Here's why Saudi Aramco's IPO could wreak havoc in the oil markets

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Saudi traders

REUTERS/Fahad Shadeed

The public listing of Saudi Arabia's state-owned oil company, Aramco could be terrible news for the oil industry in the long term, squeezing out smaller producers and causing big issues with imbalances in the market.

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In a new note from staff at Bernstein, the research firm argues that Saudi Aramco's IPO - which is stated to occur in 2018, and would make the state oil giant the most valuable publically listed company on earth - could have a huge impact on the markets.

Bernstein's basic argument is that once the company is publically listed and accountable to shareholders, it will increase its efficiency and boost production above current levels, in turn hitting smaller oil producing nations and causing price volatility to shoot up.

Here are the crucial quotes from Neil Beveridge, Oswald Clint, and Tracy Pun (emphasis ours):

Longer term however, a (partially) privatized Aramco would likely become more efficient and likely to want to increase capacity and production over current levels, assuming that the resource base can support this (which remains an 'if'). This has negative implications for oil markets given the modest levels of capacity additions which are currently expected from Saudi over the next 5 years.

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How spare capacity will be managed under a privatized Aramco is also unclear. While the recently appointed Saudi Oil minister has commented 'that it would be up to the government to make decisions on production and capacity, leaving the company to demonstrate the benefits of this arrangement to investors', there will be increased pressure to maximize spare capacity which could lead to greater volatility in oil markets.

The planned Aramco IPO is part of Saudi Arabia's Vision 2030, an initiative being spearheaded by millennial Prince Mohamed bin Salman to help wean the country off its so-called "oil addiction." Essentially, the IPO is designed to create a new revenue stream for the country, which, among other things, is also looking to increase the role of the services sector, and increasing revenues from religious tourism to Islamic holy sites like Mecca. Should it fail to address those problems, HSBC noted in May, the country faces "stagnation and decay."

Saudi is currently running a huge budget deficit, and just last month it was downgraded by credit ratings agency Moody's. While it attempts to sort out its own problems with the Aramco IPO, it could fundamentally change the oil market for the rest of the world's producers, exporters, and importers.

However, while Bernstein notes that the Aramco IPO is likely to be a negative event for the markets in the longer term, short term, it may actually be pretty good news. Essentially, Bernstein argues that when the IPO occurs in 2018, Saudi Arabia will want the oil markets to be as stable as possible and for the oil price to be "favourable." This suggests that in the next couple of years, Saudi will do everything it can to keep things steady, and keep prices reasonably high.

Here's the key line from Bernstein's report:

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We assume that Aramco will pick their timing to ensure that listing occurs in an environment of stable but favorable oil prices. This implies that in the near term we should not expect Saudi to 'flood the market' with oil as some have suggested.

Bernstein continues: "In the near term ... Saudi will not want to list Aramco at a low oil price. In the run up to 2018, we expect that Saudi will do everything in its power to ensure oil markets remain balanced and prices stable. This could be positive near term for oil equities."

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