Musings: A Real Game-Changer - Saudi Aramco's ATP Effort?

In a speech in Washington, D.C. in mid May, Saudi Aramco's President and Chief Executive Officer, Khalid A. Al-Falih, outlined for the first time in public, the company's new Accelerated Transformation Program (ATP) that will transition Aramco from "an oil and gas company to a fully integrated global energy enterprise." After reading the speech and other information about the program, one realizes this transformation may become one of the most significant game-changers impacting the international oil and gas, energy and chemical industries. The speech was delivered at a dinner in the capital city recognizing the men and women of the Saudi Aramco Management Development Seminar Class of 2011, part of a 30-year management development program. It is interesting that this program is held in Washington, but, as Mr. Al-Fatih explained, it reflects the long-standing ties of the Kingdom and the United States and the recognition that the "city provides for the participants to gain a better understanding of the complex economic and political factors that shape the formulation of international business strategy."

Mr. Al-Falih went on to cite the anchor of the relationship between the United States and Saudi Arabia as the "mutually beneficial interdependence of the world's leading consumer of energy and the world's largest petroleum exporter." While reciting the long history between the two countries and its people and how Americans and American oil companies helped build Saudi Arabia's oil company and its economy, he also stated Aramco's view of its key role in global energy markets. That role is "in fostering global energy security and petroleum market stability through both the reliability of its operations and its investment in significant spare production capacity."

In describing some of the changes the new Aramco will reflect, Mr. Al-Falih described how the company's upstream exploration and production business will extend its activities into frontier areas within the Kingdom, which includes the deep waters of the Red Sea, and developing new unconventional natural gas resources, including tight gas and shale gas. In the downstream sector, Aramco is pressing ahead with the massive expansion of its global refining capacity and continuing with refining and chemicals integration and expansion in the U.S., Korea and China. The company is also working hard to develop renewable, nonconventional resources and environmentally beneficial technologies. These latter efforts are underway despite Aramco's view that even 25 years from now the world will still derive the greatest portion of its energy supply mix from crude oil. In other words, Saudi Arabia will still be the major domo in the crude oil world!

Mr. Al-Falih went to great lengths to discuss how the world in which his company is operating is changing. These changes included energy consumption, technology, geopolitical and social relationships and environmental issues. He pointed out that energy consumption patterns in the world are shifting as living standards in the developing world rise. He believes that advanced technology continues to alter the ways in which Aramco will be running its business in the future. 

But probably the biggest challenge for the new Aramco will be the demographic changes underway at the company, and in the Kingdom itself. Saudi Arabia has a very large youth population and Aramco is facing a significant number of employees who will be retiring during the next decade, just like virtually the entire energy industry. As a result of the above changes, and especially the demographic one, Mr. Al-Falih concluded, "Such challenges and opportunities are not met simply through production capacity increases or the development of another set of megaprojects; rather, they require a set of fundamental changes in the way we do business, in the expectations we have from our people, and in the expectations they in turn have from our company."

Mr. Al-Falih closed his speech with the following point: "…the future of the energy industry – and indeed, the global business environment – will be marked by greater complexity…."  He went on to say "that complexity will be coupled with significant new opportunities which hold tremendous potential and promise." The punch line, and the point that those of us in the energy industry must contemplate is: "That is why ten years from now, when the world looks at Saudi Aramco it will see a global energy company that still has that power to provide, but which also is better, faster and smarter, and even more capable of making a lasting difference in the Kingdom and beyond."

Exhibit 1.  The Evolution Goal For Saudi Aramco
Saudi Aramco Charts a Course for the Future
Source:  Saudi Aramco News

An interesting release was issued at the end of May by Saudi Aramco News, which was a question-and-answer session with a number of senior Aramco executives answering questions about the ATP. The release began with a paragraph framing the issue thusly. "How would you like to see Saudi Aramco develop over the next 10 to 20 years? Gradually, through incremental changes and the odd improvement here and there? Or fulfilling its full potential through a fundamental transformation, not just reacting to events but creating new opportunities and proactively shaping its operating environment – inside and outside the company?" The news story related that the ATP effort was the result of a year-long strategic review that involved detailed assessments of global and regional trends and the business challenges they potentially represent for Aramco over the next two decades.

In response to a question about the timing of the ATP effort, the answer was that "many companies transform because they are faced with adversity, but the best transform while they are doing well in order to capitalize on opportunities and realize their full potential."  This is an interesting and astute observation about how successful companies evolve. 

The statement buried in the Q-and-A that we found most interesting was that "the foundations of Saudi Aramco's future will remain in those reservoirs [the current prolific producing fields of Saudi Arabia], but the Kingdom and the company will have a future that is larger and more diverse." The timing of the disclosure of the ATP initiative is curious. It comes at the same time the media discovered that the Kingdom has begun a foreign relations effort aimed at creating an alliance of Muslim countries to provide a counter-balance to a militant Islamist Iran. When this effort was revealed, much was made about the alignment being really an attempt to support countries with aging despotic rulers. Many of the target countries, however, have existing oil and gas production, some of which is in decline. They have their own national oil companies, but none of them are as technologically advanced as Saudi Aramco. Might Aramco become an agent of political development for the Kingdom in its effort to secure the alignment of these other countries? 

Why couldn't Aramco replace the international oil companies (IOCs) that are working with the national oil companies in these countries? Might the Kingdom be willing to structure more financially appealing deals with the governments than the IOCs? While we have no answers to these questions, we think it is extremely interesting to play out a scenario of what this might mean for the IOCs, Aramco, the global oil industry and Middle East politics. 

Today, national oil companies hold more than 95% of global oil reserves, up from less than 15% in the 1960s. Given this ownership mix, the IOCs have been able to work in many of the countries under cost recovery/profit sharing arrangements. Under our scenario, the IOCs could be displaced by Aramco under an arrangement that provides even more profit per barrel for the host governments. How might the IOCs respond? We would expect them to place an even greater emphasis on the unconventional resources of North America and Europe. There is little doubt but that the sandbox the IOCs currently play in would shrink, therefore to effectively use their cash flows they would have to ramp up spending and investment in these unconventional plays. The loss of some of their international opportunities would hurt the profitability of the IOCs, which in turn would force them to reassess how they allocate their cash flows between E&P investing and return of capital to shareholders. We would not be surprised if the IOCs became aggressive acquirers of domestic E&P companies as a way to build their exposures to unconventional resources. That would certainly alter the structure of the global oil and gas industry.

Inside the Kingdom, the ATP effort probably means that Aramco would be aggressively developing more lower-valued fuel supplies that could displace domestic oil use and provide the government with more oil available for export. The tie-in with other countries also would provide greater intelligence for Aramco about global oil reserves and productive capacity. It would make the Aramco-influenced group of countries a more powerful group within OPEC, or even an expanded OPEC. Saudi Arabia would be in position to exercise even greater control over global oil markets.

At the present time, on a barrel of oil equivalent basis, Iran controls the largest amount of oil and gas of any company, and it is slightly larger than Saudi Aramco. With greater influence over global oil and gas reserves, Saudi Arabia could exercise its oil market power in a geopolitical manner, similar to what happened in the 1970s through the mid 1980s. The big unknown in this scenario is who will provide

Exhibit 2.  Role Of IOCs In Global Reserves
Saudi Aramco Charts a Course for the Future
Source:  Money and Wealth

leadership for the Kingdom as its aging ruler and his aging brothers exit from the world stage. 

As we learned about the ATP effort and the political maneuvering of the Saudi Royal family, and began to consider the possible ramifications, we were struck by the idea that this could be as big a game-changer for energy industry as the peaking of U.S. oil production in 1971. Game-changers are always talked about, but true game-changers are seldom recognized at the time. Their significance is only appreciated with appropriate hindsight. We nominate this development as a possible game-changer to watch.