LONDON/DUBAI: Saudi
Aramco's biggest asset could also be a liability. The state energy giant's vast
oil reserves - it can sustain current production levels for the next 50 years -
make it more exposed than any other company to a rising tide of environmental
activism and shift away from fossil fuels.

In the three
years since Saudi Crown Prince Mohammed Bin Salman first proposed a stock
market listing, climate change and new green technologies are putting some
investors, particularly in Europe and the United States, off the oil and gas
sector. Sustainable investments account for more than a quarter of all assets
under management globally, by some estimates.

Aramco, for its
part, argues oil and gas will remain at the heart of the energy mix for
decades, saying renewables and nuclear cannot meet rising global demand, and
that its crude production has lower greenhouse gas emissions than its rivals.
But with the company talking again to banks about an initial public offering
(IPO), some investors and lawyers say the window to execute a sale at a juicy
price is shrinking and Aramco will need to explain to prospective shareholders
how it plans to profit in a lower-carbon world.

"Saudi
Aramco is a really interesting test as to whether the market is getting serious
about pricing in energy transition risk," said Natasha Landell-Mills, in
charge of integrating environment, social and governance (ESG) considerations
into investing at London-based asset manager Sarasin & Partners. "The
longer that (the IPO) gets delayed, the less willing the market will be to
price it favorably because gradually investors are going to need to ask
questions about how valuable those reserves are in a world that is trying to
get down to net zero emissions by 2050."

Aramco told
Reuters it was ready for a listing and the timing would be decided by the
government. The company also said it was investing in research to make cars
more efficient, and working on new technologies to use hydrogen in cars,
convert more crude to chemicals and capture CO2 which can be injected in its
reservoirs to improve extraction of oil.

Selling the story

Some would argue
this is not enough. A growing number of investors across the world are
factoring ESG risk into their decision-making, although the degree to which
that would stop them investing in Aramco varies wildly. Some would exclude the
company on principle because of its carbon output, while others would be
prepared to buy if the price was cheap enough to outweigh the perceived ESG
risk - especially given oil companies often pay healthy dividends. At a $1.5
trillion valuation, Aramco would be the world's largest public company. If it
were included in major equity indices it would automatically be bought by
passive investment funds that track them, regardless of their ESG credentials.
And as the world's most profitable company, Aramco shares would be snapped up by many active investors.

Talks about a
share sale were revived this year after Aramco attracted huge investor demand
for its first international bond issue. In its bond prospectus, it said climate
change could potentially have a "material adverse effect" on its
business. When it comes to an IPO, equity investors require more information
about potential risks and how companies plan to deal with them, as they are
more exposed than bondholders if a business runs into trouble.

"Companies
need to lead with the answers in the prospectus, rather than have two or three
paragraphs describing potential risks from environmental issues," said
Nick O'Donnell, partner in the corporate department at law firm Baker McKenzie.

"An oil and
gas company needs to be thinking about how to explain the story over the next
20 years and bring it out into a separate section rather than hiding it away in
the prospectus, it needs to use it as a selling tool. And also, once the IPO is
done, every annual report should have a standalone ESG section."

Aramco's senior
vice president of finance Khalid Al-Dabbagh said during an earnings call this
month that its carbon emissions from "upstream" exploration and
production were the lowest among its peers. A study published by Science
magazine last year found carbon emissions from Saudi Arabia's crude production
were the world's second lowest after Denmark, as a result of having a small
number of highly productive oilfields.

The oil price

Aramco says that,
with the global economy forecast to double in size by 2050, oil and gas will
remain essential. "Saudi Aramco is determined to not only meet the world's
growing demand for ample, reliable and affordable energy but to meet the
world's growing demand for much cleaner fuel," it told Reuters.
"Alternatives are still facing significant technological, economic and infrastructure
hurdles, and the history of past energy transitions shows that these
developments take time."

The company has
also moved to diversify into gas and chemicals and is using renewable energy in
its facilities. But Aramco still, ultimately, represents a bet on the price of
oil. It generated net income of $111 billion in 2018, over a third more than
the combined total of the five "super-majors" ExxonMobil, Royal Dutch
Shell, BP, Chevron and Total. In 2016, when the oil price hit 13-year lows,
Aramco's net income was only $13 billion, according to its bond prospectus
where it unveiled its finances for the first time, based on current exchange
rates. Its earnings fell 12 percent in the first half of 2019, mainly on lower
oil prices.

Concerns about
future demand for fossil fuels have weighed on the sector. Since 2016, when
Prince Mohammed first flagged an IPO, the 12-months forward price to earnings
ratio of five of the world's top listed oil companies has fallen to 12 from 21
on average, according to Reuters calculations, lagging the FTSE 100 and the
STOXX Europe 600 Oil & Gas index averages. By comparison, UK-listed funds
investing in renewable energy infrastructure such as wind farms are trading at
one of the biggest average premiums to net asset value.

An influx of
capital

Using a broad
measure, there was global sustainable investment of $30.1 trillion across the
world's five major markets at the end of 2018, according to the Global
Sustainable Investment Review. "Given the influx of capital into the ESG
space, Aramco's IPO would have been better off going public 5-10 years
ago," said Joseph di Virgilio, global equities portfolio manager at New
York-based Romulus Asset Management, which has $900 million in assets under
management.

"An IPO
today would still be the largest of its kind, but many asset managers focusing
solely on ESG may not participate." The world's top listed oil and gas
companies have come under heavy pressure from investors and climate groups in
recent years to outline strategies to reduce their carbon footprint. Shell, BP
and others have agreed, together with shareholders, on carbon reduction targets
for some of operations and to increase spending on renewable energies.

US major
ExxonMobil, the world's top publicly traded oil and gas company, has resisted
adopting targets. Britain's biggest asset manager LGIM removed Exxon from its 5
billion pounds ($6.3 billion) Future World funds for what it said was a failure
to confront threats posed by climate change. LGIM did not respond to a request
for comment on whether it would buy shares in Aramco's potential IPO. - Reuters