The qualitative risk analysis of the biggest IPO in century. This is one of my essay in Risk Management moduke in the University of Manchester

1. The University of Manchester
MGDI71432
Qualitative Risk Assessment of Investment in Saudi Aramco
I Made Suandi Putra
Word Count : 2,098
Course Title : Risk Management
Course Code : MGDI71432
Date : April 24th
, 2017

2. 1
Qualitative Risk Assessment of Investment in Saudi Aramco
1. Introduction
In January 2016, Deputy Crown Prince of the Kingdom of Saudi Arabia (KSA),
Mohammed bin Salman, said that the Kingdom would consider privatizing their national oil
company, Saudi Aramco. This statement immediately became a hot issue not only among oil
and gas business actors but also among investors in the capital market as this privatization will
be the largest deal in the history of the capital market as the company value could worth more
than $2 trillion (Bahgat, 2016). By selling 5% ownership of its shares to the public and privatize
its downstream businesses, Saudi Aramco is predicted to raise $100 – 150 billion of capital
(McDonald, 2016).
Some of the things that must be considered in making investments in Saudi Aramco
related to the political conditions of The KSA and the prospects of the oil industry and
downstream industry based on oil and energy market condition. This Essay will present a
qualitative risk assessment of investment in Saudi Aramco. First, risk identification will be
presented. Secondly, risk analysis and mitigation efforts that can reduce the probability and
impact of those risks are presented in detailed risk assessment. Finally, the risk assessment that
has been done will be presented in the risk register.
2. Qualitative Risk Assessment
Merna and Al-thani (2008) define risk as “the likelihood of something undesirable
happening in a given time”. In the context of investment, (Donwa et al., 2015) says that risk
for investors is the probability that the actual return on investment below the expected return.
Risk assessment is conducted to measure the probability and impact of the occurrence of
the identified risks (Merna and Al-thani, 2008). Risk assessment can be done with both
qualitative and quantitative methods, but this paper will focus on qualitative methods identify,
analyze and propose mitigation of risks. Further, investment in Saudi Aramco as an upstream
and downstream oil and gas company is exposed to three main risk, political risks, global

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market (economy) risks, and operational risk, as illustrated in Figure 1. Moreover, the detail
identified investor risk in Saudi Aramco can be seen in figure 2.
Figure 1. Risk based on company business process
Figure 2. Identified Risks
Investor risks in Saudi Aramco
Political Risk
Expropriation
of assets
Changes of
the tax system
Regional
Conflicts
Corruption
Market Risk
Price Risk
Supply risk
(downstream)
Demand Risk
Corporate
Subsidiaries
Operational
Risks
Geological
Condition
Resources
Availability
Technological
risk

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3. Detailed risk assessment
a. Political risk
Li et al. (2016) says that political risk is the effect of changes in the political climate,
regime and government systems and the government's policy on investments. Considering
that even after privatization, the Kingdom will still hold the majority share, the political
influence of the KSA is one of the most complicated factors to predict. The nationalization
history of Saudi Aramco from American oil company to be national oil company of the
KSA increases the probability of a similar political turmoil that threatens
investment. Moreover, Saudi Aramco is a source of 90% of the KSA budget (Salameh,
2016). Hence, there is a high probability that state policy will still affect the company's
performance and security of investor assets. Some political aspects that may affect
investment in Saudi Aramco include:
1) Expropriation of the private sector asset by the Kingdom
As described earlier, Saudi Aramco is a successor of the American company
operating in the KSA. Saudi Aramco is established in early 1980s when the KSA
decided to nationalized Aramco which American company owned 50% of its share.
However, instead of expropriation and seized the private assets, the KSA used the
gentler way to nationalize the company by buying the rest of the share using the
government money (Sthalekar, 2016). This history could be a mitigation factor for
expropriation risk in Saudi Aramco to lower its probability.
Furthermore, another mitigation factor of re-nationalization issue is because of
the need of the Kingdom to maintain their reputation for developing its national
investment climate. To further reduce this risk, the Kingdom should guarantee the
safety of investors asset in their country, another measure to mitigate this risk is cover
the investment with political risk insurance (Moreira, 2013)
2) Changes to the tax system
By using the Islamic financial system, the KSA is not familiar with the
tax. However, according to the Deputy Crown Prince, the introduction of value-added

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tax will be done as one of reform steps of the Kingdom financial system (Seznec, 2016).
Moreover, there is no certainty about the value-added tax tariff that will be
charged. Furthermore, with the introduction of value added taxes, it is possible for the
KSA to apply income taxes and other taxes in the future. This condition provides
uncertainty about the future of investment. Investments that look favorable today, when
highly taxed in the future will reduce the value earned by shareholders. This risk can
be reduced by ensuring the tariff of tax that will be implemented. The company also
can implement tax management system and transfer pricing system to optimize its tax
obligation.
3) Regional Conflicts
Currently, various conflicts are happening in the middle east. Conflicts such as
civil war in Syria and Iraq, and political challenge in Egypt (Bahgat, 2016), may affect
the company's performance indirectly. Moreover, given the state's ownership in the
company is high, the Kingdom’s active involvement in various conflicts such as in
Yemen, Bahrain and Syria have a high probability to adversely impact the business
performance (Bahgat, 2016; Friedman and Mauldin, 2016). The impact of this risk if
the conflict escalated is high to the investment. The company should closely monitor
the regional conflicts and The Kingdom conflict activities and cover investment with
insurance to mitigate investors’ risk.
4) Corruption
Corruption issue is a major problem for a privatized state-owned company.
Corruption will highly affect company reputation and stock price. Petrobras, a Brazil
privatized state-owned company, five years after its IPO, experienced declining in their
stock price due to several financial irregularities such as diverted funds and
unaccounted expenses that are caused by lack of transparency (Sthalekar, 2016).
The transparency issue is a big issue in Saudi Aramco. Over the years, Saudi
Aramco always publishes its company performance reports but not its financial reports.
Seznec (2016) said that the lack of transparency on the company income because there

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is a significant share of its revenue is going to the royal family. However, answering
this issue, Deputy Crown Prince said that one of the main reason of the IPO is to
increase the transparency of the company and reduce the chance of corruption (Seznec,
2016). Hence, the severity of this risks can be reduced from high to medium.
b. Market Risks
Market risk is an investment risk caused by global economic factors (Li et al.,
2016). Investment in Saudi Aramco will be affected by various global economic
factors. Further, economic risks that will affect investment in Saudi Aramco include price
volatility and demand risk.
1) Price risk
Low oil price is currently the biggest challenge of every oil companies. Oil and gas
investment is very sensitive to price volatility (Li et al., 2016). Low world oil prices
significantly reduced the profit margins of global oil companies including Saudi
Aramco. Global oil prices dropped dramatically over the years and lost 67% of its value in
2014. The decline in commodity prices will directly lead to a decrease in corporate profits
and investment value.
However, Saudi Aramco is known as one of the most efficient oil producers. It is
ranked the second on the lowest cost of production per barrel that is only $9.50 in 2015
when at the same time the United Kingdom need $52.50 per barrel (The Economist, 2016).
However, the high level of national subsidized oil consumption has burdened the Kingdom
budget. The oil price risk can be reduced by removing or reducing subsidy on oil
consumption.
2) Supply Risk
Downstream subsidiary businesses (oil refinery and petrochemical) of Saudi Aramco
is highly depended on crude oil and natural gas supply for their operation. The subsidiaries
enjoy the benefits of subsidized commodities, but not for long until the Kingdom remove
the subsidy as said by the Deputy Crown Prince (Seznec, 2016). Downstream subsidiary

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companies could implement forward contract to buy commodities they need for production
and supply contract with certain quantity to handle this risk. Although the forward contract
is not applicable to every situation (Merna and Al-thani, 2008), it can reduce part of the
risk.
3) Demand risk
Saudi Aramco’s businesses have a high demand risk. China with a very high growth
rate had become the world's largest importer country and one of the important markets for
Saudi Aramco oil production. As China's economic growth declines, China's petroleum
import demand also decreases significantly and decrease demand for Saudi Aramco’s main
production. Although Saudi Aramco has expanded its energy-based Downstream industry
to diversify markets such as petrochemical and fertilizer companies, the risk of demand
that hit the company is still considerable. The fall in demand for Saudi Aramco’s
production will immediately lower the company's earnings resulting in declining share
value. The company could make an off-take purchase agreement and try to find a new
market for its production to mitigate this risk.
c. Operational Risks
The business character of Saudi Aramco makes it vulnerable to various risks
associated with the company's operations. The parent company upstream business are
exposed to risk ranging from unpredicted geological conditions, resource availability, and
technological risks.
1) Geological condition
Geological conditions are one of the decisive factors in the exploration and
exploitation of crude oil and natural gas. Exploration activities use certain assumptions
about the geological structure of points to be explored. Geological risks are related to
unsuitable geological structures or structural changes due to natural events (Kishk and
Oladunjoye, 2009). The company should ensure that Standard Operating Procedure
related to the geological condition are in place to reduce this risk.

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2) Resource availability
Resource availability is related to oil and gas reserved that can be explored by the
company. Two main issues related to Saudi Aramco reserve are the ownership of and
the volume of its reserve base (Fattouh and Harris, 2017). The first issue focus on the
ownership of the oil reserve after privatization, whether it will be owned by Saudi
Aramco or remain with the Kingdom. This issue is relevant because the valuation of an
oil company is mainly based on their reserve base.
The second issue is about the validity of the official reserve size claimed by the
Kingdom. For the last 25 years, Saudi Aramco maintains their reserve base in a constant
size at around 260 billion barrels (Fattouh and Harris, 2017). Their production rate is
countered by the discovery of oil reserve using modern technology (Fattouh and Harris,
2017). However, in July 2016, Rystad Energy as cited by (McDonald, 2016) claimed
that proven reserve base of Saudi Aramco is 70 billion barrels if combined with reserve
not yet discovered their reserve base is around 212 billion barrels. Hence, to mitigate
this risk, the investor need to validate the company’s claim with other independent
experts.
3) Technological Risks.
Oil and gas industry use high technology equipment and mostly rely on it. The
technological failure could directly involve the production process and leads to
decrease the company’s income. The high volume of technology use in company
operation increase the probability of technological risk. However, to mitigate this risk,
an appropriate technology control and procedure must be in place and periodically
monitored.
4. Risk Register
The next step after all risks are identified and analyzed is documenting risk assessment process
in risk register. In the risk register, the probability (P) and impact of each risk is presented in

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the scale from 1 as the lowest level and 5 as the highest level (Merna, 2017). Further, severity
(S) of risk can be calculated by multiplying the probability and impact of each risk. Risk
severity is presented in three different colours, red for high risk, amber for medium risk, and
green for low risk. Risk register can be seen in Table 1.
Table 1. Risk Register

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Source: (Merna, 2017)
5. Conclusion
This essay has presented the qualitative risk assessment of investment in Saudi Aramco
and its downstream subsidiaries. Three major sources of risk identified in this paper are
political, economy, and operational. From those sources of risk can be identified several risks
that can affect the investment objective in Saudi Aramco that belong to the Kingdom, Saudi
Aramco as a company, and downstream subsidiaries of Saudi Aramco.
After the risk is identified, this paper has suggested the mitigation for the probability
and/or the impact of particular risk. However, some risks still have a medium severity even
after being mitigated. Regional conflicts risk and corruption risks remain medium. Hence,
investing in Saudi Aramco is suitable for medium risk-taker investors.

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6. Reference
Bahgat, G. (2016) ‘Lower for Longer: Saudi Arabia Adjusts to the New Oil Era.’ Middle
East Policy, XXIII(3).
Donwa, P. A., Mgbame, C. O. and Okuonghae, O. (2015) ‘Investors Risk Assessment in the
Oil and Gas Sector.’ Journal of Business Administration and Management Sciences
Research, 4(5) pp. 116–124.
Fattouh, B. and Harris, L. (2017) The IPO of Saudi Aramco : Some Fundamental Questions.
Friedman, G. and Mauldin, J. (2016) Saudi Arabia: A Failing Kingdom.
Kishk, M. and Oladunjoye, B. (2009) ‘Risk assessment and allocation in Nigerian oil and gas
projects.’ Association of Researchers in Construction Management, ARCOM 2009 -
Proceedings of the 25th Annual Conference, (September) pp. 1315–1324.
Li, H., Sun, R., Lee, W. J., Dong, K. and Guo, R. (2016) ‘Assessing risk in chinese shale gas
investments abroad: Modelling and policy recommendations.’ Sustainability
(Switzerland), 8(8).
McDonald, P. (2016) Saudi Arabia has plans to get out of oil ( nearly ); but will they work ?
Oil and Energy Trends.
Merna, A. (2017) ‘MGDI71432 Risk Management Course Notes.’
Merna, T. and Al-thani, F. (2008) Corporate Risk Management: 2nd Edition. West Sussex:
John Wiley & Sons.
Moreira, S. (2013) ‘Learning from Failure: China’s Overseas Oil Investments.’ Journal of
Current Chinese Affairs, 42(1) pp. 131–165.
Salameh, M. G. (2016) Saudi Arabia’s Vision 2030 : A Reality or Mirage. London.
Seznec, J.-F. (2016) Saudi Energy Changes: The End of the Rentier State? Washington DC.
Sthalekar, R. (2016) Saudi Aramco: A Reality Of Mythical Proportions?
The Economist (2016) Saudi Aramco: Sale of the century? The Economist. [Online]
[Accessed on 22nd April 2017] http://www.economist.com/news/briefing/21685475-
possible-ipo-saudi-aramco-could-mark-end-post-war-oil-order-sale.