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The Truth About the Aramco IPO

Written by Briton Ryle
Posted September 30, 2019

With these words, JP Morgan kicks off what will likely be the greatest campaign ever orchestrated to separate you from your money:

We believe favorable technicals, improving fundamentals with stabilizing business cycle, and ongoing geopolitical tensions in the Middle East could help redirect flows into this universally hated and cheap sector...

This quote made the rounds last Thursday. It's from a JP Morgan analyst. And the sector in question is oil. 

Somehow, the good people at JP Morgan want us all to believe that the stock market has been wrong for the last five years... that the world's biggest sovereign wealth fund is wrong... that the biggest endowment fund in America is wrong...

JP Morgan wants you to think oil is a great place to invest right now. Oh, and by the way, they are arranging it so you can buy shares of the very best quality oil in the world...

I think I speak for everyone when I say, "Thanks a lot, a***oles!"

If you don't know, the Saudi royal family picked JP Morgan to lead the public offering of shares for its state-run oil company, Aramco. It is JP Morgan's job to find investors willing to buy IPO shares at a price that will value the company for as much as $2 trillion. 

I hope I've made myself clear about this IPO: I don't like it, I don't think you should buy it, and I think the fees JP Morgan will collect amount to exactly seven pieces of silver.

Buy Low, Sell High

I make the same observation every time I discuss the Aramco IPO: Why do you think the Saudis want to sell? 

It's no secret that the oil price crash the Saudis caused in 2014 has blown a massive hole in their budget. The Saudis thought they could kill off U.S. shale companies by causing a price collapse. But, as they say, whatever doesn't kill you makes you stronger, and that proved true for U.S. oil companies...

U.S. oil companies were forced to cut costs to survive, and that's exactly what happened. Production costs for unconventional or "tight" oil fell from around $50 a barrel to as low as $15 in some parts of the Permian Basin.  

This is exactly how capitalism is supposed to work. You respond to competition by getting more efficient. It's not that big of a surprise that the Saudis didn't see this one coming. A colossal error of judgment. This one move backfired so badly that the Saudis lost control of the oil market. They've been forced to cut production just to keep oil prices above $50 a barrel.

And they've been literally paying the price ever since...

That one misstep has forced Saudi Arabia to deplete foreign currency reserves, sell bonds, and cut benefits. Because the Saudi government needs oil at about $80 to balance its budget. Total cost is likely approaching a couple hundred billion.

Foreign investment has fallen from $16 billion back in 2011 to just $4 billion last year. The economy is very nearly in recession.

So yeah, they need loot in the worst way. And so now they want the global investment community to bail them out. 

Iran's Drone Strike

Seems to me that Iranian drone strike a couple weeks ago was really aimed right at the Aramco IPO. You think investors are surprised to see how vulnerable Aramco infrastructure is? Those strikes cut Saudi production in half...

Aramco officials said the damage would be fixed and they would be back to full production in a couple months, and if you believe that, I've got a bridge you might be interested in. It's gonna be several months before that damage is fixed...

It also looks like the IPO will be delayed until the damage is repaired.

And what happens in the meantime? Will the Saudis try to exact some revenge against Iran? While I definitely don't wanna see bombs getting tossed around in the Middle East, seems to me it's a pretty good bet...

Until recently, anytime tensions rose in the Middle East, oil prices rose, too. I think that old relationship is likely to start working again. The Saudis would certainly love to see oil prices rally so they can actually get that $2 trillion valuation for Aramco.

But the irony is that if oil rises due to geopolitical tension, it actually makes Aramco less valuable. Who wants to buy oil that's sitting on a battlefield? 

I can't wait to see how JP Morgan tries to spin this disaster in the making. 

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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