Go for Reliance stake; ditch JV with SABIC: HSBC to Saudi Aramco

HSBC Securities and Capital Markets (India) Pvt Ltd has a piece of advice for the world’s biggest oil producer, Saudi Aramco, which is in a dilemma whether to invest $15 billion in the oil-to-chemical business of Reliance Industries Ltd (RIL) for a 20 per cent stake or go for a joint venture with its own chemical manufacturing unit SABIC for a home-grown oil-to-chemicals (OTC) project worth over $20 billion.

“RIL might be a better fit for Aramco than Saudi OTC,” it said in a May 13 research note. “The basic problem is that without a cost advantage or a local market, spending $20 billion seems to be a sure-fire way to generate mediocre returns. Aramco doesn’t need to do the same thing again to recognise that it doesn’t work,” said HSBC Securities, as speculation swirls that Aramco could walk away from the deal due to falling oil prices and plunging demand following the Covid-19 pandemic.

Mounting losses

Aramco has struggled to execute on world-scale organic petrochemicals projects. Its last two large domestic chemical projects, Sadara and PetroRabigh have had $40 billion in combined capex between them but have both struggled for profitability, let alone an acceptable commercial rate of return. PetroRabigh incurred losses in three of the five years to 2019 while Sadara has been consistently loss-making since its 2016 start-up.

This is particularly relevant as Aramco is close to reaching a decision for its planned OTC (oil-to-chemicals) joint venture with SABIC. A decision, if taken, is expected to be taken over the next month.

“There is basically no history of a chemical plant in Saudi Arabia being built at a cost of over $10 billion that has generated a return. Besides the PetroRabigh and Sadara projects, there is also the example of the project by Saudi Kayan Petrochemical. These projects have had over $50 billion in cumulative capex spent on them and, since starting up, have racked up aggregate losses of $3billion,” it said.

HSBC said there were “enough reasons and significant advantages” for Aramco to acquire stake in RIL.

Promising future with RIL

With a stake in RIL, Aramco would not just have a stake in one of the world’s best refineries and largest integrated petrochemical complex but also access to one of the fastest-growing markets – a ready-made market for 500kbpd of its Arabian crude and offering a potentially bigger downstream role in future, it said.

If the current oil price environment does result in a rationalisation of capex for Saudi Aramco, then we think it would be the OTC project that gets pulled rather than the RIL investment, it said.

“While the timing may be far from ideal, RIL might be a better fit for Aramco than Saudi OTC. If it comes down to capital discipline, it would be the Saudi OTC project that could be scrapped in favour of an investment in RIL,” HSBC stated.

While there are clear near-term earnings and cash-flow pressures on Aramco, a corporate strategy isn’t set by a single year’s cash flow, HSBC said, adding that RIL checked all the four boxes that decide such a strategy. These four criteria are - customer for its upstream business, integration and value capture, reduction in cyclicality and access to markets/incremental growth.

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