March 24, 2020 [Bloomberg – Published on March 19, 2020] – Saudi Aramco released its first earnings report as a public company this week, and the oil giant’s management discussed the results with analysts on a call Monday.

 
By itself, Aramco’s 2019 financial performance wasn’t as strong as 2018, but not overly disappointing. However, these numbers show that Aramco — or more accurately the Saudi monarchy, which controls it — may have some hard choices ahead in 2020.
 
Falling demand for oil from the coronavirus outbreak — combined with the significant drop in prices sparked by Saudi Arabia’s actions to boost output and offer discounts following the breakdown of OPEC+ talks — means that Aramco will make even less money in 2020. Despite Saudi Arabia’s recent announcement that it intends to sell more oil, its profit is likely to fall substantially in 2020, which will force the monarchy to choose whether Aramco will honor its responsibilities to all shareholders as a publicly traded company or whether it will focus on funding the Saudi government.

This is an inflection point for Aramco and Saudi Arabia. The kingdom receives more than 60% of its revenue from the oil industry, and while it has options to help meet its budget — debt, austerity, or new taxes — it is truly reliant on Aramco payments. The government receives funds from Aramco mostly in three ways: a 50% income tax, a royalty on barrels of oil produced and a dividend.
 
With low profit expected in 2020, the cash transferred to the government for the income tax will be limited. With low oil prices, the royalty payments, which are 15% of the price of Brent, will be exceedingly low. And if the company upholds its commitment to public shareholders, there would be less profit left to pay a dividend to the government.

In 2019, net income for Aramco was $88.2 billion, down $22.9 billion from the year before. With Brent now trading significantly below its price at the start of this year, Aramco is looking at lower profits just like every other oil producer. Aramco is taking steps to increase its sales of oil, but it is also offering discounts to do that.
 
In all, revenue will be down significantly, and everyone at the company and in the government must know that. The company plans to drop its capital expenditures to between $25 billion and $30 billion, down from $32.8 billion in 2019, but this won’t be enough to counteract the lower revenue.

Lower profit isn’t the only bad news for the Saudi government. If Brent averages $35 per barrel, the government only receives $5.25 in royalties for each new barrel produced. Even if Aramco averages production of 12 million barrels per day — a major increase from earlier this year — the government would only earn $23 billion in royalties from crude oil.
 
Even if Aramco averages production of 12 million barrels per day — a major increase from earlier this year — the government would only earn $23 billion in royalties from crude oil. Comparatively, in 2018, Aramco paid the kingdom almost $55.6 billion in royalties and excise taxes. Unless prices rise, the royalty shortfall will be significant.

When it comes to dividends, the monarchy will have to make some critical decisions. In 2019, the company paid $73.2 billion in dividends, of which $3.9 billion were paid to public shareholders as a prorated portion since the December IPO. But Aramco committed to provide public shareholders with their share of a minimum of $75 billion in dividends, starting in 2020.
 
The government, the largest shareholder, isn’t supposed to receive any ordinary dividends until after non-government shareholders are awarded their portion, based on a $75 billion total payout. However, with a lower profit expected in 2020, there may not be enough profit to cover the entire public shareholder dividend. On top of that, the Saudi government may need some sort of special dividend to fund itself.
 
Free cash flow fell to $78.3 billion in 2019 from $85.8 billion the year before. If Aramco’s board, at the direction of the monarchy, provides a special dividend to the government, it could be pulling money from Aramco’s cash reserves. This would decrease the value of the company’s shares and hurt the Saudi population, 20% of whom bought into the IPO, often on leverage. It would also hamper any plans for another offering of company shares to raise further capital for the government.

The Saudi monarchy, with the assistance of a board that isn’t independent, could revisit its commitment to provide the $75 billion dividend to public shareholders. The company also could decide to give the government leeway on the reimbursements owed to Aramco for the energy and petrochemicals it supplies to Saudi Arabia. In 2019 this equaled $35 billion.
 
But these would betray non-government shareholders and hurt the stock price. If Aramco’s board of directors fails to provide the $75 billion dividend to all public shareholders, and, worse yet, if it funds the government at the expense of the company, it will mean that the monarchy has proclaimed Aramco to be a tool for its power and not public firm at all. And, because it is listed solely on the Saudi exchange, there will be no recourse for any shareholders, except for the loss of faith in the company and a stigma on its shares.

————-