More Thoughts on the Value of Saudi Aramco

 

Takeaway

  • Valuation needs to include extraction costs, discovery and production capabilities, payouts and discount rate.

Now that I have many responses to my query about the value of Saudi Aramco, I would like to add my own two cents. The Financial Times estimate of $7 trillion is very rough. They were simply suggesting that if the Saudi Aramco reserves were 15-20 times as large as those held by ExxonMobil, then Saudi Aramco should be worth 15-20 times as much.

Costs of Extraction?
Among other things, this analysis ignores the costs of extraction – for example, I suspect that the cost of extracting Saudi Aramco’s reserves are less than the costs of extracting most of ExxonMobil’s current reserves. Moreover, ExxonMobil’s reserves will be extracted within the next 20 years, while Saudi Aramco is likely to be pumping oil from their existing reserves for at least the next 50 years.

The Financial Times analysis also ignores differences in the two firm’s abilities to profitably discover and exploit new reserves. I think I would give the nod on this dimension to ExxonMobil.
Finally, both firms have substantial assets in chemical plants, refineries etc., that are not included in these calculations.

A Rough Valuation
My own (equally rough) valuation of Saudi Aramco involves discounting the firm’s future cash flows back to the present. Saudi Aramco is currently producing about 4 billion barrels of oil per year, which at current prices is worth a bit more than $300 billion. We must then make an assumption about the annual costs of extraction--which probably run about $40 to $80 billion.

Finally, we need to estimate how much of the company’s annual profits is going to be paid to the Saudi people in the form of taxes and royalties. Let’s assume that the government takes somewhere between 30% and 50% of the profits, leaving Saudi Aramco with, very roughly speaking, between $110 billion and $180 billion in annual profits.

If we believe that the firm’s annual profits are roughly equal to its annual cash flows and we assume that this cash flow will grow by about 5% per year (because of a combination of rising oil prices and an increase in output), and if we use a 10% discount rate, then the value of Saudi Aramco would be between $2.2 trillion and $3.6 trillion. This estimate is considerably lower than the $7 trillion reported in the Financial Times.

Could we justify a $7 trillion value with this methodology? Probably, but the assumptions would have to be very aggressive. In the survey, over half of the respondents suggested that 10% of Saudi Aramco would be worth less than $400 billion, with the most respondents suggesting that the value would be between $200 billion and $400 billion. I think that is about right.

Disclaimer

The views expressed are those of the author and not necessarily The University of Texas at Austin.
 

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About The Author

Sheridan Titman

Walter W. McAllister Centennial Chair in Financial Services, McCombs School of Business

Sheridan Titman is a professor of finance at The University of Texas at Austin and a research associate of the National Bureau of Economic...

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