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Historic energy sector liberalization Partial privatization of energy sector assets could represent one of the cornerstones of the ambitious medium-term diversification strategy, and, if confirmed, serve as a highly visible and historic milestone. Such privatizations could ease key macro concerns regarding unsustainable debt accumulation and Fx reserves drawdown. We believe it would also confirm the government’s macro reform credentials, its preparedness for a prolonged period of low oil prices and likely signal no near-term energy policy capitulation. The NTP suggestion of a flat production capacity through 2020 suggests less aggressive market share strategy, in our view. Privatization of energy sector could start by 2018 In a recent interview with Bloomberg, Saudi Deputy Crown Prince Mohammed bin Salman outlined an array of measures the Saudi government could introduce to help diversify the economy, reduce its reliance on the hydrocarbon industry and ultimately support medium-term fiscal consolidation in a low oil price environment. Amongst these measures, the Deputy Crown Prince included a potential Initial Public Offering (IPO) of Saudi Aramco (at the parent level, and including various subsidiaries). With close to 250bn bbls of oil reserves, more than 10mn bbls per day of production and the world’s Ath largest gas reserves, Saudi Aramco is the leader in hydrocarbon access among state owned, private and public Oil & Gas (O&G) companies alike. Saudi Aramco is the world’s largest Oil & Gas Company by production and arguably the Kingdom’s most important asset. Specifically, he outlined a plan that would see “less than 5%” of the company being sold to investors on the Saudi stock exchange no later than 2018 (but potentially as soon as 2017). Furthermore, he indicated the Kingdom is seeking to transform Aramco into an “energy-industrial company”. The high profile stake sale would provide a highly visible anchor to diversification efforts and capitalize its newly restructured SWF. Energy assets form a major and strategic sector for the economy It is hard not to understate the central role the energy sector plays in the Saudi economy. The hydrocarbon sector represented 43.0% of the economy in real terms in 2015. Deputy Crown Prince Mohammed bin Salman suggested a USS2trn price tag for Saudi Aramco in his Bloomberg interview. Aramco is deeply intertwined with the Saudi state, and its workforce Saudization has increased over the years to 83%. Furthermore, it is the foundation of its state’s domestic and international energy policy. As such, a decision to partially privatize the energy sector will be a momentous one to be carefully examined by the technocratic and political leadership, in our view. More questions than answers at this stage Deputy Crown Prince Mohammed bin Salman’s initial suggestion in an interview with The Economist that a Saudi Aramco IPO could be considered has raised market expectations. Ensuing comments from Aramco’s management did not make clear whether a listing would occur, and if so, in what form (upstream versus downstream), although the Deputy Crown Prince’s subsequent Bloomberg interview suggested further impetus being given to studying the matter. A listing of the entity itself may force much more transparency regarding hydrocarbon reserves (broadly unchanged for several years), lifting costs (local crude oil sales suggest cUSS5/bbI if no loss is incurred) and the fiscal regime (estimates in the press have suggested that Aramco’s profits are taxed at 85%, with royalties set at 20%, but we also note from fiscal data that the fiscal transfer ratio in oil revenues to the Ministry of Finance appears to drop in years of low oil prices). It may also conflict with non- commercial ventures or strategic aspects of Saudi Aramco. This would include the maintaining of spare capacity and state policy matters (including energy policy). Note for instance that the US is the second regional destination for Saudi crude oil exports (17.5% of total Saudi crude oil exports) behind Asia. This was due to a strategic geopolitical decision to remain an important crude oil supplier to the US and was achieved through the buying of stakes in refineries in 1988. 10 GEMs Paper #26 | 30 June 2016 38 Merrill Lynch HOUSE_OVERSIGHT_016120