Opinion: How the pending Aramco IPO could cause a surge in oil prices
The Saudi energy company and its underwriters, aiming for the largest IPO in history, will ensure oil prices rise before the offering
The all-star underwriting team to the Saudi Aramco IPO will lead to a barrage of institutional support. And that could lead to higher oil prices. Investors, take note.
J.P. Morgan JPM, -1.13% Morgan Stanley MS, -1.40% and HSBC HSBC, -1.20% are the lead underwriters. But investment banks from all over the world will be clamoring to get a piece of what is expected to be the biggest initial public offering in history, expected some time next year. A Saudi official estimated the company is valued at more than $2 trillion, though the stake being offered in Saudi Arabian Oil Co., known as Saudi Aramco, is much smaller. Underwriting the IPO gives the underwriters control — and in a position to make the most money.
Ultimately, this is what it comes down to — money — and my experience suggests that in the investment-banking world, this is always true. In fact, investment bankers are typically described as money hungry and greedy. In most cases, the company going public doesn’t mind at all.
Biggest IPO in history
After all, the company going public, in this case Aramco, wants the best price possible too, and Saudi Arabia also wants the icing on the cake, which would be to have the IPO of their oil assets be the biggest IPO in history. As a result, there is an incentive both by Aramco (Saudi Arabia) and the underwriters, which have now been officially announced, to get the best price possible.
Oil prices CLK7, -0.75% today are trading at around $50 per barrel, down from almost $100 in mid-2014. That’s because OPEC nations boosted production to lower prices in an effort to damage U.S. shale companies. But that would have to end if Aramco wants a whopper of an IPO. OPEC more recently agreed to cut production to bolster prices.
IPO price tied to oil prices
Sometimes underwriting an IPO and pitching it to investors can be complicated, but in this case a relationship is relatively easy to identify. The value of the assets is directly tied to the price of oil. The higher the oil price, the higher the price of the IPO. But the opposite also holds true. If oil prices are low, the IPO will be priced lower as well, so the determining factor is obvious. There were only two energy IPOs in 2016.
This is where the institutional support can really make a difference. The underwriters that are appointed to take this deal public and advise on the finances of the deal are in a position to profit most. They largely control the international distribution of shares among other investment banks, and as a result can now comfortably set a clear precedent.
The investment-banking community is relatively small, although it’s capable of bringing massive deals to market. And within this rarefied group are unwritten agreements.
In fact, when I was working at Morgan Stanley, I knew of a policy directed at individual investors. Those who wanted to get shares of the good IPOs needed to be willing to take shares of the ones that were not so good as well. It wasn’t part of an official agreement, but everyone knew that allocations of IPOs that were more likely to open significantly higher than where they were priced, which would make an investor big money right off the bat, were not made to investors who did not consistently participate in other investment-banking deals.
Because the relationship between oil prices and the price of this upcoming IPO are so closely correlated, and because investment banks often have divisions that make this possible, we expect the investment banks that are directly participating in this IPO to be bullish on oil prices. And we expect an unwritten rule to exist too.
In other words, the investment banks that are not direct underwriters will be encouraged to support oil prices as well. I don’t, of course, expect this to be part of any contract. But given the direct relationship of oil to the pricing of this IPO and the influence institutional firms have over oil prices, it is clear to me that incentive will be there for any investment bank who wants a piece of the deal to support oil prices at the institutional level from this point forward and until the IPO comes to market.
Thomas H. Kee Jr. is a former Morgan Stanley broker and founder of Stock Traders Daily.
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