to put pressure on hydro-carbons producers.

Although well meaning, such tactics would not work in Riyadh. The country’s rulers are unlikely to give foreign shareholders any significant say in how their biggest cash cow operates. Listing Aramco in London would also be like poking at a hornets nest of political opponents, like the Extinction Rebellion activists who are eager for an excuse to bring the Square Mile to a standstill.

From the Saudi perspective, London must look utterly toxic and the last place on earth where they would entrust their most prized jewel. The fraught nature of the Brexit debate and deep political divisions it has exposed has bewildered the kingdom’s decision makers, who once viewed Britain as stable. Previously, they may have considered the City the best international financial centre for Aramco, but now Tokyo would appear a better choice.

Nor does the thought of one day being forced to deal with a potentially hostile Corbyn-led government because of Aramco appeal to Riyadh. The Labour leader has pledged to amend the Climate Change Act requiring the publication of total carbon footprint figures for all goods and services in the UK.

In theory, this could also ensnare a London-listed Aramco, which has access to over 260 billion barrels of oil under the kingdom’s deserts. Corbyn’s desire to ban arms sales to Saudi would also damage relations irreparably with one of Britain’s closest international allies and most important trading partners in the Middle East.

Saudi is determined to push on with an IPO of Aramco, but almost definitely not in the City.